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FNLC > SEC Filings for FNLC > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for FIRST BANCORP, INC /ME/

Form 10-K for FIRST BANCORP, INC /ME/


14-Mar-2014

Annual Report


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

The First Bancorp, Inc. (the "Company" or "The First Bancorp") was incorporated in the State of Maine on January 15, 1985, and is the parent holding company of The First, N.A. (the "Bank").
The Company generates almost all of its revenues from the Bank, which was chartered as a national bank under the laws of the United States on May 30, 1864. The Bank, which has sixteen offices along coastal and eastern Maine, emphasizes personal service to the communities it serves, concentrating primarily on small businesses and individuals.
The Bank offers a wide variety of traditional banking services and derives the majority of its revenues from net interest income - the spread between what it earns on loans and investments and what it pays for deposits and borrowed funds. While net interest income typically increases as earning assets grow, the spread can vary up or down depending on the level and direction of movements in interest rates. Management believes the Bank has modest exposure to changes in interest rates, as discussed in "Interest Rate Risk Management" elsewhere in Management's Discussion. The banking business in the Bank's market area historically has been seasonal with lower deposits in the winter and spring and higher deposits in the summer and fall. This seasonal swing is fairly predictable and has not had a materially adverse effect on the Bank. Non-interest income is the Bank's secondary source of revenue and includes fees and service charges on deposit accounts, income from the sale and servicing of mortgage loans, and income from investment management and private banking services through First Advisors, a division of the Bank.

Forward-Looking Statements

This report contains statements that are "forward-looking statements." We may also make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to Shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words "believe", "expect", "anticipate", "intend", "estimate", "assume", "outlook", "will", "should", "may", "might, "could", and other expressions that predict or indicate future events or trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Company to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.
Some of the factors that might cause these differences include the following:
changes in general national, regional or international economic conditions or conditions affecting the banking or financial services industries or financial capital markets, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, reductions in net interest income resulting from interest rate volatility as well as changes in the balance and mix of loans and deposits, reductions in the market value of wealth management assets under administration, changes in the value of securities and other assets, reductions in loan demand, changes in loan collectibility, default and charge-off rates, changes in the size and nature of the Company's competition, changes in legislation or regulation and accounting principles, policies and guidelines, and changes in the assumptions used in making such forward-looking statements. In addition, the factors described under "Risk Factors" in Item 1A of this Annual Report on Form 10-K, may result in these differences. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this annual report, and we assume no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company, which attempt to advise interested parties of the factors that affect the Company's business.

Critical Accounting Policies

Management's discussion and analysis of the Company's financial condition and results of operations is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. 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, goodwill, the valuation of mortgage servicing rights, and other-than-temporary impairment on securities. 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

The First Bancorp - 2013 Form 10-K - Page 24

other sources. Actual results could differ from the amounts derived from Management's estimates and assumptions under different assumptions or conditions.
Allowance for Loan Losses. Management believes the allowance for loan losses 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 to determine the appropriate level 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.
Goodwill. Management utilizes numerous techniques to estimate the value of various assets held by the Company, including methods to determine the appropriate carrying value of goodwill as required under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 350 "Intangibles - Goodwill and Other." Goodwill from purchase acquisitions is subject to ongoing periodic evaluation for impairment.
Mortgage Servicing Rights. The valuation of mortgage servicing rights is 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 at fair value when they are acquired through the 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. The rights are subsequently carried at the lower of amortized cost or fair value. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speed results in lower valuations of mortgage servicing rights. The valuation also 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. All of the assumptions are based on standards the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources.
Other-Than-Temporary Impairment on Securities. One of the significant estimates related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than-temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. Securities that are in an unrealized loss position are reviewed at least quarterly to determine if other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities' market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest when due.

Use of Non-GAAP Financial Measures

Certain information in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Management uses these "non-GAAP" measures in its analysis of the Company's performance and believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrating the effects of significant gains and charges in the current period. The Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. Management believes that investors may use these non-GAAP financial measures to analyze financial performance without 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 operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
In several places in this report, net interest income is presented on a fully taxable equivalent basis. Specifically included in interest income was tax-exempt interest income from certain investment securities and loans. An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income total, which adjustments increased net

The First Bancorp - 2013 Form 10-K - Page 25

interest income accordingly. Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices. The following table provides a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with GAAP. A 35.0% tax rate was used in 2013, 2012 and 2011.

                                         Years ended December 31,
 Dollars in thousands                  2013        2012        2011
Net interest income as presented    $  37,440    $ 38,887    $ 40,993
Effect of tax-exempt income             3,573       3,128       2,710
Net interest income, tax equivalent $  41,013    $ 42,015    $ 43,703

The Company presents its efficiency ratio using non-GAAP information. The GAAP-based efficiency ratio is noninterest expenses divided by net interest income plus noninterest income from the Consolidated Statements of Income and Comprehensive Income. The non-GAAP efficiency ratio excludes securities losses and other-than-temporary impairment charges from noninterest expenses, excludes securities gains from noninterest income, and adds the tax-equivalent adjustment to net interest income. The following table provides a reconciliation between the GAAP and non-GAAP efficiency ratio:

                                                            Years ended December 31,
In thousands of dollars                                  2013         2012         2011
Non-interest expense, as presented                    $ 28,937     $ 26,271     $ 26,038
Net interest income, as presented                       37,440       38,887       40,993
Effect of tax-exempt income                              3,573        3,128        2,710
Non-interest income, as presented                       12,087       11,278       11,750
Effect of non-interest tax-exempt income                   182          177          182
Net securities gains                                    (1,087 )     (1,968 )     (3,293 )
Adjusted net interest income plus non-interest income $ 52,195     $ 51,502     $ 52,342
Non-GAAP efficiency ratio                                55.44 %      51.01 %      49.75 %
GAAP efficiency ratio                                    58.43 %      52.37 %      49.37 %

The Company presents certain information based upon average tangible common shareholders' equity instead of total average shareholders' equity. The difference between these two measures is the Company's intangible assets, specifically goodwill from prior acquisitions, and preferred stock. Management, banking regulators and many stock analysts use the tangible common equity ratio and the tangible book value per common share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, typically stemming from the use of the purchase accounting method in accounting for mergers and acquisitions. The following table provides a reconciliation of tangible average shareholders' equity to the Company's consolidated financial statements, which have been prepared in accordance with GAAP:

                                                 Years ended December 31,
 In thousands of dollars                       2013        2012        2011
Average shareholders' equity as presented    152,722     155,822     152,254
Less preferred stock (average)                (4,020 )   (12,341 )   (20,290 )
Less intangible assets (average)             (30,664 )   (28,422 )   (28,698 )

Average tangible common shareholders' equity 118,038 115,059 103,266

The First Bancorp - 2013 Form 10-K - Page 26

Executive Summary

This was a very busy and very good year for the First Bancorp, with most of the Company's performance metrics moving in a positive direction. Net income was the best the Company has posted since 2009 and the fourth best year ever. In February, the Company's sixteenth office was opened on Exchange Street in Bangor, which gives the Company the opportunity to enter one of the most important and growing banking markets in the State of Maine. The Company had a very successful stock offering in the first quarter which enabled full repayment to the U.S. Treasury for its 2009 investment in the Company under the Capital Purchase Program. Credit quality improved significantly in 2013, with non-performing assets at their lowest level in nearly five years and net chargeoffs down $3.1 million from 2012. And perhaps the most important happening for our shareholders in 2013 was the increase in our dividend in the fourth quarter to $0.20 per share per quarter.
Net income for the year ended December 31, 2013 was $13.0 million, up $277,000 or 2.2% from the $12.7 million posted for the year ended December 31, 2012. Earnings per common share on a fully diluted basis were $1.20 for the year ended December 31, 2013, down $0.02 or 1.6% from the $1.22 posted for the year ended December 31, 2012, due to the higher number of shares outstanding in 2013 as a result of the Company's public offering of 760,771 shares on March 28, 2013. Net interest income on a tax-equivalent basis declined $1.0 million or 2.4% for the year ended December 31, 2013 compared to the year ended December 31, 2012. This decrease was attributable to a $1.1 million decline from margin compression experienced in the first half of the year that stabilized in the second half of the year, and this compression was partially offset by a $109,000 increase due to higher levels of earning assets. As a result, our net interest margin slipped from 3.14% in 2012 to 3.05% in 2013. This year-over-year decline in net interest income was offset by a lower provision for loan losses.
Non-interest income for the year ended December 31, 2013 was $12.1 million or 7.2% higher than non-interest income posted for the year ended December 31, 2012. This was attributable to an increase in origination income from the sale of refinanced mortgage loans into the secondary market as well as an increase in other operating income. Non-interest expense for the year ended December 31, 2013 was $28.9 million or 10.1% higher than non-interest expense posted for the year ended December 31, 2012, due to higher operating costs related to the opening of the de novo Bangor office in the first quarter of 2013, as well as from the Union Street Branch in Rockland that we acquired in the fourth quarter of 2012.
During 2013, total assets increased $49.0 million or 3.5%. After five years of declining balances, the loan portfolio grew $7.1 million or 0.8% in 2013. The investment portfolio was up $39.6 million or 8.8% for the year. On the liability side of the balance sheet, low-cost deposits increased $33.7 million or 9.0% for the year. This year-over-year increase is the result of healthy deposit inflows in 2013. Local certificates of deposit increased $7.6 million or 3.5%. As noted before, credit quality improved significantly in 2013. Non-performing loans stood at 1.86% of total loans on December 31, 2013 compared to 2.20% of total loans on December 31, 2012. This compares to non-performing loans at 1.21% for our Uniform Bank Performance Report peer group ("UBPR peer group") as of December 31, 2013. Net chargeoffs were $5.2 million or 0.60% of average loans in 2013 compared to net chargeoffs of $8.3 million or 0.95% of average loans in 2012. Net chargeoffs for the UBPR peer group in 2013 were 0.26% of average loans. We provisioned $4.2 million for loan losses in 2013, down $3.6 million from the $7.8 million provision made during 2012. The allowance as a percentage of loans outstanding stood at 1.31% in 2013 compared to 1.44% in 2012. Remaining well capitalized remains a top priority for The First Bancorp, Inc. Since December 31, 2008, the Company's total risk-based capital ratio has increased from 11.13 % to 16.03%, well above the well-capitalized threshold of 10.0% set by the Federal Deposit Insurance Corporation.
The Company's operating ratios remain good, with a return on average tangible common equity of 10.66% for the year ended December 31, 2013 compared to 10.40% and 10.80% for the years ended December 31, 2012 and 2011, respectively. Our return on average tangible equity was in the top 40% of all banks in the UBPR peer group, which had an average return of 9.63% for the year. Our efficiency ratio continues to be an important component in our overall performance and at 55.44% in 2013, is modestly above the 51.01% and 49.75% posted for 2012 and 2011, respectively. As of December 31, 2013, the average efficiency ratio for our UBPR peer group was 67.18%, which put us in the top 10% of all banks in the UBPR peer group.

Results of Operations

Net Interest Income

Net interest income on a tax-equivalent basis decreased 2.4% or $1.0 million to $41.0 million for the year ended December 31, 2013 from the $42.0 million reported for the year ended December 31, 2012. This decrease was attributable to a $1.1 million decline from margin compression experienced in the first half of the year that stabilized in the second half of the year, and this compression was partially offset by a $109,000 increase due to higher levels of earning assets, resulting in a decrease in the net interest margin from 3.14% in 2012 to 3.05% in 2013.
Total interest income in 2013 was $49.9 million, a decrease of $1.9 million or 3.6% from the $51.8 million posted by the Company in 2012. Total interest expense in 2013 was $12.5 million, a decrease of $442,000 or 3.4% from the $12.9 million posted by the Company in 2012. The decrease in both interest income and interest expense was attributable to lower interest

The First Bancorp - 2013 Form 10-K - Page 27

rates. Tax-exempt interest income amounted to $6.6 million for the year ended December 31, 2013, $5.8 million for the year ended December 31, 2012 and $5.0 million for the year ended December 31, 2011.
The following tables present changes in interest income and expense attributable to changes in interest rates, volume, and rate/volume1 for interest-earning assets and interest-bearing liabilities. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate.

Year ended December 31, 2013 compared to 2012

Dollars in thousands             Volume       Rate       Rate/Volume1      Total
Interest on earning assets
Interest-bearing deposits       $    3     $      -     $        1       $      4
Investment securities              532          178              5            715
Loans held for sale                 15            2              1             18
Loans                             (350 )     (1,849 )           18         (2,181 )
Total interest income              200       (1,669 )           25         (1,444 )
Interest expense
Deposits                            53         (449 )           (3 )         (399 )
Borrowings                          38          (80 )           (1 )          (43 )
Total interest expense              91         (529 )           (4 )         (442 )
Change in net interest income   $  109     $ (1,140 )   $       29       $ (1,002 )

Year ended December 31, 2012 compared to 2011

Dollars in thousands              Volume       Rate       Rate/Volume1      Total
Interest on earning assets
Interest-bearing deposits        $   (8 )   $      -     $        -       $     (8 )
Investment securities               549       (1,150 )          (35 )         (636 )
Loans held for sale                 (15 )         (6 )            3            (18 )
Loans                              (379 )     (2,441 )           23         (2,797 )
Total interest income               147       (3,597 )           (9 )       (3,459 )
Interest expense
Deposits                           (316 )     (1,068 )           34         (1,350 )
Borrowings                          438         (789 )          (70 )         (421 )
Total interest expense              122       (1,857 )          (36 )       (1,771 )
Change in net interest income    $   25     $ (1,740 )   $       27       $ (1,688 )

1 Represents the change attributable to a combination of change in rate and change in volume.

The First Bancorp - 2013 Form 10-K - Page 28

The following table presents the interest earned on or paid for each major asset and liability category, respectively, for the years ended December 31, 2013, 2012, and 2011, as well as the average yield for each major asset and liability category, and the net yield between assets and liabilities. Tax-exempt income has been calculated on a tax-equivalent basis using a 35% rate. Unrecognized interest on non-accrual loans is not included in the amount presented, but the average balance of non-accrual loans is included in the denominator when calculating yields.

                                   2013                            2012                            2011
                         Amount of        Average        Amount of        Average        Amount of        Average
Dollars in thousands     interest       Yield/Rate       interest       Yield/Rate       interest       Yield/Rate
Interest on earning
assets
Interest-bearing
deposits               $         8         0.27 %      $         4         0.25 %      $        12         0.25 %
Investment securities       18,299         3.85 %           17,584         3.81 %           18,220         4.07 %
Loans held for sale             30         4.17 %               12         3.69 %               30         4.63 %
Loans                       35,172         4.06 %           37,353         4.27 %           40,150         4.55 %
Total interest-earning
assets                      53,509         3.98 %           54,953         4.11 %           58,412         4.37 %
Interest-bearing
liabilities
. . .
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