ITEM 1. BUSINESS
ORGANIZATION
Bar Harbor Bankshares (the "Company") was incorporated January 19, 1984. As of March 7, 2005, the Company’s securities consisted of one class of common stock, par value of $2.00 per share, of which there were 3,076,748 shares outstanding held of record by approximately 1,051 shareholders. The Company has one, wholly owned, first tier operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), a community bank, which offers a wide range of deposit, loan, and related banking products, as well as brokerage services provided through a third-party brokerage arrangement. In addition, the Company offers trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services"), a Maine chartered non-depository trust company. These products and services are offered to individuals, businesses, not-for-profit organizations and municipalities.
The Company is a bank holding company ("BHC") registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent (the "Superintendent") of the Maine Bureau of Financial Institutions ("BFI").
Bar Harbor Bank & Trust
The Bank, originally founded in 1887 and now a direct, wholly owned subsidiary of the Company, is a Maine financial institution, and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum extent permitted by law. The Bank is subject to the supervision, regulation, and examination of the FDIC and the BFI. It is not a member of the Federal Reserve Bank.
The Bank has eleven branch offices located throughout Down East and Mid Coast Maine, including its principal office located at 82 Main Street, Bar Harbor. The Bank’s offices are located in Hancock, Washington, and Knox Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Blue Hill, Deer Isle, Ellsworth, Northeast Harbor, Southwest Harbor, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Knox County office, acquired in February 2004, is located in Rockland. The Bank delivers its operations and technology support services from its operations center located in Ellsworth, Maine.
The Bank is a retail bank serving individual and business customers, retail establishments and restaurants, seasonal lodging and campgrounds, and a large contingent of retirees. As a coastal bank, it serves the tourism, hospitality, lobstering, fishing, boat building and marine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. The Bank operates in a competitive market that includes other community banks, savings institutions, credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area. The Bank continues to be one of the larger independent commercial banks in the state of Maine.
The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materially adverse effect on its business. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Approximately 86% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on all of the deposit account products it offers and does not anticipate any material loss of these deposits.
The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses to which the Bank offers a wide variety of products and services.
Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include interest bearing checking accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, student loans, credit cards, installment loans, and overdraft protection. Overdraft protection is offered via a standby line of credit product. Secured and unsecured installment loans are provided for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rental, wire transfers, check collection services, foreign currency exchange, money orders, Travelers Checks, and U.S. Savings Bonds.
The Bank staffs a customer service center, providing customers with telephone and e-mail responses to their questions and needs. Free bank-by-mail services are also offered.
Retail Brokerage Services: During 2004 the Bank retained Infinex Investments, Inc, ("Infinex") as a full service third-party broker-dealer, conducting business as Bar Harbor Financial Services. Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other any government agency, are not guaranteed by the bank or any affiliate, and may be subject to investment risk, including possible loss of value.
Bar Harbor Financial Services principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. Infinex was formed by a group of member banks, and is currently the largest provider of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.
Electronic Banking Services: The Bank continues to offer free, on-line real-time Internet banking services, including free check image and electronic bill payment, through its dedicated website at http://www.bhbt.com. Additionally, the Bank offers TeleDirect, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Automated Teller Machines (ATMs) are located at each of the eleven branch locations, as well as two machines in non-Bank locations. These ATM’s access major networks throughout the United States, including Plus, NYCE, and other major ATM and credit card companies. The Bank is also a member of Maine Cash Access, providing customers with surcharge-free access to over 150 ATM’s throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.
Commercial Products and Services: The Bank serves the small business market throughout Down East and Mid Coast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate purchases, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and individuals in the tourist, hospitality, health care, blueberry, shipbuilding, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with correspondent banks, whereby the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances.
The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. The Bank also offers Premier E-corp, an on-line real-time Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and order both domestic and foreign wire transfers. Other commercial banking services include merchant credit card processing, night depository, and coin and currency handling.
Bar Harbor Trust Services
Bar Harbor Trust Services ("Trust Services") is a Maine chartered, non-depository trust company and a wholly owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities of varying asset size.
Trust Services serves as trustee of both living trusts and trusts under wills, including revocable and irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Custody, estate settlement, and fiduciary tax services, among others, are also offered. Additionally, Trust Services offers employee benefit trust services for which it acts as trustee, custodian, administrator and/or investment advisor, among other things, for employee benefit plans and for corporate, self employed, municipal and not-for-profit employers located throughout the Company’s market areas.
The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2004, Trust Services served 720 client accounts, with assets under management and held in custody amounting to $196 million and $25 million, respectively.
ECONOMY
Maine is a state of approximately 1.3 million people inhabiting a space that is roughly the size of the other five New England states combined. Maine’s economy has long been based on the bounty of its natural resources, namely: fishing, farming, forestry, and tourism. The very nature of these industries has meant that a significant portion of Maine’s employment opportunity is seasonal, and overall earnings lag behind national averages. Maine’s population growth can be described in three ways: its population is growing slowly, it is growing older and it is growing unevenly. Poverty rates are relatively high at 11.5%, but vary dramatically by region, ranging from 8.0% in York County to 20.9% in Washington County. The market place served by the Company is driven, in part, by the tourism and hospitality industries, which represent one in ten jobs in the state of Maine.
Despite Maine’s strong natural resource heritage and the independent nature of its people, Maine’s economic vitality has become dependant on regional and national activity. As Maine’s economy has transitioned from an agricultural and industrial foundation towards a service and information-based economy, it has become increasingly dependant on the global market place. As in other states, Maine’s economy is being shaped and propelled by several factors including its population dynamics, the changing composition of the job base, globalization, fiscal devolution and technology.
The Maine economy has shown slow but steady improvement in a number of key areas over the past year, including employment, income, investment and consumer sales. By mid-2004, Maine recovered all of the jobs lost during the most recent recession, well ahead of the nation and other New England states except for Rhode Island. The latest data for Maine’s gross state product and personal income growth were well above the national averages, helping to raise Maine’s per capita income ranking from 35th to 30th over this period. However, the Maine Consensus Economic Forecasting Commission (October 2004 forecast) calls for relatively slower growth in 2005, including annual growth in personal income of 4.0% and wage and salary employment of 1.7%.
According to a January 2005 joint report published by Maine Revenue Services, the State Planning Office and the Maine Department of Labor, a number of key economic indicators used to monitor the state of Maine economy remained positive during 2004. Among these:
Personal income grew 5.4% for the first three quarters of the year versus the same period last year, slightly outperforming New England (5.3%) and the U.S. (5.2%).
Maine’s seasonally adjusted unemployment rate stood at 4.5% in November 2004, having dropped from 5.1% a year earlier, and remained below the national rate of 5.4%. Payroll employment numbers showed the addition of almost five thousand net new jobs through November of 2004. The largest job gains came in health care and social assistance, retail trade, construction, and leisure and hospitality sectors. The manufacturing sector showed job losses during this period, continuing a long-term trend. Maine’s unemployment rate has been below the national average for the past 5 years, and over the 2000-2003 period, payroll employment grew while it declined in New England and the U.S.
Wage disbursements increased 4.2% during the first two quarters of 2004 and were on a faster pace than the 3.5% increase during all of 2003. Annual average total wages paid in Maine showed exceptionally strong gains of 6.4% between 2001 and 2003 while comparable wage gains for the U.S. were reported at 2.8% and the New England region reported at 0.8%.
Maine’s retail sales year-to-date growth through the third quarter of 2004 was 6.1% over the same period of last year. Growth in 2003 was 4.6%. Business operating sales, including business-to-business transactions, increased by 10% during the July to September 2004 quarter. Growth for the 2004 calendar year through September was 11% higher the same period last year.
Residential construction awards were strong throughout 2004, with year-over-year growth in the August through October period up nearly 18% from the same period last year.
Changes in the economy are difficult to predict, and the foregoing discussion may or may not be indicative of whether the northern New England economy, including the state of Maine, and particularly Down East and Mid Coast Maine, is improving or will continue to strengthen. A downturn in the local economies that the Company serves, or adverse changes in the real estate markets could negatively impact the Company’s business, financial condition, and results of operations.
COMPETITION
The Company competes principally in Down East and Mid Coast Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be in Hancock, Knox, and Washington counties, each in the state of Maine. According to the most recent Census Bureau Report (2003), the population of these three counties is 52,792, 40,406 and 33,479 respectively, representing a combined population of approximately 126,677. Their economies are based primarily on tourism, health care, fishing, aquaculture, agriculture, and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions, savings and loan institutions, and credit unions. Other competitors in the Company’s primary market area include financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.
Like most financial institutions in the United States of America, the Company competes with an ever-increasing array of financial service providers. As the national economy moves further towards a concentration of service companies and the overall health of the financial services industry continues to be strong, competitive pressures will mount.
As a bank holding company and state-chartered commercial bank, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulation that limits the type and scope of their activities. The non-bank financial service providers that compete with the Company and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, continues to be aggressive.
The financial services industry is undergoing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Further technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Company’s future success will depend in part on its ability to address customer needs by using technology. There is no assurance that the Company will be able to develop new technology-driven products and services or be successful in marketing these products to our customers. Many of the Company’s competitors have far greater resources to invest in technology.
The Company has generally been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers; however, no assurance can be given that the Bank will continue to be able to compete effectively with other financial institutions in the future.
No material part of the Company’s business is dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.
MANAGEMENT AND EMPLOYEES
The Company has two principal officers: Joseph M. Murphy, President and Chief Executive Officer, and Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer.
Joseph M. Murphy also serves as President and Chief Executive Officer of the Bank. Gerald Shencavitz also serves as Chief Financial Officer, Chief Operating Officer and Treasurer of the Bank. Mr. Dean S. Read formerly served as President of the Bank through 2004, but has resigned that position effective as of February 25, 2005. Other senior operating positions in the Company include a President of Trust Services, and Senior Vice Presidents in charge of retail banking, commercial lending, credit administration / risk management, operations, and human resources.
As of December 31, 2004, the Bank employed 140 full-time equivalent employees, Trust Services employed 12 full-time equivalent employees, and the holding company employed 4 full-time employees, representing a full-time equivalent complement of
employees of the Company.
The Company maintains comprehensive employee benefit programs, which provide health, dental, long-term and short-term disability, and life insurance. All Company employees are eligible for participation in the Bar Harbor Bankshares 401(k) Plan. Certain officers and employees of the Company and its subsidiaries also participate in the Company’s 2000 Stock Option Plan and/or have incentive bonus compensation plans, deferred compensation arrangements, Supplemental Executive Retirement Agreements and change in control, confidentiality and noncompete agreements.
The Company’s management believes that employee relations are good.
SUPERVISION AND REGULATION
The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation, and examination by various federal and state bank regulatory agencies, including the FRB, the FDIC, and the Superintendent, as well as other governmental agencies in the states in which the Company and its subsidiaries operate. The supervision, regulation, and examination to which the Company and its subsidiaries are subject are intended primarily to protect depositors and other customers, or are aimed at carrying out broad public policy goals, and are not necessarily for the protection of the shareholders.
Some of the more significant statutory and regulatory provisions applicable to banks and BHCs, to which the Company and its subsidiaries are subject, are described more fully below, together with certain statutory and regulatory matters concerning the Company and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on the Company’s business and operations, as well as those of its subsidiaries. The Company’s shareholders generally are not subject to these statutory and regulatory provisions.
Bank Holding Company Act - As a registered BHC and a Maine financial institution holding company, the Company is subject to regulation under the BHC Act and Maine law and to examination and supervision by the FRB and the Superintendent, and is required to file reports with, and provide additional information requested by, the FRB and the Superintendent. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals that violate the BHC Act or orders or regulations there under, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary of a BHC.
The BHC Act prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior FRB approval. Unless a BHC becomes a "financial holding company" (an "FHC") under the Gramm-Leach-Bliley Act ("GLBA"), as discussed below, the BHC Act also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or BHC, and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. In addition, Maine law requires approval by the Superintendent prior to acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company that controls a Maine financial institution. The Superintendent also must approve acquisition by a Maine financial institution holding company of more than 5% of a financial institution or financial institution holding company domiciled outside of the state of Maine.
Federal Reserve Act - Various other laws and regulations, including Sections 23A and 23B of the Federal Reserve Act, as amended (the "FRA"), generally limit borrowings, extensions of credit, and certain other transactions between the Company and its non-bank subsidiaries and its affiliate insured depository institutions. Section 23A of the FRA also generally requires that an insured depository institution’s loans to non-bank affiliates be secured in appropriate amounts, and Section 23B of the FRA generally requires that transactions between an insured depository institution and its non-bank affiliates be on market terms. These laws and regulations also limit BHCs and their subsidiaries from engaging in certain tying arrangements in connection with any extension of credit, sale or lease of property, or furnishing of services.
Financial Services Modernization - The Gramm-Leach-Bliley Act ("GLBA"), which significantly altered banking laws in the United States, was signed into law in 1999. GLBA enabled combinations among banks, securities firms and insurance companies beginning in 2000. As a result of GLBA, many of the depression-era laws that restricted these affiliations and other activities that may be engaged in by banks and bank holding companies, were repealed. Under GLBA, bank holding companies are permitted to offer their customers virtually any type of service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking.
The Gramm-Leach-Bliley Act established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit BHC’s that qualify and elect to be treated as financial holding companies to engage in a range of financial activities broader than would be permissible for traditional BHC’s that have not elected to be treated as FHC’s, such as the Company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
In order to elect to become an FHC, a BHC must meet certain tests and file an election form with the FRB. To qualify, all of a BHC’s subsidiary banks must be well capitalized and well managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the BHC’s banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act evaluation.
A BHC that elects to be treated as an FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. The Company has not elected to become an FHC.
Further, GLBA permits state banks, to the extent permitted under state law, to engage in certain new activities that are permissible for subsidiaries of an FHC. GLBA expressly preserves the ability of state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a state bank must be well capitalized, and such banks would be subject to certain capital deduction, risk management, and affiliate transaction rules. Also, the FDIC’s final rules governing the establishment of financial subsidiaries adopt the position that a state nonmember bank may only conduct through a financial subsidiary activities that a national bank could only engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC’s standard activities rules. Moreover, to mirror the FRB’s actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 - The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally authorizes BHCs to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers, and to a lesser extent, interstate banking.
Declaration of Dividends - According to its Policy Statement on Cash Dividends Not Fully Covered by Earnings (the "FRB Dividend Policy"), the FRB considers adequate capital to be critical to the health of individual banking organizations and to the safety and stability of the banking system. Of course, one of the major components of the capital adequacy of a bank or a BHC is the strength of its earnings and the extent to which its earnings are retained and added to capital, or paid to shareholders in the form of cash dividends. Accordingly, the FRB Dividend Policy suggests that banks and BHCs generally should not maintain their existing rate of cash dividends on common stock, unless the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The FRB Dividend Policy reiterates the FRB’s belief that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC’s ability to serve as a source of strength.
Until June 30, 2003, Maine law previously provided that a corporation’s board of directors could declare, and the corporation may pay, dividends on its outstanding shares in cash or other property, generally out of the corporation’s unreserved and unrestricted earned surplus, or out of the unreserved and unrestricted net earnings of the current fiscal year and the next preceding fiscal year taken as a single period, except under certain circumstances, including when the corporation is insolvent, or when the payment of the dividend would render the corporation insolvent, or when the declaration would be contrary to the corporation’s charter. These limitations were repealed effective as of July 1, 2003. Under current Maine corporation law, the directors of a corporation may make distributions to its shareholders (subject to restriction by the articles of incorporation) if, (1) the corporation’s assets exceed its liabilities (plus any amounts payable to preferred classes of stock), and (2) the corporation is able to pay its debts as they become due in the usual course of business (i.e., it must not be insolvent). These new limitations generally apply to investor owned Maine financial institutions and financial institution holding companies.
Federal bank regulatory agencies also have authority to prohibit banking institutions from paying dividends if those agencies determine that, based on the financial condition of the bank, such payment would constitute an unsafe or unsound practice.
Capital Adequacy Guidelines: The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a BHC and in analyzing applications to it under the BHC Act. The FRB’s capital adequacy guidelines apply on a consolidated basis to BHCs with consolidated assets of $150 million or more; thus, these guidelines apply to the Company.
The FRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items, with at least one-half of that amount consisting of Tier 1 or core capital and the remaining amount consisting of Tier 2 or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital), less goodwill and other non-qualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments; perpetual preferred stock, which is not eligible to be included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital (defined by reference to the risk-based capital guidelines) to total assets of 3.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0% leverage ratio requirement is the minimum for the strong BHCs without any supervisory, financial or operational weaknesses or deficiencies, or those that are not experiencing or anticipating significant growth. All other BHCs are required to maintain a minimum leverage ratio of at least 4.0%. BHCs with supervisory, financial, operational, or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels.
At December 31, 2004, and at the time of this report, the Company’s risk-based capital ratio and leverage ratio were well in excess of regulatory requirements, and its management expects these ratios to remain in excess of regulatory requirements. Separate, but substantially similar, capital requirements under FDIC regulations apply to the Company’s bank subsidiary, and these also exceed regulatory requirements at December 31, 2004, and at the time of this report.
Failure to meet capital guidelines could subject the Company or the Bank to a variety of FDIC corrective actions, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution’s assets, and (v) requiring prior approval of certain expansion proposals.
Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from Part II, Item 7, section entitled "Capital Resources" and from Part II, Item 8, Notes to Consolidated Financial Statements, Note 13 "Shareholders’ Equity," each in this Annual Report on Form 10-K for the year ended December 31, 2004.
Activities and Investments of Insured State-Chartered Banks: FDIC insured, state-chartered banks, such as the Bank, are also subject to similar restrictions on their business and activities. Section 24 of the Federal Deposit Insurance Act ("FDIA"), generally limits the activities as principal and equity investments of FDIC insured, state-chartered banks to those activities that are permissible to national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.
Safety and Soundness Standards: The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), as amended, directs each federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk, asset growth, compensation, asset quality, earnings, and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing federal banking agencies to publish guidelines rather than regulations covering safety and soundness.
FDICIA also contains a variety of other provisions that may affect the Company’s and the Bank’s operations, including reporting requirements, regulatory guidelines for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch.
Community Reinvestment: Pursuant to the Community Reinvestment Act ("CRA") and similar provisions of Maine law, regulatory authorities review the performance of the Company and the Bank in meeting the credit needs of the communities served by the Bank. The applicable regulatory authorities consider compliance with this law in connection with the applications for, among other things, approval for branches, branch relocations, and acquisitions of banks and bank holding companies. The Bank received a "satisfactory" rating at its most recent CRA examination, May 28, 2002.
Customer Information Security: The FDIC and other bank regulatory agencies have published final guidelines establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to, or use of such information that could result in substantial harm or inconvenience to any customer.
Privacy: The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.
USA Patriot Act: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, together with the implementing regulations of various federal regulatory agencies, have caused financial institutions, including the Bank and Trust Services, to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions. It also requires the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money-laundering activities when considering applications filed under Section 3 of the BHC Act, or under the Bank Merger Act. Management believes the Company is in compliance with all of the requirements prescribed by the Patriot Act and all applicable final implementing regulations.
Deposit Insurance - The FDIA does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. A resumption of assessments of deposit insurance premiums charged to well-capitalized institutions, such as the Company’s subsidiary bank, could have an effect on the Company’s net earnings. The Company cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.
Securities Regulation: The common stock of the Company is registered with the U. S. Securities and Exchange Commission ("SEC") under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Act"). Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Act.
Sarbanes-Oxley Act of 2002 - On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley act of 2002 ("S-O Act"), which generally establishes a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies, and strengthen the independence of auditors. Among other things the S-O Act provides for:
The creation on an independent, public company accounting oversight board which is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review. The new board is funded with mandatory fees paid by all public companies. The new legislation also improves the Financial Accounting Standards Board, giving it full financial independence from the accounting industry.
The strengthening of auditor independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer public company audit clients.
A heightened responsibility of public company directors and senior managers for the quality of the financial reporting and disclosures made by their companies. Among other things, the new legislation provides for a strong public company audit committee that will be directly responsible for the appointment, compensation, and oversight of the work performed by the public company auditors.
Provisions which will deter wrongdoing. CEO’s and CFO’s now have to certify that company financial statements fairly represent the company’s financial condition. If a misleading financial statement later results in a restatement, the CEO and CFO must forfeit and return to the company any bonus, stock or stock option compensation received in the twelve months following the misleading financial report. The new legislation also prohibits any company officer or director from attempting to mislead or coerce an auditor. Among other reforms, the new legislation empowers the SEC to bar certain persons from serving as officers or directors of a public company; prohibits insider trades during pension fund "blackout periods"; directs the SEC to adopt rules requiring attorneys to report securities law violations; and requires that civil penalties imposed by the SEC go into a disgorgement fund to benefit harmed investors.
Requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the Company.
A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on non-preferential terms and in compliance with other bank regulatory requirements;
The imposition of a broad range of new corporate disclosure requirements. Among other things, the new legislation requires public companies to report all off balance sheet transactions and conflicts, as well as to present any pro forma disclosures in a way that is not misleading and in accordance with requirements established by the SEC. The new legislation also accelerated the required reporting of insider transactions, which now generally must be reported by the end of the second business day following a covered transaction; requires that annual reports filed with the SEC include a statement by management asserting that they are responsible for creating and maintaining adequate internal controls and assessing the effectiveness of those controls; and requires companies to disclose whether or not they have adopted an ethics code for senior financial officers, and, if not, why not, and whether the audit committee includes at least one "financial expert", a term which has been defined by the SEC in accordance with specified requirements. The new legislation also requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings.
Other Proposals - Other legislative and regulatory proposals regarding changes in banking, and the regulation of banks and other financial institutions, are regularly considered by the executive branch of the federal government, Congress and various state governments, including Maine and state and federal regulatory authorities. It cannot be predicted what additional legislative and/or regulatory proposals, if any, will be considered in the future, whether any such proposals will be adopted or, if adopted, how any such proposals would affect the Company or the Bank.
Taxation: The Company is subject to those rules of federal income taxation generally applicable to corporations under the Internal Revenue Code. The Company is also subject to state taxation under the laws of the State of Maine.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The information required under this item included in the Company's financial statements, which appear in Part II, Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.
AVAILABILITY OF INFORMATION - COMPANY WEBSITE
The Company maintains a website on the World Wide Web at http://www.bhbt.com. The Company makes available, free of charge, on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at http://www.sec.gov. Information contained on the Company’s website does not constitute a part of this report.
ITEM 2.
ITEM 2. PROPERTIES
The thirteen parcels of real estate owned and utilized by the Company for its operations are described below:
1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building, which houses its banking facilities and administrative offices, and an adjacent 35-car customer parking lot. The building was renovated in 1998.
2. An office is located at 111 Main Street, Northeast Harbor, Maine. This property consists of a building constructed in 1974 that underwent interior renovations in 1998 to better meet the Bank’s needs at that location.
3. An office is located at 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975, along with a parcel of land adjacent to the branch. The branch office was added to, and renovated in 1989, to better meet the needs at that location.
4. An office is located on 25 Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the needs at that location.
5. An office is located at 21 Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that underwent renovations in 1989 to better meet the needs at that location. A parcel of land adjacent to the Blue Hill branch was purchased in 1981, but has not been developed. A second improved parcel of land contiguous to this branch was purchased in 2005. The Bank is currently evaluating expansion at its Blue Hill location.
6. An office is located at 2 Bridge Street, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994, to house an ATM that helps to better meet the needs at that location.
7. An office is located at 68 Washington Street, Lubec, Maine. This property consists of a building constructed in 1990 and is adequate for the Bank’s needs at that location.
8. An office is located 137 High Street, Ellsworth, Maine. This property consists of a building constructed in 1982. The Bank is currently evaluating expansion of the Ellsworth office.
9. An office is located at 385 Main Street, Winter Harbor, Maine. This property consists of a building constructed in 1995 and is adequate for the Bank’s needs at that location.
10. An office is located at 20 Main Street, Machias, Maine. This property consists of a building that was purchased from Key Bank of Maine in May 1990, and was renovated in 1995 to better meet the Bank’s needs at that location.
11. An office is located at 245 Camden St (Route 1), Rockland, Maine. The property consists of a building that was purchased from Androscoggin Savings Bank in February 2004. The branch facility was built in 1977 and is adequate for the Bank’s needs at that location.
12. An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data centers. The building was constructed in 1996 and is currently adequate for the Company’s needs.
13. The Company owns and occupies a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The Bank and its wholly owned subsidiary, Trust Services, occupy this facility. The facility was renovated in 2001.
Other real estate includes two out parcels (one improved) contiguous to the Company’s 135 High Street, Ellsworth location.
The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 7 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of Management will have no material effect on the Company's consolidated financial statements.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company’s security holders in the fourth quarter of 2004.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of the Company is traded on the American Stock Exchange ("AMEX") under the trading symbol BHB. Quarterly stock prices, and dividends paid during the last two years are summarized below. High and low stock prices are based on quotations provided by the American Stock Exchange.
QUARTERLY STOCK PRICES
2004 AND 2003
High and low stock prices are based on quotations provided by the American Stock Exchange. Prices of transactions between private parties may vary from the ranges quoted above.
DIVIDENDS PAID TO SHAREHOLDERS
2004 AND 2003
Dividends paid by the Company in 2004 and 2003:
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
Total
$0.20
$0.20
$0.20
$0.20
$0.80
$0.19
$0.19
$0.19
$0.19
$0.76
As of March 7, 2005, the Company had 1,051 registered shareholders of record. The Company declared and distributed dividends totaling $0.80 per share during 2004, representing an earnings payout ratio of 43.2%. In the first quarter of 2005 the Company increased its quarterly dividend by 5.0% to $0.21 per common share. The dividend was paid March 15, 2005 to shareholders of record as of the close of business on February 18, 2005.
The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including the Company’s financial condition, earnings, its needs for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.
Stock Repurchase Plan
As more fully enumerated under Item 7 of this report on Form 10-K, in November 1999 the Company announced a stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. As of the date of termination of this plan on December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The Company recorded repurchased shares as treasury stock.
In March 2004, the Company announced a second stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005. As of December 31, 2004, the Company had repurchased 49,920 shares of stock under the plan, at a total cost of $1,349 and an average price of $27.03 per share. The Company records repurchased shares as treasury stock.
The following table sets forth information with respect to any purchase made by or on behalf of the Company or any "affiliated purchaser," as defined in Sec. 240.10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during the periods indicated:
Period
(a)
Total Number of Shares Purchased
(b)
Average Price Paid per Share
(c)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
(d)
Maximum Number of
Shares that May Yet Be Purchased Under the Plans
or Programs (1)
October 1 - 31, 2004
4,041
$27.14
4,041
276,399
November 1 - 30, 2004
7,867
$27.19
7,867
268,532
December 1 - 31, 2004
8,452
$28.81
8,452
260,080
Total
20,360
$27.85
20,360
260,080
(1) In February 2004, the Company’s Board of Directors approved a program to repurchase up to 10% of the Company’s outstanding shares of common stock,
or approximately 310,000 shares. Purchases began March 4, 2004. This repurchase program is scheduled to terminate December 31, 2005, unless otherwise
extended by the Company.
Incentive Stock Option Plan
On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and its Subsidiaries Incentive Stock Option Plan of 2000 that is described more fully in Notes 1 and 14 to the Consolidated Financial Statements in this Annual Report on Form 10-K.
The following table provides information as of December 31, 2004 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.
Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants and rights, net of forfeits and exercised shares
Weighted Average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation [(excluding securities referenced in column (a)]
(a)
(b)
(c)
Equity compensation plans approved
by security holders
318,350
$17.93
131,650
Equity compensation plans not approved
by security holders
--
N/A
--
Total
318,350
$17.93
131,650
Transfer Agent Services
American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15th Avenue, 3rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: http://www.amstock.com.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The supplementary financial data presented in the following tables contain information highlighting certain significant trends in the Company’s financial condition and results of operations over an extended period of time.
The following information should be analyzed in conjunction with Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the years ended December 31, 2004, 2003 and 2002 should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on Form 10-K. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years, and provide supplemental information and analysis.
Certain amounts in the 2003 and prior years financial statements have been reclassified to conform to the presentation used in 2004.
Unless otherwise noted, all dollars are expressed in thousands except per share data.
Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in 2004, 2003 and 2002 net interest income was $1,653, $1,602 and $1,488 of tax-exempt interest income from certain tax-exempt investment securities and loans.
An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income and net interest income totals discussed in this Management’s Discussion and Analysis, resulting in tax equivalent adjustments of $721, $684 and $613, in 2004, 2003 and 2002, respectively. The analysis of net interest income tables included in this Annual Report on Form 10-K provide a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.
Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.
EXECUTIVE OVERVIEW
General Information
Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2004 the Company had consolidated assets of $667 million and was one of the larger independent community banking institutions in Maine.
The Company’s principal asset is all of the capital stock of the Bar Harbor Bank & Trust (the "Bank"), a community bank incorporated in the late 19th century. With eleven branch office locations, the Company is a diversified financial services provider, offering a full range of banking services and products to individuals, businesses, governments, and not-for-profit organizations throughout Down East and Mid Coast Maine.
The Company attracts deposits from the general public in the markets it serves and uses such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage and home equity loans, and a variety of consumer loans. The Company also invests in mortgage-backed securities, obligations of state and political subdivisions, as well as other securities. In addition to community banking, the Company provides a comprehensive array of trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services") a Maine chartered non-depository trust Company.
Major Sources of Revenue
The principal source of the Company’s revenue is net interest income generated, representing the difference or spread between interest income from its earning assets and the interest expense paid on deposits and borrowed funds. In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. The Company’s non-interest income is principally derived from financial services including trust, investment management and third-party brokerage services, as well as service charges on deposit accounts, merchant credit card processing fees, gains and losses on the sale of investment securities, and a variety of other miscellaneous product and service fees.
Business Strategy
The Company, as a diversified financial services provider, pursues a strategy of achieving long-term sustainable growth, profitability, and shareholder value, without sacrificing its soundness. The Company works toward achieving this goal by focusing on increasing its loan and deposit market share in the coastal communities of Maine, either organically or by way of strategic acquisitions. The Company believes one of its more unique strengths is an understanding of the financial needs of coastal communities and the businesses vital to Maine’s coastal economy, namely: tourism, hospitality, retail establishments and restaurants, seasonal lodging and campgrounds, fishing, lobstering, boat building, and marine services. Consistent with this strategy, in February 2004 the Company expanded into Knox County, Maine, with the Bank’s acquisition of an existing branch banking office in the vibrant community of Rockland.
The Company’s key strategic focus is vigorous financial stewardship, deploying investor capital safely yet efficiently for the highest possible returns. The Company strives to provide unmatched service to its customers, while maintaining strong asset quality and a focus towards improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well-defined credit, investment, interest-rate and liquidity guidelines. In managing its balance sheet the Company seeks to preserve the sensitivity of net interest income to changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and expected conditions, and strives to maintain a balanced and appropriate mix of loans, core deposits, and borrowed funds.
Material Risks and Challenges
In its normal course of its business, the Company faces many risks inherent with providing banking and financial services. Among the more significant risks managed by the Company are losses arising from loans not being repaid, commonly referred to as "credit risk", and losses of income arising from movements in interest rates, commonly referred to as "interest rate and market risk". The Company is also exposed to national and local economic conditions, downturns in the economy, or adverse changes in real estate markets, which could negatively impact its financial condition and results of operations.
Management has numerous policies and control processes in place which provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions, which if were changed or altered, could impact the Company’s financial condition and results of operations. The foregoing matters are more fully discussed throughout this Annual Report on Form 10-K.
Summary Financial Condition
The Company’s total assets increased 14% during 2004, ending the year at $667 million. Asset growth continued to be driven by consumer and commercial lending activities.
Loans:
Total loans stood at $448 million at December 31, 2004, representing an increase of 17% compared with the same date in 2003. Loan growth was split about equally between commercial and consumer loans, and was aided by $12 million in loans acquired in connection with the Bank’s branch office acquisition in the community of Rockland, Maine. Lending activities have benefited from the resilience of the local economy, a favorable market interest rate environment, and initiatives designed to strengthen the Bank’s loan origination and service delivery systems.
Allowance for Loan Losses:
Non-performing loans remained at low levels during 2004. At year-end, total non-performing loans amounted to $723 thousand or 0.16% of total loans, compared with $1.5 million or 0.39% at December 31, 2003. At December 31, 2004 the allowance for loan losses amounted to 1.1% of total loans, and expressed as a percent of non-performing loans, stood at 667%. Reflecting a sustained trend of strong credit quality, during 2004 the Bank recorded a provision for loan losses of $180 thousand, representing a reduction of $360 compared with 2003, and favorably impacting the current year’s earning performance.
Investment Securities:
The investment securities portfolio continued to serve as a key source of earning assets for the Bank. Investment securities totaled $176 million at December 31, 2004, representing an increase of 11% compared with December 31, 2003. Investment securities principally consist of mortgage-backed securities, and obligations of state and political subdivisions.
Deposits:
The primary source of funding for the Bank’s earning assets continued to be core customer deposits, gathered through its network of eleven banking offices throughout Down East and Mid Coast Maine. Total deposits stood at $398 million at December 31, 2004, representing an increase of 17% compared with December 31, 2003. Deposit growth was bolstered by accounts acquired in connection with the Rockland branch acquisition, a new institutional money market product, and brokered certificates of deposit obtained from the national market. Savings and money market accounts led 2004 growth with an increase of $30 million, followed by time deposits, demand deposits and NOW accounts, posting increases of $21, $5 and $3 million, respectively.
Borrowings:
Borrowed funds principally consist of advances from the Federal Home Loan Bank. During 2004 the Bank continued to utilize borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Advances from the Federal Home Loan Bank totaled $192 million at December 31, 2004, representing an increase of 13% compared with the same date in 2003. The increase in borrowed funds was principally utilized to fund growth in the investment securities portfolio.
Shareholders’ Equity:
Consistent with its long-term strategy of operating a sound and profitable organization, during 2004 the Company continued to exceed regulatory requirements for "well-capitalized" institutions. At December 31, 2004, the Company’s Tier I Leverage Capital ratio was 7.8%, compared with 5.0% for "well-capitalized" institutions. Total shareholders’ equity stood at $56 million, representing an increase of $3 million compared with December 31, 2003.
Summary Results of Operations
Net income for the year ended December 31, 2004 amounted to $5.7 million, or fully diluted earnings per share of $1.79, compared with $5.2 million or fully diluted earnings per share of $1.63 for the year ended December 31, 2003, each representing an increase of 10%.
The Company’s return on average equity ("ROE") amounted to 10.58% during 2004, compared with 9.66% during 2003.
Net Interest Income:
Net interest income continued to be the principal component of the Company’s income stream. Net interest income for the year ended December 31, 2004 amounted to $20.4 million, representing an increase of $959 thousand or 5% compared with 2003. The increase in net interest income was principally attributed to earning asset growth during 2004, as the Company’s net interest margin declined 35 basis points to 3.45%, compared with 2003. Following a long period of historically low interest rates, the net interest margin continued under pressure early in the year, but began to steadily strengthen as the Federal Reserve increased short-term interest rates five times during the second half of the year. The Company continues to maintain an asset sensitive balance sheet, and management believes it is well positioned for a variety of future interest rate scenarios.
Non-interest Income:
Non-interest income for the year ended December 31, 2004 amounted to $6.6 million, representing a decrease of $502 thousand or 7% compared with 2003. The decline in non-interest income was principally attributed to a reduced level of net gains on the sale of investment securities, which amounted to $497 thousand during 2004 compared with $1.3 million during 2003. Income from trust and financial services declined 12% to $1.9 million during 2004 compared with 2003, reflecting declines in average managed assets and revenue from third-party brokerage activities. Included in 2004 non-interest income was $404 thousand in income from interest rate swap agreements, of which $375 thousand represented net cash flows received from counterparties. In 2004, these interest rate swap agreements were de-designated as cash flow hedges and the cash flows received from counterparties were recorded as non-interest income, whereas in 2003 these cash flows were recorded as interest income. In September 2004, the interest rate swap agreements were re-designated as cash flow hedges and, prospectively, the net cash flows received from counterparties are being recorded as interest income. Service charges on deposit accounts declined $46 thousand or 3% during 2004, while credit card and merchant processing fees increased $73 thousand or 5%.
Non-interest Expense:
Non-interest expense for the year ended December 31, 2004 amounted to $18.9 million, representing an increase of $61 thousand, or less than 1%, compared with 2003. A variety of factors contributed to 2004 non-interest expense year-over-year results. Included in 2004 non-interest expense were costs associated with the Company’s corporate re-branding initiative, other-than-temporary impairment write-downs of certain non-marketable equity investments, and costs related to integration activities associated with the Rockland branch acquisition. Non-interest expenses also included costs related to the Company’s compliance with the sweeping changes in U.S. securities laws enacted under the Sarbanes-Oxley Act of 2002, particularly Section 404, which establishes extensive new requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. The Company’s success in containing the increase in 2004 non-interest expense at less than 1% was attributed in part to a variety of previously reported expenses incurred during 2003 related to organizational restructuring activities in the Company’s financial services division, certain legal settlements, and adjustments to the workforce. Salaries and employee benefits declined $148 thousand to $9.3 million during 2004, reflecting current and prior year changes to staffing levels and compensation mix.
Other 2004 Financial Highlights
Cash Dividends:
In the first quarter of 2004 the Company increased its quarterly dividend by 5.3%, to 20 cents per share. In the first quarter of 2005 the dividend was increased by 5.0%, to 21 cents per share.
Branch Acquisition
: In February 2004, the Bank completed its acquisition of a branch office in the community of Rockland, Maine. This transaction included approximately $21 million in deposits and $12 million in loans.
Stock Repurchase Plan:
In the first quarter of 2004 the Company announced its second stock repurchase plan under which the Company may purchase up to 10% of its outstanding shares of common stock. During 2004, the Company repurchased 49.9 thousand shares at an average price of $27.03.
Tangible Book Value
: In connection with the Bank’s acquisition of the Rockland branch in February 2004, the Company capitalized $3.2 million in goodwill and other intangible assets on its consolidated balance sheet. At December 31, 2004 the Company’s tangible book value per share amounted to $17.06 compared with $17.02 at December 31, 2003.
BTI Restructuring Plan: The Company completed the previously reported restructuring of its wholly owned financial services subsidiary, BTI Financial Group ("BTI") and its three operating subsidiaries: Bar Harbor Trust Services; Block Capital Management ("Block"), an SEC registered investment advisor; and Dirigo Investments, Inc. ("Dirigo"), a National Association of Securities Dealers (NASD) registered broker-dealer.
Pursuant to this plan, the following actions were taken, all of which were completed during 2004:
The portfolio management professionals at Block were unified as one team with Trust Services. Block subsequently discontinued operations as an independent subsidiary of BTI. All services provided by Block to clients of Trust Services remained unchanged.
During the first quarter of 2004 Trust Services became a wholly owned subsidiary of the Bank. All products and services provided by Trust Services remained unchanged.
In January 2004 the Bank entered into a third-party brokerage arrangement with Infinex Investments, Inc. ("Infinex"). Infinex began offering third party brokerage services in May, 2004 doing business as "Bar Harbor Financial Services." Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or any of its subsidiaries. These products are not deposits, are not insured by the FDIC or any other any government agency, are not guaranteed by the bank or any affiliate, and may be subject to investment risk, including possible loss of value.
A transfer of customer account assets of Dirigo Investments, Inc. ("Dirigo") to Bar Harbor Financial Services was completed during the third quarter of 2004, at which time Dirigo and BTI were dissolved.
One of the principal goals underlying the restructuring plan was to simplify and more closely align the Company’s brand names and operating model without diminishing functionality. The Company anticipates the changes will enable it to improve customer service, broaden its product offerings, and achieve increased operating efficiencies. The Company also believes that by reducing the number of brand names under which it operates, a clearer message will be presented to its customers and the marketplace.
Outlook
The challenges facing the Company as we entered 2005 were similar to those identified in the prior year, namely: loan and deposit growth, credit quality, interest rate risk, and risk management processes. In addition to these challenges, the Company must grow revenues and control expenses while managing an increasing regulatory burden. These are challenges the Company has met for many years while serving the citizens and businesses in the markets it serves, and the Company expects similar results over the next twelve months.
The year 2004 brought the banking world much volatility and uncertainty. Short-term interest rates increased with the Fed tightening five times, while the 10-year Treasury fluctuated between 3.65% and 4.95%, ending the year at 4.30%. While short-term interest rates were increasing during the second half of the year, the opposite was true for longer term rates, causing a dramatic flattening of the U.S. Treasury yield curve as we ended 2004. As we head into 2005, growth in net interest income will depend on many factors including: how quickly, and by how much, the Federal Reserve will continue to tighten and the effect on the rest of the yield curve; whether the economy will continue on the road to recovery and at what pace; and the impact of a potentially inverted yield curve on the net interest margin. The current and projected shape of the yield curve will be key factors driving the Company’s net interest income in 2005, and continued earning asset growth will likely be necessary in generating meaningful increases. Though these developments have not had a materially adverse affect on the Company to date, the Company continues to monitor them closely and believes it is adequately positioned for a variety of future interest rate scenarios.
Reflecting trends in the National and Regional economies, the Company’s market area generally witnessed steady economic growth during 2004. As we head into 2005, the economies and real estate markets in the Company’s primary market areas will continue to be significant determinants of the quality of the Company’s assets in future periods and, thus, its results of operations, liquidity, and financial condition. The Company believes future economic activity will in part depend on stronger employment, consumer confidence, personal consumption expenditures, and business expenditures for new capital equipment.
Other factors, which could affect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this Annual Report on Form 10-K.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of the Company’s financial condition are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates, including those related to the allowance for loan losses, on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions.
The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:
Allowance for Loan Losses - Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income and when larger provisions for loan losses are necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.
Income Taxes - The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2004 and 2003, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.
Interest Income Recognition on Loans - Interest income on loans is included in income as earned based upon the unpaid principal balance of the loan. The Company’s policy is to discontinue the accrual of interest, and to reverse any uncollected interest recorded on loans, when scheduled payments become contractually past due in excess of 90 days or, in the judgment of management, the ultimate collectibility of principal or interest becomes doubtful.
Goodwill and Other Intangible Assets - The valuation technique used by the Company to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors. Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company's results of operations. Refer to Notes 1 and 8 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.
FINANCIAL CONDITION
Asset / Liability Management
In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets represented 94.7% and 94.3% of total average assets during 2004 and 2003, respectively.
The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit products offered within the markets served, as well as through the prudent use of borrowed funds.
The Company’s objectives in managing its balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and forecasted economic conditions, and to maintain an efficient and appropriate mix of core deposits and borrowed funds.
Earning Assets
For the year ended December 31, 2004, the Company’s total average earning assets amounted to $612,031, compared with $528,791 in 2003, representing an increase of $83,240, or 15.7%. The 2004 increase in average earning assets was led by average loan growth of $49,255 or 13.4%, followed by growth in average investment securities amounting to $32,484, or 21.8%.
The tax-equivalent yield on total average earning assets amounted to 5.33% in 2004, compared with 5.90% in the prior year, representing a decline of 57 basis points. The decline in earning asset yields was principally attributed to the continuation of historically low interest rates, particularly during the first six months of 2004 when the federal funds targeted rate stood at 1.00%, representing a forty-five year low. Long-term interest rates also continued at historically low levels during 2004, with the 10-year U.S. Treasury note yielding below 4.40% for the most of the year, declining to as low as 3.68%, and ending the year at 4.22%. The Bank’s earning asset yields began to strengthen during the second half of 2004 as the Federal Reserve increased the federal funds rate five times, ending the year at 2.25% and favorably impacting the yields on the Bank’s variable rate earning assets.
Total interest earned during 2004 amounted to $32,643 compared with $31,177 in 2003, representing an increase of $1,466 or 4.7%, all of which was attributed to earning asset growth.
Total Assets
The Company’s assets principally consist of loans and investment securities, which at December 31, 2004 represented 66.5% and 26.4% of total assets, respectively.
At December 31, 2004 the Company’s total assets stood at $666,811, representing an increase of $83,065, or 14.2%, compared with December 31, 2003. The increase in total assets was principally attributed to loan growth of $65,070 or 17.0%, followed by growth in investment securities amounting to $17,950, or 11.3%.
Loans
The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine. The following table summarizes the components of the Bank’s loan portfolio, net of loan origination fees and costs, as of December 31st over the past five years.
SUMMARY OF LOAN PORTFOLIO AT DECEMBER 31
Real estate loans:
Construction and development
$ 21,339
$ 12,639
$ 16,270
$ 20,348
$ 12,297
Mortgage
362,702
322,579
287,990
229,634
208,815
Loans to finance agricultural production
and other loans to farmers
15,077
11,719
11,053
7,149
6,674
Commercial and industrial loans
35,574
19,167
20,010
22,158
23,729
Loans to individuals for household,
family and other personal expenditures
11,156
11,775
12,818
13,918
15,841
All other loans
2,153
4,554
2,684
3,699
3,978
Real estate under foreclosure
1,064
TOTAL LOANS
$448,478
$383,408
$351,535
$297,970
$271,381
Less: Allowance for loan losses
4,829
5,278
4,975
4,169
4,236
NET LOANS
$443,649
$378,130
$346,560
$293,801
$267,145
Total Loans: At December 31, 2004 total loans amounted to $448,478, compared with $383,408 at December 31, 2003, representing an increase of $65,070, or 17.0%. Commercial loans contributed 54.6% to this growth; consumer loans contributed 48.0% offset in part by a decline of 2.6% in tax-exempt loans to municipalities.
The 2004 increase in total loans reflects $12,343 in loans acquired in connection with the Bank’s acquisition of a branch office in the community of Rockland, Maine, principally consumer real estate loans. Excluding the acquired Rockland branch loan portfolio, 2004 loan growth amounted to $52,727, or 13.8%.
At December 31, 2004 total consumer loans amounted to $282,413, representing an increase of $31,244 or 12.4%, compared with December 31, 2003.
Following record refinancing activity over the past few years and a rise in interest rates that began in the latter part of 2003, consumer real estate loan originations slowed during 2004, but portfolio growth continued as new purchase transactions accounted for an increasing proportion of loan originations. In addition, home equity loan activity has been strong, accounting for 35.3% of the 2004 increase in consumer loans.
At December 31, 2004 total commercial loans amounted to $163,433, representing an increase of $35,532 or 27.8% compared with December 31, 2003. The 2004 growth in commercial loans represented a five year high, attributed in part to a stable local economy, a still-favorable market interest rate environment, and initiatives designed to strengthen the Bank’s commercial loan origination activities. Commercial loan originations were particularly strong in Knox County, a new market area forged in 2004, by way of the Bank’s acquisition of a branch office in the community of Rockland, Maine.
In April of 2004, the Bank opened a loan production office in Bangor, Maine, augmenting the Company’s long-standing Trust and Financial Services presence in this major market area. During 2004, the Bangor loan production office generated significant new commercial relationships, which benefited from a strong, locally based commercial lender. The Bank anticipates continued loan growth in this market area.
At December 31, 2004, consumer and commercial real estate loans comprised 85.7% of the loan portfolio, compared with 87.4% at December 31, 2003. The continued strength in the local real estate markets, both residential and commercial, has led to historically high property values in the Bank’s market area. Recognizing the impact this trend may have on the loan portfolio and origination pipeline, the Bank periodically reviews its underwriting standards in an effort to ensure that the quality of the loan portfolio is not jeopardized by unrealistic loan to value ratios or debt service levels. To date, there has been no significant deterioration in the performance or risk characteristics of the real estate loan portfolio.
Construction and Development Loans: Construction and development loans are both consumer and commercial in nature and represented 4.8% of total loans at December 31, 2004, compared with 3.3% at December 31, 2003.
Total construction and development loans amounted to $21,339 at December 31, 2004 compared with $12,639 at December 31, 2003, representing an increase of $8,700, or 68.8%. The increase in these types of loans was attributed in part to a higher level of commercial construction loan activity at the close of 2004. Construction and development loans generally migrate from construction status to completed projects with permanent financing arrangements within one year.
Mortgage Loans: Mortgage loans, which include consumer real estate, home equity and commercial, accounted for 81.0% of total loans at December 31, 2004, compared with 84.1% at December 31, 2003.
At December 31, 2004, total mortgage loans amounted to $363,179, compared with $322,579 at December 31, 2003, representing an increase of $40,600, or 12.6%. The increase in mortgage loans was principally attributed to strong commercial real estate loan originations, loans acquired in connection with the Rockland branch office acquisition, and continued demand for real estate in the communities served by the Bank.
Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $15,077 at December 31, 2004 compared with $11,719 at December 31, 2003, representing an increase of $3,358 or 28.7%. This category of loans represented 3.4% of the loan portfolio at December 31, 2004, compared with 3.1% at the same date in 2003. The communities served by the Bank present limited opportunities for lending in this industry sector.
Commercial and Industrial Loans: Commercial and industrial loans represented 7.9% of the loan portfolio at December 31, 2004, compared with 5.0% at December 31, 2003. Included in this category of loans are certain loans related to the Maine’s wild blueberry industry. The Bank’s market area demographics have historically limited the growth potential in this particular category of loans. During 2004 this trend did not continue. At December 31, 2004, commercial and industrial loans totaled $35,574, compared with $19,167 at the same date in 2003, representing an increase of $16,407, or 85.6%.
Loans to Individuals for Household, Family and Other Personal Expenditures: Personal consumer loans, including credit card loans and student loans, totaled $11,156 at December 31, 2004 compared with $11,775 at December 31, 2003, representing a year-over-year decline of $619, or 5.3%. This category of loans represented 2.5% of the portfolio at December 31, 2004, compared with 3.1% at December 31, 2003.
Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank has not campaigned aggressively for consumer installment loans over the past few years.
The Bank continues to be one of relatively few community banks with its own credit card loan portfolio, as large credit card processing companies continue to acquire credit card portfolios and associated sources of non-interest income from smaller organizations, particularly community banks.
All Other Loans: All other loans represented 0.5% of the loan portfolio at December 31, 2004 compared with 1.2% in 2002. The balance of all other loans at December 31, 2004 totaled $2,153 compared with $4,554 at December 31, 2003, representing a decrease of $2,401, or 52.7%.
This category of loans principally includes loans to government municipalities and, to a lesser extent, not-for-profit organizations. Government municipality loans typically have short maturities and low interest rate risk characteristics. Government municipality loans are typically available through a bid process among local financial institutions and are aggressively priced, thus generating narrow net interest income margins.
Real Estate Loans Under Foreclosure: At December 31, 2004, real estate loans under foreclosure totaled $477 compared with $975 at December 31, 2003, representing a decline of $498, or 51.1%. At December 31, 2004 real estate loans under foreclosure were represented by six consumer mortgage loans totaling $420 and one commercial mortgage loan totaling $57. At December 31, 2003, real estate loans under foreclosure were represented by six commercial mortgage loans amounting to $544
and ten consumer mortgage loans totaling $431. During 2004, foreclosure proceedings were completed on these loans and any resulting charge offs were recognized.
Loan Concentrations: Loan concentrations continued to reflect the Bank’s business region. At December 31, 2004, approximately 6.8% or $30,535 of the loan portfolio was represented by loans to the hospitality industry, compared with 8.3% or $31,493 at December 31, 2003. At December 31, 2004 loans related to Maine’s wild blueberry industry amounted to approximately $4,676 or 1.0% of total loans compared with $7,116, or 1.9% at December 31, 2003.
Other Real Estate Owned: When the Bank takes ownership of collateral property upon foreclosure of a real estate secured loan, the property is transferred from the loan portfolio to Other Real Estate Owned ("OREO") at its fair value. If the loan balance is higher than the fair value of the property, the difference is charged to the allowance for loan losses at the time of the transfer. Other Real Estate Owned is classified on the balance sheet with Other Assets. At December 31, 2004 there was no other real estate owned compared with $34 at December 31, 2003. One residential property comprised the December 31, 2003 balance and this property was sold during 2004.
Mortgage Loan Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2004, the unpaid balance of mortgage loans serviced for others totaled $9,935 compared with $12,334 at December 31, 2003, representing a decrease of $2,399, or 19.5%. The decline in 2004 balances was attributed to serviced mortgage loan principal payments, as well as prepayments resulting from loan refinancing activity. Pursuant to the Bank’s asset and liability management strategy, its need for interest earning assets, and its strong capital position, loans originated during 2004 were almost entirely held in the Bank’s loan portfolio.
Loan Maturities and Re-pricing Distribution: The following table shows fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31, 2004, and 2003. Actual maturity dates may differ from contractual maturity dates due to prepayments or loan re-financings.
Maturities
12/31/04
12/31/03
Three months or less
$168,680
$120,309
Over three months through 12 months
40,409
49,020
Over one year through three years
26,841
28,921
Over three years through five years
46,977
28,101
Over five years through 15 years
98,614
97,259
Over 15 years
66,957
59,798
Total
$448,478
$383,408
Loan Portfolio Composition: The following table summarizes the fixed and variable rate composition of the loan portfolio as of December 31, 2004 and 2003:
Commercial loans:
Real Estate- variable rate
$97,926
$72,923
Real Estate- fixed rate
6,463
4,595
Other - variable rate
40,235
31,393
Other - fixed and variable rate
18,809
18,990
163,433
127,901
Tax Exempt Municipal Loans - Fixed Rate
1,950
3,652
Consumer and Residential Real Estate Loans:
Real Estate- variable rate
$ 64,467
$ 51,529
Real Estate- fixed rate
157,223
150,573
Home equity - fixed and variable rate
47,189
35,941
Installment - fixed rate
3,961
4,250
Other - fixed and variable rate
9,573
8,876
282,413
251,169
Real estate under foreclosure
Deferred origination costs (fees), net
(289)
Allowance for loan losses
(4,829)
(5,278)
$443,649 $378,130
Allowance For Loan Losses
Credit Risk: Credit risk is managed through loan officer authorities, loan policies, the Bank's Senior Loan Officers Committee, oversight from the Bank's Senior Credit Officer, the Director's Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to Management's review, of individual credits is performed by an independent loan review function, which reports to the Audit Committee of the Board of Directors.
Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses and maximize earnings. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Non-residential mortgage consumer losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlate with regulatory definitions of Pass, Other Assets Especially Mentioned, Substandard, Doubtful, and Loss.
As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and/or interest is 90 days overdue. Consumer loans are generally charged off when principal and/or interest payments are 120 days overdue.
Non-performing Loans: Non-performing loans ("NPLs") include loans on non-accrual status, loans that have been treated as troubled debt restructurings, and loans past due 90 days or more and still accruing interest. There were no troubled debt restructurings in the loan portfolio during the last five years.
The following table sets forth the details of non-performing loans over the last five years.
TOTAL NON-PERFORMING LOANS
AT DECEMBER 31
Loans accounted for on a non-accrual basis:
Real estate loans:
Construction and development
$ 0
$ 114
$ 4
$ 0
$ 0
Mortgage
1,113
1,683
5,640
Loans to finance agricultural production and
other loans to farmers
Commercial and industrial loans
Loans to individuals for household,
family and other personal expenditures
Total non-accrual loans
1,295
2,191
6,907
Accruing loans contractually past due 90 days
or more
1,206
Total non-performing loans
$723
$1,494
$1,174
$2,342
$8,113
Allowance for loan losses to non-performing loans
668%
353%
424%
178%
52%
Non-performing loans to total loans
0.16%
0.39%
0.33%
0.79%
2.99%
At December 31, 2004, total non-performing loans amounted to $723 compared with $1,494 as of December 31, 2003, representing a decline of $771, or 51.6%. At December 31, 2004 non-performing loans represented 0.16% of total loans compared with 0.39% at December 31, 2003.
During 2004, the Bank maintained its non-performing loans at significantly lower levels compared with prior years. The Bank attributes this success to a continued strengthening of its credit administration processes and underwriting standards, aided by a stable local economy and a still favorable interest rate environment. The Bank maintains a centralized loan collection and managed asset department, providing timely and effective collection efforts for problem loans.
While the non-performing loan ratios continued to reflect the favorable quality of the loan portfolio during the year ended December 31, 2004, the Bank is cognizant of soft economic conditions overall, and is managing credit risk accordingly. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank's customers, interest rates, and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.
Allowance for Loan Losses: At December 31, 2004 the allowance for loan losses ("allowance") stood at $4,829, compared with $5,278 at December 31, 2003, representing a decrease of $449, or 8.5%.
The allowance is available to absorb losses on loans. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated quarterly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The Bank’s Board of Directors reviews the evaluation of the allowance to ensure its adequacy.
The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated losses. Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.
Loan loss provisions are recorded based upon overall aggregate data, and the allowance is increased when, on an aggregate basis, additional estimated losses are identified and deemed likely. No portion of the allowance is restricted to any loan or group of loans, and the entire allowance is available to absorb realized losses. The amount and timing of realized losses and future allowance allocations could vary from current estimates.
While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.
The following table details changes in the allowance for loan losses and summarizes loan loss experience by loan type over the past five years.
ALLOWANCE FOR LOAN LOSSES
SUMMARY OF LOAN LOSS EXPERIENCE
Balance at beginning of period
$ 5,278
$ 4,975
$ 4,169
$ 4,236
$ 4,293
Charge offs:
Commercial, financial, agricultural, others
1,416
Real estate:
Construction and development
---
---
---
Mortgage
Installments and other loans
to individuals
Total charge offs
2,304
1,223
Recoveries:
Commercial, financial,
agricultural, others
Real estate:
Mortgage
Installments and other loans
to individuals
Total recoveries
Net charge offs
2,067
1,009
Provision charged to operations
1,100
2,000
Balance at end of period
$ 4,829
$ 5,278
$ 4,975
$ 4,169
$ 4,236
Average loans outstanding during period
$416,956
$367,701
$325,712
$283,728
$271,000
Net charge offs to average loans outstanding
during period
0.15%
0.06%
0.09%
0.73%
0.37%
The Bank's loan loss experience showed an increase during 2004 compared with 2003 experience. Net charge-offs during 2004 amounted to $629, representing an increase of $392 compared with 2003. The increase in net charge-offs was principally attributed to two relationships amounting to $506, and these were adequately provided for in the Bank’s previously recorded allowance.
Expressed as a percentage of total average loans outstanding, 2004 net charge-offs amounted to 0.15%, compared with 0.06% in 2003.
The following table presents the five-year summary of the allowance by loan type at each respective year-end.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(at December 31)
At December 31, 2004, the loan loss adequacy analysis resulted in a need for specific reserves of $3,579, general reserves of $982, impaired reserves of $14 and other reserves of $254. Specific reserves are determined by way of individual review of commercial loan relationships in excess of $250, combined with reserves calculated against total outstandings by category using the Bank’s historical loss experience and other observable data.
General reserves account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no major changes loan concentrations during 2004. The December 31, 2004 allowance calculation incorporates loss estimates relating to loans to borrowers involved in the Maine wild blueberry industry, principally centered in Washington County, Maine. During the fourth quarter of 2003, certain legal matters developed regarding the blueberry industry, the uncertainties of which warranted recognition of certain increases in credit risk. While recent developments have been favorable, at December 31, 2004 the adequacy analysis of the allowance incorporated management’s estimate of inherent risk of loss with respect to loans associated with this industry segment.
Specific reserves for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $93 as of December 31, 2004, compared with $596 as of December 31, 2003.
The related allowances for loan losses on these impaired loans amounted to $14 and $190, as of December 31, 2004 and December 31, 2003, respectively. The Bank had no troubled debt restructurings at December 31, 2004, and all of its impaired loans were considered collateral dependent and were adequately reserved.
Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $3 and $23 for the years ended December 31, 2004 and 2003, respectively.
Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, the Company considers the allowance for loan losses at December 31, 2004 to be appropriate for the risks inherent in the loan portfolio, and resident in the local and national economy as of that date.
Investment Securities
The investment securities portfolio represented 29.7% of the Company’s average earning assets during 2004 and generated 25.1% of total interest income, compared with 23.7% and 26.5% in 2003, respectively.
The investment securities portfolio is primarily comprised of mortgaged-backed securities issued by U.S. government sponsored enterprises and agencies, and other corporate issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other government sponsored enterprises.
The overall objective of the Bank’s strategy for the investment securities portfolio is to maintain an appropriate level of liquidity, diversify earning assets, manage interest rate risk, leverage the Bank’s strong capital position, and generate acceptable levels of net interest income. The investment securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.
Total Investment Securities: At December 31, 2004 total investment securities stood at $176,337 compared with $158,387 at December 31, 2003, representing an increase of $17,950, or 11.3%.
The 2004 average investment securities balance amounted to $181,778, compared with $149,294 in 2003, representing an increase of $32,484, or 21.8%.
Comparing 2004 with 2003, the year-over-year growth in average investment securities outpaced the period end growth, reflecting a redeployment of cash flows from the securities portfolio in support of strong loan growth and expected seasonal deposit outflows.
The 2004 growth in average investment securities principally occurred during the second quarter of 2004. Securities added to the portfolio predominately consisted of mortgage-backed securities with average durations ranging between two and three years. This action was taken as market yields climbed to a two-year high, presenting some patiently awaited opportunities for the Bank to increase its earning assets and leverage its strong capital position. Given the historically low interest rate environment and the associated level of interest rate risk, during 2003 the Bank exercised restraint by not increasing the investment securities portfolio compared with 2002.
In light of the low interest rate environment over the past few years and the historically high degree of interest rate volatility, the Bank’s investment strategy has been focused on maintaining a securities portfolio with an overall relatively short average duration, thereby reducing the exposures associated with sustained increases in interest rates. This was accomplished through investments in securities with predictable cash flows and relatively short average lives such as, 10-year fully amortizing mortgage-backed securities and other high coupon mortgage-backed securities. The Bank’s strategy has been to position the securities portfolio defensively with a steady stream of future cash flows. While sacrificing some yield in the near-term, the Bank’s objectives were to maintain a reasonable level of net interest income, manage longer-term interest rate and market risks, and position the portfolio for a rising interest rate environment and an improving economy.
Trading Securities: Trading securities are securities bought and held principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price. As of December 31, 2004 and 2003, the Bank did not have any trading securities.
Securities Available-for-Sale: The designation of securities "available-for-sale" is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments.
Investment securities classified as available-for-sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity. Gains and losses on the sale of securities available-for-sale are determined using the specific-identification method and are shown separately in the statement of income.
The securities available-for-sale portfolio is managed on a total return basis with the objective of exceeding the return that would be experienced if investing solely in U.S. Treasury instruments. The securities available-for-sale portfolio is used for liquidity purposes while simultaneously producing earnings.
Securities available-for-sale totaled $176,337 at December 31, 2004, compared with $124,422 at December 31, 2003, representing an increase of $51,916, or 41.7%. Securities available-for-sale represented 100% of total investment securities at December 31, 2004, compared with 78.6% at December 31, 2003.
As permitted by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", during the fourth quarter of 2004 the Bank transferred into the available-for-sale securities portfolio all of its held-to-maturity investment securities. Securities transferred consisted of longer term, tax-exempt securities representing obligations of state and political subdivisions. The held-to-maturity securities were transferred to available-for sale at their fair value of $36,100, with an unrealized gain on these securities, net of taxes, amounting to $1,191 recorded in other comprehensive income, a separate component of shareholders’ equity.
The transfer of held-to-maturity securities to available-for-sale was consistent with the Bank’s asset and liability management strategies, particularly the management of interest rate risk and the need for adequate liquidity. The majority of the held-to-maturity securities transferred to available-for-sale were purchased in 2001, during a period of higher long-term interest rates, and then-current projections for even higher rates in the near future. Given the current interest rate environment and the shortening of maturities since their date of purchase, the degree of interest rate risk associated with the held-to-maturity securities transferred to available-for-sale has diminished significantly. Management believes the transfer of held-to-maturity securities to available-for-sale will provide the Bank with additional liquidity reserves and a higher degree of flexibility in managing the overall balance sheet. Management does not intend to utilize the held-to-maturity classification in the foreseeable future.
The balances of securities available-for-sale are stated on the consolidated balance sheet net of fair value adjustments, reflecting net unrealized gains of $1,941 and $692 at December 31, 2004 and 2003, respectively. The 2004 increase in unrealized gains was principally attributed to the transfer of held-to-maturity securities to available-for-sale, which at December 31, 2004 amounted to $1,804.
The following table summarizes the securities available-for-sale portfolio as of December 31, 2004, and 2003:
Securities Held to Maturity: The securities held to maturity ("HTM") portfolio has historically been managed for yield and earnings generation, liquidity through cash flow, and interest rate risk characteristics within the framework of the entire balance sheet. Investment securities held to maturity are those where the Bank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts.
As previously discussed, during the fourth quarter of 2004 the Bank transferred all securities held-to-maturity to available-for-sale. At December 31, 2003, securities held-to-maturity totaled $33,965 representing 21.4% of total investment securities at that date.
The following table summarizes the securities held-to-maturity portfolio since 2002:
SECURITIES HELD TO MATURITY AT DECEMBER 31
(at book value)
Mortgage backed Securities
$
$ 1,363
Obligations of state and political subdivisions
33,374
30,182
Total
$33,965
$31,545
At December 31, 2003, the HTM portfolio consisted exclusively of long-term, tax-exempt municipal bonds, with one exception; namely, one $591 mortgage-backed security ("MBS") originally purchased in 2002 for Community Reinvestment Act ("CRA") benefits, with an original par value of $1,518. The underlying collateral consisted of low-income housing loans in the state of Maine. By their nature, CRA investments typically have higher purchase premiums because of the positive CRA effect. Subsequent to the purchase, the Bank’s primary regulator advised that the MBS did not qualify for CRA credit because the loans were not in the Bank’s immediate market area, in effect diminishing the value of the investment security to the Bank. During 2004, the Bank sold this CRA investment security, which had a then current book value of $476, realizing a gain of $16.
Purchase Premiums and Discounts: Securities are typically purchased at premium or discounted price, depending on the coupon of the security and prevailing interest rates. The Company recognizes the amortization of premiums and accretion of discounts in interest income using the interest method over the estimated life of the security. Purchase premiums are amortized to the earliest call date, while purchase discounts are accreted to maturity. Premiums paid on mortgage backed securities are amortized proportionate to the three-month trailing average Constant Payment Rate (CPR) of each securitized pool of mortgages.
Securities Credit Risk: The Bank evaluates and monitors the credit risk of its investment securities utilizing a variety of resources including external credit rating agencies, predominantly Moody’s and Standard and Poor’s. At December 31, 2004, 95.1% of the investment portfolio was rated "AAA". The Bank held no investment securities having a credit rating below "A" as of December 31, 2004.
Securities Interest Income: During 2004 the total aggregate tax-equivalent yield on the investment securities portfolio amounted to 4.51%, compared with 4.95% in 2003, representing a decline of 44 basis points. The declining interest rate environment over the past few years has prompted increases in prepayment speeds on mortgage backed securities particularly those with higher coupons, an acceleration of premium amortization, and the exercise of call features on certain securities. Securities replaced or incrementally added to the investment securities portfolio during 2003 and 2004 had relatively short average lives and consequently, were lower yielding compared with historical levels.
Total tax-equivalent interest income from investment securities amounted to $8,197 in 2004, compared with $7,385 in 2003, representing an increase of $812, or 11.0%. The impact of the 2004 decrease in yields on interest income was more than offset by a year-over-year increase in the volume of average investment securities.
Securities Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost of the Bank’s investment securities and weighted average yields of such securities an a fully tax-equivalent basis as of December 31, 2004, based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers in most cases have the right to prepay.
MATURITY SCHEDULE FOR INVESTMENT SECURITIES
DECEMBER 31, 2004
(at fair value)
One Year Or Less
Greater than One Year to Five years
Greater than Five Years to Ten years
Greater Than Ten Years
Obligations of U.S. Government sponsored enterprises
$ ---
$1,985
$ 3,858
$ 506
Weighted average yield
0.00%
3.26%
3.37%
2.76%
Mortgage backed Securities:
U.S. Government agencies and sponsored enterprises
1,572
46,881
68,035
Weighted average yield
5.45%
4.65%
3.79%
4.54%
Other mortgage backed Securities
---
---
---
16,404
Weighted average yield
0.00%
0.00%
0.00%
4.40%
Obligations of State and Political Subdivisions
---
35,621
Weighted average yield
0.00%
5.24%
5.24%
6.95%
Other debt securities
---
---
---
Weighted average yield
0.00%
0.00%
0.00%
4.55%
Total
$ 2
$3,678
$51,097
$121,561
Securities Concentrations: The Bank does not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceed 10% of the Company’s shareholders’ equity.
Impaired Securities: The securities portfolio contains certain investments where amortized cost exceeds fair market value, which at December 31, 2004 amounted to $559, compared with $648 at December 31, 2003, representing a decline of $89 or 13.7%.
Unrealized losses that are considered other-than-temporary are recorded as a loss on the Company’s consolidated statement of income. In evaluating whether an impairment is other-than-temporary, management considers a variety of factors including the nature of the investment, the cause of the impairment, and the severity and duration of the impairment. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and any other information considered relevant in determining whether other-than-temporary impairment has occurred.
At December 31, 2004, management determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.
The following table summarizes temporarily impaired investment securities and their approximate fair values at December 31, 2004. All securities referenced are debt securities. At December 31, 2004 the Bank did not hold any common stock or equity securities in its investment securities portfolio.
TEMPORARILY IMPAIRED INVESTMENT SECURITIES
DECEMBER 31, 2004
At December 31, 2004, the total unrealized losses on temporarily impaired investments amounted to $559, representing 0.9% of their carrying value. At December 31, 2004 there were no individual investment positions where the unrealized loss exceeded 5% of its carrying value.
As of December 31, 2004, unrealized losses on investment securities that had been in an unrealized loss position more than twelve-months amounted to $244, or 1.5% of their carrying value at December 31, 2004. At December 31, 2004 there were a total of thirty-one investment securities in an unrealized loss position more than twelve months, represented by twenty-nine mortgage backed-securities and two debt securities issued by government sponsored enterprises.
For securities with unrealized losses, the following information was considered in determining that the impairments are not other-than-temporary. U.S. government securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government sponsored enterprises have minimal credit risk as they play a vital role in the nation’s financial markets. Other bonds and notes are generally comprised of corporate mortgage-backed securities and all investments maintain a credit rating of at least "A" by one of the nationally recognized rating agencies. Mortgage-backed securities and collateralized mortgage obligations are either issued by federal government agencies and sponsored enterprises, or by private issuers, all with security ratings of AAA.
Management believes the unrealized losses in the investment portfolio at December 31, 2004 were attributed to interest rates, and reflected the volatile movements in the U.S. Treasury curve over the past few years. Specifically, certain debt securities were purchased in an interest rate environment lower than where the U.S. Treasury yield curve stood on December 31, 2004.
Management believes the extent of unrealized losses on mortgage-backed securities will diminish over time as principal payments and pre-payments are received and maturities continue to shorten. In the case of debt securities, management believes unrealized losses will diminish over time as maturity dates continue to shorten. Management also believes that any declines in the U.S. Treasury yield curve will further diminish the extent of unrealized losses in the securities portfolio, as market values typically increase in a declining interest rate environment. Subsequent to December 31, 2004 the yield curve posted declines, with the 10-year Treasury, for example, closing as low as 3.99%, or 23 basis points lower than where it stood at year-end.
Funding Sources
The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of customer deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member, and certificates of deposit obtained from the national market.
Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing lines from the FHLB and cash flows from the investment securities portfolio.
Among Maine banks, strong loan growth has not been matched by core deposit growth, which according to a recent report prepared by the Maine Bureau of Financial Institutions, increased a relatively anemic 4% during the twelve-months ended June 30, 2004, the lowest growth rate in five years. As a consequence, among Maine banks, the loan-to-core deposit ratio rose to a record high of 117%, well above the national average of 90% and up from 110% one year earlier. During 2004, the Bank’s average loan-to-core deposit ratio amounted to 114%, compared with 116% in 2003. At December 31, 2004 the Bank’s loan-to-core deposit ratio stood at 120%, in part reflecting the seasonality of customer deposits and fourth-quarter 2004 loan growth of $18,926.
According to the Maine Bureau of Finanical Institutions, because core deposit growth has not kept pace with earning asset growth, Maine banks have had to rely increasingly on borrowings and other types of non-core funding, which supported 27% of Maine bank assets as of June 30, 2004, compared with the national average of 16%. During 2004 the Bank’s non-core funding averaged 31.8% of total average assets, compared with 30.3% in 2003. At December 31, 2004 the Bank’s non-core funding stood at 32.3%, compared with 30.2% at December 31, 2003.
Looking forward, management believes that the Bank’s success in growing core funding will be a determinant factor in its ability to grow earning assets and leverage its strong capital position.
Deposits
During 2004 the most significant source of funding for the Bank’s earning assets continued to be customer deposits, gathered throughout its network of eleven banking offices throughout Down East and Mid Coast Maine. Total average customer deposits accounted for 69.8% of the funding required in supporting the Bank’s earning asset portfolios during 2004, unchanged compared with 2003.
Total Deposits: At December 31, 2004 total deposits amounted to $398,272, compared with $339,080 at December 31, 2003, representing an increase of $59,192, or 17.5%.
Savings and money market accounts led 2004 growth with an increase of $29,870 or 27.3%, followed by time deposits, demand deposits, and NOW accounts, posting increases of $21,375, $4,699, and $3,248, or 17.9%, 9.4%, and 5.4%, respectively, compared with December 31, 2003. Deposit growth was bolstered by $20,459 in deposits acquired in connection with the Rockland branch acquisition, a new institutional money market product accounting for $17,437 of the increase, and $17,712 in certificates of deposit obtained from the national market.
Total average deposits amounted to $377,721 during 2004, compared with $322,414 in 2003, representing an increase of $55,307 or 17.2%.
The following table summarizes the components of the Bank’s total average deposit portfolio:
SUMMARY OF DEPOSIT PORTFOLIO
Demand Deposits: Non-interest bearing demand deposits, which are principally commercial in nature, totaled $54,579 at December 31, 2004, compared with $49,880 at December 31, 2003, representing an increase of $4,699, or 9.4%. Total average demand deposits amounted to $51,382 during 2004, compared with $45,607 in 2003, representing an increase of $5,775, or 12.7%. Demand deposits represented 13.6% of total average deposits during 2004, compared with 14.1% in 2003.
The Bank offers its business customers with a variety of cash management products including a Cash Management Sweep Account. Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Demand deposits also include balances generated by way of the Bank’s Merchant Credit Card Processing Program. The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis.
NOW Accounts: The Bank offers NOW accounts to individuals and not-for-profit organizations. At December 31, 2004, total NOW accounts stood at $63,535, compared with $60,287 at December 31, 2003, representing an increase of $3,248 or 5.4%. During 2004 total average NOW accounts amounted to $63,119, compared with $54,221 in 2003, representing an increase of $8,898, or 16.4%. NOW accounts represented 16.7% of total average deposits during 2004, compared with 16.8% in 2003.
During 2004, the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its elderly and retired customers. The Bank also introduced two new deposit products during 2004, Ideal Checking and Simple Checking, relationship products designed for families and individuals.
Savings And Money Market Accounts: At December 31, 2004, total savings and money accounts amounted to $139,179, compared with $109,309 at December 31, 2003, representing an increase of $29,870, or 27.3%. Total average savings and money market accounts amounted to $132,091 during 2004, compared with $104,275 in 2003, representing an increase of $27,816, or 26.7%. Savings and money market accounts represented 35.0% of total average deposits during 2004, compared with 32.3% in 2003.
The Bank offers statement savings accounts, and as a community oriented financial institution, continues to offer the more traditional passbook savings accounts. The Bank also offers a tiered-rate, competitively priced money market account, Investors Choice, providing businesses and individuals with short-term investment alternatives.
During 2004, the Bank began offering a new institutional money market product to clients of Bar Harbor Trust Services, the Bank’s wholly owned subsidiary. During 2004 the balance of this new money market product averaged $14,449, and at December 31, 2004, totaled $17,437. The 2004 growth in savings and money market accounts was also driven by the deposits acquired in connection with the Bank’s acquisition of a branch office in the community of Rockland, Maine.
During 2004, which saw a continuation of historically low interest rates, customers appeared to demonstrate a desire for the higher liquidity offered through savings and money market accounts, versus more traditional, longer-term certificates of deposit.
Time Deposits: At December 31, 2004 total time deposits stood at $140,979, compared with $119,604 at December 31, 2003, representing an increase of $21,375, or 17.9%. Total average time deposits amounted to $131,129 during 2004 compared with $118,311 in 2003, representing an increase of $12,818, or 10.8%. Time deposits represented 34.7% of total average deposits during 2004, compared with 36.7% in 2003.
Total time deposits include brokered time deposits obtained from the national market, which during 2004 averaged $11,658, representing an increase of $5,670 compared with 2003. At December 31, 2004, time deposits obtained from the national market amounted to $23,700, or 6.0% of total deposits, compared with $5,988 at December 31, 2003, or 1.8% of total deposits at that date. The increase in deposits obtained from the national market was primarily attributed to the funding needs associated with the Bank’s strong earning asset growth, principally loans, which outpaced core customer deposit growth during 2004. The rates of interest paid on time deposits obtained from the national market were generally more favorable than advances from the Federal Home Loan Bank, a secondary source of funding used by the Bank.
Excluding time deposits obtained from the national market, total time deposits at December 31, 2004 represented an increase $3,663, or 3.2%, compared with December 31, 2003. This increase was principally attributed to deposits acquired in connection with the Bank’s acquisition of a branch office in the community of Rockland, Maine.
The sluggish organic growth in customer time deposits was due in part to depositors’ apparent hesitation to invest in longer-term fixed rate certificates of deposits, while yields remained at historically low levels. Additionally, in light of the extended low interest rate environment and its resulting pressure on the Bank’s net interest margin, during 2004 the Bank did not compete for time deposits as aggressively as it has in the past, with respect to pricing. In pricing time deposits, particularly non-relationship time deposits, the Bank will consider other sources of funding which may be offered at more attractive terms and prices, including borrowed funds and time deposits available in the national market.
Time deposits in denominations of $100 or greater totaled $19,405 at December 31, 2004, compared with $18,784 at December 31, 2003, representing an increase of $621, or 3.3%.
The following schedule summarizes the maturity distribution of time deposits of $100 or greater:
MATURITY SCHEDULE
TIME DEPOSITS $100 THOUSAND OR GREATER
DECEMBER 31, 2004
Maturity
Three months or less
$4,319
Over three months to six months
3,342
Over six months to twelve months
5,416
Over twelve months
6,328
$19,405
Borrowed Funds
Borrowed funds principally consist of advances from the Federal Home Loan Bank of Boston ("FHLB") and, to a lesser extent, securities sold under agreements to repurchase. Advances from the FHLB are secured by stock in the FHLB, mortgage-backed securities, and blanket liens on qualifying first mortgage loans.
The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Bank’s ability to select desired amounts, terms and maturities on a daily basis.
Borrowings From the Federal Home Loan Bank: At December 31, 2004, borrowings from the FHLB totaled $191,846, compared with $170,506 at December 31, 2003, representing an increase of $21,340, or 12.5%. During 2004, borrowings from the FHLB averaged $193,927, compared with $163,724 in 2003, representing an increase of $30,203, or 18.4%.
During the fourth quarter of 2004, the Bank replaced a portion of its maturing FHLB borrowings with certificates of deposit obtained in the national market, causing the balance of FHLB borrowings at December 31, 2004 to fall below the 2004 average balance.
The 2004 increase in borrowings from the FHLB was utilized to fund earning asset growth, particularly the growth in the Bank’s investment securities portfolio.
Borrowings from the FHLB expressed as a percentage of total assets amounted to 28.8% at December 31, 2004, compared with 29.2% at December 31, 2003.
Borrowing Maturities: Borrowing maturities are managed in concert with the Bank’s asset and liability management strategies, and are closely aligned with the ongoing management of balance sheet interest rate risk. Over the past few years, the Bank has added longer-term borrowings to the balance sheet in order to hedge the interest rate risk associated with the growth in longer-term, fixed rate, earning assets generated during periods of historically low interest rates. While this strategy has pressured net interest income in the short-term, management believes it better positions the Bank for rising interest rates and an improving economy.
As of December 31, 2004, total short-term borrowings, including securities sold under repurchase agreements, amounted to $89,851, compared with $58,525 at December 31, 2003, or 43.4% and 31.4% of total borrowings, respectively. Conversely, long-term borrowings at December 31, 2004 totaled $117,072, compared with $127,906 at December 31, 2003, or 56.6% and 68.6% of total borrowings, respectively.
Capital Resources
Consistent with its long-term goal of operating a sound and profitable organization, the Company continues to be a "well capitalized" bank holding company according to applicable regulatory standards. In 2004, the Company continued to maintain a strong capital position, which is vital in promoting depositor and investor confidence and providing a solid foundation for future growth. Historically, most of the Company’s capital requirements have been provided through retained earnings and this continued to be the case during the year ended December 31, 2004.
Stock Repurchase Plans: In November 1999, the Company announced a stock repurchase plan. The Board of Directors of the Company at that time authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. The Board of Directors subsequently authorized the continuance of that program through December 31, 2003. As of December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The share repurchase program terminated on December 31, 2003. The Company records the repurchased shares as treasury stock.
In March 2004, the Company announced a second stock repurchase plan. The Board of Directors of the Company authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time-to-time, without prior notice. As of December 31, 2004, the Company had repurchased 49,920 shares of stock under this plan, at a total cost of $1,349 and an average price of $27.03 per share.
The Company believes that a stock repurchase plan is a prudent use of capital at this time. Management anticipates the stock repurchase plan will be accretive to the return on average shareholders’ equity and earnings per share.
Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of the balance sheet and other relevant factors.
In the first quarter of 2004, the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholders of record as of the close of business on February 20, 2004. Quarterly dividends continued at this rate through 2004.
The Company’s 2004 dividend payout ratio amounted to 43.2%, compared with 45.8% in 2003.
In the first quarter of 2005, the Company increased its quarterly dividend by 5.0% to $0.21 per common share. The dividend was payable to all shareholders of record as of February 18, 2005, and was paid on March 15, 2005.
Capital Ratios: The Company and its banking subsidiary are subject to the risk based capital guidelines administered by the Bank's principal regulators. The risk based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk weighted assets and off-balance sheet items. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk based capital to risk weighted assets of 8%, including a minimum ratio of Tier I capital to total risk weighted assets of 4% and a Tier I capital to average assets of 4% ("Leverage Ratio"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on the Company's financial statements.
As of December 31, 2004, the Company and the Bank are considered well capitalized under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a well capitalized institution must maintain a minimum total risk based capital to total risk weighted assets ratio of at least 10%, a minimum Tier I capital to total risk weighted assets ratio of at least 6%, and a minimum Tier I Leverage ratio of at least 5%.
At December 31, 2004, the Company’s total risk based capital was $56,260 or 13.0% of risk-weighted assets, compared with $56,403, or 14.7% of total risk-weighted assets at December 31, 2003.
At December 31, 2004, the Company’s Tier I capital totaled $51,431 or 11.9% of risk-weighted assets, compared with 51,601, or 13.5% of total risk weighted assets at December 31, 2003. The ratio of Tier I capital to average weighted assets, or Leverage Ratio, at December 31, 2004 was 7.8%, compared with 8.9% at December 31, 2003.
The following table sets forth the Company's regulatory capital at December 31, 2004 and December 31, 2003, under the rules applicable at that date.
As more fully disclosed in Note 13 of the Consolidated Financial Statements in this Annual Report on Form 10-K, during 2004 the Bank also maintained its standing as a well capitalized institution as defined by applicable regulatory standards. At December 31, 2004, the Bank’s Tier I Leverage, Tier I Risk Based and Total Risk Based capital ratios stood at 8.0%, 12.2% and 12.8%, respectively.
There are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Company’s capital resources, liquidity, or financial condition.
Contractual Obligations
The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.
The Company is also obligated to make payments on an operating lease for its office at One Cumberland Place in Bangor, Maine.
The following table summarizes the Company’s contractual obligations at December 31, 2004. Borrowings are stated at their contractual maturity due dates and do not reflect call features on certain borrowings.
CONTRACTUAL OBLIGATIONS
(Dollars in thousands)
In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATM, Visa Debit and Credit Card processing, trust services accounting support, student loan servicing, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.
The majority of the Company’s core operating systems and software applications are maintained "in-house" with traditional third party maintenance agreements of one year or less.
Off-Balance Sheet Arrangements
The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors. "Off-balance sheet arrangements" include any transactions, agreements, or other contractual arrangements to which an entity unconsolidated with the Company is a party, under which the Company has:
(i) Any obligation under certain guarantee contracts;
(ii) A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;
(iii) Any obligation under certain derivative instruments;
(iv) Any obligation under a material variable interest held by the Company in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging, or research and development services with the Company.
At December 31, 2004 the Company had the following Off-Balance Sheet Arrangements:
Standby Letters of Credit: The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.
At December 31, 2004, commitments under existing standby letters of credit totaled $1,155, compared with $2,205 at December 31, 2003. The fair value of the standby letters of credit was not significant as of December 31, 2004 and 2003.
Other Off-Balance Sheet Arrangements: At December 31, 2004 and 2003, the Company did not have any other "off-balance sheet arrangements".
Off Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and interest rate swap agreements.
Commitments to Extend Credit: Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.
Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments, such as loans. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.
The following table summarizes the Bank’s commitments to extend credit as of December 31:
Commitments to originate loans
$14,435
$32,575
Unused lines of credit
$76,482
$62,616
Un-advanced portions of construction loans
$ 7,336
$ 3,683
Total
$98,253
98,874
Derivative Instruments / Counter-party Risk: As part of the Bank’s overall asset liability/management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on net income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements. A policy statement, approved by the Board of Directors of the Bank, governs use of derivative instruments.
At December 31, 2004 the Bank had two outstanding derivative instruments, both interest rate swap agreements. The details are summarized as follows:
Description
Maturity
Notional Amount
(in thousands)
Fixed Interest Rate
Variable Interest Rate
Receive fixed rate, pay variable rate
09/01/07
$10,000
6.04%
Prime (5.25%)
Receive fixed rate, pay variable rate
01/24/09
$10,000
6.25%
Prime (5.25%)
The Bank is required to pay a counter-party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively, over the term of each respective agreement.
The following table summarizes the contractual cash flows of the interest rate swap agreements outstanding at December 31, 2004, based upon the then-current Prime interest rate of 5.25%:
The notional amounts of the agreements do not represent exposure to credit loss. The Bank is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements. Management does not anticipate non-performance by the counter-party to the agreements, and regularly reviews the credit quality of the counter-party from which the instruments have been purchased.
As more fully enumerated in Part II, Item 8, Notes to the Consolidated Financial Statements, Note 16, in this Annual Report on report Form 10-K, during the third quarter of 2004, the Bank designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are being recorded on the consolidated balance sheet in other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties are recorded in interest income. During the first quarter of 2004, these interest rate swap agreements had been de-designated as cash flow hedges and, from the time of de-designation, changes in their fair value and current period net cash flows related to these agreements were recorded in the consolidated statement of income and included as part of non-interest income.
At December 31, 2004 and December 31, 2003, the unrealized (loss) gain on the interest rate swap agreements was ($225) and $86, respectively, and included in other assets on the consolidated balance sheets.
At December 31, 2004, the unrealized loss on these interest rate swap agreements included in other comprehensive income, net of tax, amounted to $149, compared with an unrealized gain of $57 at December 31, 2003. Also included in other comprehensive income for the year ended December 31, 2004 was a net deferred loss, net of tax, of $15 related to the de-designation and re-designation of these swaps as cash flow hedges in 2004. There were no deferred gains or losses recorded in other comprehensive income in 2003.
During 2004, the net unrealized gains on interest rate swap agreements recorded in non-interest income amounted to $29 during the period in which hedge accounting was not applied.
During, 2004, the total net cash flows received from counterparties amounted to $455, compared with $498 and $117 in 2003 and 2002, respectively. Of the $455 in net cash flows received from counterparties during 2004, $375 was recorded in non-interest income (non-hedge period) and $80 in interest income (hedge period). The net cash flows received from counterparties during 2003 and 2002 were recorded in interest income.
Liquidity
Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.
The Bank actively manages its liquidity position through target ratios established under its asset/liability management policy approved by the Bank’s Board of Directors. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity.
The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Bank’s policy is to maintain its liquidity position at approximately 5% of total assets. At December 31, 2004, liquidity, as measured by the basic surplus model, was 4.6% over the 30-day horizon and 3.8% over the 90-day horizon. Including its available lines from the FHLB, at December 31, 2004 the Bank’s basic surplus amounted to 5.6% over the 30-day horizon and 4.1% over the 90-day horizon.
The basic surplus model does not incorporate the short-term liquidity generated by cash flows from the investment securities portfolio, which during the first quarter of 2005 are expected to generate approximately $13,000 in additional liquidity, available to absorb anticipated deposit outflows. In this regard, a portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.
At December 31, 2004, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB approximating $48 million. The Bank also had capacity to borrow funds on a secured basis utilizing certain un-pledged securities in its investment securities portfolio. The Bank’s loan portfolio and investment portfolio provide a source of contingent liquidity that could be accessed in a reasonable time period through sales. The Bank also has access to the national brokered deposit market.
Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.
The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements presented elsewhere in this report have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates and the U.S. Treasury yield curve may not necessarily move in the same direction or in the same magnitude as inflation.
While the financial nature of the Company’s consolidated balance sheets and statements of income is more clearly affected by changes in interest rates than by inflation, inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total Company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on the Company’s financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of the Company’s income stream and represents the difference or spread between interest generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.
Total Net Interest Income: For the year ended December 31, 2004, net interest income on a fully tax- equivalent basis amounted to $21,098 compared with $20,102 and $20,190 in 2003 and 2002, representing an increase of $996 or 5.0%, and a decrease of $88 or 0.4%, respectively.
The increase in 2004 net interest income was entirely attributed to an $83,240 or 15.7% increase in average earning assets during the year, as the 2004 net interest margin declined 35 basis points to 3.45%, compared with 2003. Likewise, the decline in net interest income during 2003 was also entirely attributed to the net interest margin, which declined 34 basis points to 3.80% during 2003, compared with 4.14% in 2002.
Factors contributing to the changes in net interest income and the net interest margin are further enumerated in the following discussion and analysis.
Net Interest Income Analysis: The following tables summarize the Company’s average balance sheets and the components of net interest income, including a reconciliation of tax equivalent adjustments, for the years ended December 31, 2004, 2003 and 2002:
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 2004
Average
Balance
Interest
Average
Rate
Interest Earning Assets:
Loans (1,3)
$416,956
$24,100
5.78%
Taxable investment securities
147,836
5,937
4.02%
Non-taxable investment securities (3)
33,942
2,260
6.66%
Total Investments
181,778
8,197
4.51%
Investment in Federal Home Loan Bank stock
10,571
2.81%
Fed funds sold, money market funds, and time
deposits with other banks
2,726
1.80%
Total Earning Assets
612,031
32,643
5.33%
Non Interest Earning Assets:
Cash and due from banks
8,308
Allowance for loan losses
(5,051)
Other assets (2)
30,917
Total Assets
$646,205
Interest Bearing Liabilities:
Deposits
$326,339
$ 4,409
1.35%
Securities sold under repurchase agreements
13,427
1.12%
Borrowings from the Federal Home Loan Bank
193,927
6,985
3.60%
Total Borrowings
207,354
7,136
3.44%
Total Interest Bearing Liabilities
533,693
11,545
2.16%
Rate Spread
3.17%
Non Interest Bearing Liabilities:
Demand deposits
51,382
Other liabilities
6,930
Total Liabilities
592,005
Shareholders' Equity
54,200
Total Liabilities and Shareholders' Equity
$646,205
Net Interest Income and Net Interest Margin (3)
21,098
3.45%
Less: Tax Equivalent Adjustment
(721)
Net Interest Income
$20,377
3.33%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
AVERAGE BALANCE SHEETS AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 2003
Average
Balance
Interest
Average
Rate
Interest Earning Assets:
Loans (1,3)
$367,701
$23,463
6.38%
Taxable investment securities
118,021
5,252
4.45%
Non-taxable investment securities (3)
31,273
2,133
6.82%
Total Investments
149,294
7,385
4.95%
Investment in Federal Home Loan Bank stock
8,700
3.05%
Fed Funds sold, money market funds, and time
deposits with other banks
3,096
2.07%
Total Earning Assets
528,791
31,177
5.90%
Non Interest Earning Assets:
Cash and due from banks
8,227
Allowance for loan losses
(5,235)
Other assets (2)
29,054
Total Assets
$560,837
Interest Bearing Liabilities:
Deposits
$276,807
$ 4,336
1.57%
Securities sold under repurchase agreements
13,086
1.32%
Borrowings from the Federal Home Loan Bank
163,724
6,566
4.01%
Total Borrowings
176,810
6,739
3.81%
Total Interest Bearing Liabilities
453,617
11,075
2.44%
Rate Spread
3.45%
Non Interest Bearing Liabilities:
Demand deposits
45,607
Other liabilities
7,689
Total Liabilities
506,913
Shareholders’ Equity
53,924
Total Liabilities and Shareholders’ Equity
$560,837
Net Interest Income and Net Interest Margin (3)
20,102
3.80%
Less: Tax Equivalent Adjustment
(684)
Net Interest Income
$19,418
3.67%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 2002
Average
Balance
Interest
Average
Rate
Interest Earning Assets:
Loans (1,3)
$325,712
$23,788
7.30%
Taxable investment securities
118,684
6,751
5.69%
Non-taxable investment securities (3)
29,142
1,984
6.81%
Total Investments
147,826
8,735
5.91%
Investment in Federal Home Loan Bank stock
7,812
3.69%
Fed Funds sold, money market funds, and time
deposits with other banks
6,461
2.38%
Total Earning Assets
487,811
32,965
6.76%
Non Interest Earning Assets:
Cash and due from banks
15,884
Allowance for loan losses
(4,607)
Other assets (2)
19,851
Total Assets
$518,939
Interest Bearing Liabilities:
Deposits
$259,802
$ 5,880
2.26%
Securities sold under repurchase agreements
13,124
2.19%
Borrowings from the Federal Home Loan Bank
144,026
6,607
4.59%
Total Borrowings
157,150
6,895
4.39%
Total Interest Bearing Liabilities
416,952
12,775
3.06%
Rate Spread
3.69%
Non Interest Bearing Liabilities:
Demand deposits
43,673
Other liabilities
5,501
Total Liabilities
466,126
Shareholders' Equity
52,813
Total Liabilities and Shareholders' Equity
$518,939
Net Interest Income and Net Interest Margin (3)
20,190
4.14%
Less: Tax Equivalent Adjustment
(613)
Net Interest Income
$ 19,577
4.01%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
Net Interest Margin: The net interest margin, expressed on a tax-equivalent basis, represents the difference between interest and dividends earned on interest-bearing assets and interest paid to depositors and other creditors, expressed as a percentage of average earning assets.
The net interest margin is determined by dividing tax-equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average tax-equivalent yield earned on interest earning-assets and the average rate paid on interest bearing liabilities. The net interest margin is generally higher than the interest rate spread due to the additional income earned on those assets funded by non-interest bearing liabilities, primarily demand deposits and shareholders’ equity.
The following table summarizes the net interest margin components, on a quarterly basis, over the past two years. Factors contributing to the changes in the net interest margin are enumerated in the following discussion and analysis.
NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, reported on a tax equivalent basis
The prolonged, historically low interest rate environment during the past few years caused sharp yield declines on the Bank’s variable rate earning assets and accelerated prepayment speeds on fixed rate earning assets, driven in part by loan refinancing activity and accelerated cash flows from the investment securities portfolio.
The interest rate environment over the past few years caused considerable margin erosion given the Bank’s asset sensitive balance sheet; specifically, the decline in yields on earning assets occurred at a faster pace than the decline in the cost of interest bearing funds.
The yield on average earning assets amounted to 5.33% during 2004, compared with 5.90% and 6.76% in 2003 and 2002, representing declines of 57 and 86 basis points, respectively. Similarly, the cost of interest bearing liabilities amounted to 2.16% in 2004, compared with 2.44% and 3.06% in 2003 and 2002, representing declines of 28 and 62 basis points, respectively. Driven by loan refinancing activity and accelerated cash flows from the investment portfolio, during 2004 and 2003, the declines in yields on earning assets exceeded the declines in the cost of interest bearing liabilities by 29 and 24 basis points, respectively.
During 2004 and 2003, the Bank pursued a number of strategies to achieve a reasonably stable net interest margin in an extended low interest rate environment, while it continued to manage exposure to rising rates over the longer-term horizon. These strategies included a repositioning of a portion of the investment securities portfolio, utilization of interest rate swap agreements, and effective loan and deposit pricing strategies, orchestrated within well-established asset/liability management policies and the overall management of balance sheet interest rate risk.
During 2003, the Bank successfully marketed 10-year, fully amortizing 10-year mortgage products, including a bi-weekly payment 10-year mortgage product. In 2004, the loan products of choice included adjustable rate mortgages and commercial loans. While the foregoing types of products typically generate lower yields than longer maturity, fixed rate products, their cash flow and adjustable rate characteristics diminish the degree of long-term interest rate risk, and better positions the Bank for rising interest rates in the future.
The Bank has utilized longer-term borrowings to fund a portion of earning asset growth over the past few years. While the use of longer-term borrowing maturities naturally resulted in higher funding costs and less net interest income, they more closely matched the maturities of fixed rate earning assets that were being added to the Bank’s balance sheet, thereby preserving the sensitivity of net interest income in a rising interest rate environment.
The Bank has been deliberate in its efforts to hedge the interest rate risk associated with the addition of long term, fixed rate earning assets to the balance sheet during a period of historically low interest rates. Management believes the strategy of maintaining an asset sensitive balance sheet has contributed to the net interest margin declines over the past two years. While an asset sensitive balance sheet pressures the net interest margin and net interest income in an extended flat or declining interest rate environment, it typically strengthens it in a rising rate environment, a scenario management anticipated was more likely to occur. The Bank has been deliberate in its efforts to manage the interest rate risk associated with the addition of fixed rate earning assets to the balance sheet during a period of historically low interest rates. Management believes that its strategy of maintaining an asset sensitive balance sheet is important to the Company’s long-term success and such posture better positions it for rising interest rates and an improving economy.
During the six-months ended June 30, 2004, the Bank continued to experience considerable margin erosion in the low interest rate environment compared with prior years. In the second half of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") increased short-term interest rates five times, with the Fed funds targeted rate ending the year at 2.25%. As management anticipated, these increases favorably impacted the Bank’s net interest margin during this period of time, with the yield on average earning assets increasing 34 basis points to 5.48%, and the cost of interest bearing funds increasing only 13 basis points to 2.23%. Consequently, the net interest margin increased to 3.55% in fourth quarter of 2004, compared with the two-year low of 3.28% experienced during the quarter ended June 30, 2004, representing an improvement of 27 basis points. In line with the current interest rate environment, management anticipates the net interest margin will continue to stabilize into the first quarter of 2005.
The Bank’s interest rate sensitivity position is more fully described in Part II, Item 7a
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.
The responsibility for interest rate risk management oversight is the function of the Bank’s Asset/Liability Committee ("ALCO"), chaired by the Chief Financial Officer and composed of various members of corporate senior management. ALCO meets regularly to review balance sheet structure, formulate strategy in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.
Interest Rate Risk: Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk.
The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by the Bank’s ALCO and Board of Directors.
The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.
Interest rate risk is monitored through the use of two complementary measures: static gap analysis ("gap") and interest rate sensitivity modeling. While each measurement may have its limitations, taken together they form a reasonably comprehensive view of the magnitude of the Bank’s interest rate risk, the level of risk over time, and the quantification of exposure to changes in certain interest rate relationships.
Static Gap Analysis: Interest rate gap analysis provides a static view of the maturity and re-pricing characteristics of the Bank’s on and off-balance sheet positions. Gap is defined as the difference between assets and liabilities re-pricing or maturing within specified periods. An asset-sensitive position, or "positive gap," indicates that there are more rate sensitive assets than rate-sensitive liabilities re-pricing or maturing within a specified time period, which would imply a favorable impact on net interest income during periods of rising interest rates. Conversely, a liability-sensitive position, or "negative gap," generally implies a favorable impact on net interest income during periods of falling interest rates.
There are certain limitations inherent in static gap analysis. These limitations include the fact that it is a static measurement and it does not reflect the degrees to which interest earning assets and interest bearing liabilities may respond non-proportionally to changes in market interest rates. Although the ALCO reviews all assumptions used in the model in detail, assets and liabilities do not always have clear re-pricing dates, and re-pricing may occur earlier or later than assumed in the model.
The Bank’s static interest rate sensitivity gap is summarized below:
INTEREST RATE RISK
CUMULATIVE STATIC GAP POSITION
December 31, 2004 and 2003
One Day To Six Months
Over Six Months To One Year
One Year To Five Years
Over Five Years
December 31, 2004
$12,231
$43,487
$137,317
$ 6
December 31, 2003
$ (3,532)
$30,921
$ 75,221
$ (3)
Change ($)
$15,763
$12,566
$ 62,096
$ 9
The Bank’s December 31, 2004 cumulative interest rate risk sensitivity static gap position indicates the Bank’s balance sheet is asset sensitive over all future periods. The December 31, 2003 gap position indicated the Bank’s balance sheet was asset sensitive, but not to the same degree as of December 31, 2004. Changes in the Bank’s cumulative static gap position principally reflect a higher level of variable rate earning assets at December 31, 2004 compared with the same date in 2003.
Based in part upon the cumulative static gap position, management believes that the Bank’s balance sheet is favorably positioned for rising rates and an improving economy, but is moderately exposed to declining rates and a stalled economy.
Interest Rate Sensitivity Modeling: The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense of all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposits accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions, are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:
A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.
A 100, 200, and 400 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve- month period together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products that will continue to change the balance sheet profile for each of the rate conditions.
Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.
The following table summarizes the Bank's net interest income sensitivity analysis as of December 31, 2004, over one and two year horizons and under different interest rate scenarios. Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken in order to maintain the balance sheet interest rate risk within established policy guidelines.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31, 2004
-100 Basis Points Parallel Yield Curve Shift
+200 Basis Points Parallel Yield Curve Shift
+200 Basis Points Short Term Rates
+400 Basis Points Short Term Rates
Year 1
Net interest income change ($)
$88
$65
$28
$97
Net interest income change (%)
0.39%
0.29%
0.12%
0.42%
Year 2
Net interest income change vs.
year one base ($)
($118)
$1,225
$1,059
$884
Net interest income change vs.
year 1 base (%)
(0.52%)
5.40%
4.67%
3.90%
The foregoing interest rate sensitivity modeling results indicate that the Bank’s balance sheet is about evenly matched in a variety of interest rate scenarios. Accordingly, management believes interest rate risk will not have a material adverse impact on future net interest income.
The foregoing interest rate sensitivity modeling results indicate that the Bank’s balance sheet is about evenly matched over the one-year horizon. Beyond the one-year horizon, the model results indicate the Bank is positively positioned for a rising interest rate environment without assuming interest rate risk exposure should interest rates remain flat or begin to decline. Accordingly, management believes interest rate risk will not have a material adverse impact on future net interest income. Management also believes the Bank's balance sheet is well positioned for rising interest rates and an improving economy.
Assuming interest rates remain at or near their current levels and the Bank maintains a static balance sheet, the interest rate sensitivity simulation model suggests that the net interest margin will slowly trend upward, as most of the Bank’s asset base has already re-cycled into the current interest rate environment while most of the funding base has already reset to low interest rate levels. The upward trend principally results from the re-investment of security and loan cash flows into higher current interest rate levels. Although short-term market interest rates have risen with the recent increases in the Federal Funds rate, the Bank has successfully lagged the market with the pricing of deposit rates without any material run-off in balances. However, margins could narrow if the Bank is eventually forced to increase deposit interest rates in response to competitive market pricing pressures. Management anticipates continued balance sheet growth will be needed to meaningfully increase the Bank’s net interest income, should interest rates remain at current levels.
Assuming interest rates decline from current levels and the Bank maintains a static balance sheet, management believes net interest income will decline slightly but remain relatively stable over the one and two-year horizons. The interest rate sensitivity simulation model suggests that funding cost reductions will essentially keep pace with falling asset yields, without significantly impacting margins and net interest income, however, as funding costs reach their assumed floors, asset yields will continue to decline as cash flows from securities and loans are reinvested into the low rate environment and variable rate assets will adjust downward, resulting in lower levels of net interest income. Management anticipates continued balance sheet growth will be needed to sustain the Bank’s current level of net interest income, should interest rates decline.
While the simulated interest rate decline of 100 basis points would mildly reduce net interest income over the two-year horizon, Management believes that such a decline in interest rates, to a Federal Funds Targeted rate of 1.25%, represents a scenario that is not likely to occur. Further, a repositioning of the balance sheet to manage such a decline, would likely have an adverse impact on net interest income in a rising or flat interest rate environment, scenarios management believes are more likely to occur over the longer term.
In a rising rate environment with the Bank maintaining a static balance sheet, management anticipates net interest income will begin increasing over the one-year horizon and continue to accelerate in year two and subsequent years. The interest rate sensitivity simulation model suggests that as interest rates rise, the Bank’s asset base will re-price more quickly than funding costs, principally due to a large floating rate loan base, combined with the re-investment of cash flows from the securities and loan portfolios in a higher interest rate environment. Over the two-year horizon and beyond, the model suggests assets yields will continue to reset at higher levels and margins will widen as funding costs begin to stabilize more quickly. Management believes rising interest rates will increase net interest income without continued balance sheet growth.
Since June of 2004 through December 31, 2004, the U.S. Treasury yield curve (the "yield curve") has flattened substantially. While the Federal Reserve has increased short-term interest rates by 125 basis points, the 10-year U.S. Treasury note has declined 65 basis points from its 2004 high, thus flattening the yield curve by 190 basis points. Management models the Bank’s interest rate risk sensitivity position under a variety of future interest rate scenarios, including a flattening of the yield curve. The interest rate sensitivity simulation model suggests that if short-term interest rates continue to rise and the yield curve flattens further, the Bank’s net interest income will increase mildly over the one-year horizon and will continue to accelerate in year two and subsequent years, but not to the same degree as would a parallel shift in the yield curve. This increase is principally attributed to the Bank’s large floating rate loan base. Management believes continued increases in short-term interest rates will increase net interest income, particularly over the two-year horizon, without continued balance sheet growth.
Following the short-term interest rate increases by the Federal Reserve in the second half of 2004, as was anticipated by management through use of the interest rate sensitivity model, during the six months ended December 31, 2004 the Bank’s net interest margin increased 27 basis points, compared with the quarter ended June 30, 2004.
The following table summarized the Bank’s net interest income sensitivity analysis as of December 31, 2003, over one and two-year horizons, and assuming a parallel shift in the yield curve. The table also summarized net interest income sensitivity under a non-parallel shift in the yield curve, whereby short-term rates rise by 200 and 400 basis points.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31, 2003
-100 Basis Points Parallel Yield
Curve Shift
+200 Basis Points Parallel Yield
Curve Shift
+200 Basis Points Short Term
Rates
+400 Basis Points Short Term
Rates
Year 1
Net interest income change ($)
($121)
$171
($83)
$122
Net interest income change (%)
(0.59%)
0.83%
(0.40%)
0.60%
Year 2
Net interest income change vs.
year one base ($)
($1,309)
$500
($117)
$341
Net interest income change vs.
year 1 base (%)
(6.38%)
2.44%
(0.57%)
1.66%
As was anticipated by Management through use of the interest rate sensitivity model, the Bank’s net interest income was moderately impacted and this trend continued into the first six-months of 2004. Management believes that were it not for the growth in earning assets during this period of time combined with a variety of strategies designed to adjust the posture of the balance sheet, net interest income would have posted declines.
The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment / replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment/refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis does not reflect additional actions that ALCO might take in responding to or anticipating changes in interest rates.
The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31, 2004, there were no significant differences between the views of the independent consultant and management regarding the Bank’s interest rate risk exposure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Bar Harbor Bankshares:
We have audited the accompanying consolidated balance sheet of Bar Harbor Bankshares and subsidiaries (the Company) as of December 31, 2004, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for the year then ended, in conformity with U. S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Albany, New York
March 14, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Bar Harbor Bankshares
We have audited the accompanying consolidated balance sheet of Bar Harbor Bankshares and Subsidiaries as of December 31, 2003, and the related consolidated statements of income, changes in shareholders’ equity, cash flows and comprehensive income for each of the two years in the two-year period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bar Harbor Bankshares and Subsidiaries as of December 31, 2003, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the two-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/ BERRY, DUNN, MCNEIL & PARKER
Portland, Maine
February 19, 2004
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004, AND 2003
(Dollars in thousands, except share and per share data)
December 31,
December 31,
Assets
Cash and due from banks
$ 8,924
$ 14,199
Overnight interest bearing money market funds
Total cash and cash equivalents
9,571
14,469
Securities:
Available for sale, at fair value
176,337
124,422
Held to maturity (fair value $35,093 at December 31, 2003)
---
33,965
Total investment securities
176,337
158,387
Investment in Federal Home Loan Bank stock
10,500
8,969
Loans
448,478
383,408
Allowance for loan losses
(4,829)
(5,278)
Loans, net of allowance for loan losses
443,649
378,130
Premises and equipment, net
11,935
11,410
Goodwill
3,158
Bank owned life insurance
5,710
5,488
Other assets
5,951
6,593
TOTAL ASSETS
$666,811
$583,746
Liabilities
Deposits
Demand deposits
$ 54,579
$ 49,880
NOW accounts
63,535
60,287
Savings and money market deposits
139,179
109,309
Time deposits
140,979
119,604
Total deposits
398,272
339,080
Short-term borrowings
89,851
58,525
Long-term debt
117,072
127,906
Other liabilities
5,574
5,120
TOTAL LIABILITIES
610,769
530,631
Shareholders' equity
Capital stock, par value $2.00; authorized 10,000,000 shares;
issued 3,643,614 shares at December 31, 2004 and December 31, 2003
7,287
7,287
Surplus
4,002
4,002
Retained earnings
51,733
48,746
Accumulated other comprehensive income:
Net unrealized appreciation on securities available for sale
and derivative instruments, net of taxes of $576 and $264
at December 31, 2004 and December 31, 2003, respectively
1,118
Less: cost of 564,155 shares and 540,193 shares of treasury
stock at December 31, 2004 and December 31, 2003, respectively
(8,098)
(7,434)
TOTAL SHAREHOLDERS' EQUITY
56,042
53,115
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$666,811
$583,746
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share and per share data)
Interest and dividend income:
Interest and fees on loans
$ 24,067
$ 23,421
$ 23,754
Interest and dividends on securities and federal funds
7,855
7,072
8,598
Total interest and dividend income
31,922
30,493
32,352
Interest expense:
Deposits
4,409
4,336
5,880
Short-term borrowings
1,026
Long-term debt
6,110
6,190
6,125
Total interest expense
11,545
11,075
12,775
Net interest income
20,377
19,418
19,577
Provision for loan losses
1,100
Net interest income after provision for loan losses
20,197
18,878
18,477
Noninterest income:
Trust and other financial services
1,929
2,192
2,261
Service charges on deposit accounts
1,463
1,509
1,483
Other service charges, commissions and fees
Credit card service charges and fees
1,687
1,614
1,654
Net securities gains
1,257
Income on interest rate swap agreements, net
---
---
Other operating income
Total noninterest income
6,572
7,074
6,322
Noninterest expenses:
Salaries and employee benefits
9,335
9,483
9,235
Occupancy expense
1,170
1,058
1,020
Furniture and equipment expense
1,716
1,540
1,535
Credit card expenses
1,249
1,187
1,224
Other operating expense
5,444
5,585
5,231
Total noninterest expenses
18,914
18,853
18,245
Income before income taxes and cumulative effect of accounting change
7,855
7,099
6,554
Income taxes
2,123
1,892
1,742
Income before cumulative effect of accounting change
5,732
5,207
4,812
Less: cumulative effect of change in accounting for goodwill, net of tax
---
---
Net income
$ 5,732
$ 5,207
$ 4,565
Computation of Earnings Per Share:
Weighted average number of common shares outstanding
Basic
3,098,959
3,124,230
3,219,377
Effect of dilutive employee stock options
110,047
78,974
50,743
Diluted
3,209,006
3,203,204
3,270,120
Basic earnings per share before cumulative effect of accounting change
$ 1.85
$ 1.67
$ 1.49
Cumulative effect of change in accounting for goodwill, net of tax
---
---
(0.07)
Basic earnings per share
$ 1.85
$ 1.67
$ 1.42
Diluted earnings per share before cumulative effect of accounting change
$ 1.79
$ 1.63
$ 1.47
Cumulative effect of change in accounting for goodwill, net of tax
---
---
(0.07)
Diluted earnings per share
$ 1.79
$ 1.63
$ 1.40
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share and per share data)
Accumulated
Other
Total
Capital
Retained
Comprehensive
Treasury
Shareholders'
Stock
Surplus
Earnings
Income
Stock
Equity
Balance December 31, 2001
$7,287
$4,002
$43,875
$1,707
$(4,333)
$52,538
Net income
---
---
4,565
---
---
4,565
Total other comprehensive income
---
---
---
---
Cash dividends declared ($0.76 per share)
---
---
(2,445)
---
---
(2,445)
Purchase of treasury stock (82,840 shares)
---
---
---
---
(1,563)
(1,563)
Stock options exercised, net (5,241 shares)
---
---
(1)
---
Balance December 31, 2002
$7,287
$4,002
$45,994
$2,347
$(5,794)
$53,836
Balance December 31, 2002
$7,287
$4,002
$45,994
$2,347
$(5,794)
$53,836
Net income
---
---
5,207
---
---
5,207
Total other comprehensive loss
---
---
---
(1,833)
---
(1,833)
Cash dividends declared ($0.76 per share)
---
---
(2,386)
---
---
(2,386)
Purchase of treasury stock (87,535 shares)
---
---
---
---
(1,888)
(1,888)
Stock options exercised, net (11,255 shares)
---
---
(69)
---
Balance December 31, 2003
$7,287
$4,002
$48,746
$ 514
$(7,434)
$53,115
Balance December 31, 2003
$7,287
$4,002
$48,746
$ 514
$(7,434)
$53,115
Net income
---
---
5,732
---
---
5,732
Total other comprehensive income
---
---
---
---
Cash dividends declared ($0.80 per share)
---
---
(2,478)
---
---
(2,478)
Purchase of treasury stock (50,645 shares)
---
---
---
---
(1,369)
(1,369)
Stock options exercised, net (26,683 shares)
---
---
(267)
---
Balance December 31, 2004
$7,287
$4,002
$51,733
$1,118
$(8,098)
$56,042
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(Dollars in thousands)
Net income
$5,732
$5,207
$4,565
Unrealized appreciation (depreciation) on securities available for sale, net of
reclassification adjustment, net of tax of $425, ($881), and $237 at
December 31, 2004, 2003, and 2002, respectively
(1,710)
Net unrealized (depreciation) appreciation on interest rate swap agreements,
net of tax of ($106), ($63), and $93, at December 31, 2004, 2003, and 2002,
respectively
(205)
(123)
Accretion of net deferred gains related to interest rate swap agreements de-designated
and re-designated, in 2004, net of tax of ($7), at December 31, 2004
(15)
---
---
Total other comprehensive income
(1,833)
Total comprehensive income
$6,336
$3,374
$5,205
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands)
Cash flows from operating activities:
Net income
$ 5,732
$ 5,207
$ 4,565
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
1,716
1,107
1,117
Deferred income taxes
(129)
Amortization of core deposit intangible
---
---
Provision for loan losses
1,100
Net realized gains on sale of securities available for sale
(481)
(1,257)
(450)
Net realized gains on sale of securities held to maturity
(16)
---
---
Net realized gains on interest rate swap agreements classified as trading
(29)
---
---
Net amortization of bond premiums
1,105
Goodwill impairment loss
---
Venture Capital Fund investment impairment loss
---
---
Income on bank owned life insurance
(222)
(204)
(221)
Net change in other assets
(153)
3,160
(306)
Net change in other liabilities
(2,346)
Net cash provided by operating activities
8,856
6,702
6,760
Cash flows from investing activities:
Net receipt from branch acquisition
4,528
---
---
Purchases of securities held to maturity
(1,906)
(2,857)
(4,527)
Proceeds from maturities, calls and principal paydowns of securities held to maturity
1,489
Purchases of securities available for sale
(114,639)
(118,883)
(92,391)
Proceeds from maturities, calls and principal paydowns of securities available for sale
54,668
74,905
45,025
Proceeds from sale of securities held to maturity
---
---
Proceeds from sale of securities available for sale
42,588
46,337
26,025
Net increase in Federal Home Loan Bank stock
(1,531)
(1,041)
(174)
Net loans made to customers
(53,356)
(32,110)
(53,859)
Capital expenditures
(1,261)
(1,204)
(312)
Net cash used in investing activities
(68,929)
(34,002)
(79,976)
Cash flows from financing activities:
Net increase in deposits
38,092
17,065
30,182
Net (decrease) increase in securities sold under repurchase agreements
(848)
1,982
(1,216)
Proceeds from Federal Home Loan Bank advances
35,100
50,700
74,740
Repayment of Federal Home Loan Bank advances
(13,760)
(36,752)
(39,082)
Purchase of treasury stock
(1,369)
(1,888)
(1,563)
Proceeds from stock option exercises
Payments of dividends
(2,478)
(2,386)
(2,445)
Net cash provided by financing activities
55,175
28,900
60,717
Net increase (decrease) in cash and cash equivalents
(4,898)
1,600
(12,499)
Cash and cash equivalents at beginning of period
14,469
12,869
25,368
Cash and cash equivalents at end of period
$ 9,571
$ 14,469
$ 12,869
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest
$ 11,575
$ 11,075
$ 12,754
Income taxes, net of refunds
2,067
1,382
Non-cash transactions:
Transfer from loans to other real estate owned
$ ---
$ ---
$ 100
Transfer investment securities from held to maturity to available for sale
34,296
---
---
Unrealized appreciation on securities transferred from held-to-maturity to
available for sale, net of taxes of $613, at December 31, 2004
1,804
---
---
Unrealized appreciation(depreciation) on securities available for sale, net of
tax of $425, ($881) and $237 at December 31, 2004, 2003, and 2002,
respectively
(1,710)
Net unrealized (depreciation) appreciation on interest rate swap agreements,
net of tax of ($106), ($63), and $93 at December 31, 2004, 2003, and
2002, respectively
(205)
(123)
Accretion of net deferred gains related to interest rate swap agreements
de-designated and re-designated, in 2004, net of tax of ($7), at
December 31, 2004
(15)
---
---
Acquired in branch purchase:
Carrying value of loans
$ 12,343
$ ---
$ ---
Carrying value of premises and equipment
---
---
Carrying value of core deposit intangible
---
---
Carrying value of deposits
(21,200)
---
---
Excess of fair value of assets over liabilities (goodwill)
2,858
---
---
$ (4,528)
$ ---
$ ---
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BAR HARBOR BANKSHARES AND SUBSIDIARIES
(All dollar amounts expressed in thousands, except share and per share data)
Note 1: Summary of Significant Accounting Policies
The accounting and reporting policies of Bar Harbor Bankshares ("the Company") and its wholly owned operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), conform to accounting principles generally accepted in the United States of America and to general practice within the banking industry.
The Company’s principal business activity is retail and commercial banking and, to a lesser extent, financial services including trust, financial planning, investment management and third-party brokerage services. The Company’s business is conducted through the Company’s eleven banking offices located throughout Down East and Mid Coast Maine.
The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. The Bank is subject to the supervision, regulation, and examination of the FDIC and the Maine Bureau of Financial Institutions.
Financial Statement Presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.
The consolidated financial statements include the accounts of Bar Harbor Bankshares and its wholly owned subsidiary, Bar Harbor Bank & Trust. All significant inter-company balances and transactions have been eliminated in consolidation. Whenever necessary, amounts in the prior years financial statements are reclassified to conform to current presentation. Assets held in a fiduciary capacity are not assets of the Company and, accordingly, are not included in the consolidated balance sheets.
In preparing financial statements in conformity with U. S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, subsequent reviews of goodwill and intangible assets for impairment, and accounting for post-retirement plans and income taxes.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and other short-term investments with maturities less than 90 days.
The Bank is required to comply with certain laws and regulations of the Federal Reserve Board, which require that the Bank maintain certain amounts of restricted cash on deposit. At December 31, 2004, the Bank's reserve requirement at the Federal Reserve Bank was $132.
In the normal course of business, the Bank has funds on deposit at other financial institutions in amounts in excess of the $100 that is insured by the Federal Deposit Insurance Corporation.
Investment Securities: Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" ("HTM") and reflected at amortized cost. Investments not classified as "held to maturity" are classified as "available-for-sale" ("AFS"). Securities available-for-sale consist of debt securities that are available-for-sale in order to respond to: changes in market interest rates and related changes in the security’s prepayment risk; needs for adequate liquidity; changes in funding sources and terms; and changes in the availability of and yield on alternative investments. These securities are specifically identified and are carried at market value. Changes in market value of available-for-sale securities, net of applicable income taxes, are reported as a separate component of shareholders’ equity and comprehensive income. The Company does not have a securities trading portfolio. In 2004, the Company transferred all HTM securities to the AFS classification and does not intend to utilize the HTM classification in the foreseeable future.
When a decline in market value of a security is considered other-than-temporary, the cost basis of the individual security is written down to market value as the new cost basis and the loss is charged to net securities gains (losses) in the consolidated statements of income.
Premiums and discounts on securities are amortized and accreted over the term of the securities using the interest method. Gains and losses on the sale of securities are recognized at the trade date using the specific-identification method and are shown separately in the consolidated statement of income.
Federal Home Loan Bank Stock: As a member of the Federal Home Loan Bank of Boston ("FHLB"), the Bank is required to hold stock in the FHLB. FHLB stock is carried at cost since there is not readily available market value. The stock cannot be sold, but can be redeemed by the FHLB at cost.
Loans: Loans are carried at the principal amounts outstanding adjusted by partial charge-offs and net deferred loan origination costs or fees.
Interest on loans is accrued and credited to income based on the principal amount of loans outstanding. Residential real estate loans are generally placed on non-accrual when reaching 120 days past due, or in process of foreclosure, or sooner if judged appropriate by management. All consumer loans are generally placed on non-accrual status when reaching 90 days or more past due, or sooner if judged appropriate by management, and any equity line in the process of foreclosure is generally placed on non-accrual status, or sooner if judged appropriage by management. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management. When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when collectibility of principal is reasonably assured and the loan has performed for a period of time, generally six months.
Commercial real estate and commercial business loans are considered impaired when it becomes probable the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and collateral value.
Loan origination and commitment fees and direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield, using the level yield method over the estimated lives of the related loans.
Allowance For Loan Losses: The allowance for loan losses is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance for loan losses ("allowance") is available to absorb losses on loans. The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. The allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off.
Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The ongoing evaluation process includes a formal analysis, which considers among other factors: the character and size of the loan portfolio, business and economic conditions, real estate market conditions, collateral values, changes in product offerings or loan terms, changes in underwriting and/or collection policies, loan growth, previous charge-off experience, delinquency trends, nonperforming loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral.
Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.
While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.
Premises and Equipment: Premises and equipment and related improvements are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of related assets; generally 25 to 40 years for premises and 3 to 7 years for furniture and equipment.
Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and identifiable intangible assets, such as core deposit intangibles.
The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event as defined by SFAS No. 142, using several fair value techniques, discounted future cash flows and multiples of revenues/earnings. The valuation techniques contain estimates such as discount rate, projected future cash flows and time period in their calculations, all of which are susceptible to change based upon changes in economic conditions and other factors.
Identifiable intangible assets consist of core deposit intangibles amortized over their estimated useful lives on a straight line method, which approximates the amount of economic benefits to Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Furthermore, the determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.
Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s consolidated results of operations.
Bank-Owned Life Insurance: Bank-owned life insurance ("BOLI") represents life insurance on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value is included in assets on the Company’s consolidated balance sheet. The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and annually thereafter. The Company’s policy is to limit BOLI with any individual carrier to 10% of capital.
Mortgage Servicing Rights: Mortgage servicing rights are recognized as separate assets when acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to unamortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the carrying value of the rights.
Other Real Estate Owned: Real estate acquired in satisfaction of a loan is reported in other assets. Properties acquired by foreclosure or deed in lieu of foreclosure are transferred to other real estate owned and recorded at the lower of cost or fair market value less estimated costs to sell based on appraised value at the date actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Subsequent reductions in market value below the carrying costs are charged to other operating expenses.
Derivative Financial Instruments: The Company recognizes all derivative instruments on the consolidated balance sheet at fair value. On the date the derivative is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.
Changes in fair value of derivative instruments that are highly effective, and qualify as a cash flow hedge, are recorded in other comprehensive income. For fair value hedges that are fully effective, the gain or loss on the hedge would offset the loss or gain on the hedged item attributable to the hedged risk. Any difference that does arise would be the result of hedge ineffectiveness, which is recognized in earnings. The Company discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk of the hedge item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.
Off-balance Sheet Financial Instruments: In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Stock Compensation Plan: On October 3, 2000 the shareholders of the Company approved the Bar Harbor Bankshares and Subsidiaries Incentive Stock Option Plan of 2000 for officers and employees that is described more fully in Note 14 of these consolidated financial statements. Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," whereby compensation cost is the excess, if any, of the quoted market price of the underlying stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock upon exercise of the stock option.
The Company has elected to continue with the accounting methodology in Opinion No. 25 and, as a result, must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The pro forma disclosures include the effects of all awards granted. Had the Company determined cost based on the fair value at the grant date for its stock options and expense related to the employee stock option plan under SFAS No. 123, its net income and earnings per share data would have been reduced to the pro forma amounts indicated as follows:
401(k) and Other Benefit Plans: The Company maintains a Section 401(k) savings plan for substantially all of its employees. Employees are eligible to participate in the 401(k) Plan on the first day of any quarter following their date of hire. Under the plan, the Company makes a matching contribution of a portion of the amount contributed by each participating employee, up to a percentage of the employee’s annual salary. The plan allows for supplementary profit sharing contributions by the Company, at its discretion, for the benefit of participating employees.
In addition to the 401(k) plan, the Company has non-qualified supplemental retirement plans for certain active and retired officers. The Company also sponsors a postretirement benefit plan, which provides medical and life insurance coverage to eligible employees. The cost of providing the foregoing benefits is accrued during the active service period of the employee.
Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt that it is more likely than not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings Per Share: Earnings per share have been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share have been calculated by dividing net income by weighted average shares outstanding before any dilution. Diluted earnings per share incorporates the effect of stock options outstanding at the end of the reporting period, and have been calculated by dividing net income by weighted average shares outstanding after giving effect to the potential dilution that could occur if the potential common shares were converted into common stock using the treasury stock method.
Segment Reporting: An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance. The Company’s primary business is community banking, which provided 95.0%, 94.2%, and 94.2% of its total revenues for the years ended December 31, 2004, 2003, and 2002, respectively. Accordingly, disaggregated segment information is not presented in the notes to the financial statements.
Note 2: Recently Issued Accounting Pronouncements
The following information addresses new or proposed accounting pronouncements that could have an impact on the Company’s financial condition, results of operations, earnings per share, or cash flows.
Accounting For Share-Based Payments: In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R") which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees, including employee stock purchase plans. Current disclosure provisions under SFAS No. 123 are still applicable. In addition to stock option awards granted after July 1, 2005, compensation expense on unvested equity-based awards that were granted prior to the effective date must be recognized in the consolidated income statement. SFAS No. 123R is effective for interim or annual periods beginning after June 15, 2005. The adoption of SFAS No. 123R is expected to decrease earnings per share by approximately $0.02 in 2005, based upon the current level of invested options. SFAS No. 123R is not expected to have a material effect on the Company's consolidated financial condition or cash flows.
Cash Flow Hedges: In July 2004, the FASB issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges: Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interest-bearing loans (or other interest-bearing financial assets), provided all other conditions for a cash flow hedge have been met. Entities that choose to use the first-payments-received technique are still required by SFAS No. 133 (as amended) to assess the effectiveness of the cash flow hedging relationship and to recognize ineffectiveness in earnings, if any. The effective date of the guidance for each reporting entity is the first day of the first fiscal quarter beginning after August 9, 2004. Early application of the guidance covering this Implementation Issue is permitted. During the third quarter of 2004, the Company implemented this guidance and designated its prime-rate-based interest rate swap agreements as cash flow hedges. The adoption of this guidance did not have a significant impact on the Company's 2004 consolidated financial position or results of operations.
Other-Than-Temporary Impairment: In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a consensus on Issue 03-1, "The Meaning of Other Than Temporary Impairment (Issue 03-1)". The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an investment is impaired. An investment is considered impaired if its fair value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and debt securities that can contractually be prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost, an impairment is presumed to be other-than-temporary unless: the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. For other debt securities, an impairment is deemed other-than-temporary if: the investor does not have the ability and intent to hold the investment until a forecasted market price recovery (may mean until maturity), or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment loss equal to the difference between the investment's amortized cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and generally cannot be adjusted for subsequent recoveries in fair value.
In December 2004, the FASB announced it would reconsider in its entirety all guidance on disclosing, measuring and recognizing other-than-temporary impairments of debt and equity securities (including such guidance in EITF 03-1). Until new guidance is issued, companies must continue to comply with the disclosure requirements of EITF 03-1 and all relevant measurement and recognition requirements in other accounting literature. Certain guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. steps of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22 have not been deferred and should be applied based on the transition provisions in EITF 03-1. Based on the composition of the investment securities portfolio held at December 31, 2004, EITF 03-1 is not expected to have a material effect on the Company's financial position or results of operations.
Variable Interest Entities: In January 2003, FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities", (or VIEs). The objective of this interpretation is to provide guidance on how to identify a VIE and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in the company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. FIN 46 was effective for all VIE’s created after January 31, 2003. However, the FASB postponed that effective date to December 31, 2003. In December 2003, the FASB issued a revised FIN 46 (FIN 46 R), which has an effective date of March 31, 2004 for VIE’s created prior to February 1, 2003, except for special purpose entities, which much adopt either FIN 46 or FIN 46 R as of December 31, 2003. The adoption of FIN 46 did not have an impact on the Company's consolidated financial position or results of operations.
Note 3: Business Segments
The Company has determined that its primary business operations are in the community banking industry and include the traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and third party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities.
SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information" requires public companies to report certain financial information about operating segments for which such information is available and utilized by the chief operating decision maker in deciding how to allocate resources and in assessing performance. In prior reporting periods the Company had also included Financial Services as a business segment and, accordingly, provided segment information for that segment. In December 2003 the Company’s Board of Directors approved a restructuring plan for its wholly owned subsidiary, BTI Financial Group ("BTI"). The restructuring plan simplified and aligned BTI’s brand names and operating model with the Bank. During 2004 the plan was completed, with the results of all operations now viewed as a single strategic unit by the chief operating decision maker.
For the years ended December 31, 2004, 2003, and 2002 revenue from Financial Services represented 5.0%, 5.8%, and 5.8% of the Company’s total revenue, respectively. Accordingly, segment disclosures are not required.
Note 4: Securities Available-For-Sale and Held-To-Maturity
A summary of the amortized cost and market values of securities available-for-sale and held-to-maturity follows:
As permitted by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", during the fourth quarter of 2004 the Company transferred into the available-for-sale securities portfolio all of its held-to-maturity investment securities. Securities transferred consisted of longer term, tax-exempt securities representing obligations of state and political subdivisions. The held-to-maturity securities were transferred to available-for sale at their fair value of $36,100, with an unrealized gain on these securities, net of taxes, amounting to $1,191 recorded in other comprehensive income. Management does not intend to utilize the held-to-maturity classification in the foreseeable future.
Impairment: The following table summarizes the fair value of investments with continuous unrealized losses for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer as of December 31, 2004. All securities referenced are debt securities. At December 31, 2004, the Company did not hold any common stock or other equity securities in its investment securities portfolio.
In evaluating whether impairments are other-than-temporary, the Company considers a variety of factors including the nature of the investment, the cause of the impairment, and the severity and duration of the impairment. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and or any other information considered relevant. At December 31, 2004, and 2003 the Company determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.
For securities with unrealized losses, the following information was considered in determining that the impairments are not other-than-temporary. U.S. government securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government sponsored enterprises have minimal credit risk as they play a vital role in the nation’s financial markets. Other bonds and notes are generally comprised of corporate mortgage-backed securities and all investments maintain a credit rating of at least "A" by one of the nationally recognized rating agencies. Mortgage-backed securities and collateralized mortgage obligations are either issued by federal government agencies and sponsored enterprises, or by private issuers, all with security ratings of AAA.
Management believes the unrealized losses in the investment portfolio at December 31, 2004 were attributed to interest rates, and reflected the volatile movements in the U.S. Treasury curve over the past few years. Specifically, certain debt securities were purchased in an interest rate environment lower than where the U.S. Treasury yield curve stood on December 31, 2004.
Maturity Distribution: At December 31, 2004, the amortized cost and estimated fair value of securities available-for-sale are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or with or without call or prepayment penalties.
Realized Gains and Losses:
The following table summarizes realized gains and losses on securities available-for-sale for the years ended December 31, 2004, 2003 and 2002.
In addition, in 2004 the Company recorded a gain on the sale of a held-to-maturity security of $16.
Note 5: Loans
The Company’s lending activities are principally conducted in Down East and Mid Coast, Maine. The following table summarizes the composition of the loan portfolio as of December 31, 2004 and 2003:
Residential real estate mortgages
$ 221,690
$202,102
Commercial and commercial real estate mortgages
148,356
116,182
Agricultural and other loans to farmers
15,077
11,719
Consumer
13,534
13,126
Home equity
47,189
35,941
Tax exempt
1,950
3,652
447,796
382,722
Real estate under foreclosure
Deferred origination costs (fees), net
(289)
Allowance for loan losses
(4,829)
(5,278)
$443,649
$378,130
Nonperforming Loans and Accruing Loans 90 days or more Overdue: The following table sets forth information regarding nonaccruing loans and accruing loans 90 days or more overdue at December 31, 2004, 2003 and 2002.
Loans accounted for on a non-accrual basis:
Real estate loans:
Construction and development
$ ---
$ 114
$ 4
Mortgage
1,113
Loans to finance agricultural production and
other loans to farmers
Commercial and industrial loans
Loans to individuals for household,
family and other personal expenditures
Total non-accrual loans
$572
$1,295
$986
Accruing loans contractually past due 90 days
or more
$151
$ 199
$188
During the year ended December 31, 2004, the total interest not recorded on non-accrual loans amounted to $112.
Loan Concentrations: Because of the Company’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31, 2004 and 2003, loans to the hospitality industry amounted to approximately $30,535 and $31,493, respectively.
Loans to Related Parties: In the ordinary course of business, the Company has made loans at prevailing rates and terms to directors, officers and other related parties. All such loans, in management’s opinion, do not present more than the normal risk of collectibility or incorporate other unfavorable features, and were made under terms that are consistent with the Company’s normal lending policies.
Loans to related parties at December 31 are summarized below. Balances have been adjusted to reflect changes in status of directors and officers for each year presented.
Beginning balance
$ 5,677
$9,390
Changes in Composition
1,016
(5,029)
New loans
5,995
2,477
Repayments
(183)
(1,161)
Ending balance
$12,505
$5,677
As of December 31, 2004, and 2003, there were no non-performing loans to related parties.
Mortgage Loan Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2004, the unpaid balance of mortgage loans serviced for others totaled $9,935 compared with $12,334 at December 31, 2003.
Note 6: Allowance For Loan Losses
A summary of changes in the allowance for loan losses for each of the three years ended December 31 follows:
Balance, beginning of year
$5,278
$4,975
$4,169
Provision for loan losses
1,100
Loans charged off
(851)
(427)
(482)
Less: recoveries on loans previously charged off
Net loans charged off
(629)
(237)
(294)
Balance, end of year
$4,829
$5,278
$4,975
Impaired Loans: Impaired loans are commercial and commercial real estate loans, which the Company believes will probably not result in the collection of all amounts due according to the contractual terms of the loan agreement. The amount of reserves for impaired loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral less cost to sell.
The majority of the Company's impaired loans are collateral dependent.
Information pertaining to impaired loans at December 31, 2004, 2003 and 2002 follows:
Investment in impaired loans
$93
$596
$59
Portion of impaired loan balance for which
an allowance for loan losses is allocated
$93
$596
$59
Portion of allowance for loan losses allocated
to the impaired loan balance
$14
$190
$ 9
Interest not recorded on impaired loans during the year
$ 3
$ 23
$59
During the year ended December 31, 2004, the total average balance of impaired loans amounted to approximately $300.
Note 7: Premises and Equipment
The detail of premises and equipment as of December 31 follows:
Land
$ 1,774
$ 1,321
Buildings and improvements
12,838
12,453
Furniture, fixtures and equipment
7,924
7,522
Less: accumulated depreciation
(10,601)
(9,886)
Total net book value
$11,935
$11,410
Note 8: Goodwill and Other Identifiable Intangible Assets
Goodwill: A summary of goodwill capitalized on the Company’s consolidated balance sheet follows.
During the first quarter of 2004, the Company recorded $2,858 in goodwill in connection with the Bank's acquisition of a branch in Rockland, Maine.
Goodwill is required to be tested for impairment at least annyally, or more often if certain events occur. The Company estimates the value of goodwill utilizing certain fair value techniques. Management determined the Company's goodwill balance related to the acquisition of Dirigo Investments, Inc., its then second tier broker-dealer subsidiary, was impaired, resulting in an impairment charge of $375, recorded during 2002, and reported as a cumulative effect of change in accounting for goodwill in the consolidated income statement. As of December 31, 2003, the Company completed its annual review of the Dirigo Investments goodwill and recorded additional impairment of $75, recorded as other operating expense in the consolidated statment of income. The Company determined there was no further goodwill impairment as of December 31, 2004.
Core Deposit Intangible Asset: The Company has a finite-lived intangible asset capitalized on its consolidated balance sheet in the form of a core deposit intangible asset related to the Bank’s acquisition of a branch office in Rockland, Maine. The core deposit intangible asset is being amortized over an estimated useful life of six-years, and is included in other assets on the December 31, 2004 consolidated balance sheet. There was no core deposit intangible asset at December 31, 2003.
A summary of the core deposit intangible asset follows as of December 31, 2004:
Core deposit intangibles:
Gross carrying amount
$391
Less: accumulated amortization
Net carrying amount
$335
Amortization expense on core deposit intangible assets is expected to total $67 each year for years 2005 through 2009.
Note 9: Income Taxes
The following table summarizes the current and deferred components of income tax expense (benefit) for the years ended December 31:
Current
Federal
$1,695
$1,666
$1,781
State
1,806
1,765
1,871
Deferred
(129)
$2,123
$1,892
$1,742
The following table reconciles the expected federal income tax expense (computed by applying the federal statutory tax rate to income before taxes) to recorded income tax expense, for the years ended December 31:
Computed tax expense
$2,671
$2,414
$2,229
Increase (reduction) in income taxes resulting from
Officers' life insurance
(74)
(70)
(74)
Tax exempt interest
(518)
(500)
(455)
State taxes, net of federal benefit
Other, net
(38)
(43)
(28)
Recorded income tax expense
$2,123
$1,892
$1,742
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities, which are included in other assets, at December 31, 2004 and 2003 are as follows:
The Company has determined that a valuation allowance is not required for its net deferred tax asset since it is more likely than not that this asset will is realizable principally through the ability to carry-back to taxable income in prior years, future reversals of existing taxable temporary differences, and future taxable income.
Note 10: Deposits
The aggregate amount of short-term jumbo certificates of deposit, each with a minimum denomination of $100, was $19,405 and $18,784 at December 31, 2004 and 2003, respectively.
At December 31, 2004, the scheduled maturities of time deposits were as follows:
$ 76,651
19,201
12,304
10,709
3,723
and thereafter
Individual Retirement Accounts (IRAs)
without scheduled maturities
17,951
$140,979
Note 11: Short-term Borrowings
The Company’s short-term borrowings consist of borrowings from the Federal Home loan Bank and securities sold under agreements to repurchase. The following table summarizes short-term borrowings at December 31, 2004, 2003 and 2002.
Securities Sold Under Agreements to Repurchase: Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Information concerning securities sold under agreements to repurchase for 2004, 2003, and 2002 is summarized as follows:
Average daily balance during the year
$13,427
$13,086
Average interest rate during the year
1.12%
1.32%
Maximum month-end balance during the year
$17,745
$17,083
Amount outstanding at end of year
$15,077
$15,925
Securities collateralizing repurchase agreements, which are held in safekeeping by nonaffiliated financial institutions and under the Bank's control, were as follows at December 31:
Amortized cost
$22,257
$20,069
Carrying value $22,317
$20,256
Note 12: Long-term Debt
A summary of long-term debt, all of which represent advances from the Federal Home Loan Bank, is as follows:
All FHLB advances are fixed-rate instruments. Advances are payable at their call dates or final maturity. Advances are stated at their contractual maturity dates and do not reflect call features. At December 31, 2004, the Bank had
$60 million in callable advances with maturity dates ranging from 2005 to 2011.
Pursuant to an agreement with the FHLB, advances are collateralized by stock in the FHLB, a blanket lien on qualifying first mortgage loans, loans guaranteed by the U. S. Government, certain multi-family loans, U.S. Government Agency debentures, U.S. Government mortgage-backed securities, and other non-Government mortgage backed securities.
Note 13: Shareholders' Equity
Dividend Limitations: Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to its shareholders. The Bank is subject to certain requirements imposed by federal banking laws and regulations. These requirements, among other things, establish minimum levels of capital and restrict the amount of dividends that may be distributed by the Bank to the Company. At December 31, 2004, the Bank had $19,662 available for dividends that could be paid without prior regulatory approval.
Regulatory Capital Requirements: The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and average assets. Management believes, as of December 31, 2004, that the Company and Bank exceed all capital adequacy requirements to which they are subject. As of December 31, 2004, the most recent notification from the federal regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The following table sets forth the Company’s and the Bank’s regulatory capital at December 31, 2004, under the rules applicable at that date.
The following table sets forth the Company’s and the Bank’s regulatory capital at December 31, 2003, under the rules applicable at that date.
Stock Repurchase Plans: In November 1999, the Company announced a stock repurchase plan, which was subsequently continued through December 31, 2003, at which time it terminated. Under that plan the Company was authorized to make open market and privately negotiated purchases of up to 10% of its outstanding shares of common stock, or 344,000 shares. As of December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The Company recorded the repurchased shares as treasury stock.
In March 2004, the Company announced a second stock repurchase plan which allows the Company to make open market and privately negotiated purchases of up to 10% of its outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time-to-time, without prior notice. As of December 31, 2004, the Company had repurchased 49,920 shares of stock under this plan, at a total cost of $1,349 and an average price of $27.03 per share.
Note 14: Stock Based Compensation Plan:
The Bar Harbor Bankshares and its Subsidiaries Incentive Stock Option Plan (ISO) for officers and employees was established October 3, 2000, providing for the issuance of up to 450 thousand shares of common stock. The purchase price of the stock covered by each option shall be its fair market value, which must be equal to at least 100% of the fair market value on the date such option is granted. Initial grants were made in 2001 totaling 228 thousand shares. Vesting terms range from five to seven years. No option shall be granted after October 3, 2010, ten years after the effective date of the ISO.
The following table provides information as of December 31, 2004 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.
Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants and rights, net of forfeits and exercised shares
Weighted Average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation [(excluding securities referenced in column (a)]
(a)
(b)
(c)
Equity compensation plans approved
by security holders
318,350
$17.93
131,650
Equity compensation plans not approved
by security holders
--
N/A
--
Total
318,350
$17.93
131,650
A summary of the status of the plan as of December 31, 2004, 2003 and 2002, and changes during the years then ended is presented below.
The following information applies to options outstanding at December 31, 2004:
The following information applies to options outstanding at December 31, 2003:
The per share weighted average fair value of all stock options granted by the Company during 2004, 2003, and 2002 was $2.69, $1.80, and $1.71 on the date of the grants using the Black Scholes option-pricing model with the following weighted average assumptions:
Expected dividend yield
2.94%
2.81%
3.93%
Risk free interest rate
2.79%
2.63%
2.23%
Volatility
11.99%
17.20%
11.00%
Expected life (years)
3.5
3.5
3.5
Weighted average fair value
$2.69
$1.80
$1.71
During the years ended December 31, 2004, 2003, and 2002, the total anti-dilutive stock options amounted to 13, 6, and 29 thousand shares, respectively
Note 15: Retirement Benefit Plans
Medical and Life Insurance Benefits: The Company sponsors a limited post-retirement benefit program which funds medical coverage and life insurance benefits to a closed group of retired employees who meet minimum age and service requirements. It is the Company's policy to record the cost of postretirement health care and life insurance plans based on actuarial estimates, which are dependent on claims and premiums paid. The cost of providing these benefits is accrued during the active service period of the employee. Net periodic postretirement benefit cost includes the following components:
Interest cost on accumulated postretirement benefit obligation
$ 73
$ 80
$ 84
Amortization of actuarial gain
(16)
(23)
(23)
Net periodic postretirement benefit cost
$ 57
$ 57
$ 61
The following table sets forth the change in benefit obligations for the years ended December 31:
Benefit obligation at beginning of year
$1,262
$1,235
$1,247
Interest cost on accumulated postretirement benefit obligation
Amortization
(13)
(17)
Benefits paid
(77)
(70)
(79)
Benefit obligation at end of year
$1,245
$1,262
$1,235
Unrecognized gain at end of year
$
$
$
Accrued benefit cost included in other liabilities
$1,548
$1,567
$1,581
The accumulated postretirement benefit obligation (APBO) in 2004 and 2003 was determined using a 6.0% weighted average discount rate. The net periodic benefit cost in 2004, 2003, and 2002 was determined using a 6.00%, 6.75%, and 7.00%, respectively, weighted average discount rate.
The health care cost trend rate was 12% in 2004, gradually declining to 6% after 12 years and remaining at that level thereafter. An increase in the health care trend of 1% would increase the APBO by approximately $98 and the net periodic cost by $6. A decrease in the health care trend of 1% would decrease the APBO by approximately $87 and the net periodic cost by $5.
The Company expects to contribute the following amounts to the postretirmenet medical and life insurance benefit plan for the years ending December 31:
$
2010 and thereafter
Total $1,006
401(k) Plan: The Company has a 401(k) Plan available to full-time employees and officers. The Company matches employee contributions based on a predetermined formula and may make additional discretionary contributions. The total expense for this plan in 2004, 2003 and 2002 was $391, $393, and $325, respectively.
Supplemental Executive Retirement Plans: The Company has non-qualified supplemental executive retirement agreements for certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations. In 2004, 2003, and 2002, the expense of these supplemental retirement agreements was $118, $ 122, and $128, respectively.
The Company also has Supplemental Executive Retirement Plans for certain executive officers. These plans provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the executive leaves the Company following a change of control event. In 2004, 2003 and 2002, the expense of these supplemental retirement agreements was $336, $253 and $316, respectively. As of December 31, 2004, the Company had accrued a total of $905 to provide for these future payment obligations.
The following table provides the net periodic benefit costs for the supplemental executive retirement plans for the years ended December 31, 2004 and 2003:
Service Cost
$298
$239
Interest Cost
Net Periodic Benefit Cost
$454
$375
The Company expects to contibute the following amounts to the Supplemental Executive Retirement Plans for the years ending December 31:
$ 213
2010 and thereafter
7,035
Total $8,136
Note 16: Financial Derivative Instruments
As part of its overall asset liability/management strategy, the Company periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Company’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant effect on net income.
At December 31, 2004 the Company had two outstanding derivative instruments with notional principal amounts totaling $20 million, both of which were interest rate swap agreements. The details are summarized as follows:
Description
Maturity
Notional Amount
(in thousands)
Fixed Interest Rate
Variable Interest Rate
Receive fixed rate, pay variable rate
09/01/07
$10,000
6.04%
Prime (5.25%)
Receive fixed rate, pay variable rate
01/24/09
$10,000
6.25%
Prime (5.25%)
The Company is required to pay a counter-party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively, over the term of each agreement.
These interest rate swap agreements were designated as cash flow hedges at December 31, 2003 and had total unrealized gains of $86. The fair value of these instruments, net of tax, was recorded as a component of accumulated other comprehensive income on the consolidated balance sheet. Changes in fair value were recorded as a component of other comprehensive income. Current period net cash flows representing net amounts received from or paid to counter-parties were recorded as interest income.
During the first quarter of 2004, these interest rate swap agreements were de-designated as cash flow hedges and, from the time of de-designation, changes in their fair value and current period net cash flows representing net amounts received from or paid to counterparties agreements were recorded in the consolidated statement of income and included as part of non-interest income. The unrealized gain on these interest rate swap agreements at December 31, 2003 of $86 remained in accumulated other comprehensive income, net of tax, to be accreted into interest income over the remaining terms of the respective swap agreements.
In July 2004, the Financial Accounting Standards Board ("FASB") issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges: Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interest-bearing loans, provided all other conditions for a cash flow hedge have been met. During the third quarter of 2004 the Company designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are recorded in other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties are recorded as interest income.
At December 31, 2004 and December 31, 2003, the unrealized (loss) gain on the interest rate swap agreements was ($225) and $86, respectively, and included in other assets on the consolidated balance sheets.
At December 31, 2004 the unrealized loss on these interest rate swap agreements included in other comprehensive income, net of tax, amounted to $149, compared with an unrealized gain of $57 at December 31, 2003. Also included in other comprehensive income for the year ended December 31, 2004, was a net deferred loss, net of tax, of $15 related to the de-designation and re-designation of these swaps as cash flow hedges in 2004. There were no deferred gains or losses recorded in other comprehensive income in 2003.
During 2004, the net unrealized gains on interest rate swap agreements recorded in non-interest income amounted to $29, during the period in which hedge accounting was not applied.
During, 2004, the total net cash flows received from counterparties amounted to $455, compared with $498 and $117 in 2003 and 2002, respectively. Of the $455 in net cash flows received from counterparties during 2004, $375 was recorded in non-interest income (non-hedge period) and $80 in interest income (hedge period). The net cash flows received from counterparties during 2003 and 2002 were recorded in interest income.
Note 17: Commitments and Contingent Liabilities
The Company is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.
Commitments to originate loans, including unused lines of credit, are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.
The Company guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are primarily issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Exposure to credit loss in the event of nonperformance by the counter-party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. Typically, these standby letters of credit have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.
The following table summarizes the contractual amounts of commitments and contingent liabilities as of December 31, 2004, 2003 and 2002.
Commitments to originate loans
$14,435
$32,575
$14,581
Unused lines of credit
$75,732
$62,616
$52,611
Un-advanced portions of construction loans
$ 7,336
$ 3,683
$ 3,950
Standby letters of credit $ 1,155
$ 2,205
$ 2,800
As of December 31, 2004, and 2003, the fair values of the standby letters of credit were not significant to the Company’s consolidated financial statements.
Note 18: Fair Value of Financial Instruments
The Company discloses fair value information about financial instruments for which it is practicable to estimate fair value. Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Where available, quoted market prices are used. In other cases, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience and other factors. Changes in assumptions could significantly affect these estimates. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in certain cases, could not be realized in an immediate sale of the instrument.
Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amounts presented do not purport to represent the underlying market value of the Company. For certain assets and liabilities, the information required under SFAS No. 107 is supplemented with additional information relevant to an understanding of the fair value.
The following describes the methods and assumptions used by the Company in estimating the fair values of significant financial instruments:
Cash and cash equivalents: For cash and cash equivalents, including cash and due from banks and other short-term investments with maturities of 90 days or less, the carrying amounts reported on the consolidated balance sheet approximate fair values.
Securities available-for-sale and held-to-maturity: Fair values are based on quoted bid market prices, where available. Where quoted market prices for an instrument are not available, fair values are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instrument being valued. The carrying value of securities available-for-sale reported on the consolidated balance sheet represent estimated fair value, whereas securities held-to-maturity are carried at cost, adjusted for premium amortization or discount accretion.
Loans: For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposits: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on wholesale funding products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding ("deposit base intangibles").
Borrowings: For borrowings that mature or re-price in 90 days or less, carrying value approximates fair value. The fair value of the Company’s remaining borrowings is estimated by using discounted cash flows based on current rates available for similar types of borrowing arrangements taking into account any optionality.
Accrued interest receivable and payable: The carrying amounts of accrued interest receivable and payable approximate their fair values.
Off-balance sheet financial instruments
: The fair values of the interest rate swap agreements are based on quoted market prices. The Company’s other off-balance sheet instruments consist of loan commitments and standby letters of credit. Fair values for standby letters of credit and loan commitments were insignificant.
A summary of the carrying values and estimated fair values of the Company’s significant financial instruments at December 31, 2004 and 2003 follows:
Note 19: Legal Contingencies
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of the Company's business, which in the opinion of management will have no material effect on the Company's consolidated financial statements.
Note 20: Condensed Financial Information - Parent Company Only
The condensed financial statements of Bar Harbor Bankshares as of December 31, 2004 and 2003, and for each of the three-years in the period ended December 31, 2004, are presented below:
BALANCE SHEETS
December 31
Cash
$ 561
$ 376
Investment in subsidiaries
54,859
51,849
Premises
Other assets
Total Assets
$56,579
$53,430
Liabilities
Total Liabilities
$ 537
$ 315
Total Shareholders’ equity
56,042
53,115
Liabilities & Shareholders’ Equity
$56,579
$53,430
STATEMENTS OF INCOME
Years Ended December 31
Dividend income from subsidiaries
$2,409
$5,075
$5,369
Equity in undistributed earnings of subsidiaries (1)
3,652
(387)
Bankshares expenses, net of tax benefit
(329)
(582)
(417)
Net income
$5,732
$5,207
$4,565
(1)
Amount in parentheses represents the excess of dividends over net income of subsidiaries.
STATEMENTS OF CASH FLOWS
Years Ended December 31
Cash flow from operating activities:
Net income
$ 5,732
$ 5,207
$ 4,565
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation
Net decrease (increase) in other assets
(6)
(77)
Equity in undistributed earnings of subsidiaries
(3,652)
(714)
Net cash used by operating activities
2,717
4,495
4,882
Cash flows from investing activities:
Additional investments in subsidiaries
(350)
(854)
Capital expenditures
(11)
(8)
(6)
Net cash used in investing activities
(358)
(860)
Cash flows from financing activities:
Purchase of treasury stock
(1,369)
(1,888)
(1,563)
Proceeds from stock issuance
Dividend paid
(2,478)
(2,386)
(2,445)
Net cash used in financing activities
(3,409)
(4,095)
(3,907)
Net increase (decrease) in cash
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
$ 561
$ 376
$ 334
Note 21: Selected Quarterly Financial Data (Unaudited)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures: The Company carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are operating in an effective manner.
Management Report on Internal Control over Financial Reporting: Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework.
Based on our assessment, management believes that as of December 31, 2004, the Company’s internal control over financial reporting is effective, based on the criteria set forth by COSO in Internal Control -- Integrated Framework.
The Company’s independent registered public accounting firm has issued an audit report on our assessment of, and the effective operation of, the Company’s internal control over financial reporting. This report appears within Item 9A of this report on Form 10-K.
Changes in Internal Control Over Financial Reporting- No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Bar Harbor Bankshares:
We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting that Bar Harbor Bankshares (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in a reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Bar Harbor Bankshares maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Bar Harbor Bankshares and subsidiaries as of December 31, 2004, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity and cash flows for the year ended December 31, 2004, and our report dated March 14, 2005 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Albany, New York
March 14, 2005
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers: Information required by this item is incorporated by reference from the sections entitled "Management of the Company", and "Executive Officers", in the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders, which will be filed with the Commission on or before April 30, 2005 (the "Proxy").
Compliance with Section 16(a) of the Securities Exchange Act of 1934: The information required under this item is incorporated herein by reference from the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company’s definitive Proxy.
Audit Committee Financial Expert: The information required under this item is incorporated herein by reference from "Appendix A" Report of the Audit Committee, contained in the Company’s definitive Proxy.
Code of Ethics: The information required under this item is incorporated herein by reference from the section entitled "Other Matters," "Code of Ethics" contained in the Company’s definitive Proxy.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is incorporated by reference from the section entitled "Compensation of Directors and Executive Officers" in the Company’s definitive Proxy.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is incorporated by reference from the sections entitled "Voting Securities and Principal Holders thereof" and "Equity Compensation Plan Information" in the definitive Proxy.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is incorporated by reference from the section entitled "Transactions with Directors, Officers, and Principal Shareholders" in the definitive Proxy.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this item is incorporated by reference to the section entitled "Selection of Auditors" in the Company’s definitive Proxy
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements Filed herewith at Item 8
2. Financial Statement Schedules Filed herewith at Item 8
3. Exhibits:
The following exhibits are included as part of this Form 10-K.
EXHIBIT NUMBER
2.1
Plan of Acquisition, Reorganization Agreement, Liquidation, or Succession
Incorporated by reference to Form S-14 filed with the Commission March 26, 1984 (Commission Number 2-90171).
2.2 BTI Restructuring Plan
Incorporated by Reference to Form 10-K, Item 15(a)(3)((2)(b), filed with the Commission on March 29, 2004 (Commission Number 001-13349)
3.1
Articles of Incorporation.
Articles as amended July 11, 1995, are incorporated by reference to Form S-14 filed with the Commission March 26, 1984 (Commission Number 2-90171).
3.2 Bylaws
Bylaws as amended are incorporated by reference to Form 10-K, Item 14(a)(3) filed with the Commission March 28, 2002.
(Commission Number 001-13349)
Material Contracts
10.1
Deferred Compensation Plans
Incorporated by reference to Form 10-K filed with the Commission March 31, 1987 (Commission Number 0-13666).
10.2
Supplemental Exeuctive Retirement Plan
adopted by the Board of Directors on
September 16, 2003, and effective as of
January 1, 2003, providing Joseph M.
Murphy, President and CEO of the
Company, Gerald Shencavitz, the
Company's Chief Financial Officer, and
Dean S. Read, former President of the
Bank, with certain defined retirement
benefits.
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.3 Joseph M. Murphy
Employment Contract Incorporated by reference to Form 10-K Item 15(a)(10.2), filed with the Commission May 27, 2003 (Commission File Number 001-13349)
10.4
Incentive Stock Option Plan 2000
Incorporated by reference to Form 10-K, Item 14(a)(3) filled with the Commission March 28, 2002 (Commission File Number 001-13349).
10.5
Amendment to Employment Agreement, Change in Control, Confidentiality and Non-competition Agreement between the Company and Joseph M. Murphy.
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.6
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Gerald Shencavitz.
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.7
Change in Control, Confidentiality, and Non-competition Agreement between the Company and former Bank President
Dean S. Read.
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.8
Purchase and Assumption Agreement between Bar Harbor Banking and Trust Company and Androscoggin Savings Bank, dated October 24, 2003.
Incorporated by reference to Form 10-Q, Part II, Item 6 filled with the Commission November 13, 2003 (Commission File Number 001-13349).
10.9
Executive Compensation Arrangements
Filed herewith
10.10
Infinex Aggeement
Filed herewith
10.11
Resignation Agreement and Release
Filed herewith
Annual Report to Shareholders
Filed herewith
Code of Ethics
Incorporated by reference to Form 10-K Item 15(a)(3)(14), filed with the Commission March 14, 2004 (Commission File Number 001-13349)
Subsidiaries of the Registrant
Filed herewith
Consent letters
Filed herewith
31.1
Certification of Chief Executive Officer under Rule 13a-14/15d-14(a)
Filed herewith.
31.2 Certification of Chief Financial Officer under Rule 13a-14/15d-14(a)
Filed herewith.
32.1
Certification of Chief Executive Officer under 18 U.S.C. Sec. 1350.
Filed herewith.
32.2 Certification of Chief Financial Officer under 18 U.S.C. Sec. 1350.
Filed herewith.
The Company’s management contracts and compensatory plans or arrangements consist of Exhibits 10.1 through 10.4 and 10.6.
(c) There are no other financial statements and financial statement schedules, which were excluded from this report, which are required to be included herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 16, 2005
BAR HARBOR BANKSHARES
(Registrant)
/s/ Joseph M. Murphy
Joseph M. Murphy
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons have signed this report in the capacities indicated on behalf of the Registrant.
/s/ Thomas A. Colwell
Thomas A. Colwell
Chairman, Board of Directors
/s/ Joseph M. Murphy
Joseph M. Murphy, Director
President and Chief Executive Officer
/s/ Robert C. Carter
Robert C. Carter, Director
/s/ Robert M. Phillips
Robert M. Phillips, Director
/s/ Peter Dodge
Peter Dodge, Director
/s/ Gerald Shencavitz
Gerald Shencavitz, Senior Vice President,
Chief Financial Officer and Treasurer
/s/ Martha Tod Dudman
Martha Tod Dudman, Director
/s/ Kenneth E. Smith
Kenneth E. Smith, Director
/s/ Dwight L. Eaton
Dwight L. Eaton, Director
/s/ Constance C. Shea
Constance C. Shea, Director
/s/ Cooper F. Friend
Cooper F. Friend, Director
/s/ Scott G. Toothaker
Scott G. Toothaker, Director
/s/ John P. McCurdy
John P. McCurdy, Director
/s/ David B. Woodside
David B. Woodside, Director