UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Period:Commission File No.
September 30, 2005 0-26589
FIRST NATIONAL LINCOLN CORPORATION
(Exact name of registrant as specified in its charter)
MAINE
01-0404322
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No)
MAIN STREET, DAMARISCOTTA, MAINE
04543
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code:
(207) 563 - 3195
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Indicate the number of shares outstanding of each of the issuer's classes of common stock,
as of the latest practicable date.
Class
Outstanding at November 4, 2005
Common Stock, Par One Cent
9,830,621
Table of Contents
Part I. Financial Information
1
Selected Financial Data (Unaudited)
Item 1 – Financial Statements
2
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets (Unaudited)
3
Consolidated Statements of Income (Unaudited)
4
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
5
Consolidated Statements of Cash Flows (Unaudited)
6
Notes to Consolidated Financials Statements
7
Note 1 – Basis of Presentation
Note 2 – Common Stock
Note 3 – Stock Options
Note 4 – Earnings Per Share
8
Note 5 – Postretirement Benefit Plans
9
Note 6 – Pro-Forma Financial Information
10
Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations
12
Critical Accounting Policies
GAAP vs. Pro-Forma Results
Executive Summary
13
Net Interest Income
Provision for Loan Losses
16
Non-Interest Income
Non-Interest Expense
Income Taxes
Average Daily Balance Sheets
Value of Assets Acquired
18
Investments
19
Loans
Allowance for Loan Losses
Deposits
20
Borrowed Funds
21
Shareholders' Equity
Non-Performing Assets
22
Off-Balance Sheet Financial Instruments
Sale of Loans
Contractual Obligations
Liquidity Management
Forward-Looking Statements
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
23
Market-Risk Management
Asset/Liability Management
Interest Rate Risk Management
24
Item 4: Controls and Procedures
25
Part II – Other Information
26
Item 1 – Legal Proceedings
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 – Default Upon Senior Securities
Item 4 – Other Information
Item 5 – Exhibits
27
Signatures
28
First National Lincoln Corporation and Subsidiary
For the nine months ended
For the quarters ended
Dollars in thousands,
September 30
except for per share amounts
2005
2004
Summary of Operations
Operating Income
$43,174
$25,937
$16,092
$9,175
Operating Expense
29,927
17,270
11,403
$6,079
23,398
15,798
7,989
5,612
100
720
0
240
Net Income
9,477
6,197
3,347
2,216
Per Common Share Data
Basic Earnings per Share
$0.98
$0.85
$0.34
$0.30
Diluted Earnings per Share
0.96
0.83
0.34
0.30
Cash Dividends Declared
0.390
0.328
0.135
0.115
Book Value
10.36
7.02
Market Value
19.25
Financial Ratios
Return on Average Equity1
12.97%
16.85%
13.14%
17.78%
Return on Average Tangible Equity1
17.79%
16.97%
18.16%
17.82%
Return on Average Assets1
1.37%
1.40%
1.44%
Average Equity to Average Assets
10.55%
8.29%
10.42%
8.12%
Average Tangible Equity to Average Assets
7.69%
8.45%
7.54%
8.10%
Net Interest Margin Tax-Equivalent1
3.88%
3.95%
3.76%
4.06%
Dividend Payout Ratio
39.80%
38.59%
39.71%
38.33%
Allowance for Loan Losses/Total Loans
0.88%
1.02%
Non-Performing Loans to Total Loans
0.40%
0.37%
Non-Performing Assets to Total Assets
0.30%
0.28%
Efficiency Ratio2
53.31%
49.07%
54.64%
49.18%
At Period End
Total Assets
$ 993,321
$ 630,202
Total Loans
739,597
461,504
Total Investment Securities
163,439
137,210
Total Deposits
755,324
401,479
Total Shareholders’ Equity
101,844
51,532
Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a
200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.
1Annualized using a 365-day basis
2The Company uses the following formula in calculating its efficiency ratio:
Non-Interest Expense - Loss on Securities Sales
Tax-Equivalent Net Interest Income + Non-Interest Income – Gains on Securities Sales
Page 1
The Board of Directors and Shareholders
First National Lincoln Corporation
We have reviewed the accompanying interim consolidated financial information of First National Lincoln Corporation and Subsidiary as of September 30, 2005 and 2004, and for the three-month and nine-month periods then ended. These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is to express an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
/s/ Berry, Dunn, McNeil & Parker
Portland, Maine
November 4, 2005
Page 2
September 30,
December 31,
In thousands of dollars
Assets
Cash and due from banks
$29,507
$14,770
$16,659
Overnight funds sold
2,500
-
Investments:
Available for sale
49,171
51,892
52,900
Held to maturity (market values $114,098 at 9/30/2005,
$75,600 at 12/31/2004, and $85,316 at 9/30/2004)
114,268
74,935
84,310
Loans held for sale (fair value approximates cost)
40
478,332
Less: allowance for loan losses
6,474
4,714
4,727
Net loans
733,123
473,618
456,777
Accrued interest receivable
4,759
2,791
3,026
Bank premises and equipment
16,987
9,061
9,149
Other real estate owned
Goodwill
27,960
125
Other assets
15,006
7,046
7,256
$993,321
$634,238
$630,202
Liabilities
Demand deposits
$66,792
$31,181
$33,734
NOW deposits
127,312
60,550
60,088
Money market deposits
119,419
76,411
85,651
Savings deposits
116,440
68,673
67,182
Certificates of deposit
140,450
63,900
75,423
Certificates $100,000 and over
184,911
69,129
79,401
Total deposits
369,844
Borrowed funds
126,647
207,206
172,442
Other liabilities
9,506
4,373
4,749
Total Liabilities
891,477
581,423
578,670
Common stock
99
74
Additional paid-in capital
47,806
3,973
3,851
Retained earnings
52,798
46,809
45,378
Accumulated other comprehensive income
Net unrealized gains on available-for-sale securities
1,141
1,959
2,229
Total Shareholders' Equity
52,815
Total Liabilities & Shareholders' Equity
Common Stock
Number of shares authorized
18,000,000
Number of shares issued and outstanding
9,827,356
7,356,836
7,350,040
Book value per share
$10.36
$7.18
$7.01
Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a 200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.
See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.
Page 3
For the nine months
For the quarters
ended September 30,
Interest income
Interest and fees on loans
$30,619
$17,470
$11,157
$6,172
Interest on deposits with other banks
Interest and dividends on investments
5,701
4,940
1,976
1,702
Total interest income
36,329
22,414
13,138
7,875
Interest expense
Interest on deposits
8,978
3,868
3,911
1,342
Interest on borrowed funds
3,953
2,748
1,238
921
Total interest expense
12,931
6,616
5,149
2,263
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
23,298
15,078
5,372
Non-interest income
Investment management and fiduciary income
1,245
644
426
214
Service charges on deposit accounts
1,779
881
628
301
Net securities gains
Mortgage origination and servicing income
481
310
106
59
Other operating income
3,340
1,688
1,794
726
Total non-interest income
6,845
3,523
2,954
1,300
Non-interest expense
Salaries and employee benefits
8,349
5,138
2,875
1,835
Occupancy expense
1,016
655
319
227
Furniture and equipment expense
1,564
1,094
529
340
Amortization of identified intangibles
200
71
Other operating expense
5,767
3,047
2,460
1,174
Total non-interest expense
16,896
9,934
6,254
3,576
Income before income taxes
13,247
8,667
4,689
3,096
Applicable income taxes
3,770
2,470
880
NET INCOME
$9,477
$6,197
$3,347
$2,216
Earnings per common share:
Basic earnings per share
Diluted earnings per share
$0.96
$0.83
Cash dividends declared per share
$0.390
$0.328
$0.135
$0.115
Weighted average number of shares outstanding
9,717,011
7,322,255
9,823,370
7,347,208
Incremental Shares
124,417
149,414
128,621
152,290
Page 4
In thousands of dollars except number of shares and per share amounts
Number of common shares
Net unrealized gain on securities available for sale
Treasury stock
Total
shareholders’
equity
Balance at December 31, 2003
7,264,140
$74
$4,650
$42,988
$2,497
($2,491)
$47,718
Net income
Net unrealized loss on securities available for sale, net of tax benefit of $138
(268)
Comprehensive Income
5,929
Cash dividends declared
(2,411)
Treasury stock purchases
(24,394)
(404)
Treasury stock sold
110,294
(747)
1,447
700
Retirement of Treasury Stock
(52)
(1,396)
1,448
Balance at September 30, 2004
$3,851
$45,378
$2,229
$51,532
Balance at December 31, 2004
$3,973
$46,809
$1,959
$52,815
Net unrealized loss on securities available for sale, net of tax benefit of $421
(818)
8,659
(3,835)
Payment to repurchase common stock
(162,199)
(1)
(2,773)
(2,774)
Proceeds from sale of common stock
168,121
1,246
Tax benefit of disqualifying disposition of incentive stock option shares
347
Acquisition of FNB Bankshares
2,464,598
45,361
45,386
Balance at September 30, 2005
$99
$47,806
$52,798
$1,141
$101,844
Page 5
Nine months ended September 30
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
958
773
Loans originated for resale
(19,222)
(10,774)
Proceeds from sales and transfers of loans
19,773
11,756
Net gain on sale of other real estate owned
Net increase in other assets and accrued interest
(817)
(267)
Net increase in other liabilities
2,001
692
Net amortization of premiums on investments
95
90
Net amortization of acquisition costs
245
Net cash provided by operating activities
12,610
9,191
Cash flows from investing activities
Proceeds from maturities, payments and calls of securities available for sale
4,153
4,934
Proceeds from maturities, payments and calls of securities to be held to maturity
20,234
35,951
Proceeds from sales of other real estate owned
47
Purchases of securities available for sale
(683)
(824)
Purchases of securities to be held to maturity
(35,087)
(41,078)
Net increase in loans
(76,656)
(62,802)
Capital expenditures
(1,117)
(874)
Cash for acquisition, net of cash acquired
3,493
Net cash used in investing activities
(85,663)
(64,646)
Cash flows from financing activities
Net increase in demand deposits, savings, money market and club accounts
51,587
21,678
Net increase in certificates of deposit
141,208
20,724
Advances on long-term borrowings
8,216
Repayment on long-term borrowings
(37,118)
(25,331)
Net increase (decrease) in short-term borrowings
(60,459)
31,735
Payments to repurchase common stock
Dividends paid
(3,400)
(2,291)
Net cash provided by financing activities
90,290
55,027
Net increase (decrease) in cash and cash equivalents
17,237
(428)
Cash and cash equivalents at beginning of period
14,770
17,087
Cash and cash equivalents at end of period
$32,007
Interest paid
$12,285
$6,622
Income taxes paid
$3,490
$2,532
Non-cash transactions
Change in unrealized gain on available for sale securities
$(1,239)
$(406)
Non-cash assets acquired with common stock
$258,631
$-
Less liabilities assumed
$214,266
Page 6
First National Lincoln Corporation (the Company) is a financial holding company that owns all of the common stock of The First, N.A. (the Bank). The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of Management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions and balances are eliminated in consolidation. On January 14, 2005, the Company completed the acquisition of FNB Bankshares (FNB) of Bar Harbor, Maine, and operating results include the effect of the FNB acquisition only after the closing date (see Note 6 -- Pro-Forma Financial Information).
The income reported for the 2005 period is not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2004.
On April 27, 2004, the Company's Board of Directors declared a three-for-one split of the Company's common stock payable in the form of a 200% stock dividend to shareholders of record on May 12, 2004, with a payment date of June 1, 2004. All share and per share data included in the consolidated financial statements and elsewhere in this report have been restated to reflect the stock split.
On January 20, 2005, the Company announced that its Board of Directors had authorized the repurchase of up to 250,000 shares of the Company's common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company's stock and the level of stock issuances under the Company's employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated.
As of September 30, 2005, the Company had repurchased 162,188 shares under the new repurchase plan at an average price of $17.09.
The Company established a stock option plan in 1995. Under the plan, the Company may grant options to its employees for up to 600,000 shares of common stock. Only incentive stock options may be granted under the plan. The option price of each option grant is determined by the Options Committee of the Board of Directors, and in no instance shall be less than the fair market value on the date of the grant. An option's maximum term is ten years from the date of grant. As a result of the FNB acquisition, options to acquire 40,630 FNB shares were converted into options to acquire an aggregate of 95,479 common shares of the Company at a purchase price of $3.80 per share.
A summary of the status of the Company's Stock Option Plan as of September 30, 2005, and changes during the nine months then ended, is presented below.
Number of
Weighted Average
Shares
Exercise Price
205,500
$ 4.81
Granted in 2005
42,000
18.00
Assumed in 2005
95,479
3.80
Exercised in 2005
(125,229)
4.05
217,750
$ 7.34
Page 7
The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for the stock option plan. Accordingly, no compensation cost has been recognized. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation. Share and per share data have been adjusted to reflect the three-for-one stock split in the form of a 200% stock dividend paid June 1, 2004, to shareholders of record on May 12, 2004.
As reported
Value of option grants, net of tax
136
Pro forma
$9,341
0.01
$0.97
0.85
$0.95
The fair market value of options granted, net of tax, was $136,000 in 2005. No options were granted in 2004. The weighted average fair market value of options granted was $3.24 in 2005. The fair market value in 2005 is estimated using the Black-Scholes option pricing model and the following assumptions: quarterly dividends of $0.12, risk-free interest rate of 4.20%, volatility of 17.80%, and an expected life of 10 years.
The following table sets forth the computation of basic and diluted earnings per share for the nine months ended September 30, 2005 and 2004:
Income
Per-Share
In thousands, except for number of shares and per share data
(Numerator)
(Denominator)
Amount
For the nine months ended September 30, 2005
Net income as reported
Basic EPS: Income available to common shareholders
Effect of dilutive securities: incentive stock options
Diluted EPS: Income available to common shareholders plus assumed conversions
9,841,428
For the nine months ended September 30, 2004
7,471,669
Page 8
The following table sets forth the computation of basic and diluted earnings per share for the quarter ended September 30, 2005 and 2004:
For the quarter ended September 30, 2005
9,951,991
For the quarter ended September 30, 2004
7,499,498
All earnings per share calculations have been made using the weighted average number of shares outstanding during the period. All of the dilutive securities are incentive stock options granted to certain key members of Management. The dilutive number of shares has been calculated using the treasury method, assuming that all granted options were exercisable at the end of each period.
The Bank sponsors postretirement benefit plans which provide certain life insurance and health insurance benefits for certain retired employees and health insurance for retired directors. None of these plans are pre-funded. The following table sets forth the accumulated post-retirement benefit obligation and funded status:
At September 30,
Change in benefit obligations
Benefit obligation at beginning of year
$531
$542
Plan assumed in FNB acquisition
1,189
Service cost
Interest cost
89
Benefits paid
(81)
(21)
Actuarial gain
(18)
Benefit obligation at end of period
1,718
551
Funded status
(1,718)
(551)
Unamortized prior service cost
(11)
Unamortized net actuarial loss
42
48
Unrecognized transition obligation
215
251
Accrued benefit cost
$(1,472)
$(263)
The following table sets forth the net periodic pension cost:
Page 9
For nine months ended September 30,
For the quarters ended September 30,
Components of net periodic benefit cost
$8
$4
$1
$2
Amortization of unrecognized transition obligation
Amortization of prior service cost
(2)
(4)
Amortization of accumulated losses
Net periodic benefit cost
$122
$57
$25
$19
A weighted average discount rate of 7.0% was used in determining both the accumulated benefit obligation and the net benefit cost. The measurement date for benefit obligations was as of year-end for both years presented. The estimated amount of related benefit expense in 2005 is $162,000, and the estimated amount of benefits to be paid is $121,000.
On August 25, 2004, the Company entered into an agreement to acquire FNB Bankshares (FNB) of Bar Harbor, Maine, and its subsidiary, The First National Bank of Bar Harbor. This acquisition was completed on January 14, 2005. In its 2004 Strategic Plan, the Company identified certain markets in which it would consider future growth opportunities, including the area served by FNB Bankshares. Management expects that the products and services available in the FNB Bankshares market area will be enhanced as a result of the combination of the two companies, and this will also provide a larger capacity to lend money and a stronger overall funding base. It is expected that the combined entity will realize cost savings from redundant expenses, such as regulatory fees, audit costs, legal costs, and outsourced costs.
As part of the acquisition, the Company issued 2.35 shares of its common stock to the shareholders of FNB in exchange for each of the 1,048,814 shares of the common stock outstanding of FNB. Cash in lieu of fractional shares of the Company's stock was paid at the rate of $17.87 per share, which was the average high/low price of the Company's stock for the 30-day period ending January 9, 2005, under terms specified in the Merger Agreement. At the time of the acquisition, there were outstanding options to purchase 126,208 shares of FNB common stock under the FNB Bankshares Stock Option Plan. Of these, options to acquire 40,630 FNB shares were converted into options to acquire an aggregate of 95,479 common shares of the Company at a purchase price of $3.80 per share. Holders of unexercised options to purchase FNB shares that were not converted were paid cash to retire their options at the rate of $42.00 for each share subject to the option, less the option exercise price per share. The total amount paid to retire the remaining options was approximately $2.6 million.
The total value of the transaction was $47,955,000, and all of the voting equity interest of FNB was acquired in the transaction. The Company assumed all outstanding liabilities of FNB, including liabilities under certain Employment Continuity Agreements and Split Dollar Agreements with executive officers of FNB. The acquisition was intended to qualify as a reorganization for federal income tax purposes and provide for a tax-free exchange of shares.
The transaction was accounted for as a purchase and, accordingly, the operations of FNB are included in the Company’s consolidated financial statements from the date of acquisition. The purchase price was allocated to assets acquired and liabilities assumed at the date of acquisition. The excess of purchase price over the fair value of net tangible assets acquired was recorded as goodwill, none of which is expected to be deductible for tax purposes. Goodwill related to the core deposit intangible is being amortized over its expected economic life, and remaining goodwill is evaluated annually for possible impairment under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. In the tables which follow, pro forma financial information is presented.
The pro forma balance sheets in the following table show how the financial position of the Company would have been presented if the transaction had closed prior to September 30, 2004. The adjustments show the effect of recording all assets and liabilities acquired to current fair value as well as the amount of identified intangibles (core deposit intangible). The excess of purchase price over the fair value of net tangible and intangible assets acquired is recorded as goodwill.
Page 10
September 30, 2005
December 31, 2004
September 30, 2004
Cash and cash equivalents
$ 32,007
$ 22,777
$ 36,838
154,081
165,255
179
316
664,466
645,213
6,719
6,870
657,747
638,343
16,861
16,934
19,765
18,573
18,972
$ 898,178
$ 904,618
Liabilities & Shareholders' Equity
$ 755,324
$ 559,500
$ 609,075
228,241
186,559
9,193
9,387
796,934
805,021
101,244
99,597
The pro forma statements of income in the following table show how the Company's results of operations would have been presented if the Company and FNB had operated as one entity for the entire periods presented. Management has made adjustments to reflect the amortization of the premium on loans acquired, increased depreciation on premises, and amortization of the core deposit intangible. Average shares outstanding and incremental shares used in earnings per share calculations are based upon the exchange ratio of 2.35 shares of the Company for each share of FNB.
For quarters ended September 30,
In thousands of dollars, except share and per share information
Interest Income:
$36,710
$30,374
$13,138
$10,628
Interest expense:
13,040
8,455
2,851
23,670
21,919
7,777
900
300
23,570
21,019
7,477
Other operating income:
6,990
6,551
2,551
Other operating expenses:
17,590
16,701
6,130
12,970
10,869
3,897
3,668
3,013
1,077
$9,302
$7,856
$2,821
Operating Statistics
$0.80
$0.29
$0.79
$0.28
$0.125
$0.103
Dividend payout ratio
40.63%
41.00%
36.76%
35.63%
Return on average assets
1.34%
1.29%
1.39%
1.33%
Return on average equity
12.74%
16.19%
13.31%
17.20%
Return on average tangible equity
17.46%
16.22%
18.49%
17.23%
Efficiency ratio (tax equivalent)
54.75%
56.50%
54.03%
57.65%
Page 11
Management's discussion and analysis of the Company's financial condition is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, Management evaluates its estimates, including those related to the allowance for loan losses and the valuation of mortgage servicing rights. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis 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.
Allowance for Loan Losses. Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on Management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses.
Mortgage Servicing Rights. The valuation of mortgage servicing rights also requires significant estimates and assumptions. The Bank often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 0.25% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized when they are acquired through sale of loans and are reported in other assets. They 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. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value which is recorded on the balance sheet. This includes an evaluation for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. The use of different assumptions could produce a different valuation for both mortgage servicing rights and impairment.
Acquired Assets and Liabilities. Management utilizes numerous techniques to estimate the value of various assets held by the Company, including methods to determine the appropriate carrying value of goodwill as required under SFAS No. 142. In addition, goodwill from a purchase acquisition is subject to ongoing periodic impairment tests which include an evaluation of the ongoing assets. liabilities and revenues from an acquisition and an estimation of the impact of business conditions. Different estimates or assumptions are also utilized to determine the appropriate carrying value of other assets including, but not limited to, property, plant and equipment, overall collectibility of loans and receivables. The use of different estimates or assumptions could produce different estimates of carrying value. Management prepares the valuation analyses, which are then reviewed by the Board of Directors of the Company.
Operating results for the Company are prepared using accounting principles generally accepted in the United States of America (GAAP) which, under the purchase methods of accounting, exclude FNB Bankshares results prior to the closing date of the acquisition on January 14, 2005. This discussion also includes pro-forma information which shows how the Company's results of operations would have been presented if the Company and FNB had operated as one entity for the entire periods presented (for a presentation of pro-forma results, see Note 6 to the Consolidated Financial Statements -- Pro-Forma Financial Information).
Page 12
Net income for the nine months ended September 30, 2005 was $9,477,000, an increase of 52.9% over net income of $6,197,000 for the comparable period of 2004. The Company's increase in net income for the nine months ended September 30, 2005 in comparison to the same period in 2004 was the result of a 62.1% increase in net interest income driven by the FNB Bankshares acquisition and organic growth. In addition, non-interest income increased 94.3% in comparison to 2004. The level of increase in operating expenses was lower than growth in revenues and assets as a result of economies realized from the FNB acquisition. Fully diluted earnings per share for the nine months ended September 30, 2005 were $0.96, a 15.7% increase over the $0.83 reported for the third quarter of 2004.
Net income for the three months ended September 30, 2005 was $3,347,000, an increase of 51.0% over net income of $2,216,000 in the comparable period of 2004. The increase in net income for the three months ended September 30, 2005 in comparison to 2004 included a 42.4% increase in net interest income driven by the FNB Bankshares acquisition and organic growth. In addition, non-interest income increased 127.2% in comparison to 2004. The level of increase in operating expenses was lower than growth in revenues and assets as a result of economies realized from the FNB acquisition. Fully diluted earnings per share for the three months ended September 30, 2005 were $0.34, a 13.3% increase over the $0.30 reported for the third quarter of 2004.
On a pro-forma basis, net income for the nine months ended September 30, 2005, was $9,302,000, an increase of $1,445,000 or 18.4% over pro-forma net income of $7,856,000 for the first nine months of 2004. Pro-forma fully diluted earnings per share for the first nine months of 2005 were $0.95, an increase of $0.16 or 20.3% over the $0.79 calculated for the first nine months of 2004.
On a pro-forma basis, net income for the three months ended September 30, 2005, was $3,347,000, an increase over pro-forma net income of $2,821,000 for the three months ended September 30, 2004. Pro-forma fully diluted earnings per share for the three months ended September 30, 2005 were $0.34, and increase of $0.06 or 21.4% over the $0.28 calculated for the three months ended September 30, 2004.
Total interest income of $36,329,000 for the nine months ended September 30, 2005 is a 62.1% increase from total interest income of $22,414,000 in the comparable period of 2004. In addition to the interest income related to the FNB acquisition, rising interest rates resulted in higher asset yields in 2005 compared to 2004. Total interest expense of $12,931,000 for the first nine months of 2005 is a 95.5% increase from total interest expense of $6,616,000 for the first nine months of 2004. This was a direct result of the rising interest rate climate and the FNB acquisition.
The combination of higher interest rates, asset growth and the FNB acquisition resulted in net interest income of $23,398,000 for the nine months ended September 30, 2005, which represents a 48.1% increase from the $15,798,000 reported for the same period in 2004.
The Company's net interest margin on a tax-equivalent basis decreased from 3.95% in the first nine months of 2004 to 3.88% for the nine months ended September 30, 2005 due to liability costs accruing at a faster rate than the yield on assets. Tax-exempt interest income amounted to $2,485,000 and $1,580,000 for the nine months ended September 30, 2005 and 2004, respectively. Tax equivalency is calculated using a 35% effective tax rate. These results are consistent with the Company's expectations for changes in its net interest margin in the current rate environment.
Total interest income of $13,138,000 for the three months ended September 30, 2005 is a 66.8% increase from total interest income of $7,875,000 in the comparable period of 2004. In addition to the interest income related to the FNB acquisition, rising interest rates resulted in higher asset yields in 2005 compared to 2004. At the same time, total interest expense of $5,149,000 for the three months ended September 30, 2005 is a 127.5% increase from total interest expense of $2,263,000 for the third quarter of 2004. This was a direct result of the rising interest rate climate and the FNB acquisition.
The combination of higher interest rates, asset growth and the FNB acquisition resulted in net interest income of $7,989,000 for the three months ended September 30, 2005, a 42.4% increase from the $5,612,000 reported for the same period in 2004.
The Company's net interest margin on a tax-equivalent basis decreased from 4.06% for the three months ended September 30, 2004 to 3.76% for the three months ended September 30, 2005 due to liability costs increasing at a faster rate than yield on assets. Tax-exempt interest income amounted to $869,000 and $571,000 for the three months ended September 30, 2005 and 2004, respectively. Tax equivalency is calculated using a 35% effective tax rate.
Page 13
The following table presents the effect of tax-exempt income on the calculation of the net interest margin, using a 35.0% tax rate in 2005 and 2004:
For the quarter ended
Net interest income as presented
$23,398
$15,798
$7,989
$5,612
Effect of tax-exempt income
1,338
851
468
308
Net interest income, tax equivalent
$24,736
$16,649
$8,457
$5,920
The following table presents the amount of interest earned or paid, as well as the average yield or rate on an annualized basis, for each major category of assets or liabilities for the nine months ended September 30, 2005 and 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.
Nine months ended September 30,
Dollars in thousands
Amount of interest
Average Yield/Rate
Interest on earning assets
Interest-bearing deposits
$9
2.62%
0.89%
6,684
5.64%
5,660
5.51%
Loans held for sale
5.70%
5.62%
30,950
5.97%
17,597
5.52%
Total interest-earning assets
37,667
5.91%
23,265
Interest-bearing liabilities
1.89%
Other borrowings
2.82%
2.47%
Total interest-bearing liabilities
2.11%
1.65%
Interest rate spread
3.81%
3.87%
Net interest margin
The following table presents changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and interest-bearing liabilities for the nine months ended September 30, 2005 compared to 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.
Nine months ended September 30, 2005 compared to 2004
Volume
Rate
Rate/Volume1
$(1)
$(2)
$5
Investment securities
879
1,024
11,023
1,432
898
13,353
11,914
1,566
922
14,402
2,445
1,633
1,032
5,110
Other borrowings2
714
390
101
1,205
3,159
2,023
1,133
6,315
Change in net interest income
$8,755
$(457)
$(211)
$8,087
1 Represents the change attributable to a combination of change in rate and change in volume.
2 Includes federal funds purchased.
Page 14
The following table presents the amount of interest earned or paid, as well as the average yield or rate on an annualized basis, for each major category of assets or liabilities for the quarters ended September 30, 2005 and 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.
Quarter ended September 30,
3.02%
0.98%
2,324
1,948
5.71%
5.58%
11,270
6.15%
6,233
5.61%
13,606
6.05%
8,183
5.60%
2.17%
3.25%
2.38%
2.36%
1.62%
3.69%
3.98%
The following table presents changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and interest-bearing liabilities for the quarter ended September 30, 2005 compared to 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.
Quarter ended September 30, 2005 compared to 2004
360
14
376
4,013
623
401
5,037
4,380
639
404
5,423
1,049
853
667
2,569
(17)
(6)
317
1,193
661
2,886
$3,348
$(554)
$(257)
$2,537
On a pro-forma basis, net interest income for the first nine months of 2005 was $23,670,000, an increase of $1,751,000 or 8.0% over net interest income of $21,919,000 for the first nine months of 2004. This increase was the result of asset growth, primarily in the loan portfolio.
On a pro-forma basis, net interest income for the three months ended September 30, 2005 was $7,989,000, an increase of $212,000 or 2.7% over net interest income of $7,777,000 for the three months ended September 30, 2004. This increase was the result of asset growth, primarily in the loan portfolio.
Page 15
A $100,000 provision to the allowance for loan losses was made during the first nine months of 2005, compared to a $720,000 provision made for the same period of 2004. The decrease in provision is a result of the analysis of credit quality in the loan portfolio and the level of net chargeoffs experienced by the Company.
Non-interest income was $6,845,000 for the nine months ended September 30, 2005, an increase of 94.3% from the $3,523,000 reported for the first nine months of 2004. The increase in non-interest income was primarily due to the acquisition of FNB Bankshares. On a pro-forma basis, non-interest income increased by $439,000 or 6.7% from $6,551,000 in 2004 to $6,990,000 in 2005. Although investment management and fiduciary income increased by 10.8%, income from mortgage origination declined due to higher interest rates and lower levels of loans sold to the secondary market.
Non-interest income was $2,954,000 for the three months ended September 30, 2005, an increase of 127.2% from the $1,300,000 reported for the three months ended September 30, 2004. The increase in non-interest income was due to the acquisition of FNB Bankshares. On a pro-forma basis, non-interest income increased by $403,000 or 15.8% from $2,551,000 in 2004 to $2,954,000 in 2005, with increases in deposit account income and fiduciary fees.
Non-interest expense of $16,896,000 for the nine months ended September 30, 2005, is an increase of 70.1% over non-interest expense of $9,934,000 for the first nine months of 2004. In addition to a higher expense base as a result of the FNB acquisition, this increase is due to higher personnel and premises costs to provide more comprehensive and competitive services for customers, as well as increased costs for marketing, supplies and professional fees, in line with the Company's revenue and asset growth. On a pro-forma basis, non-interest expense increased by $889,000 or 5.3% during the first nine months of 2005 compared to the first nine months of 2004, with the largest increase in furniture and equipment expense, which were up by 10.7%.
Non-interest expense of $6,254,000 for the three months ended September 30, 2005, is an increase of 74.9% over non-interest expense of $3,576,000 for the three months ended September 30, 2004. This level of increase in non-interest expense for the quarter was for the same reasons cited above. On a pro-forma basis, non-interest expense increased by $124,000 or 2.0% during the three months ended September 30, 2005 compared to the three months ended September 30, 2004, with the largest increase in furniture and equipment expense, which was up by 14.0%. In Management's opinion, this low rate of increase in non-interest expense on a pro-forma basis is indicative of the cost savings which the Company is realizing as a result of the FNB Bankshares acquisition.
Income taxes on operating earnings increased to $3,770,000 for the first nine months of 2005 from $2,470,000 for the same period a year ago. The increase is in line with the increase in pre-tax income.
Page 16
The following table shows the Company's average daily balance sheets for the nine-month periods ended September 30, 2005 and 2004.
For nine months ended
For quarters ended
$20,904
$12,140
$25,586
$13,123
459
599
656
405
U.S. Treasury securities & government agency securities
64,771
60,781
66,390
61,750
Obligations of states and political subdivisions
51,254
34,288
55,004
35,406
Other securities
42,376
42,043
42,073
40,836
Total investments
158,401
137,112
163,467
137,992
420
520
Commercial
280,383
146,206
297,901
149,751
Consumer
34,745
26,042
35,432
26,082
State and municipal
22,226
10,767
21,508
13,928
Real estate
355,336
242,884
372,307
252,611
Total loans
692,690
425,899
727,148
442,372
Allowance for loan losses
(6,525)
(4,417)
(6,529)
(4,520)
686,165
421,482
720,619
437,852
Fixed assets
16,501
8,950
16,849
8,877
18,397
10,416
19,662
10,588
26,430
27,961
Total assets
$927,677
$590,924
$975,320
$609,062
Liabilities and shareholders' equity
Demand
$57,802
$28,277
$64,869
$30,180
NOW
105,713
54,932
113,018
57,795
Money market
112,502
81,107
115,752
81,786
Savings
111,832
64,412
117,229
65,890
115,686
76,279
131,687
77,755
Certificates of deposit over $100,000
130,297
83,331
171,654
87,464
633,832
388,338
714,209
400,870
187,342
148,718
151,067
153,889
8,848
4,868
8,966
4,853
Total liabilities
830,022
541,924
874,242
559,612
98
77
46,208
2,750
47,912
3,777
49,687
43,762
51,588
43,651
Unrealized gain/loss on AFS
1,662
2,414
1,480
1,945
Total shareholders' equity
97,655
49,000
101,078
49,450
Total liabilities and shareholders' equity
Page 17
On January 14, 2005, the Company completed the FNB acquisition. In its 2004 Strategic Plan, the Company identified certain markets in which it would consider future growth opportunities, including the area served by FNB Bankshares. Management expects that the products and services available in the FNB Bankshares market area will be enhanced as a result of the combination of the two companies, and this will also provide a larger capacity to lend money and a stronger overall funding base. It is expected that the combined entity will realize cost savings from redundant expenses, such as regulatory fees, audit costs, legal costs, and outsourced costs which the company has experienced in the period since the transaction closed.
The total value of the transaction was $47,955,000, and all of the voting equity interest of FNB was acquired in the transaction. As required under GAAP, the purchase price was allocated to assets acquired and liabilities assumed at the date of acquisition. The excess of purchase price over the fair value of net tangible and identified intangible assets acquired was recorded as goodwill, which totaled $27,835,000 and included $972,000 for direct expenses to consummate the transaction. The majority of the $1,830,000 difference between actual goodwill booked and the $26,005,000 of goodwill which Management estimated in the Company's December 31, 2004 financial statements was due to deferred income taxes.
There have been no changes in the opening balance sheet since the end of the first quarter. The following table shows the fair value of assets and liabilities recorded on the Company's balance sheet from the FNB acquisition, including the associated goodwill in the transaction:
January 14, 2005
$6,963
26,562
591
185,357
(2,164)
183,193
7,767
27,835
9,311
$262,222
$192,860
17,044
4,362
214,266
Shareholders' equity
47,956
Page 18
The Company's investment portfolio increased by $36.6 million or 28.9% to $163.4 million between December 31, 2004, and September 30, 2005. At September 30, 2005, the Company's available-for-sale portfolio had an unrealized gain, net of taxes, of $1.1 million. Between September 30, 2004 and September 30, 2005, the Company's investment portfolio increased by $26.2 million or 19.1%. This growth was the result of the FNB acquisition.
On a pro-forma basis, the Company's investment portfolio increased by $9.4 million or 6.1% during the first nine months of 2005. Year-over-year, the investment portfolio declined by $1.8 million or 1.1% on a pro-forma basis, the result of the decline in investments on the FNB balance sheet to fund loan growth.
Loans grew by $261.3 million or 54.6% during the first nine months of 2005. The growth in commercial loans was $137.8 million or 87.3% and municipal loans increased $7.2 million or 52.7%. The residential mortgage portfolio increased by $85.2 million or 39.7%, and home equity lines of credit grew $20.3 million or 31.3% year-to-date. The majority of this growth was due to the FNB acquisition. Between September 30, 2004 and September 30, 2005, the loan portfolio increased $278.1 million or 60.5%, as a result of strong customer demand and the FNB acquisition
On a pro-forma basis, the loan portfolio increased by $75.1 million or 11.3% during the nine months ended September 30, 2005. Year-over-year, the loan portfolio increased by $94.4 million or 14.6% on a pro-forma basis, the result of strong loan growth seen by the Company in both the Mid-Coast and Down East Maine regions.
The allowance for loan losses represents the amount available for credit losses inherent in the Company's loan portfolio. Loans are charged off when they are deemed uncollectible, after giving consideration to factors such as the customer's financial condition, underlying collateral and guarantees, as well as general and industry economic conditions.
Adequacy of the allowance for loan losses is determined using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for loan losses, Management also takes into consideration other factors such as changes in the mix and size of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio which have similar attributes. The Company’s historical loss experience, industry trends, and the impact of the local and regional economy on the Company’s borrowers, were considered by Management in determining the adequacy of the allowance for loan losses.
The allowance for loan losses is increased by provisions charged against current earnings. Loan losses are charged against the allowance when management believes that the collectibility of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. While Management uses available information to assess possible losses on loans, future additions to the allowance may be necessary based on increases in non-performing loans, changes in economic conditions, growth in loan portfolios, or for other reasons. Any future additions to the allowance would be recognized in the period in which they were determined to be necessary. In addition, various regulatory agencies periodically review the Company’s allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to record additions to the allowance based on judgments different from those of Management.
Credit quality of the commercial portfolios is quantified by a corporate credit rating system designed to parallel regulatory criteria and categories of loan risk. Individual loan officers monitor their loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of the commercial loan portfolio are also assessed on a regular basis by an independent loan review consulting firm. An ongoing portfolio trend analyses and individual credit reviews to evaluate loan risk and compliance with corporate lending policies are also performed. The level of allowance allocable to each group of risk-rated loans is then determined by applying a loss factor that estimates the amount of probable loss in each category. The assigned loss factor for each risk rating is based upon Management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience.
Page 19
Consumer loans, which include residential mortgages, home equity loans/lines, and direct/indirect loans, are generally evaluated as a group based on product type and on the basis of delinquency data and other credit data available due to the large number of such loans and the relatively small size of individual credits. Allocations for these loan categories are principally determined by applying loss factors that represent Management’s estimate of inherent losses. In each category, inherent losses are estimated based upon Management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience. In addition, certain loans in these categories may be individually risk-rated if considered necessary by Management.
The other method used to allocate the allowance for loan losses entails the assignment of reserve amounts to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when Management believes it is probable that the Company will not collect all of the contractual interest and principal payments as scheduled in the loan agreement. Under this method, loans are selected for evaluation based on internal risk ratings or non-accrual status. A specific reserve is allocated to an individual loan when that loan has been deemed impaired and when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. At September 30, 2005, impaired loans with specific reserves totaled $1,707,000 (all of these loans were on non-accrual status) and the amount of such reserves were $598,000.
All of these analyses are reviewed and discussed by the Directors' Loan Committee, and recommendations from these processes provide Management and the Board of Directors with independent information on loan portfolio condition. As a result of these analyses, the Company has concluded that the level of the allowance for loan losses was adequate as of September 30, 2005. As of that date, the balance of $6,474,000 was 0.88% of total loans, compared to 0.99% at December 31, 2004 and 1.02% at September 30, 2004. Loans considered to be impaired according to SFAS 114/118 totaled $2,996,000 at September 30, 2005, compared to $1,601,000 at December 31, 2004. The portion of the allowance for loan losses allocated to impaired loans at September 30, 2005, was $598,000 compared to $228,000 at December 31, 2004.
In Management's opinion, the level of the Company's allowance for loan losses is adequate. Although the allowance is lower as a percentage of loans than many peers, the Bank's loan portfolio has a higher percentage of residential mortgage loans than peers, and the overall credit quality of the portfolio and historically low level of chargeoffs support this.
On a pro-forma basis, the allowance for loan losses decreased by $245,000 or 3.6% in the first nine months of 2005. This was the result of limited additional provision to the allowance due to the analysis of credit quality in the loan portfolio and the level of loan chargeoffs during the period.
During the first nine months of 2005, deposits increased by $385.5 million or 104.2% over December 31, 2004. Core deposits (demand, NOW, savings and money market accounts) increased by $192.8 million or 80.9% in the first nine months of 2005. During the same period, certificates of deposit increased $192.3 million or 144.6%. Between September 30, 2004, and September 30, 2005, deposits grew by 88.1%, or $353.8 million. Demand deposits grew $32.8 million, NOW accounts $67.2 million, savings $49.3 million, and money market accounts $33.8 million, while certificates of deposit increased $170.5 million. The majority of the growth, both year-to-date and year-over-year, was due to the FNB acquisition and in certificates of deposit, primarily from wholesale and brokered sources. The Company also saw good growth in core deposits in the first nine month of 2005, although this growth was at lower levels than with wholesale and brokered sources of funding.
On a pro-forma basis, deposits grew by $195.8 million or 35.0% during the first nine months of 2005. This growth was in certificate of deposits, primarily from wholesale and brokered sources.
Page 20
The Company's funding includes borrowings from the Federal Home Loan Bank of Boston, the Federal Reserve System, and repurchase agreements, enabling it to grow its balance sheet and, in turn, grow its revenues. They may also be used to carry out interest rate risk management stategies, and are increased to replace or supplement other sources of funding, including core deposits and certificates of deposit. During the nine months ended September 30, 2005, borrowed funds decreased by $80.6 million or 38.9% from December 31, 2004. Between September 30, 2004 and September 30, 2005, borrowed funds decreased $45.8 million or 26.6%.
On a pro-forma basis, borrowed funds decreased by $101.6 million or 44.5% during the first nine months of 2005. This was the result of growth in wholesale and brokered sources, as noted above. Year-over-year, borrowed funds decreased $59.9 million or 32.1%.
Shareholders' equity as of September 30, 2005 was $101.8 million, compared to $52.8 million as of December 31, 2004. The Company's strong earnings performance in the first nine months of 2005, net of dividends paid, added to shareholders' equity, in addition to the significant increase from the FNB acquisition. The net unrealized gain on available-for-sale securities, presented in accordance with SFAS 115, decreased by $0.8 million from December 31, 2004, as a result of a recent rise in interest rates and by maturing securities replaced at lower yields.
In 2005, a cash dividend of 13.5 cents per share was declared in the third quarter compared to 11.5 cents in the third quarter of 2004. The dividend payout ratio was 39.71% in the third quarter of 2005 compared to 38.33% in the third quarter of 2004.
In determining future dividend payout levels, the Board of Directors carefully analyzes capital requirements and earnings retention, as set forth in the Company's Dividend Policy. The ability of the Company to pay cash dividends to its shareholders depends on receipt of dividends from its subsidiary, the Bank. The subsidiary may pay dividends to its parent out of so much of its net profits as the Bank's directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. The amount available for dividends in 2005 is this year's net income plus $9.7 million.
Regulatory leverage capital ratios for the Company were 7.67% and 8.03% at September 30, 2005 and December 31, 2004, respectively. The Company had a tier one risk-based capital ratio of 10.81% and tier two risk-based capital ratio of 11.78% at September 30, 2005, compared to 11.62% and 12.71%, respectively, at December 31, 2004. These are comfortably above the standards to be rated "well-capitalized" by regulatory authorities -- qualifying the Company for lower deposit-insurance premiums.
Page 21
At September 30, 2005, loans on non-accrual status totaled $2.9 million, which compares to non-accrual loans of $1.6 million as of December 31, 2004. In addition to loans on non-accrual status at September 30, 2005, loans past due 90 days or more and accruing (calculated on a constant 30-day month basis) totaled $408,000 which compares to $281,000 as of December 31, 2004. The Company continues to accrue interest on these loans because it believes collection of the interest is reasonably assured. The majority of the increase in non-performing assets in the third quarter of 2005 was the result of the FNB acquisition.
No material off-balance sheet risk exists that requires a separate liability presentation.
No recourse obligations have been incurred in connection with the sale of loans.
The following table sets forth the contractual obligations of the Company as of September 30, 2005:
Less than 1 year
1-3 years
3-5 years
More than 5 years
$126,647
$84,938
$14,000
$15,000
$12,709
Operating leases
686
119
338
171
58
325,361
260,038
51,692
13,508
123
$452,694
$345,095
$66,030
$28,679
$12,890
Commitments to extend credit and unused lines of credit
$159,917
As of September 30, 2005 the Bank had primary sources of liquidity of $182.2 million. It is Management's opinion this is adequate. In its Asset/Liability policy, the Bank has guidelines for liquidity. The Company is not aware of any recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on the Company's liquidity, capital resources or results of operations.
Certain disclosures in Management's Discussion and Analysis of Financial Condition and Results of Operations contain certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In preparing these disclosures, Management must make assumptions, including, but not limited to, the level of future interest rates, prepayments on loans and investment securities, required levels of capital, needs for liquidity, and the adequacy of the allowance for loan losses. These forward-looking statements may be subject to significant known and unknown risks uncertainties, and other factors, including, but not limited to, those matters referred to in the preceding sentence.
Although First National Lincoln Corporation believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company which attempt to advise interested parties of the facts which affect the Company's business.
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Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. First National Lincoln Corporation's market risk is composed primarily of interest rate risk. The Bank's Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. All guidelines and policies established by ALCO have been approved by the Board of Directors.
The primary goal of asset/liability management is to maximize net interest income within the interest rate risk limits set by ALCO. Interest rate risk is monitored through the use of two complementary measures: static gap analysis and earnings simulation modeling. While each measurement has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships.
Static gap analysis measures the amount of repricing risk embedded in the balance sheet at a point in time. It does so by comparing the differences in the repricing characteristics of assets and liabilities. A gap is defined as the difference between the principal amount of assets and liabilities which reprice within a specified time period. The Bank's cumulative one-year gap, at September 30, 2005, 1.59% of total assets. ALCO's policy limit for the one-year gap is plus or minus 20% of total assets. Core deposits with non-contractual maturities are presented based upon historical patterns of balance attrition and pricing behavior which are reviewed at least annually.
The gap repricing distributions include principal cash flows from residential mortgage loans and mortgage-backed securities in the time frames in which they are expected to be received. Mortgage prepayments are estimated by applying industry median projections of prepayment speeds to portfolio segments based on coupon range and loan age.
A summary of the Bank's static gap, as of September 30, 2005 is presented in the following table:
0-90
90-365
1-5
5+
Days
Years
Investment securities at amortized cost
$17,643
$24,487
$87,016
$33,839
297,581
106,082
274,574
60,305
Other interest-earning assets
8,144
Non-rate-sensitive assets
213
1,134
49,631
317,795
130,782
362,724
151,959
250,257
92,955
65,204
347,958
79,464
5,428
14,101
27,654
Non-rate-sensitive liabilities and equity
1,281
3,843
20,496
54,619
Total liabilities and equity
331,002
102,226
99,801
430,231
Period gap
$(13,207)
$28,556
$262,923
$(278,272)
Percent of total assets
-1.37%
2.96%
27.30%
-28.89%
Cumulative gap (current)
(13,207)
15,349
278,272
1.59%
28.89%
0.00%
The earnings simulation model forecasts capture the impact of changing interest rates on one-year and two-year net interest income. The modeling process calculates changes in interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflected on the Company's balance sheet. None of the assets used in the simulation are held for trading purposes. The modeling is done for a variety of scenarios that incorporate changes in the absolute level of interest rates as well as basis risk, as represented by changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effects on income of alternative interest rate scenarios
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against earnings in a stable interest rate environment. This analysis is also most useful in determining the short-run earnings exposures to changes in customer behavior involving loan payments and deposit additions and withdrawals.
The Bank's most recent simulation model projects net interest income would increase by approximately 4.90% of stable-rate net interest income if short-term rates affected by Federal Open Market Committee actions fall gradually by two percentage points over the next year, and decrease by approximately 5.92% if rates rise gradually by two percentage points. Both scenarios are well within ALCO's policy limit of a decrease in net interest income of no more than 10.0% given a 2.0% move in interest rates, up or down. Management believes this reflects a reasonable interest rate risk position. In year two, and assuming no additional movement in rates, the model forecasts that net interest income would be higher than that earned in a stable rate environment by 11.66% in a falling-rate scenario and decrease by 9.16% in a rising rate scenario when compared to the year-one base scenario.
A summary of the Bank's interest rate risk simulation modeling, as of September 30, 2005 is presented in the following table:
Changes in Net Interest Income
Year 1
Projected change if rates decrease by 2.0%
+4.90%
Projected change if rates increase by 2.0%
-5.92%
Year 2
+11.66%
-9.16%
This dynamic simulation model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. Loans and deposits are projected to maintain stable balances. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in similar assets. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Non-contractual deposit volatility and pricing are assumed to follow historical patterns. The sensitivities of key assumptions are analyzed annually and reviewed by ALCO.
The information for static gap and changes in net interest income presented in this section pertains to the Bank only and does not include goodwill and a small volume of assets and liabilities owned by the Company and included in its consolidated financial statements as of September 30, 2005. This 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, among others, the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/ replacement of asset and liability cash flows. 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.
A variety of financial instruments can be used to manage interest rate sensitivity. These may include investment securities, interest rate swaps, and interest rate caps and floors. Frequently called interest rate derivatives, interest rate swaps, caps and floors have characteristics similar to securities but possess the advantages of customization of the risk-reward profile of the instrument, minimization of balance sheet leverage and improvement of liquidity. As of September 30, 2005, the Company was not using any derivative instruments for interest rate risk management.
The Company engages an independent consultant to periodically review its interest rate risk position, as well as the effectiveness of simulation modeling and reasonableness of assumptions used. As of September 30, 2005, there were no significant differences between the views of the independent consultant and Management regarding the Company's interest rate risk exposure. Management expects interest rates will continue to rise in the near term and believes that the current level of interest rate risk is acceptable.
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As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2005, the end of the quarter covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal controls over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
Page 25
The Company was not involved in any legal proceedings requiring disclosure under Item 103 of Regulation S-K during the reporting period.
The Company issues shares to the Bank's 401k Investment and Savings Plan pursuant to an exemption from registration under the Securities Act of 1933, as amended (the "Securities Act"), contained in Section 3(a)(11) thereof and Rule 147 promulgated thereunder. During the first nine months of 2005, 24,514 shares were issued pursuant to this Plan, as presented in the following table:
Month
January 2005
6,088
February 2005
1,514
March 2005
560
April 2005
1,417
May 2005
11,292
June 2005
1,099
July 2005
1,534
August 2005
457
September 2005
552
24,514
None.
A.
B.
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Exhibit 2.1 Agreement and Plan of Merger With FNB Bankshares Dated August 25, 2004, incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K dated August 25, 2004, filed under item 1.01 on August 27, 2004.
Exhibit 3.1 Conformed Copy of the Registrants Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.
Exhibit 3.2 Conformed Copy of the Registrant's Bylaws, incorporated by reference to Exhibit 3.2 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.
Exhibit 10.1(a) FNB Bankshares' Stock Option Plan. incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.
Exhibit 10.1(b) Specimen FNB Bankshares Non-Qualified Stock Option Agreement entered into with Messrs. Rosborough, McKim, Wrobel, Dalrymple and Lay, whose FNB Bankshares options have been converted into options to purchase 5,287, 34,086, 15,275, 11,750 and 21,150 shares of the Registrant's stock, respectively, all at $3.80 per share, incorporated by reference to Exhibit 10.1(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.
Exhibit 10.2(a) Specimen Employment Continuity Agreement entered into with Messrs. McKim, Wroble, Dalrymple and Lay, incorporated by reference to Exhibit 10.2(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.
Exhibit 10.2(b) Specimen Amendment to Employment Continuity Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay, incorporated by reference to Exhibit 10.2(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.
Exhibit 10.3(a) Specimen Split Dollar Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay. For Mr. McKim, the amount of the death benefit is $250,000; for Messrs. Lay, Dalrymple and Wrobel, the death benefit is $150,000. Incorporated by reference to Exhibit 10.3(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.
Exhibit 10.3(b) Specimen Amendment to Split Dollar Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay, incorporated by reference to Exhibit 10.3(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.
Exhibit 31.1 Certification of Chief Executive Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934
Exhibit 31.2 Certification of Chief Financial Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934
Exhibit 32.1 Certification of Chief Executive Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification of Chief Financial Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002
Page 27
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Daniel R. Daigneault
Daniel R. Daigneault
President & Chief Executive Officer
Date: November 9, 2005
/s/ F. Stephen Ward
F. Stephen Ward
Executive Vice President & Chief Financial Officer
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