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CAC > SEC Filings for CAC > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for CAMDEN NATIONAL CORP



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The discussion below focuses on the factors affecting our consolidated results of operations for the years ended December 31, 2013, 2012 and 2011 and financial condition at December 31, 2013 and 2012 and, where appropriate, factors that may affect our future financial performance, unless stated otherwise. The information within the tables is presented in thousands, except for number of shares and per share data. This discussion should be read in conjunction with the consolidated financial statements, notes to the consolidated financial statements and selected consolidated financial data.

The acronyms and abbreviations identified below are used in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as in Item 8. "Financial Statements and Supplementary Data". The following is provided to aid the reader and provide a reference page when reviewing the consolidated financial statements.

Acadia       Acadia Trust, N.A., a          Freddie Mac:  Federal Home Loan Mortgage
Trust:       wholly-owned subsidiary of                   Corporation
             Camden National Corporation
Act:         Medicare Prescription Drug,    GAAP:         Generally accepted
             Improvement and                              accounting principles in the
             Modernization Act                            United States
AFS:         Available-for-sale             IRS:          Internal Revenue Service
ALCO:        Asset/Liability Committee      LIBOR:        London Interbank Offered
ALL:         Allowance for loan losses      LTIP:         Long-Term Performance Share
AOCI:        Accumulated other              MaineHousing: Maine State Housing
             comprehensive income (loss)                  Authority
ASC:         Accounting Standards           Management    Management Asset/Liability
             Codification                   ALCO:         Committee
ASU:         Accounting Standards Update    MSPP:         Management Stock Purchase
Bank:        Camden National Bank, a        MSRs:         Mortgage servicing rights
             wholly-owned subsidiary of
             Camden National Corporation
BOLI:        Bank-owned life insurance      Non-Agency or Non-agency private issue
                                            Non-Agencies: collateralized mortgage
Board ALCO:  Board of directors'            OCC:          Office of the Comptroller of
             Asset/Liability Committee                    the Currency
Branch       The acquisition of 14          OCI:          Other comprehensive income
Acquisition: branches from Bank of                        (loss)
             America, N.A. in 2012, after
             divesting of one branch as
             required by the Department
             of Justice
Branch       The divestiture of five        OFAC:         Office of Foreign Assets
Divestiture: Franklin County branches in                  Control
BSA:         Bank Secrecy Act               OREO:         Other real estate owned
CCTA:        Camden Capital Trust A, an     OTTI:         Other-than-temporary
             unconsolidated entity formed                 impairment
             by Camden National
CSV:         Cash surrender value           SERP:         Supplemental executive
                                                          retirement plans
Company:     Camden National Corporation    TDR:          Troubled-debt restructuring
DCRP:        Defined Contribution           UBCT:         Union Bankshares Capital
             Retirement Plan                              Trust I, an unconsolidated
                                                          entity formed by Union
                                                          Bankshares Company that was
                                                          subsequently acquired by
                                                          Camden National Corporation
EPS:         Earnings per share             U.S.:         United States of America
FASB:        Financial Accounting           2003 Plan     2003 Stock Option and
             Standards Board                              Incentive Plan
FDIC:        Federal Deposit Insurance      2012 Plan     2012 Equity and Incentive
             Corporation                                  Plan
FHLB:        Federal Home Loan Bank         2013          2013 Common Stock Repurchase
                                            Repurchase    Program, approved by the
                                            Plan:         Company's board of directors
FHLBB:       Federal Home Loan Bank of      2012          2012 Common Stock Repurchase
             Boston                         Repurchase    Program, approved by the
                                            Plan:         Company's board of directors
FRB:         Federal Reserve Bank

Executive Overview

The Company reported net income for the year ended December 31, 2013 of $22.8 million and diluted earnings per share of $2.97 for 2013 compared to net income and diluted earnings per share of $23.4 million and $3.05, respectively, for 2012. Return on average assets and return on average shareholders' equity for 2013 were 0.88% and 9.74%, respectively, compared to a return on average assets and return on average shareholders' equity for 2012 of 0.98% and 10.31%, respectively.

The fourth quarter of 2013 was the mark of two major milestones for the Company:
(i) October was the one-year anniversary of the acquisition of 15 branches from Bank of America, National Association; and (ii) in October the Company divested its five Franklin County branches. The Branch Acquisition provided the Company with an instant increase in market present and customer-base within some of Maine's major markets. The Branch Acquisition provided over 25,000 new customers and approximately $287.6 million in low-cost deposits. The Company saw the benefit of these additional customers and low-cost deposits in 2013 as non-interest income increased and average cost of funds decreased 26 basis points to 0.55% compared to 2012. In addition, non-interest expense increased in 2013 due to recognition of a full year of associated costs with operating and maintaining the new branches and increased customer activity. The Branch Divestiture included the sale of $46.0 million of loans, $85.9 million in total deposits and borrowings, and a pre-tax gain of $2.7 million. Company management recognizes that these transactions have an immediate impact on short-term earnings; however, their focus continues to be on driving long-term shareholder value through strategic repositioning.

Net income and diluted earnings per share for 2013 decreased $645,000 and $0.08 per share, respectively, compared to 2012. The decrease in net income was largely due to non-recurring transactions that are not representative of the Company's core operations. In the fourth quarter of 2013, a goodwill impairment charge of $2.8 million was recorded related to the Company's financial services reporting unit. This goodwill write-down decreased 2013 net income by $2.8 million as the write-down does not provide for any tax benefit. This loss was partially offset by a $1.5 million after-tax gain recognized from the Branch Divestiture, including related divestiture costs.

Total assets grew 2% during the year to $2.6 billion at December 31, 2013. The largest contributors to this growth were loans and investments, with organic loan growth of $62.6 million, or 4%, after adjusting for the Branch Divestiture, and an increase in the investment portfolio of $26.1 million, or 3%. Total deposits were $1.8 billion at December 31, 2013, reflecting the sale of $80.4 million of deposits as part of the Branch Divestiture. Core deposits (demand, interest checking, savings and money market) continue to represent the majority of total deposits.

The Company declared dividends payable of $1.08 per share during 2013, representing an increase of $0.08 per share, or 8%, compared to 2012.

Critical Accounting Policies

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. In preparing the Company's consolidated financial statements, management is required to make significant estimates and assumptions that affect assets, liabilities, revenues, and expenses reported. Actual results could materially differ from our current estimates, as a result of changing conditions and future events. Several estimates are particularly critical and are susceptible to significant near-term change, including the allowance for credit losses, accounting for acquisitions and the review of goodwill and other identifiable intangible assets for impairment, valuation of other real estate owned, other-than-temporary impairment of investments, effectiveness of hedging derivatives, accounting for postretirement plans, stock-based compensation, and income taxes. Our significant accounting policies and critical estimates are summarized in Note 1 to the consolidated financial statements included in Item
8. "Financial Statements and Supplementary Data".

Allowance for Credit Losses. Management is committed to maintaining an allowance for loan losses ("ALL") that is appropriate to absorb likely loss exposure in the loan portfolio. Evaluating the appropriateness of the ALL is a key management function, one that requires the most significant amount of management estimates and assumptions. The ALL, which is established through a charge to the provision for credit losses, consists of two components: (i) a reduction to total gross loans in the asset section of the balance sheet, and (ii) the reserve for unfunded commitments included in other liabilities on the balance sheet. We regularly evaluate the ALL for adequacy by taking into consideration, among other factors, historical trends in charge-offs and delinquencies, overall risk characteristics and size of the portfolios, ongoing review of significant individual loans, trends in levels of watched or criticized assets, business and economic conditions, local industry trends, evaluation of results of examinations by regulatory authorities and other third parties, and other relevant factors.

In determining the appropriate level of ALL, we use a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio. The methodology focuses on four key elements: (i) identification of loss allocations for specific loans, (ii) loss allocation factors for certain loan types based on credit grade and loss experience, (iii) general loss allocations for other environmental factors, and (iv) the unallocated portion of the allowance.

In accordance with GAAP, a loan is impaired when it is probable we will be unable to collect all contractual payments as scheduled. We have concluded that loans that meet this definition are risk rated as substandard or doubtful. As such, quarterly we review individual loans with a carrying value greater than $250,000 and that are risk rated as substandard or doubtful or are on non-accrual status for impairment. If deemed impaired, an allowance is established for these loans to reduce the net carrying value of the loan to fair value. The fair value of an impaired loan is determined by one of three methods in accordance with GAAP: (i) the present value of expected future cash flows,
(ii) the observable market price, or (iii), if the loan is collateral-dependent, the fair value of the collateral, less the estimated costs to sell the collateral.

We use a risk rating system to determine the credit quality of our loans and apply the related loss allocation factors. In assessing the risk rating of a particular loan, we consider, among other factors, the obligor's debt capacity, financial condition, the level of the obligor's earnings, the amount and sources of repayment, the performance with respect to loan terms, the adequacy of collateral, the level and nature of contingent liabilities, management strength, and the industry in which the obligor operates. These factors are based on an evaluation of historical information, as well as a subjective assessment and interpretation of current conditions. Emphasizing one factor over another, or considering additional factors that may be relevant in determining the risk rating of a particular loan but which are not currently an explicit part of our methodology, could impact the risk rating assigned to that loan.

Three times annually, management conducts a thorough review of adversely risk rated commercial and commercial real estate exposures exceeding certain thresholds to re-evaluate the risk rating and identify impaired loans. This extensive review takes into account the obligor's repayment history and financial condition, collateral value, guarantor support, local economic and industry trends, and other factors relevant to the particular loan relationship.

We periodically reassess and revise the loss allocation factors used in the assignment of loss exposure to appropriately reflect our analysis of loss experience. Portfolios of more homogenous populations of loans including home equity and consumer loans are analyzed as groups taking into account delinquency rates and other economic conditions which may affect the ability of borrowers to meet debt service requirements, including interest rates and energy costs. An additional allocation is determined based on a judgmental process whereby management considers qualitative and quantitative assessments of other environmental factors. Finally, an unallocated portion of the total allowance is maintained to allow for measurement imprecision attributable to uncertainty in the economic environment.

Because the methodology is based upon historical experience and trends as well as management's judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in our market area, concentration of risk, declines in local property values, and the results of regulatory examinations. While management's evaluation of the ALL as of December 31, 2013 determined the allowance to be appropriate, under adversely different conditions or assumptions, we may need to increase the allowance. Monthly, management reviews the ALL to assess recent asset quality trends and impact on the Company's financial condition. Quarterly, the ALL is brought before the Bank's board of directors for discussion, review, and approval. Refer to Item 7. "Management's Discussion and Analysis - Financial Condition - Asset Quality" for further discussion of our ALL process.

The adequacy of the reserve for unfunded commitments is determined in a similar manner as the ALL, with the exception that management must also estimate the likelihood of these commitments being funded and becoming loans. This is accomplished by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the historical utilization rates could change in the future.

Branch Purchase Price Allocation and Impairment of Goodwill and Identifiable Intangible Assets. We record all assets and liabilities acquired in purchase acquisitions at fair value, which is an estimate determined by the use of internal and other valuation techniques. We utilize third-party services for the valuation of real estate and core deposit intangibles. These valuation estimates result in goodwill and other intangible assets, which are subject to ongoing periodic impairment tests using various fair value techniques. Goodwill impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exist. Our policy is to perform the goodwill impairment analysis as of November 30 of each year, or more frequently as warranted, at the reporting unit level - (i) banking and (ii) financial services. The banking reporting unit is representative of our core banking business line, while the financial services reporting unit is representative of our wealth management, trust and services business line. Identifiable intangible assets are amortized over their estimated useful lives and are subject to impairment tests if events or circumstances indicate a possible

inability to realize the carrying amount. Goodwill is evaluated for impairment using several standard valuation techniques including discounted cash flow analyses, as well as an estimation of the impact of business conditions. The use of different estimates or assumptions could produce different estimates of carrying value.

In 2013, goodwill impairment of $2.8 million was recorded related to the financial services reporting unit. This impairment was 42% of the December 31, 2012 goodwill balance attributable to the financial service reporting unit. We also performed the annual goodwill impairment analysis for the banking reporting unit and determined it was not impaired.

Valuation of OREO. Periodically, we acquire property in connection with foreclosures or in satisfaction of debt previously contracted. The valuation of this property is accounted for individually based on its fair value on the date of acquisition. At the acquisition date, if the fair value of the property, less the costs to sell is less than the book value of the loan, a charge or reduction in the ALL is recorded. If the value of the property becomes permanently impaired, as determined by an appraisal or an evaluation in accordance with our appraisal policy, we will record the decline by charging against current earnings. Upon acquisition of a property, we use a current appraisal or broker's opinion to substantiate fair value for the property.

OTTI of Investments. We record an investment impairment charge at the point we believe an investment has experienced a decline in value that is other-than-temporary. In determining whether an OTTI has occurred, we review information about the underlying investment that is publicly available, analysts' reports, applicable industry data and other pertinent information, and assess our ability to hold the securities for the foreseeable future. The investment is written down to its current market value at the time the impairment is deemed to have occurred. Future adverse changes in market conditions, continued poor operating results of underlying investments or other factors could result in further losses that may not be reflected in an investment's current carrying value, possibly requiring an additional impairment charge in the future.

Effectiveness of Hedging Derivatives. The Company maintains an overall interest rate risk management strategy that incorporates the use of interest rate contracts, which are generally non-leveraged generic interest rate and basis swaps, to minimize significant fluctuations in earnings that are caused by interest rate volatility. Interest rate contracts are used by the Company in the management of its interest rate risk position. The Company's goal is to manage interest rate sensitivity so that movements in interest rates do not significantly adversely affect earnings and cash flows. When interest rates fluctuate, hedged assets and liabilities appreciate or depreciate in fair value or cash flows. Gains or losses on the derivative instruments that are linked to the hedged assets and liabilities are expected to substantially offset this unrealized appreciation or depreciation or changes in cash flows. The Company utilizes a third-party service to evaluate the effectiveness of its cash flow hedges on a quarterly basis. The effective portion of a gain or loss on a cash flow hedge is recorded in other comprehensive income, net of tax, and other assets or other liabilities on the consolidated statements of condition. The ineffective portions of cash flow hedging transactions are included in "other income" in the consolidated statements of income, if material.

Accounting for Postretirement Plans. We use a December 31 measurement date to determine the expenses for our postretirement plans and related financial disclosure information. Postretirement plan expense is sensitive to changes in the number of eligible employees (and their related demographics) and to changes in the discount rate and other expected rates, such as medical cost trends rates. As with the computations on plan expense, cash contribution requirements are also sensitive to such changes.

Stock-Based Compensation. The fair value of restricted stock and stock options is determined on the date of grant and amortized to compensation expense, with a corresponding increase in common stock, over the longer of the service period or performance period, but in no event beyond an employee's retirement date. For performance-based restricted stock, we estimate the degree to which performance conditions will be met to determine the number of shares that will vest and the related compensation expense. Compensation expense is adjusted in the period such estimates change. Non-forfeitable dividends, if any, paid on shares of restricted stock are recorded to retained earnings for shares that are expected to vest and to compensation expense for shares that are not expected to vest.

Income Taxes. We account for income taxes by deferring income taxes based on the estimated future tax effects of differences between the book and tax bases of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in the consolidated statements of condition. We must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined not likely to be recoverable. Judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. Although we have determined a valuation allowance is not required for all deferred tax assets, there is no guarantee that these assets will be realized. Although not currently under review, income tax returns for the years ended December 31, 2010 through 2012 are open to audit by federal and Maine authorities. If we, as a result of an audit, were assessed interest and penalties, the amounts would be recorded through other non-interest expense on the consolidated statements of income.

Non-GAAP Financial Measures and Reconciliation to GAAP

In addition to evaluating the Company's results of operations in accordance with GAAP, management supplements this evaluation with an analysis of certain non-GAAP financial measures, such as the efficiency ratio, tax equivalent net interest income, return on average tangible shareholders' equity, and tangible book value per share. We believe these non-GAAP financial measures help investors in understanding the Company's operating performance and trends and allow for better performance comparisons to other banks. In addition, these non-GAAP financial measures remove the impact of unusual items that may obscure trends in the Company's underlying performance. These disclosures should not be viewed as a substitute for GAAP operating results, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other financial institutions.

Efficiency Ratio. The efficiency ratio, which represents an approximate measure of the cost required for the Company to generate a dollar of revenue, is the ratio of (i) total non-interest expense excluding (a) Branch Acquisition and Divestiture costs, (b) prepayment penalties on borrowings, and (c) goodwill impairment (the numerator) to (ii) net interest income on a fully taxable equivalent basis (assumed 35% tax rate) plus total non-interest income excluding
(a) net gains or losses on sale of securities, net of OTTI, (b) gain on the Branch Divestiture, (c) gain on sale of branch facility, and (d) proceeds from a 2010 legal settlement (the denominator).

                                               At or for the Year Ended December 31,
(In Thousands)                    2013           2012           2011           2010           2009
Non-interest expense, as
presented                     $   66,333     $   59,031     $   55,579     $   52,937     $   51,005
Less: Branch Acquisition
and Divestiture costs                374          2,324              -              -              -
Less: prepayment penalties
on borrowings                          -          2,030          2,318              -              -
Less: goodwill impairment          2,830              -             50              -              -
Adjusted non-interest
expense                       $   63,129     $   54,677     $   53,211     $   52,937     $   51,005
Net interest income, as
presented                     $   75,475     $   73,745     $   75,219     $   74,290     $   73,011
Effect of tax-exempt income          808            988          1,212          1,452          1,628
Non-interest income               27,801         23,412         23,053         20,825         19,423
Less: net gains or (losses)
on sale of securities, net
of OTTI                              785          2,498          2,076           (409 )           41
Less: gain on Branch
Divestiture                        2,742              -              -              -              -
Less: gain on sale of
branch facility                        -            479              -              -              -
Less: legal settlement
proceeds                               -              -              -          2,000              -
Adjusted net interest
income plus
non-interest income           $  100,557     $   95,168     $   97,408     $   94,976     $   94,021
Non-GAAP efficiency ratio          62.78 %        57.45 %        54.63 %        55.74 %        54.26 %
GAAP efficiency ratio              64.23 %        60.76 %        56.49 %        55.53 %        55.17 %

Tax Equivalent Net Interest Income. Tax-equivalent net interest income is net interest income plus the taxes that would have been paid had tax-exempt securities been taxable. This number attempts to enhance the comparability of the performance of assets that have different tax liabilities. The following table provides a reconciliation of tax equivalent net interest income to GAAP net interest income using a 35% tax rate.

                                                At or for the Year Ended December 31,
(In Thousands)                          2013        2012        2011        2010        2009
Net interest income, as presented     $ 75,475    $ 73,745    $ 75,219    $ 74,290    $ 73,011
Effect of tax-exempt income                808         988       1,212       1,452       1,628
Net interest income, tax equivalent   $ 76,283    $ 74,733    $ 76,431    $ 75,742    $ 74,639

Return on Average Tangible Shareholders' Equity. Return on average tangible shareholders' equity is the ratio of (i) net income, adjusted for (a) tax effected amortization of intangible assets and (b) goodwill impairment (the numerator) to (ii) average shareholders' equity, adjusted for goodwill and other intangible assets. We believe this is a meaningful measure of our financial performance as it reflects the return on the equity deployed in our business and is a common measure within our industry.

. . .

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