UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarter ended September 30, 1996 C ommission File No. 841105-D BAR HARBOR BANKSHARES Maine 01-0393663 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) P.O. Box 400, 82 Main Street, Bar Harbor, ME 04609-0400 (Address of principal executive offices) (Zip Code) Registrants's telephone number, including area code: (207) 288-3314 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES: XX NO: Indicate the number of shares outstanding of each of the issuer s classes of common stock as of September 30, 1996: Common Stock: 1,818,237 PAGE TABLE OF CONTENTS Financial Information Page Item I. Financial Statements Consolidated Balance Sheets 2 December 31, 1995 and September 30, 1996 Consolidated Statements of Earnings 3 Three months and nine months ended September 30, 1994, 1995 and 1996 Consolidated Statements of Changes in Stockholders Equity 4 Nine months ended September 30, 1995 and 1996 Consolidated Statements of Cash Flows 5 Nine months ended September 30, 1995 and 1996 Rate Volume Analysis 6 Nine months ended September 30, 1995 and 1996 Rate Sensitivity Report 7 As of September 30, 1996 Notes to Financial Statements 8-10 Item II. Management s Discussion and Analysis of Financial Condition and Results of Operations 11-14 Signature Page 15 PAGE BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF FINANCIAL CONDITION SEPTEMBER 30, 1996 AND DECEMBER 31, 1995 (UNAUDITED) SEPTEMBER 30 DECEMBER 31 1996 1995 ASSETS Cash and Due from Banks $10,697,921 $ 8,759,797 Federal Funds Sold 0 3,800,000 Investment Securities Securities Available for Sale, At market 24,357,033 19,885,555 Securities Held to Maturity (Market Value $83,312,478 in 1996 and $83,180,706 in 1995) 83,771,708 82,209,062 Total Investment Securities 108,128,141 102,094,617 Loans Held for Sale 163,151 68,326 Gross Loans 211,360,948 201,765,717 Allowance for possible Loan losses (4,287,650) (4,047,883) Net Loans 207,073,298 197,717,834 Premises and Equipment 7,547,748 6,219,569 Other Assets 8,423,844 7,948,556 TOTAL ASSETS 342,034,103 326,608,699 LIABILITIES AND STOCKHOLDERS EQUITY LIABILITIES Deposits Demand Deposits 40,093,949 32,394,610 NOW Accounts 39,541,940 38,300,119 Savings Deposits 55,907,356 53,660,526 Time, $100,000 and over 14,311,191 14,005,187 Other Time 107,127,970 113,110,959 TOTAL DEPOSITS 256,982,406 251,471,401 Securities sold under Repurchase Agreements 6,862,376 5,791,193 Advances from Federal Home Loan Bank 36,589,485 32,700,000 Other Liabilities 4,442,483 3,403,281 TOTAL LIABILITIES 304,876,750 293,365,875 Capital Stock, par value $2 Authorized 10,000,000 shares issued 1,818,237 in 1996 and 1,813,605 in 1995 3,636,474 3,627,210 Surplus 7,489,127 7,368,695 Retained Earnings 27,527,907 23,523,626 Net unrealized appreciation (Depreciation) on securities available for sale, net of tax, Benefit of $80,712 in 1996 and tax of $32,606 in 1995 (156,155) 63,293 Less: Cost of 100,000 shares Of Treasury Stock (1,340,000) (1,340,000) TOTAL STOCKHOLDERS EQUITY 37,157,353 33,242,824 TOTAL LIABILITIES AND STOCKHOLDERS EQUITY 342,034,103 326,608,699 The accompanying notes are an integral part of these consolidated financial statements PAGE BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF EARNINGS (UNAUDITED) THREE MONTHS THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS NINE MONTHS ENDING ENDING ENDING ENDING ENDING ENDING 09-30-96 09-30-95 09-30-94 09-30-96 09-30-95 09-30-94 Interest & Fees on Loans $5,150-807 $5,121,406 $4,205,264 $25,147,611 $14,330,622 $11,742,788 Interest & Dividends on Investment Securities: Taxable Interest Income 1,581,668 1,445,337 1,172,225 4,498,022 4,057,080 3,312,142 Non-taxable Interest Inc. 191,830 215,313 208,013 581,432 647,061 618,545 Dividends 88,910 77,982 116,949 260,781 286,046 265,482 Federal Funds Sold 5,933 41,790 3,706 22,916 91,141 31,159 Total Interest Income 7,019,148 6,901,828 5,706,157 20,510,762 19,411,950 15,970,116 Interest on Deposits 2,161,816 2,233,392 1,615,156 6,718,418 6,077,427 4,347,566 Interest in Short Term Borrowings 624,714 533,699 359,700 1,754,156 1,719,723 1,185,198 Total Interest Expense 2,786,530 2,767,091 1,974,856 8,472,571 7,797,150 5,533,764 Net Interest Income 4,232,618 4,134,737 3,731,301 12,038,191 11,614,800 10,436,352 Provision for Loan Losses 120,000 240,000 240,000 600,000 720,000 720,000 Net Interest Income after Provision for Loan Losses 4,112,618 3,894,737 3,491,301 11,438,191 10,894,800 9,716,352 Other Income 1,684,273 1,362,041 1,251,090 3,741,703 3,183,547 3,059,539 Investment Securities Gains 0 0 32,532 16,934 0 58,494 Other Expenses: Salaries & Emp. Benefits 1,467,981 1,245,330 1,321,864 4,265,530 3,639,676 3,749,390 Other 1,512,297 1,305,752 974,447 3,759,334 3,698,848 3,276,061 Investment Securities Losses 0 0 0 0 0 0 Income Before Income Taxes 2,816,613 2,705,696 2,478,612 7,171,964 6,739,813 5,808,934 Income Tax Expense 726,837 859,275 677,957 2,050,829 2,084,741 1,688,471 Net Income 2,089,776 1,846,421 1,800,655 5,121,135 4,655,082 4,120,463 Earnings per Share: Based on 1,709,835 Shares for 1994, 1,713,605 for 1995 and 1,718,237 Shares for 1996* $1.22 $1.08 $1.05 $2.98 $2.72 $2.41 Dividends per Share $0.25 $0.00 $0.00 $0.65 $0.36 $0.30 *Earnings per share have been restated in 1994 to reflect a five-for-one stock split declared July 11, 1995. PAGE BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY QUARTERS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED) NET UNREA- NET LIZED LOSS STOCK- CAPITAL RETAINED TREASURY ON EQUITY HOLDERS STOCK SURPLUS EARNINGS STOCK SECURITIES EQUITY Balance, 12/31/94 $3,619,670 $7,314,408 $19,118,678 ($1,340,000) 48,027 $28,760,783 Net Earnings 4,655,082 4,655,082 Cash Dividends Declared (616,897) (616,897) Net Unrealized appreciation on securities available for sale, net of tax of $44,067 37,516 37,516 Sale of Stock (3,770 Shares) 7,540 54,288 61,828 Balance, 9/30/95 $3,627,210 $7,368,696 $23,156,863 ($1,340,000) $85,543 $32,898,312 Balance, 12/31/95 3,627,210 7,368,695 23,523,626 (1,340,000) 63,293 33,242,824 Net Earnings 5,121,135 5,121,135 Cash Dividends Declared (1,116,854) (1,116,854) Net Unrealized Depreciation on Securities Available for Sale, Net of Tax benefit of $80,712 37,516 37,516 Sale of Stock (4,632 Shares) 9,264 120,432 0 0 0 129,696 Balance, 9/30/96 $3,636,474 $7,489,127 $27,527,907 ($1,340,000) ($156,155) $37,157,353 The accompanying notes are an integral part of these consolidated financial statements. PAGE BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) SEPTEMBER 30, SEPTEMBER 30 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 5,121,135 $ 4,655,082 ADJUSTMENTS TO RECONCILE NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES: DEPRECIATION 566,161 436,354 PROVISION FOR LOAN LOSSES 600,000 720,000 PROVISION FOR LOSSES ON OTHER REAL ESTATE OWNED (4,664) 9,778 NEW LOANS ORIGINATED FOR SALE (7,108,320) (5,422,883) PROCEEDS FROM SALE OF MORTGAGES HELD FOR SALE 7,028,603 5,442,126 GAIN ON SALE OF MORTGAGES ORIGINATED FOR SALE (15,108) (19,243) NET SECURITIES GAINS (16,934) 0 NET AMORTIZATION OF BOND PREMIUM 224,207 137,185 NET CHANGE IN OTHER ASSETS (287,745) (556,533) NET CHANGE IN OTHER LIABILITIES 1,039,202 53,020 NET CASH PROVIDED BY OPERATING ACTIVITIES 7,146,537 5,454,886 CASH FLOWS FROM INVESTING ACTIVITIES: PURCHASES OF SECURITIES HELD TO MATURITY (13,636,697) (20,927,848) PROCEEDS FROM MATURITY & PRINCIPAL PAYDOWNS OF SECURITIES HELD TO MATURITY 6,481,601 6,276,134 PROCEEDS FROM CALL OF SECURITIES HELD TO MATURITY 5,420,608 5,750,000 PURCHASES OF SECURITIES AVAILABLE FOR SALE (5,503,125) (1,997,188) PROCEEDS FROM MATURITY & PRINCIPAL PAYDOWNS OF SECURITIES AVAILABLE FOR SALE 148,128 4,549 PROCEEDS FROM CALL OF SECURITIES AVAILABLE FOR SALE 500,000 0 NET LOANS MADE TO CUSTOMERS (10,009,102) (13,582,338) CAPITAL EXPENDITURES (1,894,340) (1,043,719) NET CASH USED IN INVESTING ACTIVITIES (18,492,928) (25,520,410) CASH FLOWS FROM FINANCING ACTIVITIES: NET CHANGE IN SAVINGS, NOW AND DEMAND DEPOSITS 11,187,990 2,224,501 NET CHANGE IN TIME DEPOSITS (5,676,985) 28,215,467 NET CHANGE IN REPURCHASE AGREEMENTS 1,071,183 9,403,755 PURCHASE OF ADVANCES FROM FHLB 33,000,000 19,000,000 REPAYMENT OF ADVANCES FROM FHLB (13,000,000) (20,000,000) NET CHANGE IN OTHER SHORT TERM BORROWED FUNDS (16,110,515) (16,000,000) PROCEEDS FROM SALE OF CAPITAL STOCK 129,696 61,828 PAYMENT OF DIVIDENDS (1,116,854) (616,898) NET CASH PROVIDED BY FINANCING ACTIVITIES 9,484,515 22,288,653 NET INCREASE IN CASH AND CASH EQUIVALENTS (1,861,876) 2,223,129 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 12,559,797 9,714,713 CASH AND CASH EQUIVALENTS AT END OF QUARTER 10,6977921 11,937,842 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: CASH PAID DURING THE YEAR FOR INTEREST 8,533,008 7,708,377 INCOME TAXES 1,450,000 2,026,679 NON-CASH TRANSACTIONS: TRANSFER FROM LOANS TO REAL ESTATE OWNED (OTHER A 193,000 186,000 See accompanying notes to Consolidated Financial Statements PAGE RATE VOLUME ANALYSIS The following table represents a summary of the changes in interest earned and interest paid as a result of changes in rates and changes in volumes. For each category of earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to change in rate (change in rate multiplied by old volume) and change in volume (change in volume multiplied by old rate). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. YEAR-TO-DATE FIGURES AS OF SEPTEMBER 30, 1996 COMPARED TO SEPTEMBER 30, 1995 INCREASES (DECREASES) DUE TO: VOLUME RATE NET LOANS $ 853,768 ($36,779) $816,989 TAXABLE SECURITIES 545,049 (129,372) 415,677 TAX EXEMPT SECURITIES (57,057) (8,572) (65,629) FEDERAL FUNDS SOLD AND MONEY MARKET FUNDS (58,848) (9,377) (68,225) TOTAL EARNING ASSETS $1,282,912 (184,100) $1,098,812 DEPOSITS $357,112 283,876 640,988 BORROWINGS $116,955 (82,522) 34,433 TOTAL INTEREST BEARING LIABILITIES $474,067 $201,354 $675,421 NET CHANGE IN INTEREST $808,845 ($385,454) $423,391 YEAR-TO-DATE FIGURES AS OF SEPTEMBER 30, 1995 COMPARED TO SEPTEMBER 30, 1994 INCREASES (DECREASES) DUE TO: VOLUME RATE NET LOANS $1,588,681 $ 999,153 $2,587,834 TAXABLE SECURITIES $ 411,623 $ 353,879 765,502 TAX EXEMPT SECURITIES $ 900 $ 27,616 28,516 FEDERAL FUNDS SOLD AND MONEY MARKET FUNDS $ 38,677 $ 21,305 59,982 TOTAL EARNING ASSETS $2,039,881 $1,401,953 $3,441,834 DEPOSITS $ 574,059 $1,155,802 1,729,861 BORROWINGS $ 49,653 $ 483,872 533,525 TOTAL INTEREST BEARING LIABILITIES $ 623,712 $1,639,674 $2,263,386 NET CHANGE IN INTEREST $1,416,169 ($237,721) $1,178,448 PAGE INTEREST RATE SENSITIVITY ANALYSIS AS OF SEPTEMBER 30, 1996 (UNAUDITED) Amounts in Thousands The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at September 30, 1996 which are anticipated by the Bank, based upon certain assumptions, to reprice or mature in each of the future time periods shown. ONE TO GREATER TOTAL TO FIVE THAN FIVE ONE YEAR YEARS YEARS TOTAL Loans - Fixed Rate $ 10,064 $ 30,346 $ 22,885 $ 63,295 Loans - Variable Rate 120,941 22,110 2,036 145,087 Investments 42,025 41,622 24,479 108,126 Federal Funds Sold 0 0 0 0 Interest Rate Swap/Floor 0 15,000 0 15,000 Total Earning Assets $173,030 $109,078 $ 49,400 $331,508 Deposits $139,010 $ 18,867 $ 99,026 $256,903 Repurchase Agreements 6,789 0 1,135 7,924 Borrowings 25,681 10,908 0 36,589 Interest Rate Swap/Floor 5,000 10,000 0 15,000 Total Sources $176,480 $ 39,775 $100,161 $316,416 Net Gap Position ($3,450) $ 69,303 ($50,761) $ 15,092 Cumulative Gap ($3,450) $ 65,853 $15,092 $ 15,092 Except as stated below, the amounts of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual terms of the asset or liability. The Bank has assumed that 4% of its savings is more rate sensitive and will react to rate changes, and has therefore categorized it in the 3-12 month time horizon. The remainder is stable and is listed in the greater than five year category. NOW accounts, other than seasonal fluctuations approximating $4,000,000, are stable and are listed in the greater than five year category. Money market accounts are assumed to reprice in three months or less. Certificates of deposit are assumed to reprice at the date of contractual maturity. Fixed rate mortgages, totaling $40,000,000 are amortized using the weighted average maturity of 143 months, with an additional prepayment rate of 9%, which approximates the Bank s prior experience. PAGE NOTES TO FINANCIAL STATEMENTS DATED SEPTEMBER 30, 1996 1. Summary of interim financial statement adjustments. The accompanying unaudited statements reflect all adjustments (all of which are normal and recurring in nature) which are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented. The financial statements should be read in conjunction with the Consolidated Financial Statements and related Notes included in the Bank s 1995 Annual Report. SEPTEMBER 30, 1996 CARRYING MARKET VALUE VALUE 2. INVESTMENT SECURITIES: a. U.S. Treasury and other Government agencies $ 79,180,491 $ 78,065,735 b. States of the U.S. and other Political subdivisions 12,771,113 13,142,754 c. Other securities 16,412,392 16,461,022 Total Securities $108,363,996 $107,669,511 Securities held to maturity 83,771,108 83,312,478 Securities available For sale 24,592,888 24,357,033 The Bank does not hold any securities for a single Issuer which exceed 10% of the Bank s stockholders equity. September 30, December 31, 1996 1995 3. LOANS a. Commercial, agricultural And other loans $43,914,307 $40,190,313 b. Real Estate - Construction 8,750,023 8,072,230 c. Real Estate - Mortgage 141,926,931 135,862,776 d. Installment loans 16,769,687 17,640,398 Total Loans $211,360,948 $201,765,717 4. CHANGES IN ALLOWANCE FOR POSSIBLE LOAN LOSSES: September 30, September 30 1996 1995 Balance, beginning January 1: $ 4,047,883 $ 3,891,835 Provision charged to income 600,000 720,000 Recoveries of amounts charged 100,840 78,144 Losses charged to provision 461,073 464,264 Balance, ending September 30: $ 4,287,650 $ 4,225,715 PAGE Information regarding impaired loans is as follows for September 30, 1996: Average investment in impaired loans $ 1,375,683 Interest income recognized on impaired loans, including interest income recognized on cash basis 107,730 Interest income recognized on impaired loans on cash basis 107,730 Balance of impaired loans` 1,604,919 Less portion for which no allowance for loan losses is allowed 0 Portion of impaired loan balance for which An allowance for credit losses is allocated 1,604,919 Portion of allowance for loan losses allocated to the impaired loan balance 124,598 5. CHANGES IN ALLOWANCE FOR OTHER REAL ESTATE: 9/30/96 9/30/95 9/30/94 Balance, beginning Jan. 1 $26,000 $30,486 $ 53,286 Provision charged to income (4,664) 9,778 1,800 Losses charged to provision 21,336 15,110 24,600 Balance, ending Sept. 30 $ 0 $25,154 $ 30,486 6. The aggregate dollar amount of loans made to directors, executive officers or principal holders of equity securities as of September 30, 1996 and December 31, 1995 respectively were: Aggregate amount, beginning 1-1 $3,279,479 $ 3,409,868 New Loans 294,012 349,935 Repayments 63,576 480,324 Aggregate amount, ending 9-30-96 $3,509,915 Aggregate amount, ending 12-31-95 $ 3,279,479 7. OTHER ASSETS: September 30, December 31 1996 1995 a. Interest earned but Not paid on: Loans $ 1,513,648 $ 1,471,216 Investments 1,253,210 1,008,678 b. Other Real Estate Owned 275,744 443,652 PAGE 8. INCOME TAXES: The Company adopted Financial Accounting Standards No. 109 Accounting for Income Taxes effective January 1, 1993. The standard requires adoption of a liability method of accounting for income taxes. The accounting change had no effect on the company s net income or retained earnings. Components of income tax expense for the period ended September 30, 1996 are as follows: Current Federal $2,215,053 State 68,036 $2,283,089 Deferred (232,260) $2,050,829 Actual tax expense differs from the expected tax expense computed by applying the applicable federal corporate income tax rate of 34% is as follows for the nine months ended September 30, 1996: Computed tax expense $2,240,987 Tax exempt interest (240,264) Other 50,106 $2,050,829 At September 30, 1996, items giving rise to the deferred income tax assets and liabilities, using a tax rate of 34%, are as follows: ASSET LIABILITY Allowance for possible loan losses On loans and real estate owned $1,295,759 Deferred and accrued employee benefits 916,960 Deferred loan origination fees 78,123 Securities losses not currently Deductible 0 Core deposit intangibles 92,439 Depreciation 51,244 Other 25,935 $2,460,460 $0 No valuation allowance is deemed necessary for the deferred tax asset. 9. INCOME TAX EXPENSE: 1996 1995 Federal Income Tax $1,982,793 $2,018,482 State Income Tax 68,036 66,259 PAGE MANAGEMENT S DISCUSSION AND ANALYSIS The results of operations for September 30, 1996 are reflected through the growth in the balance sheet. Total assets grew by more than $18,000,000 in 1996 and $30,000,000 in 1995 each compared to the previous year s third quarter end. The major changes are found in the investment and loan portfolios. The investment portfolio growth of just under $6,000,000 has predominantly been in the area of US Government agency debentures. The most recent purchases totaling $2,500,000, have been callable securities with two or three years of call protection and final maturities of 10 years. These, like other longer term government sponsored securities have been placed in the available for sale portion of the portfolio. In addition, when comparing September 30, 1996 to September 30, 1995, the Bank s available for sale portfolio has changed by the one-time transfer of securities at market value totaling $5,600,000 in accordance with the Financial Accounting Standards Board implementation guidance issued in November of 1995. The Bank s available for sale portfolio also includes $5,400,000 in Federal Home Loan Bank stock. Ownership of stock is required by the FHLB for participation in their funding programs. The market value of the held to maturity portion of the portfolio is $460,000 less than the book value, with the AFS portfolio market value at $226,000 less than the book value. The potential for loss, if the entire investment portfolio of the Bank were sold as of September 30, 1996, would be a loss of less than one-half of one percent of the book value of the portfolio. The appreciation of net unrealized gains to $85,500 as of September 30, 1995 was gradual in line with the increase in the market. The market value of the entire portfolio, which was approximately $470,000 greater than the book value, had risen in 1995, following national economic trends including lower interest rates. The Bank does not hold any securities (such as structured debt tied to multiple indices, interest only or principal only securities) that may experience considerable change in their market values by a greater degree than traditional debt and could materially affect the entire portfolio. It does hold one structured note, a 10-year step-up government agency debenture, which steps annually by 1/8 of 1% after 3 years during which time it is earning 7%. The taxable portion of the Bank s securities have been earning 7.10 for the first nine months of 1996, a reduction of only 7 basis points since September 30, 1995. In the loan portfolio, which has grown by $12,000,000 (6.2%) in the past twelve months, the Bank s concentration has been through the extension of loans secured by real estate to its consumer customers totaling $8,000,000 more than one year ago. This compares to 1995's growth of $16,000,000 (8.8%) in loan growth, with $11,000,000 being secured by real estate and granted to the Bank s consumer customers. The Bank continues to experience strong competition from other financial institutions in its market area. During 1996, the funding for the asset growth has come from borrowings primarily through the Federal Home Loan Bank. Total advances increased by $28,000,000 and include $12,000,000 in longer term borrowings as funding for certain specific commercial credits. The Bank had found it cheaper to solicit deposits in 1995 as competitive deposit rates were below other options of funding sources. The Bank increased i t s deposit by $23,000,000, predominantly in interest bearing certificates of deposit promotions. Likewise, as opportunities surfaced to attract lower cost deposits and repurchase agreements, advances from the Federal Home Loan Bank decreased in 1995 by $7,000,000. During both years, short term borrowings were reduced through seasonal deposit growth, investment maturities and/or calls and principal paydowns from the Bank s mortgage backed securities portfolio. Liquidity is measured by the Bank s ability to meet cash needs at a reasonable cost or minimum loss to the Bank. Liquidity management involves the ability to meet cash flow requirements of its customers, which may come from depositors withdrawing funds or borrowers requiring funds to meet credit needs. Without adequate liquidity management, the Bank would not be able to meet the needs of the individuals and communities it serves. The Bank utilizes a Basic Surplus/Deficit model to measure its liquidity over a 30-day and a 90-day time horizon. We e x a mine the relationship between liquid assets and short term liabilities which are vulnerable to non-replacement within a 30-day period. The 90-day analysis extends to include a projection of subsequent cash flow funding needs over an additional 60-day time horizon. The Bank s policy is to maintain its liquidity position at a minimum of 5% of total assets. For the past twelve months, the Bank has maintained liquidity in its balance sheet in excess of 9.9%. Liquidity as measured by the Basic Surplus/Deficit model was 15% for the 30-day horizon and 10.8% for the 90-day horizon as of September 30, 1996. How the changes in the balance sheet have affected the Bank may be viewed through the earnings statement for the periods ending September 30, 1994, 1995 and 1996. Overall, the net earnings for the Bank are $466,000 ahead of last year s first nine months earnings which represents a 10% increase. Net interest income for the first nine months of 1996 has added strong earnings and is affected by rates, volumes and the mix of earning assets and interest bearing liabilities. Interest income earned from loans increased in 1996 by $850,000 due to volumes of loans with a small reduction in earnings of $37,000 due to changes in rates. Overall yields from the loan portfolio remained within 5 basis points of 1995's yields. In 1995, increases in the loan portfolio afforded the Bank additional interest income of $1,590,000 due to increases in volumes, with further increases of $1,000,000 due to changes in rates. The Bank had increased its base lending rate by 75 basis points between September 30, 1994 and September 30, 1995. Although only a portion of loans are immediately affected by changes in the Bank s base rate, the effect of the increase has over time increased the yields in the portfolio. The commercial real estate rate for variable rate mortgages increased as well in 1995 and by 100 basis points since September 30, 1994. As the loans in that portion of the portfolio, totaling over $50,000,000 in mortgages, reached their annual anniversary dates, the yield improved the overall yield for loans. Loan yields increased by 99 basis points between September 30, 1995 and 1994 and represented the first increase in several years. Similar to the loan portfolio for 1996, the investment interest increased by virtue of purchases (totaling $429,000); however, as rates remained flat and with larger coupons maturing the portfolio experienced decreases due to rate changes totaling $147,000. Overall the yield on investments has dropped the same as the loan yield, 5 basis points from year to year. For 1995, interest on investments increased both due to volumes ($451,000) and to increased rates ($403,000). Similar to the loan yields, 1995 was the first year in several in which the overall investment yield increased rather than decreased. Yields on investments increased by 24 basis points during 1995 compared with 43 basis point drops in 1994. With the Bank well matched in the repricing of its balance sheet, the funding costs followed a similar pattern as is described above for loans and investments. In 1996, the cost of deposits rose based on volumes ($357,000) and rates ($284,000) while the cost of borrowed funds increased due to volumes $117,000) but decreased by $82,500 because of rate changes. Reference is made to the earlier discussion that the Bank elected to fund its asset growth through borrowings instead of deposits. The cost of deposits increased by 21 basis points whereas the cost of borrowings decreased by 26 basis points. The overall net interest income for 1996 is $423,000 more than for the first nine months of 1995. Looking at 1995, however, the cost of deposited funds increased from September 1994 to 1995 by 78 basis points. Additionally rates rose on borrowed funds during the same period by over 117 basis points. These two factors increased the cost of interest bearing liabilities by $2,263,000 in 1995. Due to the increase in borrowed funds costs, the Bank elected to promote certificates of deposit early in 1995, locking in acceptable rates for the Bank which were lower than alternative sources of funding. With increases on both sides of the balance sheet, the net effect on the Bank s earnings remained strong with its net interest income totaling $1,178,000 more in 1995 than in 1994. With regard to interest rate sensitivity, the Bank is positioned favorably for the current interest rate cycle with $3,500,000 more of its liabilities repricing within a year when compared to its assets. Based on simulations, if interest rates were to rise by 200 basis points and if the Bank were to maintain the balance sheet as it today, the Bank would experience virtually no change in its net interest income ($88,000 increase) in the next two years. If rates were to drop by 200 basis points, the Bank would only see a reduction in its net interest income of $193,000. Neither change in rates (up or down) would indicate interest rate risk concerns for the Bank. Due to changes in the methodology used for computing the reserve for possible loan losses and due to the recessionary nature of the economy in the early 1990's, the Bank increased its ratio to gross loans to over 2% and has maintained that reserve to loan ratio through September 30, 1996. The Bank reviews its allocation to the reserve on a monthly basis and funds the reserve as deemed necessary. The review includes a provision for specific credits, provisions due to historic l o a n l osses by loan types and reserved reflecting industry concentrations, credit concentrations, current economic conditions and underwriting standards. In 1995, the Bank added a provision for impaired loans in accordance with FASB 114, Accounting by Creditors for Impairment of a Loan , as amended by Statement No.118. A loan is impaired when it is probable that the Bank will not collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are loans that are carried on a non-accrual status. Loans are returned to accrual status and are no longer considered to be impaired when they become current as to principal and interest or demonstrate a period of performance under the contractual terms, and in management s opinion are fully collectable. Certain loans are exempt from the provisions including large groups of smaller balance homogenous loans that are collectively evaluated for impairment, such as consumer and residential mortgage loans. Impaired loans totaled $1,604,919 and $1,041,882 at September 30, 1996 and 1995, respectively. Reference is made to the notes included with this filing that outline the impaired loan figures. Losses in the loan portfolio were estimated at $840,000 for 1996, with charged off loans totaling $461,000 for the first nine months of this year. Losses for 1995 were originally estimated at $950,000 with $464,000 charged off through September 30, 1995, compared to $337,000 charged off in the first nine months of 1995. The amounts represented below are the total dollars outstanding for the first nine months of each year listed. Category 1996 1995 1994 90-day past due and still accruing $ 830,532 $ 711,943 $ 645,920 Non-accruing 3,557,518 2,584,343 2,627,314 Gross loans 211,360,948 199,190,024 175,399,428 Percentage of gross loans 2.08% 1.65% 1.87% A review of the Bank s non-interest income shows the first nine months of 1996 ahead of the same period for 1995 by $558,000. $2300,000 of that pertains to the Trust Department s charge to its customers of scheduled fees. These fees are based on increased book assets of almost $25,000,000 and are based on the market value of total assets per account. In addition, as of January 1, 1996, the Bank implemented FASB Statement No. 122, Accounting for Mortgage Servicing Rights that has positively impacted the Bank s earnings by $126,000 year to date. A non- recurring entry of $278,000 in the form of an insurance payoff from a policy written on certain key persons in the Bank. Robert Avery, director and former president of the Bank, passed away in August of 1995 resulting in this one-time tax deductible payment. In 1995, non-interest earnings were $124,000 ahead of the same period in 1994, which was attributable to the Trust Department s scheduled fees based on increased book assets of more than $18,000,000. In 1994, the Bank experienced a modest increase in non-interest income of $70,000 more than the previous year. Accruing for an incentive program reflects the increase in salary and benefit costs in 1996 over 1995. Although the program is not new to the Bank in 1996, this is the first year that the dollars have been allocated prior to year end. Excluding the accrual, salary and benefits would be 1.6% higher than the first nine months of 1995. Salary and employee benefits for 1995 are actually three percent below 1994's expense and compare favorably with 1994 which shows a $435,000 (or 13%) increase over 1993. The increase in 1994 represents merit increases in compensation of 5% and costs incurred with the addition of a deferred plan for certain senior officers (Messrs. Reeves, Eaton, Goldthwait and MacDonald) in light of the termination of the defined benefit pension plan. Other expense for the first nine months of 1996 is above the comparable period in 1996 by $60,000 or 1.6%. A portion of that containment of costs is attributable to the temporary relief from FDIC insurance premiums. As a well-capitalized bank, Bar Harbor Banking and trust Company has not been required to pay premiums this year. As of September 30, 1995, the bank had incurred $240,000 in FDIC premiums. In the fourth quarter of 1995, the Bank sought the services of a consulting firm to review existing procedures, seeking greater efficiencies while maintaining quality customer service. The Bank incurred approximately $120,000 in expenses for these services during the first nine months of 1996 as the project was being completed. Additionally, the Bank is involved in numerous project, including item and document imaging, the conversion of its banking software to a client server model created by its current software vendor, the building of an operations center to house the loan, deposit, credit card and item processing operations of the Bank. Startup and non-recurring costs for these projects are included in the other expenses through September 30, 1996. W i th regard to other expense for 1995, expenses totaling $3,700,000 compared more with 1993's expenses of $3,560,000 than those of 1994. 1994 marked a year in which other expenses actually went down by $285,000 when compared to 1993. During 1993, the Bank took losses on properties owned which resulted from loan problems totaling $264,000. There were no comparable losses in either 1994 or 1995. There was no one category of expense which exceeded $50,000 in increased expenditures in 1995. The Trust Department had recently outsourced its tax preparation f o r customers and the initial outlay for that operation was approximately $44,000. Fees are now being generated from Trust customers and are reflected in the income earned by the Trust Department as discussed earlier. The Bank s year-to-date efficiency ratio is 55% remains consistent with the 1995 ratio and is well under the national average. Subsequent to September 30, 1996, the Bank was examined by the Bureau of Banking for the Sate of Maine with a safety and soundness audit and there were no recommendations made which would have a material effect on the registrant s capital resources, liquidity or operating earnings. The Bank s capital to asset ratio is 10.86% and the Bank far exceeds the required risk based capitol ratio of 8% with its Tier I ratio of 17.0%, total capital ratio of 18.25% and leverage ratio of 10.63%. Using the risk based capital formula, the Bank has capital in excess of requirements of $21,757,000. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BAR HARBOR BANKSHARES Sheldon F. Goldthwait, Jr. /s/ Date: November 12, 1996 Sheldon F. Goldthwait, Jr. President Virginia M. Vendrell /s/ Date: November 12, 1996 Virginia M. Vendrell S e n ior Vice President, Treasurer and Chief Accounting Officer PAGE