UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: Commission File No.
September 30, 2004 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
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 whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [X] No[ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at November 5, 2004
Common Stock, Par One Cent 7,354,527
FIRST NATIONAL LINCOLN CORPORATION
INDEX
PART 1 Financial Information
Page No.
Selected Financial Data ........................................ 1
Item 1: Financial Statements (Unaudited)
Independent Accountants' Review Report ......................... 2
Financial Statements
Consolidated Balance Sheets -
September 30, 2004, September 30, 2003 and December 31, 2003 . 3 - 4
Consolidated Statements of Income - for the nine months
ended September 30, 2004 and September 30, 2003 .............. 5
Consolidated Statements of Income - for the three months
ended September 30, 2004 and September 30, 2003 ............... 6
Consolidated Statements of Changes in Shareholders' Equity -
for the nine months ended September 30, 2004 and September 30, 2003 7 - 8
Consolidated Statements of Cash Flows - for the nine months
ended September 30, 2004 and September 30, 2003 .............. 9 - 10
Notes to Consolidated Financial Statements ..................... 11 - 16
Item 2: Management's discussion and analysis of
financial condition and results of operations .......... 16 - 25
Item 3: Quantitative and qualitative disclosures
about market risk ...................................... 26 - 28
Item 4: Controls and Procedures .................................. 29
PART II Other Information
Item 1: Legal Proceedings ........................................ 30
Item 2: Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities .................. 31
Item 3: Defaults Upon Senior Securities .......................... 32
Item 4: Submission of Matters to a Vote of Security Holders ...... 33
Item 5: Other Information ........................................ 34
Item 6: Exhibits and reports on Form 8-K ......................... 35
Signatures .......................................................... 36
Exhibits .......................................................... 37 - 40
PART I. FINANCIAL INFORMATION
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
SELECTED FINANCIAL DATA (Unaudited)
- -----------------------------------------------------------------------------
For the nine months For the quarters
Dollars in thousands, ended Sept 30, ended Sept 30,
except for per share amounts 2004 2003 2004 2003
- -----------------------------------------------------------------------------
Summary of Operations
Operating Income $25,937 $24,463 $9,175 $8,358
Operating Expense 17,270 16,903 6,079 5,530
Net Interest Income 15,798 12,850 5,612 4,586
Provision for Loan Losses 720 675 240 225
Net Income 6,197 5,420 2,216 2,012
- -----------------------------------------------------------------------------
Per Common Share Data(b)
Basic Earnings per Share $0.85 $0.75 $0.30 $0.28
Diluted Earnings per Share 0.83 0.73 0.30 0.27
Cash Dividends Declared 0.33 0.28 0.12 0.10
Book Value 7.01 6.42 7.01 6.42
Market Value 19.25 14.33 19.25 14.33
- -----------------------------------------------------------------------------
Financial Ratios
Return on Average Equity (a) 16.85% 16.23% 17.78% 17.24%
Return on Average Assets (a) 1.40% 1.40% 1.44% 1.49%
Average Equity to Average Assets 8.29% 8.63% 8.12% 8.64%
Net Interest Margin Tax-Equivalent (a) 3.95% 3.69% 4.06% 3.78%
Dividend Payout Ratio 38.59% 37.50% 38.33% 34.94%
Allowance for Loan
Losses to Total Loans 1.02% 1.09% 1.02% 1.09%
Non-Performing Loans
to Total Loans 0.37% 0.32% 0.37% 0.32%
Non-Performing Assets
to Total Assets 0.28% 0.23% 0.28% 0.23%
Efficiency Ratio (c) 49.07% 48.66% 49.18% 47.95%
- -----------------------------------------------------------------------------
At Period End
Total Assets 630,202 551,818 630,202 551,818
Total Loans 461,504 383,032 461,504 383,032
Total Investment Securities 137,210 139,196 137,210 139,196
Total Deposits 401,479 370,952 401,479 370,952
Total Shareholders' Equity 51,532 46,733 51,532 46,733
- -----------------------------------------------------------------------------
(a) Annualized using a 366-day basis in 2004 and a 365-day basis in 2003
(b) Adjusted for a three-for-one stock split, in the form of a 200% stock
dividend, payable June 1, 2004, to shareholders of record on May 12, 2004.
(c) The Company uses the following formula in calculating its efficiency ratio:
Non-Interest Expense - Loss on Securities Sales
- ------------------------------------------------------------------------------
Tax-Equivalent Net Interest Income + Non-Interest Income - Gains on Securities
- ------------------------------------------------------------------------------
Page 1
ITEM 1. FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Shareholders
First National Lincoln Corporation
We have reviewed the accompanying interim consolidated financial information of
First National Lincoln Corporation and Subsidiary as of September 30, 2004 and
2003, and for the three-month and nine-month periods then ended. These
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit in accordance with
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is to express an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying financial statements for them to be in
conformity with accounting principles generally accepted in the United States
of America.
Berry, Dunn, McNeil & Parker
Portland, Maine
November 5, 2004
Page 2
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Unaudited)
- ------------------------------------------------------------------------------
(000 OMITTED except per share data Sept 30, Sept 30, December 31,
and number of shares) 2004 2003 2003
- ------------------------------------------------------------------------------
Assets
Cash and due from banks $ 16,659 $ 13,758 $ 17,087
Overnight funds sold - - -
------- ------- -------
Cash and cash equivalents 16,659 13,758 17,087
------- ------- -------
Investments:
Available for sale at market value 52,900 62,815 57,445
Held to maturity at cost
(market values $85,316 at 9/30/04,
$78,174 at 9/30/03 and
$80,820 at 12/31/03) 84,310 76,381 79,244
Loans held for sale
(fair value approximates cost) - 1,884 982
Loans 461,504 383,032 398,895
Less: allowance for loan losses 4,727 4,177 4,200
------- ------- -------
Net loans 456,777 378,855 394,695
------- ------- -------
Accrued interest receivable 3,026 2,814 2,743
Premises and equipment at cost,
net of accumulated depreciation 9,149 7,466 9,007
Other real estate owned - 51 51
Other assets 7,381 7,794 7,558
------- ------- -------
Total Assets $ 630,202 $ 551,818 $ 568,812
======= ======= =======
Page 3
CONSOLIDATED BALANCE SHEETS CONTINUED
- -------------------------------------------------------------------------------
Sept 30, Sept 30, December 31,
2004 2003 2003
- -------------------------------------------------------------------------------
Liabilities
Demand deposits $ 33,734 $ 33,425 $ 28,874
NOW deposits 60,088 55,593 52,161
Money market deposits 85,651 86,366 80,586
Savings deposits 67,182 65,093 63,356
Certificates of deposit 75,423 69,522 69,880
Certificates $100,000 and over 79,401 60,953 64,220
------- ------- -------
Total deposits 401,479 370,952 359,077
------- ------- -------
Borrowed funds 172,442 129,583 157,822
Other liabilities 4,749 4,550 4,195
------- ------- -------
Total Liabilities 578,670 505,085 521,094
------- ------- -------
Shareholders' Equity
Common stock 74 74 74
Additional paid-in capital 3,851 4,638 4,650
Retained earnings 45,378 41,707 42,988
Net unrealized gain on
securities available for sale 2,229 2,558 2,497
Treasury stock - (2,244) (2,491)
------- ------- -------
Total Shareholders' Equity 51,532 46,733 47,718
------- ------- -------
Total Liabilities
& Shareholders' Equity $ 630,202 $ 551,818 $ 568,812
======= ======= =======
- -------------------------------------------------------------------------------
Number of shares authorized 18,000,000 18,000,000 18,000,000
Number of shares issued 7,350,040 7,443,810 7,443,810
Number of shares outstanding 7,350,040 7,279,725 7,264,140
Book value per share $7.01 $6.42 $6.57
- -------------------------------------------------------------------------------
Share and per share data have been adjusted to reflect the three-for-one stock
split, in the form of a 200% stock dividend, payable June 1, 2004, to
shareholders of record on May 12, 2004.
- -------------------------------------------------------------------------------
See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.
Page 4
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
- ------------------------------------------------------------------------------
(000 OMITTED except per share data For the nine months ended Sept 30,
and number of shares) 2004 2003
- ------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $ 17,470 $ 15,949
Interest on deposits with other banks 4 52
Interest and dividends on investments 4,940 4,486
-------- --------
Total interest and dividend income 22,414 20,487
-------- --------
Interest expense
Interest on deposits 3,868 4,600
Interest on borrowed funds 2,748 3,037
-------- --------
Total interest expense 6,616 7,637
-------- --------
Net interest income 15,798 12,850
Provision for loan losses 720 675
-------- --------
Net interest income after provision for loan losses 15,078 12,175
-------- --------
Non-interest income:
Fiduciary income 644 577
Service charges on deposit accounts 881 833
Mortgage origination and servicing income 310 794
Other operating income 1,688 1,772
-------- --------
Total non-interest income 3,523 3,976
-------- --------
Non-interest expense:
Salaries and employee benefits 5,138 4,377
Occupancy expense 655 569
Furniture and equipment expense 1,094 1,039
Other 3,047 2,606
-------- --------
Total non-interest expense 9,934 8,591
-------- --------
Income before income taxes 8,667 7,560
Applicable income taxes 2,470 2,140
-------- --------
NET INCOME $ 6,197 $ 5,420
======== ========
- -----------------------------------------------------------------------------
Earnings per common share
Basic earnings per share $0.85 $0.75
Diluted earnings per share $0.83 $0.73
Cash dividends declared per share $0.328 $0.280
Weighted average number of shares outstanding 7,322,255 7,264,782
Incremental shares 149,414 190,494
Share and per share data have been adjusted to reflect the three-for-one stock
split, in the form of a 200% stock dividend, payable June 1, 2004, to
shareholders of record on May 12, 2004.
- -----------------------------------------------------------------------------
See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.
Page 5
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
- ------------------------------------------------------------------------------
(000 OMITTED except per share data For the quarters ended September 30,
and number of shares) 2004 2003
- ------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $ 6,172 $ 5,358
Interest on deposits with other banks 1 4
Interest and dividends on investments 1,702 1,453
-------- --------
Total interest and dividend income 7,875 6,815
-------- --------
Interest expense
Interest on deposits 1,342 1,318
Interest on borrowed funds 921 911
-------- --------
Total interest expense 2,263 2,229
-------- --------
Net interest income 5,612 4,586
Provision for loan losses 240 225
-------- --------
Net interest income after provision for loan losses 5,372 4,361
-------- --------
Non-interest income:
Fiduciary income 214 203
Service charges on deposit accounts 301 268
Mortgage origination and servicing income 59 304
Other operating income 726 768
-------- --------
Total non-interest income 1,300 1,543
-------- --------
Non-interest expense:
Salaries and employee benefits 1,835 1,546
Occupancy expense 227 176
Furniture and equipment expense 340 338
Other 1,174 1,016
-------- --------
Total non-interest expense 3,576 3,076
-------- --------
Income before income taxes 3,096 2,828
Applicable income taxes 880 816
-------- --------
NET INCOME $ 2,216 $ 2,012
======== ========
- -----------------------------------------------------------------------------
Earnings per common share
Basic earnings per share $0.30 $0.28
Diluted earnings per share $0.30 $0.27
Cash dividends declared per share $0.115 $0.097
Weighted average number of shares outstanding 7,347,208 7,274,082
Incremental shares 152,290 200,262
Share and per share data have been adjusted to reflect the three-for-one stock
split, in the form of a 200% stock dividend, payable June 1, 2004, to
shareholders of record on May 12, 2004.
- -----------------------------------------------------------------------------
See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.
Page 6
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
<table>
<caption>
- ----------------------------------------------------------------------------------------------
For the nine months ended September 30, 2004
- ----------------------------------------------------------------------------------------------
(000 omitted except for share data) Net
unrealized
gain 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,
2003 7,264,140 $74 $4,650 $42,988 $2,497 $(2,491) $47,718
--------- --- ------ ------- ----- ------- -------
Net income - - - 6,197 - - 6,197
Net unrealized
(loss) on
securities
available for
sale, net of
tax benefit
of $138 - - - - (268) - (268)
--------- --- ------ ------ ------ ------- -------
Comprehensive
income - - - 6,197 (268) - 5,929
Cash dividends
declared - - - (2,411) - - (2,411)
Treasury stock
purchases (24,394) - - - - (404) (404)
Treasury stock
sales 110,294 - (747) - - 1,447 700
Retirement of
treasury
stock - - (52) (1,396) - 1,448 -
--------- --- ------ ------- ------ ------- --------
Balance
at September 30,
2004 7,350,040 $74 $3,851 $45,378 $2,229 $ - $51,532
========= === ====== ======= ====== ======= =======
- ----------------------------------------------------------------------------------------------
Share and per share data have been adjusted to reflect the three-for-one stock split, in the form
of a 200% stock dividend, payable June 1, 2004, to shareholders of record on May 12, 2004.
See Independent Accountants' Review Report. The accompanying notes are an integral part of these
consolidated financial statements.
Page 7
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, CONTINUED
- ---------------------------------------------------------------------------------------------
For the nine months ended September 30, 2003
- ----------------------------------------------------------------------------------------------
(000 omitted except for share data) Net
unrealized
gain 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 7,244,079 $74 $4,638 $38,322 $2,170 $(2,509) $42,695
--------- --- ------ ------- ----- ------- -------
Net income - - - 5,420 - - 5,420
Net unrealized
gain on
securities
available for
sale, net of
taxes of
$200 - - - - 388 - 388
--------- --- ------ ------ ------ ------- -------
Comprehensive
income - - - 5,420 388 - 5,808
Cash dividends
declared - - - (2,035) - - (2,035)
Treasury stock
purchases (17,778) - - - - (209) (209)
Treasury stock
sales 53,427 - - - - 474 474
--------- --- ------ ------- ------ ------- --------
Balance
at September 30,
2003 7,279,728 $74 $4,638 $41,707 $2,558 $(2,244) $46,733
========= === ====== ======= ====== ======= =======
- ----------------------------------------------------------------------------------------------
Share and per share data have been adjusted to reflect the three-for-one stock split, in the form
of a 200% stock dividend, payable June 1, 2004, to shareholders of record on May 12, 2004.
See Independent Accountants' Review Report. The accompanying notes are an integral part of these
consolidated financial statements.
</table>
Page 8
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
- -------------------------------------------------------------------------------
For the nine months ended September 30,
(000 omitted) 2004 2003
- -------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 6,197 $ 5,420
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 773 737
Provision for loan losses 720 675
Loans originated for resale (10,774) (50,569)
Proceeds from sales and transfers of loans 11,756 51,298
Net (gain) loss on sale of other real estate owned 4 (24)
Net (increase) decrease in other assets
and accrued interest (267) 428
Net increase in other liabilities 692 490
Net amortization of premiums on investments 90 361
------ ------
Net cash provided by operating activities 9,191 8,816
------ ------
Cash flows from investing activities
Proceeds from maturities, payments and calls of
securities available for sale 4,934 9,430
Proceeds from maturities, payments and calls of
securities to be held to maturity 35,951 24,555
Proceeds from sales of other real estate owned 47 228
Purchases of securities available for sale (824) (15,311)
Purchases of securities to be held to maturity (41,078) (35,570)
Net increase in loans (62,802) (51,156)
Capital expenditures (874) (1,992)
------ ------
Net cash used in investing activities (64,646) (69,816)
------ ------
Cash flows from financing activities
Net increase in demand deposits, savings,
money market and club accounts 21,678 27,678
Net increase in
certificates of deposit 20,724 9,050
Advances on long-term borrowings 8,216 25,000
Repayment on long-term borrowings (25,331) (28,000)
Net increase in short-term borrowings 31,735 19,218
Payment to repurchase common stock (404) (209)
Proceeds from sale of common stock 700 474
Dividends paid (2,291) (1,959)
------ ------
Net cash provided by financing activities 55,027 51,252
------ ------
Page 9
CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED
- -------------------------------------------------------------------------------
For the nine months ended September 30,
2004 2003
- -------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (428) (9,748)
Cash and cash equivalents at beginning of period 17,087 23,506
------ ------
Cash and cash equivalents at end of period $16,659 $13,758
====== ======
- -------------------------------------------------------------------------------
Interest paid $ 6,622 $ 8,019
Income taxes paid 2,532 1,874
Non-cash transactions
Change in net unrealized gain on
available for sale securities (406) 588
- -------------------------------------------------------------------------------
See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.
Page 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
First National Lincoln Corporation (the Company) is a financial holding company
that owns all of the common stock of The First National Bank of Damariscotta
(the Bank). The accompanying unaudited consolidated financial statements have
been prepared in accordance with U.S. generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of Management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. All significant intercompany
transactions and balances are eliminated in consolidation. The income reported
for the 2004 period is not necessarily indicative of the results that may be
expected for the year ending December 31, 2004. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 2003.
NOTE 2 - COMMON STOCK
On April 27, 2004, the Company's Board of Directors declared a three-for-one
split of the Company's common stock payable in the form of a 200% stock
dividend to shareholders of record on May 12, 2004, with a payment date of June
1, 2004. All share and per share data included in the consolidated financial
statements and elsewhere in this report have been restated to reflect the stock
split.
A summary of the status of the Company's Stock Option Plan as of September
30, 2004, and changes during the nine months then ended, is presented below.
- -------------------------------------------------------------------------------
Number of Weighted Average
Shares Exercise Price
- -------------------------------------------------------------------------------
Balance at December 31, 2003 294,600 $4.41
Granted during the period - -
Exercised during the period (86,100) 3.41
Forfeited during the period (3,000) 6.17
------- ------
Balance at September 30, 2004 205,500 $4.81
======= ======
- -------------------------------------------------------------------------------
Page 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 3 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share for the nine months ended September 30, 2004 and 2003:
- -----------------------------------------------------------------------------
For the nine months ended September 30, 2004
- -----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- -----------------------------------------------------------------------------
Net income as reported $ 6,197
-------
Basic EPS: Income available
to common shareholders $ 6,197 7,322,255 $ 0.85
Effect of dilutive securities:
incentive stock options 149,414
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 6,197 7,471,669 $ 0.83
======= ========= ======
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
For the nine months ended September 30, 2003
- -----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- -----------------------------------------------------------------------------
Net income as reported $ 5,420
-------
Basic EPS: Income available
to common shareholders $ 5,420 7,264,782 $ 0.75
Effect of dilutive securities:
incentive stock options 190,494
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 5,420 7,455,276 $ 0.73
======= ========= ======
- -----------------------------------------------------------------------------
All earnings per share calculations have been made using the weighted
average number of shares outstanding during the period. 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 the end
of each period.
Page 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table sets forth the computation of basic and diluted earnings
per share for the three months ended September 30, 2004 and 2003:
- -----------------------------------------------------------------------------
For the three months ended September 30, 2004
- -----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- -----------------------------------------------------------------------------
Net income as reported $ 2,216
-------
Basic EPS: Income available
to common shareholders $ 2,216 7,347,208 $ 0.30
Effect of dilutive securities:
incentive stock options 152,290
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 2,216 7,499,498 $ 0.30
======= ========= ======
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
For the three months ended September 30, 2003
- -----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- -----------------------------------------------------------------------------
Net income as reported $ 2,012
-------
Basic EPS: Income available
to common shareholders $ 2,012 7,274,082 $ 0.28
Effect of dilutive securities:
incentive stock options 200,262
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 2,012 7,474,344 $ 0.27
======= ========= ======
- -----------------------------------------------------------------------------
All earnings per share calculations have been made using the weighted
average number of shares outstanding during the period. 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 the end
of each period.
NOTE 4 -- TREASURY STOCK
A revision to the Maine Business Corporation Act requires that stock reacquired
by a corporation be classified as "authorized but unissued", effectively
eliminating a corporation's ability to hold treasury stock.
In order to recognize the effect of the revision, the Company retired its
treasury stock as of June 30, 2004. The 101,120 shares so retired are available
for reissuance as authorized, but unissued shares.
Page 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 5 - POSTRETIREMENT BENEFIT PLANS
The Bank sponsors two postretirement 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 postretirement benefit obligation as of
January 1, 1993 of $578,000 as a component of net periodic postretirement
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. The following tables set forth the net periodic pension cost:
- -------------------------------------------------------------------------------
For the nine months For the three months
ended Sept 30, ended Sept 30,
In thousands of dollars 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Components of net periodic benefit cost
Service cost $ 4 $ 4 $ 2 $ 1
Interest cost 26 25 8 9
Amortization of unrecognized
transition obligation 22 22 7 7
Amortization of prior service cost 2 (2) 1 (1)
Amortization of accumulated gains 3 2 1 1
--- --- --- ---
Net periodic benefit cost $57 $51 $19 $17
=== === === ===
- -------------------------------------------------------------------------------
A weighted average discount rate of 7.0% was used in determining both the
accumulated benefit obligation and the net benefit cost. The measurement
date for benefit obligations was as of year-end for both years presented. The
estimated amount of related benefit expense in 2004 is $76,000.
Page 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 6 - MATERIAL TRANSACTION
On August 25, 2004, the Company (FNLC) entered into a merger agreement with FNB
Bankshares of Bar Harbor, Maine (FNB). It is expected FNB's bank subsidiary,
The First National Bank of Bar Harbor, will be merged with The First National
Bank of Damariscotta, the bank subsidiary of FNLC, to create a single bank
subsidiary of the combined company. The resulting bank subsidiary will have 14
banking offices and three investment management offices serving coastal Maine
communities from Brunswick to Calais. As a result of the merger, the combined
company will have assets of approximately $870 million, with combined loans of
approximately $645 million and combined deposits of approximately $610 million,
based upon September 30, 2004 balances. In addition, the combined bank will
have nearly $275 million of investments under management.
In the proposed merger, FNB will merge into FNLC and FNLC will issue
shares of its common stock to the shareholders of FNB in exchange for their
shares in FNB. Each outstanding share of FNB is expected to be converted into
FNLC stock valued at $42.00. The actual exchange ratio, and hence the number of
FNLC shares into which FNB stock will be converted, will vary depending on the
per share market price of FNLC common stock prior to closing, but FNB
shareholders will receive not less than 1.91, nor more than 2.47, shares of
FNLC for each share of FNB they hold.
The merger will require regulatory approval and the satisfaction of other
customary conditions, as well as the approval of the shareholders of both
companies. It is expected to close in the first quarter of 2005.
Page 15
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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. 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 in
making judgments about the carrying values of assets that are not readily
apparent from other sources. Actual results could differ from the amount
derived from Management's estimates and assumptions under different assumptions
or conditions.
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 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 16
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
EXECUTIVE SUMMARY
Net income for the nine months ended September 30, 2004 was $6,197,000, an
increase of 14.3% over net income of $5,420,000 in the comparable period of
2003. The Company's increase in net income for the first nine months of 2004 in
comparison to 2003 was the result of a 22.9% increase in net interest income
due to wider margins and growth in earning assets. In addition to a decline in
non-interest income due to decreased mortgage origination activity, the Company
saw a controlled level of increase in operating expenses in line with growth in
revenues. Fully diluted earnings per share for the first nine months of 2004
were $0.83, a 13.7% increase over the $0.73 reported for the first nine months
of 2003.
Net income for the three months ended September 30, 2004 was $2,216,000,
an increase of 10.1% over net income of $2,012,000 in the comparable period of
2003. The Company's increase in net income for the three months ended September
30, 2004 in comparison to 2003 was the result of a 22.4% increase in net
interest income due to wider margins and growth in earning assets. In addition
to a decline in non-interest income due to decreased mortgage origination
activity, the Company saw a controlled level of increase in operating expenses
in line with growth in revenues. Fully diluted earnings per share for the three
months ended September 30, 2004 were $0.30, a 11.1% increase over the $0.27
reported for the third quarter of 2003.
NET INTEREST INCOME
Total interest income of $22,414,000 for the nine months ended September 30,
2004 is a 9.4% increase from total interest income of $20,487,000 in the
comparable period of 2003. While the low interest rate climate resulted in
lower asset yields in 2004 compared to 2003, these were more than offset by
increased interest income from strong growth in the level of earning assets and
lower liability costs. Total interest expense of $6,616,000 for the first nine
months of 2004 is a 13.4% decrease from total interest expense of $7,637,000
for the first nine months of 2003. This was a direct result of the low interest
rate climate.
The combination of lower interest rates and asset growth resulted in net
interest income of $15,798,000 for the nine months ended September 30, 2004, a
22.9% increase from the $12,850,000 reported for the same period in 2003.
The Company's net interest margin on a tax-equivalent basis increased from
3.69% in the first nine months of 2003 to 3.95% in the first nine months of
2004. Tax-exempt interest income amounted to $1,580,000 and $1,395,000 for the
nine months ended September 30, 2004 and 2003, respectively. Tax equivalency is
calculated using a 35% effective tax rate. These results are consistent with
the widening which occurred in the Company's net interest margin beginning in
the third quarter of 2003 after repricing a significant amount of liabilities
in the second and third quarters of 2003.
Total interest income of $7,875,000 for the three months ended September
30, 2004 is a 15.6% increase from total interest income of $6,815,000 in the
comparable period of 2003. While the low interest rate climate resulted in
lower asset yields in 2004 than in 2003, this was more than offset by increased
interest income from strong gowth in the level of earning assets and lower
liability costs. At the same time, total interest expense of $2,263,000 for the
three months ended September 30, 2004 is a 1.5% increase from total interest
expense of $2,229,000 for the third quarter of 2003. This was the result of
increased funding costs due to higher liability volumes to fund the increased
level of earning assets.
Page 17
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
The combination of a wider net interest margin and asset growth resulted in
net interest income of $5,612,000 for the three months ended September 30,
2004, a 22.4% increase from the $4,586,000 reported for the same period in
2003.
The Company's net interest margin on a tax-equivalent basis increased from
3.78% in the three months ended September 30, 2003 to 4.06% for the three
months ended September 30, 2004. Tax-exempt interest income amounted to
$575,000 and $486,000 for the three months ended September 30, 2004 and 2003,
respectively. Tax equivalency is calculated using a 35% effective tax rate.
These results are consistent with the widening which occurred in the Company's
net interest margin beginning in the third quarter of 2003 after repricing a
significant amount of liabilities in the second and third quarters of 2003.
The following tables present changes in interest income and expense
attributable to changes in interest rates, volume, and rate/volume (1) 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 and 2002.
- -------------------------------------------------------------------------------
Nine months ended September 30, 2004 compared to 2003
Dollars in thousands Volume Rate Rate/volume (1) Total
- -------------------------------------------------------------------------------
Interest on earning assets
Interest-bearing deposits $ (48) $ (8) $ 8 $ (48)
Investment securities 435 102 9 546
Loans held for sale (82) 20 (19) (80)
Loans 3,079 (1,233) (238) 1,608
- -------------------------------------------------------------------------------
Total interest income 3,384 (1,119) (240) 2,026
- -------------------------------------------------------------------------------
Interest expense
Deposits 525 (1,128) (129) (732)
Other borrowings (2) 775 (848) (216) (289)
- -------------------------------------------------------------------------------
Total interest expense 1,300 (1,976) (345) (1,021)
- -------------------------------------------------------------------------------
Change in net interest income $ 2,084 $ 857 $ 105 $ 3,047
===============================================================================
(1) Represents the change attributable to a combination of change in rate
and change in volume.
(2) Includes federal funds purchased.
The following table presents the effect of tax-exempt income on the
calculation of the net interest margin:
- ------------------------------------------------------------------------------
For the nine months For the three months
ended September 30, ended September 30,
(in thousands) 2004 2003 2004 2003
- ------------------------------------------------------------------------------
Net interest income as presented $15,798 $12,850 $ 5,612 $ 4,586
Effect of tax-exempt income 850 751 308 262
------ ------ ------ ------
Net interest income, tax equivalent $16,648 $13,601 $ 5,920 $ 4,848
====== ====== ====== ======
- ------------------------------------------------------------------------------
Page 18
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
PROVISION FOR LOAN LOSSES
A $720,000 provision to the allowance for loan losses was made during the first
nine months of 2004, a $45,000 increase from the $675,000 provision made for
the same period of 2003. The slightly higher level of provision in 2004
compared to 2003 is in line with the Company's loan growth and is not
indicative of a decline in overall asset quality.
NON-INTEREST INCOME
Non-interest income was $3,523,000 for the nine months ended September 30,
2004, a decrease of 11.4% from the $3,976,000 reported for the first nine
months of 2003. The decrease in non-interest income was due primarily to a
decline in income related to mortgage sales. While demand for residential
mortgages remained strong in the first nine months of 2004, much of new
mortgage production was in variable-rate loans and the Bank opted to retain a
significant amount in its portfolio given the opportunity to increase earning
assets without taking on substantial interest rate risk.
Non-interest income was $1,300,000 for the three months ended September 30,
2004, a decrease of 15.7% from the $1,543,000 reported for the same period in
2003. The decrease in non-interest income was due primarily to a decline in
income related to mortgage sales.
NON-INTEREST EXPENSE
Non-interest expense of $9,934,000 for the nine months ended September 30,
2004, is an increase of 15.6% over non-interest expense of $8,591,000 for the
first nine months of 2003. This increase is primarily due to higher personnel
and premises costs to provide more comprehensive and competitive services for
customers, as well as increased costs for marketing, supplies and professional
fees, in line with the Company's revenue and asset growth.
Non-interest expense of $3,576,000 for the three months ended September
30, 2004, is an increase of 16.3% over non-interest expense of $3,076,000 for
the same period in 2003. This level of increase in non-interest expense for the
quarter was for the same reasons cited above.
INCOME TAXES
Income taxes on operating earnings increased to $2,470,000 for the first nine
months of 2004 from $2,140,000 for the same period a year ago. The increase is
in line with the increase in pre-tax income.
Page 19
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
AVERAGE DAILY BALANCE SHEET
The following table shows the Company's average daily balance sheets for the
nine-month periods ended September 30, 2004 and 2003
- --------------------------------------------------------------------------
Nine-Month Periods ended September 30,
Dollars in thousands 2004 2003
- --------------------------------------------------------------------------
Cash and due from banks $ 12,140 $ 10,222
Overnight funds sold 599 7,224
Investments
U.S. Treasury securities & government agencies 60,781 49,415
Obligations of states & political subdivisions 34,288 28,361
Other securities 42,043 48,580
--------- ---------
Total investments 137,112 126,356
--------- ---------
Loans held for sale - 1,957
--------- ---------
Loans
Commercial 146,206 131,136
Consumer 26,042 26,572
State and municipal 10,767 12,258
Real estate 242,984 187,226
--------- ---------
Total loans 425,999 357,192
Allowance for loan losses (4,417) (3,889)
--------- ---------
Net loans 421,582 353,303
--------- ---------
Bank premises and equipment, net 8,950 7,755
Other assets 10,541 10,439
--------- ---------
Total assets $590,924 $ 517,256
========= =========
Deposits
Demand $ 28,277 $ 26,469
NOW 54,932 50,086
Money market 81,107 87,194
Savings 64,412 61,816
Certificates of deposit 76,279 70,083
Certificates of deposit over $100,000 83,331 54,003
--------- ---------
Total deposits 388,338 349,651
--------- ---------
Borrowed funds 148,718 118,480
Other liabilities 4,868 4,470
--------- ---------
Total liabilities 541,924 472,601
--------- ---------
Common stock 74 74
Additional paid-in capital 4,122 4,638
Retained earnings 43,762 39,877
Net unrealized gain on
securities available for sale 2,414 2,476
Treasury stock (1,372) (2,410)
--------- ---------
Total shareholders' equity 49,000 44,655
--------- ---------
Total liabilities and shareholders' equity $590,924 $ 517,256
========= =========
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
INVESTMENTS
The Company's investment portfolio increased by $0.5 million or 0.4% between
December 31, 2003, and September 30, 2004. At September 30, 2004, the Company's
available-for-sale portfolio had an unrealized gain, net of taxes, of $2.2
million, which is in line with the interest rate climate.
Between September 30, 2003 and September 30, 2004, the Company's
investment portfolio decreased by $2.0 million or 1.4%. This was the result of
Management's decision to favor assets in the loan portfolio instead of the
investment portfolio based upon the interest rate climate.
LOANS
Loans grew by $62.6 million or 15.7% during the first nine months of 2004. The
growth in commercial loans was $13.6 million or 9.9% and municipal loans
increased $8.3 million or 92.1%. The residential mortgage portfolio increased
by $30.1 million or 17.3%, and home equity lines of credit grew $10.4 million
or 19.9% year-to-date.
Between September 30, 2003 and September 30, 2004, the loan portfolio
increased $77.9 million or 20.6%, as a result of strong customer demand.
ALLOWANCE FOR LOAN LOSSES
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 and 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.
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 (loans on
non-accrual status, as well as loans with a credit risk rating of "8"), 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
Page 21
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
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 the 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 allowance for loan losses based
upon an analysis of risk characteristics, demonstrated losses, loan
segmentations, and other factors. Allowance methodology is reviewed on a
periodic basis and modified as appropriate. 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 specifically identified.
Based on this analysis, including the aforementioned assumptions, the
Company believes that the allowance for loan losses is adequate as of September
30, 2004. As of that date, the balance of $4,727,000 was 1.02% of total loans,
compared to 1.05% at December 31, 2003 and 1.09% at September 30, 2003. Loans
considered to be impaired according to SFAS 114/118 totalled $1,728,000 at
September 30, 2004, compared to $1,537,000 at December 31, 2003. The portion of
the allowance for loan losses allocated to impaired loans at September 30,
2004, was $198,000 compared to $204,000 at December 31, 2003.
DEPOSITS
During the first nine months of 2004, deposits increased by $42.4 million or
11.8% over December 31, 2003. Core deposits (demand, NOW, savings and money
market accounts) increased by $21.7 million or 9.6% in the first nine months of
2004. During the same period, certificates of deposit increased $20.7 million,
primarily due to pricing strategies which resulted in attracting low-cost
short-term time deposits, primarily from wholesale and brokered CD's.
Between September 30, 2003, and September 30, 2004, deposits grew by 8.2%,
or $30.5 million. Demand deposits grew $0.3 million, NOW accounts $4.5 million,
savings $2.1 million, and money market accounts decreased $0.7 million, while
certificates of deposit increased $24.3 million. The increase in certificates
of deposit was primarily from wholesale and brokered CD's.
BORROWED FUNDS
The Company's funding includes borrowings from the Federal Home Loan Bank, the
Federal Reserve System, and repurchase agreements, enabling it to grow its
balance sheet and, in turn, grow its revenues. They may also be used to carry
out interest rate risk management stategies, and are increased to replace or
supplement other sources of funding, including core deposits and certificates
of deposit. During the nine months ended September 30, 2004, borrowed funds
increased by $14.6 million or 9.3% from December 31, 2003.
Between September 30, 2003 and September 30, 2004, borrowed funds
increased $42.9 million or 33.1% to fund the level of asset growth which
exceeded the level of deposit growth.
SHAREHOLDERS' EQUITY
Shareholders' equity as of September 30, 2004 was $51.5 million, compared
to $47.7 million as of December 31, 2003. The Company's strong earnings
performance in the first nine months of 2004 provided a significant addition to
retained earnings. The net unrealized gain on available-for-sale securities,
presented in accordance with SFAS 115, has decreased by $0.3 million since
December 31, 2003, as a result of a recent rise in interest rates.
Page 22
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
On April 27, 2004, the Company's Board of Directors declared a three-for-
one split of the Company's common stock payable in the form of a 200% stock
dividend to shareholders of record on May 12, 2004, with a payment date of June
1, 2004. All share and per share data included in the consolidated financial
statements and elsewhere in this report have been restated to reflect the stock
split.
During 2003, the Company increased its dividend each quarter to end the
year at a quarterly dividend rate of 10.0 cents per share. In 2004, a cash
dividend of 10.3 cents per share was declared in the first quarter compared to
9.0 cents in the first quarter of 2003, a cash dividend of 11.0 cents per share
was declared in the second quarter of 2004 compared to 9.3 cents in the second
quarter of 2003, and a cash dividend of 11.5 cents per share was declared in
the third quarter of 2004 compared to 9.7 cents in the third quarter of 2003.
Regulatory leverage capital ratios for the Company were 8.25% and 8.22% at
September 30, 2004 and December 31, 2003, respectively. The Company had a tier
one risk-based capital ratio of 11.59% and tier two risk-based capital ratio of
12.70% at September 30, 2004, compared to 11.69% and 12.80%, respectively, at
December 31, 2003. These are comfortably above the standards to be rated "well-
capitalized" by regulatory authorities -- qualifying the Company for lower
deposit-insurance premiums.
On September 23, 2002, the Company announced that its Board of Directors
authorized the repurchase of up to 5.0% of the outstanding shares of the
Company's common stock, or slightly more than 360,000 shares, during a period
of up to 24 months. This repurchase program was suspended on August 25, 2004,
in accordance with the Merger Agreement with FNB Bankshares of Bar Harbor,
Maine, which is discussed in the section titled "Material Transaction." The
Company has no current plans to renew or extend the program once the merger is
completed. As of September 30, 2004, the Company had repurchased 131,778 shares
under the 2002 repurchase plan - including 24,394 shares in the first nine
months of 2004.
A revision to the Maine Business Corporation Act requires that stock
reacquired by a corporation be classified as "authorized but unissued",
effectively eliminating a corporation's ability to hold treasury stock.
In order to recognize the effect of the revision, the Company retired its
treasury stock as of June 30, 2004. The 101,120 shares so retired are
available for reissuance as authorized, but unissued shares.
NON-PERFORMING ASSETS
At September 30, 2004, loans on non-accrual status totaled $1.7 million, which
compares to non-accrual loans of $1.5 million as of December 31, 2003. In
addition to loans on non-accrual status at September 30, 2004, loans past due
90 days or more and accruing (calculated on a constant 30-day month basis)
totaled $148,000, which compares to $378,000 as of December 31, 2003. The
Company continues to accrue interest on these loans because it believes
collection of the interest is reasonably assured.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
No material off-balance sheet risk exists that requires a separate liability
presentation.
Page 23
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
CONTRACTUAL OBLIGATIONS
The following table sets forth the contractual obligations of the Company as of
September 30, 2004:
- -------------------------------------------------------------------------------
Less than 1-3 4-5 More than
Dollars in thousands Total 1 Year Years Years 5 Years
- -------------------------------------------------------------------------------
Borrowed funds $ 172,442 122,727 22,000 - 27,715
Operating leases 213 64 130 19 -
Certificates of deposit 154,824 125,594 26,738 2,492 -
------- ------- ------ ------ ------
Total $ 327,479 248,385 48,868 2,511 27,215
======= ======= ====== ====== ======
Commitments to extend credit
and unused lines of credit $ 87,219 87,219 - - -
- -------------------------------------------------------------------------------
LIQUIDITY MANAGEMENT
As of September 30, 2004 the Bank had primary sources of liquidity of $69.1
million and an additional $105.6 million of secondary sources. It is
Management's opinion that this is adequate. In its Asset/Liability policy, the
Bank has adopted guidelines for liquidity. The Company is not aware of any
recommendations by the regulatory authorities which, if they were to be
implemented, would have a material effect on the Corporation's liquidity,
capital resources or results of operations.
MATERIAL TRANSACTION
On August 25, 2004, the Company (FNLC) entered into a merger agreement with FNB
Bankshares of Bar Harbor, Maine (FNB). It is expected FNB's bank subsidiary,
The First National Bank of Bar Harbor, will be merged with The First National
Bank of Damariscotta, the bank subsidiary of FNLC, to create a single bank
subsidiary of the combined company. The resulting bank subsidiary will have 14
banking offices and three investment management offices serving coastal Maine
communities from Brunswick to Calais. As a result of the merger, the combined
company will have assets of approximately $870 million, with combined loans of
approximately $645 million and combined deposits of approximately $610 million,
based upon September 30, 2004 balances. In addition, the combined bank will
have nearly $275 million of investments under management.
In the proposed merger, FNB will merge into FNLC and FNLC will issue
shares of its common stock to the shareholders of FNB in exchange for their
shares in FNB. Each outstanding share of FNB is expected to be converted into
FNLC stock valued at $42.00. The actual exchange ratio, and hence the number of
FNLC shares into which FNB stock will be converted, will vary depending on the
per share market price of FNLC common stock prior to closing, but FNB
shareholders will receive not less than 1.91, nor more than 2.47, shares of
FNLC for each share of FNB they hold.
The merger will require regulatory approval and the satisfaction of other
customary conditions, as well as the approval of the shareholders of both
companies. It is expected to close in the first quarter of 2005.
SALE OF LOANS
No recourse obligations have been incurred in connection with the sale of
loans.
Page 24
MANAGEMENT'S DISCUSSION AND ANALYSIS, CONTINUED
FORWARD-LOOKING STATEMENTS
Certain disclosures in Management's Discussion and Analysis 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, the level of future interest rates, prepayments on loans and
investment securities, 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 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 facts which affect the Company's business.
Forward-looking statements regarding the FNLC/FNB Bankshares merger
involve certain risks and uncertainties that may cause actual results to differ
materially from those contemplated including, among others, the following
possibilities: (1) costs or difficulties related to the integration of the
businesses of the two banks are greater than expected; (2) cost savings from
the merger cannot be realized ; (3) revenues following the merger are lower
than expected; (4) deposit volumes will change over time; (5) competitive
pressure among depository institutions increases significantly; (6) changes in
the interest rate environment reduce net interest margins; (7) general economic
conditions, either nationally or in the markets in which the two banks will be
doing business, are less favorable than expected; (8) legislation or changes in
regulatory requirements adversely affect banks operating in Maine, or (9)
factors which would result in a condition to the transaction not being met.
First National Lincoln Corporation has filed, and will be filing, relevant
documents concerning the merger with the Securities and Exchange Commission
(SEC), including a registration statement on Form S-4 containing a
prospectus/proxy statement. WE URGE INVESTORS TO READ THESE DOCUMENTS BECAUSE
THEY CONTAIN IMPORTANT INFORMATION ABOUT THE MERGER. Investors may obtain these
documents free of charge at the SEC's website, www.sec.gov. In addition,
documents filed with the SEC are available free of charge from First National
Lincoln Corporation. The directors and executive officers of FNB Bankshares may
be deemed to be participants in the solicitation of proxies to approve the
merger. Additional information about the interest of those participants may be
obtained from reading the definitive prospectus/proxy statement regarding the
proposed merger. INVESTORS SHOULD READ THE PROSPECTUS/PROXY STATEMENT AND OTHER
DOCUMENTS TO BE FILED WITH THE SEC CAREFULLY BEFORE MAKING A DECISION
CONCERNING THE MERGER.
Page 25
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET 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. 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 represent 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 Bank's cumulative one-year gap, at
September 30, 2004, was -5.1% 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 26
QUANTITATIVE AND QUALITATIVE MARKET RISK, CONTINUED
A summary of the Bank's static gap, as of September 30, 2004 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 $ 28,629 19,884 53,269 31,371
Loans held for sale - - - -
Loans 182,848 72,291 159,650 46,715
Other interest-earning assets 4,783 - - -
Non-rate-sensitive assets - - - 29,286
-------- -------- -------- --------
Total assets $ 216,260 92,175 212,919 107,372
-------- -------- -------- --------
Interest-bearing deposits 155,627 58,337 29,228 124,554
Borrowed funds 98,775 23,951 22,000 27,716
Non-rate-sensitive
liabilities and equity 918 2,967 19,778 64,875
-------- -------- -------- --------
Total liabilities and equity $ 255,320 85,255 71,006 217,145
-------- -------- -------- --------
Period gap $ (39,060) 6,920 141,913 (109,773)
========= ======== ======== ========
Percent of total assets -6.21% 1.10% 22.57% -17.46%
Cumulative gap (current) $ (39,060) (32,140) 109,773 -
Percent of total assets -6.21% -5.11% 17.46% 0.0%
- -------------------------------------------------------------------------------
The earnings simulation model forecasts captures the impact of changing
interest rates on one-year and two-year net interest income. The modeling
process calculates changes in interest income received and interest expense
paid on all interest-earning assets and interest-bearing liabilities reflected
on the Company's balance sheet. None of the assets used in the simulation are
held for trading purposes. The modeling is done for 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 Bank's most recent simulation model projects net interest income would
increase by approximately 1.63% of stable-rate net interest income if rates
fall gradually by one percentage point over the next year, and decrease by
approximately 5.09% 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. In
year two, 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 4.46% in a falling-rate scenario and decrease by 7.32% in a
rising rate scenario when compared to the year-one base scenario.
Page 27
QUANTITATIVE AND QUALITATIVE MARKET RISK, CONTINUED
A summary of the Bank's interest rate risk simulation modeling, as of
September 30, 2004 is presented in the following table:
- -------------------------------------------------------------
Changes in Net Interest Income 2004
- -------------------------------------------------------------
Year 1
Projected change if rates decrease by 1.0% +1.63%
Projected change if rates increase by 2.0% -5.09%
- -------------------------------------------------------------
Year 2
Projected change if rates decrease by 1.0% +4.46%
Projected change if rates increase by 2.0% -7.32%
- -------------------------------------------------------------
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 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.
The information for static gap and changes in net interest income
presented in this section pertains to the Bank only and does not include a
small volume of assets and liabilities owned by the Company and included in its
consolidated financial statements as of September 30, 2004. In Management's
opinion, the Bank-only information would not be materially different than that
for the Company's consolidated balances. This sensitivity analysis does not
represent a Company forecast and should not be relied upon as being indicative
of expected operating results. These hypothetical estimates are based upon
numerous assumptions including, among others, the nature and timing of interest
rate levels, yield curve shape, prepayments on loans and securities, deposit
decay rates, pricing decisions on loans and deposits, and reinvestment/
replacement of asset and liability cash flows. While assumptions are developed
based upon current economic and local market conditions, the Company cannot
make any assurances as to the predictive nature of these assumptions, including
how customer preferences or competitor influences might change.
INTEREST RATE RISK MANAGEMENT
A variety of financial instruments can be used to manage interest rate
sensitivity. These may include investment securities, 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 September 30, 2004, 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 September 30, 2004,
there were no significant differences between the views of the independent
consultant and Management regarding the Company's interest rate risk exposure.
Management expects interest rates may rise again in the final quareter of 2004
and believes that the current level of interest rate risk is acceptable.
Page 28
Item 4: Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), the Company's management conducted an evaluation
with the participation of the Company's Chief Executive Officer and Chief
Financial Officer, regarding the effectiveness of the Company's disclosure
controls and procedures, as of the end of the last fiscal quarter. 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 a reasonable assurance of
achieving the desired control objectives, and 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 they believe the Company's disclosure
controls and procedures are reasonably effective to ensure 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. We intend to continue to review and document our disclosure controls
and procedures, including our internal controls and procedures for financial
reporting, and we may from time to time make changes to the disclosure controls
and procedures to enhance their effectiveness and to ensure that our systems
evolve with our business.
There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
Page 29
PART II
ITEM 1. LEGAL PROCEEDINGS
The Company was not involved in any legal proceedings requiring disclosure
under Item 103 of Regulation S-K during the reporting period.
Page 30
ITEM 2. CHANGES IN SECURITIES, USE OF PROECEEDS,
AND ISSUER PURCHASES OF EQUITY SECURITIES
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 the first nine months of 2004, 6,655 shares
were issued pursuant to this Plan, as presented in the following table:
- -------------------------------------------
Month Number of Shares
- -------------------------------------------
January 2004 1,460
February 2004 534
March 2004 777
April 2004 1,640
May 2004 243
June 2004 238
July 2004 1,163
August 2004 272
Septmeber 2004 328
------
6,655
======
- -------------------------------------------
Page 31
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
Page 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Page 33
ITEM 5: Other Information
A. None.
B. Material changes to the procedures by which security holders may recommend
nominees to the registrant's board of directors.
On October 7, 2004, the registrant's board of directors approved changes to the
registrant's bylaws, effective upon adoption. The changes are summarized as
follows:
Section 3.8. This provision defines the manner in which shareholders may
propose items for consideration at the annual meeting of shareholders. A person
wishing to nominate a director or bring other business before the annual
meeting must be a record shareholder and give timely notice in writing to the
Clerk containing specific information required by the registrant's bylaws. The
notice must be received by the registrant not less than 90 nor more than 135
days before the anniversary date of the prior year's annual meeting, unless the
annual meeting is to be held on a date more than thirty days before or after
such anniversary date, in which case the notice must be received not later than
10 days after the registrant announces publicly the intended date of the annual
meeting.
Page 34
ITEM 6: Exhibits, Financial Statement Schedules, and reports on Form 8-K
EXHIBITS
2.1 Agreement and Plan of Merger With FNB Bankshares Dated August 25, 2004,
incorporated by reference to Form 8-K dated August 25, 2004, filed
under item 1.01 on August 27, 2004.
3.1 Conformed Copy of the Registrants Articles of Incorporation,
incorporated by reference to Exhibit 3.1 to the Company's Form 8-K
filed under item 5.03 on October 7, 2004.
3.2 Conformed Copy of the Registrant's Bylaws, incorporated by reference
to Exhibit 3.2 to the Company's Form 8-K filed under item 5.03 on
October 7, 2004.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13A-14(A) of
The Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer Pursuant to Rule 13A-14(A) of
The Securities Exchange Act of 1934
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of
2002
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of
2002
Page 35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST NATIONAL LINCOLN CORPORATION
November 9, 2004 /s/ Daniel R. Daigneault
Date Daniel R. Daigneault
President & Chief Executive Officer
November 9, 2004 /s/ F. Stephen Ward
Date F. Stephen Ward
Treasurer & Chief Financial Officer
Page 36