UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the Fiscal Year ended December 31, 2003
Commission File Number 0-26589
FIRST NATIONAL LINCOLN CORPORATION
(Exact name of Registrant as specified in its charter)
MAINE 01-0404322
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
MAIN STREET, DAMARISCOTTA, MAINE 04543
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (207) 563-3195
Securities registered pursuant to Section 12(b) or Section 12(g)
of the Securities Exchange Act of 1934
Common Stock, $.01 par value per share
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 twelve months (or for such shorter period
that the Registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K
or any amendment to this form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [X] No[ ]
State the aggregate market value of voting stock held by
non-affiliates of the Registrant as of June 30, 2003:
Common Stock, $.01 par value per share: $84,547,000
Indicate the number of shares outstanding of each of the
registrant's classes of common stock as of March 1, 2004:
Common Stock: 2,443,332 shares
TABLE OF CONTENTS
PART I
ITEM 1. Discussion of Business ........................................... 1
ITEM 2. Properties ....................................................... 9
ITEM 3. Legal Proceedings ................................................ 10
ITEM 4. Submission of Matters to a Vote of Security Holders .............. 11
PART II
ITEM 5. Market for Registrant's Common Equity and
Related Shareholder Matters....................................... 12
ITEM 6. Selected Financial Data .......................................... 13
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 14
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk ....... 34
ITEM 8. Financial Statements and Supplementary Data ...................... 41
ITEM 9. Changes in and/or Disagreements with Accountants on
Accounting and Financial Disclosure............................... 77
ITEM 9A. Controls and Procedures .......................................... 77
PART III
ITEM 10. Directors and Executive Officers of the Registrant ............... 78
ITEM 11. Executive Compensation ........................................... 84
ITEM 12. Security Ownership of Certain Beneficial Owners and Management ... 93
ITEM 13. Certain Relationships and Related Transactions ................... 95
PART IV
ITEM 14. Principal Accountant Fees and Services ........................... 96
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8.K. 97
Signatures ................................................................ 98
ITEM 1. Discussion of Business
First National Lincoln Corporation (the "Company") was incorporated under
the general business laws of the State of Maine on January 15, 1985, for the
purpose of becoming the parent holding company of The First National Bank of
Damariscotta (the "Bank"). The common stock of the Bank is the principal asset
of the Company, which has no other subsidiaries. As of December 31, 2003, the
Company's securities consisted of one class of common stock, $.01 par value per
share, of which there were 2,421,380 shares outstanding and held of record by
approximately 700 shareholders.
The Bank was chartered as a national bank under the laws of the United
States on May 30, 1864. The Bank's capital stock consists of one class of
common stock of which 120,000 shares, par value $2.50 per share, are authorized
and outstanding. All of the Bank's common stock is owned by the Company.
The Bank has seven offices in Mid-Coast Maine, including its principal
office located on Main Street, Damariscotta, Lincoln County, Maine and six
branch offices located at U.S. Route 1, Waldoboro, Maine; Townsend Avenue,
Boothbay Harbor, Maine; Route 27, Wiscasset, Maine; U.S. Route 1, Rockport,
Maine; Elm Street, Camden, Maine; and Route 1, Rockland, Maine. The Bank also
maintains an Operations Center at the corner of Bristol Road and Cross Street in
Damariscotta. The Bank has not consummated any mergers, consolidations or other
acquisitions of assets with any other person during the past five years, other
than as described elsewhere herein.
The Bank emphasizes personal service to the community, concentrating on
retail banking. Customers are primarily small businesses and individuals for
whom the Bank offers a wide variety of services, including checking, savings
and investment accounts, consumer and commercial and mortgage loans. The Bank
has not made any material changes in its mode of conducting business during the
past five years. The banking business in the Bank's market area historically has
been seasonal with lower deposits in the winter and spring and higher deposits
in the summer and fall. This swing is fairly predictable and has not had a
materially adverse effect on the Bank.
In addition to providing traditional banking services, the Company provides
investment management and private banking services through Pemaquid Advisors,
which is an operating division of the Bank. In 2000, the Bank separated its
Trust and Investment Services Department into a separate division with a
different brand identity. Under the name of Pemaquid Advisors, the division is
focused on taking advantage of opportunities created as the larger banks have
altered their personal service commitment to clients not meeting established
account criteria. Pemaquid Advisors is able to offer a comprehensive array of
private banking, financial planning, investment management and trust services to
individuals, businesses, non-profit organizations and municipalities of varying
asset size, and to provide the highest level of personal service. The staff
includes investment and trust professionals with extensive experience.
In June, 2001, the Bank acquired White Pine Asset Management of Portland,
Maine, which then became part of Pemaquid Advisors. Pemaquid Advisors operates
from its offices on Bristol Road in Damariscotta, Maine and Monument Square,
Portland, Maine.
The financial services landscape has changed considerably over the past
five years in the Bank's primary market area. Two large out-of-state banks have
continued to experience local change as a result of mergers and acquisitions at
the regional and national level. Credit unions have continued to expand their
membership and the scope of banking services offered. Non-banking entities such
as brokerage houses, mortgage companies and insurance companies are offering
very competitive products. Many of these entities and institutions have
resources substantially greater than those available to the Bank and are not
subject to the same regulatory restrictions as the Company and the Bank.
Interstate banking also could intensify competition if out-of-state institutions
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increasingly take advantage of recent legislation liberalizing interstate
banking and branching opportunities in Maine.
In November of 1999, Congress adopted the Gramm-Leach-Bliley Financial
Modernization Act ("GLBA"). This legislation breaks down the firewalls
separating related business in order to create more competition and a level
playing field. In this case, the Act eliminates depression-era restrictions
which separate the business of banking from the business of insurance and
securities underwriting, and also resulted in modifications to protect consumers
and streamline regulation. While the Company views this legislation as an
opportunity to offer a more comprehensive range of financial products and
services, at the same time it will also provide additional competition in the
marketplace.
Over the past decade, due to more liberal interstate banking laws, Maine
has seen an increase in acquisitions of locally-owned Maine-based banks. It is
Management's view that these acquisitions often result in customer
dissatisfaction as the decision-making on loans, marketing, and other aspects of
the acquired banks' businesses are shifted from local bank management possessing
independent decision-making power to management operating under policies and
guidelines from corporate headquarters in other states. The Company believes
that this shift often results in delayed decision-making by management which is
not familiar with the needs of the acquired bank's customers or the communities
they serve. Individuals and small businesses are particularly sensitive to these
changes since they may not fit the product parameters established by the larger
banks.
Thus, the Company believes that there will continue to be a need for a bank
in the Bank's primary market area with local management having decision-making
power and emphasizing loans to small and medium-sized businesses and to
individuals. The Bank has concentrated on extending business loans to such
customers in the Bank's primary market area and to extending investment and
trust services to clients with accounts of all sizes. The Bank's management also
makes decisions based upon, among other things, the knowledge of the Bank's
employees regarding the communities and customers in the Bank's primary market
area. The individuals employed by the Bank, to a large extent, reside near the
branch offices and thus are generally familiar with their communities and
customers. This is important in local decision-making and allows the Bank to
respond to customer questions and concerns on a timely basis and fosters quality
customer service.
The Bank has worked and will continue to work to position itself to be
competitive in its market area. The Bank's ability to make decisions close to
the marketplace, Management's commitment to providing quality banking products,
the caliber of the professional staff, and the community involvement of the
Bank's employees are all factors affecting the Bank's ability to be competitive.
If the Company and the Bank are unable to compete successfully, however, the
business and operations could be adversely affected.
Supervision and Regulation
The Company is a financial holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Act"), and section 225.82 of
Regulation Y issued by the Board of Governors of the Federal Reserve System (the
"Federal Reserve Board"), and is required to file with Federal Reserve Board an
annual report and other information required pursuant to the Act. The Company is
subject to examination by the Federal Reserve Board.
The Act requires the prior approval of the Federal Reserve Board for a
financial holding company to acquire or hold more than a 5% voting interest in
any bank, and controls interstate banking activities. The Act restricts First
National Lincoln Corporation's non-banking activities to those which are
determined by the Federal Reserve Board to be closely related to banking. The
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Act does not place territorial restrictions on the activities of non-bank
subsidiaries of financial holding companies.
The majority of the Company's cash revenues are generally derived from
dividends paid to the Company by the Bank. These dividends are subject to
various legal and regulatory restrictions which are summarized in Note 17 to the
accompanying financial statements.
The Bank is regulated by the Office of the Comptroller of the Currency
(OCC) and is subject to the provisions of the National Bank Act. As a result, it
must meet certain liquidity and capital requirements, which are discussed in the
following sections.
Customer Information Security.
The FDIC, the OCC and other bank regulatory agencies have published final
guidelines establishing standards for safeguarding nonpublic personal
information about customers that implement provisions of the GLBA (the
"Guidelines"). Among other things, the Guidelines require each financial
institution, under the supervision and ongoing oversight of its Board of
Directors or an appropriate committee thereof, to develop, implement and
maintain a comprehensive written information security program designed to ensure
the security and confidentiality of customer information, to protect against any
anticipated threats or hazards to the security or integrity of such information,
and to protect against unauthorized access to or use of such information that
could result in substantial harm or inconvenience to any customer.
Privacy.
The FDIC, the OCC and other regulatory agencies have published final
privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy
Rules, which govern the treatment of nonpublic personal information about
consumers by financial institutions, require a financial institution to provide
notice to customers (and other consumers in some circumstances) about its
privacy policies and practices, describe the conditions under which a financial
institution may disclose nonpublic personal information to nonaffiliated third
parties, and provide a method for consumers to prevent a financial institution
from disclosing that information to most nonaffiliated third parties by
"opting-out" of that disclosure, subject to certain exceptions.
USA Patriot Act.
The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny
terrorists and others the ability to obtain access to the United States
financial system, has significant implications for depository institutions,
broker-dealers and other businesses involved in the transfer of money. The
Patriot Act requires financial institutions to implement additional policies and
procedures with respect to money laundering, suspicious activities, currency
transaction reporting and due diligence on customers. Implementation of the
Patriot Act's requirements will occur in stages, as rules regarding its
provisions are finalized by government agencies.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 ("S-O Act") implements a broad range of
corporate governance and accounting measures for public companies (including
publicly-held bank holding companies such as the Company) designed to promote
honesty and transparency in corporate America and better protect investors from
the type of corporate wrongdoings that occurred at Enron and WorldCom, among
other companies. The S-O Act's principal provisions, many of which have been
Page 3
interpreted through regulations released in 2003, provide for and include, among
other things:
* The creation of an independent accounting oversight board;
* Auditor independence provisions which restrict non-audit services that
accountants may provide to their audit clients;
* Additional corporate governance and responsibility measures, including the
requirement that the chief executive officer and chief financial officer of a
public company certify financial statements;
* The forfeiture of bonuses or other incentive-based compensation and profits
from the sale of an issuer's securities by directors and senior officers in the
twelve-month period following initial publication of any financial statements
that later require restatement;
* An increase in the oversight of, and enhancement of certain requirements
relating to, audit committees of public companies and how they interact with
the Company's independent auditors;
* Requirements that audit committee members must be independent and are barred
from accepting consulting, advisory or other compensatory fees from the issuer;
* Requirements that companies disclose whether at least one member of the audit
committee is a 'financial expert' (as such term is defined by the SEC) and if
not, why not;
* Expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a prohibition on
insider trading during pension blackout periods;
* A prohibition on personal loans to directors and officers, except certain
loans made by insured financial institutions, such as the Bank, on
nonpreferential terms and in compliance with other bank regulatory
requirements;
* Disclosure of a code of ethics and filing a Form 8-K for a change or waiver
of such code; and
* A range of enhanced penalties for fraud and other violations.
The Company has taken steps to comply with and anticipates that it will
incur additional expenses in continuing to comply with the provisions of the S-O
Act and its underlying regulations. Management believes that such compliance
efforts have strengthened the Company's overall corporate governance structure
and does not expect that such compliance has to date, or will in the future have
a material impact on the Company's results of operations or financial condition.
Capital Requirements and FDICIA
The OCC has established guidelines with respect to the
maintenance of appropriate levels of capital by FDIC-insured banks. The Federal
Reserve Board has established substantially identical guidelines with respect to
the maintenance of appropriate levels of capital, on a consolidated basis, by
bank holding companies. If a banking organization's capital levels fall below
the minimum requirements established by such guidelines, a bank or bank holding
company will be expected to develop and implement a plan acceptable to the FDIC
or the Federal Reserve Board, respectively, to achieve adequate levels of
capital within a reasonable period, and may be denied approval to acquire or
establish additional banks or non-bank businesses, merge with other institutions
or open branch facilities until such capital levels are achieved. Federal
legislation requires federal bank regulators to take "prompt corrective action"
with respect to insured depository institutions that fail to satisfy minimum
capital requirements and imposes significant restrictions on such institutions.
See "Prompt Corrective Action" below.
Page 4
Leverage Capital Ratio
The regulations of the OCC requires national banks to maintain a minimum
"Leverage Capital Ratio" or "Tier 1 Capital" (as defined in the Risk-Based
Capital Guidelines discussed in the following paragraphs) to Total Assets of
4.0%. Any bank experiencing or anticipating significant growth is expected to
maintain capital well above the minimum levels. The Federal Reserve Board's
guidelines impose substantially similar leverage capital requirements on bank
holding companies on a consolidated basis.
Risk-Based Capital Requirements.
The regulations of the OCC also require national banks to maintain minimum
capital levels measured as a percentage of such banks' risk-adjusted assets. A
bank's qualifying total capital ("Total Capital") for this purpose may include
two components: "Core" (Tier 1) Capital and "Supplementary" (Tier 2) Capital.
Core Capital consists primarily of common stockholders' equity, which generally
includes common stock, related surplus and retained earnings, certain non-
cumulative perpetual preferred stock and related surplus, and minority
interests in the equity accounts of consolidated subsidiaries, and (subject to
certain limitations) mortgage servicing rights and purchased credit card
relationships, less all other intangible assets (primarily goodwill).
Supplementary Capital elements include, subject to certain limitations, a
portion of the allowance for losses on loans and leases, perpetual preferred
stock that does not qualify for inclusion in Tier 1 capital, long-term
preferred stock with an original maturity of at least 20 years and related
surplus, certain forms of perpetual debt and mandatory convertible securities,
and certain forms of subordinated debt and intermediate-term preferred stock.
The risk-based capital rules assign a bank's balance sheet assets and the
credit equivalent amounts of the bank's off-balance sheet obligations to one of
four risk categories, weighted at 0%, 20%, 50% or 100%, respectively. Applying
these risk-weights to each category of the bank's balance sheet assets and to
the credit equivalent amounts of the bank's off-balance sheet obligations and
summing the totals results in the amount of the bank's total Risk-Adjusted
Assets for purposes of the risk-based capital requirements. Risk-Adjusted
Assets can either exceed or be less than reported balance sheet assets,
depending on the risk profile of the banking organization. Risk-Adjusted Assets
for institutions such as the Bank will generally be less than reported balance
sheet assets because its retail banking activities include proportionally more
residential mortgage loans and certain investment securities with a lower risk
weighting and relatively smaller off-balance sheet obligations.
The risk-based capital regulations require all banks to maintain a minimum
ratio of Total Capital to Risk-Adjusted Assets of 8.0%, of which at least
one-half (4.0%) must be Core (Tier 1) Capital. For the purpose of calculating
these ratios: (i) a banking organization's Supplementary Capital eligible for
inclusion in Total Capital is limited to no more than 100% of Core Capital; and
(ii) the aggregate amount of certain types of Supplementary Capital eligible for
inclusion in Total Capital is further limited. For example, the regulations
limit the portion of the allowance for loan losses eligible for inclusion in
Total Capital to 1.25% of Risk-Adjusted Assets. The Federal Reserve Board has
established substantially identical risk-based capital requirements, which are
applied to bank holding companies on a consolidated basis. The risk-based
capital regulations explicitly provide for the consideration of interest rate
risk in the overall evaluation of a bank's capital adequacy to ensure that banks
effectively measure and monitor their interest rate risk, and that they maintain
capital adequate for that risk. A bank deemed by its federal banking regulator
to have excessive interest rate risk exposure may be required to
maintain additional capital (that is, capital in excess of the minimum ratios
discussed above). The Bank believes, based on its level of interest rate risk
exposure, that this provision will not have a material adverse effect on it.
Page 5
On December 31, 2003, the Company's consolidated Total and Tier 1
Risk-Based Capital Ratios were 12.92% and 11.82%, respectively, and its Leverage
Capital Ratio was 8.06%. Based on the above figures and accompanying discussion,
the Company exceeds all regulatory capital requirements and is considered well
capitalized.
Prompt Corrective Action.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires, among other things, that the federal banking regulators
take "prompt corrective action" with respect to, and imposes significant
restrictions on, any bank that fails to satisfy its applicable minimum capital
requirements. FDICIA establishes five capital categories consisting of "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under applicable
regulations, a bank that has a Total Risk-Based Capital Ratio of 10.0% or
greater, a Tier 1 Risk-Based Capital Ratio of 6.0% or greater and a Leverage
Capital Ratio of 5.0% or greater, and is not subject to any written agreement,
order, capital directive or prompt corrective action directive to meet and
maintain a specific capital level for any capital measure is deemed to be "well
capitalized." A bank that has a Total Risk-Based Capital Ratio of 8.0% or
greater, a Tier 1 Risk-Based Capital Ratio of 4.0% or greater and a Leverage
Capital Ratio of 4.0% (or 3% for banks with the highest regulatory examination
rating that are not experiencing or anticipating significant growth or
expansion) or greater and does not meet the definition of a well capitalized
bank is considered to be "adequately capitalized." A bank that has a Total Risk-
Based Capital Ratio of less than 8.0% or has a Tier 1 Risk-Based Capital Ratio
that is less than 4.0%, except as noted above, a Leverage Capital Ratio of less
than 4.0% is considered "undercapitalized." A bank that has a Total Risk-Based
Capital Ratio of less than 6.0%, or a Tier 1 Risk-Based Capital Ratio that is
less than 3.0% or a Leverage Capital Ratio that is less than 3.0% is considered
to be "significantly undercapitalized," and a bank that has a ratio of tangible
equity to total assets equal to or less than 2% is deemed to be "critically
undercapitalized." A bank may be deemed to be in a capital category lower than
is indicated by its actual capital position if it is determined to be in an
unsafe or unsound condition or receives an unsatisfactory examination rating.
FDICIA generally prohibits a bank from making capital distributions (including
payment of dividends) or paying management fees to controlling stockholders or
their affiliates if, after such payment, the bank would be undercapitalized.
Under FDICIA and the applicable implementing regulations, an
undercapitalized bank will be (i) subject to increased monitoring by its primary
federal banking regulator; (ii) required to submit to its primary federal
banking regulator an acceptable capital restoration plan (guaranteed, subject to
certain limits, by the bank's holding company) within 45 days of being
classified as undercapitalized; (iii) subject to strict asset growth
limitations; and (iv) required to obtain prior regulatory approval for certain
acquisitions, transactions not in the ordinary course of business, and entries
into new lines of business. In addition to the foregoing, the primary federal
banking regulator may issue a "prompt corrective action directive" to any
undercapitalized institution. Such a directive may (i) require sale or
re-capitalization of the bank, (ii) impose additional restrictions on
transactions between the bank and its affiliates, (iii) limit interest rates
paid by the bank on deposits, (iv) limit asset growth and other activities, (v)
require divestiture of subsidiaries, (vi) require replacement of directors and
officers, and (vii) restrict capital distributions by the bank's parent holding
company. In addition to the foregoing, a significantly undercapitalized
institution may not award bonuses or increases in compensation to its senior
executive officers until it has submitted an acceptable capital restoration
plan and received approval from its primary federal banking regulator.
Page 6
Not later than 90 days after an institution becomes critically
undercapitalized, the primary federal banking regulator for the institution must
appoint a receiver or, with the concurrence of the FDIC, a conservator, unless
the agency, with the concurrence of the FDIC, determines that the purpose of the
prompt corrective action provisions would be better served by another course of
action. FDICIA requires that any alternative determination be "documented" and
reassessed on a periodic basis. Notwithstanding the foregoing, a receiver must
be appointed after 270 days unless the appropriate federal banking agency and
the FDIC certify that the institution is viable and not expected to fail.
Deposit Insurance Assessments.
The FDIC uses a risk-based system which assigns the Bank to one of three
capital categories (1) well capitalized, (2) adequately capitalized, or (3)
undercapitalized, and to one of three subgroups within a capital category on
the basis of supervisory evaluations by the applicable Bank's primary federal
regulator and, if applicable, other information relevant to the Bank's
financial condition and the risk posed to the BIF. An institution's assessment
rate depends on the capital category and supervisory category to which it is
assigned. The FDIC is authorized to raise the assessment rates in certain
circumstances. If the FDIC determines to increase the assessment rates for all
institutions, institutions in all risk categories could be affected. The FDIC
has exercised this authority several times in the past and may raise BIF
insurance premiums again in the future. If the FDIC takes such action, it could
have an adverse effect on the earnings of the Bank, the extent of which is not
currently quantifiable. The risk classification to which an institution is
assigned by the FDIC is confidential and may not be disclosed. Assessment rates
in 2003 ranged from 0% of domestic deposits for an institution in the lowest
risk category (i.e. well capitalized and healthy from a supervisory standpoint)
to 0.27% of domestic deposits for institutions in the highest risk category
(i.e., undercapitalized and unhealthy from a supervisory standpoint). The
Deposit Insurance Funds Act of 1996 eliminates the minimum assessment and
authorizes the Financing Corporation (FICO) to levy assessments on BIF-
assessable deposits. The actual assessment rates for FICO are adjusted on a
quarterly basis to reflect changes in the assessment bases of the insurance
funds. FDICIA also directs regulators to establish underwriting and operations
standards, encompassing such areas as real estate lending, consumer disclosure
rules, internal controls and new reporting requirements.
Brokered Deposits and Pass-Through Deposit Insurance Limitations.
Under FDICIA, a bank cannot accept brokered deposits unless it either (i)
is "Well Capitalized" or (ii) is "Adequately Capitalized" and has received a
written waiver from its primary federal banking regulator. For this purpose,
"Well Capitalized" and "Adequately Capitalized" have the same definitions as in
the Prompt Corrective Action regulations. See "Prompt Corrective Action" above.
Banks that are not in the "Well Capitalized" category are subject to certain
limits on the rates of interest they may offer on any deposits (whether or not
obtained through a third-party deposit broker). Pass-through insurance coverage
is not available in banks that do not satisfy the requirements for acceptance of
brokered deposits for deposits of certain employee benefit plans, except that
pass-through insurance coverage will be provided for employee benefit plan
deposits in institutions which at the time of acceptance of the deposit meet all
applicable regulatory capital requirements and send written notice to their
depositors that their funds are eligible for pass-through deposit insurance. The
Bank currently accepts brokered deposits.
Real Estate Lending Standards.
FDICIA requires the federal bank regulatory agencies to adopt uniform real
estate lending standards. The FDIC and the OCC have adopted regulations which
Page 7
establish supervisory limitations on Loan-to-Value ("LTV") ratios in real estate
loans by FDIC-insured banks, including national banks. The regulations require
banks to establish LTV ratio limitations within or below the prescribed uniform
range of supervisory limits.
Standards for Safety and Soundness.
Pursuant to FDICIA the federal bank regulatory agencies have prescribed,
by regulation, standards and guidelines for all insured depository institutions
and depository institution holding companies relating to: (i) internal controls,
information systems and internal audit systems; (ii) loan documentation; (iii)
credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and
(vi) compensation, fees and benefits. The compensation standards prohibit
employment contracts, compensation or benefit arrangements, stock option plans,
fee arrangements or other compensatory arrangements that would provide
"excessive" compensation, fees or benefits, or that could lead to material
financial loss. In addition, the federal bank regulatory agencies are required
by FDICIA to prescribe standards specifying; (i) maximum classified assets to
capital ratios; (ii) minimum earnings sufficient to absorb losses without
impairing capital; and (iii) to the extent feasible, a minimum ratio of market
value to book value for publicly-traded shares of depository institutions and
depository institution holding companies.
Consumer Protection Provisions.
FDICIA also includes provisions requiring advance notice to regulators and
customers for any proposed branch closing and authorizing (subject to future
appropriation of the necessary funds) reduced insurance assessments for
institutions offering "lifeline" banking accounts or engaged in lending in
distressed communities. FDICIA also includes provisions requiring depository
institutions to make additional and uniform disclosures to depositors with
respect to the rates of interest, fees and other terms applicable to consumer
deposit accounts.
FDIC Waiver of Certain Regulatory Requirements.
The FDIC issued a rule, effective on September 22, 2003, that includes a
waiver provision which grants the FDIC Board of Directors extremely broad
discretionary authority to waive FDIC regulatory provisions that are not
specifically mandated by statute or by a separate regulation.
Impact of Monetary Policy
The monetary policies of regulatory authorities, including the Federal
Reserve Board, have a significant effect on the operating results of banks and
bank holding companies. Through open market securities transactions and changes
in its discount rate and reserve requirements, the Board of Governors exerts
considerable influence over the cost and availability of funds for lending and
investment. The nature of future monetary policies and the effect of such
policies on the future business and earnings of the Company and the Bank cannot
be predicted. See Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations, regarding the Bank's net interest margin
and the effect of interest-rate volatility on future earnings.
Employees
At December 31, 2003, the Company had 134 employees and full-time
equivalency of 131 employees. The Company enjoys good relations with its
employees. A variety of employee benefits, including health, group life and
disability income, a defined contribution retirement plan, and an incentive
bonus plan, are available to qualifying officers and employees.
Page 8
ITEM 2. Properties
The principal office of the Bank is located in Damariscotta, Maine, and
serves the people of Damariscotta, Newcastle, Edgecomb, Jefferson, Bremen,
Wiscasset, Nobleboro, South Bristol and Bristol. A branch office opened in
Waldoboro in 1975, which is located approximately ten miles from Damariscotta
on U.S. Rt. 1, serves the population of Waldoboro and the surrounding towns of
Friendship, Warren, Washington and Monhegan Island.
In 1979, a branch office was opened in Boothbay Harbor, which is situated
approximately 16 miles from Damariscotta. This office serves the towns of
Boothbay, West Boothbay, Boothbay Harbor, Southport and neighboring areas.
Expansion of the Bank's Boothbay Harbor office began in the Fall of 1995 to
better serve customer needs and included utilization of an adjacent property
that was purchased in 1994. The project was completed in the summer of 1996. In
2002, the Bank purchased additional property in Boothbay Harbor for use as an
auxiliary office for the branch and for Pemaquid Advisors.
In 1988, a branch office was opened in Wiscasset, which is approximately
eight miles from Damariscotta. This office serves the towns of Wiscasset,
Edgecomb, Alna, Woolwich and Dresden.
In 1997, the Bank purchased and renovated a property on Route 1 in
Rockport, Maine, in which to open its first branch office outside of Lincoln
County, Maine. Rockport is located in Knox County, Maine, which is contiguous to
Lincoln County, Maine, and with similar demographic characteristics. This move
into Knox County was made to provide additional growth opportunities for the
Bank, which has limited potential for growth in its existing market area.
In May of 1998, the Bank opened a sixth branch in Camden, Maine, which is
geographically contiguous to Rockport, Maine. The addition of this branch in the
Knox County market has allowed the Bank to better serve customers in this area
by providing both in-town and out-of-town locations that meet different customer
needs.
In September of 2001, the Bank opened its Rockland office at the corner of
Route One and Broadway in Rockland Maine. Located in Knox County between the
Waldoboro and Rockport offices, the Rockland office serves the towns of
Rockland, Thomaston, Owl's Head and St. George.
An operations center is located in the block adjacent to the Damariscotta
office, fronting on Bristol Road. It was put in service in July, 1989. The Bank
also owns real estate on Water Street in Damariscotta, Maine, which was put into
use for additional office space during 1995.
In 2001, the Bank purchased property at 9 Bristol Road in Damariscotta,
Maine and moved its Pemaquid Advisors division into the facility. The division
also occupies leased office space at 2 Monument Square in Portland, Maine, from
which it provides its services to the Portland community.
In 2002, the Bank purchased property formerly owned by Fleet Bank on
Townsend Avenue in Boothbay Harbor for use as a conference and loan closing
facility as well as to provide space for Pemaquid Advisors. In 2003, the Company
purchased an abutting property to this to provide potential for future
expansion.
The Company owns all of its facilities except for the Camden and Portland
locations, for which the Bank entered into long-term leases. Management believes
that the Bank's current facilities are suitable and adequate in light of its
current needs and its anticipated needs over the near term.
Page 9
ITEM 3. Legal Proceedings
There are no material pending legal proceedings to which the Company or the
Bank is a party or to which any of its property is subject, other than routine
litigation incidental to the business of the Bank. None of these
proceedings is expected to have a material effect on the financial condition
of the Company or of the Bank.
Page 10
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no items submitted to a vote of security holders of the Company
during the fourth quarter of 2003.
Page 11
ITEM 5. Market for Registrant's Common Equity and Related Shareholder Matters
The common stock of First National Lincoln Corporation (ticker symbol FNLC)
trades on the NASDAQ National Market System. The following table reflects the
high and low prices of actual sales in each quarter of 2003 and 2002. Such
quotations do not reflect retail mark-ups, mark-downs or brokers' commissions.
- -------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------
High Low High Low
1st Quarter $ 37.50 $ 30.00 $ 28.20 $ 21.75
2nd Quarter 41.30 33.52 32.00 27.35
3rd Quarter 43.00 39.18 31.00 25.60
4th Quarter 51.05 42.50 34.50 27.00
- -------------------------------------------------------------------
The last known transaction of the Company's stock during 2003 was on
December 31 at $49.90 per share. There are no warrants outstanding with respect
to the Company's common stock, and the Company has no securities outstanding
which are convertible into common equity.
The table below sets forth the cash dividends declared in the last two
fiscal years:
- -------------------------------------------------------------------
Date Declared Amount Per Share Date Payable
- -------------------------------------------------------------------
March 27, 2002 $0.2300 April 30, 2002
June 20, 2002 $0.2400 July 31, 2002
September 19, 2002 $0.2500 October 31, 2002
December 19, 2002 $0.2600 January 31, 2003
- -------------------------------------------------------------------
March 20, 2003 $0.2700 April 30, 2003
June 19, 2003 $0.2800 July 31, 2003
September 25, 2003 $0.2900 October 31, 2003
December 18, 2003 $0.3000 January 30, 2004
- -------------------------------------------------------------------
The ability of the Company to pay cash dividends depends on receipt of
dividends from the Bank. Dividends may be declared by the Bank out of its net
profits as the directors deem appropriate, subject to the limitation that the
total of all dividends declared by the Bank in any calendar year may not exceed
the total of its net profits of that year plus retained net profits of the
preceding two years. The Bank is also required to maintain minimum amounts of
capital-to-total-risk-weighted-assets, as defined by banking regulators. At
December 31, 2003, the Bank was required to have minimum Tier 1 and Tier 2
risk-based capital ratios of 4.00% and 8.00%, respectively. The Bank's actual
ratios were 11.31% and 12.42%, respectively, as of December 31, 2003.
The Company issues shares to the Bank's 401k Investment and Savings Plan
pursuant to an exemption from registration under the Securities Act of 1933, as
amended (the "Securities Act"), contained in Section 3(a)(11) thereof and Rule
147 promulgated thereunder. During 2003, 6,163 shares were issued pursuant to
this Plan.
Page 12
ITEM 6. Selected Financial Data
- -------------------------------------------------------------------------------
Dollars in thousands, except for per share amounts
Years ended December 31, 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------
Summary of Operations
Operating Income $ 32,688 34,258 33,960 30,890 26,348
Operating Expense 22,303 25,072 26,239 24,390 20,025
Net Interest Income 17,744 17,103 15,031 12,770 11,949
Provision for Loan Losses 907 1,323 1,230 700 645
Net Income 7,427 6,507 5,493 4,607 4,451
Per Common Share Data
Net Income
Basic 3.07 2.71 2.30 1.93 1.84
Diluted 2.99 2.64 2.24 1.89 1.77
Cash Dividends (Declared) 1.14 0.98 0.82 0.66 0.50
Book Value 19.71 17.68 15.61 13.94 12.09
Market Value 49.90 31.48 22.10 15.50 16.25
Financial Ratios
Return on Average Equity 16.39% 16.34% 15.51% 15.15% 15.67%
Return on Average Assets 1.41 1.39 1.33 1.27 1.39
Average Equity to Average Assets 8.58 8.49 8.55 8.36 8.88
Net Interest Margin (Tax-Equivalent) 3.73 4.00 3.99 3.88 4.12
Dividend Payout Ratio (Declared) 37.13 36.16 35.65 34.20 27.17
Allowance for Loan Losses/Total Loans 1.05 1.11 1.00 0.87 0.88
Non-Performing Loans to Total Loans 0.39 0.32 0.22 0.89 0.29
Non-Performing Assets to Total Assets 0.29 0.27 0.20 0.69 0.30
Efficiency Ratio (Tax-Equivalent) 48.32 50.49 50.60 52.06 50.93
At Year End
Total Assets $ 568,812 494,068 434,466 393,216 341,287
Total Loans 398,895 332,074 301,304 264,929 232,526
Total Investment Securities 136,689 122,073 108,186 105,220 87,999
Total Deposits 359,077 334,224 262,689 254,566 205,458
Total Shareholders' Equity 47,718 42,695 37,334 33,160 28,662
- -------------------------------------------------------------------------------
High Low
Market price per common share of stock during 2003 $ 51.05 30.00
- -------------------------------------------------------------------------------
Page 13
Management's Discussion of Financial Condition and Results of Operations
- -------------------------------------------------------------------------------
Overview
First National Lincoln Corporation (the "Company") was incorporated in the State
of Maine on January 15, 1985, to become the parent holding company of The First
National Bank of Damariscotta (the "Bank"). The Company generates almost all of
its revenues from the Bank, which was chartered as a national bank under the
laws of the United States on May 30, 1864. The Bank has seven offices in
Mid-Coast Maine, including its principal office in Damariscotta, as well as
branch offices in Boothbay Harbor, Camden, Rockland, Rockport, Waldoboro and
Wiscasset. The Bank emphasizes personal service to the communities it serves,
concentrating primarily on small businesses and individuals.
The Bank offers a wide variety of traditional banking services and derives
the majority of its revenues from net interest income - the spread between what
it earns on loans and investments and what it pays for deposits and borrowed
funds. While net interest income typically increases as earning assets grow, the
spread can vary up or down depending on the level and direction of movements in
interest rates. Management believes the Bank has limited exposure to changes in
interest rates, as discussed in "Interest Rate Risk Management" elsewhere in
Management's Discussion. In addition, the banking business in the Bank's market
area historically has been seasonal with lower deposits in the winter and spring
and higher deposits in the summer and fall. This seasonal swing is fairly
predictable and has not had a materially adverse effect on the Bank.
Non-interest income is the Bank's secondary source of revenue and includes
fees and service charges on deposit accounts, fees for processing merchant
credit card receipts, income from the sale and servicing of mortgage loans, and
income from investment management and private banking services through Pemaquid
Advisors, which is an operating division of the Bank. Pemaquid Advisors operates
three offices in Damariscotta, Boothbay Harbor and Portland, Maine.
The Company posted record earnings in 2003, the result of continued
positive growth in both assets and income seen during the past ten years. During
this period, the Company focused on cost reduction and increased efficiency
prior to 1997 to increase its profitability. In the subsequent years, however,
the Company's strategy has changed to controlled, profitable, "organic" growth.
The value of this strategy can be seen in the Company's expansion into Knox
County during the past six years, where offices were opened in Rockport and
Camden in 1997 and 1998, respectively, and in Rockland in 2001. These offices
have far exceeded their initial goals and have provided the opportunity for
substantial new market growth. The Company's expansion has not come at the
expense of profitability, however. Since the Bank has traditionally operated on
a lower net interest margin than its peers, it operates with lower expenses than
its peers, and this is reflected in its efficiency ratio, which is consistently
better than its peer's, on average. In 2003, the Company's non-interest
operating expenses increased only 0.5% or $55,000 over 2002's total, and posted
an efficiency ratio of 0.48, calculated on a tax-equivalent basis. The impact of
this can be seen in the Company's return on average assets and return on average
equity, which were on 1.41% and 16.39%, respectively, in 2003, and significantly
higher than those of its peer group, on average.
Page 14
Management's Discussion of Financial Condition and Results of Operations,
Continued
Critical Accounting Policies
Management's discussion and analysis of the Company's financial condition is
based on the consolidated financial statements which are prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of such financial statements requires Management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosure of contingent assets and
liabilities. On an ongoing basis, Management evaluates its estimates, including
those related to the allowance for loan losses and the valuation of mortgage
servicing rights. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets that are not readily apparent from other sources.
Actual results are likely to differ from the amount derived from Management's
estimates and assumptions, and such differences could be substantial.
Management believes the allowance for loan losses is a critical accounting
policy that requires the most significant estimates and assumptions used in the
preparation of the consolidated financial statements. The allowance for loan
losses is based on Management's evaluation of the level of the allowance
required in relation to the estimated loss exposure in the loan portfolio.
Management believes the allowance for loan losses is a significant estimate and
therefore regularly evaluates it for adequacy by taking into consideration
factors such as prior loan loss experience, the character and size of the loan
portfolio, business and economic conditions and Management's estimation of
potential losses. The use of different estimates or assumptions could produce
different provisions for loan losses. The allowance for loan losses is discussed
in more detail in the Assets and Asset Quality section of this report.
The valuation of mortgage servicing rights is also a critical accounting
policy which requires significant estimates and assumptions. The Bank often
sells mortgage loans it originates and retains the ongoing servicing of such
loans, receiving a fee for these services, generally 0.25% of the outstanding
balance of the loan per annum. Mortgage servicing rights are recognized when
they are acquired through sale of loans and are reported in other assets. They
are amortized into non-interest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying financial assets.
Management uses an independent firm which specializes in the valuation of
mortgage servicing rights to determine the fair value which is recorded on the
balance sheet. This includes an evaluation for impairment based upon the fair
value of the rights, which can vary depending upon current interest rates and
prepayment expectations, as compared to amortized cost. Impairment is determined
by stratifying rights by predominant characteristics, such as interest rates and
terms. The use of different assumptions could produce a different valuation for
both mortgage servicing rights and impairment.
Page 15
Management's Discussion of Financial Condition and Results of Operations,
Continued
Results of Operations
- -------------------------------------------------------------------------------
Net income for the year ended December 31, 2003 was $7.4 million - the highest
ever recorded by the Company. This represents a 14.1% or $0.9 million increase
from net income of $6.5 million posted in 2002 and is $1.9 million, or 35.2%,
above 2001 net income of $5.5 million. The results are attributable to strong
asset growth, increased non-interest income and controlled operating expenses.
Net Interest Income
Net interest income in 2003 was $17.7 million, an increase of $0.6 million or
3.7% over the $17.1 million posted by the Company in 2002. While significant
growth in earning assets was posted in 2003, at the same time the Company
experienced margin compression in the first half of the year as a result of
Federal Reserve policy on interest rates. This reversed in the second half of
the year with the repricing of $61.8 million in borrowed funds at an average
savings of 2.87%.
Asset growth was responsible for net interest income, on a tax-equivalent
basis, increasing by $2.5 million in 2003, while margin compression reduced the
increase by $1.4 million, resulting in a net increase of $0.9 million after
adjusting for other factors of $0.2 million.
Page 16
Management's Discussion of Financial Condition and Results of Operations,
Continued
The following tables present changes in interest income and expense
attributable to changes in interest rates, volume, and rate/volume1 for
interest-earning assets and interest-bearing liabilities. Tax-exempt income is
calculated on a tax-equivalent basis, using a 35.0% tax rate in 2003, 2002 and
2001.
- -------------------------------------------------------------------------------
Year ended December 31, 2003 compared to 2002
Dollars in thousands Volume Rate Rate/volume1 Total
- -------------------------------------------------------------------------------
Interest on earning assets
Interest-bearing deposits $ 10 (18) (2) (10)
Investment securities 673 (1,279) (112) (718)
Loans held for sale (28) (27) 5 (50)
Loans 3,211 (3,422) (496) (707)
- -------------------------------------------------------------------------------
Total interest income 3,866 (4,746) (605) (1,485)
- -------------------------------------------------------------------------------
Interest expense
Deposits 1,282 (2,713) (451) (1,882)
Other borrowings2 108 (619) (15) (526)
- -------------------------------------------------------------------------------
Total interest expense 1,390 (3,332) (466) (2,408)
- -------------------------------------------------------------------------------
Change in net interest income $ 2,476 (1,414) (139) 923
===============================================================================
- -------------------------------------------------------------------------------
Year ended December 31, 2002 compared to 2001
Dollars in thousands Volume Rate Rate/volume1 Total
- -------------------------------------------------------------------------------
Interest on earning assets
Interest-bearing deposits $ 106 (51) (70) (15)
Investment securities 593 (413) (32) 148
Loans held for sale 110 2 6 118
Loans 3,098 (3,610) (483) (995)
- -------------------------------------------------------------------------------
Total interest income 3,907 (4,072) (579) (744)
- -------------------------------------------------------------------------------
Interest expense
Deposits 1,347 (3,218) (433) (2,304)
Other borrowings2 589 (995) (117) (523)
- -------------------------------------------------------------------------------
Total interest expense 1,936 (4,213) (550) (2,827)
- -------------------------------------------------------------------------------
Change in net interest income $1,971 141 (29) 2,083
===============================================================================
1 Represents the change attributable to a combination of change in rate
and change in volume.
2 Includes federal funds purchased.
Page 17
Management's Discussion of Financial Condition and Results of Operations,
Continued
The following table presents, for the years ended December 31, 2003, 2002
and 2001, the interest earned or paid for each major asset and liability
category, the average yield for each major asset and liability category, and the
net yield between assets and liabilities. Tax-exempt income has been calculated
on a tax-equivalent basis using a 35% rate. Unrecognized interest on non-accrual
loans is not included in the amount presented, but the average balance of
non-accrual loans is included in the denominator when calculating yields.
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
--------------- -------------- ---------------
Amount Avg Amount Avg Amount Avg
of Yield/ of Yield/ of Yield/
Dollars in thousands interest Rate interest Rate interest Rate
- -------------------------------------------------------------------------------
Interest-earning assets
Interest-bearing deposits $ 52 0.96% 62 1.34% 77 3.94%
Investments 6,967 5.37% 7,685 6.44% 7,537 6.82%
Loans held for sale 101 6.11% 151 7.46% 33 7.05%
Loans 21,436 5.86% 22,143 6.93% 23,138 8.21%
- -------------------------------------------------------------------------------
Total interest-earning
assets 28,556 5.67% 30,041 6.74% 30,785 7.79%
- -------------------------------------------------------------------------------
Interest-bearing liabilities
Deposits 5,820 1.79% 7,702 2.76% 10,006 4.07%
Other borrowings 3,976 3.18% 4,502 3.68% 5,025 4.59%
- -------------------------------------------------------------------------------
Total interest-bearing
liabilities 9,796 2.17% 12,204 3.04% 15,031 4.23%
- -------------------------------------------------------------------------------
Net interest income $ 18,760 17,837 15,754
===============================================================================
Interest rate spread 3.50% 3.70% 3.56%
Net interest margin 3.73% 4.00% 3.99%
- -------------------------------------------------------------------------------
Non-Interest Income
Non-interest income increased by 4.0% from $5.0 million in 2002 to $5.1 million
in 2003. The increase was attributable to increased income on mortgage
origination and servicing due to higher volumes of loan sales in a favorable
interest rate climate, and increased document preparation fees on loans.
Non-interest income increased 27.0% in 2002 to $5.0 million from 2001's level of
$3.9 million. The increase was attributable to increased income on mortgage
origination and servicing due to higher volumes of loan sales, newly instituted
document preparation fees on loans, increased merchant credit card volume, and a
one-time gain of $0.2 million resulting from the sale of the Bank's credit card
portfolio, net of taxes and related expenses.
Page 18
Management's Discussion of Financial Condition and Results of Operations,
Continued
Non-Interest Expense
Non-interest expense increased 0.5% to $11.6 million in 2003 from $11.5 million
in 2002. This very small increase was the result of budgeted but not filled
staff positions, higher levels of deferred loan origination costs in accordance
with SFAS 91, and a reduction in costs associated with asset liquidation. In
2002, non-interest expense increased 15.7% to $11.5 million from $10.0 million
in 2001. This increase was attributable to increased employee expenses for staff
expansion and increased equipment and software expense. These were necessary to
maintain the high level of service we are committed to delivering to our
customer base.
Net Income
Net income for 2003 was $7.4 million - a 14.1% or $0.9 million increase from net
income of $6.5 million that was posted in 2002. While net interest income
increased only 3.7%, the significant increase in non-interest income and
controlled operating expense played a major role in the Company's overall
results. Earnings per share for the year ended December 31, 2003 increased 13.3%
to $3.07, compared to $2.71 in 2002, and $2.30 in 2001. Earnings per share on a
fully diluted basis increased 13.3% for the year ended December 31, 2003, to
$2.99, compared to $2.64 in 2002, and $2.24 in 2001. Both the EPS and net income
reported set new records in 2003. Book value per share was $19.71 on December
31, 2003, up from $17.68 on December 31, 2002 and $15.61 on December 31, 2001.
Net income for the year ended December 31, 2002 was $6.5 million - an 18.5% or
$1.0 million increase from net income of $5.5 million that was posted in 2001.
As in 2003, strong asset growth, higher levels of non-interest income and
controlled operating expenses were the major factors in these results.
Key Ratios
Return on average assets in 2003 was 1.41%, up from 1.39% in 2002 and 1.33% in
2001. Return on average equity was 16.39% in 2003, compared to 16.34% in 2002
and 15.51% in 2001. The increase in 2003 was primarily due to the record
earnings caused by the factors noted above.
The Company's efficiency ratio - a benchmark measure of the amount spent to
generate a dollar of income - was 0.48 in 2003 compared to 0.60 for its peer
group, on average. The efficiency ratio is calculated by dividing the Company's
operating expenses (which excludes the provision for loan losses) by the total
of net interest income on a tax-equivalent basis before provision for loan
losses and other operating income (which excludes securities gains). The
Company's efficiency ratio was 0.50 in 2002 compared to 0.59 for its peer group
average.
Investment Management and Fiduciary Activities
As of December 31, 2003, Pemaquid Advisors, the Bank's private banking and
investment management division, had assets under management with a market value
of $134.8 million, consisting of 614 trust accounts, estate accounts, agency
accounts, and self-directed individual retirement accounts. This compares to
December 31, 2002 when 628 accounts with market value of $119.0 million were
under management. The growth in assets under management during 2003 was the
result of a combination of new assets as well as an increase in the market value
of existing assets.
Page 19
Average Daily Balance Sheets
The following table shows the Company's average daily balance sheets for the
years ended December 31, 2003, 2002 and 2001.
- -------------------------------------------------------------------------------
Dollars in thousands
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Cash and due from banks $ 10,734 9,419 5,997
Interest-bearing deposits 5,418 4,640 1,954
Investments
U.S. Treasury securities
& government agencies 52,201 60,480 53,094
Obligations of states
& political subdivisions 29,045 21,774 18,514
Other securities 48,507 37,045 38,992
- -------------------------------------------------------------------------------
Total investments 129,753 119,299 110,600
- -------------------------------------------------------------------------------
Loans held for sale 1,646 2,025 466
- -------------------------------------------------------------------------------
Loans
Commercial 132,650 112,483 95,401
Consumer 26,475 29,898 31,645
State and municipal 12,006 8,377 9,059
Real estate 194,851 168,872 145,783
- -------------------------------------------------------------------------------
Total loans 365,982 319,630 281,888
Allowance for loan losses 3,964 3,401 2,583
- -------------------------------------------------------------------------------
Net loans 362,018 316,229 279,305
Fixed assets 7,680 7,803 6,119
Other assets 10,735 9,526 9,764
- -------------------------------------------------------------------------------
Total assets $ 527,984 468,941 414,205
- -------------------------------------------------------------------------------
Deposits
Demand $ 27,689 24,316 20,529
NOW 51,462 45,916 40,616
Money market 86,199 50,490 12,297
Savings 62,496 53,313 42,004
Certificates of deposit 69,754 76,115 67,776
Certificates of deposit
over $100,000 55,376 53,022 83,075
- -------------------------------------------------------------------------------
Total deposits 352,976 303,172 266,297
Borrowed funds 125,191 122,253 109,418
Other liabilities 4,490 3,698 3,072
- -------------------------------------------------------------------------------
Total liabilities 482,657 429,123 378,787
- -------------------------------------------------------------------------------
Common stock 25 25 25
Additional paid in capital 4,687 4,687 4,687
Retained earnings 43,007 37,296 32,929
Treasury stock (2,392) (2,190) (2,223)
-------------------------------------------------------------------------------
Total capital 45,327 39,818 35,418
- -------------------------------------------------------------------------------
Total liabilities and capital $ 527,984 468,941 414,205
===============================================================================
Management's Discussion of Financial Condition and Results of Operations,
Continued
Assets and Asset Quality
- -------------------------------------------------------------------------------
The Company experienced strong asset growth in 2003, with the loan portfolio
increasing by $66.8 million or 20.1%, and the investment portfolio increasing
$14.6 million or 12.0%. When combined, total assets increased by 15.1% or $74.7
million from $494.1 million to $568.8 million. Asset growth was funded with
deposits, which increased $24.9 million, or 7.4%. Despite a slightly lower net
interest margin, 2003's balance sheet growth enabled the Company to increase net
interest income by $0.6 million or 3.7% to $17.7 million. The Bank's loan
delinquency ratio compares very well to its peers, decreasing in 2003 to 1.00%
at year end, versus 1.04% on December 31, 2002 and 1.45% on December 31, 2001.
In Management's opinion, there has been no pattern or trend in loan
delinquencies which is of concern. The levels seen in 2003 and 2002 are related
to the Bank's ability to control loan quality and resolve delinquency issues
quickly.
Investment Activities
During 2003, the Company's investment portfolio increased 12.0% to end the year
at $136.7 million, compared to $122.1 million on December 31, 2002. Much of the
Company's investment portfolio consists of callable securities, and the
declining interest rate environment in 2003 resulted in a number of these
securities being called by issuers. The Company was able to replace these
securities at favorable levels, and also posted $14.6 million net growth in the
portfolio in 2003.
The Company's investment securities are classified into two categories:
securities available for sale and securities to be held to maturity. Securities
available for sale consists primarily of debt securities which Management
intends to hold for indefinite periods of time. They may be used as part of the
Company's funds management strategy, and may be sold in response to changes in
interest rates, changes in prepayment risk, changes in liquidity needs, to
increase capital ratios, or for other similar reasons. Securities to be held to
maturity consists primarily of debt securities that the Company has acquired
solely for long-term investment purposes, rather than for trading or future
sale. For securities to be categorized as held to maturity, Management must have
the intent and the Company must have the ability to hold such investments until
their respective maturity dates. The Company does not hold trading account
securities.
All investment securities are managed in accordance with a written
investment policy adopted by the Board of Directors. It is the Company's general
policy that investments for either portfolio be limited to government debt
obligations, time deposits, banker's acceptances, corporate bonds and commercial
paper with one of the three highest ratings given by a nationally recognized
rating agency.
Page 21
Management's Discussion of Financial Condition and Results of Operations,
Continued
In 2003, the growth in the Company's investment portfolio was primarily in
U.S. Government Agency securities, and tax-exempt obligations of states and
political subdivisions. These were selected to enhance the portfolio's overall
yield while not materially adding to the Company's level of interest rate risk.
The following table sets forth the Company's investment securities at their
carrying amounts as of December 31, 2003, 2002, and 2001.
- -------------------------------------------------------------------------------
Dollars in thousands 2003 2002 2001
- -------------------------------------------------------------------------------
Securities available for sale
U.S. Treasury and agency $ 2,925 -- --
Mortgage-backed securities 5,463 6,397 2,425
State and political subdivisions 14,852 14,626 13,770
Corporate securities 26,461 28,288 27,861
Federal Home Loan Bank stock 6,871 6,195 6,005
Federal Reserve Bank stock 53 53 53
Other equity securities 820 851 800
- -------------------------------------------------------------------------------
$ 57,445 56,410 50,914
- -------------------------------------------------------------------------------
Securities to be held to maturity
U.S. Treasury and agency 44,419 30,952 35,444
Mortgage-backed securities 8,409 16,090 13,851
State and political subdivisions 17,823 12,032 6,393
Corporate securities 8,593 6,589 1,584
- -------------------------------------------------------------------------------
79,244 65,663 57,272
- -------------------------------------------------------------------------------
Total securities $136,689 122,073 108,186
===============================================================================
Page 22
Management's Discussion of Financial Condition and Results of Operations,
Continued
The following table sets forth certain information regarding the yields and
expected maturities of the Company's investment securities as of December 31,
2003. Yields on tax-exempt securities have been computed on a tax-equivalent
basis using a tax-rate of 35%. Mortgage-backed securities are presented
according to their final contractual maturity date, while the calculated yield
takes into effect the intermediate cashflows from repayment of principal which
results in a much shorter average life.
- -------------------------------------------------------------------------------
Available for sale Held to maturity
------------------ ----------------
Dollars in thousands Fair Yield to Amortized Yield to
value maturity cost maturity
- -------------------------------------------------------------------------------
U.S. Treasury and agency
Due in 1 year or less $ - - $ - -
Due in 1 to 5 years - - - -
Due in 5 to 10 years - - 19,161 4.85%
Due after 10 years 2,925 3.00% 25,258 5.25%
- -------------------------------------------------------------------------------
2,925 3.00% 44,419 5.08%
- -------------------------------------------------------------------------------
Mortgage-backed securities
Due in 1 year or less - - - -
Due in 1 to 5 years 295 10.80% 534 3.24%
Due in 5 to 10 years 937 1.61% 481 6.20%
Due after 10 years 4,231 3.13% 7,394 3.86%
- -------------------------------------------------------------------------------
5,463 3.28% 8,409 3.95%
- -------------------------------------------------------------------------------
State and political subdivisions
Due in 1 year or less - - - -
Due in 1 to 5 years - - - -
Due in 5 to 10 years 3,539 4.57% 6,049 5.05%
Due after 10 years 11,313 5.04% 11,774 4.57%
- -------------------------------------------------------------------------------
14,852 4.93% 17,823 4.73%
- -------------------------------------------------------------------------------
Corporate debt securities
Due in 1 year or less 2,858 7.22% - -
Due in 1 to 5 years 7,813 7.48% 598 7.21%
Due in 5 to 10 years 14,180 7.77% - -
Due after 10 years 1,610 3.32% 7,995 3.61%
- -------------------------------------------------------------------------------
26,461 7.35% 8,593 3.86%
- -------------------------------------------------------------------------------
Equity securities 7,744 3.30% - -
- -------------------------------------------------------------------------------
$ 57,445 5.57% $ 79,244 4.75%
===============================================================================
Page 23
Management's Discussion of Financial Condition and Results of Operations,
Continued
Lending Activities
The loan portfolio experienced growth in all areas during 2003, with the most
significant increase seen in residential real estate loans and commercial loans.
Total loans were $398.9 million at December 31, 2003, a 20.1% increase from
total loans of $332.1 million at December 31, 2002. The strong growth in the
loan portfolio seen in 2003 was the result of significant refinancing activity
due to low interest rates as well as growth in the Bank's newest offices in Knox
County. This continues the loan growth trend experienced by the Company over the
past five years. In Management's opinion, should refinancing activity slow down
given an increase in interest rates, net income will not have a significant
adverse impact due to the potential for increased market share and the
opportunity to retain loans in the Bank's portfolio.
The following tables summarize the Bank's loan portfolio as of December 31,
2003, 2002, 2001, 2000 and 1999.
<table> <caption>
- -----------------------------------------------------------------------------------------------------------------
Dollars in thousands
As of December 31, 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Commercial loans
Real estate $ 40,521 10.2% $ 37,082 11.2% $ 32,638 10.8% $ 30,695 11.6% $ 30,305 13.0%
Other 97,487 24.4% 82,504 24.8% 68,378 22.7% 53,362 20.1% 41,970 18.0%
Residential real estate loans
Construction 2,483 0.6% 1,019 0.3% 2,522 0.9% 1,060 0.4% 1,661 0.7%
Term 223,251 56.0% 174,070 52.4% 159,743 53.0% 139,300 52.6% 121,599 52.4%
Consumer loans 26,123 6.5% 27,925 8.4% 30,727 10.2% 33,028 12.5% 29,227 12.6%
Municipal 9,030 2.3% 9,474 2.9% 7,296 2.4% 7,484 2.8% 7,764 3.3%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total $398,895 100.0% $332,074 100.0% $301,304 100.0% $264,929 100.0% $232,526 100.0%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
- -----------------------------------------------------------------------------------------------------------------
</table>
The Bank issued both VISA and MasterCard credit cards until December 2002
when outstanding balances totaling $2.5 million were sold. Credit cards included
in consumer loans in the table above totaled $2.5 million in 2001, $2.7 million
in 2000, and $2.5 million in 1999.
The following table sets forth certain information regarding the
contractual maturities of the Bank's loan portfolio as of December 31, 2003.
- -------------------------------------------------------------------------------
Dollars in thousands < 1 Year 1-5 Years 5-10 Years >10 Years Total
- -------------------------------------------------------------------------------
Commercial real estate $ 361 884 2,819 36,457 40,521
Commercial other 15,588 14,677 14,828 52,394 97,487
Residential real estate 8 1,397 7,242 214,604 223,251
Residential construction 2,483 -- -- -- 2,483
Consumer 4,658 8,579 4,008 8,968 26,123
Municipal 517 570 1,050 6,893 9,030
- -------------------------------------------------------------------------------
Totals $23,525 26,107 29,947 319,316 398,895
===============================================================================
Page 24
Management's Discussion of Financial Condition and Results of Operations,
Continued
The following table provides a listing of loans by category, excluding
loans held for sale, between variable and fixed rates as of December 31, 2003.
- -------------------------------------------------------------------------------
Dollars in thousands Amount % of total
- -------------------------------------------------------------------------------
Variable-rate loans
Commercial loans $117,139 29.4%
State and municipal loans 6,337 1.6%
Consumer loans 5,480 1.4%
Equity loans 51,979 13.0%
Residential adjustable-rate mortgages 87,786 22.0%
- -------------------------------------------------------------------------------
Total variable-rate loans 268,721 67.4%
Fixed-rate loans 130,174 32.6%
- -------------------------------------------------------------------------------
Total loans $398,895 100.0%
===============================================================================
Loan Concentrations
As of December 31, 2003, the Bank did not have any concentration of loans in one
particular industry that exceeded 10% of its total loan portfolio.
Loans Held for Sale
In 2003, the Bank placed a large volume of residential mortgages into the
secondary market, the result of increased mortgage underwriting opportunities
resulting from lower interest rates. While this resulted in a lower level of
loans remaining on the balance sheets and lower net interest income, the sale of
these loans in 2003 resulted in a higher level of non-interest income. Loans
held for sale are carried at the lower of cost or market value, which was $1.0
million at December 31, 2003 compared to $2.6 million at December 31, 2002.
Allowance for Loan Losses and Loan Loss Experience
The allowance for loan losses represents the amount available for credit losses
inherent in the Company's loan portfolio. Loans are charged off when they are
deemed uncollectible, after giving consideration to factors such as the
customer's financial condition, underlying collateral and guarantees, as well as
general and industry economic conditions.
In general, the Company determines the appropriate overall reserve for loan
losses based upon periodic, systematic reviews of its portfolio to identify
inherent losses based on Management's judgment about various qualitative
factors. These reviews result in the identification and quantification of loss
factors, which are used in determining the amount of the allowance for loan
losses. The Company periodically evaluates prevailing economic and business
conditions, industry concentrations, changes in the size and characteristics of
the portfolio and other pertinent factors. Portions of the allowance for loan
losses are quantified to cover the estimated losses inherent in each loan
category based on the results of this detailed review process.
Page 25
Management's Discussion of Financial Condition and Results of Operations,
Continued
Commercial loans are individually reviewed and assigned a credit risk
rating from "1" (low risk of loss) to "8" (high risk of loss). For non-impaired
loans with a credit risk rating of "1" to "7", estimated loss factors based on
historical loss experience (ranging from two to five years) are used to
calculate a loan loss reserve for each credit risk rating classification.
Qualitative adjustments are also made based upon Management's assessment of
prevailing economic conditions, trends in volumes and terms of loans, levels and
trends in delinquencies and non-accruals, and the effect of changes in lending
policies. A specific allocation is made for impaired loans, or loans no longer
accruing interest as a result of the deemed uncollectibility of interest due,
which are measured at the net present value of future cash flows, discounted at
the loan's effective interest rate, or at fair market value of collateral if the
loan is collateral dependent. The combination of these analyses is the basis for
the determination of the commercial loan portion of the allowance for loan
losses.
Consumer loans, which include residential mortgages, home equity
loans/lines, and direct/indirect loans, are generally evaluated as a group based
on product type. The determination of the consumer loan portion of the allowance
for loan losses is based on a five-year average of annual historical losses,
adjusted for the qualitative factors noted above.
The results of all analyses are reviewed and discussed by the Directors'
Loan Committee. An integral component of the Company's risk management process
is to ensure the proper quantification of the reserve for loan losses based upon
an analysis of risk characteristics, demonstrated losses, loan segmentations,
and other factors. Reserve methodology is reviewed on a periodic basis and
modified as appropriate. Based on this analysis, including the aforementioned
assumptions, the Company believes that the allowance for loan losses is adequate
as of December 31, 2003. The unallocated component of the allowance for loan
losses represents Management's view that, given the complexities of the loan
portfolio, there are estimable losses that have been incurred within the
portfolio but not yet tied to specific loans. Although Management utilizes its
best judgment in providing for possible losses, there can be no assurance the
Bank will not have to increase its provision for possible losses in the future
due to increases in non-performing assets or otherwise, which would adversely
affect the results of operations.
The following table reflects the Bank's allowance for loan losses by
category of loan as of December 31, 2003, 2002, 2001, 2000 and 1999. The
unallocated portion of the allowance for loan losses is a general reserve that
is not allocated to a specific portion of the loan portfolio. The commercial
category includes commercial real estate loans.
- -------------------------------------------------------------------------------
Dollars in thousands
As of December 31, 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------
Real estate $ 690 56% 568 53% 618 54% 562 53% 488 53%
Commercial 2,237 37% 1,835 39% 1,467 36% 907 35% 686 34%
Consumer 752 7% 806 8% 604 10% 631 12% 580 13%
Unallocated 521 -- 491 -- 311 -- 201 -- 281 --
- -------------------------------------------------------------------------------
Total $4,200 100% 3,700 100% 3,000 100% 2,301 100% 2,035 100%
===============================================================================
Percentage is amount of loans in each category as a percent of total loans for
the stated year.
Page 26
Management's Discussion of Financial Condition and Results of Operations,
Continued
Net loans charged off in 2003 were $0.4 million, or 0.10% of average loans
outstanding for the year, which is significantly lower than the level of net
chargeoffs in the past five years. This compares to net loan chargeoffs of $0.6
million, or 0.19% in 2002 and $0.5 million or 0.19% in 2001. The following table
summarizes the activity with respect to loan losses for the years ended December
31, 2003, 2002, 2001, 2000 and 1999.
- -------------------------------------------------------------------------------
Dollars in thousands
As of December 31, 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------
Balance at beginning of period $3,700 3,000 2,301 2,035 1,822
Loans charged off:
Commercial 1 184 432 391 164 153
Real estate mortgage 19 24 1 5 31
Consumer 352 268 243 388 359
- -------------------------------------------------------------------------------
Total 555 724 635 557 543
- -------------------------------------------------------------------------------
Recoveries on loans previously
charged off:
Commercial1 52 16 34 44 12
Real estate mortgage 2 -- 1 6 8
Consumer 94 85 69 73 91
- -------------------------------------------------------------------------------
Total 148 101 104 123 111
- -------------------------------------------------------------------------------
Net loans charged off 407 623 531 434 432
Provision for loan losses 907 1,323 1,230 700 645
- -------------------------------------------------------------------------------
Balance at end of period $4,200 3,700 3,000 2,301 2,035
===============================================================================
Ratio of net loans charged off to
average loans outstanding 0.10% 0.19% 0.19% 0.17% 0.19%
===============================================================================
1 Includes commercial real estate loans
During 2003, a provision of $0.9 million was made to the allowance for loan
losses, compared to a provision of $1.3 million in 2002, and $1.2 million in
2001. In Management's opinion, this decreased level of provision in 2003 was
appropriate given the amount of growth in the loan portfolio and the overall
credit quality of the portfolio. At December 31, 2003, the allowance for loan
losses stood at $4.2 million, or 1.05% of total loans outstanding. This compares
to $3.7 million or 1.11% of total loans outstanding at December 31, 2002, and
$3.0 million, or 1.00% of total loans outstanding at December 31, 2001. In
Management's opinion, past levels of provision to the allowance for loan losses
have been adequate, as demonstrated by net loans charged off shown in the table
above.
Page 27
Management's Discussion of Financial Condition and Results of Operations,
Continued
Non-Performing Assets
The Bank's loan delinquency ratio decreased in 2003 and was 1.00% on
December 31, 2003, versus 1.04% on December 31, 2002. The aggregate dollar
amount of loans more than 90 days past-due or on non-accrual status increased
during 2003, but remains low relative to the Bank's peer group average. In
Management's opinion, there has been no pattern or trend in non-performing
assets of concern. An increase in 2000 was related to isolated circumstances
involving a small number of borrowers. The levels at December 31, 2003, 2002 and
2001 are in line with the Bank's normal delinquency rates. The following table
sets forth a summary of delinquent loans (more than ninety days past due) by
category, total loans carried on a non-accrual basis, and income not recognized
from non-accrual loans as of December 31, 2003, 2002, 2001, 2000 and 1999.
- -------------------------------------------------------------------------------
Dollars in thousands
As of December 31, 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------
Commercial real estate & business $1,320 921 655 2,479 822
Residential real estate 517 463 275 267 260
Consumer 78 92 150 103 90
- -------------------------------------------------------------------------------
Total 1,915 1,476 1,080 2,849 1,172
===============================================================================
Non-accrual loans included
in above total $1,537 1,070 667 2,366 681
Income not recognized from
non-accrual loans $ 85 108 77 185 64
===============================================================================
The Bank places a loan on non-accrual status only after a careful review of
the loan circumstances and a determination that payment in full of principal
and/or interest is not expected. Income not recognized from non-accrual loans
represents the interest income, as of the end of each period, that would have
been recorded on loans placed on non-accrual status if they were current in
accordance with their original terms. None of these amounts were included in
interest income for the same periods.
Other real estate owned decreased during 2003. At December 31, 2003 it
included two properties valued at $51,000, compared to three properties valued
at $255,000 at December 31, 2002. Other real estate owned and repossessed assets
are comprised of properties or other assets acquired through a foreclosure
proceeding, or acceptance of a deed or title in lieu of foreclosure. They can
also include properties which secure loans where the Bank obtains possession of
the underlying collateral from the borrower or other assets repossessed in
connection with non-real estate loans. Other real estate owned and repossessed
assets are carried at the lower of cost or fair value less the estimated selling
expenses of the collateral. An allowance is established for the amount by which
cost exceeds fair value less estimated selling expenses on a property by
property basis. Losses arising from the acquisition of such properties are
charged against the allowance for loan losses. Operating expenses and any
subsequent provisions to reduce the carrying value of the property are charged
to operations. Gains and losses upon disposition of the property are reflected
in earnings as realized.
Page 28
Management's Discussion of Financial Condition and Results of Operations,
Continued
Funding, Liquidity and Capital Resources
- -------------------------------------------------------------------------------
The Company's principal sources of funding are deposits and borrowed funds from
the Federal Home Loan Bank. The Company has a comprehensive liquidity management
program in place. It maintains adequate funding for its assets by monitoring
anticipated sources and uses of funding. In addition to acquiring deposits in
its local market, the Bank also has the ability to quickly obtain funding
through wholesale sources, including brokers and on-line marketing services
which enable the Bank to post rates for qualified online purchasers. The Bank's
liquidity position is further supplemented with securities repurchase agreements
with certain brokers and a $5.0 million credit line with a correspondent bank.
While the Bank maintains an available for sale portfolio of securities to
enhance its overall liquidity position, its present policy is not to liquidate
securities to meet short-term liquidity needs. Instead, the Bank uses Federal
Home Loan Bank advances or its securities repurchase agreements for this
purpose. At December 31, 2003, the Company had a net unrealized gain of $2.5
million (net of $1.3 million in deferred income taxes) on available for sale
securities. This unrealized gain is in line with Management's expectations given
the drop in interest rates experienced in 2003.
Deposit balances generally increase during the summer and autumn months of
each year due to increased seasonal business activity. In 2003, the maximum
amount of deposits at any month end was $371.0 million on September 30. Because
of uncertainty about future interest rates, in recent years investors have shown
a preference for short-term deposits which could reprice quickly should rates
rise.
As of December 31, 2003, the Bank had primary sources of liquidity of $58.2
million, or 10.3% of its assets. It is Management's opinion that this is
adequate. The Bank has established guidelines for liquidity management, with
policies and procedures prescribed in its funds management policy. Management
has not seen any recent significant deposit trends which would have a material
effect on the Bank's liquidity position.
Deposits
The Bank realized an increase in deposits of 7.4% in 2003, compared to a 27.2%
increase in 2002 and a 3.2% increase in 2001. Much of the growth in 2003 was
seen in core deposits, which are typically added at favorable cost relative to
borrowed funds and certificates of deposit. The addition of three offices in
Knox County during the past six years has provided additional deposit gathering
opportunities for the Bank, and in 2003, these offices posted deposit growth of
$4.6 million. In Management's opinion, the growth posted in 2003 was comprised
primarily of non-volatile deposits.
Page 29
Management's Discussion of Financial Condition and Results of Operations,
Continued
The Bank's average cost of deposits (including non-interest-bearing
accounts) was 1.65% for the year ended December 31, 2003, compared to 2.54% for
the year ended December 31, 2002 and 3.76% for the year ended December 31, 2001.
This reduction in average cost realized over the past two years is consistent
with the policy for lower interest rates set by the Open Market Committee of the
Federal Reserve Board. The following table sets forth the average daily balance
for the Bank's principal deposit categories for each period.
- -------------------------------------------------------------------------------
Dollars in thousands %growth
Years ended December 31, 2003 2002 2001 2003 vs.2002
- -------------------------------------------------------------------------------
Demand deposits $ 27,689 24,316 20,529 13.9%
NOW accounts 51,462 45,916 40,616 12.1%
Money market accounts 86,199 50,490 12,297 70.7%
Savings 62,496 53,313 42,004 17.2%
Certificates of deposit 125,130 129,137 150,851 (3.1%)
- -------------------------------------------------------------------------------
Total deposits $352,976 303,172 266,297 16.4%
===============================================================================
The following table sets forth the average cost of each category of
interest-bearing deposits for the periods indicated.
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
NOW accounts 0.20% 0.49% 1.05%
Money market accounts 1.47% 2.47% 3.40%
Savings accounts 0.93% 1.83% 2.57%
Certificates of deposit 3.09% 4.07% 5.36%
- -------------------------------------------------------------------------------
Total interest-bearing deposits 1.79% 2.76% 4.07%
===============================================================================
Of all certificates of deposit, $80.6 million or 60.1% will mature by
December 31, 2004. As of December 31, 2003, the Bank held a total of $64.2
million in certificate of deposit accounts with balances in excess of $100,000.
The following table summarizes the time remaining to maturity for these
certificates of deposit:
- -------------------------------------------------------------------------------
Dollars in thousands
- -------------------------------------------------------------------------------
Within 3 months $ 11,949
3 months through 6 months 5,940
6 months through 12 months 18,524
Over 12 months 27,807
- -------------------------------------------------------------------------------
Total $ 64,220
===============================================================================
Page 30
Management's Discussion of Financial Condition and Results of Operations,
Continued
Borrowed Funds
Borrowed funds consists mainly of advances from the Federal Home Loan Bank
(FHLB) which are secured by FHLB stock, funds on deposit with FHLB, U.S.
Treasury and Agency notes and mortgage-backed securities and qualifying first
mortgage loans. At FHLB, the Bank has a credit line of $8.0 million for
overnight borrowings, plus short-term and long-term advance capacity of $169.0
million. As of December 31, 2003, advances totaled $136.4 million, with a
weighted average interest rate of 2.73% and remaining maturities ranging from
one month to eight years. This compares to advances totaling $90.5 million, with
a weighted average interest rate of 4.32% and remaining maturities ranging from
five months to eight years, as of December 31, 2002.
The Bank offers securities repurchase agreements to municipal and corporate
customers as an alternative to deposits. The balance of these agreements as of
December 31, 2003 was $20.3 million, compared to $19.3 million on December 31,
2002, and $22.4 million on December 31, 2001. The Bank also had a repurchase
agreement with a brokerage firm at December 31, 2001 in the amount of $9.8
million, which was repaid in 2002.
The Bank participates in the Note Option Depository which is offered by the
U.S. Treasury Department. Under the Treasury Tax & Loan Note program, the Bank
accumulates tax deposits made by its customers and is eligible to receive
additional Treasury Direct investments up to an established maximum balance of
$5.0 million. The balances invested by the Treasury are increased and decreased
at the discretion of the Treasury. The deposits are generally made at interest
rates that are favorable in comparison to other borrowings. The balances on the
Treasury Tax & Loan note at December 31, 2003, 2002 and 2002 were $1.1 million,
$3.5 million and $0.2 million, respectively.
The maximum amount of borrowed funds outstanding at any month-end during
each of the last three years was $151.7 million at the end of November during
2003, $143.6 million at the end of May for the year 2002, and $131.4 million at
the end of December for the year 2001. The average amount outstanding during
2003 was $125.2 million with a weighted average interest rate of 3.18%. This
compares to an average outstanding amount of $122.3 million with a weighted
average interest rate of 3.68% in 2002, and an average outstanding amount of
$109.4 million with a weighted average interest rate of 4.59% in 2001.
Capital Resources
Capital at December 31, 2003 was sufficient to meet the requirements of
regulatory authorities. For the year, average equity to average assets was 8.58%
in 2003, versus 8.49% in 2002. Leverage capital of the Company, or total
shareholders' equity divided by average total assets for the current quarter
less goodwill and any net unrealized gain or loss on securities available for
sale, stood at 8.06% on December 31, 2003, versus 8.19% in 2002.
At December 31, 2003, the Company had tier-one risk-based capital of 11.82%
and tier-two risk-based capital of 12.92%, versus 12.32% and 13.45%,
respectively, in 2002. To be rated "well-capitalized", regulatory requirements
call for minimum tier-one and tier-two risk-based capital ratios of 6.00% and
10.00%, respectively. The Company's actual levels of capitalization were
comfortably above the standards to be rated "well-capitalized" by regulatory
authorities. During 2003, the Company declared cash dividends of $0.27 per share
for the first quarter, $0.28 per share for the second quarter, $0.29 per share
for the third quarter, and $0.30 per share for the fourth quarter. The Company's
dividend payout ratio was 37.13% of earnings in 2003, 36.16% in 2002, and 35.65%
in 2001.
Page 31
Management's Discussion of Financial Condition and Results of Operations,
Continued
In determining future dividend payout levels, the Board of Directors
carefully analyzes capital requirements and earnings retention, as set forth in
the Company's Dividend Policy. The ability of the Company to pay cash dividends
to its shareholders depends on receipt of dividends from its subsidiary, the
Bank. The subsidiary may pay dividends to its parent out of so much of its net
profits as the Bank's directors deem appropriate, subject to the limitation that
the total of all dividends declared by the Bank in any calendar year may not
exceed the total of its net profits of that year combined with its retained net
profits of the preceding two years. The amount available for dividends in 2004
will be that year's net income plus $8.5 million. A total of $2.8 million in
dividends was declared in 2003.
In 2003, 6,600 shares of common stock were issued in conjunction with the
exercise of stock options for consideration totaling $50,000. The Company also
purchased 14,757 shares of common stock for total consideration of $0.6 million,
of which 14,844 shares were reissued via employee stock programs and the
dividend reinvestment plan during the year.
Management knows of no present trends, events or uncertainties that will
have, or are reasonably likely to have, a material effect on capital resources,
liquidity, or results of operations.
Contractual Obligations and Off-Balance Sheet Activities
The following table sets forth the contractual obligations and commitments to
extend credit of the Company as of December 31, 2003:
- -------------------------------------------------------------------------------
Less than 1-3 4-5 More than
Dollars in thousands Total 1 Year Years Years 5 Years
- -------------------------------------------------------------------------------
Borrowed funds $157,822 88,322 42,000 -- 27,500
Operating leases 254 79 111 64 --
Certificates of deposit 134,100 80,559 42,333 11,208 --
- -------------------------------------------------------------------------------
Total contractual obligations $292,176 168,960 84,444 11,272 27,500
===============================================================================
Unused lines, collateralized
by residential real estate $ 34,651 34,651 -- --
Other unused commitments 31,929 31,929 -- -- --
Standby letters of credit 50 50 -- -- --
Commitments to extend credit 9,175 9,175 -- -- --
- -------------------------------------------------------------------------------
Total loan commitments and
unused lines of credit $ 75,805 75,805 -- -- --
===============================================================================
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These include commitments to originate loans, commitments for unused lines of
credit, and standby letters of credit. The instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
consolidated balance sheets. Commitments for unused lines are agreements to lend
to a customer provided there is no violation of any condition established in the
contract and generally have fixed expiration dates. Standby letters of credit
are conditional commitments issued by the Bank to guarantee a customer's
performance to a third party. The credit risk involved in issuing letters of
Page 32
Management's Discussion of Financial Condition and Results of Operations,
Continued
credit is essentially the same as that involved in extending loans to customers.
As of December 31, 2003, the Company's off-balance-sheet activities consisted
entirely of commitments to extend credit.
Capital Purchases
In 2003, the Company made capital purchases totaling $2.2 million. This cost
will be amortized over an average of seventeen years, adding approximately
$131,000 to pre-tax operating costs per year. The capital purchases included
primarily real estate improvements for branch premises and equipment related to
technology.
Effect of Future Interest Rates on Post-retirement Benefit Liabilities
In evaluating the Company's post-retirement benefit liabilities, Management
believes changes in discount rates will not have a significant impact on future
operating results or financial condition.
Page 33
Management's Discussion of Financial Condition and Results of Operations,
Continued
Risk Management
- -------------------------------------------------------------------------------
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, and First National
Lincoln Corporation's market risk is composed primarily of interest rate risk.
The Bank's Asset/Liability Committee (ALCO) is responsible for reviewing the
interest rate sensitivity position of the Company and establishing policies to
monitor and limit exposure to interest rate risk. All guidelines and policies
established by ALCO have been approved by the Board of Directors.
Asset/Liability Management
The primary goal of asset/liability management is to maximize net interest
income within the interest rate risk limits set by ALCO. Interest rate risk is
monitored through the use of two complementary measures: static gap analysis and
earnings simulation modeling. While each measurement has limitations, taken
together they present a reasonably comprehensive view of the magnitude of
interest rate risk in the Company, the level of risk through time, and the
amount of exposure to changes in certain interest rate relationships.
Static gap analysis measures the amount of repricing risk embedded in the
balance sheet at a point in time. It does so by comparing the differences in the
repricing characteristics of assets and liabilities. A gap is defined as the
difference between the principal amount of assets and liabilities which reprice
within a specified time period. The cumulative one-year gap, at year-end, was
5.7% of total assets. ALCO's policy limit for the one-year gap is plus or minus
20% of total assets. Core deposits with non-contractual maturities are presented
based upon historical patterns of balance attrition and pricing behavior which
are reviewed at least annually.
The gap repricing distributions include principal cash flows from
residential mortgage loans and mortgage-backed securities in the time frames in
which they are expected to be received. Mortgage prepayments are estimated by
applying industry median projections of prepayment speeds to portfolio segments
based on coupon range and loan age.
Page 34
Management's Discussion of Financial Condition and Results of Operations,
Continued
The Company's summarized static gap, as of December 31, 2003, is presented
in the following table:
- -------------------------------------------------------------------------------
0-90 91-365 1-5 5+
Dollars in thousands days days years years
- -------------------------------------------------------------------------------
Investment securities at
amortized cost $ 35,140 21,862 45,315 30,588
Loans held for sale 10 42 338 592
Loans 150,234 75,385 141,482 31,794
Other interest-earning assets 4,648 - - -
Non-rate-sensitive assets 54 - - 31,328
- -------------------------------------------------------------------------------
Total assets $190,086 97,289 187,135 94,302
===============================================================================
Interest-bearing deposits $108,420 54,719 53,541 113,523
Borrowed funds 71,075 17,247 42,000 27,500
Non-rate-sensitive liabilities
and equity 775 2,475 16,163 61,374
- -------------------------------------------------------------------------------
Total liabilities and equity $180,270 74,441 111,704 202,397
===============================================================================
Period gap $ 9,816 22,848 75,431 (108,095)
Percent of total assets 1.73% 4.02% 13.26% (19.00%)
===============================================================================
Cumulative gap (current) $ 9,816 32,664 108,095 -
Percent of total asset 1.73% 5.74% 19.00% 0.00%
===============================================================================
The earnings simulation model forecasts one- and two-year net interest
income under a variety of scenarios that incorporate changes in the absolute
level of interest rates as well as basis risk, as represented by changes in the
shape of the yield curve and changes in interest rate relationships. Management
evaluates the effects on income of alternative interest rate scenarios against
earnings in a stable interest rate environment. This analysis is also most
useful in determining the short-run earnings exposures to changes in customer
behavior involving loan payments and deposit additions and withdrawals.
The most recent simulation model projects net interest income would
increase by approximately 2.2% of stable-rate net interest income if rates fall
gradually by one percentage point over the next year, and decrease by
approximately 0.4% if rates rise gradually by two percentage points. Both
scenarios are well within ALCO's policy limit of a decrease in net interest
income of no more than 10.0% given a 2.0% move in interest rates, up or down.
Management believes this reflects a reasonable interest rate risk position.
Within a two-year horizon and assuming no additional movement in rates, the
model forecasts that net interest income would be higher than that earned in a
stable rate environment by 2.8% in a falling rate scenario and decrease by 5.6%
in a rising rate scenario.
This dynamic simulation model includes assumptions about how the balance
sheet is likely to evolve through time and in different interest rate
environments. Loans and deposits are projected to maintain stable balances. All
maturities, calls and prepayments in the securities portfolio are assumed to be
reinvested in similar assets. Mortgage loan prepayment assumptions are developed
from industry median estimates of prepayment speeds for portfolios with similar
Page 35
Management's Discussion of Financial Condition and Results of Operations,
Continued
coupon ranges and seasoning. Non-contractual deposit volatility and pricing are
assumed to follow historical patterns. The sensitivities of key assumptions are
analyzed annually and reviewed by ALCO.
A summary of the Company's interest rate risk simulation modeling, as of
December 31, 2003 and 2002 is presented in the following table:
- -------------------------------------------------------------------------------
Changes in Net Interest Income 2003 2002
- -------------------------------------------------------------------------------
Year 1
Projected change if rates decrease by 1.0% +2.2% +0.8%
Projected change if rates increase by 2.0% -0.4% +0.2%
- -------------------------------------------------------------------------------
Year 2
Projected change if rates decrease by 1.0% +2.8% +1.5%
Projected change if rates increase by 2.0% -5.6% -1.3%
- -------------------------------------------------------------------------------
A variety of financial instruments can be used to manage interest rate
sensitivity. These may include the securities in the investment portfolio,
interest rate swaps, and interest rate caps and floors. Frequently called
interest rate derivatives, interest rate swaps, caps and floors have
characteristics similar to securities but possess the advantages of
customization of the risk-reward profile of the instrument, minimization of
balance sheet leverage and improvement of liquidity. As of December 31, 2003,
the Company was not using any derivative instruments for interest rate risk
management.
The Company engages an independent consultant to periodically review its
interest rate risk position, as well as the effectiveness of simulation modeling
and reasonableness of assumptions used. As of December 31, 2003, there were no
significant differences between the views of the independent consultant and
Management regarding the Company's interest rate risk exposure. Management
believes that the current level of interest rate risk is acceptable and expects
interest rates will remain constant for much of 2004 with a possibility of an
increase in the third or fourth quarters.
Page 36
Management's Discussion of Financial Condition and Results of Operations,
Continued
Other Information
- -------------------------------------------------------------------------------
Impact of Recently Issued Accounting Standards
In April 2003, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. SFAS 149 is effective for contracts entered into or modified
after June 30, 2003, except as stated below and for hedging relationships
designated after June 30, 2003. The guidance should be applied prospectively.
The provisions of this Statement that relate to Statement 133 Implementation
Issues that have been effective for fiscal quarters that began prior to June 15,
2003, should continue to be applied in accordance with their respective
effective dates. In addition, certain provisions relating to forward purchases
or sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered into
after June 30, 2003. SFAS No. 149 does not affect the Company's consolidated
financial condition and results of operations.
In May 2003, FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities. This Statement does not impact the
Company's consolidated financial statements as the Company does not have
financial instruments with characteristics of both liabilities and equity.
FASB's Emerging Issues Task Force, in its Issue No. 03-1, has issued new
disclosure requirements with respect to investment securities with unrealized
losses that have not been classified as other-than-temporary. Companies are
required to disclose separately investments that have had continual unrealized
losses for twelve months or more, and those that have had continual unrealized
losses for less than twelve months. For investments in the former category, a
narrative disclosure is required that would allow financial statement users to
understand the positive and negative information management considered in
reaching the conclusion that the impairments are not other-than-temporary. The
new disclosure requirements, which are effective for years ending after December
15, 2003, did not have a material impact on the Company's consolidated financial
statements.
Page 37
Management's Discussion of Financial Condition and Results of Operations,
Continued
In December 2003, the President signed the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) into law. The Act includes
the following two new features to Medicare (Medicare Part D) that could affect
the measurement of the accumulated postretirement benefit obligation (APBO) and
net periodic postretirement benefit cost for the Plan: a subsidy to plan
sponsors that is based on 28% of an individual beneficiary's annual prescription
drug costs between $250 and $5,000 and the opportunity for a retiree to obtain a
prescription drug benefit under Medicare. The effects of the Act on the APBO or
net periodic postretirement benefit cost are not reflected in the financial
statements or accompanying notes. Pending specific authoritative guidance on the
accounting for the federal subsidy could require the Company to change
previously reported information when the guidance is issued.
In December 2003, FASB issued a revised version of SFAS 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." The Statement
retains all of the previous requirements and introduces additional disclosure
requirements and interim reporting requirements. SFAS 132 (revised 2003) is
effective for years ending after December 15, 2003.
Forward-Looking Statements
Certain disclosures in Management's Discussion of Financial Condition and
Results of Operations contain certain forward-looking statements (as defined in
the Private Securities Litigation Reform Act of 1995). In preparing these
disclosures, Management must make assumptions, including, but not limited to,
assumptions concerning the level of future interest rates, general local,
regional and national economic conditions, competitive pressures, prepayments on
loans and investments, required levels of capital, needs for liquidity, and the
adequacy of the allowance for loan losses. These forward-looking statements may
be subject to significant known and unknown risks and uncertainties, and other
factors, including, but not limited to, those matters referred to in the
preceding sentence.
Although First National Lincoln Corporation believes that the expectations
reflected in such forward-looking statements are reasonable, actual results may
differ materially from the results discussed in these forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to republish revised forward-looking statements to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Readers are also urged to carefully review
and consider the various disclosures made by the Company which attempt to advise
interested parties of the factors which affect the Company's business.
Page 38
Management's Discussion of Financial Condition and Results of Operations,
Continued
Quarterly Information
The following tables provide unaudited financial information by quarter for each
of the past two years:
- -------------------------------------------------------------------------------
Dollars in thousands 2003 Q1 2003 Q2 2003 Q3 2003 Q4
- -------------------------------------------------------------------------------
Balance Sheets
Cash $ 13,946 19,073 13,758 17,087
Investments 128,667 128,291 139,196 136,689
Net loans 343,821 365,090 380,739 395,677
Other assets 17,654 18,673 18,125 19,359
- -------------------------------------------------------------------------------
Total assets $504,088 531,127 551,818 568,812
===============================================================================
Deposits $340,377 359,010 370,952 359,077
Borrowed funds 115,151 121,933 129,583 157,822
Other liabilities 4,608 4,582 4,550 4,195
Shareholders' equity 43,952 45,602 46,733 47,718
- -------------------------------------------------------------------------------
Total liabilities & equity $504,088 531,127 551,818 568,812
===============================================================================
Income Statements
Interest income $ 6,868 6,804 6,815 7,053
Interest expense 2,768 2,640 2,229 2,159
- -------------------------------------------------------------------------------
Net interest income 4,100 4,164 4,586 4,894
Provision for loan losses 225 225 225 232
- -------------------------------------------------------------------------------
Net interest income after provision 3,875 3,939 4,361 4,662
Non-interest income 1,223 1,210 1,543 1,173
Non-interest expense 2,758 2,757 3,076 3,010
- -------------------------------------------------------------------------------
Income before taxes 2,340 2,392 2,828 2,825
Income taxes 661 663 816 818
- -------------------------------------------------------------------------------
Net income $ 1,679 1,729 2,012 2,007
===============================================================================
Basic earnings per share $ 0.69 0.71 0.83 0.84
Diluted earnings per share $ 0.68 0.70 0.81 0.80
- -------------------------------------------------------------------------------
Page 39
Management's Discussion of Financial Condition and Results of Operations,
Concluded
- -------------------------------------------------------------------------------
Dollars in thousands 2002 Q1 2002 Q2 2002 Q3 2002 Q4
- -------------------------------------------------------------------------------
Balance Sheets
Cash $ 7,829 9,573 26,304 23,506
Investments 107,200 128,350 124,104 122,073
Net loans 303,637 323,315 329,497 330,987
Other assets 18,053 17,384 17,343 17,502
- -------------------------------------------------------------------------------
Total assets $436,719 478,622 497,248 494,068
===============================================================================
Deposits $276,397 308,294 336,800 334,224
Borrowed funds 118,763 126,734 113,975 113,365
Other liabilities 3,424 3,691 4,359 3,784
Shareholders' equity 38,135 39,903 42,114 42,695
- -------------------------------------------------------------------------------
Total liabilities & equity $436,719 478,622 497,248 494,068
===============================================================================
Income Statements
Interest income $ 7,154 7,403 7,513 7,237
Interest expense 2,992 3,077 3,174 2,961
- -------------------------------------------------------------------------------
Net interest income 4,162 4,326 4,339 4,276
Provision for loan losses 410 280 255 378
- -------------------------------------------------------------------------------
Net interest income after provision 3,752 4,046 4,084 3,898
Non-interest income 919 1,017 1,368 1,647
Non-interest expense 2,619 2,709 3,041 3,176
- -------------------------------------------------------------------------------
Income before taxes 2,052 2,354 2,411 2,369
Income taxes 579 708 722 670
- -------------------------------------------------------------------------------
Net income $ 1,473 1,646 1,689 1,699
===============================================================================
Basic earnings per share $ 0.62 0.69 0.70 0.70
Diluted earnings per share $ 0.60 0.66 0.68 0.70
- -------------------------------------------------------------------------------
Page 40
Report of Management
First National Lincoln Corporation and Subsidiary
The Management of First National Lincoln Corporation is responsible for the
preparation, content, and integrity of the financial statements and other
statistical data presented in this report. The financial statements have been
prepared in conformity with U.S. generally accepted accounting principles and
necessarily include amounts based on Management's best estimates and judgment.
Management also prepared the other information in this report and is responsible
for its accuracy and consistency with the financial statements.
First National Lincoln Corporation maintains internal control systems
designed to produce reliable financial statements. Management recognizes that
although controls established for these systems are applied in a prudent manner,
errors and irregularities may occur. However, Management believes that its
internal accounting and reporting systems provide reasonable assurance that
material errors or irregularities are prevented or would be detected and
corrected on a timely basis.
The Company's internal auditor continually reviews, evaluates, and monitors
internal control systems and recommends programs to Management to further
safeguard assets. The Board of Directors discharges its responsibility for
financial statements through its Audit Committee. The Audit Committee regularly
meets with the independent auditors, internal auditor, and representatives of
Management to assure that each is meeting its responsibility. The Committee also
reviews the independent and internal auditors' reports and findings as they are
submitted throughout the year. Both the independent auditors and internal
auditor have direct access to the Audit Committee to discuss the scope and
results of their work, the adequacy of internal controls, and the quality of
financial reporting.
/s/ DANIEL R. DAIGNEAULT /s/ F. STEPHEN WARD
Daniel R. Daigneault F. Stephen Ward
President & Chief Executive Officer Treasurer & Chief Financial Officer
Page 41
Report of Independent Auditors
Berry, Dunn, McNeil & Parker
The Board of Directors and Shareholders
First National Lincoln Corporation
We have audited the accompanying consolidated balance sheets of First
National Lincoln Corporation and Subsidiary as of December 31, 2003 and 2002,
and the related consolidated statements of income, changes in shareholders'
equity and cash flows for each of the three years in the three-year period ended
December 31, 2003. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of First National
Lincoln Corporation and Subsidiary as of December 31, 2003 and 2002, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the three-year period ended December 31, 2003, in
conformity with U.S. generally accepted accounting principles.
/s/ BERRY, DUNN, McNEIL & PARKER
Berry, Dunn, McNeil & Parker
Portland, Maine
January 30, 2004
Page 42
Consolidated Balance Sheets
First National Lincoln Corporation and Subsidiary
- -------------------------------------------------------------------------------
As of December 31, 2003 2002
- -------------------------------------------------------------------------------
Assets
Cash and due from banks $ 17,087,000 $ 14,181,000
Federal funds sold -- 9,325,000
- -------------------------------------------------------------------------------
Cash and cash equivalents 17,087,000 23,506,000
Securities available for sale 57,445,000 56,410,000
Securities to be held to maturity,
market value of $80,820,000 at
December 31, 2003 and $67,421,000
at December 31, 2002 79,244,000 65,663,000
Loans held for sale at cost,
which approximates market value 982,000 2,613,000
Loans 398,895,000 332,074,000
Less allowance for loan losses 4,200,000 3,700,000
- -------------------------------------------------------------------------------
Net loans 394,695,000 328,374,000
Accrued interest receivable 2,743,000 2,642,000
Premises and equipment 9,007,000 7,833,000
Other real estate owned 51,000 255,000
Other assets 7,558,000 6,772,000
- -------------------------------------------------------------------------------
Total assets $ 568,812,000 $ 494,068,000
===============================================================================
Page 43
Consolidated Balance Sheets, Concluded
First National Lincoln Corporation and Subsidiary
- -------------------------------------------------------------------------------
As of December 31, 2003 2002
- -------------------------------------------------------------------------------
Liabilities
Demand deposits $ 28,874,000 $ 25,484,000
NOW deposits 52,161,000 46,989,000
Money market deposits 80,586,000 80,805,000
Savings deposits 63,356,000 59,521,000
Certificates of deposit
(including certificates of
$100,000 or more of $64,220,000
in 2003 and $50,256,000 in 2002) 134,100,000 121,425,000
- -------------------------------------------------------------------------------
Total deposits 359,077,000 334,224,000
Borrowed funds 157,822,000 113,365,000
Other liabilities 4,195,000 3,784,000
- -------------------------------------------------------------------------------
Total liabilities 521,094,000 451,373,000
Commitments and contingent liabilities
(notes 12, 13 and 17)
- -------------------------------------------------------------------------------
Shareholders' equity
Common stock, one cent par value 25,000 25,000
Additional paid-in capital 4,699,000 4,687,000
Retained earnings 42,988,000 38,322,000
Accumulated other comprehensive income
Net unrealized gain on securities
available for sale, net of tax of
$1,286,000 in 2003 and $1,118,000 in 2002 2,497,000 2,170,000
Treasury stock, at cost,
59,890 shares in 2003 and
66,577 shares in 2002 (2,491,000) (2,509,000)
- -------------------------------------------------------------------------------
Total shareholders' equity 47,718,000 42,695,000
- -------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 568,812,000 $ 494,068,000
===============================================================================
Common stock
Number of shares authorized 6,000,000 6,000,000
Number of shares issued 2,481,270 2,481,270
Number of shares outstanding 2,421,380 2,414,693
- -------------------------------------------------------------------------------
The accompanying footnotes are an integral part of these
consolidated financial statements
Page 44
Consolidated Statements of Income
First National Lincoln Corporation and Subsidiary
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Interest income
Interest and fees on loans $21,374,000 $22,154,000 $22,953,000
Interest on deposits with other banks 52,000 62,000 77,000
Interest and dividends on investments
(includes tax-exempt income of
$1,585,000 in 2003, $1,075,000 in
2002, and $926,000 in 2001) 6,114,000 7,091,000 7,032,000
- -------------------------------------------------------------------------------
Total interest income 27,540,000 29,307,000 30,062,000
- -------------------------------------------------------------------------------
Interest expense
Interest on deposits 5,820,000 7,702,000 10,006,000
Interest on borrowed funds 3,976,000 4,502,000 5,025,000
- -------------------------------------------------------------------------------
Total interest expense 9,796,000 12,204,000 15,031,000
- -------------------------------------------------------------------------------
Net interest income 17,744,000 17,103,000 15,031,000
Provision for loan losses 907,000 1,323,000 1,230,000
- -------------------------------------------------------------------------------
Net interest income after provision
for loan losses 16,837,000 15,780,000 13,801,000
- -------------------------------------------------------------------------------
Other operating income
Fiduciary and investment management income 773,000 728,000 698,000
Service charges on deposit accounts 1,110,000 985,000 901,000
Net realized gain on securities
available for sale -- -- 73,000
Mortgage origination and servicing income 930,000 685,000 357,000
Other 2,335,000 2,553,000 1,869,000
- -------------------------------------------------------------------------------
Total other operating income 5,148,000 4,951,000 3,898,000
- -------------------------------------------------------------------------------
Other operating expenses
Salaries and employee benefits 6,017,000 5,766,000 4,903,000
Occupancy expense 772,000 738,000 573,000
Furniture and equipment expense 1,339,000 1,286,000 1,023,000
Other 3,472,000 3,755,000 3,479,000
- -------------------------------------------------------------------------------
Total other operating expenses 11,600,000 11,545,000 9,978,000
- -------------------------------------------------------------------------------
Income before income taxes 10,385,000 9,186,000 7,721,000
Income tax expense 2,958,000 2,679,000 2,228,000
- -------------------------------------------------------------------------------
Net income $ 7,427,000 $ 6,507,000 $ 5,493,000
===============================================================================
Basic earnings per share $ 3.07 $ 2.71 $ 2.30
Diluted earnings per share $ 2.99 $ 2.64 $ 2.24
Cash dividends declared per share $ 1.14 $ 0.98 $ 0.82
Weighted average number of shares
outstanding 2,422,223 2,404,965 2,384,402
- -------------------------------------------------------------------------------
The accompanying footnotes are an integral part of these
consolidated financial statements
Page 45
Consolidated Statements of Changes in Shareholders' Equity
First National Lincoln Corporation and Subsidiary
<table> <caption>
- ------------------------------------------------------------------------------------------------------
Year ended December 31, 2001
- ------------------------------------------------------------------------------------------------------
Net
unrealized
gain (loss) Total
Number of Additional on securities share-
common Common paid-in Retained available Treasury holders'
shares stock capital earnings for sale Stock Equity
<s> <c> <c> <c> <c> <c> <c> <c>
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2000 2,378,613 25,000 4,687,000 30,495,000 203,000 (2,250,000) 33,160,000
======================================================================================================
Net income - - - 5,493,000 - - 5,493,000
Net unrealized
gain on
securities
available for
sale, net of
tax expense of
$299,000 - - - - 581,000 - 581,000
- ------------------------------------------------------------------------------------------------------
Comprehensive
income - - - 5,493,000 581,000 - 6,074,000
Cash dividends
declared - - - (1,958,000) - - (1,958,000)
Treasury stock
purchases (13,953) - - - - (254,000) (254,000)
Treasury stock
sales 26,715 - - - - 312,000 312,000
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2001 2,391,375 25,000 4,687,000 34,030,000 784,000 (2,192,000) 37,334,000
======================================================================================================
Page 46
Consolidated Statements of Changes in Shareholders' Equity, Continued
First National Lincoln Corporation and Subsidiary
- ------------------------------------------------------------------------------------------------------
Year ended December 31, 2002
- ------------------------------------------------------------------------------------------------------
Net
unrealized
gain (loss) Total
Number of Additional on securities share-
common Common paid-in Retained available Treasury holders'
shares stock capital earnings for sale Stock Equity
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2001 2,391,375 25,000 4,687,000 34,030,000 784,000 (2,192,000) 37,334,000
======================================================================================================
Net income - - - 6,507,000 - - 6,507,000
Net unrealized
gain on
securities
available for
sale, net of
tax expense of
$714,000 - - - - 1,386,000 - 1,386,000
- ------------------------------------------------------------------------------------------------------
Comprehensive
income - - - 6,507,000 1,386,000 - 7,893,000
Cash dividends
declared - - - (2,363,000) - - (2,363,000)
Treasury stock
purchases (32,067) - - - - (945,000) (945,000)
Treasury stock
sales 55,385 - - - - 628,000 628,000
Tax benefit of
disqualifying
disposition
of shares - - - 148,000 - - 148,000
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2002 2,414,693 $25,000 $4,687,000 $38,322,000 $2,170,000 $(2,509,000)$42,695,000
======================================================================================================
Page 47
Consolidated Statements of Changes in Shareholders' Equity, Concluded
First National Lincoln Corporation and Subsidiary
- ------------------------------------------------------------------------------------------------------
Year ended December 31, 2003
- ------------------------------------------------------------------------------------------------------
Net
unrealized
gain (loss) Total
Number of Additional on securities share-
common Common paid-in Retained available Treasury holders'
shares stock capital earnings for sale Stock Equity
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2002 2,414,693 25,000 4,687,000 38,322,000 2,170,000 (2,509,000) 42,695,000
======================================================================================================
Net income - - - 7,427,000 - - 7,427,000
Net unrealized
gain on
securities
available for
sale, net of
tax expense
of $168,000 - - - - 327,000 - 327,000
- ------------------------------------------------------------------------------------------------------
Comprehensive
income - - - 7,427,000 327,000 - 7,754,000
Cash dividends
declared - - - (2,761,000) - - (2,761,000)
Treasury stock
purchases (14,757) - - - - (605,000) (605,000)
Treasury stock
sales 21,444 - 12,000 - - 623,000 635,000
- ------------------------------------------------------------------------------------------------------
Balance at
December 31,
2003 2,421,380 $25,000 $4,699,000 $42,988,000 $2,497,000 $(2,491,000)$47,718,000
======================================================================================================
The accompanying footnotes are an integral part of these consolidated financial statements
</table>
Page 48
Consolidated Statements of Cash Flows
First National Lincoln Corporation and Subsidiary
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 7,427,000 $ 6,507,000 $ 5,493,000
Adjustments to reconcile net income
to net cash
provided by operating activities:
Depreciation 966,000 952,000 774,000
Deferred income taxes -- (255,000) --
Provision for loan losses 907,000 1,323,000 1,230,000
Loans originated for resale (53,859,000) (42,531,000) (18,451,000)
Proceeds from sales of loans 55,490,000 40,384,000 17,985,000
Net gain on sale of credit
card portfolio -- (219,000) --
Net gain on sale or call of
securities available for sale -- -- (73,000)
Net gain (losses) on other
real estate owned (24,000) -- 55,000
Net change in other assets and
accrued interest receivable (896,000) (308,000) 485,000
Net change in other liabilities 243,000 30,000 119,000
Net accretion (amortization) of
discount (premium) on investments 458,000 (604,000) (278,000)
- -------------------------------------------------------------------------------
Net cash provided by operating
activities 10,712,000 5,279,000 7,339,000
- -------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales, maturities and
calls of securities
available for sale 15,364,000 2,255,000 17,629,000
Proceeds from maturities and calls
of securities to be held
to maturity 27,606,000 40,172,000 31,025,000
Proceeds from sales of
other real estate owned 228,000 15,000 537,000
Net proceeds from sale of
credit card portfolio -- 2,718,000 --
Purchases of securities
available for sale (15,987,000) (5,581,000) (4,585,000)
Purchases of securities
to be held to maturity (41,562,000) (48,029,000) (45,804,000)
Net increase in loans (67,228,000) (33,960,000) (37,344,000)
Capital expenditures (2,229,000) (1,222,000) (2,985,000)
- -------------------------------------------------------------------------------
Net cash used in investing activities (83,808,000) (43,632,000) (41,527,000)
- -------------------------------------------------------------------------------
Page 49
Consolidated Statements of Cash Flows, Concluded
First National Lincoln Corporation and Subsidiary
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase (decrease) in demand
deposits, savings, and money
market accounts 12,178,000 83,926,000 (17,733,000)
Net increase (decrease) in
certificates of deposit 12,675,000 (12,391,000) (9,610,000)
Advances on long-term borrowings 30,000,000 24,000,000 51,500,000
Repayments on long-term borrowings (28,000,000) -- (7,114,000)
Net increase (decrease) in
short-term borrowings 42,457,000 (41,992,000) (15,948,000)
Purchase of treasury stock (605,000) (945,000) (254,000)
Proceeds from sale of treasury stock 635,000 628,000 312,000
Dividends paid (2,663,000) (2,261,000) (1,861,000)
- -------------------------------------------------------------------------------
Net cash provided by
financing activities 66,677,000 50,965,000 34,758,000
- -------------------------------------------------------------------------------
Net (decrease) increase in
cash and cash equivalents (6,419,000) 12,612,000 570,000
Cash and cash equivalents at
beginning of year 23,506,000 10,894,000 10,324,000
- -------------------------------------------------------------------------------
Cash and cash equivalents at
end of year $ 17,087,000 $ 23,506,000 $ 10,894,000
===============================================================================
Interest paid $ 10,148,000 $ 12,228,000 $ 15,003,000
Income taxes paid 2,756,000 2,668,000 2,526,000
Non-cash transactions:
Loans transferred to
other real estate owned -- (68,000) (438,000)
Change in unrealized gain on
available for sale securities 495,000 2,100,000 880,000
- -------------------------------------------------------------------------------
The accompanying footnotes are an integral part of these
consolidated financial statements
Page 50
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
The accounting and reporting policies of First National Lincoln Corporation
conform to U.S. generally accepted accounting principles and to general practice
within the banking industry. The following is a description of the significant
policies.
Principles of Consolidation
The consolidated financial statements include the accounts of First
National Lincoln Corporation (the Company) and its wholly-owned subsidiary, The
First National Bank of Damariscotta (the Bank). All intercompany accounts and
transactions have been eliminated in consolidation.
Business
The Bank provides a full range of banking services to individual and
corporate customers in Mid-Coast Maine. The Bank is subject to competition from
other financial institutions. The Bank is subject to the regulations of certain
federal agencies and undergoes periodic examinations by those regulatory
authorities. Pemaquid Advisors, a division of the Bank, provides investment
management, private banking and financial planning services. Pemaquid Advisors
has offices in Damariscotta, Boothbay Harbor and Portland, Maine.
Basis of Financial Statement Presentation
In preparing the financial statements, Management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities as of the date
of the balance sheet and revenues and expenses for the period. Actual results
could differ significantly from those estimates. Material estimates that are
particularly susceptible to significant change in the near-term relate to the
determination of the allowance for loan losses and the valuation of real estate
acquired in connection with foreclosures or in satisfaction of loans. In
connection with the determination of the allowance for loan losses and the
carrying value of real estate owned, Management obtains independent appraisals
for significant properties.
Investment Securities
Investment securities are classified as available for sale or held to
maturity when purchased. There are no trading account securities.
Securities available for sale consist primarily of debt securities which
Management intends to hold for indefinite periods of time. They may be used as
part of the Bank's funds management strategy, and may be sold in response to
changes in interest rates or prepayment risk, changes in liquidity needs, to
increase capital, or for other similar reasons. These assets are accounted for
at fair value, with unrealized gains or losses adjusted through shareholders'
equity, net of related income taxes.
Securities to be held to maturity consist primarily of debt securities
which Management has acquired solely for long-term investment purposes, rather
than for purposes of trading or future sale. For securities to be held to
maturity, Management has the intent and the Company has the ability to hold such
securities until their respective maturity dates. Such securities are carried at
cost adjusted for the amortization of premiums and accretion of discounts.
Investment securities transactions are accounted for on a settlement date
basis; reported amounts would not be materially different from those accounted
for on a trade date basis. Gains and losses on the sales of investment
securities are determined using the amortized cost of the specific security
sold.
Page 51
Notes to Consolidated Financial Statements, Continued
Loans Held for Sale
Loans held for sale consist of residential real estate mortgage loans and
are carried at the lower of aggregate cost or market value, as determined by
current investor yield requirements.
Loans
Loans that Management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are generally reported at their
outstanding principal balances, adjusted for chargeoffs, the allowance for loan
losses and any deferred fees or costs to originate loans. Loan commitments are
recorded when funded.
Loan Fees and Costs
Loan origination fees and certain direct loan origination costs are
deferred and recognized in interest income as an adjustment to the loan yield
over the life of the related loans. The unamortized net deferred fees and costs
are included on the balance sheets with the related loan balances, and the
amortization is included with the related interest income.
Allowance for Loan Losses
Loans considered to be uncollectible are charged against the allowance for
loan losses. The allowance for loan losses is maintained at a level determined
by Management to be adequate to absorb probable losses. This allowance is
increased by provisions charged to operating expenses and recoveries on loans
previously charged off. Arriving at an appropriate level of allowance for loan
losses necessarily involves a high degree of judgment. In determining the
appropriate level of allowance for loan losses, Management takes into
consideration the following factors: reviews of individual non-performing loans
and performing loans listed on the watch report requiring periodic evaluation,
loan portfolio size by category, recent loss experience, delinquency trends and
current economic conditions. Loans more than 30 days past due are considered
delinquent.
Impaired loans, including restructured loans, are measured at the present
value of expected future cash flows discounted at the loan's effective interest
rate or at the fair value of the collateral if the loan is collateral dependent.
Management takes into consideration impaired loans in addition to the above
mentioned factors in determining the appropriate level of allowance for loan
losses.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect of a change in tax rates on deferred tax
assets and liabilities is recognized in income in the period the change is
enacted.
Page 52
Notes to Consolidated Financial Statements, Continued
Accrual of Interest Income and Expense
Interest on loans and investment securities is taken into income using
methods which relate the income earned to the balances of loans and investment
securities outstanding. Interest expense on liabilities is derived by applying
applicable interest rates to principal amounts outstanding. Recording of
interest income on problem loans, which includes impaired loans, ceases when
collectibility of principal and interest within a reasonable period of time
becomes doubtful. Cash payments received on non-accrual loans, which includes
impaired loans, are applied to reduce the loan's principal balance until the
remaining principal balance is deemed collectible, after which interest is
recognized when collected. As a general rule, a loan may be restored to accrual
status when payments are current and repayment of the remaining contractual
amounts is expected or when it otherwise becomes well secured and in the process
of collection.
Premises and Equipment
Premises, furniture and equipment are stated at cost, less accumulated
depreciation. Depreciation expense is computed by straight-line and accelerated
methods over the asset's estimated useful life.
Other Real Estate Owned (OREO)
Real estate acquired by foreclosure or deed in lieu of foreclosure is
transferred to OREO and recorded at the lower of cost or fair market value, less
estimated costs to sell, based on appraised value at the date actually or
constructively received. Loan losses arising from the acquisition of such
property are charged against the allowance for loan losses. Subsequent
provisions to reduce the carrying value of a property are recorded to the
allowance for OREO losses and a charge to operations on a specific property
basis.
Earnings Per Share
Basic earnings per share data are based on the weighted average number of
common shares outstanding during each year. Diluted earnings per share gives
effect to the stock options outstanding, determined by the treasury stock
method.
Post-Retirement Benefits
The cost of providing post-retirement benefits is accrued during the active
service period of the employee.
Segments
First National Lincoln Corporation, through the branches of its subsidiary,
The First National Bank of Damariscotta, provides a broad range of financial
services to individuals and companies in Mid-Coast Maine. These services include
demand, time, and savings deposits; lending; credit card servicing; ATM
processing; and investment management and trust services. Operations are managed
and financial performance is evaluated on a corporate-wide basis. Accordingly,
all of the Company's banking operations are considered by Management to be
aggregated in one reportable operating segment.
Comprehensive Income
Comprehensive income includes both net income and other comprehensive
income. Other comprehensive income includes the change in unrealized gains and
losses on securities available for sale, net of tax, and is disclosed in the
consolidated statements of changes in shareholders' equity.
Page 53
Notes to Consolidated Financial Statements, Continued
Stock Options
The Company established a stock option plan in 1995. Under the plan, the
Company may grant options to its employees for up to 200,000 shares of common
stock. Only incentive stock options may be granted under the plan. The option
price of each option grant is determined by the Options Committee of the Board
of Directors, and in no instance shall be less than the fair market value on the
date of the grant. An option's maximum term is ten years from the date of grant.
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for the stock option plan. Accordingly, no
compensation cost has been recognized. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation", to stock-based employee
compensation.
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Net income
As reported $ 7,427,000 6,507,000 5,493,000
Value of option grants, net of tax -- 60,000 --
- -------------------------------------------------------------------------------
Pro forma $ 7,427,000 6,447,000 5,493,000
===============================================================================
Basic earnings per share
As reported $ 3.07 2.71 2.30
Value of option grants, net of tax -- 0.03 --
- -------------------------------------------------------------------------------
Pro forma $ 3.07 2.68 2.30
===============================================================================
Diluted earnings per share
As reported $ 2.99 2.64 2.24
Value of option grants, net of tax -- 0.02 --
- -------------------------------------------------------------------------------
Pro forma $ 2.99 2.62 2.24
===============================================================================
The fair market value of options granted, net of tax, was $60,000 in 2002.
No options were granted in 2003 or 2001. The weighted average fair market value
of options granted was $8.32 in 2002. The fair market value in 2002 is estimated
using the Black-Scholes option pricing model and the following assumptions:
quarterly dividends of $0.22, risk-free interest rate of 1.59%, volatility of
37.73%, and an expected life of 10 years.
Loan Servicing
Servicing rights are recognized when they are acquired through sale of
loans. Capitalized servicing rights are reported in other assets and are
amortized into non-interest income in proportion to, and over the period of, the
estimated future net servicing income of the underlying financial assets.
Servicing rights are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, such as interest rates and terms.
Impairment is recognized through a valuation allowance for an individual
stratum, to the extent that fair value is less than the capitalized amount for
the stratum.
Page 54
Notes to Consolidated Financial Statements, Continued
Note 2. Cash and Cash Equivalents
For the purposes of reporting consolidated cash flows, cash and cash equivalents
include cash on hand, amounts due from banks and federal funds sold. At December
31, 2003 the Company had a contractual clearing balance of $500,000 and a
reserve balance requirement of $4,776,000 at the Federal Reserve Bank, which are
satisfied by both cash on hand at branches and balances held at the Federal
Reserve Bank of Boston. The Company maintains a portion of its cash in bank
deposit accounts which, at times, may exceed federally insured limits. The
Company has not experienced any losses in such accounts. The Company believes it
is not exposed to any significant risk with respect to these accounts.
Note 3. Investment Securities
The following tables summarize the amortized cost and estimated fair value of
investment securities at December 31, 2003 and 2002:
- -------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Value
December 31, 2003 Cost Gains Losses (Estimated)
- -------------------------------------------------------------------------------
Securities available for sale
U.S. Treasury & Agency $ 3,000,000 -- (75,000) 2,925,000
Mortgage-backed securities 5,405,000 88,000 (30,000) 5,463,000
State and political subdivisions 13,981,000 871,000 -- 14,852,000
Corporate securities 23,585,000 2,896,000 (20,000) 26,461,000
Federal Home Loan Bank stock 6,871,000 -- -- 6,871,000
Federal Reserve Bank stock 53,000 -- -- 53,000
Other equity securities 766,000 56,000 (2,000) 820,000
- -------------------------------------------------------------------------------
$53,661,000 3,911,000 (127,000) 57,445,000
- -------------------------------------------------------------------------------
Securities to be held to maturity
U.S. Treasury and agency $44,419,000 714,000 (31,000) 45,102,000
Mortgage-backed securities 8,409,000 225,000 (30,000) 8,604,000
State and political subdivisions 17,823,000 717,000 (14,000) 18,526,000
Corporate securities 8,593,000 -- (5,000) 8,588,000
- -------------------------------------------------------------------------------
$79,244,000 1,656,000 (80,000) 80,820,000
===============================================================================
Page 55
Notes to Consolidated Financial Statements, Continued
- -------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Value
December 31, 2002 Cost Gains Losses (Estimated)
- -------------------------------------------------------------------------------
Securities available for sale
Mortgage-backed securities $ 6,275,000 152,000 (30,000) 6,397,000
State and political subdivisions 13,899,000 727,000 -- 14,626,000
Corporate securities 25,860,000 2,531,000 (103,000) 28,288,000
Federal Home Loan Bank stock 6,195,000 -- -- 6,195,000
Federal Reserve Bank stock 53,000 -- -- 53,000
Other equity securities 841,000 21,000 (11,000) 851,000
- -------------------------------------------------------------------------------
$53,123,000 3,431,000 (144,000) 56,410,000
- -------------------------------------------------------------------------------
Securities to be held to maturity
U.S. Treasury and agency $30,952,000 923,000 -- 31,877,000
Mortgage-backed securities 16,090,000 445,000 (78,000) 16,456,000
State and political subdivisions 12,032,000 508,000 (22,000) 12,518,000
Corporate securities 6,589,000 -- (18,000) 6,570,000
- -------------------------------------------------------------------------------
$65,663,000 1,876,000 (118,000) 67,421,000
===============================================================================
The following table summarizes the contractual maturities of investment
securities at December 31, 2003:
- -------------------------------------------------------------------------------
Securities Securities
available for sale: to be held to maturity:
Amortized Fair Value Amortized Fair Value
Cost (Estimated) Cost (Estimated)
- -------------------------------------------------------------------------------
Due in 1 year or less $ 2,814,000 2,858,000 -- --
Due in 1 to 5 years 7,242,000 8,108,000 1,132,000 1,126,000
Due in 5 to 10 years 16,474,000 18,656,000 25,691,000 26,269,000
Due after 10 years 19,441,000 20,079,000 52,421,000 53,425,000
Equity securities 7,690,000 7,744,000 -- --
- -------------------------------------------------------------------------------
$53,661,000 57,445,000 79,244,000 80,820,000
===============================================================================
At December 31, 2003 securities carried at $49,896,000, with a fair value
of $50,287,000, were pledged to secure borrowings from the Federal Home Loan
Bank, public deposits, and for other purposes as required by law. Gains and
losses on the sale of securities available for sale are computed by subtracting
the amortized cost at the time of sale from the security's selling price, net of
accrued interest to be received. A realized gain on securities of $73,000 in
2001 was the result of a security which was called at par value by the issuer.
There were no realized gains or losses in 2002 or 2003.
Page 56
Notes to Consolidated Financial Statements, Continued
Management reviews securities with unrealized losses for other than
temporary impairment. As of December 31, 2003, there were 21 securities with
unrealized losses held in the Company's portfolio. These securities were
temporarily impaired as a result of changes in interest rates reducing their
fair market value, of which five had been temporarily impaired for 12 months or
more. At the present time, there have been no material changes in the credit
quality of these securities resulting in temporary impairment. Information
regarding securities temporarily impaired is summarized below:
- -------------------------------------------------------------------------------
Less Than 12 Months 12 Months or Longer Total
------------------- ------------------- -----
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
- -------------------------------------------------------------------------------
U.S. Treasury
and agency $ 8,026,000 (106,000) -- -- 8,026,000 (106,000)
Mortgage-backed
securities 3,319,000 (56,000) 530,000 (4,000) 3,849,000 (60,000)
State and
political
subdivisions 1,456,000 (14,000) -- -- 1,456,000 (14,000)
Corporate
securities 1,463,000 (5,000) 1,610,000 (20,000) 3,073,000 (25,000)
Other equity
securities -- -- 23,000 (2,000) 23,000 (2,000)
- -------------------------------------------------------------------------------
$14,264,000 (181,000) 2,163,000 (26,000) 16,427,000 (207,000)
===============================================================================
Note 4. Loan Servicing
At December 31, 2003 and 2002, the Bank serviced loans for others totaling
$87,906,000 and $70,097,000, respectively. Net gains from the sale of loans
totaled $550,000 in 2003, $482,000 in 2002 and $161,000 in 2001.
In 2003, mortgage servicing rights of $589,000 were capitalized, and
amortization for the year totaled $357,000. After deducting for a valuation
allowance of $125,000 and impairment reserve of $20,000, at December 31, 2003,
mortgage servicing rights had a fair value of $581,000, which is included in
other assets. In 2002, mortgage servicing rights of $315,000 were capitalized
and amortization for the year totaled $183,000. After deducting for a valuation
allowance of $190,000, at December 31, 2002, mortgage servicing rights had a
fair value of $303,000.
Page 57
Notes to Consolidated Financial Statements, Continued
Note 5. Loans
The following table shows the composition of the Company's loan portfolio as of
December 31, 2003 and 2002:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Real estate loans
Residential $223,251,000 174,070,000
Commercial 40,521,000 37,082,000
Commercial and industrial loans 97,487,000 82,504,00
State and municipal loans 9,030,000 9,474,000
Consumer loans 26,123,000 27,925,000
Residential construction loans 2,483,000 1,019,000
- -------------------------------------------------------------------------------
Total loans $398,895,000 332,074,000
===============================================================================
Loan balances include net deferred loan costs of $986,000 in 2003 and
$807,000 in 2002.
At December 31, 2003 and 2002, loans on non-accrual status totaled
$1,537,000 and $1,070,000, respectively. Interest income which would have been
recognized on these loans, if interest had been accrued, was $85,000 for 2003,
$108,000 for 2002, and $77,000 for 2001. Loans past due greater than 90 days
which are accruing interest totaled $378,000 at December 31, 2003 and $406,000
at December 31, 2002. The Company continues to accrue interest on these loans
because it believes collection of principal and interest is reasonably assured.
Transactions in the allowance for loan losses for the years ended December 31,
2003, 2002 and 2001 were as follows:
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Balance at beginning of year $ 3,700,000 3,000,000 2,301,000
Provision charged to
operating expenses 907,000 1,323,000 1,230,000
- -------------------------------------------------------------------------------
4,607,000 4,323,000 3,531,000
- -------------------------------------------------------------------------------
Loans charged off (555,000) (724,000) (635,000)
Recoveries on loans 148,000 101,000 104,000
- -------------------------------------------------------------------------------
Net loans charged off (407,000) (623,000) (531,000)
- -------------------------------------------------------------------------------
Balance at end of year $ 4,200,000 3,700,000 3,000,000
===============================================================================
Page 58
Notes to Consolidated Financial Statements, Continued
Information regarding impaired loans is as follows:
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Average investment
in impaired loans $ 1,222,000 1,367,000 1,055,000
Interest income recognized
on impaired loans,
including cash basis $ 11,000 17,000 38,000
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Balance of impaired loans $ 1,537,000 1,070,000
Less portion for which no allowance
for loan losses is allocated (980,000) (309,000)
- -------------------------------------------------------------------------------
Portion of impaired loan balance for which an
allowance for loan losses is allocated $ 557,000 761,000
===============================================================================
Portion of allowance for loan losses
allocated to the impaired loan balance $ 204,000 297,000
- -------------------------------------------------------------------------------
Loans to directors, officers and employees totaled $16,599,000 at December
31, 2003 and $11,730,000 at December 31, 2002. A summary of loans to directors
and executive officers, which in the aggregate exceed $60,000, is as follows:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Balance at beginning of year $ 7,281,000 5,925,000
New loans 4,579,000 3,397,000
Repayments (2,812,000) (2,041,000)
- -------------------------------------------------------------------------------
Balance at end of year $ 9,048,000 7,281,000
===============================================================================
Page 59
Notes to Consolidated Financial Statements, Continued
Note 6. Premises and Equipment
Premises and equipment are carried at cost and consist of the following:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Land $ 1,608,000 1,551,000
Land improvements 539,000 444,000
Buildings 7,091,000 5,963,000
Equipment 8,094,000 7,233,000
- -------------------------------------------------------------------------------
17,332,000 15,191,000
Less accumulated depreciation 8,325,000 7,358,000
- -------------------------------------------------------------------------------
$ 9,007,000 7,833,000
===============================================================================
Note 7. Other Real Estate Owned
The following summarizes other real estate owned:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Real estate acquired in settlement of loans $ 51,000 255,000
===============================================================================
Changes in the allowance for each of the three years ended December 31 were
as follows:
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Beginning balance $ - - 36,000
Losses charged to allowance - - (36,000)
Provision charged to income - - -
- -------------------------------------------------------------------------------
Ending balance $ - - -
===============================================================================
Page 60
Notes to Consolidated Financial Statements, Continued
Note 8. Income Taxes
The current and deferred components of income tax expense were as follows:
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Federal income tax
Current $ 2,838,000 2,830,000 2,138,000
Deferred - (255,000) -
- -------------------------------------------------------------------------------
2,838,000 2,575,000 2,138,000
State income tax 120,000 104,000 90,000
- -------------------------------------------------------------------------------
$ 2,958,000 2,679,000 2,228,000
===============================================================================
The actual tax expense differs from the expected tax expense (computed by
applying the applicable U.S. Federal corporate income tax rate to income before
income taxes) as follows:
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Expected tax expense $ 3,531,000 3,123,000 2,625,000
Non-taxable income (651,000) (484,000) (452,000)
State income taxes 79,000 69,000 59,000
Qualified housing tax credit - - (8,000)
Other (1,000) (29,000) 4,000
- -------------------------------------------------------------------------------
$ 2,958,000 2,679,000 2,228,000
===============================================================================
Items that give rise to the deferred income tax assets and liabilities and
the tax effect of each at December 31, 2003 and 2002 are as follows:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Allowance for loan losses and OREO $ 1,270,000 1,092,000
Deferred loan fees (380,000) (329,000)
Accrued pension and post-retirement 322,000 281,000
Depreciation (81,000) (93,000)
Unrealized gain on securities available for sale (1,286,000) (1,118,000)
Mortgage servicing rights (165,000) (103,000)
Other assets (108,000) (14,000)
Other liabilities (34,000) 6,000
- -------------------------------------------------------------------------------
Net deferred income tax liability $ (462,000) (278,000)
===============================================================================
Page 61
Notes to Consolidated Financial Statements, Continued
These amounts are included in other assets on the balance sheets, except
for the deferred tax liability on unrealized gains on securities available for
sale which is included in other liabilities. The deferred income tax asset and
liability at December 31, 2003 and 2002 are as follows:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Asset $ 1,558,000 1,379,000
===============================================================================
Liability $ 2,020,000 1,657,000
===============================================================================
No valuation allowance is deemed necessary for the deferred tax asset.
Note 9. Certificates of Deposit
At December 31, 2003, the scheduled maturities of certificates of deposit are as
follows:
- -------------------------------------------------------------------------------
2004 $ 80,559,000
2005 36,216,000
2006 6,117,000
2007 4,747,000
2008 6,461,000
- -------------------------------------------------------------------------------
Total $ 134,100,000
===============================================================================
Interest on certificates of deposit of $100,000 or more was $1,834,000,
$2,343,000 and $3,680,000 in 2003, 2002 and 2001, respectively.
Note 10. Borrowed Funds
Borrowed funds consist of advances from the Federal Home Loan Bank (FHLB),
Treasury Tax & Loan Notes, and securities sold under agreements to repurchase
with municipal and commercial customers.
Pursuant to collateral agreements, FHLB advances are collateralized by all
stock in the Federal Home Loan Bank, with a value of $6,871,000 at December 31,
2003 and $6,195,000 at December 31, 2002; qualifying first mortgage loans, which
were valued at $187,202,000 and $155,348,000 in 2003 and 2002, respectively;
U.S. Government and Agency securities not pledged to others, which were valued
at $38,495,000 in 2003 and $26,620,000 in 2002; and funds on deposit with FHLB.
As of December 31, 2003, the Bank's total FHLB borrowing capacity was
$176,972,000, of which $40,558,000 was unused and available for additional
borrowings. All FHLB advances as of December 31, 2003 had fixed rates of
interest until their respective maturity dates, except for the FHLB overnight
line of credit, which has an interest rate which can fluctuate daily.
Page 62
Notes to Consolidated Financial Statements, Continued
Under the Treasury Tax & Loan Note program, the Bank accumulates tax
deposits made by customers and is eligible to receive Treasury Direct
investments up to an established maximum balance. Securities sold under
agreements to repurchase include U.S. Treasury and Agency securities and other
securities with an aggregate amortized cost of $19,960,000 and $19,290,000 at
December 31, 2003 and 2002, respectively, and an aggregate fair value of
$20,690,000 and $19,670,000 at December 31, 2003 and 2002, respectively.
Repurchase agreements have maturity dates ranging from one to 365 days. The Bank
also has in place a $5.0 million credit line with a correspondent bank which is
currently not in use.
Borrowed funds at December 31, 2003 and 2002 have the following range of
interest rates and maturity dates:
- -------------------------------------------------------------------------------
December 31, 2003
- -------------------------------------------------------------------------------
Federal Home Loan Bank Advances
2004 1.14%-4.89% $ 66,914,000
2005 1.48%-2.08% 23,000,000
2006 1.19%-2.04% 7,000,000
2007 3.99%-4.47% 12,000,000
2010 and thereafter 3.93%-5.41% 27,500,000
- -------------------------------------------------------------------------------
136,414,000
Treasury Tax & Loan Notes
(rate in effect at December 31, 2003 was 0.73%) variable 1,110,000
Repurchase agreements
Municipal and commercial customers 0.8%-1.50% 20,298,000
- -------------------------------------------------------------------------------
$ 157,822,000
===============================================================================
- -------------------------------------------------------------------------------
December 31, 2002
- -------------------------------------------------------------------------------
Federal Home Loan Bank Advances
2003 4.19%-4.81% $ 28,000,000
2004 2.01%-4.89% 23,000,000
2007 3.99%-4.47% 12,000,000
2010 and thereafter 3.93%-5.41% 27,500,000
- -------------------------------------------------------------------------------
90,500,000
Treasury Tax & Loan Notes
(rate in effect at December 31, 2002 was 0.99%) variable 3,548,000
Repurchase agreements
Municipal and commercial customers 1.14%-2.65% 19,317,000
- -------------------------------------------------------------------------------
$ 113,365,000
===============================================================================
Page 63
Notes to Consolidated Financial Statements, Continued
Note 11. Employee Benefit Plans
401(k) Plan
The Bank has a defined contribution plan available to substantially all
employees who have completed six months of service. Employees may contribute up
to 50.0% of their compensation (not to exceed $12,000 if under age 50 and
$14,000 if over age 50), and the Bank may provide a match of up to 3.0% of
compensation. Subject to a vote of the Board of Directors, the Bank may also
make a profit-sharing contribution to the Plan. Such contribution equaled 2.5%
of each eligible employee's compensation in 2003, 3.0% in 2002, and 3.0% in
2001. The expense related to the 401(k) plan was $217,000, $216,000, and
$146,000, in 2003, 2002, and 2001, respectively.
Supplemental Retirement Plan
The Bank also sponsors an unfunded, non-qualified supplemental retirement plan
for certain officers. The agreement provides supplemental retirement benefits
payable in installments over 20 years upon retirement or death. The costs for
this plan are recognized over the service periods of the participating officers.
The expense of this supplemental plan was $135,000 in 2003, $113,000 in 2002,
and $141,000 in 2001. As of December 31, 2003 and 2002, the accrued liability of
this plan was $709,000 and $591,000, respectively.
Post-Retirement Benefit Plans
The Bank sponsors two post-retirement benefit plans. One plan provides health
insurance benefits to employees hired prior to June 30, 1988 and who retired
before June 30, 1996. The other plan provides life insurance coverage to
employees who retired prior to December 31, 2002. The Bank also provides health
insurance for retired directors. None of these plans are pre-funded. The Bank
elected to recognize the accumulated post-retirement benefit obligation as of
January 1, 1993 of $578,000 as a component of net periodic post-retirement
benefit cost over a 20-year period.
In December 2003, the President signed the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) into law. The Act includes
the following two new features to Medicare (Medicare Part D) that could affect
the measurement of the accumulated postretirement benefit obligation (APBO) and
net periodic postretirement benefit cost for the Plan: a subsidy to plan
sponsors that is based on 28% of an individual beneficiary's annual prescription
drug costs between $250 and $5,000 and the opportunity for a retiree to obtain a
prescription drug benefit under Medicare. The effects of the Act on the APBO or
net periodic postretirement benefit cost are not reflected in the financial
statements or accompanying notes. Pending specific authoritative guidance on the
accounting for the federal subsidy could require the Company to change
previously reported information when the guidance is issued.
Page 64
Notes to Consolidated Financial Statements, Continued
The following tables set forth the accumulated post-retirement benefit
obligation, funded status, and net periodic pension cost:
- -------------------------------------------------------------------------------
At December 31, 2003 2002
- -------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at beginning of year: $ 415,000 428,000
Service cost 6,000 5,000
Interest cost 35,000 34,000
Benefits paid (41,000) (52,000)
Actuarial loss 127,000 -
- -------------------------------------------------------------------------------
Benefit obligation at end of year $ 542,000 415,000
Funded status
Benefit obligation at end of year $(542,000) (415,000)
Unrecognized prior service cost (11,000) (43,000)
Unamortized net actuarial gain 48,000 (46,000)
Unrecognized transition obligation 266,000 290,000
- -------------------------------------------------------------------------------
Accrued benefit cost $ (239,000) (214,000)
===============================================================================
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Components of net periodic benefit cost
Service cost $ 6,000 5,000 5,000
Interest cost 35,000 34,000 32,000
Amortization of unrecognized
transition obligation 29,000 29,000 29,000
Amortization of prior service cost 3,000 (3,000) (5,000)
Amortization of accumulated gains 4,000 2,000 (2,000)
- -------------------------------------------------------------------------------
Net periodic benefit cost $77,000 67,000 59,000
===============================================================================
Weighted average assumptions
as of December 31:
Discount rate 7.0% 7.0% 7.0%
- -------------------------------------------------------------------------------
The above discount rate assumption was used in determining both the
accumulated benefit obligation as well as the net benefit cost. The measurement
date for benefit obligations was as of year-end for all years presented. The
estimated amount of benefits to be paid in 2004 is $45,000.
Page 65
Notes to Consolidated Financial Statements, Continued
Note 12. Shareholders' Equity
The Company has reserved 160,000 shares of its common stock to be made available
to directors and employees who elect to participate in the stock purchase or
savings and investment plans. As of December 31, 2003, 119,014 shares had been
issued pursuant to these plans, leaving 40,986 shares available for future use.
The issuance price is based on the market price of the stock at issuance date.
Sales of stock to directors and employees amounted to 8,491 shares in 2003,
5,157 shares in 2002, and 7,573 shares in 2001. Stock sold to directors and
employees in 2003 was all from treasury shares.
In 2001, the Company established a dividend reinvestment plan to allow
shareholders to use their cash dividends for the automatic repurchase of shares
in the Company. When the plan was established, 200,000 shares were registered
with the Securities and Exchange Commission, and as of December 31, 2003, 15,354
shares have been issued, leaving 184,646 shares for future use. Participation in
this plan is optional and at the individual discretion of each shareholder.
Shares are purchased for the plan from the Company at a price per share equal to
the average of the daily bid and asked prices reported on the NASDAQ System for
the five trading days immediately preceding, but not including, the dividend
payment date. Sales of stock under the Dividend Reinvestment Plan amounted to
6,175 shares in 2003, 7,028 shares in 2002, and 2,151 shares in 2001. All stock
sold in 2003 was from treasury shares.
In 1995, the Company's shareholders adopted a Stock Option Plan and
authorized 200,000 shares to be reserved for options to be granted to certain
key officers of the Company and the Bank. The option exercise price is equal to
or exceeds the fair market value of the shares on the date of the grant, and
options are generally not exercisable before two years from the date granted.
All options expire ten years from the date of grant.
The following table sets forth the status of the plan as of December 31,
2003, 2002 and 2001, and changes during the years then ended:
- -------------------------------------------------------------------------------
Weighted Average
Number of Shares Exercise Price
- -------------------------------------------------------------------------------
Balance at December 31, 2000 155,000 $ 9.62
Exercised in 2001 (17,000) 7.84
- -------------------------------------------------------------------------------
Balance at December 31, 2001 138,000 9.84
Granted in 2002 11,000 28.00
Exercised in 2002 (43,200) 6.81
Forfeited in 2002 (1,000) 22.50
- -------------------------------------------------------------------------------
Balance at December 31, 2002 104,800 12.88
Exercised in 2003 (6,600) 7.59
- -------------------------------------------------------------------------------
Balance at December 31, 2003 98,200 $ 13.23
===============================================================================
Page 66
Notes to Consolidated Financial Statements, Continued
The number and weighted average exercise price of exercisable options was
73,700 and $10.11 at December 31, 2003, 68,300 and $9.55 at December 31, 2002,
and 93,500 and $8.28 at December 31, 2001. The range of prices for outstanding
and exercisable stock options at December 31, 2003 was as follows:
- -------------------------------------------------------------------------------
Weighted Average Weighted Average
Number Remaining Exercise
Outstanding Contractual Life Price
- -------------------------------------------------------------------------------
Options outstanding
$6.38 to $10.00 37,000 1.5 $ 7.26
$10.01 to $15.00 24,000 3.1 10.25
$15.01 to $20.00 23,200 5.9 17.65
$20.01 to $25.00 3,000 5.0 22.50
$25.01 to $28.00 11,000 8.1 28.00
- -------------------------------------------------------------------------------
98,200 3.8 $ 13.23
===============================================================================
Options exercisable
$6.38 to $10.00 37,000 1.5 $ 7.26
$10.01 to $15.00 24,000 3.1 10.25
$15.01 to $20.00 11,200 5.5 17.57
$20.01 to $25.00 1,500 5.0 22.50
$25.01 to $28.00 - 8.1 28.00
- -------------------------------------------------------------------------------
73,700 2.7 $ 10.11
===============================================================================
Note 13. Off-Balance-Sheet Financial Instruments and
Concentrations of Credit Risk
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to originate loans, commitments for
unused lines of credit, and standby letters of credit. The instruments involve,
to varying degrees, elements of credit risk in excess of the amount recognized
in the consolidated balance sheets. The contract amounts of those instruments
reflect the extent of involvement the Company has in particular classes of
financial instruments.
Commitments for unused lines are agreements to lend to a customer provided
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
Management's credit evaluation of the borrower.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee a customer's performance to a third party, with the customer being
obligated to repay (with interest) any amounts paid out by the Bank under the
letter of credit. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers.
Page 67
Notes to Consolidated Financial Statements, Continued
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby letters
of credit is represented by the contractual amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. At December 31, the
Company had the following off-balance-sheet financial instruments, whose
contract amounts represent credit risk:
- -------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------
Unused lines, collateralized
by residential real estate $ 34,651,000 22,472,000
Other unused commitments 31,929,000 30,890,000
Standby letters of credit 50,000 50,000
Commitments to extend credit 9,175,000 11,253,000
===============================================================================
The Company grants residential, commercial and consumer loans to customers
principally located in the Mid-Coast region of Maine. Collateral on these loans
typically consists of residential or commercial real estate, or personal
property. Although the loan portfolio is diversified, a substantial portion of
borrowers' ability to honor their contracts is dependent on the economic
conditions in the area, especially in the real estate sector.
Page 68
Notes to Consolidated Financial Statements, Continued
Note 14. Earnings Per Share
The following tables provide detail for basic earnings per share and diluted
earnings per share for the years ended December 31, 2003, 2002 and 2001:
- -------------------------------------------------------------------------------
Income Shares Per-Share
For the Year Ended December 31, 2003 (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------
Net income as reported $ 7,427,000
- -------------------------------------------------------------------------------
Basic EPS: Income available
to common shareholders $ 7,427,000 2,422,223 $ 3.07
Effect of dilutive securities:
incentive stock options 65,014
- -------------------------------------------------------------------------------
Diluted EPS: Income available
to common shareholders
plus assumed conversions $ 7,427,000 2,487,237 $ 2.99
===============================================================================
- -------------------------------------------------------------------------------
Income Shares Per-Share
For the Year Ended December 31, 2002 (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------
Net income as reported $ 6,507,000
- -------------------------------------------------------------------------------
Basic EPS: Income available
to common shareholders $ 6,507,000 2,404,965 $ 2.71
Effect of dilutive securities:
incentive stock options 56,804
- -------------------------------------------------------------------------------
Diluted EPS: Income available
to common shareholders
plus assumed conversions $ 6,507,000 2,461,769 $ 2.64
===============================================================================
- -------------------------------------------------------------------------------
Income Shares Per-Share
For the Year Ended December 31, 2001 (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------
Net income as reported $ 5,493,000
- -------------------------------------------------------------------------------
Basic EPS: Income available
to common shareholders $ 5,493,000 2,384,402 $ 2.30
Effect of dilutive securities:
incentive stock options 70,547
- -------------------------------------------------------------------------------
Diluted EPS: Income available
to common shareholders
plus assumed conversions $ 5,493,000 2,454,949 $ 2.24
===============================================================================
Page 69
Notes to Consolidated Financial Statements, Continued
All earnings per share calculations have been made using the weighted
average number of shares outstanding for each year. All of the dilutive
securities are incentive stock options granted to certain key members of
Management. The dilutive number of shares has been calculated using the treasury
method, assuming that all granted options were exercisable at each year end.
Note 15. Fair Value of Financial Instruments
Fair value estimates, methods, and assumptions are set forth below for the
Company's financial instruments.
Cash and Cash Equivalents
The carrying values of cash, cash equivalents, due from banks and federal funds
sold approximate their relative fair values.
Investment Securities
The fair values of investment securities are estimated based on bid prices
published in financial newspapers or bid quotations received from securities
dealers. The fair value of certain state and municipal securities is not readily
available through market sources other than dealer quotations, so fair value
estimates are based on quoted market prices of similar instruments, adjusted for
differences between the quoted instruments and the instruments being valued.
Fair values are calculated based on the value of one unit without regard to any
premium or discount that may result from concentrations of ownership of a
financial instrument, possible tax ramifications, or estimated transaction
costs. If these considerations had been incorporated into the fair value
estimates, the aggregate fair value could have been changed. The carrying values
of restricted equity securities approximate fair values.
Loans Held for Sale
The fair value of loans held for sale is determined by the current investor
yield requirements.
Loans
Fair values are estimated for portfolios of loans with similar financial
characteristics. The fair values of performing loans are calculated by
discounting scheduled cash flows through the estimated maturity using estimated
market discount rates that reflect the credit and interest risk inherent in the
loan. The estimates of maturity are based on the Company's historical experience
with repayments for each loan classification, modified, as required, by an
estimate of the effect of current economic and lending conditions, and the
effects of estimated prepayments.
Fair values for significant non-performing loans are based on estimated
cash flows and are discounted using a rate commensurate with the risk associated
with the estimated cash flows. Assumptions regarding credit risk, cash flows,
and discount rates are judgmentally determined using available market
information and specific borrower information. Management has made estimates of
fair value using discount rates that it believes to be reasonable. However,
because there is no market for many of these financial instruments, Management
has no basis to determine whether the fair value presented above would be
indicative of the value negotiated in an actual sale.
Cash Surrender Value of Life Insurance
The fair value is based on the actual cash surrender value of life insurance
policies.
Page 70
Notes to Consolidated Financial Statements, Continued
Accrued Interest Receivable
The fair value estimate of this financial instrument approximates the carrying
value as this financial instrument has a short maturity. It is the Company's
policy to stop accruing interest on loans for which it is probable that the
interest is not collectible. Therefore, this financial instrument has been
adjusted for estimated credit loss.
Deposits
The fair value of deposits is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities. The fair value estimates do not
include the benefit that results from the low-cost funding provided by the
deposits compared to the cost of borrowing funds in the market. If that value
were considered, the fair value of the Company's net assets could increase.
Borrowed Funds
The fair value of borrowed funds is based on the discounted value of contractual
cash flows. The discount rate is estimated using the rates currently available
for borrowings of similar remaining maturities.
Accrued Interest Payable
The fair value estimate approximates the carrying amount as this financial
instrument has a short maturity.
Off-Balance-Sheet Instruments
Off-balance-sheet instruments include loan commitments. Fair values for loan
commitments have not been presented as the future revenue derived from such
financial instruments is not significant.
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These values
do not reflect any premium or discount that could result from offering for sale
at one time the Company's entire holdings of a particular financial instrument.
Because no market exists for a significant portion of the Company's financial
instruments, fair value estimates are based on Management's judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance-sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets and liabilities that are not
considered financial instruments include the deferred tax asset, premises and
equipment, and other real estate owned. In addition, tax ramifications related
to the realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in any of the
estimates.
Page 71
Notes to Consolidated Financial Statements, Continued
The estimated fair values for the Company's financial instruments as of
December 31, 2003 and 2002 were as follows:
- -------------------------------------------------------------------------------
December 31, 2003 December 31, 2002
Carrying Estimated Carrying Estimated
amount fair value amount fair value
- -------------------------------------------------------------------------------
Financial assets
Cash and due from banks $ 17,087,000 17,087,000 14,181,000 14,181,000
Overnight funds sold -- -- 9,325,000 9,325,000
Securities available
for sale 57,445,000 57,445,000 56,410,000 56,410,000
Securities to be
held to maturity 79,244,000 80,820,000 65,663,000 67,421,000
Loans held for sale 982,000 982,000 2,613,000 2,613,000
Loans (net of allowance for
loan losses) 394,695,000 395,892,000 328,374,000 334,928,000
Cash surrender value of
life insurance 4,648,000 4,648,000 4,468,000 4,468,000
Accrued interest receivable 2,743,000 2,743,000 2,642,000 2,642,000
- -------------------------------------------------------------------------------
Financial liabilities
Deposits $359,077,000 345,382,000 334,224,000 329,671,000
Borrowed funds 157,822,000 165,750,000 113,365,000 115,938,000
Accrued interest payable 539,000 539,000 786,000 786,000
- -------------------------------------------------------------------------------
Note 16. Other Operating Income and Expense
Other operating income includes the following items greater than 1% of
revenues.
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Merchant discount fees $ 988,000 967,000 880,000
===============================================================================
Other operating expense includes the following items greater than 1% of
revenues.
- -------------------------------------------------------------------------------
2003 2002 2001
- -------------------------------------------------------------------------------
Stationery and supplies $ 295,000 293,000 215,000
Merchant interchange fees 733,000 681,000 620,000
Postage, freight and express 213,000 182,000 186,000
Exams and audits 263,000 233,000 231,000
===============================================================================
Page 72
Notes to Consolidated Financial Statements, Continued
Note 17. Regulatory Capital Requirements
The ability of the Company to pay cash dividends to its shareholders depends
primarily on receipt of dividends from its subsidiary, the Bank. The subsidiary
may pay dividends to its parent out of so much of its net income as the Bank's
directors deem appropriate, subject to the limitation that the total of all
dividends declared by the Bank in any calendar year may not exceed the total of
its net income of that year combined with its retained net income of the
preceding two years and subject to minimum regulatory capital requirements. The
amount available for dividends in 2004 will be 2004 earnings plus retained
earnings of $8,465,000 from 2003 and 2002.
The payment of dividends by the Company is also affected by various
regulatory requirements and policies, such as the requirements to maintain
adequate capital. In addition, if, in the opinion of the applicable regulatory
authority, a bank under its jurisdiction is engaged in or is about to engage in
an unsafe or unsound practice (which, depending on the financial condition of
the bank, could include the payment of dividends), that authority may require,
after notice and hearing, that such bank cease and desist from that practice.
The Federal Reserve Bank and the Comptroller of the Currency have each indicated
that paying dividends that deplete a bank's capital base to an inadequate level
would be an unsafe and unsound banking practice. The Federal Reserve Bank, the
Comptroller and the Federal Deposit Insurance Corporation have issued policy
statements which provide that bank holding companies and insured banks should
generally only pay dividends out of current operating earnings.
In addition to the effect on the payment of dividends, failure to meet
minimum capital requirements can also result in mandatory and discretionary
actions by regulators that, if undertaken, could have an impact on the Company's
operations. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measurements of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of Tier 1 capital and Tier 2 or total capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2003, that the Bank meets all capital adequacy requirements to which it is
subject.
As of December 31, 2003, the most recent notification from the Office of
the Comptroller of the Currency classified the Bank as well-capitalized under
the regulatory framework for prompt corrective action. To be categorized as
adequately capitalized the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since this notification that Management believes have
changed the institution's category.
Page 73
Notes to Consolidated Financial Statements, Continued
The actual and minimum capital amounts and ratios for the Bank are
presented in the following table:
- -------------------------------------------------------------------------------
To be
well-capitalized
For capital under prompt
adequacy corrective action
Actual purposes provisions
- -------------------------------------------------------------------------------
As of December 31, 2003
Tier 2 capital to $ 47,163,000 30,386,000 37,983,000
risk-weighted assets 12.42% 8.00% 10.00%
Tier 1 capital to 42,963,000 15,193,000 22,790,000
risk-weighted assets 11.31% 4.00% 6.00%
Tier 1 capital to 42,963,000 22,307,000 27,884,000
average assets 7.70% 4.00% 5.00%
- -------------------------------------------------------------------------------
As of December 31, 2002
Tier 2 capital to $ 42,086,000 26,143,000 32,679,000
risk-weighted assets 12.88% 8.00% 10.00%
Tier 1 capital to 38,386,000 13,072,000 19,607,000
risk-weighted assets 11.75% 4.00% 6.00%
Tier 1 capital to 38,386,000 19,667,000 24,584,000
average assets 7.81% 4.00% 5.00%
- -------------------------------------------------------------------------------
The actual and minimum capital amounts and ratios for the Company, on a
consolidated basis, are presented in the following table:
- -------------------------------------------------------------------------------
To be
well-capitalized
For capital under prompt
adequacy corrective action
Actual purposes provisions
- -------------------------------------------------------------------------------
As of December 31, 2003
Tier 2 capital to $ 49,238,000 30,481,000 n/a
risk-weighted assets 12.92% 8.00% n/a
Tier 1 capital to 45,038,000 15,241,000 n/a
risk-weighted assets 11.82% 4.00% n/a
Tier 1 capital to 45,038,000 22,355,000 n/a
average assets 8.06% 4.00% n/a
- -------------------------------------------------------------------------------
As of December 31, 2002
Tier 2 capital to $ 44,070,000 26,222,000 n/a
risk-weighted assets 13.45% 8.00% n/a
Tier 1 capital to 40,370,000 13,111,000 n/a
risk-weighted assets 12.32% 4.00% n/a
Tier 1 capital to 40,370,000 19,707,000 n/a
average assets 8.19% 4.00% n/a
- -------------------------------------------------------------------------------
Page 74
Notes to Consolidated Financial Statements, Continued
Note 18. Condensed Financial Information of Parent
Condensed financial information for First National Lincoln Corporation exclusive
of its subsidiary is as follows:
Balance Sheets
- -------------------------------------------------------------------------------
December 31, 2003 2002
- -------------------------------------------------------------------------------
Assets
Cash $ 922,000 560,000
Dividends receivable 750,000 750,000
Investments 735,000 766,000
Investment in subsidiary 45,607,000 40,704,000
Premises and equipment 230,000 -
Other assets 222,000 565,000
- -------------------------------------------------------------------------------
$ 48,466,000 43,345,000
===============================================================================
Liabilities and shareholders' equity
Dividends payable $ 726,000 628,000
Other liabilities 22,000 22,000
Shareholders' equity 47,718,000 42,695,000
- -------------------------------------------------------------------------------
$ 48,466,000 43,345,000
===============================================================================
Statements of Income
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Investment income $ 60,000 56,000 56,000
Operating expense 63,000 84,000 47,000
- -------------------------------------------------------------------------------
Income (loss) before Bank earnings (3,000) (28,000) 9,000
Equity in earnings of Bank
Remitted 2,825,000 2,618,000 2,200,000
Unremitted 4,605,000 3,917,000 3,284,000
- -------------------------------------------------------------------------------
Net income $ 7,427,000 6,507,000 5,493,000
===============================================================================
Page 75
Notes to Consolidated Financial Statements, Concluded
Statements of Cash Flows
- -------------------------------------------------------------------------------
Years ended December 31, 2003 2002 2001
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 7,427,000 6,507,000 5,493,000
Adjustments to reconcile
net income to net cash
provided by operating activities:
Depreciation 2,000 - -
(Increase) decrease in other assets 328,000 (86,000) 5,000
Increase (decrease) in other liabilities - (22,000) 23,000
Unremitted earnings of Bank (4,605,000) (3,917,000) (3,284,000)
- -------------------------------------------------------------------------------
Net cash provided by operating activities 3,152,000 2,482,000 2,237,000
- -------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from maturities of investments 75,000 - -
Capital expenditures (232,000) - -
- -------------------------------------------------------------------------------
Net cash used in financing activities (157,000) - -
- -------------------------------------------------------------------------------
Cash flows from financing activities:
Purchase of Treasury stock (605,000) (945,000) (254,000)
Sale of Treasury stock 635,000 628,000 312,000
Dividends paid (2,663,000) (2,261,000) (1,861,000)
- -------------------------------------------------------------------------------
Net cash used in financing activities (2,633,000) (2,578,000) (1,803,000)
- -------------------------------------------------------------------------------
Net increase (decrease) in cash 362,000 (96,000) 434,000
Cash, beginning of year 560,000 656,000 222,000
- -------------------------------------------------------------------------------
Cash, end of year $ 922,000 560,000 656,000
===============================================================================
Page 76
ITEM 9. Changes in and/or Disagreements with Accountants on
Accounting and Financial Disclosure
None.
ITEM 9A. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as
of December 31, 2003, the end of the period covered by this report, the Company
carried out an evaluation under the supervision and with the participation of
the Company's Management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. In designing and evaluating the
Company's disclosure controls and procedures, the Company and its Management
recognize that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and the Company's Management necessarily was required to apply its
judgment in evaluating and implementing possible controls and procedures. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective to
provide reasonable assurance that information required to be disclosed by the
Company in the reports it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. There was no change in the
Company's internal control over financial reporting that occurred during the
period ended December 31, 2003 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting. The Company reviews its disclosure controls and procedures, which may
include its internal controls over financial reporting on an ongoing basis, and
may from time to time make changes aimed at enhancing their effectiveness and to
ensure that the Company's systems evolve with its business.
(b) Changes in internal controls.
None.
Page 77
ITEM 10. Directors and Executive Officers of the Registrant
The Articles of Incorporation of the Company provide that the Board of
Directors shall consist of not fewer than five nor more than twenty-five persons
as determined by the Board prior to each Annual Meeting, with Directors serving
for "staggered terms" of three years. A resolution of the Board of Directors
adopted pursuant to the Company's Articles of Incorporation has established the
number of Directors at ten. In order to be a candidate for a Director of the
Company, each individual must meet the following criteria:
* Be a citizen of the United States.
* Have the financial capacity to own and/or purchase the minimum equity interest
in First National Lincoln Corporation as specified in the Company's bylaws.
* Be available to attend the monthly meetings of the Board of Directors and
Board Committee meetings, as scheduled from time to time.
* Be of good character and an experienced business professional.
* Contribute to the range of talent, skill and expertise appropriate for the
Board.
* Have the ability and willingness to represent the interests of the
Shareholders of the Company.
* Meet any additional criteria that the Office of the Comptroller of the
Currency may establish for Directors of a National Bank.
Each person listed below has consented to be named as a nominee, and the
Board of Directors knows of no reason why any of the nominees listed below may
not be able to serve as a Director if elected.
The following are nominees for three-year terms as Director Expiring in 2007 as
proposed by the Nominating Committee of the Board of Directors:
Malcolm E. Blanchard has served as a Director of the Company since its
organization in 1985 and as a Director of The First National Bank of
Damariscotta (the "Bank"), the Company's wholly owned subsidiary, since 1976.
Mr. Blanchard has been actively involved, either as sole proprietor or as a
partner, in real estate development since 1970.
Randy A. Nelson has served as a Director of the Company and the Bank since
2004. He currently is the Douglas Professor of Economics and Finance at Colby
College, where he teaches corporate finance and economics. Prior to joining the
faculty of Colby in 1987, he taught for eight years in the business school at
the University of Delaware.
Stuart G. Smith has served as a Director of the Company and the Bank since
1997. A resident of Camden, he and his wife own and operate Maine Sport
Outfitters in Rockport and Lord Camden Inn and Bayview Landing in Camden, Maine.
Mr. Smith is also on the board and part owner of the Mid Coast Recreation Center
in Rockport, an indoor tennis and ice skating facility. In addition, Mr. Smith
serves as the Chairperson of the MSAD #28 Elementary School New School Site
Selection Committee.
Directors Continuing in Office:
The following Directors' terms will expire in 2005:
Katherine M. Boyd has served as a Director of the Company and the Bank
since 1993. A resident of Boothbay Harbor, she owns the Boothbay Region
Greenhouses with her husband. Ms. Boyd serves as President of the Boothbay
Region YMCA.
Carl S. Poole, Jr. has served as a Director of the Company since its
organization in 1985 and has served as a Director of the Bank since 1984. Mr.
Poole is President, Secretary, and Treasurer of Poole Brothers Lumber, a lumber
and building supply company with locations in Damariscotta, Pemaquid and
Boothbay Harbor, Maine.
Page 78
David B. Soule, Jr. has served as a Director of the Company and the Bank
since 1989. Mr. Soule has been practicing law in Wiscasset since 1971. He served
two terms in the Maine House of Representatives, is a past President of the
Lincoln County Bar Association and is a former Public Administrator, Lincoln
County. He also serves as Trustee of the Wiscasset Public Library and has served
as Selectman, Planning Board Chair and other volunteer positions with the Town
of Westport.
Bruce B. Tindal has served as a Director of the Company and the Bank since
1999. Mr. Tindal has been a licensed real estate broker since 1974. Mr. Tindal
formed and is owner of Tindal & Callahan Real Estate in Boothbay Harbor, which
has been in operation since 1985. Mr. Tindal serves on the Board of Directors of
the St. Andrews Village Association, a subsidiary of St. Andrews Hospital. Mr.
Tindal is also a member of the National Association of Realtors, Council of
Residential Specialists, Real Estate Buyers Agent Council and the Boothbay
Harbor Rotary Club.
The following Directors' terms will expire in 2006:
Daniel R. Daigneault has served as President, Chief Executive Officer and
as a member of the Board of Directors of the Company and the Bank since 1994.
Prior to being employed by the Bank, Mr. Daigneault was Vice President, Senior
Commercial Loan Officer and Chief Financial Officer at Camden National Bank,
Camden, Maine. He is a member of the American Bankers Association's Government
Relations Council and a member of the University of Maine Business School
Advisory Board. Mr. Daigneault is past Chairman of the Maine Bankers Association
and past President of the Boothbay Region YMCA Board of Trustees.
Dana L. Dow has served as a Director of the Company and the Bank since
1999. Mr. Dow is President of Dow Furniture, located in Waldoboro, Maine, which
he purchased from his father in 1977 and Dow's Fine Furniture located in
Rockland, Maine. Prior to purchasing Dow Furniture, Mr. Dow taught chemistry and
physics at Medomak Valley High School.
Robert B. Gregory has served as a Director of the Company and the Bank
since 1987 and has served as Chairman of both the Company and the Bank since
September 1998. Mr. Gregory has been a practicing attorney since 1980, first in
Lewiston, Maine and since 1983 in Damariscotta, Maine.
There are no family relationships among any of the Directors of the
Company, and there are no arrangements or understandings between any Director
and any other person pursuant to which that Director has been or is to be
elected. No Director of the Bank or the Company serves as a Director on the
board of any other corporation with a class of securities registered pursuant to
Section 12 of the Securities Exchange Act of 1934 or that is subject to the
reporting requirements of Section 15(d) of the Securities Exchange Act of 1934,
or of any company registered as an investment company under the Investment
Company Act of 1940, as amended.
Director Independence
The Board reviewed the independence of the Company's directors in February
2004 on the basis of the standards adopted by the NASDAQ. In this review, the
Board considered transactions and relationships between each director, and any
member of his or her immediate family and of the Company or the Bank and between
certain entities in which any director or any immediately family member has
certain interest, on the one hand and the Company or the Bank, on the other
hand. The purpose of this review was to determine which of such transactions or
relationships were inconsistent with a determination that the director is
independent under the NASDAQ rules.
As a result of the review, the Board affirmatively determined that all
of the directors are independent of the Company, the Bank and under the NASDAQ
rules with the exception of President Daigneault.
Page 79
About the Board of Directors and Its Committees
As of March 1, 2004, First National Lincoln Corporation had a Board
comprised of ten directors. During 2003 there were 12 regular Board
meetings, one special Board meeting and one Annual Meeting. All directors
attended at least 75% of Board meetings and meetings held by Committees of which
they were members in 2003, and the aggregate attendance at Board and Committee
meetings by all members of the Board of Directors in 2003 was in excess of 90%.
All Directors are expected to attend the Annual Meeting of Shareholders, and all
Directors were in attendance at the 2003 Annual Meeting.
There are three standing committees of the Company's Board of Directors:
Audit, Options and Nominating.
Audit Committee. The members of the Company's Audit Committee are
David B. Soule, Jr., Chairman, Dana L. Dow, Robert B. Gregory and Randy A.
Nelson. This committee met four times during 2003. The Company's Audit
Committee receives and reviews reports on examinations and accounting audits
of the Company, and works to ensure the adequacy of operating practices,
procedures and controls. The Company's Board of Directors has adopted a written
charter for the Company's Audit Committee.
Nominating Committee. The members of the Company's Nominating Committee
consisted of Malcolm E. Blanchard, Chair, Robert B. Gregory, Carl S. Poole, Jr.,
and Stuart G. Smith. This committee met three times during 2003. The Company's
Nominating Committee is responsible for the nomination of Board of Director
members, establishing the tenure and the retirement policies for members of the
Board of Directors and reviewing the Board of Directors' overall effectiveness.
Each of the members of the Nominating Committee is independent as defined under
the listing standards of the NASDAQ stock market.
Options Committee. The members of the Company's Options Committee
consisted of Malcolm E. Blanchard, Chair, Robert B. Gregory, Carl S. Poole, Jr.,
and Stuart G. Smith. This committee met one time during 2003. The Company's
Options Committee is responsible for administering the 1995 Stock Option Plan
which provides for grants of incentive stock options to purchase Company
common stock.
Compensation Committee. The Company's Compensation Committee is a standing
committee of the Bank's Board of Directors since all executive compensation is
paid by the Bank. The Committee consisted of Malcolm E. Blanchard, Chair,
Robert B. Gregory, Carl S. Poole, Jr., and Stuart G. Smith. This committee met
one time during 2003. None of the members of this committee served on a similar
committee for any other company. The function of this committee is to establish
the compensation of the Chief Executive Officer and to review the compensation
of other senior executive officers.
In addition to the Compensation Committee, there are five other standing
committees of the Bank's Board of Directors: Executive, Audit, Asset/Liability,
Trust, and Directors' Loan. Certain members of management also serve on some
committees of the Bank.
Page 80
Executive Officers
Each Executive Officer of the Company and the Bank is identified in the
following table, which also sets forth their respective ages, offices and
periods served as an Executive Officer of the Company or the Bank:
- -------------------------------------------------------------------------------
Name & Age (1) Office & Position Period Served
- -------------------------------------------------------------------------------
Daniel R. Daigneault President & Chief Executive Officer 1994 to date
51 of the Company and of the Bank
F. Stephen Ward Treasurer & Chief Financial Officer 1993 to date
50 of the Company; Senior Vice President and
Chief Financial Officer of the Bank;
Principal of Pemaquid Advisors
Charles A. Wootton Clerk of the Company, Senior Vice President 2000 to date
47 Banking Services Officer and Senior Loan
Officer of the Bank
Walter F. Vietze Senior Vice President and Senior 1984 to date
62 Operations Officer of the Bank
Michael T. Martin Senior Vice President and Credit 1993 to date
48 Administration Officer of the Bank
Richard M. Elder Vice President, Retail Services 2002 to date
38
Susan A. Norton Vice President, Human Resources and 2002 to date
43 Compliance
William M. Hunter, II Managing Principal, Pemaquid Advisors 2003 to date
53
R. Kraig Buthy Controller 2003 to date
38
- -------------------------------------------------------------------------------
(1) As of December 31, 2003
Daniel R. Daigneault has served as President, Chief Executive Officer and as a
member of the Board of Directors of both the Company and the Bank since 1994.
Prior to being employed by the Company and the Bank, Mr. Daigneault was Vice
President, Senior Commercial Loan Officer and Chief Financial Officer at Camden
National Bank, Camden, Maine.
F. Stephen Ward has served as Treasurer & Chief Financial Officer of the Company
since 1994 and as Chief Financial Officer of the Bank since 1993. Mr. Ward has
been employed by the Bank since 1990 and served as Assistant Vice President and
Marketing Officer from 1990 to 1993. From 1978 to 1990 Mr. Ward was employed by
Down East Enterprises, Inc.
Charles A. Wootton has been employed by the Bank since January 2000. In 2001,
Mr. Wootton was promoted to Senior Vice President for Banking Services and
Senior Loan Officer. From 1981 to 2000 Mr. Wootton was employed by Camden
National Bank, serving as branch manager, commercial loan and business
development officer. In 1996, Mr. Wootton became Vice President responsible for
branch administration.
Walter F. Vietze has been employed by the Bank since 1984. From 1979 to 1984,
Mr. Vietze was employed by Casco Bank, Portland, Maine. His primary
responsibilities involved providing online banking services to correspondent
banks. Prior to 1979, Mr. Vietze was affiliated with BayBanks in Massachusetts.
Page 81
Michael T. Martin has been employed by the Bank since 1993 and was promoted to
Senior Vice President for Credit Administration in 2001. He was employed by
Fleet Bank from 1980 to 1992 and by Canal National Bank from 1977 to 1980. His
primary responsibilities were in Loan Review and Credit Administration.
Richard M. Elder has served as Vice President, Retail Services since 2000. Mr.
Elder previously served as Manager of the Bank's Boothbay Harbor branch and
Senior Commercial Loan Officer. He has been employed by the Bank since 1993.
Susan A. Norton has been employed by the Bank since 1992 and was promoted to
Vice President, Human Resources and Compliance in 2000. In 1995, Ms. Norton was
the Assistant Compliance Officer and Education Officer. She also holds the
position of CRA Officer as well as being the Compliance Officer for the Company.
William M. Hunter, II joined the Company in 2001 with the acquisition by
Pemaquid Advisors of White Pine Asset Management. In 2002, Mr. Hunter was named
as Chief Investment Officer and in 2003 he was promoted to Managing Principal of
Pemaquid Advisors. Prior to joining the Company, Mr. Hunter was Executive Vice
President in charge of KeyCorp's national trust business.
R. Kraig Buthy has been employed by the Bank as Controller since 2003. Prior to
joining the Bank, Mr. Buthy was Controller at Sunday River Ski Resort in Bethel,
Maine.
There are no family relationships among any of the Executive Officers, nor
are there any arrangements or understandings between any Executive Officer and
any other person pursuant to which that Executive Officer has been or is to be
elected.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires that the Company's directors,
executive officers, and any person holding more than ten percent of the
Company's Common Stock file with the SEC reports of ownership changes, and that
such individuals furnish the Company with copies of the reports.
Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons, the Company believes
that all of its executive officers and directors complied with all Section 16(a)
filing requirements applicable to them in 2003.
Page 82
Audit Committee Financial Expert
Pursuant to Section 407 of the Sarbanes-Oxley Act of 2002 and Item 306 of
Regulation S-K promulgated by the Securities and Exchange Commission, First
National Lincoln Corporation ("the Company") is required to disclose whether it
has at least one "Financial Expert" serving on its Audit Committee, and if so,
the name of the expert and whether the expert is independent of management. A
company that does not have an Audit Committee Financial Expert must disclose
this fact and explain why it has no such expert.
At the present time, the Company's Audit Committee does not have a member who
meets the Securities and Exchange Commission's complete definition of a
financial expert. It is the opinion of the Company's Board of Directors,
however, that the Company addresses its audit functions with a depth of
penetration and rigor that meets the intent of the requirements of the
Sarbanes-Oxley Act for the following reasons:
* The Company is a one-bank holding company owning all of the capital stock in
The First National Bank of Damariscotta ("the Bank"). All Directors of the Bank
meet the requirements and qualifications imposed by the Office of the
Comptroller of the Currency, the Bank's principal regulator which conducts
regular supervisory examinations of the Bank. In addition to requiring knowledge
of the banking industry and financial regulatory system, these qualifications
require a "background, knowledge, and experience in business or another
discipline to oversee the Bank."
* All members of the Audit Committees of the Bank and the Company are
independent directors, as defined by the Securities and Exchange Commission and
NASDAQ. Three of the members operate their own businesses and have knowledge of
accounting for both their own businesses as well as for the Bank and the
Company. The fourth member of the Committee has a PhD in Economics and is a
Chaired Professor of Economics and Finance. The members of the Audit Committee
have a combined experience of 37 years as directors of the Bank and the Company.
* Internal audit work of the Bank and the Company is outsourced to a
professional firm which conducts all internal audits except for loan review, for
which a second professional firm performs quality control loan review. Both
firms provide detailed quarterly reports to the Audit Committee and the Director
Loan Committees, respectively.
* The Bank is a highly regulated entity which undergoes regular and thorough
examination by the Office of the Comptroller of the Currency, with additional
oversight by the Federal Deposit Insurance Corporation. The Company is a
"Financial Holding Company" as defined by the Federal Reserve Board and as such
is regulated and regularly examined by the Federal Reserve Board.
The Company also continuously reviews, at its own initiative, the expertise of
the members of its Board of Directors and its Audit Committee.
Page 83
ITEM 11. Executive Compensation
Executive Compensation
The table below sets forth the cash compensation and certain other
compensation paid to the President & Chief Executive Officer as well as the
Treasurer & Chief Financial Officer, the Senior Vice President/Senior Loan
Officer and the Senior Vice President/Senior Operations Officer during 2003,
2002 and 2001. No other Executive Officers of the Company received compensation
in excess of $100,000 for the years ended December 31, 2003, 2002 and 2001.
- -------------------------------------------------------------------------------
Name Annual Long-Term
and Compensation Compensation
Principal ----------------------------- ------------
Position Year Salary Bonus(1) Other(2) # Options
- -------------------------------------------------------------------------------
Daniel R. Daigneault 2003 $ 241,500 $ 44,678 $ 17,387 -0-
President and CEO 2002 $ 230,000 $ 49,960 $ 19,217 -0-
2001 $ 195,000 $ 48,750 $ 14,660 -0-
- -------------------------------------------------------------------------------
F. Stephen Ward 2003 $ 131,250 $ 31,281 $ 13,728 -0-
Treasurer and CFO 2002 $ 125,000 $ 25,000 $ 11,283 -0-
2001 $ 115,000 $ 10,560 $ 11,972 -0-
- -------------------------------------------------------------------------------
Charles A. Wootton 2003 $ 115,500 $ 28,868 $ 12,079 -0-
SVP and Senior Loan 2002 $ 110,000 $ 22,720 $ 11,800 5,000
Officer 2001 $ 80,000 $ 11,200 $ 10,000 -0-
- -------------------------------------------------------------------------------
Walter F. Vietze 2003 $ 86,500 $ 18,503 $ 6,684 -0-
SVP and Senior 2002 $ 83,000 $ 13,836 $ 5,973 -0-
Operations Officer 2001 $ 78,000 $ 10,920 $ 5,396 -0-
- -------------------------------------------------------------------------------
(1) Bonuses are listed in the year earned and normally accrued. Such bonuses may
be paid in the following year. (2) (a) Amounts shown include contributions paid
by the Company to the respective accounts of the named Executive Officers in the
401(k) Plan. In 2003 the Company and the Bank contributed to the Bank's 401(k)
Plan a matching amount for the salary deferred by Messrs. Daigneault, Ward,
Wootton and Vietze equal to 3.0% of their respective earnings and a
profit-sharing component of 2.5% for 2003 and 3.0% for 2002 and 2001, of their
respective earnings, which were subject to IRS regulations limiting the maximum
amount of an officer's earnings eligible for matching or profit-sharing 401(k)
contributions to $200,000. These percentages were equivalent to the 401(k) Plan
match and profit sharing contributions made for all eligible employees.
(b) This figure also recognizes the value to the officers of a Company-owned
vehicle to Messrs. Daigneault, Ward and Wootton which were $5,665, $5,273 and
$5,150 respectively for 2003. (c) Also included in 2003 is the economic value of
split dollar life insurance benefits provided to Messrs. Daigneault, Ward and
Vietze under the Life Insurance Endorsement Split Dollar Plan agreement for Bank
Owned Life Insurance. This value was $722 for Mr. Daigneault, $466 for Mr. Ward
and $490 for Mr. Vietze.
Page 84
Report of Compensation Committee on Executive Compensation
The Compensation Committee consists of four outside members of the Board
of Directors. This Committee has the responsibility for conducting the annual
performance evaluation of the Chief Executive Officer. The Committee is also
responsible for determining the compensation of the Chief Executive Officer and
approving the compensation of the other senior executive officers. The Company
is committed to providing competitive compensation packages to attract and
retain quality high performance executives who can and do make major
contributions to the Company's overall success. The compensation package
generally includes base salary, cash bonuses, stock option grants and other
benefits which the Committee may deem appropriate to remain competitive and
reward the executive for high performance.
Base Salaries
The amount of base compensation potentially payable to the Chief Executive
Officer and other senior executive officers is determined by reviewing
independent salary surveys of compensation of officers for similar financial
institutions located primarily in the New England region. Base salaries are
targeted at market levels taking into consideration the executive's level of
responsibility, experience, knowledge, leadership and attainment of performance
goals and objectives.
Annual Bonuses
In 1994, the Company instituted a formal performance-based compensation
program called "Performance Compensation for Stakeholders". The objective of the
program is to align the performance of all employees with the Company's short
term and long term objectives. In 2003, total cash payout under this Stakeholder
Performance Compensation program was 18.50% of the participating employees' base
salaries paid to all eligible employees.
The performance compensation program's overall objective is to maximize
the long-term viability of the Company and increase shareholder value. It
addresses this by tying the bonus payout to multiple goals which include
profitability, growth, productivity and loan quality. The guiding principle is
to reach a balance of profitability, growth, productivity and loan quality which
should collectively have a positive impact on maximizing long-term shareholder
value. The Committee believes that this bonus program rewards current
performance without sacrificing the achievement of long-term goals. Each year
specific key performance indicators are chosen along with company wide financial
performance trigger levels. In 2003 some of the indicators were: loan volume,
deposit volume, nonperforming loan levels, non-interest income, net interest
income and the efficiency ratio. Since its introduction in 1994 in the opinion
of Management and this Committee, the program has been successful in meeting its
objectives as measured by the Company's performance over this same period.
In addition to this bonus program the Committee, with the consent of the
Board of Directors, may also establish a discretionary bonus pool. From this
available pool the CEO with the consent of this Committee may grant additional
cash bonuses to selected employees in recognition of their outstanding
performance during the year. The Chief Executive Officer has been excluded for
eligibility under this discretionary bonus program since 2003. This Committee,
however, may from time to time with the consent of the Board of Directors grant
the Chief Executive Officer a cash bonus in addition to the formal Stakeholder
Performance Compensation program.
Page 85
Compensation of Chief Executive Officer
As previously noted, the amount of base salary potentially payable to the
Chief Executive Officer was determined by reviewing independent salary surveys
of CEOs of similar financial institutions located in New England. The Committee
took into consideration the actual salaries paid to CEOs of these banks and the
performance of the Company in comparison to the selected peer group.
At the beginning of each year the Chief Executive Officer and the Board of
Directors agree to a set of performance objectives for the Company as a whole
and the CEO individually. Throughout the year the attainment of the performance
objectives is carefully monitored and evaluated. These performance objectives
are a combination of Company financial targets such as attainment of certain net
income levels, return on equity levels, and increases in earnings per share. In
addition, goals are set for asset growth as well as loan quality targets. Goals
are also set for non-financial performance items such as implementation of
strategic plan goals and compliance with regulatory matters.
For the year ended December 31, 2002, the Company posted outstanding
performance results with an 18.46% increase in net income and a Return on
Average Equity of 16.34%. In addition to these strong financial performance
results the Chief Executive Officer also did an excellent job at meeting all of
his other performance objectives. Therefore, based on these results as well as
the review of base salaries of CEOs of peer group companies, the Chief Executive
Officer's base compensation for 2003 was set at $241,500, representing an
$11,500 or 5.00% increase in base salary over the $230,000 base salary set for
2002. In addition to the above base salary, the Chief Executive Officer also
earned a cash bonus of 18.50% under the Company's Stakeholder Performance
Compensation program for all employees. This accounted for the $44,678 disclosed
in the compensation table.
2003 Compensation Committee Members:
Malcolm E. Blanchard, Chair
Robert B. Gregory
Carl S. Poole, Jr.
Stuart G. Smith
Compensation Committee Interlocks and Insider Participation
in Compensation Decisions
During 2003, Directors Gregory, Blanchard, Poole and Smith served as
members of the Compensation Committee. No member of the Committee was, or ever
has been, an officer or employee of the Company or the Bank. All Committee
members are customers of and engage in transactions with the Bank in the
ordinary course of business. As described in the section entitled "Certain
Relationships and Related Transactions", all loans to such individuals were made
on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other persons and,
in the opinion of Management, did not involve more than the normal risk of
collectibility or present other unfavorable features.
Page 86
Director Compensation
In 2003, each of the outside directors of the Bank, with the exception of
the Chairman of the Board, received a director's fee in the amount of $550 for
each meeting attended and $300 for each meeting attended of a committee of which
the director is a member. The Chairman of the Board received an annual fee of
$19,000. The Chairman of the Executive Committee also received a stipend of
$4,500 in addition to meeting fees paid for meetings attended. In addition to
the above referenced fees, each of the outside directors was reimbursed for 85%
of the cost of his or her health insurance premiums. This reimbursement amount
is equivalent to the average rate provided to employees of the Company. Certain
Board members were also paid fees for appraisals, consulting services and legal
services, and such fees are on terms no more favorable to the recipient than are
generally paid by the Bank for such services to other providers in the area.
Fees and health insurance premiums paid by the Bank to its Directors as a group
totaled $168,000 in 2003, but no fees are paid to Directors of the Company.
President Daigneault, who is the only director who is also an employee of the
Company, receives no additional compensation for serving on the Board of
Directors of the Company or the Bank.
Stock Option Plan
In April 1995, the stockholders approved a Stock Option Plan. The purpose
of the Stock Option Plan is to encourage the retention of key employees by
facilitating their purchase of a stock interest in the Company and to align
their interest with those of the shareholders. The 1995 Stock Option Plan
provides for grants of options to purchase Company common stock and is
administered by an Options Committee, which consists of four outside directors.
During 2003, no stock options were granted under the 1995 Stock Option Plan. The
following table sets forth the status of the Stock Option Plan as of December
31, 2003:
- -------------------------------------------------------------------------------
Options approved by Shareholders 200,000
- -------------------------------------------------------------------------------
Options granted (194,000)
Options forfeited 7,000
- -------------------------------------------------------------------------------
Ungranted options remaining 13,000
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Outstanding Weighted average Number of
unexercised options exercise price options
- -------------------------------------------------------------------------------
Exercisable $ 10.11 73,700
Non-exercisable 19.12 24,500
- -------------------------------------------------------------------------------
$ 13.23 98,200
- -------------------------------------------------------------------------------
2003 Option Committee Members:
Malcolm E. Blanchard, Chair
Robert B. Gregory
Carl S. Poole, Jr.
Stuart G. Smith
Page 87
Long-Term Compensation
Long-term compensation may be distinguished from annual compensation by
the time frame for which performance results are measured to determine awards.
While annual compensation covers a calendar year, long-term compensation is
provided through the Company's stock option plan, which covers a period of two
to ten years. The following table sets forth information with respect to the
named executives and all other employees concerning grants of stock options
during 2003:
- -------------------------------------------------------------------------------
Option Grants During the Year Ended December 31, 2003
- -------------------------------------------------------------------------------
% of Potential realizable
Number of options value at assumed rates
securities granted Exercise of stock appreciation
underlying in price for option term(1)
options fiscal per Expiration ---------------------
granted year Share(2) Date 5% 10%
- -------------------------------------------------------------------------------
Daniel R. Daigneault -0- 0.0% $ -0- - $ -0- $ -0-
F. Stephen Ward -0- 0.0% $ -0- - $ -0- $ -0-
Charles A. Wootton -0- 0.0% $ -0- - $ -0- $ -0-
Walter F. Vietze -0- 0.0% $ -0- - $ -0- $ -0-
All other employees -0- 0.0% $ -0- - $ -0- $ -0-
- -------------------------------------------------------------------------------
All -0- 0.0% $ -0- - $ -0- $ -0-
- -------------------------------------------------------------------------------
1) The dollar gains under these columns result from calculations assuming 5% and
10% growth rates compounded over a 10-year period as set by the Securities and
Exchange Commission and are not intended to forecast future price appreciation
of the Company's common stock. The gains reflect a future value based upon
growth at these prescribed rates. The values have not been discounted to present
value. It is important to note that options have value to the listed executive
and to all option recipients only if the stock price advances beyond the
exercise price shown on the table during the effective option period.
2) Under the Stock Option Plan, the exercise price may not be less than the fair
market value of the common stock on the date the option is granted.
Page 88
The following table sets forth information with respect to exercisable and
unexercisable options held as of December 31, 2003:
- -------------------------------------------------------------------------------
Aggregated Option Exercises in 2003 and December 31, 2003 Option Values
- -------------------------------------------------------------------------------
Number of
securities underlying Value of unexercised
unexercised options in-the-money
Shares at year end options at year end
acquired ------------------ ---------------------
on Value Exer- Unexer- Exer- Unexer-
exercise realized cisable cisable cisable cisable
- -------------------------------------------------------------------------------
Daniel R. Daigneault -0- $ -0- 39,000 4,000 $ 1,634,000 $ 126,000
F. Stephen Ward -0- $ -0- 11,500 1,500 $ 434,000 $ 45,000
Charles A. Wootton -0- $ -0- 5,000 10,000 $ 166,000 $ 276,000
Walter F. Vietze 4,000 $ 95,000 10,000 1,000 $ 386,000 $ 29,000
All other employees 2,600 $ 69,000 8,200 8,000 $ 313,000 $ 192,000
- -------------------------------------------------------------------------------
All optionees 6,600 $164,000 73,700 24,500 $ 2,933,000 $ 668,000
- -------------------------------------------------------------------------------
Description of the Company's Benefit Plans
Overview
The Company has reserved 160,000 shares of its common stock to be made
available to directors and employees who elect to participate in the directors'
deferral, employee stock purchase, or 401(k) savings and investment plans. As of
December 31, 2003, 119,014 shares had been issued pursuant to these plans,
leaving 40,986 shares available for future issuance. The issuance price is based
on the market price of the stock at issuance date. All shares issued under the
401(k) savings and investment plans are issued pursuant to an exemption from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), contained in Section 3(a)(11) thereof and Rule 147 promulgated
thereunder. During the period ending nine months after the date of issuance of
these shares, these shares may be transferred only to residents of the State of
Maine. Each certificate issued for these plan shares bears a legend referring to
this restriction.
Shares issued under the employee stock purchase plan prior to September
11, 1998, were issued pursuant to exemptions from registration under Section
3(a)(11) and Rule 147 of the Securities Act. Shares issued under the employee
stock purchase plan on or after September 11, 1998, have been issued pursuant to
a registration statement filed under the Securities Act. The members of the
Board of Directors and certain officers of the Company, who may be deemed to be
"affiliates", may resell shares of the Company's common stock purchased or
acquired under this plan only in accordance with certain restrictions imposed by
the Securities Act and Rule 144 promulgated thereunder.
Page 89
401(K) Plan
The Bank's 401(k) Plan (The First National Bank of Damariscotta Savings
and Investment Plan) is the Bank's sole retirement plan, and was modified in
1996 after termination of the Bank's traditional defined benefit pension plan.
It is available to any employee who has attained the age of 21 and completed six
months of continuous service. Employees may contribute up to 50.0% of their
compensation (not to exceed $12,000 if under age 50 and $14,000 if over age 50),
and the Bank may provide a match of up to 3.0% of compensation. Subject to a
vote of the Board of Directors, the Bank may also make a profit-sharing
contribution to the Plan, and in 2003 this contribution equaled 2.5% of each
eligible employee's compensation. The 401(k) Plan is administered by a special
committee appointed by the Board of Directors.
Employee contributions are 100% vested at all times, while employer
contributions are vested over a five-year period. Upon termination of employment
for any reason, a plan participant may receive his or her contribution account
and earnings allocated to it, as well as the vested portion of his or her
employer-matching account and earnings allocated to it. Non-vested amounts are
forfeited and are used by the Bank to help defray plan administration expenses
incurred by the Bank. The Bank paid $104,000 in matching contributions and
$113,000 in profit-sharing contributions to this plan in 2003. Plan participants
may direct the trustees of the 401(k) Plan to purchase specific assets for their
accounts from a selection which includes seven mutual funds as well as the
Company's stock. As of December 31, 2003, 63,484 shares of the Company's stock
had been purchased by the 401(k) Plan at the direction of plan participants.
Stock Purchase Plan
The Bank instituted an employee and director stock purchase plan effective
February 1, 1987, and the Board of Directors has allocated 80,000 shares of
stock to be available for purchase under this plan. Employees who have been
employed by the Bank for three consecutive calendar months are eligible to
purchase shares on a quarterly basis through payroll deduction. The price per
share for shares sold pursuant to the plan is defined as the closing price on
the day the shares are purchased. As of December 31, 2003, 55,530 shares of the
Company's stock had been purchased pursuant to the plan.
Employee Benefits
The Bank provides all full-time employees with group life, health, and
long-term-disability insurance through the Independent Bankers' Employee
Benefits Trust of Maine. A Flexible Benefits Plan is available to all full-time
employees after satisfying eligibility requirements and to part-time employees
scheduled to work 20 or more hours a week.
Supplemental Executive Retirement Plan
The Bank also sponsors an un-funded, non-qualified supplemental retirement
plan for certain officers. The plan provides supplemental retirement benefits
payable in installments over 20 years upon retirement or death. The costs for
this plan are recognized over the service lives of the participating officers.
The projected retirement benefit for Mr. Daigneault, assuming he remains
employed by the Bank until normal retirement age of 65, is $169,329 per year,
with such payments beginning in the year 2017. The projected retirement benefit
for Mr. Ward, assuming he remains employed by the Bank until normal retirement
age of 65, is $61,127 per year, with such payments beginning in the year 2018.
The projected retirement benefit for Mr. Vietze, assuming he remains employed by
the Bank until normal retirement age of 65, is $39,235 per year, with such
payments beginning in the year 2006. The expense for all participants in this
supplemental plan was $135,000 in 2003, $112,000 in 2002 and $141,000 in 2001.
As of December 31, 2003 and 2002, the accrued liability of this plan was
$709,000 and $591,000, respectively.
Page 90
Stock Option Plan
On December 15, 1994, the Company's board of directors adopted a Stock
Option Plan (the "Option Plan") for the benefit of officers and other full-time
employees of the Company and the Bank. This plan was approved by the Company's
shareholders at the 1995 Annual Meeting. Under the Option Plan, 200,000 shares
(subject to adjustment to reflect stock splits and similar events) are reserved
from the authorized but unissued common stock of the Company for future issuance
by the Company for exercise of stock options granted to certain key employees of
the Company and the Bank from time to time. The purpose of the Option Plan is to
encourage the retention of such key employees by facilitating their purchase of
a stock interest in the Company. The Option Plan is intended to provide for the
granting of incentive stock options under Section 422 of the Internal Revenue
Code of 1986, as amended (the "Code") to employees of the Company or the Bank.
The Option Plan is administered by the Options Committee of the Company's
board of directors, which is comprised solely of directors who are ineligible to
receive grants of stock options under the Option Plan and who have not received
grants of options within the 12 months preceding their appointment to the
Options Committee. The Options Committee selects the employees of the Bank and
the Company to whom options are to be granted and designates the number of
options to be granted. The Option Plan may be amended only by the vote of the
holders of a majority of the Company's outstanding common stock if such
amendment would increase the number of shares available for issuance under the
Option Plan, change the eligibility criteria for grants of options under the
Option Plan, change the minimum option exercise price or increase the maximum
term of options. Other amendments may be effected by the Options Committee.
Employees selected by the Options Committee receive, at no cost to them,
options under the Option Plan. The option exercise prices are equal to or exceed
the fair market value of the shares on the date of the grant, and no option is
exercisable after the expiration of ten years from the date it is granted. The
fair market value of the shares is determined by the Options Committee as
specified in the Option Plan. The optionee cannot transfer or assign any option
other than by will or in accordance with the laws of descent and distribution,
and the option may be exercised only by the employee during the employee's
lifetime. After an employee's death, options may be exercised by the employee's
estate or heirs up to one year following the date of death. Code Section 422
limits option grants by providing that during the term of the Option Plan, no
grant may be made to any employee owning more than 10% of the Company's
outstanding shares unless the exercise price is at least 110% of the underlying
shares' fair market value and such option is not exercisable more than five
years following the option grant. The aggregate fair market value of the stock
for which any employee may be granted incentive stock options which are first
exercisable in any calendar year may generally not exceed $100,000.
While generally no options may be exercisable before the second
anniversary of the grant date, in the event of a change in control involving the
Company all options (other than those held by officers or directors of the
Company or the Bank for less than six months) shall become immediately
exercisable. Also, an employee whose employment is terminated in connection with
or within two years after such a change in control event shall be entitled to
exercise all options for up to three months following the date of termination;
provided that options held by officers or directors shall not be exercisable
until six months after the grant date. Employees whose services are terminated,
other than following a change in control as described above, shall thereupon
forfeit any options held; provided, however, that following termination due to
disability an employee shall be entitled to exercise options for up to one year
(provided, further, that officers may exercise only with respect to options held
for at least six months).
Page 91
The Company receives no monetary consideration for the granting of
incentive stock options. Upon the exercise of options, the Company receives
payment in cash from optionees in exchange for shares issued. No federal income
tax consequences are incurred by the Company at the time incentive stock options
are granted or exercised, unless the optionee incurs liability for ordinary
income tax treatment upon exercise of the option, as discussed below, in which
event the Company would be entitled to a deduction equal to the optionee's
ordinary income attributable to the options. Provided the employee holds the
shares received on exercise of a stock option for the longer of two years after
the option was granted or one year after it was exercised, the optionee will
realize capital gains income (or loss) in the year of sale in an amount equal to
the difference between the sale price and the option exercise price paid for
shares. If the employee sells the shares prior to the expiration of the period,
the employee realizes ordinary income in the year of disposition equal to the
difference between the fair market value of the shares on the date of exercise
and the exercise price and capital gains income (or loss) equal to the
difference (if any) between the sale price of the shares and the fair market
value of the shares on the date of exercise.
In addition to the tax consequences discussed above, the excess of the
option price over the fair market value of the optioned stock at the time of
option exercise is required to be treated by an incentive optionee as an item of
tax preference for purposes of the alternative minimum tax.
Performance Graph
Set forth below is a line graph comparing the five-year cumulative total return
of $100.00 invested in the Company's common stock ("FNLC"), assuming
reinvestment of all cash dividends and retention of all stock dividends, with a
comparable amount invested in the Standard & Poor's 500 Index ("S&P 500") and
the NASDAQ Combined Bank Index ("NASD Bank"). The NASD Bank index is a
capitalization-weighted index designed to measure the performance of all NASDAQ
stocks in the banking sector.
[GRAPHIC OMITTED]
- -------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
- -------------------------------------------------------------------------------
FNLC 100.00 74.44 74.03 110.97 163.66 267.18
- -------------------------------------------------------------------------------
NASD Bank 100.00 92.02 105.52 116.15 121.40 161.51
- -------------------------------------------------------------------------------
S&P 500 100.00 120.84 109.93 96.90 75.48 97.14
- -------------------------------------------------------------------------------
Page 92
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
Security Ownership of Directors, Management and Principal Shareholders(1)
The following table sets forth the number of shares of common stock of the
Company beneficially owned as of February 17, 2004 by (i) each person known by
the Company to own beneficially more than five percent of the Company's common
stock, (ii) each current director of the Company and nominee for a position on
the Board, (iii) the named executive officers, and (iv) all executive officers
and directors of the Company as a group. Except as otherwise indicated below,
each of the directors, executive officers and shareholders owning more than five
percent of the Company's stock has sole voting and investment power with respect
to all shares of stock beneficially owned as set forth opposite his or her name.
Directors & Executive Officers
- -------------------------------------------------------------------------------
Name Position Term Shares Percent
Age(2) Expires Owned Owned
- -------------------------------------------------------------------------------
Malcolm E. Blanchard Director of the Bank and the Company; 2004 27,361 1.12%
69 Chairman, Executive Committee
Katherine M. Boyd Director of the Bank and the Company; 2005 11,283 *
52 Chairman, Trust Committee
Daniel R. Daigneault President, Chief Executive Officer 2006 78,890(3) 3.24%
51 and Director of the Bank and the Company
Dana L. Dow Director of the Bank and the Company 2006 1,795 *
52
Robert B. Gregory Chairman of the Board of Directors of 2006 14,557 *
50 the Bank and the Company
Randy A. Nelson Director of the Bank and the Company 2004 325 *
51
Carl S. Poole, Jr. Director of the Bank and the Company; 2005 91,834 3.77%
58 Chairman, Asset/Liability Committee
Stuart G. Smith Director of the Bank and the Company; 2004 30,163 1.24%
51 Chairman, Directors' Loan Committee
David B. Soule, Jr. Director of the Bank and the Company; 2005 5,889 *
58 Chairman, Audit Committees of the
Bank and the Company
Bruce B. Tindal Director of the Bank and the Company 2005 2,930 *
53
Walter F. Vietze Senior Vice President - Senior n/a 20,714(3) *
62 Operations Officer of the Bank.
F. Stephen Ward Treasurer & Chief Financial Officer n/a 27,542(3) 1.13%
50 of the Company; Senior Vice President
and Chief Financial Officer of the Bank
Charles A. Wootton Clerk of the Company; Senior Vice n/a 5,089(3) *
47 President Banking Services Officer
and Senior Loan Officer of the Bank
- -------------------------------------------------------------------------------
Total Ownership of all Directors and
Executive Officers as a group 332,592 13.66%
- -------------------------------------------------------------------------------
Owners of 5% Daniel P. & Edith I. Thompson 162,804 6.69%
or More 20 Pounds Road, New Harbor, ME 04545
- -------------------------------------------------------------------------------
* Less than one percent of total outstanding shares
Page 93
(1)For purposes of this table, beneficial ownership has been determined in
accordance with the provisions of Rule 13d-3 promulgated under the Securities
Exchange Act of 1934, as amended. In general, a person is deemed to be the
beneficial owner of a security if he/she has or shares the power to vote or to
direct the voting of the security or the power to dispose or direct the
disposition of the security, or if he/she has the right to acquire beneficial
ownership of the security within 60 days. The figure set forth includes
director's qualifying shares owned by each person.
(2)As of December 31, 2003.
(3)Includes exercisable stock options.
Page 94
ITEM 13. Certain Relationships and Related Transactions
The Federal Reserve Act permits the Bank to contract for or purchase
property from any of its Directors only when such purchase is made in the
regular course of business upon terms not less favorable to the Bank than those
offered by others unless the purchase has been authorized by a majority of the
Board of Directors not interested in the transaction. Similarly, the Federal
Reserve Act prohibits loans to Executive Officers of the Bank unless such loans
are on terms not more favorable than those afforded other borrowers and certain
other prescribed conditions have been met.
The Bank has had, and expects to have in the future, banking transactions
in the ordinary course of its business with Directors, Officers and principal
shareholders of the Company and their affiliates. All such transactions have
been made upon substantially the same terms, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with others. In the opinion of management, such loans have not involved more
than the normal risk of collectibility nor have they presented other unfavorable
features. The total amount of loans outstanding at December 31, 2003 to the
Company's Directors, Executive Officers and their associates, which to any one
borrower exceeds $60,000, was $9,048,000, which constituted 2.27% of the Bank's
total loans outstanding at that date.
Page 95
ITEM 14. Principal Accountant Fees and Services
Audit Fees
The aggregate fees billed for professional services rendered by the
principal accountant, Berry, Dunn, McNeil & Parker (BDMP), for the audit of the
Company's annual financial statements and review of financial statements
included in the Company's Form 10-Q for the years ended December 31, 2003 and
2002 were $54,462 and $48,340, respectively.
Audit-Related Fees
The aggregate fees billed for assurance and related services
rendered by BDMP related to the performance of the audit or review of the
Company's financial statements for the years ended December 31, 2003 and 2002
were $1,042 and $1,364, respectively. These services related to audit
requirements under the Sarbanes Oxley Act of 2002 and implementation of internal
control reporting under FDICIA.
Tax Fees
The aggregate fees billed for professional services rendered by BDMP
for tax compliance, tax advice and tax planning for the years ended December 31,
2003 and 2002 were $13,451 and $14,858, respectively. The nature of the services
comprising the fees disclosed under this category are preparation of federal and
state tax returns, review of estimated tax payments, review of compliance with
information reporting requirements and tax planning.
All Other Fees
The aggregate fees billed for services provided by BDMP, other
than the services reported in the paragraphs above, for the years ended December
31, 2003 and 2002 were $32,710 and $29,055, respectively. The nature of the
services comprising the fees disclosed under this category are administration
and recordkeeping for an employee benefit plan and an employee benefit plan
audit.
In its audit charter, the Audit Committee sets forth its responsibility to
pre-approve any audit or non-audit services to be performed by the independent
auditors. The Audit Committee may, in its discretion, delegate to one or more of
its members the authority to pre approve any audit or non-audit services to be
performed by the independent auditors, provided that any such approvals are
presented to the Audit Committee at its next scheduled meeting.
None of the services described in each of the paragraphs above were provided
under the de minimis exception set forth in Rule 2-01 (c)(7)(i)(C).
Page 96
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Exhibits
Exhibit 3 Articles of Incorporation and Bylaws, filed as Exhibit 3 to
Company's Registration Statement No. 2-96573.
Exhibit 3.1 Articles of Amendment, filed as part of Exhibit 3 to the
Company's Registration Statement No. 2-96573.
Exhibit 3.2 Amendments to Articles of Incorporation filed as part of Exhibit 3
to the Company's quarterly filing on Form 10-Q for the second quarter of 1996.
Exhibit 4.1 Articles of Incorporation and Bylaws, filed as Exhibit 3 to the
Company's Registration Statement No. 2-96573.
Exhibit 14.1 Code of Ethics for Senior Financial Officers Under Section 406
of the Sarbanes Oxley Act of 2002
Exhibit 31.1 Certification of Chief Executive Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002 Regarding the Annual Report on Form 10-K for the Year
Ended December 31, 2003
Exhibit 31.2 Certification of Chief Financial Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002 Regarding the Annual Report on Form 10-K for the Year
Ended December 31, 2003
Exhibit 32.1 Certification of Chief Executive Officer Under Section 906 of The
Sarbanes-Oxley Act of 2002 Regarding the Annual Report on Form 10-K for the Year
Ended December 31, 2003
Exhibit 32.2 Certification of Chief Financial Officer Under Section 906 of The
Sarbanes-Oxley Act of 2002 Regarding the Annual Report on Form 10-K for the Year
Ended December 31, 2003
(b) Reports on Form 8-K Filed During the Fourth Quarter of 2003
The Company's press release announcing its third quarter earnings was filed on
Form 8-K under item 5 on October 15, 2003.
The Company's press release announcing the retirement of Bruce A. Bartlett as a
Director of the Company was filed under Item 5 on October 23, 2003.
The Company's press release announcing the fourth quarter 2003 dividend
declaration was filed on Form 8-K under item 5 on December 18, 2003.
Page 97
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
FIRST NATIONAL LINCOLN COPORATION
By /s/Daniel R. Daigneault
Daniel R. Daigneault, President
March 11, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title and Date
/s/Daniel R. Daigneault President and Director
Daniel R. Daigneault (Principal Executive Officer)
March 11, 2004
/s/F Stephen Ward Treasurer and Chief Financial Officer
F. Stephen Ward (Principal Financial Officer,
Principal Accounting Officer)
March 11, 2004
/s/Robert B. Gregory Director and Chairman of the Board
Robert B. Gregory March 11, 2004
/s/Malcolm E. Blanchard Director
Malcolm E. Blanchard March 11, 2004
/s/Katherine M. Boyd Director
Katherine M. Boyd March 11, 2004
/s/Dana L. Dow Director
Dana L. Dow March 11, 2004
/s/Randy A. Nelson Director
Randy A. Nelson March 11, 2004
/s/Carl S. Poole, Jr. Director
Carl S. Poole, Jr. March 11, 2004
/s/Stuart G. Smith Director
Stuart G. Smith March 11, 2004
/s/David B. Soule, Jr. Director
David B. Soule, Jr. March 11, 2004
/s/Bruce A. Tindal Director
Bruce A. Tindal March 11, 2004
Page 98