UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
x Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the quarterly period ended September 30, 2007
Commission File Number 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)
(207) 563-3195
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No[_]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [_] Accelerated filer x Non-accelerated filer [_]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [_] No x
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of November 2, 2007
Common Stock: 9,816,677 shares
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 Financial 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 – Goodwill and Other Intangible Assets
10
Note 7 – Mortgage Servicing Rights
Note 8 – Derivative Financial Instruments
11
Note 9 – Income Taxes
Note10 – Reclassifications
Note11 – Impact of Recently Issued Accounting Standards
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
12
Critical Accounting Policies
Executive Summary
13
Net Interest Income
Provision for Loan Losses
16
Non-Interest Income
Non-Interest Expense
Income Taxes
Investments
Loans
17
Allowance for Loan Losses
Non-Performing Assets
18
Goodwill
Deposits
Borrowed Funds
Shareholders’ Equity
19
Average Daily Balance Sheets
20
Off-Balance Sheet Financial Instruments
21
Sale of Loans
Contractual Obligations
Liquidity Management
Forward-Looking Statements
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
22
Market-Risk Management
Asset/Liability Management
Interest Rate Risk Management
23
Item 4: Controls and Procedures
24
Part II – Other Information
25
Item 1 – Legal Proceedings
Item 1a –Risk Factors
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 – Default Upon Senior Securities
26
Item 4 – Submission of Matters to a Vote of Security Holders
Item 5 – Other Information
Item 6 – 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
2007
2006
Summary of Operations
Interest Income
$ 52,989
$ 47,475
$ 18,538
$ 16,829
Interest Expense
29,655
24,494
10,381
9,091
23,334
22,981
8,157
7,738
850
900
300
7,603
7,679
2,985
3,246
16,602
16,752
6,000
6,235
Net Income
9,613
9,325
3,414
3,177
Per Common Share Data
Basic Earnings per Share
$ 0.98
$ 0.95
$ 0.35
$ 0.32
Diluted Earnings per Share
0.98
0.94
0.35
0.32
Cash Dividends Declared
0.510
0.450
0.175
0.155
Book Value
11.43
10.93
Tangible Book Value
8.61
8.09
Market Value
15.08
16.92
Financial Ratios
Return on Average Equity 1
11.74%
11.85%
12.22%
11.95%
Return on Average Tangible Equity 1
15.71%
16.07%
16.29%
16.21%
Return on Average Assets 1
1.13%
1.16%
1.15%
1.17%
Average Equity to Average Assets
9.60%
9.80%
9.38%
9.77%
Average Tangible Equity to Average Assets
7.17%
7.22%
7.03%
7.20%
Net Interest Margin Tax-Equivalent 1
3.11%
3.29%
3.28%
Dividend Payout Ratio
52.04%
47.37%
50.00%
48.44%
Allowance for Loan Losses/Total Loans
0.75%
Non-Performing Loans to Total Loans
0.20%
0.46%
Non-Performing Assets to Total Assets
0.15%
0.34%
Efficiency Ratio 2
50.96%
51.97%
51.28%
54.08%
At Period End
Total Assets
$1,202,579
$1,095,440
Total Loans
891,675
828,539
Total Investment Securities
219,855
178,954
Total Deposits
811,395
848,048
Total Shareholders’ Equity
112,105
106,664
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, 2007 and 2006 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 5, 2007
Page 2
September 30,
December 31,
In thousands of dollars
Assets
Cash and due from banks
$ 27,339
$ 24,188
$ 26,512
Overnight funds sold
-
Securities available for sale
44,430
44,815
45,190
Securities to be held to maturity (fair value $171,645 at September 30, 2007, $134,649 at December 31, 2006, and $133,015 at September 30, 2006)
175,425
135,734
133,764
Loans held for sale (fair value approximates cost)
1,313
460
838,145
Less: allowance for loan losses
6,714
6,364
6,221
Net loans
884,961
831,781
822,318
Accrued interest receivable
7,360
6,140
6,677
Premises and equipment
15,526
15,845
15,697
Other real estate owned
625
1,144
1,413
27,684
Other assets
17,916
17,078
16,185
$1,104,869
Liabilities
Demand deposits
$ 72,597
$ 62,157
$ 68,455
NOW deposits
110,051
99,612
106,785
Money market deposits
114,620
137,163
143,600
Savings deposits
91,708
98,131
103,272
Certificates of deposit
311,773
164,770
178,164
Certificates $100,000 and over
110,646
243,402
247,772
Total deposits
805,235
Borrowed funds
267,011
179,862
130,300
Other liabilities
12,068
12,445
10,428
Total Liabilities
1,090,474
997,542
988,776
Shareholders' Equity
Common stock
98
Additional paid-in capital
45,926
45,587
45,958
Retained earnings
65,911
61,298
59,859
Net unrealized gains on securities available-for-sale
507
696
749
Net unrealized loss on postretirement benefit costs
(337)
(352)
Total Shareholders' Equity
107,327
Total Liabilities & Shareholders' Equity
Common Stock
Number of shares authorized
18,000,000
Number of shares issued and outstanding
9,810,329
9,770,792
9,762,868
Book value per share
$11.43
$10.98
$10.93
See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.
Page 3
For the quarters ended
Interest income
Interest and fees on loans
$ 44,959
$ 40,164
$ 15,554
$ 14,253
Interest on deposits with other banks
61
Interest and dividends on investments
8,030
7,250
2,984
2,515
Total interest income
52,989
47,475
18,538
16,829
Interest expense
Interest on deposits
22,661
18,539
7,792
7,486
Interest on borrowed funds
6,994
5,955
2,589
1,605
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
22,484
22,081
7,857
7,438
Non-interest income
Investment management and fiduciary income
1,345
1,447
389
474
Service charges on deposit accounts
2,059
2,054
659
704
Net securities gains
Mortgage origination and servicing income
378
361
164
109
Other operating income
3,821
3,817
1,773
1,959
Total non-interest income
Non-interest expense
Salaries and employee benefits
8,153
8,207
2,819
3,037
Occupancy expense
1,089
1,058
341
301
Furniture and equipment expense
1,456
1,557
487
560
Amortization of identified intangibles
213
71
Other operating expense
5,691
5,717
2,282
2,266
Total non-interest expense
Income before income taxes
13,485
13,008
4,842
4,449
Applicable income taxes
3,872
3,683
1,428
1,272
NET INCOME
$ 9,613
$ 9,325
$ 3,414
$ 3,177
Earnings per common share:
Basic earnings per share
Diluted earnings per share
$ 0.94
Cash dividends declared per share
$0.510
$0.450
$0.175
$0.155
Weighted average number of shares outstanding
9,792,944
9,829,157
9,807,680
9,793,172
Incremental shares
26,097
84,199
25,522
84,310
Page 4
In thousands of dollars except number of shares
Number of common shares
Accumulated other comprehensive income
Total
shareholders’ equity
Balance at December 31, 2005
9,832,777
$ 99
$ 47,718
$ 54,901
$ 734
$ 103,452
Net income
Net unrealized gain on securities available for sale, net of tax benefit of $12
15
Comprehensive income
9,340
Cash dividends declared
(4,422)
Payment to repurchase common stock
(135,503)
(1)
(2,330)
(2,331)
Proceeds from sale of common stock
65,594
570
Tax benefit of disqualifying disposition of incentive stock option shares
55
Balance at September 30, 2006
$ 98
$ 45,958
$ 59,859
$ 749
$ 106,664
Balance at December 31, 2006
$ 45,587
$ 61,298
$ 344
$ 107,327
Net unrealized loss on securities available for sale, net of tax benefit of $140
(189)
Net change in unrecognized transition obligation for postretirement benefits, net of tax of $9
(174)
9,439
(5,000)
Equity compensation expense
48
(23,157)
(375)
62,694
666
Balance at September 30, 2007
$ 45,926
$ 65,911
$ 170
$ 112,105
Page 5
For nine months ended Sept 30,
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
921
1,044
Loans originated for resale
(19,027)
(11,248)
Proceeds from sales and transfers of loans
18,174
11,248
Net loss on sale of other real estate owned
Net increase in other assets and accrued interest
(2,292)
(1,477)
Net increase (decrease) in other liabilities
(412)
723
Net amortization of premiums on investments
(1,933)
(142)
Net acquisition amortization
235
194
Provision for losses on other real estate owned
75
Net gain on sale of real estate
(27)
Net cash provided by operating activities
6,245
10,567
Cash flows from investing activities
Proceeds from maturities, payments and calls of securities available for sale
3,173
9,618
Proceeds from maturities, payments and calls of securities to be held to maturity
78,989
13,320
Proceeds from sales of other real estate owned
959
551
Purchases of securities available for sale
(2,985)
(8)
Purchases of securities to be held to maturity
(116,840)
(17,734)
Net increase in loans
(54,610)
(59,048)
Proceeds from sale of premises and equipment
355
Capital expenditures
(825)
(384)
Net cash used in investing activities
(92,139)
(53,330)
Cash flows from financing activities
Net increase (decrease) in demand, savings, and money market accounts
(8,087)
13,634
Net increase in certificates of deposit
14,302
120,570
Advances on long-term borrowings
90,000
Repayment on long-term borrowings
(62,000)
Net increase (decrease) in short-term borrowings
59,138
(84,872)
Payments to repurchase common stock
Proceeds from sale of real estate
250
Dividends paid
(4,849)
(4,278)
Net cash provided by financing activities
89,045
43,293
Net increase in cash and cash equivalents
3,151
530
Cash and cash equivalents at beginning of year
24,188
25,982
Cash and cash equivalents at end of period
Interest paid
$ 29,102
$ 23,596
Income taxes paid
$ 4,363
$ 3,193
Non-cash transactions
Change in net unrealized gain on available for sale securities, net of tax
$ (189)
$ 15
Change in net unrecognized postretirement benefit costs, net of tax
$ -
Net transfer from loans to other real estate owned
$ 535
$ 1,964
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. The income reported for the 2007 period is not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the consolidated financial statements and notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.
On August 16, 2007, the Company announced that its Board of Directors had authorized a new program for the repurchase of up to 300,000 shares of the Company’s common stock or approximately 3.1% of the outstanding shares. The Board of Directors feels that repurchasing shares continues to be in the best interest of the Company's shareholders and sees stock repurchases as an appropriate use of capital, especially given the recent decline in stock prices for the banking industry.
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, 2007, the Company had repurchased seven shares under the new repurchase plan at an average price of $15.28.
This new stock plan supersedes the buyback program that had been in place since July 21, 2006, which had authorized the repurchase of up to 250,000 or 2.5% of the Company’s outstanding shares. As of August 16, 2007, the date the new plan was effective, the Company had repurchased 130,186 shares under the old repurchase plan at an average price of $16.89 and at a total cost of $2.2 million.
The Company established a shareholder-approved stock option plan in 1995, under which the Company may grant options to its employees for up to 600,000 shares of common stock. The Company believes that such awards align the interests of its employees with those of its shareholders. 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, with 50% of the options granted vesting two years from the date of grant and the remaining 50% vesting five years from date of grant. As of January 16, 2005, all options under this plan had been granted.
The Company applies the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payment”, to stock-based employee compensation for fiscal years beginning on or after January 1, 2006. As a result, $48,000 in compensation cost is included in the Company’s financial statements for the current year. The unrecognized compensation cost to be amortized over a weighted average remaining vesting period of 2.7 years is $124,000, which is comprised of $3,000 for 9,000 options granted in 2002 and $121,000 for 42,000 options granted in 2005.
The weighted average fair market value per share was $2.77 for options granted in 2002 and $4.41 for options granted in 2005. The fair market value was estimated using the Black-Scholes option pricing model and the following assumptions: quarterly dividends of $0.07 in 2002 and $0.12 in 2005, risk-free interest rate of 1.58% in 2002 and 4.20% in 2005, volatility of 37.73% in 2002 and 25.81% in 2005, and an expected life of 10 years for both years, the options’ maximum term. Volatility is based on the actual volatility of the Company’s stock during the quarter in which
Page 7
the options were granted. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of the option grant.
The following table summarizes the status of the Company’s non-vested options as of September 30, 2007:
Number of Shares
Weighted Average Grant Date Fair Value
Non-vested at December 31, 2006
58,500
$3.95
Granted in 2007
Vested in 2007
37,500
3.69
Forfeited in 2007
Non-vested at September 30, 2007
21,000
$4.41
During 2007, 33,500 options were exercised, with proceeds paid to the Company of $196,000. The excess of the fair value of the stock issued upon exercise over the exercise price was $346,000. A summary of the status of the Company’s Stock Option Plan as of September 30, 2007 and changes during the nine months then ended, is presented below.
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
(In thousands)
Outstanding at December 31, 2006
123,000
$10.53
Exercised in 2007
(33,500)
5.85
Outstanding at September 30, 2007
89,500
$12.28
4.7
$451
Exercisable at September 30, 2007
68,500
3.9
The following table sets forth the computation of basic and diluted earnings per share (EPS) for the nine months ended September 30, 2007 and 2006:
Income
Shares
Per-Share
In thousands, except number of shares and per share data
(Numerator)
(Denominator)
Amount
For the nine months ended September 30, 2007
Net income as reported
$9,613
Basic EPS: Income available to common shareholders
$0.98
Effect of dilutive securities: incentive stock options
Diluted EPS: Income available to common shareholders plus assumed conversions
9,819,041
For the nine months ended September 30, 2006
$9,325
$0.95
9,913,356
$0.94
Page 8
The following table sets forth the computation of basic and diluted earnings per share (EPS) for the quarters ended September 30, 2007 and 2006:
For the quarter ended September 30, 2007
$3,414
$0.35
9,833,202
For the quarter ended September 30, 2006
$3,177
$0.32
9,877,482
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.
In December 2006, the Company implemented SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. This Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its balance sheet and to recognize changes in the funded status in the year in which the changes occur through comprehensive income of a business entity. 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 postretirement benefit obligation and funded status:
At September 30,
Change in benefit obligation
Benefit obligation at beginning of year
$ 2,005
$ 1,705
Service cost
Interest cost
94
89
Benefits paid
(87)
(118)
Actuarial gain
239
Benefit obligation at end of period
2,022
1,923
Funded status
(2,022)
(1,923)
Unamortized prior service cost
(11)
Unamortized net actuarial loss
278
Unrecognized transition obligation
186
Accrued benefit cost
$(2,022)
$(1,470)
Page 9
The following table sets forth the net periodic pension cost:
For nine months ended
For the quarters ended September 30,
Components of net periodic benefit cost
$ 10
$ 8
$ 4
$ 2
31
29
Amortization of unrecognized transition obligation
Amortization of prior service credit
(2)
Amortization of accumulated losses
Net periodic benefit cost
$ 127
$122
$ 43
$40
Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income are as follows:
Unamortized prior service credit
$ 7
(368)
(157)
(518)
Deferred tax benefit at 35%
181
Net unrecognized postretirement benefits included in accumulated other comprehensive income
$ (337)
A weighted average discount rate of 7.0% was used in determining the accumulated benefit obligation and the net periodic benefit cost. The measurement date for benefit obligations was as of year-end for prior years presented. The expected benefit payments for the fourth quarter of 2007 are $29,000 and the expected benefit payments for all of 2007 are $116,000. Plan expense for 2007 is estimated to be $168,000.
As of December 31, 2006, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company completed its annual review of goodwill and determined there has been no impairment.
In the first quarter of 2007, the Company implemented SFAS No. 156, “Accounting for Servicing of Financial Assets”, which requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. Servicing assets and servicing liabilities are reported using the amortization method or the fair value measurement method. In evaluating 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 model utilizes several assumptions, the most significant of which is loan prepayments, calculated using a three-month moving average of weekly prepayment data published by the Public Securities Association (PSA) and modeled against the serviced loan portfolio, and the discount rate to discount future cash flows. As of September 30, 2007, the prepayment assumption using the PSA model was 185, which translates into an anticipated prepayment rate of 11.13%. The discount rate is the quarterly average ten-year U.S. Treasuries plus 5.0%. Other assumptions include delinquency rates, foreclosure rates, servicing cost inflation, and annual unit loan cost. All assumptions are adjusted periodically to reflect current circumstances. Amortization of mortgage servicing rights, as well as write-offs due to prepayments of the related mortgage loans, are recorded as a charge against mortgage servicing fee income. For the nine months ended September 30, 2007 and 2006, servicing rights amortized totaled $326,000 and $311,000, respectively. Servicing rights amortized for the three month periods ended September 30, 2007 and 2006, were $109,000 and $104,000, respectively. At
Page 10
September 30, 2007 and 2006, the Bank serviced loans for others totaling $168.0 million and $161.8 million, respectively. Mortgage servicing rights are included in other assets and detailed in the following table:
At September 30
Mortgage servicing rights
$ 3,685
$ 3,324
Accumulated amortization
(2,801)
(2,310)
Impairment reserve
(5)
(3)
$ 879
$ 1,011
The Bank uses an interest rate protection agreement (cap) as a cash flow hedge to eliminate the cash flow exposure of interest rate movements on money-market deposits. The premium paid for the cap is amortized over its life. Any cash payments received are recorded as an adjustment to net interest income. The Bank documents its risk management strategy and hedge effectiveness at the inception of and during the term of the hedge. The cap is designated and qualifies as a cash flow hedge, and thus is recorded at fair value. SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, provides that a cash flow hedge is effective to the extent the variability in its cash flows offsets the variability in the cash flows of the hedged item, in this case the increase in cost of money market deposits. Management has determined that the hedge relationship is 100 percent effective. The amortized cost of the cap, $58,000 at September 30, 2007, is recorded on the balance sheet. This approximates the fair value of the derivative, and as a result, no unrealized gain or loss, net of applicable income taxes, is recorded in other comprehensive loss in the statement of changes in shareholders’ equity for the period ended September 30, 2007.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company has adopted the provisions of FIN 48 and there was no material effect on the financial statements, and no cumulative effect. The Company is currently open to audit under the statute of limitations by the IRS for the years ended December 31, 2004 through 2006.
Note 10 – Reclassifications
Certain items from the prior year were reclassified in the financial statements to conform with the current year presentation. These do not have a material impact on the balance sheet or statement of income presentations.
Note 11 – Impact of Recently Issued Accounting Standards
In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and early application is encouraged. This Statement does not require any new fair value measurements and the Company does not expect application of this Statement to change current practice.
In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which gives entities the option to measure eligible financial assets and financial liabilities at fair value on an instrument-by-instrument basis. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability, with subsequent changes in fair value recorded in earnings. SFAS No. 159 contains provisions to apply the fair value option to existing eligible financial instruments at the date of adoption. This statement is effective as of the beginning of an entity’s first fiscal year after November 15, 2007. The Company is in the process of analyzing the impact of SFAS No. 159.
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, the valuation of mortgage servicing rights, and goodwill. 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.
Goodwill. 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 the acquisition and an estimation of the impact of business conditions.
Mortgage Servicing Rights. The valuation of mortgage servicing rights is a critical accounting policy which 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 the 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. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speed results in lower valuations of mortgage servicing rights. The valuation also 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. All of the assumptions are based on standards the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources.
Page 12
Net income for the nine months ended September 30, 2007 was $9,613,000, an increase of $288,000 or 3.1% over net income of $9,325,000 for the comparable period of 2006. This increase in earnings was attributable to higher net interest income due to excellent growth in earning assets during the third quarter. The net interest margin on a tax-equivalent basis declined to 3.11% for the first nine months of 2007 from 3.29% for the same period in 2006. Fully diluted earnings per share for the nine months ended September 30, 2007 were $0.98, a 4.3% increase from the $0.94 reported for the first nine months of 2006.
Net income for the three months ended September 30, 2007, was $3,414,000, an increase of $237,000 or 7.5% from net income of $3,177,000 for the comparable period of 2006 and up $219,000 or 6.9% from the previous quarter. The Company saw an increase in net interest income for the quarter due to growth in earning assets as well as an improved net interest margin. Although the net interest margin on a tax-equivalent basis declined to 3.11% for the three months ended September 30, 2007, from 3.28% for the same period in 2006, it improved from 3.07% in the second quarter 2007 to 3.11% in the third quarter 2007. Fully diluted earnings per share for the three months ended September 30, 2007 were $0.35, a 9.4% increase from the $0.32 reported for the third quarter of 2006.
Asset quality remains strong. The ratio of non-performing assets to total assets, at 0.15%, has improved significantly compared to 0.34% a year ago and 0.18% as of the end of the previous quarter. Net chargeoffs for the quarter were $300,000 and year to date are $499,000.
Total interest income of $53.0 million for the nine months ended September 30, 2007 is a 11.6% increase from total interest income of $47.5 million in the comparable period of 2006. Higher asset yields in 2007 compared to 2006 were the result of certain assets continuing to reprice upward after interest rate increases in 2006. The lowering of interest rates by the FOMC in September of 2007 has yet to affect the yield on the Company’s loan portfolio. Total interest expense of $29.7 million for the first nine months of 2007 is a 21.1% increase from total interest expense of $24.5 million for the first nine months of 2006. This was a result of the above-noted interest rate climate and increased volume of higher-cost sources of funding. Net interest income increased 1.5% to $23.3 million for the nine months ended September 30, 2007, from the $23.0 million reported for the same period in 2006.
Total interest income of $18.5 million for the three months ended September 30, 2007 is a 10.2% increase from total interest income of $16.8 million for the comparable period of 2006. Total interest expense of $10.4 million for the three months ended September 30, 2007 is a 14.2% increase from total interest expense of $9.1 million for the same period in 2006. These increases were for the same reasons stated above. Net interest income increased 5.4% to $8.2 million for the three months ended September 30, 2007, from the $7.7 million reported for the same period in 2006.
The Company’s net interest margin on a tax-equivalent basis decreased from 3.29% in the first nine months of 2006 to 3.11% for the nine months ended September 30, 2007. For the three months ended September 30, 2007, the Company’s net interest margin was 3.11%, a decrease from the 3.28% in the same period of 2006. The Company saw an improved net interest margin from the second quarter 2007 to the third quarter 2007 due to lower funding costs, with growth in low-cost deposits from normal seasonal inflows and a restructuring of a significant portion of our wholesale funding.
Tax-exempt interest income amounted to $2,833,000 and $2,722,000 for the nine months ended September 30, 2007 and 2006, respectively. For the three months ended September 30, 2007 and 2006, tax-exempt interest income amounted to $964,000 and $948,000, respectively. 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 2007 and 2006:
For the nine months
ended September 30,
For the quarter
Net interest income as presented
$ 23,334
$ 8,157
Effect of tax-exempt income
1,525
1,465
519
510
Net interest income, tax equivalent
$ 24,859
24,446
$ 8,676
8,248
Page 13
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, 2007 and 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2007 and 2006.
Nine months ended September 30,
Dollars in thousands
Amount of interest
Average Yield/Rate
Interest on earning assets
Interest-bearing deposits
0.00%
$ 61
5.33%
9,106
5.96%
8,328
5.97%
Loans held for sale
7.78%
5.36%
45,399
40,549
6.74%
Total interest-earning assets
54,514
6.83%
48,940
6.59%
Interest-bearing liabilities
3.96%
3.45%
Other borrowings
4.82%
4.44%
Total interest-bearing liabilities
4.13%
3.64%
$ 24,446
Interest rate spread
2.70%
2.95%
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, 2007 compared to 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2007 and 2006.
Nine months ended September 30, 2007 compared to 2006
Volume
Rate
Rate/Volume1
$ (61)
Investment securities
798
(18)
778
2,953
1,768
129
4,850
3,694
1,690
190
5,574
1,200
2,744
178
4,122
Other borrowings2
489
508
42
1,039
1,689
3,252
220
5,161
Change in net interest income
$ (1,562)
$ (30)
$ 413
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 quarter ended September 30, 2007 and 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2007 and 2006.
Quarters ended September 30,
10.55%
3,343
5.99%
2,885
6.16%
7.33%
6.24%
15,708
14,392
7.05%
19,057
6.82%
17,339
6.89%
3.97%
4.05%
4.80%
3.78%
4.15%
4.00%
$ 8,248
2.66%
2.90%
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, 2007 compared to 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2007 and 2006.
Quarter ended September 30, 2007 compared to 2006
556
(81)
(16)
459
1,358
(38)
(4)
1,316
1,856
(180)
43
1,719
456
(141)
(9)
306
435
432
117
984
891
291
108
1,290
$ 965
$ (471)
$ (65)
$ 429
Page 15
An $850,000 provision to the allowance for loan losses was made during the first nine months of 2007, compared to a $900,000 provision made for the same period of 2006. The amount of provision made during the first nine months of 2007 and 2006 was to maintain the allowance for loan losses at an adequate level given continued growth in our loan portfolio and our level of chargeoffs. For the quarters ended September 30, 2007 and 2006, a $300,000 provision each quarter was made to the allowance for loan losses for the same reasons noted above.
Non-interest income was $7,603,000 for the nine months ended September 30, 2007, a decrease of 1.0% from the $7,679,000 reported for the first nine months of 2006. This decrease in non-interest income year-to-date was primarily due to decreased levels of investment management and fiduciary income.
Non-interest income was $2,985,000 for the three months ended September 30, 2007, a decrease of 8.0% from the $3,246,000 reported in the same period for 2006. This decrease in non-interest income for the quarter was primarily due to decreased levels of investment management and fiduciary income as well as a decrease in other operating income.
Non-interest expense of $16,602,000 for the nine months ended September 30, 2007, is a decrease of 0.9% compared to non-interest expense of $16,752,000 for the same period in 2006. This decrease was attributable to lower employee costs and occupancy expense. Due to the challenges produced by the current interest rate environment, the Company has aggressively sought to control operating expense during 2007.
Non-interest expense of $6,000,000 for the three months ended September 30, 2007, is a decrease of 3.8% compared to non-interest expense of $6,235,000 for the three months ended September 30, 2006. This level of decrease is due to the reasons stated above.
Income taxes on operating earnings were $3,872,000 for the nine months ended September 30, 2007, up from $3,683,000 in the same period a year ago. For the quarter ended September 30, 2007, income taxes on operating earnings were $1,428,000, up from the $1,272,000 for the same quarter in 2006. This is in line with the Company’s level of income before taxes.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company has adopted the provisions of FIN 48 and there was no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48. However, certain amounts have been reclassified in the statement of financial position in order to comply with the requirements of the statement. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2004 through 2006.
The Company’s investment portfolio increased by $39.3 million or 21.8% to $219.9 million between December 31, 2006, and September 30, 2007. Due to the slight steepening in the yield curve in 2007, there has been opportunity to add to the investment portfolio at levels that have not been available for some time. Between June 30, 2007, and September 30, 2007, the Company's investment portfolio increased $19.7 million. At September 30, 2007, the Company’s available for sale portfolio had an unrealized gain, net of taxes, of $0.5 million. Between September 30, 2006, and September 30, 2007, the Company’s investment portfolio increased by $40.9 million or 22.9%.
Page 16
During the first nine months of 2007, loans grew by $53.5 million or 6.4%. The growth in commercial loans was $28.2 million or 8.5% while municipal loans increased by $4.4 million or 18.6%. The residential mortgage portfolio increased by $16.8 million or 4.7% and home equity lines of credit decreased $3.2 million or 4.4% year-to-date. Between June 30, 2007, and September 30, 2007, the Company’s loan portfolio increased $14.5 million or 1.6%. Between September 30, 2006 and September 30, 2007 the loan portfolio increased $63.1 million or 7.6%, as a result of customer demand.
The allowance for loan losses represents the amount available for credit losses inherent in the Company’s loan portfolio. Loans are charged off when 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 that 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, are 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 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. 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.
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
Page 17
anticipated future cash flows, or its net realizable value. At September 30, 2007, impaired loans with specific reserves totaled $1.1 million (all of these loans were on non-accrual status) and the amount of such reserves were $0.6 million.
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, 2007. As of that date, the balance of $6,714,000 was 0.75% of total loans, compared to 0.76% at December 31, 2006 and 0.75% at September 30, 2006. Loans considered to be impaired according to SFAS 114/118 totaled $1.8 million at September 30, 2007 compared to $3.5 million at December 31, 2006. The portion of the allowance for loan losses allocated to impaired loans at September 30, 2007, was $0.6 million compared to $0.2 million at December 31, 2006.
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, which typically reflects a much lower level of credit risk. The Company’s actual historical experience supports this by the overall credit quality of the portfolio and historically low level of chargeoffs.
At September 30, 2007, loans on non-accrual status totaled $1.8 million, which compares to non-accrual loans of $3.5 million as of December 31, 2006. In addition to loans on non-accrual status at September 30, 2007, loans past due 90 days or more and accruing (calculated on a constant 30-day month basis) totaled $2.3 million which compares to $0.7 million as of December 31, 2006. The Company continues to accrue interest on these loans because it believes collection of the interest is reasonably assured.
On January 14, 2005, the Company completed the acquisition of FNB Bankshares of Bar Harbor, Maine, and its subsidiary, The First National Bank of Bar Harbor, which was merged into the Bank. The total value of the transaction was $48.0 million, and all of the voting equity interest of FNB Bankshares was acquired in the transaction. As of December 31, 2006, in accordance with SFAS No. 142, the Company completed its annual review of goodwill and determined there has been no impairment.
During the first nine months of 2007, total deposits increased by $6.2 million or 0.8% over December 31, 2006. Low-cost deposits (demand, NOW, and savings accounts) increased by $14.5 million or 5.6% in the first nine months of 2007, and during the same period, certificates of deposit increased $14.2 million or 3.5%. Between September 30, 2006, and September 30, 2007, deposits decreased by 4.3%, or $36.7 million. Certificates of deposit decreased by $3.5 million, while low-cost deposits decreased by $4.2 million and money market accounts decreased $29.0 million or 20.2%. During the third quarter of 2007, the Company experienced its usual seasonal lift in low-cost deposits, which increased $19.6 million or 7.7%, while certificates of deposit declined by $52.6 million or 11.1%. The decrease in in certificates of deposit in the third quarter was due to a change in funding from wholesale certificates of deposit to borrowed funds as a result of current rates available from the Federal Home Loan Bank.
The Company uses funding from the Federal Home Loan Bank of Boston, the Federal Reserve System, and repurchase agreements, enabling it to grow its balance sheet and its revenues. This funding may also be used to carry out interest rate risk management stategies, and is increased to replace or supplement other sources of funding, including core deposits and certificates of deposit. During the nine months ended September 30, 2007, borrowed funds increased $87.1 million or 48.5% from December 31, 2006. Between September 30, 2006 and September 30, 2007, borrowed funds increased by $136.7 million or 104.9%. These increases are due to a change in funding from certificates of deposit to borrowed funds as a result of current rates available from the Federal Home Loan Bank.
Page 18
Shareholders’ equity as of September 30, 2007 was $112.1 million, compared to $107.3 million as of December 31, 2006. The Company’s earnings in the first nine months of 2007, net of dividends paid, added to shareholders’ equity. The net unrealized loss on available-for-sale securities, presented in accordance with SFAS 115, decreased by $0.2 million from December 31, 2006.
In 2007, a cash dividend of 17.5 cents per share was declared in the third quarter compared to 15.5 cents in the third quarter of 2006. The dividend payout ratio was 50.00% in the third quarter of 2007 compared to 48.44% in the third quarter of 2006. 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 2007 is this year’s net income plus retained earnings of $10.2 million from 2006 and 2005.
Regulatory leverage capital ratios for the Company were 7.29% and 7.22% at September 30, 2007 and December 31, 2006, respectively. The Company had a tier one risk-based capital ratio of 10.51% and tier two risk-based capital ratio of 11.39% at September 30, 2007, compared to 10.40% and 11.26%, respectively, at December 31, 2006. These are comfortably above the standards to be rated “well-capitalized” by regulatory authorities – qualifying the Company for lower deposit-insurance premiums.
Page 19
The following table shows the Company’s average daily balance sheets for the nine month and three month periods ended September 30, 2007 and 2006.
$ 20,993
$ 21,066
$ 22,451
$ 21,465
1,530
2,295
U.S. Treasury & government agency securities
105,218
89,947
122,592
89,369
Obligations of states and political subdivisions
60,284
56,830
62,318
57,298
Other securities
38,734
39,598
36,578
39,089
Total investments
204,236
186,375
221,488
185,756
156
51
302
60
Commercial
351,366
327,932
363,288
329,353
Consumer
57,866
45,307
61,858
46,829
State and municipal
24,884
21,816
26,476
22,122
Real estate
428,878
409,364
434,475
411,430
Total loans
862,994
804,419
886,097
809,734
Allowance for loan losses
(6,569)
(6,131)
(6,707)
(6,129)
856,425
798,288
879,390
803,605
15,706
16,413
15,600
16,357
15,080
22,719
15,202
22,703
27,679
Total assets
$1,140,280
$1,074,126
$1,182,117
$1,079,920
Liabilities and shareholders' equity
Demand
$ 60,310
$ 61,377
$ 67,908
$ 63,020
NOW
100,290
101,131
106,222
101,668
Money market
126,423
121,885
114,440
123,071
Savings
92,943
102,698
92,634
102,441
329,302
164,614
343,409
170,125
Certificates of deposit over $100,000
116,867
228,927
121,873
236,593
826,135
780,632
846,486
796,918
193,908
179,192
213,873
168,301
10,765
9,058
10,930
9,241
Total liabilities
1,030,808
968,882
1,071,289
974,460
99
45,748
47,126
45,882
46,965
63,262
57,457
64,765
57,872
Unrealized gains on securities available for sale
597
562
428
524
Unrealized loss on postretirement benefit costs
(233)
(345)
Total shareholders' equity
109,472
105,244
110,828
105,460
Total liabilities and shareholders' equity
Page 20
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, 2007:
Less than 1 year
1-3 years
3-5 years
More than 5 years
$ 267,011
129,818
92,000
25,000
20,193
Operating leases
370
132
171
58
422,419
351,209
66,516
4,694
$ 689,800
481,159
158,687
29,752
20,202
Unused line, collateralized by residential real estate
$ 78,083
78,083
Other unused commitments
$ 50,126
50,126
Standby letters of credit
$ 1,466
1,466
Commitments to extend credit
$ 20,869
20,869
Total loan commitments and unused lines of credit
$ 136,870
136,870
As of September 30, 2007 the Bank had primary sources of liquidity of $167.3 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 that affect the Company’s business.
Page 21
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 that reprice within a specified time period. The Bank’s cumulative one-year gap, September 30, 2007, was -11.11% 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, 2007 is presented in the following table:
0-90
90-365
1-5
5+
Days
Years
Investment securities at amortized cost
$ 30,639
$ 22,827
$ 69,657
$ 95,565
314,503
120,763
354,822
101,587
Other interest-earning assets
8,711
Non-rate-sensitive assets
74
221
1,140
52,337
355,240
143,811
425,619
249,489
256,319
216,066
71,329
195,084
129,759
20,060
117,059
133
Non-rate-sensitive liabilities and equity
1,750
5,550
37,200
123,850
Total liabilities and equity
387,828
241,676
225,588
319,067
Period gap
$ (32,588)
$ (97,865)
$200,031
$ (69,578)
Percent of total assets
-2.78%
-8.33%
17.04%
-5.93%
Cumulative gap (current)
(32,588)
(130,453)
69,578
-11.11%
5.93%
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 4.78% 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 6.24% 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 17.08% in a falling-rate scenario, and lower than that earned in a stable rate environment by 13.07% 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, 2007 is presented in the following table:
Changes in Net Interest Income
Year 1
Projected change if rates decrease by 2.0%
+4.78%
Projected change if rates increase by 2.0%
-6.24%
Year 2
+17.08%
-13.07%
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, 2007. 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, 2007, the Company was using interest rate caps 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, 2007, 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 may decline in the next two-to-four quarters 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, 2007, 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, 2007 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.
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The Company was not involved in any legal proceedings requiring disclosure under Item 103 of Regulation S-K during the reporting period.
Item 1A – Risk Factors
There have been no material changes to the Risk Factors previously disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.
a. 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, as presented in the following table:
Month
Average Price
Proceeds
January 2007
1,191
$16.61
$ 20,000
February 2007
1,381
16.54
22,000
March 2007
776
16.19
13,000
April 2007
957
16.02
15,000
May 2007
484
16.13
8,000
June 2007
353
16.18
July 2007
320
16.48
5,000
August 2007
535
15.17
September 2007
319
14.95
4,000
6,316
$16.18
$102,000
b. None
c. On August 16, 2007, the Company announced that its Board of Directors had authorized a new program for the repurchase of up to 300,000 shares of the Company’s common stock or approximately 3.1% of the outstanding shares. The Board of Directors feels that repurchasing shares continues to be in the best interest of the Company's shareholders and sees stock repurchases as an appropriate use of capital, especially given the recent decline in stock prices for the banking industry. 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, 2007, the Company had repurchased seven shares under the new repurchase plan at an average price of $15.28. This new stock plan supersedes the buyback program that had been in place since July 21, 2006, which had authorized the repurchase of up to 250,000 or 2.5% of the Company’s outstanding shares. As of August 16, 2007, the date the new plan was effective, the Company had repurchased 130,186 shares under the old repurchase plan at an average price of $16.89 and at a total cost of $2.2 million. The following table details repurchases under both the old and new programs during the nine months ended September 30, 2007:
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Number of
Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program
Maximum Number of Shares that may yet be Purchased under the Plan or Program
5,210
$16.49
137,753
808
16.50
136,945
650
16.31
136,295
91
15.97
136,204
11,803
124,401
735
15.66
123,666
3,859
15.73
299,994
299,993
23,157
$16.15
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 10.2(a) Specimen Employment Continuity Agreement entered into with Messrs. McKim, Wroble and Dalrymple, 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 and Dalrymple, 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 and Dalrymple. For Mr. McKim, the amount of the death benefit is $250,000; for Messrs. 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 and Dalrymple, 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 10.4 Specimen Amendment to Employment Continuity Agreement entered into with Messrs. McKim and Wrobel, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 1.01 on January 31, 2005.
Exhibit 10.4 Specimen Amendment to Employment Continuity Agreement entered into with Mr. Dalrymple, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 1.01 on September 27, 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
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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 7, 2007
/s/ F. Stephen Ward
F. Stephen Ward
Executive Vice President & Chief Financial Officer
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