UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2005
OR
Commission File No. 0-28190
CAMDEN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (207) 236-8821
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:
Outstanding at August 5, 2005: Common stock (no par value) 7,588,461 shares.
Form 10-Q for the quarter ended June 30, 2005
TABLE OF CONTENTS OF INFORMATION REQUIRED IN REPORT
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Directors
Camden National Corporation
We have reviewed the accompanying interim consolidated financial information of Camden National Corporation and Subsidiaries as of June 30, 2005, and for the six-month and three-month periods ended June 30, 2005 and 2004. 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 financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
Berry, Dunn, McNeil & Parker
Portland, Maine
July 29, 2005
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Camden National Corporation and Subsidiaries
Consolidated Statements of Income
(unaudited)
(In thousands, except number
of shares and per share data)
Interest Income
Interest and fees on loans
Interest on U.S. government and agency obligations
Interest on state and political subdivision obligations
Interest on interest rate swap agreements
Interest on federal funds sold and other investments
Total interest income
Interest Expense
Interest on deposits
Interest on other borrowings
Total interest expense
Net interest income
Provision for Loan and Lease Losses
Net interest income after provision for loan and lease losses
Non-interest Income
Service charges on deposit accounts
Other service charges and fees
Income from fiduciary services
Brokerage and insurance commissions
Mortgage servicing income, net
Life insurance earnings
Gain on sale of securities
Other income
Total non-interest income
Non-interest Expenses
Salaries and employee benefits
Net occupancy
Furniture, equipment and data processing
Amortization of core deposit intangible
Other expenses
Total non-interest expenses
Income before income taxes
Income Taxes
Net Income
Per Share Data
Basic earnings per share
Diluted earnings per share
Cash dividends per share
Weighted average number of shares outstanding
See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these Consolidated Financial Statements.
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(In thousands, except number of
shares and per share data)
The accompanying notes are an integral part of these Consolidated Financial Statements
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Consolidated Statements of Comprehensive Income
(In thousands)
Six Months Ended
June 30,
Net income
Other comprehensive loss, net of tax:
Change in unrealized gains and losses on securities available for sale, net of tax benefit of $714 and $2,288 for 2005 and 2004, respectively
Change in effective cash flow hedge component of unrealized appreciation on derivative instruments marked to market, net of tax benefit of $120 for 2004
Comprehensive income
Consolidated Statements of Comprehensive Income (Loss)
Three Months Ended
Other comprehensive income (loss), net of tax:
Change in unrealized gains and losses on securities available for sale, net of tax expense (benefit) of $527 and $(3,313) for 2005 and 2004, respectively
Comprehensive income (loss)
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Consolidated Statements of Condition
2005
Assets
Cash and due from banks
Securities available for sale, at market
Securities held to maturity (market value $13,884 and $2,078 at June 30, 2005 and December 31, 2004, respectively)
Loans, less allowance for loan and lease losses of $14,040 and $13,641 at June 30, 2005 and December 31, 2004, respectively
Premises and equipment, net
Interest receivable
Core deposit intangible
Goodwill
Other assets
Total assets
Liabilities
Deposits:
Demand
NOW
Money market
Savings
Certificates of deposit
Total deposits
Borrowings from Federal Home Loan Bank
Other borrowed funds
Accrued interest and other liabilities
Total liabilities
Shareholders’ Equity
Common stock, no par value; authorized 20,000,000 shares, issued and outstanding 7,588,461 and 7,634,975 shares on June 30, 2005 and December 31, 2004, respectively
Surplus
Retained earnings
Accumulated other comprehensive (loss) income:
Net unrealized appreciation (depreciation) on securities available for sale, net of income tax
Total shareholders’ equity
Total liabilities and shareholders’ equity
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Consolidated Statements of Cash Flows
Operating Activities
Adjustment to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses
Depreciation and amortization
(Increase) decrease in interest receivable
Decrease in core deposit intangible
Decrease (increase) in other assets
Decrease in other liabilities
Net cash provided by operating activities
Investing Activities
Proceeds from maturities of securities held to maturity
Proceeds from sale and maturities of securities available for sale
Purchase of securities held to maturity
Purchase of securities available for sale
Purchase of Federal Home Loan Bank stock
Net increase in loans
Net increase in other real estate owned
Purchase of premises and equipment
Net cash used in investing activities
Financing Activities
Net increase in deposits
Proceeds from Federal Home Loan Bank borrowings
Repayments on Federal Home Loan Bank borrowings
Net increase in other borrowed funds
Repurchase of issued common stock
Proceeds from stock issuance under option plan
Cash dividends
Net cash provided by (used in) financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures required by accounting principles generally accepted in the United States of America for complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the consolidated statements of condition of Camden National Corporation, as of June 30, 2005, and December 31, 2004, the consolidated statements of income for the six and three months ended June 30, 2005 and June 30, 2004, the consolidated statements of comprehensive income (loss) for the six and three months ended June 30, 2005 and June 30, 2004, and the consolidated statements of cash flows for the six months ended June 30, 2005 and June 30, 2004. All significant intercompany transactions and balances are eliminated in consolidation. Certain items from the prior year were reclassified to conform to the current year presentation. The income reported for the six-month period ended June 30, 2005 is not necessarily indicative of the results that may be expected for the full year. The information in this report should be read in conjunction with the consolidated financial statements and accompanying notes included in the December 31, 2004 Annual Report on Form 10-K.
NOTE 2 – EARNINGS PER SHARE
Basic earnings per share data is computed based on the weighted average number of common shares outstanding during each period. Potential common stock, which consists of incentive stock options granted to key members of management and the Board of Directors, is considered in the calculation of weighted average shares outstanding for diluted earnings per share, and is determined using the treasury method.
The following tables set forth the computation of basic and diluted earnings per share:
(Dollars in thousands, except number
Net income, as reported
Weighted average shares outstanding
Effect of dilutive employee stock options
Adjusted weighted average shares and assumed conversion
All outstanding and exercisable stock options at June 30, 2005 and 2004 were in-the-money options as the exercise price was less than the average market price of the common stock. At June 30, 2005, the Company
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had 57,750 non-vested stock option grants, of which 14,000 were in-the-money and 43,750 were not in-the-money. At June 30, 2004, the Company had 17,500 non-vested stock option grants, all of which were in-the-money.
NOTE 3 – DERIVATIVE FINANCIAL INSTRUMENTS
The Company had interest rate protection agreements with notional amounts of $30.0 million, which matured on February 1, 2005. Under these agreements, the Company exchanged a variable rate asset for a fixed rate asset, thus protecting certain asset yields from falling interest rates. In accordance with Statement of Financial Accounting Standards (SFAS) No. 133 “Accounting for Derivative Instruments and Hedging Activities,” management designated these swap agreements as cash-flow hedges since they converted a portion of the loan portfolio from a variable rate based upon the Prime Rate to a fixed rate. The hedge relationship was estimated to be 100% effective; therefore, there was no impact on the statement of income resulting from changes in fair value.
On July 14, 2005, the Company purchased interest rate protection agreements (floors) with notional amounts of $50.0 million. These floors were acquired to limit the company’s exposure to falling rates on Prime rate loans. Under these agreements, the company paid up front premiums of $410,000 for the right to receive cash flow payments below the predetermined floor rate, thus effectively flooring its interest income for the duration of the agreement. In accordance with SFAS No. 133, management designated these floors as cash flow hedges.
NOTE 4 – INVESTMENTS
Management evaluates investments for other-than-temporary impairment based on the type of investment and the period of time the investment has been in an unrealized loss position. At June 30, 2005, the Company had a greater than 12 months unrealized loss of $837,600, which represents 1.8% of the $45.1 million fair value of the specific securities. The position included five mortgage-backed securities issued by Fannie Mae, one issued by Freddie Mac and two collateralized mortgage obligations, which accounted for 81.7%, 7.9% and 10.4%, respectively, of the greater than 12 months unrealized loss position. Management feels that the unrealized loss positions are primarily due to the changes in the interest rate environment and that there is little risk of loss and, therefore, the securities are not considered other-than-temporarily impaired. At June 30, 2004, management determined that no investments were other-than-temporarily impaired.
NOTE 5 – CORE DEPOSIT INTANGIBLE
The Company has a core deposit intangible asset related to the acquisition of bank branches between 1995 and 1998. The core deposit intangible is amortized on a straight-line basis over 10 years, and reviewed for possible impairment when it is determined that events or changed circumstances may affect the underlying basis of the asset. The carrying amount is as follows:
(Dollars in thousands)
Core deposit intangible, cost
Accumulated amortization
Core deposit intangible, net
Amortization expense related to the core deposit intangible for the six- and three-month periods ended June 30, 2005 amounted to $443,000 and $221,000, respectively. Amortization expense for the six- and three-month periods ended June 30, 2004 amounted to $454,000 and $223,000 respectively. The expected amortization expense for each year until the core deposit intangible is fully amortized is estimated to be $884,000 in 2005, $864,000 in 2006, $856,000 in 2007, and $320,000 in 2008.
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NOTE 6 – GOODWILL
The value of the Company’s goodwill balances, including the related impairment loss, is as follows:
Goodwill, at cost
Transitional impairment loss
Goodwill, net
As of June 30, 2005, in accordance with SFAS No. 142, the Company completed its annual review of the goodwill and determined that there has been no additional impairment.
NOTE 7 – COMMON STOCK REPURCHASE
On July 27, 2004, the Board of Directors of the Company voted to authorize the Company to purchase up to 5% or approximately 395,000 shares of its authorized and issued common stock. The authority may be exercised from time to time and in such amounts as market conditions warrant. Any repurchases are intended to make appropriate adjustments to the Company’s capital structure, including meeting share requirements related to employee benefit plans and for general corporate purposes. Through the six month period ended June 30, 2005, the Company repurchased 94,907 shares of common stock at an average price of $32.15 under the July, 2004 plan, of which 58,935 shares were purchased within the second quarter of 2005 at an average price of $32.03. In July 2005, the Board of Directors extended the Common Stock Repurchase Program for an additional one year period, expiring July 1, 2006, authorizing the Company to purchase up to 750,000 shares during the year for the same reasons noted under the prior year plan.
NOTE 8 – SHAREHOLDERS’ EQUITY
On April 29, 2003, the shareholders of the Company approved the 2003 Stock Option and Incentive Plan (the “current plan”). The maximum number of shares of stock reserved and available under the current plan is 800,000 shares. Awards may be granted in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, deferred stock, unrestricted stock, performance share and dividend equivalent rights, or any combination of the preceding. Prior to the approval of the current plan, the Company had three stock option plans, which the Company accounted for under the recognition and measurement provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. On August 27, 2002, the Company announced that it voluntarily adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” prospectively to all employee awards granted, modified, or settled.
Stock Option Awards
Under the current plan, the exercise price of incentive stock options shall not be less than 100% of the fair market value on the date of grant, or 85% of the fair market value on the date of grant in the case of non-qualified stock options. No stock options shall be exercisable more than ten years after the date the stock
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option is granted. During the first six months of 2005, the Company issued, under the current plan, 42,750 stock options to employees, all of which vest over a five-year period. Of the 42,750 options issued in 2005, 2,500 were granted and 1,500 were forfeited during the second quarter. During the second quarter of 2004, the Company issued 7,500 stock options to employees, all of which vest over a five-year period. In accordance with the provisions of SFAS No. 123, the Company recorded approximately $15,500 of compensation expense during the first six months of 2005, of which $5,800 was in the second quarter, related to the 2004 and 2005 grants. There was no compensation expense for the six months ended June 30, 2004 as none of the options vested during that period.
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants: in 2005, dividend yield of 2.3%, expected volatility of 4.5%, risk-free interest rate of 3.92%, and expected lives of 10 years, and in 2004, dividend yield of 2.3%, expected volatility of 4.4%, risk-free interest rate of 3.75%, and expected lives of 10 years.
Restricted Stock Awards
In January 2005, under the current plan, the Company issued 4,687 shares of restricted stock, all of which vest over a three-year period. The Company recorded approximately $21,200 of compensation expense during the first six months of 2005, of which $12,200 was recorded in the second quarter.
Management Stock Purchase Plan
The Management Stock Purchase Plan, which is a component of the current plan, provides equity incentive compensation to selected management employees of the Company. Participants in the Plan who are senior executives of the Company are required to receive restricted shares in lieu of a portion of their annual incentive bonus, while certain other executive management may elect to receive restricted shares in lieu of a portion of their annual incentive bonus. Restricted shares are granted at a discount of one-third of the fair market value of the stock on the date of grant. Restricted shares will vest two years after the date of grant if the participant remains employed by the Company for such period. During the first quarter of 2005, under the Management Stock Purchase Plan, the Company issued 3,455 shares of restricted stock at a discounted price of $24.91. Related to the discount on the restricted stock, the Company recorded approximately $7,500 of compensation expense during the six month period ended June 30, 2005, of which $4,700 was recorded during the second quarter.
Long-term Performance Share Plan
The Long-term Performance Share Plan, which is a component of the current plan, is intended to create incentives for certain executive officers of the Company to allow the Company to attract and retain in its employ persons who will contribute to the future success of the Company. It is further the intent of the Company that awards made under this plan will be used to achieve the twin goals of aligning executive incentive compensation with increases in shareholder value and using equity compensation as a tool to retain key employees. The long-term performance period is a period of three consecutive fiscal years beginning on January 1 of the first year and ending on December 31 of the third year. Awards are based upon the attainment of certain financial goals over the three-year period.
NOTE 9 – MORTGAGE SERVICING RIGHTS
Residential real estate mortgages are originated by the Company both for portfolio and for sale into the secondary market. The sale of loans is to institutional investors such as Freddie Mac. Under loan sale and servicing agreements with the investor, the Company generally continues to service the residential real estate mortgages. The Company pays the investor an agreed-upon rate on the loan, which is less than the interest rate the Company receives from the borrower. The Company retains the difference as a fee for servicing the residential real estate mortgages. As required by SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, the Company capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment. The balance of capitalized mortgage servicing rights, net of a valuation allowance, included in other assets at June 30, 2005 and 2004 and December 31, 2004 was $643,000, $780,000, and $777,000, respectively, which equaled the net book value of these rights. For the
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same periods, the fair market value of the mortgage servicing rights approximated $983,000, $1.1 million, and $1.0 million, respectively. Amortization of the mortgage servicing rights, as well as write-offs of capitalized rights due to prepayments of the related mortgage loans, are recorded as a charge against mortgage servicing fee income. The Company’s assumptions with respect to prepayments, which are affected by the estimated average life of the loans, are adjusted periodically to reflect current circumstances. In evaluating the reasonableness of the carrying values of mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans.
The following summarizes mortgage servicing rights capitalized and amortized, along with the activity in the related valuation allowance:
Balance of loans serviced for others
Mortgage Servicing Rights:
Balance at beginning of year
Mortgage servicing rights capitalized
Amortization charged against mortgage servicing fee income
Change in valuation allowance
Balance at end of period
Valuation allowance:
Increase in impairment reserve
Reduction of impairment reserve
NOTE 10 – EMPLOYEE BENEFIT PLANS
Post-retirement Plan
The Company’s post-retirement plan provides medical and life insurance to certain eligible retired employees. The components of the net periodic benefit cost are:
Service cost
Interest cost
Amortization of transition obligation
Amortization of prior service cost
Recognized net actuarial loss
Net periodic benefit cost
Weighted-average discount rate assumption used to determine benefit obligation
Weighted-average discount rate assumption used to determine net benefit cost
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The Company’s expected benefit payments for the third quarter of 2005 are $9,750 and the expected benefit payments for all of 2005 are $39,000.
Supplemental Executive Retirement Plan
The Company also sponsors an unfunded, non-qualified supplemental executive retirement plan for certain officers. The agreement provides that current active participants with five years of service (vested) will be paid a life annuity upon retirement at age 55 or older, while vested participants who leave the Company prior to to age 55 will be paid a 15 year benefit starting at age 65. The agreement provides for a minimum 15-year guaranteed benefit for all vested participants. The components of the net periodic benefit cost are:
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The Company’s expected benefit payments for the third quarter of 2005 are $43,750 and the expected benefit payments for all of 2005 are $175,000.
NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R)—Share-Based Payment, which replaces SFAS No. 123 – Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25 – Accounting for Stock Issued to Employees. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107 – Share-Based Payment, which provides interpretive guidance related to SFAS No. 123(R). SFAS No. 123 (R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. SFAS No. 123(R) requires liability awards to be remeasured each reporting period and compensation costs to be recognized over the period that an employee provides service in exchange for the award. In April 2005, the SEC delayed the effective date of SFAS No. 123(R) to the beginning of the annual reporting period that begins after June 15, 2005, which is January 1, 2006 for the Company. The adoption of SFAS No. 123(R) is not expected to have a material effect on the Company’s consolidated financial statements.
NOTE 12 – LITIGATION
The Company is a party to litigation and claims arising in the normal course of business. In addition to the routine litigation incidental to its business, the Company’s subsidiary, Camden National Bank, was named a defendant in a lawsuit brought by a former commercial customer. The customer claimed the Bank broke a verbal promise for a loan to fund operating expenses of its ski resort. During 2004, the litigation was brought to trial where 20 of the original 21 counts were dismissed, leaving the single breach of contract count, in which, the jury returned a verdict against Camden National Bank and awarded damages of $1.5 million. Camden National Bank has also obtained and recorded judgments against the Plaintiff, and management believes these judgments partially offset the verdict and, as a result, any exposure is immaterial. Management of Camden National Bank and the Company has reviewed this matter with counsel and the Company’s outside auditors. Based on legal counsel’s opinion, management continues to believe that the allegations are unfounded and that it is probable that the judgment will be reversed upon appeal. A motion was filed asking the judge to reverse the jury verdict and the accompanying award of damages. On January 11, 2005 this motion was denied. On February 1, 2005 Camden National Bank filed an appeal of the verdict with the Law Court. Accordingly, no reserve for potential settlement expenditure has been recorded as of June 30, 2005.
ITEM 2. MANAGEMENT’S DISCUSSION OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
FORWARD LOOKING INFORMATION
The discussions set forth below and in the documents we incorporate by reference herein contain certain statements that may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. The Company may make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to stockholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “will,” “should,” and other expressions which predict or indicate future events or trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Company to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.
Some of the factors that might cause these differences include, but are not limited to, the following:
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You should carefully review all of these factors, and you should be aware that there might be other factors that could cause these differences, including, among others, the factors listed under “Certain Factors Affecting Future Operating Results,” beginning on page 28 of our Annual Report on Form 10-K for the year ended December 31, 2004. Readers should carefully review the factors described under “Certain Factors Affecting Future Operating Results” and should not place undue reliance on our forward-looking statements.
These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of the Company’s financial condition are based on the interim consolidated financial statements and related notes, which are prepared in accordance with accounting principles generally accepted in the United States of America, 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. 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 and lease losses (“ALLL”), mortgage servicing rights and accounting for acquisitions and the related review of goodwill and intangible assets for impairment. 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 under different assumptions or conditions.
Allowance for Loan and Lease Losses. In preparing the interim consolidated financial statements, the ALLL requires the most significant amount of management estimates and assumptions. Management regularly evaluates the ALLL 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 probable losses. The use of different estimates or assumptions could produce different provisions for loan and
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lease losses, which would affect the earnings of the Company. A smaller provision for loan and lease losses results in higher net income and when a greater amount of provision for loan and lease losses is necessary the result is lower net income. Monthly, the Corporate Risk Management Group reviews the ALLL with the board of directors for each bank subsidiary. On a quarterly basis, a more in-depth review of the ALLL, including the methodology for calculating and allocating the ALLL, is reviewed with the Company’s Board of Directors, as well as the board of directors for each subsidiary bank. If the assumptions are incorrect, the ALLL may not be sufficient to cover the losses the Company could experience, which would have an adverse effect on operating results, and may also cause the Company to increase the ALLL in the future. The Company’s net income would decrease if additional amounts needed to be provided to the ALLL.
Other Real Estate Owned (OREO). Periodically the Company acquires property in connection with foreclosures or in satisfaction of debt previously contracted. The valuation of this property is accounted for individually at the lower of the “book value of the loan satisfied” or its net realizable value on the date of acquisition. At the time of acquisition, if the net realizable value of the property is less than the book value of the loan, a change or reduction in the ALLL, is recorded. If the value of the property becomes permanently impaired, as determined by an appraisal or an evaluation in accordance with the Company’s appraisal policy, the Company will record the decline by showing a charge against current earnings. Upon acquisition of a property valued at $25,000 or more, a current appraisal or a broker’s opinion must substantiate “market value” for the property.
Mortgage Servicing Rights. Servicing assets are recognized as separate assets when servicing rights are acquired through sale of residential mortgage 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 residential mortgage assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized costs. Fair value is determined based upon discounted cash flows using market-based assumptions. In periods of falling market interest rates, accelerated loan prepayment speeds can adversely impact the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets were to increase in the future, the Company can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. When the book value exceeds the fair value, an impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact the Company’s financial condition and results of operations either positively or adversely. Management has engaged, on a quarterly basis, a recognized third party to evaluate the valuation of the Company’s mortgage servicing rights asset.
Valuation of Acquired Assets and Liabilities. Management utilizes numerous techniques to estimate the value of various assets held by the Company. As previously discussed, management utilized various 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. Goodwill is evaluated for impairment using several standard valuation techniques including discounted cash flow analyses, as well as 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.
Interest Income Recognition. Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are non-accruing. Interest on non-accruing loans is recognized as income when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current-period interest income, therefore, an increase in loans on non-accrual status reduces interest income. If a loan is removed from non-accrual status, all previously unrecognized interest is collected and recorded as interest income.
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RESULTS OF OPERATIONS
Executive Overview
For the six months ended June 30, 2005:
Net income increased $827,000, or 8.7%, for the six month period ended June 30, 2005 compared to the six month period ended June 30, 2004. The following were major factors contributing to the results of the first half of 2005 compared to the same period of 2004:
For the three months ended June 30, 2005:
Net income increased $506,000, or 10.2%, for the three month period ended June 30, 2005 compared to the three month period ended June 30, 2004. The following were major factors contributing to the results of the second quarter of 2005 compared to the same period of 2004:
Financial condition at June 30, 2005 compared to December 31, 2004:
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Net Interest Income
The Company’s net interest income, on a fully taxable equivalent basis, for the six months ended June 30, 2005 was $26.7 million, a 9.3%, or $2.3 million, increase over the net interest income of $24.4 million for the first six months of 2004. Interest income on loans increased $5.3 million, or 18.7%, during the six-month period of 2005 compared to the same period of 2004 due to an increase in loans and increases in the Prime Rate, which had a positive impact on adjustable rate loans and resulted in an overall increase in the yields on loans. Negatively impacting net interest income $397,000 during the first six months of 2005 compared to the same period of 2004 was the decline in net interest income from interest rate swap agreements that matured on February 1, 2005. The Company experienced an increase in interest income on investments during the first six months of 2005 compared to the same period in 2004 due to increases in volumes, which were partially offset by a reduction in the yields as a result of new investments being added to the portfolio at lower yields than maturing investments. The Company’s total interest expense increased $4.2 million during the first six months of 2005 compared to the same period in 2004. This increase was the result of increases in deposit and borrowing volumes and the rising interest rate environment affecting both deposit and borrowing costs, primarily in money market accounts and borrowings from the FHLBB, respectively. Net interest income, expressed as a percentage of average interest-earnings assets for the first six months of 2005 and 2004, was 3.67% and 3.81%, respectively.
Net interest income, on a fully taxable equivalent basis, for the three months ended June 30, 2005 was $13.7 million, a 13.9%, or $1.7 million, increase compared to $12.0 million in net interest income for the same period in 2004 due to an increase in loans and increases in the Prime Rate, partially offset by a decline in net interest income on interest rate swap agreements.
The following tables, which present changes in interest income and interest expense by major asset and liability category for six months ended June 30, 2005 and 2004, illustrate the impact of average volume growth and rate changes. The income from tax-exempt assets, municipal investments and loans, has been adjusted to a tax-equivalent basis, thereby allowing a uniform comparison to be made between asset yields. Changes in net interest income are the result of interest rate movements, changes in the amounts and mix of interest-earning assets and interest-bearing liabilities, and changes in the level of non-interest-earning assets and non-interest-bearing liabilities. The Company utilized derivative financial instruments, such as interest rate swap agreements, that have an effect on net interest income. There was an increase in net interest income of $31,000 during the first six months of 2005 compared to an increase of $428,000 in the first six months of 2004 due to the net impact of the derivative financial instruments, which matured on February 1, 2005. The average amount of non-accrual loans can also affect the average yield on all outstanding loans. Average non-accrual loans for the periods ended June 30, 2005 and 2004 were $6.1 million and $5.7 million, respectively.
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ANALYSIS OF CHANGES IN NET INTEREST MARGIN
Dollars in thousands
Interest-earning assets:
Investments (including federal funds sold)
Loans
Total earning assets
Interest-bearing liabilities:
Demand deposits
NOW accounts
Savings accounts
Money market accounts
Borrowings
Brokered certificates of deposit
Total interest-bearing liabilities
Net interest income (fully-taxable equivalent)
Less: fully-taxable equivalent adjustment
Net Interest Rate Spread (fully-taxable equivalent)
Net Interest Margin (fully-taxable equivalent)
Notes: Nonaccrual loans are included in total loans. Tax exempt interest was calculated using a rate of 35% for fully-taxable equivalent.
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AVERAGE BALANCE SHEETS
Total interest-earning assets
Less allowance for loan and lease losses
Sources of funds:
Certificates of deposits
Total sources of funds
Other liabilities
Shareholders’ equity
ANALYSIS OF VOLUME AND RATE CHANGES ON
NET INTEREST INCOME
Net interest income (fully taxable equivalent)
During the first six months of 2005, the Company provided $575,000 of expense to the ALLL compared to an
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expense of $165,000 in the first six months of 2004. Provisions are made to the ALLL in order to maintain the ALLL at a level which management believes is reasonable and reflective of the overall risk of loss inherent in the loan portfolio. The Company’s Corporate Risk Management Group actively addresses existing and anticipated asset quality issues. The Company had net charge-offs of $175,000 during the first six months of 2005, compared to net recoveries of $220,000 during the first six months of 2004. At the same time, non-performing assets as a percent of total loans decreased to 0.57% at June 30, 2005, compared to 0.60% at December 31, 2004, and 0.59% at June 30, 2004. The determination of an appropriate level of ALLL, and subsequent provision for loan and lease losses, which would affect earnings, is based on management’s judgment of the adequacy of the reserve based on analysis of various economic factors and review of the Company’s loan portfolio, which may change due to numerous factors including loan growth, payoffs of lower quality loans, recoveries on previously charged-off loans, improvement or deterioration in the financial condition of the borrowers, risk rating downgrades/upgrades and charge-offs. Management believes that the ALLL at June 30, 2005 of $14.0 million, or 1.24% of total loans outstanding, was appropriate based on the economic conditions in the Company’s service area and management’s estimation of the quality of the Company’s loan portfolio at June 30, 2005. Several factors, as explained above, may materially affect the level of future provisions for loan and lease losses, which could impact earnings. The ALLL of $13.6 million and $14.5 million was 1.28% and 1.44% of total loans outstanding at December 31, 2004 and June 30, 2004, respectively.
Total non-interest income decreased $811,000, or 13.7%, for the six months ended June 30, 2005 compared to the six months ended June 30, 2004. Service charges on deposit accounts decreased $164,000, or 8.8%, due to relationship pricing changes. Earnings on bank-owned life insurance decreased $142,000 due to lower yields. In the first six months of 2004, the Company recorded a gain on the sale of securities of $684,000, which did not occur during the first six months of 2005. Brokerage and insurance commission income increased $88,000 for the first six months of 2005 compared to the same period of 2004 primarily as a result of the growth in the customer base at Acadia Financial Consultants, a division of the bank subsidiaries. Other non-interest income increased $142,000 primarily due to increased debit card income, which resulted from increased customer transaction volume.
Total non-interest income decreased $695,000, or 20.7%, during the second quarter of 2005 compared to the second quarter of 2004 primarily due to the second quarter 2004 gain on the sale of securities.
Non-interest Expense
Total non-interest expense decreased by $18,000 for the six-month period ended June 30, 2005 compared to the six months ended June 30, 2004. Salaries and employee benefit costs increased $269,000, or 3.1%, during the first six months of 2005 compared to 2004, primarily due to normal annual salary and benefit cost increases and an increase in employee incentive expenses. Other non-interest expenses decreased by $201,000, or 4.5%, for the first six months of 2005 compared to the first six months of 2004, primarily due to a decline in director fees of $143,900 as the stock price has declined since December 31, 2004 and a portion of the fees are paid with phantom stock, and a reversal of $269,000 in expense as a result of an abatement of penalties related to a Form 945 tax withholding remittance issue. These reductions in other non-interest expenses were somewhat offset by increases in marketing, postage and data processing costs.
Total non-interest expense increased $127,000, or 1.6%, for the quarter ended June 30, 2005 compared to the quarter ended June 30, 2004. Salaries and employee benefit costs increased by $488,000, or 11.6%, during the second quarter of 2005 compared to 2004, primarily due to normal annual salary increases, higher healthcare costs, and increased employee incentive expenses. Although paid once per year, employee incentive expenses are accrued monthly based upon the calculations of an incentive compensation model, which takes into account actual and forecasted financial performance, among other drivers, within a set of key performance indicators. During the second quarter of 2005, the model calculated a higher projected payout than was calculated for the second quarter of 2004 and resulted in an increase of $220,000 in incentive expenses in the second quarter of 2005 compared to the same period in 2004. Other non-interest expenses decreased by $295,000, or 13.3%, for the three months ended June 30, 2005 compared to the prior year due to decline in directors fees and the abatement of penalties related to a tax withholding remittance issue.
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FINANCIAL CONDITION
During the six months of 2005, average assets of $1.5 billion increased $182.5 million, or 13.4%, compared to the same period in 2004. This increase was the result of an increase in the loan portfolio, which averaged $1.1 billion during the first six months of 2005, an increase of $117.2 million, or 12.0%, as compared to $978.6 million during the first six months of 2004. The largest increase in average loan balances was in commercial real estate loans, which increased $39.5 million, or 10.7%, during the first six months of 2005 compared to the first six months of 2004. In addition, average residential real estate loans increased $36.4 million, or 12.4%, reflecting a steady demand for mortgage loans caused by continued low long-term interest rates, strong new and existing home sales, and refinance activity. Average consumer loans increased $36.0 million, or 25.9%, primarily reflecting increased home equity loan activity. Average investments increased $64.0 million, or 21.1%, to $367.6 million for the first six months of 2005 from $303.6 million for the first six months of 2004, as the Company took advantage of a favorable security market, primarily during the first quarter of 2005.
Total assets of $1.6 billion have increased $97.1 million, or 6.5%, since December 31, 2004, as loan balances have increased $61.2 million, or 5.7%, and securities balances have increased $36.6 million, or 11.3%, due to reasons similar to those stated above.
Liabilities and Shareholders’ Equity
During the first six months of 2005, average deposits of $1.0 billion increased by $99.7 million, or 10.7%, compared to the same period in 2004. Average brokered certificates of deposit increased $47.2 million as the Company has increased its use of brokered certificates of deposit as a funding source, while average money market and demand deposit account balances have increased $21.0 million and $13.5 million, respectively. To further support the increase in average earning assets, the Company’s average borrowings increased $78.1 million to $371.6 million, the majority of which are with the FHLBB.
Total liabilities have increased $96.9 million, or 7.1%, since December 31, 2004, to $1.5 billion at June 30, 2005. Total deposits increased $63.4 million led by increases in certificates of deposit (excluding brokered certificates of deposit) of $18.7 million and money market accounts of $10.2 million as rate increases on non-transaction accounts have pulled consumers back into these products. In addition, the Company has increased its use of brokered certificates of deposit as a funding source, resulting in an increase of $34.4 million from December 31, 2004 to June 30, 2005. As the increase in total earning assets was greater than the increase in total deposits over the first six months of 2005, the Company increased its borrowings $34.4 million, primarily at the FHLBB.
LIQUIDITY
The liquidity needs of the Company require the availability of cash to meet the withdrawal demands of depositors and credit commitments to borrowers. Liquidity is defined as the Company’s ability to maintain availability of funds to meet customer needs as well as to support its asset base. The primary objective of liquidity management is to maintain a balance between sources and uses of funds to meet the cash flow needs of the Company in the most economical and expedient manner. Due to the potential for unexpected fluctuations in both deposits and loans, active management of the Company’s liquidity is necessary. The Company maintains various sources of funding and levels of liquid assets in excess of regulatory guidelines in order to satisfy its varied liquidity demands. The Company monitors its liquidity in accordance with its internal guidelines and all applicable regulatory requirements. As of June 30, 2005 and June 30, 2004, the Company’s level of liquidity exceeded its target levels. Management believes that the Company currently has appropriate liquidity available to respond to long- and short-term liquidity demands. Sources of funds utilized by the Company consist of deposits, borrowings from the FHLBB and other sources, cash flows from operations, prepayments and maturities of outstanding loans, investments including mortgage-backed securities, and the sales of mortgage loans.
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Deposits continue to represent the Company’s primary source of funds. For the first six months of 2005, average deposits of $1.0 billion increased $99.7 million, or 10.7%, from $935.7 million reported during the first six months of 2004. The Company experienced growth in all deposit categories during this period. Comparing average deposits for the first six months of 2005 to 2004, transaction accounts (demand deposits and NOW accounts) increased $19.7 million, savings accounts increased $345,000, money market accounts increased $21.0 million, and certificates of deposit increased $58.7 million. Included in the money market deposit category are deposits from Acadia Trust, N.A., representing client funds. The balance in the Acadia Trust, N.A. client money market account, which was $56.8 million on June 30, 2005, could increase or decrease depending upon changes in the portfolios of the clients of Acadia Trust, N.A. The increase in certificates of deposit during the first half of 2005 was the result of the Company utilizing brokered certificates of deposit as a funding source when the market for these funds was more favorable compared to other alternatives. Borrowings supplement deposits as a source of liquidity. In addition to borrowings from the FHLBB, the Company purchases federal funds, sells securities under agreements to repurchase and utilizes treasury tax and loan accounts. Average borrowings for the first six months of 2005 were $371.6 million, an increase of $78.1 million, from $293.5 million during the first six months of 2004. The majority of the borrowings were from the FHLBB, whose advances remained the largest non-deposit-related, interest-bearing funding source for the Company. The Company secures these borrowings with qualified residential real estate loans, certain investment securities and certain other assets available to be pledged. The carrying value of loans pledged as collateral at the FHLBB was $333.3 million and $295.7 million at June 30, 2005 and 2004, respectively. The carrying value of securities pledged as collateral at the FHLBB was $178.4 million and $109.4 million at June 30, 2005 and 2004, respectively. The Company, through its bank subsidiaries, has an available line of credit with FHLBB of $13.0 million at June 30, 2005 and 2004. The Company had no outstanding balance on its line of credit with the FHLBB at June 30, 2005 and 2004.
In addition to the liquidity sources discussed above, the Company believes its investment portfolio and residential loan portfolio provide a significant amount of contingent liquidity that could be accessed in a reasonable time period through sales of those portfolios. The Company also believes that it has additional untapped access to the national brokered deposit market. These sources are considered as liquidity alternatives in the Company’s contingent liquidity plan. The Company believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer saving habits and availability or access to the national brokered deposit market could significantly impact the Company’s liquidity position.
CAPITAL RESOURCES
Under Federal Reserve Board (“FRB”) guidelines, bank holding companies such as the Company are required to maintain capital based on risk-adjusted assets. These capital requirements represent quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.
The Company’s capital classification is also subject to qualitative judgments by its regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). These guidelines apply to the Company on a consolidated basis. Under the current guidelines, banking organizations must maintain a risk-based capital ratio of 8%, of which at least 4% must be in the form of core capital (as defined). The capital ratios of the Company and its subsidiaries exceeded regulatory guidelines at June 30, 2005 and June 30, 2004. The Company’s Tier 1 to risk-weighted assets was 10.76% and 11.58% at June 30, 2005 and 2004, respectively. In addition to risk-based capital requirements, the FRB requires bank holding companies to maintain a minimum leverage capital ratio of core capital to total assets of 4.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted. The Company’s leverage ratio at June 30, 2005 and 2004 was 7.40% and 7.91%, respectively.
The principal cash requirement of the Company is the payment of dividends on the Company’s common stock as and when declared by the Board of Directors. The Company is primarily dependent upon the payment of
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cash dividends by its subsidiaries to service its commitments. The Company, as the sole shareholder of its subsidiaries, is entitled to dividends when and as declared by each subsidiary’s Board of Directors from legally available funds. The Company declared dividends in the aggregate amount of $6.9 million and $3.1 million in the first six months of 2005 and 2004, respectively.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
In the normal course of business, the Company is a party to credit related financial instruments with off-balance sheet risk, which are not reflected in the Consolidated Statements of Condition. These financial instruments include lending commitments and letters of credit. Those instruments involve varying degrees of credit risk in excess of the amount recognized in the Consolidated Statements of Condition.
The Company follows the same credit policies in making commitments to extend credit and conditional obligations as it does for on-balance sheet instruments, including requiring similar collateral or other security to support financial instruments with credit risk. The Company’s exposure to credit loss in the event of nonperformance by the customer is represented by the contractual amount of those instruments. Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements. At June 30, 2005, the Company had the following levels of commitments to extend credit:
Total Amount
Committed
Letters of Credit
Other Commitments to Extend Credit
Total
The Company, in the normal course of business, is a party to several off-balance sheet contractual obligations through operating lease agreements on a number of branch facilities. The Company has an obligation and commitment to make future payments under these contracts, as outlined in the table below. The future payments will be expensed as incurred and are expected to be made from operating cash flow.
Borrowings from the FHLBB consist of short- and long-term fixed rate borrowings and are collateralized by all stock in the FHLBB and a blanket lien on qualified collateral consisting primarily of loans with first mortgages secured by one-to-four family properties, certain pledged investment securities and other qualified assets. The Company has an obligation and commitment to repay all borrowings from the FHLBB. These commitments, borrowings and the related payments are made during the normal course of business. At June 30, 2005, the Company had the following levels of contractual obligations for the remainder of 2005 and the fiscal years thereafter:
of Obligations
Operating Leases
Capital Leases
Long-Term Debt
Other Long-Term Obligations
The Company may use derivative instruments as partial hedges against large fluctuations in interest rates. The Company may use interest rate swap and floor instruments to partially hedge against potentially lower yields on the variable prime rate loan category in a declining rate environment. If rates were to decline, resulting in reduced income on the adjustable rate loans, there would be an increase income flow from the interest rate swap and floor instruments. The Company may also use cap instruments to partially hedge against increases in short-term borrowing rates. If rates were to rise, resulting in an increased interest cost, there would be an increased income flow from the cap instruments. These financial instruments are factored
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into the Company’s overall interest rate risk position. At June 30, 2005, the Company had no derivative instruments. On July 14, 2005, the Company purchased $50.0 million in floor contracts with a strike rate of 6.0% and terminates in 2010.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE
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. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by the subsidiary’s Boards of Directors and are reviewed and approved annually. Each bank subsidiary’s Board of Directors’ Asset/Liability Committee (“Board ALCO”) delegates responsibility for carrying out the asset/liability management policies to the Company’s Management Asset/Liability Committee (“Management ALCO”). In this capacity, Management ALCO develops guidelines and strategies impacting the Company’s asset/liability management-related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends. The Management ALCO and Board ALCO jointly meet on a quarterly basis to review strategies, policies, economic conditions and various activities as part of the management of these risks.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, thereby impacting net interest income (“NII”), the primary component of the Company’s earnings. Board and Management ALCO utilize the results of a detailed and dynamic simulation model to quantify the estimated exposure of NII to sustained interest rate changes. While Board and Management ALCO routinely monitor simulated NII sensitivity over a rolling 2-year horizon, they also utilize additional tools to monitor potential longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-earning assets and liabilities reflected on the Company’s balance sheet as well as for derivative financial instruments. None of the assets used in the simulation were held for trading purposes. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given both a 200 basis point (bp) upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed. The following reflects the Company’s NII sensitivity analysis as measured during the second quarter of 2005.
Rate Change
+200bp
-200bp
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, 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.
The most significant factors affecting the changes in market risk exposures during the first six months of 2005 were the continued rise in interest rates, with four 25 basis point increases in the Prime Rate, increases in variable rate residential, consumer and commercial real estate loans, and the level of short-term overnight FHLBB borrowings. If rates remain at or near current levels and the balance sheet mix remains similar, net
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interest income is projected to trend slightly upward as prime-based loans drive interest income levels upward. In a sustained rising rate environment, net interest income benefits from the Company’s asset sensitive profile, asset yield improvements are expected to outpace funding cost increases. In a falling interest rate environment, net interest income is expected to trend lower as asset sensitivity drives asset yields down more quickly with falling market rates, while funding costs are slower to react. Management has positioned the balance sheet to be asset sensitive based on current economic views and estimates, this strategy may change in the future causing the balance sheet to react differently in various rate environments. The current risk in the various rate scenarios is within the Company’s policy limits.
The Company periodically, if deemed appropriate, uses interest rate swaps, floors and caps, which are common derivative financial instruments, to hedge interest rate risk position. The Board of Directors has approved hedging policy statements governing the use of these instruments by the bank subsidiaries. As of June 30, 2005, the Company had no derivative instruments. On July 14, 2005, the Company purchased $50.0 million in floor contracts with a strike rate of 6.0% and terminates in 2010. Board and Management ALCO monitor derivative activities relative to its expectation and the Company’s hedging policy. The risks associated with entering into such transactions are the risk of default from the counterparty with which the Company has entered into agreement, and a poor correlation between the rate being swapped and the liability cost of the Company. The Company’s risk of default of a counterparty is limited to the expected cash flow anticipated from the counterparty, not the notional value.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company’s management conducted an evaluation with the participation of the Company’s Chief Executive Officer and Chief Financial Officer (Principal Financial & Accounting Officer), regarding the effectiveness of the Company’s disclosure controls and procedures, as of the end of the last fiscal quarter covered by this report. 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 a reasonable assurance of achieving the desired control objectives, and 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 (Principal Financial & Accounting Officer) concluded that they believe the Company’s disclosure controls and procedures are reasonably effective 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. The Company intends to continue to review and document the disclosure controls and procedures, including the internal controls and procedures for financial reporting, and may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that the systems evolve with the Company’s business.
There was no change in the internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to litigation and claims arising in the normal course of business. In addition to routine litigation incidental to its business, the Company’s subsidiary, Camden National Bank, was a defendant in a lawsuit brought by a former commercial customer. The customer claimed the Bank broke a verbal promise for a $300,000 loan to fund operating expenses of its ski resort. As a result of this litigation 20 of the original 21 counts were dismissed, leaving only the single breach of contract count, in which, the jury returned a verdict against Camden National Bank and awarded damages of $1.5 million. Management of Camden National Bank and the Company has reviewed this matter with counsel and the Company’s outside auditors. Management continues to believe that the allegations are unfounded and that it is probable that this judgment will be reversed upon appeal. A motion has been filed asking the judge to reverse the jury verdict and accompanying
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award of damages. On January 11, 2005, this motion was denied. On February 1, 2005, Camden National Bank filed an appeal of the verdict with the Law Court. Accordingly, no reserve for potential settlement expenditure has been recorded as of June 30, 2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) None
(b) None
(c) Furnish the information required by Item 703 of Regulation S-K for any repurchase made in the quarter covered by the report. Provide disclosures covering repurchases made on a monthly basis.
Period
(a)
Total Numberof SharesPurchased
(b)
AveragePrice Paidper Share
(c)
Total Number ofShares Purchasedas Part of PubliclyAnnounced Plansor Programs
(d)
Maximum Numberof Shares that MayYet Be PurchasedUnder the Plans orPrograms
4/1/05 – 4/30/05
5/1/05 – 5/31/05
6/1/05 – 6/30/05
On July 27, 2004, the Board of Directors of the Company voted to authorize the Company to purchase up to 5%, or approximately 395,000 shares of its authorized and issued common stock. The authority may be exercised from time to time and in such amounts as market conditions warrant. Any repurchases are intended to make appropriate adjustments to the Company’s capital structure, including meeting share requirements related to employee benefit plans and for general corporate purposes. In July 2005, the Board of Directors extended the Common Stock Repurchase Program for an additional one year period, expiring July 1, 2006, authorizing the Company to purchase up to 750,000 shares during the year for the same reasons noted under the prior year plan.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of shareholders was held on April 26, 2005.
(b) Robert J. Campbell, Ward I. Graffam, John W. Holmes and Winfield F. Robinson were elected as directors at the annual meeting. Ann W. Bresnahan, Robert W. Daigle, Theodore C. Johanson, Rendle A. Jones, Robin A. Sawyer, Richard N. Simoneau and Arthur E. Strout continued in office as directors after the meeting.
(c) Matters voted upon at the meeting. 1) To elect as director nominees – Robert J. Campbell (Total votes cast: 6,054,356, with 5,895,829 for and 158,527 withholding authority), Ward I. Graffam (Total votes cast: 6,054,356, with 5,921,935 for and 132,421 withholding authority), John W. Holmes (Total votes cast: 6,054,357, with 5,884,929 for and 169,428 withholding authority) and Winfield F. Robinson (Total votes cast: 6,6,054,356, with 5,921,467 for and 132,889 withholding authority) to serve a three-year term to expire at the annual meeting in 2008. 2) To ratify the selection of Berry, Dunn, McNeil & Parker as the Company’s independent registered public accounting firm for 2005 (Total votes cast: 6,054,357, with 5,988,383 for, 46,905 against, and 19,069 abstaining).
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ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
(3.1) The Articles of Incorporation of Camden National Corporation (incorporated by reference to Exhibit 3.i to the Company’s Form 10-Q filed with the Commission on August 10, 2001)
(3.2) Articles of Amendment to the Articles of Incorporation of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.3 to the Company’s Form 10-Q filed with the Commission on May 9, 2003)
(3.3) The Bylaws of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.ii to the Company’s Form 10-Q filed with the Commission on November 14, 2001)
(11.1) Statement re computation of per share earnings (Data required by SFAS No. 128, Earnings Per Share, is provided in Note 2 to the consolidated financial statements in this report)
(23.1) Consent of Berry, Dunn, McNeil & Parker relating to the financial statements of Camden National Corporation*
(31.1) Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934*
(31.2) Certification of Principal Financial & Accounting Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934)*
(32.1) Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
(32.2) Certification of Principal Financial & Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Robert W. Daigle
August 5, 2005
Date
/s/ Sean G. Daly
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Exhibit Index
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