UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 12 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 1997. Commission File No. 841105-D BAR HARBOR BANKSHARES MAINE 01- 0393663 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) Bar Harbor, Maine 04609- 0400 (Address of principal executive (ZIP Code) offices) Registrant'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 June 30, 1997: Common Stock: 1,820,583 TABLE OF CONTENTS Page Financial Information Item 1. Financial Statements Consolidated Balance Sheets 3 December 31, 1996, and June 30, 1997 Consolidated Statements of Earnings Three months and six months ended June 4 30, 1996 and 1997 Consolidated Statements of Changes in Stockholders' Equity three months and 5 six months ended June 30, 1996 and 1997 Consolidated Statement of Cash Flows Six months ended June 30, 1996 and 1997 6-7 Rate Volume Analysis Six months ended June 30, 1996 and 1997 8 Rate Sensitivity Report As of June 30, 1997 9 Notes to Financial Statements 10-12 Item 2 Management's Discussion and Analysis of 13-17 Financial Condition and Results of Operations Signature Page 18 BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF FINANCIAL CONDITION JUNE 30, 1997 AND DECEMBER 31, 1996 June 30 December 31 1997 1996 ASSETS Cash and Due from Banks $10,967,452 $11,298,408 Federal Funds Sold 0 2,000,000 Securities available for sale, at 20,449,694 19,384,433 market Securities held to maturity (Market Value $77,053,468 in 76,824,499 82,716,836 1997 and $85,503,679 in 1996 Other Securities 5,902,269 5,623,639 Loans held for sale 0 336,540 Loans, Net of Allowance for possible loan losses of 217,086,864 207,667,053 $4,434,409 in 1997 and $4,249,128 in 1996 Premises and Equipment 7,787,540 7,498,046 Other Assets 9,116,344 8,617,790 TOTAL ASSETS $348,134,66 $345,142,74 2 5 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Demand Deposits $36,291,238 $35,918,779 NOW Accounts 39,196,729 40,529,509 Savings Deposits 50,681,982 53,085,062 Time, $100,000 and over 13,437,596 14,611,616 Other Time 107,623,891 107,530,192 Total Deposits 247,231,436 251,675,158 Securities Sold Under Repurchase 2,046,970 8,246,079 Agreements Advances from Federal Home Loan 55,039,377 43,908,263 Bank Other Liabilities 3,879,749 3,426,320 Total Liabilities 308,197,532 307,255,820 COMMITMENTS AND CONTINGENT LIABILITIES Capital Stock, Par Value $2 Authorized 10,000,000 shares Issued 1,820,583 in 1997 and 1,818,237 in 1996 3,641,166 3,636,474 Surplus 7,574,170 7,489,127 Retained Earnings 30,195,837 28,204,829 Net Unrealized Appreciation on Securities available for sale, Net (134,043) (103,505) of Tax Benefit of $69,110 in 1997 and $53,321 in 1996 Less: Cost of 100,0006 shares of (1,340,000) (1,340,000) Treasury Stock TOTAL STOCKHOLDERS' EQUITY 39,937,130 37,886,925 TOTAL LIABILITIES AND STOCKHOLDERS'S $348,134,66 $345,142,74 EQUITY 2 5 The accompanying notes are an integral part of these consolidated financial statements. BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF EARNINGS (Unaudited) THREE THREE SIX SIX MONTHS MONTHS MONTHS MONTHS ENDING ENDING ENDING ENDING 06/30/97 06/30/96 06/30/97 06/30/96 Interest & Fees on Loans $5,176,33 $4,994,29 $10,202, $9,996,8 2 7 751 04 Interest & Dividends on Investment Securities: Taxable Interest 1,614,552 1,448,225 3,210,24 2,916,35 Income 4 4 Non-taxable 167,004 194,126 346,569 389,602 Interest Inc. Dividends 99,069 86,373 195,077 171,871 Federal Funds Sold 4,943 11,790 14,126 16,983 TOTAL INTEREST INCOME $7,061,90 6,734,811 13,968,7 13,491,6 0 67 14 Interest on Deposits 2,142,907 2,249,523 4,281,78 4,556,59 1 9 Interest in Short Term 844,163 619,500 1,570,24 1,129,44 Borrowings 2 2 TOTAL INTEREST EXPENSE 2,987,070 2,869,023 5,852,02 5,686,04 3 1 Net Interest Income 4,074,830 3,865,788 8,116,74 7,805,57 4 3 Provision for Loan Losses 180,000 240,000 360,000 480,000 Net Interest Income after Provision for Loan 3,894,830 3,625,788 7,756,74 7,325,57 Losses 4 3 Other Income 1,111,764 1,056,003 2,138,60 2,057,43 3 0 Investment Security Gains 16,934 0 16,934 Other Expenses: Salaries & Employee 1,429,951 1,395,727 2,889,45 2,797,54 Benefits 7 9 Other 1,498,982 1,137,597 2,553,90 2,247,03 7 7 Investment 0 0 55,854 0 Securities Losses Income Before Income 2,077,661 2,165,401 4,396,12 4,355,35 Taxes 9 1 Income Tax Expense 663,231 656,292 1,407,18 1,323,99 4 2 NET INCOME $1,414,43 $1,509,10 $2,988,9 $3,031,3 0 9 45 59 PER COMMON SHARE DATA, BASED ON 1,718,237 SHARES FOR 1996, AND 1,720,583 $0.82 $0.88 $1.74 $1.76 FOR 1997 DIVIDENDS PER SHARE $0.30 $0.20 $0.58 $0.40 The accompanying notes are an integral part of these consolidated financial statements. BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY QUARTERS ENDED JUNE 30, 1996, AND 1997 NET NET UNREA- STOCK- CAPITAL RETAINED LIZED TREASURY HOLDERS STOCK SURPLUS EARNINGS LOSS STOCK ' ON EQUITY EQUITY SECURIT IES Balance, 12/31/95 $3,627,2 $7,368,6 $23,523, $63,293 $(1,340, $33,242 10 95 626 000) ,824 Net Earnings 3,031,35 3,031,3 9 59 Cash Dividends Declared (687,295 (687,29 ) 5) Net unrealized depreciation on Securities (236,54 (236,54 Available for Sale, 9) 9) Net of Tax of $89,253 Sale of Stock (4,632 9,264 120,432 129,696 shares) Balance, 06/30/96 $3,636,4 $7,489,1 $25,867, ($173,2 ($1,340, $35,480 74 27 690 56) 000) ,035 Balance 12/31/96 $3,636,4 $7,489,1 $28,204, ($103,5 ($1,340, $37,886 74 27 829 05) 000) ,926 Net Earnings 2,988,94 $2,988, 5 945 Cash dividends declared (997,938 ($997,9 ) 38) Net unrealized depreciation on securities (30,538 ($30,53 available for sale, ) 8) net of tax benefit of $15,751 Sale of Stock (2,346 4,692 85,043 $89,735 shares) Balance 06/30/97 $3,641,1 $7,574,1 $30,195, ($134,0 ($1,340, $39,937 66 70 836 43) 000) ,130 The accompanying notes are an integral part of these consolidated financial statements. BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) JUNE 30, JUNE 30, 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $2,988,9 $3,031,35 45 9 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 442,793 329,704 Provision for Loan Losses 360,000 480,000 Provision for Losses on Other Real 0 (2,510) Estate Owned New Loans Originated for Sale (1,738,4 (5,687,09 90) 0) Proceeds from Sale of Mortgages 2,153,54 5,597,589 Held for Sale 9 Gain on Sale of Mortgages (50,412) (11,929) Originated for Sale Net Securities Gains 55,852 (16,934) Net Amortization of Bond Premium 53,826 195,777 (Gain) Loss on Sale of Premises 0 0 and Equipment Net Change in Other Assets (459,495 (862,617) ) Net Change in Other Liabilities 453,429 59,735 Net Cash Provided by Operating Activities 4,259,99 3,113,083 7 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of Securities Held to Maturity (7,675,4 (13,636,6 21) 97) Proceeds from the Maturity & Principal Paydowns 9,263,93 4,137,496 of Securities Held to Maturity 8 Proceeds from Call of Securities Held to 4,250,00 5,420,608 Maturity 0 Purchases of Securities Available for Sale (1,250,0 (3,001,87 00) 5) Proceeds from the Maturity & Principal Paydowns 78,385 110,710 of Securities Available for Sale Proceeds from Call of Securities Available 60,021 500,000 for Sale Purchases of Other Securities (453,700 0 ) Proceeds from Sales of Other Securities 119,218 0 Net Loans Made to Customers (9,831,1 (7,054,43 87) 7) Capital Expenditures (732,287 (1,092,82 ) 0) Proceeds from Sale of Fixed Assets 0 0 Net Cash Used in Investing Activities (6,171,0 (14,617,0 33) 15) CASH FLOWS FROM FINANCING ACTIVITIES: Net Change in Savings, NOW and Demand (3,363,4 (4,185,46 Deposits 01) 7) Net Change in Time Deposits (1,080,3 1,940,668 21) Net Change in Repurchase Agreements (6,199,1 (1,320,49 09) 9) Purchase of Advances from FHLB 13,500,0 15,000,00 00 0 Repayment of Advances from FHLB (15,000, (4,000,00 000) 0) Net Change in Other Short Term Borrowed 12,631,1 1,217,151 Funds 14 Proceeds of Sale from Capital Stocks 89,735 129,696 Payments of Dividends (997,938 (687,295) ) NET CASH PROVIDED BY FINANCING ACTIVITIES (419,920 8,094,254 ) NET INCREASE (DECREASE) IN CASH AND CASH (2,330,9 (3,409,67 EQUIVALENTS 56) 7) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 13,298,4 12,559,79 08 7 CASH AND CASH EQUIVALENTS AT END OF QUARTER $10,967, $ 452 9,150,120 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash Paid During the Year for: Interest $5,853,7 $5,715,65 80 3 Income Taxes, Net of Refunds $1,041,0 $1,362,00 00 0 NON-CASH TRANSACTIONS: Transfer from loans to Real Estate Owned $0 $ (Other Assets) 155,000 Transfer of Securities from Held to Maturity to 0 0 Available for Sale The accompanying notes an integral part of these Consolidated Financial Statements 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 JUNE 30, 1997 COMPARED TO JUNE 30, 1996 INCREASES (DECREASES) DUE TO: VOLUME RATE NET Loans $580,385 ($374,438 $205,947 ) Taxable Securities 130,824 186,272 317,096 Tax Exempt Securities (44,814) 1,781 (43,033) Federal Funds Sold and Money Market Funds (3,319) 462 (2,857) Total Earning Assets $663,076 ($185,923 $477,153 ) Deposits ($44,857) ($229,961 ($274,818 ) ) Borrowings $385,631 $55,169 $440,800 Total Interest Bearing Liabilities $340,774 ($174,792 $165,982 ) Net change in interest $322,302 ($11,131) $311,171 YEAR-TO-DATE FIGURES AS OF JUNE 30, 1996 COMPARED TO JUNE 30, 1995 INCREASES (DECREASES) DUE TO: VOLUME RATE NET Loans $570,888 $216,700 $787,588 Taxable Securities 400,827 (132,409) 268,418 Tax Exempt Securities (38,901) (3,245) (42,146) Federal Funds Sold and Money Market Funds (25,939) (6,429) (32,368) Total Earning Assets $906,874 $74,618 $981,492 Deposits $310,464 $402,100 $712,564 Borrowings 4,886 (61,468) (56,582) Total Interest Bearing Liabilities $315,350 $340,632 $655,982 Net change in interest $591,525 ($266,015 $325,510 ) INTEREST RATE SENSITIVITY ANALYSIS AS OF JUNE 30, 1997 (UNAUDITED) Amounts in Thousands The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at June 30, 1997, which are anticipated by the Bank, based upon certain assumptions, to reprice 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 $13,739 $33,366 $17,125 $64,230 - Variable 118,521 34,608 2,252 155,381 Rate Investments 39,926 36,204 27,249 103,379 Federal Funds Sold 0 0 0 0 Interest Rate Swap 5,000 10,000 0 15,000 Total Earning Assets $177,186 $114,178 $46,626 $337,99 0 Deposits $136,412 $11,936 $99,784 $248,13 2 Repurchase Agreements 2,046 0 796 2,842 Borrowings 48,010 9,229 0 57,239 Interest Rate Swap 5,000 10,000 0 15,000 Total Sources $191,468 $31,165 $100,580 $323,21 3 Net Gap Position ($14,282) $83,013 ($53,954) $14,777 Cumulative Gap ($14,282) $68,731 $14,777 $14,777 Rate Sensitive Assets/ Rate Sensitive 92.54% 366.37% 46.36% 104.57% Liabilities 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 3/4% of its savings is more rate sensitive and will react to rate changes, and has therefore categorized it in the one year time horizon. The remainder is stable and is listed in the greater than five year category. NOW accounts, other than seasonal fluctuations approximating $2,500,000, 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 $44,000,000 and amortized using a 11% rate, which approximates the Bank's prior experience. NOTES TO FINANCIAL STATEMENTS DATED JUNE 30, 1997 1. Summary of interim financial statement adjustments. The accompanying 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. 2. INVESTMENT SECURITIES June 30, 1997 Market Carrying Value Value a. U. S. Treasury and other government agencies $20,102,84 $19,891,44 7 5 b. Marketable equity 550,000 558,250 securities Total Securities Available for $20,652,84 $20,449,69 Sale 7 5 HELD TO MATURITY: a. U.S. Treasury and other government agencies $57,524,71 $57,474,52 7 7 b. States of the U.S. and other 10,540,444 10,818,972 political subdivisions c. Corporate bonds 8,759,338 8,759,968 Total Securities Held to $76,824,49 $77,053,46 Maturity 9 7 OTHER SECURITIES $5,902,269 $5,902,269 TOTAL SECURITIES $103,379,6 $103,405,4 15 31 The Bank does not hold any securities for a single issuer which exceed 10% of the Bank's stockholders' equity. June 30, December 3. LOANS: 1997 31, 1997 a. Commercial, agricultural and other loans $44,786,794 $39,451,440 b. Real Estate - Construction 6,743,127 8,905,823 c. Real Estate - Mortgage 152,760,232 146,361,313 d. Installment Loans 17,231,020 17,241,472 Total Loans $221,521,173 $211,960,04 8 4. CHANGES IN ALLOWANCE FOR POSSIBLE LOAN LOSSES: June 30, June 30, 1997 1996 Balance, beginning January 1: $4,292,995 $4,047,883 Provision charged to income 360,000 480,000 Recoveries of amounts charged 51,376 69,767 Losses charged to provision 270,062 348,522 Balance, ending June 30 $4,434,309 $4,249,128 Information regarding impaired loans is as follows for June 30, 1997: Average investment in impaired $1,720,858 loans Interest income recognized on impaired loans, including interest 48,596 income recognized on cash basis Interest income recognized on impaired 48,596 loans on cash basis Balance of impaired loans 1,810,192 Less portion for which no allowance for $0 loan losses is allowed Portion of impaired loan balance for which an allowance for $1,810,192 credit losses is allocated Portion of allowance for loan losses 74,796 allocated to the impaired loan balance 5. CHANGES IN ALLOWANCE FOR OTHER REAL ESTATE: 6/30/97 6/30/96 6/30/95 Balance, beginning January 1: $22,589 $26,000 $30,486 Provision charged to income 0 (2,510) 20,398 Losses charged to provision 5,124 0 19,231 Balance, ending June 30 $17,465 $23,490 $31,653 6. The aggregate dollar amount of loans made to directors, executive officer or principal holders of equity securities as of June 30, 1997, and December 31, 1996, respectively were: Aggregate amount, beginning 1/1 $3,806,55 $3,279,47 5 9 New Loans 1,173,100 912,044 Repayments 139,269 384,968 Aggregate amount, ending 6/30/97 $4,840,38 6 Aggregate amount, ending 3/31/97 $3,806,55 5 7. OTHER ASSETS: June 30, December 1997 31, 1996 a. Interest earned but not paid on: Loans $2,237,520 $1,426,296 Investments 1,081,539 1,237,564 b. Other Real Estate Owned 64,463 270,430 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 not effect on the company's net income or retained earnings. Components of income tax expense for the period ended June 30, 1997, are as follows: Current Federal $1,541,080 State 46,029 Deferred (179,925) $1,407,184 Actual tax expense differs from the expected tax expense computer by applying the applicable federal corporate income tax rate of 34% is as follows for the three months ended June 30, 1997: Computed tax expense $1,498,081 Tax exempt interest (125,214) Other 34,317 $1,407,184 At June 30, 1997, 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 losses on loans $1,353,30 and real estate owned 4 Deferred and accrued employee 945,867 benefits Deferred loan origination fees 65,401 Security losses not currently deductible 0 Core deposit intangibles 80,443 Depreciation 0 53,920 Other 17,031 $2,462,04 $53,920 6 No valuation allowance is deemed necessary for the deferred tax asset. 9. INCOME TAX EXPENSE: 1997 1996 Federal Income Tax $1,361,155 $1,281,694 State Income Tax 46,029 42,298 MANAGEMENT'S DISCUSSION AND ANALYSIS The following review of results of the operations of Bar Harbor Banking & Trust Company for June 30, 1997, as compared to June 30, 1996, shows earnings one percent under the earnings for the first six months of 1996 and will be discussed below. Total assets have remained stable with 3% growth or $10,500,000 over the past twelve months with growth in the loan portfolio and with the investment portfolio remaining at the same level as 1996. Unrealized losses decreased in 1997, which is indicative of the current national economic interest rate structure. This holds true as well for the market value of the held to maturity portfolio that is currently $229,000 above book value. The taxable portion of the portfolio has increased its yield from 7.09% to 7.23%. The Bank holds one structured note, a 10-year step-up government agency debenture, which steps annually by 1/8 of 1% after 2 years at 7%. This debenture matures in November of 2005 and is callable in November of this year. The loan growth of $12,800,000 since June 30, 1996, has been predominantly in loans secured by real estate. The Bank's loan portfolio's growth has slowed down over the past several years with percentage of growth in the double digits in the early 1990's. However, the growth for 1997 over 1996 of $12,800,000 surpasses the growth from 1995 to 1996, when loans grew by $9,800,000. The Bank continues to experience strong competition from other financial institutions within its marketplace. As of mid-July, Union Trust Company will be opening a branch in Bar Harbor which could add to the competition in that community, although Union Trust is already a competitor within the larger communities served by Bar Harbor Banking and Trust Company. Funding for the asset growth has come from increases in advances totaling $10,100,000. Deposits decreased overall by $2,000,000 over the past twelve months. In 1995, the Bank had a certificate of deposit promotion for terms of one or two years. This promotion was offered at nationally competitive interest rates, which, at the time, were lower than other funding opportunities. The Bank secured funds outside its market area through this campaign. As these began maturing in 1996 and this year, the Bank's options for funding were significantly lower through the Federal Home Loan Bank, so elected not to promote to retain the funds. Short term borrowings will begin dropping during the next three months through seasonal deposit growth, investment maturities 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. The relationship between liquid assets and short term liabilities that are vulnerable to non-replacement within a 30-day period are examined. The Bank's policy is to maintain its liquidity position at a minimum of 5% of total assets. The Bank has maintained liquidity in its balance sheet in excess of 14% for the past twelve months. Liquidity as measured by the Basic Surplus/Deficit model was 16.95% as of June 30, 1997 for the 30-day horizon and 19.7% for the 90- day horizon. How changes in the balance sheet have affected the Bank may be viewed through the earnings statement for the periods ending June 30, 1996 and 1997. The Bank's net income for the first six months of 1997 are one percent ($42,000) below the earnings at June 30, 1996 and is discussed below. Income before taxes for June 30, 1997 was $41,000 higher than June 30, 1996. Interest income is affected by rates, volumes and the mix of earning assets and interest bearing liabilities. For the first six months of 1997, increases in the loan portfolio have afforded the Bank additional interest income of $206,000 that was achieved through increases in volumes totaling $580,000 and decreases in rates totaling $374,000. Yields on loans decreased by 40 basis points from June 1996 to June 1997. In comparison, 1996's increase over 1995 was $788,000. Loan yields decreased 38 basis points during that twelve month period. On the investment side, interest and dividend income as of June 30, 1997 grew by $271,000, with the increase related to volumes totaling $83,000 and a increase from yields of $188,000 and an actual increase in 16 basis points in yields on the entire investment portfolio from year to year. Investment interest increased by $194,000 in 1996 compared to 1995 with increases in volumes and decreases in yields, (a decrease of 19 basis points). Increased costs on the liability side have been contained by the Bank by not increasing its rates on savings, NOW and money market funds. For the past several years, the Bank has chosen to promote specific term CDs at close to current national market rates, thereby increasing its cost of funds on those deposits only. Interest bearing liability costs increased by $166,000 based on increases in liabilities of $5,700,000. The increase in the cost of funds came from increased costs incurred due to volume increases totaling $341,000 with an offset in liability costs due to rates creating a reduction of $175,000. The total cost of purchased funds increased by 6 basis points over the past twelve months. In 1996, the Bank's cost of interest bearing funds increased by $656,000 and was evenly split between rate and volume increases. The cost of purchased funds went up only 7 basis points between June of 1995 and June of 1996. It has been the Bank's approach to lag increases on both sides of the balance sheet throughout the year. The Bank is well positioned with regard to interest rate sensitivity with assets and liabilities matched for repricing within a year, with $14,000,000 more liabilities than assets repricing within the next twelve months. If rates were to rise by 200 basis points, simulations indicate that the Bank's net interest income could increase by approximately $323,000 and $465,00 during the first and second years of the rise. Even closer to the current interest rate environment, should rates fall by 200 basis points, the Bank's net interest income would drop by approximately $100,000 the first year and $287,000 the second year. The ratio for the reserve for possible loan losses has been over 2% for the past several years, and continues with a ratio of 2% as of June 30, 1997. The Bank reviews its allocation to the reserve on a monthly basis and funds the reserve as deemed necessary. This review includes a provision for specific credits, provisions due to historic loan losses by loan types and reserves 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 114/118. Reference is made to the notes included in this filing that outlines the impaired loan figures. Losses in the loan portfolio were estimated at $500,000 for 1997, with charged off loans totaling $270,000 for the first six months. This compares with charged off loans for year to date June 30, 1996 totaling $349,000. The amounts represented below are the total dollars past due for the first six months of each year listed. Included in loans that are 90 days or more past due and still accruing are approximately $900,000 in outstanding loans for which the customers have commitments from other banks to pay the Bank out for the loans. Category 1997 1996 90-day past due and still accruing $1,990,399 $ 350,183 Non-accruing $3,503,052 $3,399,214 $5,493,451 $3,749,397 Gross loans $221,521,173 $208,481,646 Percentage of gross loans 2.48% 1.63% In reviewing non-interest income for 1997, the Bank has earned $81,000 more than as of June 30, 1996, with the increase attributable to the Trust Department's earnings before expenses which have exceeded last year's income by $210,000. Service charges on deposit accounts are $30,000 less than last year and are reflective of the Bank's conservative posture toward charging fees in light of a computer software conversion that experienced some instability in its customer data base during the first months of its inception. Additionally, fees generated from the origination and sale of mortgages are less than a year ago. In the spring of 1997, the Bank ran a promotion for mortgages choosing to keep them in its own portfolio instead of selling them in the secondary market, thus reducing its income from origination and sold loan fees. During the first six months of 1996, non- interest income grew by 13% increase over 1995. This growth was attributed to the Trust Department's earnings before expenses growing by $140,000 more than the first six months of 1995. In the fall of 1995, the Trust Department converted their tax preparation and began charging customers for the service. The cost of this tax service is shown in other expenses. Additionally, as of January 1, 1996, the Bank implemented FASB Statement No. 122, "Accounting for Mortgage Servicing Rights" that positively impacted the earnings of the Bank by $106,000. Salaries and benefits for 1997 exceeded 1996 by 4.7% and is indicative of merit increases granted as of January 1, 1997, increases in the cost of benefits for employees, and additional time worked and additional staff required in connection with the conversion of the Bank's software, which took place in late November of 1996. Accruing for the Bank's incentive program reflects the increase in salary and benefit costs in 1996 over 1995. Although the program was not new to the Bank in 1996, that was the first year that the dollars were allocated prior to year end. Excluding the accrual, salary and benefits would be one tenth of 1% higher than the first six months of 1995. Other expense, the category on the earnings statement that encompasses the majority of accounts that are not interest or human resource related, is $307,000 or 13% higher than twelve months prior and is attributable to enhancements started in 1996. In 1996, the Bank implemented new software and hardware for its banking applications, including document and check imaging and servers to run these applications. With the installation of new banking software, individual personal computers were upgraded and the central processing unit was upgraded. The Bank was also building an Operations Center, centrally located to its 10 branch locations, which would house the Bank's computer networking systems as well as check clearing and operational functions. At the same time, the Bank elected to upgrade its communications systems, including more robust lines between the Operations Center and the branches. Each of these installations has increased not only the bank's assets, but also its depreciation expense, which is $152,000 more than a year ago. The upgrade in the communication lines, which has increased the speed of transmitting information to all locations, has increased the Bank's telephone charges by $50,000 more than last year. With the conversions, the Bank has utilized its external audit firm for guidance in areas of control and procedures, increasing the expense paid to them by $77,000 above last year's expenses. Finally, the cost of processing merchant credit card deposits has increased by $63,000 more than a year ago. Overall, the Bank's efficiency ratio remains below national averages at 56%, which has not increased since June 30, 1996. Other expense for the first six months of 1996 was below the comparable period in 1995 by $146,000 and due to the temporary relief from FDIC insurance premiums. As a well-capitalized bank, Bar Harbor Banking and Trust Company was not required to pay premiums in 1996. In the fall 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 $120,000 in expenses for these services during the first six months of 1996. The Bank's capital to asset ratio is 11.5% and the Bank far exceeds the required risk based capital ratio of 8% with its Tier I ratio of 18.5% and total capital ratio of 19.7% or additional capital of $25,300,000. SFAS No. 125 and No.127 relate to the accounting for transfers and servicing of financial assets and extinguishment of certain liabilities and were adopted effective January 1, 1997. The adoption of these standards has had no material effect on the financial statements. SFAS No. 128 relates to the computation for earnings per share. The effect of adopting SFAS 128 has not been determined as of June 30, 1997. 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 Date: August 7, 1997 /s/ Sheldon F. Goldthwait, Jr. Chief Executive Officer Date: August 7, 1997 /s/ Virginia M. Vendrell Treasurer and Chief Financial Officer