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, 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.) P. O. Box 400 82 Main Street, Bar Harbor, ME 04609- 0400 (Address of principal executive offices) (Zip Code) 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 f shares outstanding of each of the issuer's classes of common stock as of September 30, 1997: Common Stock: 1,820,583 TABLE OF CONTENTS Financial Information Page Item 1. Financial Statements Consolidated Balance Sheets 3-4 December 31, 1996 and September 30, 1997 Consolidated Statements of Earnings 5 Three months and nine months ended September 30, 1996 and 1997 Consolidated Statements of Changes in Stockholders' 6 Equity Nine months ended September 30, 1996 and 1997 Consolidated Statement of Cash Flows 7-8 Nine months ended September 30, 1996 and 1997 Rate Volume Analysis 9 Nine months ended September 30, 1996 and 1997 Rate Sensitivity Report 10 As of September 30, 1997 Notes to Financial Statements 11-14 Item II. Management's Discussion and Analysis of 15-20 Financial Condition and Results of Operations Signature Page 21 BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENT OF FINANCIAL CONDITION SEPTEMBER 30, 1997 AND DECEMBER 31, 1996 SEPTEMBER 30 DECEMBER 1997 31, 1996 ASSETS Cash and Due from Banks $11,848,684 $11,298,408 Federal Funds Sold 0 2,000,000 Investment Securities 19,594,802 19,384,433 Securities Available for Sale, at market Securities Held to Maturity (Market Value 84,259,797 82,716,836 $84,937,139 in 1997 and $85,503,679 in 1996) Other Securities 5,992,156 5,623,639 Loans Held for Sale 154,600 336,540 Loans, net of allowance for possible loan losses 215,646,132 207,667,053 of $4,470,196 in 1997 and $4,249,128 in 1996 Premises and Equipment 7,755,035 7,498,046 Other Assets 8,493,200 8,617,790 Total Assets $353,744,406 $345,142,74 5 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Demand Deposits $42,184,730 $35,918,779 NOW Accounts 41,893,275 40,529,509 Savings Deposits 54,306,807 53,085,062 Time, $100,000 and over 14,716,135 14,611,616 Other Time 109,696,865 107,530,192 Total Deposits 262,797,812 251,675,158 Securities sold under Repurchase 6,150,441 8,246,079 Agreements Advances from Federal Home Loan 39,351,495 43,908,263 Bank Other Liabilities 4,225,978 3,426,320 Total Liabilities 312,525,726 307,255,820 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 31,368,973 28,204,829 Net unrealized appreciation on securities available (25,629) (103,505) for sale, net of tax benefit Less: Cost of 100,000 shares of (1,340,000) (1,340,000) Treasury Stock TOTAL STOCKHOLDERS' EQUITY 41,218,680 37,886,925 TOTAL LIIABILITIES AND STOCKHOLDERS' $353,744,406 $345,142,74 EQUITY 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 NINE NINE MONTHS MONTHS MONTHS MONTHS ENDING ENDING ENDING ENDING 09/30/97 09/30/96 09/30/97 09/30/96 Interest & Fees on $5,506,167 $5,150,807 $15,708,9 $1,147,611 Loans 18 Interest and Dividends on Investment 1,577,767 1,581,668 4,788,011 4,498,022 Securities: Taxable Interest Income Non-taxable 159,852 191,830 506,421 581,432 Interest Income Dividends 104,711 88,910 299,788 260,781 Federal Funds 23,381 5,933 37,507 22,916 Sold Total Interest 7,371,878 7,019,148 21,340,64 20,510,762 Income 5 Interest on 2,254,863 2,161,816 6,536,644 6,718,415 Deposits Interest in Short 697,316 624,714 2,267,558 1,754,156 Term Borrowings Total Interest 2,952,179 2,786,530 8,804,202 8,472,571 Expense Net Interest Income 4,419,699 4,232,618 12,536,44 12,038,191 3 Provision for Loan 180,000 120,000 540,000 600,000 Losses Net Interest Income after 4,239,699 4,112,618 11,996,44 11,438,191 Provision for 3 Loan Losses Other Income 1,44,644 1,684,273 3,581,247 3,741,703 Investment 140,751 0 140,751 16,934 Securities Gains Other Expenses:: Salaries & 1,534,273 1,467,981 4,423,730 4,265,530 Employee Benefits Other 1,788,000 1,512,297 4,341,907 3,759,334 Investment 22,250 0 78,104 0 Securities Losses Income Before 2,478,571 2,816,613 6,874,700 7,171,964 Income Taxes Income Tax Expense 789,261 726,837 2,196,445 2,050,829 Net Income 1,689,310 2,089,776 4,678,255 5,121,135 Earnings per Share: Based on 1,718,237 for 1996 and 1,720,583 $0.98 $1.22 $2.72 $2.98 shares for 1997 Dividends Per Share $0.30 $0.25 $0.88 $0.65 BAR HARBOR BANKSHARES AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY QUARTERS ENDED SEPTEMBER 30, 1996 AND 1997 NET UNREALIZ ED NET CAPITAL RETAINED TREASURY LOSS ON STOCKHOLDER STOCK SUIRPLU EARNINGS STOCK EQUITY S' S SECURITI EQUITY ES Balance, 12/31/95 $3,627, $7,368, $23,523, ($1,340, $63,293 $33,242,824 210 695 626 000) Net Earnings 5,121,13 5,121,135 5 Cash Dividends (1,116,8 (1,116,854) Declared 54) Net Unrealized Depreciation on Securities Available for Sale (219,448 (219,448) Net of Tax ) benefit of $80,712 Sale of Stock 9,264 120,432 0 0 0 129,696 (4,632 shares) Balance, 9/30/96 3,636,4 7,489,1 27,527,9 (1,340,0 (156,155 37,157,353 74 27 07 00) ) Balance, 12/31/96 3,636,4 7,489,1 28,204,8 (1,340,0 (103,505 37,886,926 74 27 29 00) ) Net Earnings 4,678,25 5 Cash Dividends (1,514,1 4,678,255 Declared 12) Net Unrealized Depreciation on Securities Available for 77,876 77,876 Sale, Net of Tax benefit of $47,334 Sale of Stock 4,692 85,043 0 0 0 89,735 (2,346 shares) Balance, 9/30/97 $3,641, $7,574, $31,368, ($1,340, ($25,629 $41,218,680 166 170 972 000) ) The accompanying notes are an integral part of these consolidated financial statements. BAR HARBOR BANKSHARES AND SUBSIDIARY COLSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) SEPTEMBER SEPTEMBER 30, 1997 30, 1996 Cash Flows from Operating Activities: Net Income $4,678,255 $5,121,135 Adjustments to reconcile net earnings to net cash provided by operating activities: 693,083 566,161 Depreciation Provision for Loss Losses 540,000 600,000 Provision for Losses on Other Real 0 (4,664) Estate Owned New Loans Originated for Sale (3,369,340) (7,108,320) Proceeds from Sale of Mortgages Held 3,651,076 7,028,603 for Sale Gain on Sale of Mortgages Originated (13,537) (15,108) for Sale Net Securities Gains (62,648) (16,934) Net Amortization of Bond Premium 89,855 224,207 (Gain) Loss on sale of premises and 1,953 0 equipment Net Change in Other Assets 40,076 (287,745) Net Change in Other Liabilities 799,658 1,039,202 Net Cash Provided by Operating Activities 7,048,431 7,146,537 Cash Flows from Investing Activities: Purchases of Securities Held to Maturity (19,843,240) (13,636,697 ) Proceeds from Maturity and Principal Paydowns of Securities 12,460,509 6,591,798 Held to Maturity Proceeds from Call of Securities Held to 5,750,000 5,420,608 Maturity Purchases of Securities Available for Sale (1,250,000) (5,503,125) Proceeds from Maturity and Principal Paydowns of Securities 118,741 0 Available for Sale Proceeds from Sale of Securities Available 1,060,021 500,000 for Sale Purchase of Other Securities (453,700) Proceeds from sales of Other Securities 147,831 37,930 Net Loans Made to Customers (8,611,570) (10,009,102 ) Capital Expenditures (938,619) (1,894,340) Proceeds from Sale of Fixed Assets 16,000 0 Net Cash Used in Investing Activities (11,544,027) (18,492,928 ) Cash Flows from Financing Activities: Net Change in Savings, NOW and Demand 8,851,462 11,187,990 Deposits Net Change in Time Deposits 2,271,192 (5,676,985) Net Change in Repurchase Agreements (2,095,638) 1,071,183 Purchase of Advances from FHLB 24,000,000 33,000,000 Repayment of Advances from FHLB (25,000,000) (13,000,000 ) Net Change in Other Short Term Borrowed (3,556,768) (16,110,515 Funds ) Proceeds from Sale of Capital Stock 89,735 129,696 Payment of Dividends (1,514,111) (1,116,854) Net Cash Provided by Financing Activities 3,045,872 9,484,515 Net Increase In Cash and Cash Equivalents (1,449,724) (1,861,876) Cash and Cash Equivalents at Beginning of 13,298,408 12,559,797 Year Cash and Cash Equivalents at End of Quarter $11,848,684 10,697,921 Supplemental Disclosures of Cash Flow Information: Cash Paid during the Year for: $8,797,662 8,533,008 Interest Income Taxes, Net of Refunds $1,678,000 1,450,000 Non-Cash Transactions:; Transfers from Loans to Real Estate Owned $0 193,000 (Other Assets) Transfer of Securities from Held to $0 $0 Maturity to Available for Sale Available for Sale The accompanying notes are 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 relationships of the absolute collar amounts of the change in each. YEAR-TO-DATE FIGURES AS OF SEPTEMBER 30, 1997 COMPARED TO SEPTEMBER 30, 1996 INCREASES (DECREASES) DUE TO: VOLUME RATE NET Loans $846,105 ($284,798 $561,307 ) Taxable Securities 154,135 174,861 328,996 Tax Exempt Securities (85,893) 10,882 (75,011) Federal Funds Sold and Money 13,501 1,090 14,591 Market Funds TOTAL EARNING ASSETS 927,848 (97,965) 829,883 Deposits (4,746) (177,025) (181,771) Borrowings 416,398 97,004 513,402 Total Interest Bearing 411,651 (80,020) 331,631 Liabilities NET CHANGE IN INTEREST $516,197 ($17,945) $498,252 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 (58,848) (9,377) (68,225) Market Funds 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 474,067 201,354 675,421 Liabilities NET CHANGE IN INTEREST $808,845 ($385,454 $423,391 ) INTEREST RATE SENSITIVITY ANALYSIS AS OF SEPTEMBER 30, 1997 (UNAUDITED) Amounts in Thousands The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at September 30, 1997, which are anticipated by the Bank, based upon certain assumptions, to reprice or mature in each of the future time periods shown. TOTAL TO ONE TO FIVE GREATER THAN ONE YEAR YEARS FIVE YEARS TOTAL Loans - Fixed Rate $22,348 $32,197 $16,855 $71,400 Loans - Variable Rate 103,715 38,973 2,058 144,746 Investments 47,394 32,465 30,004 109,863 Federal Funds Sold 0 0 0 0 Interest Rate/Swap 5,000 10,000 0 15,000 Floor Total Earning Assets $178,457 $113,635 $48,917 $341,009 Deposits $147,446 $10,975 $104,376 $262,797 Repurchase Agreements 6,150 0 281 6,431 Borrowings 29,324 10,028 0 39,352 Interest Rate 5,000 10,000 0 15,000 Swap/Floor Total Sources $187,920 $31,003 $104,657 $323,580 Net Gap Position ($9,463) $82,632 ($55,740) $17,429 Cumulative Gap (9,462) $73,169 $17,429 $17,429 Rate Sensitive Asset/Rate Sensitive 94.96% 366.53% 46.74% 105.93% 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 1/2% 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 $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 $42,000,000 are amortized using the weighted average maturity of 147 months, with an additional prepayment rate of 9%, which approximates the Bank's prior experience. NOTES TO FINANCIAL STATEMENTS DATED SEPTEMBER 30, 1997 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 1996 Annual Report. September 30, 1997 INVESTMENT SECURITIES CARRYING CARRYING AVAILABLE FOR SALE VALUE VALUE a: U. S. Treasury and other government $19,062,412 $19,029,402 agencies b: Marketable equity securities 550,000 565,400 Total Securities Available For Sale $19,612,412 $19,594,802 HELD TO MATURITY: a: U. S. Treasury and other government $65,965,950 $66,365,062 agencies b: States of the U.S. and other political 10,034,504 10,300,681 subdivisions c: Corporate bonds 8,259,343 8,271,396 Total Securities Held to Maturity $84,259,797 $84,937,139 OTHER SECURITIES $5,992,156 $5,992,156 TOTAL SECURITIES $109,864,365 $110,524,097 The Bank does not hold any securities for a single issuer which exceed 10% of the Bank's stockholders' equity. September 30, December 31, 1997 1996 3. LOANS a: Commercial, agricultural and other $40,472,832 $39,451,440 loans b: Real Estate - Construction 7,002,109 8,905,823 c: Real Estate - Mortgage 156,393,879 146,361,313 d: Installment Loans 16,247,508 17,241,472 Total Loans $220,116,328 $211,960,048 4. CHANGES IN ALLOWANCE FOR POSSIBLE LOAN September 30, September 30, LOSSES: 1997 1996 Balance, beginning January 1 $4,292,995 $4,047,883 Provision charged to income 540,000 600,000 Recoveries of amounts charged 92,491 100,840 Losses charged to provision 455,290 461,073 Balance, ending September 30 $4,470,196 $4,287,650 Information regarding impaired loans is as follows for September 30, 1997: Average investment in impaired loans $1,837,397 Interest income recognized on impaired loans including interest income 107,260 recognized on cash basis Interest income recognized on impaired loans on cash basis 107,260 Balance of impaired loans 2,070,475 Less portion for which no allowance for loan losses is 0 allowed Portion of impaired loan balance for which an allowance for 2,070,475 credit losses is allocated Portion of allowance for loan losses allocated to the 122,502 impaired loan balance 5. CHANGES IN ALLOWANCE FOR OTHER REAL ESTATE: 9/30/97 9/30/96 9/30/95 Balance, beginning January 1 $22,589 $26,000 $30,486 Provision charged to income 0 (4,664) 9,778 Losses charged to provision 5,124 21,336 15,110 Balance, ending September 30 $17,465 $0 $25,154 6. The aggregate dollar amount of loans made to directors, executive officers or principal holders of equity securities as of September 30, 1997 and December 31, 1996 respectively, were: Aggregate amount, beginning 1/1 $3,806,555 $3,279,479 New loans 1,600,011 912,044 Repayments 1,267,063 384,968 Aggregate amount, ending 9/30/97 $4,139,503 Aggregate amount, ending 12/31/96 $3,806,555 7. OTHER ASSETS September December 30, 1997 31, 1996 a: Interest earned but not paid on: Loans $1,499,649 $1,426,296 Investments 1,105,491 1,237,564 b: Other Real Estate Owned 58,950 270,430 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 no effect on the company's net income or retained earnings. Components of income tax expense for the period ended September 30, 1997 are as follows: Current Federal $2,342,974 State 70,277 Deferred (216,806) $2,196,445 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 six months ended September 30, 1997: Computed tax expense $2,330,796 Tax exempt interest (186,532) Other 52,181 $2,196,445 At September 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 and real $1,363,764 estate owned Deferred and accrued employee benefits 955,440 Deferred loan origination fees 67,839 Securities losses not currently deductible 0 Core deposit intangibles 76,665 Depreciation 0 44,637 Other 25,935 $2,489,643 $44,637 No valuation allowance is deemed necessary for the deferred tax asset. 9. INCOME TAX EXPENSE 1997 1996 Federal Income Tax $2,126,168 $1,982,793 State Income Tax 70,277 68,036 MANAGEMENT'S DISCUSSION AND ANALYSIS The results of operations for September 30, 1997 are reflected through changes in the balance sheet. Total assets grew by $11,700,000 in 1997 and $18,000,000 in 1996, each compared to the previous year's third quarter end. The major changes are found in the loan portfolio with small growth visible through the investment portfolio. The investment portfolio net growth of $1,700,000 has been in the area of US Government agency debentures. Purchases in the past twelve months have totaled $27,000,000, of which $10,500,000 have been in callable agencies and the majority of the remaining purchases have been in government sponsored mortgage backed pools. The bank has had $6,750,000 called in the past twelve months, $ 11,000,000 in principal paydowns from mortgage backed securities, $2,500,000 in maturing tax-exempt securities and $2,500,000 in other security paydowns. As a comparison, from September 30, 1996 to September 30, 1995, the Bank's available for sale portfolio 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 other securities portfolio includes $5,853,000 in Federal Home Loan Bank (FHLB) 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 $677,000 more than the book value, with the AFS portfolio market value at $17,600 less than the book value. At September 30, 1996, the market value of the entire investment portfolio was $695,000 below book value and represented a potential loss of less than one-half of one percent of the book value of the portfolio, had the entire portfolio been sold at that date. 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 that matures in November of 2005. The structure is to step up annually by 1/8 of 1% after three years (November 1998). It is currently earning 7% and is being called as of November of this year. The taxable portions of the Bank's securities have been earning 7.23% for the first nine months of 1997, an increase of 13 basis points since September 30, 1996. In the loan portfolio, which has grown by almost $8,800,000 (4%) in the past twelve months, the Bank's concentration has been through the extension of loans secured by real estate to its customers totaling $14,000,000 more than one year ago. Reductions in the loan portfolio were found in the commercial loan portfolio ($3,400,000) and the construction portfolio ($1,700,000). This compares to 1996's growth of $12,000,000 (6.2%) in loan growth, with $8,000,000 of the loan growth 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. From September 30, 1996 to September 30, 1997, a mixture of increased deposits and funding from the Federal Home Loan Bank funded the bank's assets. Total deposits increased by $5,800,000 with equal growth in the demand deposit accounts, NOW accounts and certificates of deposit. Also, for the same period, advances through the Federal Home Loan Bank increased by almost $2,800,000. In 1996, the funding for the asset growth had 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. 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 examine the relationship between liquid assets and short-term liabilities that 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 14%. Liquidity as measured by the Basic Surplus/Deficit model was 16.7% for the 30-day horizon and 15.7% for the 90-day horizon as of September 30, 1997. How the changes in the balance sheet have affected the Bank may be viewed through net interest income in the earnings statement for the periods ending September 30, 1996 and 1997. Net interest income, affected by rates, volumes and the mix of earning assets and interest bearing liabilities, is ahead of September 1996's net interest income by almost $500,000. Interest income earned from loans increased in 1997 by $846,000 due to volumes of loans with an offsetting reduction in earnings of $285,000 due to changes in rates. This is indicative of the competitive market in Downeast Maine. Overall yields from the loan portfolio decreased by 39 basis points of 1996's yields. Net interest income for the first nine months of 1996 added earnings of $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. The investment portfolio, with net growth in assets of only $1,700,000, has shown increases in interest income due both to volumes ($82,000) and rates ($187,000). The overall yield on the entire investment portfolio has actually increased by 5 basis points during the past twelve months. Looking at 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, similar to the loan portfolio. Overall the yield on investments dropped the same as the loan yield, 5 basis points from year to year. 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. The cost of interest bearing liabilities increased by 4% in 1997 as compared to 1996, with the interest paid on deposits decreasing primarily due to rates ($177,000). The cost of borrowings increased predominantly due to volumes ($416,000), but also by rates ($97,000). The overall cost of funding the bank's assets has increased by 19 basis points over the past twelve months. 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 for 1996. The cost of deposits increased by 21 basis points whereas the cost of borrowings decreased by 26 basis points between September 30, 1995 and 1996. With regard to interest rate sensitivity, the Bank is somewhat liability sensitive with $9,500,000 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 stands today, the Bank would reduce its net interest income by $350,000 during the next two years. If rates were to drop by 200 basis points the Bank would experience an increase in its net interest income of $676,000. 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, 1997. 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 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, "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 $2,070,475 and $1,604,919 at September 30, 1997 and 1996, 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 $500,000 for fiscal year 1997, with charged off loans totaling $455,000 for the first nine months of this year. Losses for 1996 were originally estimated at $840,000 with $461,000 charged off through September 30, 1996. The amounts represented below are the total dollars outstanding for the first nine months of each year listed. The bank retains a conservative posture with regard to non- accruing loans, placing loans onto non-accrual status once they become past due 90 days or more. This is shown through the figures below, with the bank retaining only $428,000 in loans that are still accruing and are 90 days or more past due. This represents two-tenths of one percent of gross loans outstanding for the bank. Category 1997 1996 1995 90-day past due and still accruing $427,618 $830,532 $711,943 Non-accruing $4,599,245 $3,557,518 $2,584,343 $5,026,863 $4,388,050 $3,296,286 Gross Loans $220,116,328 $211,360,9 $199,190,0 48 24 Percentage of gross 2.28% 2.08% 1.65% loans Non-interest income for the first nine months of 1997 is below the comparable period in 1996 by $160,000. The Trust Department has produced $320,000 more income in this period, based on fees structured on market values of total assets per customer account and an increase in book assets of more than $8,000,000. However, in September of 1996, the bank received a non-recurring income entry of $278,000 representing 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 1996 resulting in this one-time, tax deductible payment. The 1996 non-recurring income entry is creating the variance between the two years. 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. $200,000 of that pertains to the Trust Department's charge to its customers of scheduled fees, based on increased book assets of almost $25,000,000. 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. Salaries and benefits are 3.7% more than as of September 30, 1996 and include merit increases and accruals for the bank's incentive plan. Depreciation expense is $100,000 more than a year ago and includes the addition of the Operations Center, opened in January of 1997 and the depreciation of technology that has been purchased over the past twelve months. New personal computers, networking servers, communication lines, document and check imaging equipment are some of the investments made into technology during this period. The bank has experienced a number of non-recurring charges including expenses to complete the installation of and subsequent training in enhancements in technology begun in 1996. Additionally, the bank paid $123,000 to the Internal Revenue Service for taxes incurred on a loss taken in 1994 from the sale of a bond fund. This fund was taxed as ordinary income in the 1994 return, but was challenged by the IRS in a subsequent audit of that year's return. The bank appealed the decision by the examiner. Ultimately the appeal was denied. The bank has refiled the tax return for 1994, as well as 1992 and 1993, based on the determination by the IRS audit of the classification of the loss on the bond fund. If the amended returns are accepted, a potential refund totaling $84,000 would be due the bank. Audit costs are $80,000 higher than in September of 1996 and include the outsourcing of a large portion of the bank's internal audit function. Furthermore, with the conversion of the banking software very close to year-end last year, the bank sought additional help early in 1997 (reconciling accounts and reviewing controls) from the bank's accounting firm, Berry, Dunn, McNeil and Parker. These added costs are non-recurring expenses for the bank. Accruing for an 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, it was the first year that the dollars have been allocated prior to year- end. Excluding the accrual, salary and benefits would have been 1.6% higher than the first nine months of 1995. Other expense for the first nine months of 1996 is above the comparable period in 1995 by $60,000 or 1.6%. A portion of that containment of costs was 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 in either 1996 or 1997. 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 began numerous projects as mentioned above. Startup and non-recurring costs for these projects were included in other expenses through September 30, 1996. The Bank's year-to-date efficiency ratio is 56% remains consistent with the 1996 ratio and is well under the national average. The Bank's capital to asset ratio is 11.65% and the Bank far exceeds the required risk based capital ratio of 8% with its Tier I ratio of 19.0%, total capital ratio of 20.39% and leverage ratio of 11.9%. Using the risk based capital formula, the Bank has capital in excess of requirements of $6,500,000. 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 Date: November 14, 1997 Sheldon F. Goldthwait, Jr. Chief Executive Officer Date: November 14, 1997 Virginia M. Vendrell Treasurer and Chief Financial Officer