Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File No.      0-28190

CAMDEN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

MAINE
01-0413282
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
   
2 ELM STREET, CAMDEN, ME
04843
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code:  (207) 236-8821

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                

Yes ¨         No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨
Accelerated filer x
Non-accelerated filer ¨
Smaller reporting company  ¨
(Do not check if a smaller reporting company)
  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨         No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date:
Outstanding at October 30, 2009:  Common stock (no par value) 7,644,829 shares.
 
 
 
 

CAMDEN NATIONAL CORPORATION

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2009
TABLE OF CONTENTS OF INFORMATION REQUIRED IN REPORT

   
PAGE
   
PART I.  FINANCIAL INFORMATION
  
   
ITEM 1.
FINANCIAL STATEMENTS
  
     
 
Report of Independent Registered Public Accounting Firm
  3
     
 
Consolidated Statements of Condition
September 30, 2009 and December 31, 2008
  4
     
 
Consolidated Statements of Income
Three and Nine Months Ended September 30, 2009 and 2008
  5
     
 
Consolidated Statements of Changes in Shareholders’ Equity
Nine Months Ended September 30, 2009 and 2008
  6
     
 
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2009 and 2008
  7
     
 
Notes to Consolidated Financial Statements
Nine Months Ended September 30, 2009 and 2008
  8-20
     
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  21-32
     
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
  33-34
     
ITEM 4.
CONTROLS AND PROCEDURES
  35
     
PART II. OTHER INFORMATION
  
     
ITEM 1.
LEGAL PROCEEDINGS
  36
     
ITEM 1A.
RISK FACTORS
  36
     
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS
  36
     
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
  36
     
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  36
     
ITEM 5.
OTHER INFORMATION
  36
     
ITEM 6.
EXHIBITS
  37
     
SIGNATURES
  38
     
EXHIBIT INDEX
  39
     
EXHIBITS
40-44
 
Page 2
 
PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Shareholders and Board of Directors
Camden National Corporation

We have reviewed the accompanying interim consolidated financial information of Camden National Corporation and Subsidiaries as of September 30, 2009, and for the nine-month and three-month periods ended September 30, 2009 and 2008. 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.
 
/s/ Berry, Dunn, McNeil & Parker
Berry, Dunn, McNeil & Parker

Bangor, Maine
October 30, 2009

 
Page 3
 

CAMDEN NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

  
  
September 30,
    
December 31,
  
   
2009
    
2008
  
(In Thousands, Except Number of Shares and per Share Data)
  
(unaudited)
        
ASSETS
            
Cash and due from banks
  
$
30,081
    
$
35,195
  
Securities
                
Securities available for sale, at fair value
    
525,966
      
606,031
  
Securities held to maturity, at amortized cost (fair value $41,751 and $41,954 at September 30, 2009 and December 31, 2008, respectively)
    
39,366
      
42,040
  
Federal Home Loan and Federal Reserve Bank stock, at cost
    
21,965
      
21,969
  
Total securities
    
587,297
      
670,040
  
Trading account assets
    
1,667
      
1,304
  
Loans held for sale
    
1,298
      
—
  
Loans
    
1,519,681
      
1,500,908
  
Less allowance for loan losses
    
(19,435
)   
    
(17,691
)   
Net loans
    
1,500,246
      
1,483,217
  
Goodwill
    
41,780
      
41,857
  
Bank-owned life insurance
    
41,310
      
40,459
  
Premises and equipment, net
    
25,234
      
25,872
  
Interest receivable
    
7,649
      
8,325
  
Core deposit intangible
    
4,142
      
4,518
  
Other real estate owned
    
5,465
      
4,024
  
Other assets
    
26,577
      
26,685
  
Total assets
  
$
2,272,746
    
$
2,341,496
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                
Liabilities
                
Deposits:
                
Demand
  
$
201,451
    
$
180,407
  
Interest checking, savings and money market
    
699,230
      
632,664
  
Retail certificates of deposit
    
567,210
      
593,013
  
Brokered deposits
    
45,443
      
83,433
  
Total deposits
    
1,513,334
      
1,489,517
  
Federal Home Loan Bank advances
    
210,495
      
258,925
  
Other borrowed funds
    
290,427
      
359,470
  
Junior subordinated debentures
    
43,487
      
43,410
  
Accrued interest and other liabilities
    
28,232
      
23,774
  
Total liabilities
    
2,085,975
      
2,175,096
  
                 
Shareholders’ Equity
                
Common stock, no par value; authorized 20,000,000 shares, issued and outstanding 7,644,829 and 7,638,713 shares on September 30, 2009 and December 31, 2008, respectively
    
3,150
      
2,851
  
Surplus
    
46,139
      
46,133
  
Retained earnings
    
130,320
      
118,564
  
Accumulated other comprehensive income (loss)
                
Net unrealized gains (losses) on securities available for sale, net of tax
    
8,163
      
(89
) 
Net unrealized gains on derivative instruments, net of tax
    
11
      
—
  
Net unrecognized losses on postretirement plans, net of tax
    
(1,012
)   
    
(1,059
)   
Total accumulated other comprehensive income (loss)
    
7,162
      
(1,148
)
Total shareholders’ equity
    
186,771
      
166,400
  
Total liabilities and shareholders’ equity
  
$
2,272,746
    
$
2,341,496
  

See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.

 
Page 4
 
 
CAMDEN NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

  
  
Three Months Ended September 30,
    
Nine Months Ended September 30,
  
(In Thousands, Except Number of Shares and per Share Data)
  
2009
    
2008
    
2009
    
2008
  
Interest Income
                        
Interest and fees on loans
  
$
21,121
    
$
24,080
    
$
64,012
    
$
73,803
  
Interest on U.S. government and sponsored enterprise obligations
    
6,229
      
6,412
      
20,229
      
18,921
  
Interest on state and political subdivision obligations
    
602
      
674
      
1,876
      
2,026
  
Interest on federal funds sold and other investments
    
28
      
318
      
99
      
1,726
  
Total interest income
    
27,980
      
31,484
      
86,216
      
96,476
  
Interest Expense
                                
Interest on deposits
    
5,413
      
7,752
      
17,743
      
24,253
  
Interest on borrowings
    
3,630
      
5,466
      
11,267
      
17,500
  
Interest on junior subordinated debentures
    
712
      
752
      
2,136
      
2,195
  
Total interest expense
    
9,755
      
13,970
      
31,146
      
43,948
  
Net interest income
    
18,225
      
17,514
      
55,070
      
52,528
  
Provision for Loan Losses
    
2,000
      
1,170
      
6,514
      
2,120
  
Net interest income after provision for loan losses
    
16,225
      
16,344
      
48,556
      
50,408
  
Non-Interest Income (Loss)
                                
Service charges on deposit accounts
    
1,361
      
1,377
      
3,943
      
4,069
  
Other service charges and fees
    
778
      
724
      
2,202
      
2,059
  
Income from fiduciary services
    
1,471
      
1,653
      
4,332
      
5,031
  
Brokerage and insurance commissions
    
378
      
345
      
1,021
      
1,068
  
Mortgage banking income (loss), net
    
351
      
(1
)
    
1,222
      
(216
)
Bank-owned life insurance
    
368
      
305
      
1,108
      
883
  
Net gain (loss) on sale of securities
    
1
      
(804
)
    
1
      
(624
)
Other income
    
441
      
98
      
918
      
529
  
Total non-interest income before security impairment write-down
    
   5,149
      
3,697
      
14,747
      
12,799
  
Loss on security impairment write-down
    
—
      
(13,950
)
    
—
      
(13,950
)
Total non-interest income (loss)
    
5,149
      
(10,253
)
    
14,747
      
(1,151
)
Non-Interest Expenses
                                
Salaries and employee benefits
    
6,071
      
6,079
      
18,195
      
19,130
  
Net occupancy
    
862
      
927
      
2,954
      
3,008
  
Furniture, equipment and data processing
    
1,123
      
1,038
      
3,233
      
3,467
  
Consulting and service fees
    
698
      
786
      
2,140
      
2,229
  
Other real estate owned and collection costs
    
779
      
119
      
1,941
      
518
  
Regulatory assessments
    
693
      
417
      
3,304
      
676
  
Amortization of core deposit intangible
    
125
      
193
      
376
      
697
  
Other expenses
    
1,801
      
2,100
      
5,716
      
6,108
  
Total non-interest expenses
    
12,152
      
11,659
      
37,859
      
35,833
  
Income (loss) before income taxes
    
9,222
      
(5,568
) 
    
25,444
      
13,424
  
Income Taxes
    
2,894
      
2,452
      
7,898
      
8,143
  
Net Income (Loss)
  
$
6,328
    
$
(8,020
) 
  
$
17,546
    
$
5,281
  
                                 
Per Share Data
                                
Basic earnings (loss) per share – common stock
  
$
0.83
    
$
(1.05
) 
  
$
2.30
    
$
0.69
  
Basic earnings (loss) per share – unvested share-based payment awards
    
0.83
      
(1.05
) 
    
2.30
      
0.69
  
Diluted earnings (loss) per share – common stock
    
0.83
      
(1.05
) 
    
2.29
      
0.69
  
Diluted earnings (loss) per share– unvested share-based payment awards
    
0.83
      
(1.05
) 
    
2.29
      
0.69
  
Weighted average number of common shares outstanding
    
7,644,829
      
7,659,811
      
7,641,705
      
7,682,737
  

See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.

 
Page 5
 

CAMDEN NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)

(In Thousands, Except Number of
Shares and per Share Data)
  
Common
Stock
    
Surplus
    
Retained
Earnings
    
Net
Unrealized
Gains
(Losses) on
Securities
Available
for Sale
    
Net
Unrealized
Gains on
Derivative
Instruments
    
Net
Unrecognized
Losses on
Postretirement
Plans
    
Total
Shareholders’
Equity
  
Balance at December 31, 2007
  
$
2,522
    
$
2,629
    
$
 114,289
    
$
1,516
    
$
—
    
$
(753
)
  
$
120,203
  
                                                         
Net income
    
—
      
—
      
5,281
      
—
      
—
      
—
      
5,281
  
Change in net unrealized gains on securities available for sale, net of taxes of $1,969
    
—
      
—
      
—
      
(3,656
)
    
—
      
—
      
(3,656
)
Change in net unrecognized losses on post-retirement plans, net of taxes of ($216)
    
—
      
—
      
—
      
—
      
—
      
402
      
402
  
Total comprehensive income
    
—
      
—
      
5,281
      
(3,656
)
    
—
      
402
      
2,027
  
Shares issued during acquisition of Union Bankshares Company (1,222,497 shares)
    
—
      
43,523
      
—
      
—
      
—
      
—
      
43,523
  
Equity compensation expense
    
—
      
182
      
—
      
—
      
—
      
—
      
182
  
Exercise of stock options and issuance of restricted stock (total 9,733 shares)
    
292
      
(146
)
    
—
      
—
      
—
      
—
      
146
  
Common stock repurchase (109,362 shares)
    
—
      
(134
)
    
(3,383
)
    
—
      
—
      
—
      
(3,517
)
Cash dividends declared ($0.50/share)
    
—
      
—
      
(3,853
)
    
—
      
—
      
—
      
(3,853
)
Balance at  September 30, 2008
  
$
$ 2,814
    
$
46,054
    
$
112,334
    
$
(2,140
)
  
$
—
    
$
(351
)
  
$
158,711
  
                                                         
Balance at December 31, 2008
  
$
2,851
    
$
46,133
    
$
118,564
    
$
(89
)
  
$
—
    
$
(1,059
)
  
$
166,400
  
                                                         
Net income
    
—
      
—
      
17,546
      
—
      
—
      
—
      
17,546
  
Change in unrealized losses on securities available for sale, net of taxes of ($4,443)
    
—
      
—
      
—
      
8,252
      
—
      
—
      
8,252
  
Change in unrealized gains on derivative instruments at fair value, net of taxes of ($6)
    
—
      
—
      
—
      
—
      
11
      
—
      
11
  
Change in net unrecognized losses on postretirement plans, net of taxes of ($25)
    
—
      
—
      
—
      
—
      
—
      
47
      
47
  
Total comprehensive income
    
—
      
—
      
17,546
      
8,252
      
11
      
47
      
25,856
  
Equity compensation expense
    
—
      
295
      
—
      
—
      
—
      
—
      
295
  
Exercise of stock options and issuance of restricted stock (total 6,116 shares)
    
299
      
(289
)
    
(55
)
    
—
      
—
      
—
      
(45
)
Cash dividends declared ($0.75/share)
    
—
      
—
      
(5,735
)
    
—
      
—
      
—
      
(5,735
)
                                                         
Balance at September 30, 2009
  
$
3,150
    
$
46,139
    
$
130,320
    
$
8,163
    
$
11
    
$
(1,012
)
  
$
186,771
  
 
 See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.

 
Page 6
 

CAMDEN NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

  
  
Nine Months Ended September 30,
  
(In Thousands)
  
2009
    
2008
  
Operating Activities
            
Net income
   $ 17,546     $ 5,281  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Provision for loan losses
     6,514       2,120  
Depreciation and amortization
     2,028       1,643  
Equity compensation expense
     295       182  
Decrease in interest receivable
     676       405  
Amortization of core deposit intangible
     376       697  
Net increase in trading assets
     (363 )     —  
Net investment securities (gains) losses
     (1 )      624  
Write-down of other-than-temporarily impaired security
     —       13,950  
Increase in other real estate owned valuation allowance
     1,011       —  
Originations of mortgage loans held for sale
     (72,529 )     —  
Proceeds from the sale of mortgage loans
     71,231       —  
Gain on sale of mortgage loans
     (102 )     —  
Liquidation of defined benefit pension plan
     (735 )     —  
Increase in other assets
     (4,350 )     (1,579 )
Increase (decrease) in other liabilities
     898       (3,703 )
Net cash provided by operating activities
     22,495       19,620  
Investing Activities
                
Acquisition of Union Bankshares Company
     —       (29,299 )
Proceeds from sales and maturities of securities held to maturity
     2,606       90  
Proceeds from sales and maturities of securities available for sale
     138,200       183,807  
Purchase of securities held to maturity
     —       (39 )
Purchase of securities available for sale
     (45,616 )     (211,485 )
Purchase of bank-owned life insurance
     —       (7,450 )
Premium received on deposit sale
     —       1,400  
Net increase in loans
     (22,468 )      (8,592 )
Proceeds from the sale of other real estate owned
     448       420  
Purchase of premises and equipment
     (1,152 )     (882 )
Net cash provided (used) by investing activities
     72,018       (72,030 )
Financing Activities
                
Net increase in deposits
     23,794       75,525  
Proceeds from Federal Home Loan Bank long-term advances
     8,163       199,278  
Repayments on Federal Home Loan Bank long-term advances
     (56,593 )     (218,336 )
Net change in short-term Federal Home Loan Bank borrowings
     (116,375 )     (23,965 )
Net increase in other borrowed funds and junior subordinated debentures
     47,164       38,008  
Common stock repurchase
     —       (3,517 )
Exercise of stock options
     (45 )     146  
Cash dividends paid on common stock
     (5,735 )     (5,405 )
Net cash (used) provided by financing activities
     (99,627 )     61,734  
Net (decrease) increase in cash and cash equivalents
     (5,114 )      9,324  
Cash and cash equivalents at beginning of year
     35,195       28,790  
Cash and cash equivalents at end of period
   $ 30,081     $ 38,114  
Supplemental information
                
Interest paid
   $ 31,837     $ 44,322  
Income taxes paid
     5,200       8,419  
Common stock issued in acquisition
     —       43,523  
Transfer from loans to loans held for sale
     1,298       —  
Transfer from loans to other real estate owned
     2,900       2,599  
 
See Report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated financial statements.

 
Page 7
 

CAMDEN NATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Tables Expressed in Thousands, Except Number of Shares and per Share Data)

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures required by accounting principles generally accepted in the United States of America for complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the consolidated statements of condition of Camden National Corporation (the “Company”) as of September 30, 2009 and December 31, 2008, the consolidated statements of income for the three and nine months ended September 30, 2009 and 2008, the consolidated statements of changes in shareholders' equity for the nine months ended September 30, 2009 and 2008, and the consolidated statements of cash flows for the nine months ended September 30, 2009 and 2008. All significant intercompany transactions and balances are eliminated in consolidation. Certain items from the prior year were reclassified to conform to the current year presentation. The income reported for the three-month and nine-month periods ended September 30, 2009 is not necessarily indicative of the results that may be expected for the full year. The information in this report should be read in conjunction with the consolidated financial statements and accompanying notes included in the December 31, 2008 Annual Report on Form 10-K.

NOTE 2 – EARNINGS PER SHARE

Basic earnings per share (“EPS”) is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Unvested restricted shares and stock options outstanding are not included in common shares outstanding. Diluted EPS reflects the potential that could occur if contracts to issue common stock (such as stock options) were exercised or converted into common shares that would then share in the earnings of the Company. Diluted EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period, plus an incremental number of common-equivalent shares computed using the treasury stock method. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. The Company’s restricted share grants and management stock purchase grants receive non-forfeitable dividends at the same rate as common stock. The following table sets forth the computation of basic and diluted earnings per share under the two-class method:

 
Page 8
 

   
Three Months Ended September 30,
    
Nine Months Ended September 30,
  
   
2009
    
2008
    
2009
    
2008
  
Net income (loss), as reported
  
$
6,328
    
$
(8,020
)
  
$
17,546
    
$
5,281
  
Weighted-average common shares outstanding – basic
    
7,644,829
      
7,659,811
      
7,641,705
      
7,682,737
  
Dilutive effect of stock-based compensation
    
9,346
      
—
      
4,119
      
1,066
  
Weighted-average common and potential common shares – diluted
  
  
7,654,175
      
7,659,811
      
7,645,824
      
7,683,803
  
Basic earnings (loss) per share – common stock
  
$
0.83
    
$
(1.05
)
  
$
2.30
    
$
0.69
  
Basic earnings (loss) per share – unvested share-based payment awards
    
0.83
      
(1.05
)
    
2.30
      
0.69
  
Diluted earnings (loss) per share – common stock
    
0.83
      
(1.05
)
    
2.29
      
0.69
  
Diluted earnings (loss) per share– unvested share-based payment awards
    
0.83
      
(1.05
)
    
2.29
      
0.69
  

At September 30, 2009 and 2008, options to purchase 64,750 and 60,750 shares, respectively, of common stock were not considered in the computation of potential common shares for purposes of diluted EPS, since the exercise prices of the options were greater than the average market price of the common stock for the respective periods.

NOTE 3 – SECURITIES

The following tables summarize the amortized costs and fair values of securities available for sale and held to maturity, as of the dates indicated:

   
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
September 30, 2009
                        
Available for sale
                        
Obligations of U.S. government sponsored enterprises
  
$
4,503
    
$
9
    
$
—
    
$
4,512
  
Obligations of states and political subdivisions
    
21,525
      
637
      
—
      
22,162
  
Mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises
    
437,654
      
18,606
      
(56
)
    
456,204
  
Private issue collateralized mortgage obligations
    
44,726
      
25
      
(5,985
)
    
38,766
  
Total debt securities
    
508,408
      
19,277
      
(6,041
)
    
521,644
  
Equity securities
    
5,000
      
—
      
(678
)
    
4,322
  
Total securities available for sale
  
$
513,408
    
$
19,277
    
$
(6,719
)
  
$
525,966
  
Held to maturity
                                
Obligations of states and political subdivisions
  
$
39,366
    
$
2,385
    
$
—
    
$
41,751
  
Total securities held to maturity
  
$
39,366
    
$
2,385
    
$
—
    
$
41,751
  
 
                               
December 31, 2008
                                
Available for sale
                                
Obligations of U.S. government sponsored enterprises
  
$
4,539
    
$
64
    
$
—
    
$
4,603
  
Obligations of states and political subdivisions
    
25,457
      
105
      
(215
)   
    
25,347
  
Mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises
    
514,049
      
11,339
      
(52
)   
    
525,336
  
Private issue collateralized mortgage obligations
    
57,123
      
1
      
(10,347
)   
    
46,777
  
Total debt securities
    
601,168
      
11,509
      
(10,614
)   
    
602,063
  
Equity securities
    
5,000
      
—
      
(1,032
)   
    
3,968
  
Total securities available for sale
  
$
606,168
    
$
11,509
    
$
(11,646
)
  
$
606,031
  
Held to maturity
                                
Obligations of states and political subdivisions
  
$
42,040
    
$
213
    
$
(299
)
  
$
41,954
  
Total securities held to maturity
  
$
42,040
    
$
213
    
$
(299
)
  
$
41,954
  

For the first nine months of 2009, there were three sales totaling $530,000 in the available for sale and one sale for $224,000 in the held to maturity portfolios. The sale in the held to maturity portfolio was due to a drop in credit rating.  Unrealized gains on securities available for sale arising during the first three quarters of 2009 and included in other comprehensive income amounted to $12.6 million, net of deferred taxes of $4.4 million.
 
 
Page 9
 
 
At September 30, 2009, securities with an amortized cost of $396.5 million and a fair value of $412.1 million were pledged to secure Federal Home Loan Bank (“FHLBB”) advances, public deposits, securities sold under agreements to repurchase and other purposes required or permitted by law.
 
The amortized cost and fair values of debt securities by contractual maturity at September 30, 2009 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
Amortized
Cost
  
Fair
Value
  
Available for sale
    
  
    
  
  
Due in one year or less
  
$
8,438
  
$
8,496
  
Due after one year through five years
    
36,147
    
37,434
  
Due after five years through ten years
    
59,777
    
61,693
  
Due after ten years
    
404,046
    
414,021
  
  
  
$
508,408
  
$
521,644
  
Held to maturity
              
Due after one year through five years
  
$
1,456
  
$
1,471
  
Due after five years through ten years
    
23,830
    
25,414
  
Due after ten years
    
14,080
    
14,866
  
  
  
$
39,366
  
$
41,751
  

Management reviews the investment portfolio on a periodic basis to determine the cause, magnitude and duration of declines in the fair value of each security. Thorough evaluations of the causes of the unrealized losses are performed to determine whether the impairment is temporary or other than temporary in nature. Considerations such as the ability of the securities to meet cash flow requirements, levels of credit enhancements, risk of curtailment, recoverability of invested amount over a reasonable period of time and the length of time the security is in a loss position, for example, are applied in determining other than temporary impairment.

The following table shows the gross unrealized losses and fair values of investment securities at September 30, 2009 and December 31, 2008, by length of time that individual securities in each category have been in a continuous loss position.

   
Less Than 12 Months
    
12 Months or More
    
Total
  
  
  
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
September 30, 2009
                                    
Mortgage-backed securities
  
$
10,793
    
$
(55
)
  
$
59
    
$
(1
)
  
$
10,852
    
$
(56
)
Private issue collateralized mortgage obligations
    
507
      
(94
)
    
32,628
      
(5,891
)
    
33,135
      
(5,985
)
Equity securities
    
4,322
      
(678
)
    
—
      
—
      
4,322
      
(678
)
Total
  
$
15,622
    
$
(827
)
  
$
32,687
    
$
(5,892
)
  
$
48,309
    
$
(6,719
)
                                                 
December 31, 2008
                                                
Obligations of states and political subdivisions
  
$
32,393
    
$
(477
)
  
$
770
    
$
(37
)
  
$
33,163
    
$
(514
)
Mortgage-backed securities
    
18,440
      
(38
)
    
4,407
      
(14
)
    
22,847
      
(52
)
Private issue collateralized mortgage obligations
    
37,106
      
(6,193
)
    
9,652
      
(4,154
)
    
46,758
      
(10,347
)
Equity securities
    
3,968
      
(1,032
)
    
—
      
—
      
3,968
      
(1,032
)
Total
  
$
91,907
    
$
(7,740
)
  
$
14,829
    
$
(4,205
)
  
$
106,736
    
$
(11,945
)
 
 
Page 10
 

At September 30, 2009, $48.3 million of the Company’s investment securities had unrealized losses that are considered temporary. The majority of the unrealized loss was related to the private issue collateralized mortgage obligations (“CMOs”), which are all rated as Triple-A except for $10.6 million that have been downgraded to non-investment grade. The Company’s share of these downgraded CMOs is in the senior tranches. Management believes the unrealized loss for the CMOs is the result of current market illiquidity and the underestimation of value in the market. Including the CMOs, there were 20 securities with a fair value of $32.7 million in the portfolio which had unrealized losses for twelve months or longer. Management currently has the intent and ability to retain these investment securities with unrealized losses until the decline in value has been recovered.

At September 30, 2009, the Company held Duff & Phelps Select Income Fund Auction Preferred Stock with an amortized cost of $5.0 million which has failed at auction. The security is rated Triple-A by Moody’s and Standard and Poor’s. Management believes the failed auctions are a temporary liquidity event related to this asset class of securities. The Company is currently collecting all amounts due according to contractual terms and has the ability and intent to hold the securities until they clear auction, are called, or mature; therefore, the securities are not considered other than temporarily impaired.
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the Company’s loan portfolio, including residential loans held for sale, at September 30, 2009 and December 31, 2008 was as follows:

   
September 30,
    
December 31,
  
   
2009
    
2008
  
Residential real estate loans
  
$
627,662
    
$
620,956
  
Commercial real estate loans
    
428,059
      
400,312
  
Commercial loans
    
195,818
      
213,683
  
Consumer loans
    
269,919
      
265,865
  
Deferred loan fees net of costs
    
(479
)
    
92
  
Total loans
  
$
1,520,979
    
$
1,500,908
  

Non-accrual loans at September 30, 2009 were $16.6 million, or 1.09% of total loans, compared to $12.5 million, or 0.83% of total loans, at December 31, 2008. Non-accrual loans at September 30, 2009 were comprised of $4.2 million in commercial loans, $5.3 million in commercial real estate loans, $5.8 million in residential real estate loans, and $1.3 million in consumer loans. Non-accrual loans at December 31, 2008 consisted of $5.0 million in commercial real estate loans, $4.0 million in residential real estate loans, $2.4 million in commercial loans, and $1.1 million in consumer loans.

During the nine months ended September 30, 2009, the Company sold $71.2 million of residential mortgage loans to the secondary market, which resulted in a gain on the sale of $102,400 and an increase in mortgage servicing income of $796,000 due to the recognition of the related mortgage servicing asset.

The allowance for loan losses (“ALL”) is management’s best estimate of inherent risk of loss in the loan portfolio as of the statement of condition date. Management makes various assumptions and judgments about the collectability of the loan portfolio and provides an allowance for potential losses based on a number of factors. If the assumptions are wrong, the ALL may not be sufficient to cover losses and may cause an increase in the allowance in the future. Among the factors that could affect the Company’s ability to collect loans and require an increase to the allowance in the future are: general real estate and economic conditions; regional credit concentration; industry concentration, for example in the hospitality, tourism and recreation industries; and a requirement by the Federal and state regulators to increase the provision for loan losses or recognize additional charge-offs.
 
 
Page 11
 

The following is a summary of activity in the allowance for loan losses:

   
Three Months Ended
    
Nine Months Ended
  
  
  
September 30, 2009
    
September 30, 2008
    
September 30, 2009
    
September 30, 2008
  
Balance at beginning of period
  
$
18,654
    
$
17,266
    
$
17,691
    
$
13,653
  
Acquired from Union Trust
    
—
      
—
      
—
      
4,369
  
Loan charge-offs
    
(1,356
)
    
(1,478
)
    
(5,354
)
    
(3,549
)
Recoveries on loans previously charged off
    
137
      
254
      
584
      
619
  
Net charge-offs
    
(1,219
)
    
(1,224
)
    
(4,770
)
    
(2,930
)
Provision for loan losses
    
2,000
      
1,170
      
6,514
      
2,120
  
Balance at end of period
  
$
19,435
    
$
17,212
    
$
19,435
    
$
17,212
  

NOTE 5 – GOODWILL, CORE DEPOSIT AND TRUST RELATIONSHIP INTANGIBLES

During the first quarter of 2008, the Company acquired $37.8 million of goodwill, $5.0 million of core deposit intangible and $753,000 of trust relationship intangible related to the acquisition of Union Bankshares Company (“Union Bankshares”). During the quarter ended March 31, 2009, the Company completed its final adjustments to the goodwill related to the Union Bankshares acquisition.  The changes in goodwill, core deposit intangible and trust relationship intangible for the nine months ended September 30, 2009 are shown in the table below:

   
Goodwill
  
   
Banking
    
Financial Services
    
Total
  
Balance at December 31, 2008
  
$
34,797
    
$
7,060
    
$
41,857
  
2009 activity
    
(77
)
    
—
      
(77
)
Balance at September 30, 2009
  
$
34,720
    
$
7,060
    
$
41,780
  
 
   
Core Deposit Intangible
  
   
Total
    
Accumulated Amortization
    
Net
  
Balance at December 31, 2008
  
$
14,444
    
$
(9,926
)
  
$
4,518
  
2009 activity
    
—
      
(376
)
    
(376
)
Balance at September 30, 2009
  
$
14,444
    
$
(10,302
)
  
$
4,142
  

   
Trust Relationship Intangible
  
   
Total
    
Accumulated Amortization
    
Net
  
Balance at December 31, 2008
  
$
753
    
$
            (75
)
  
$
678
  
2009 activity
    
—
      
(57
)
    
(57
)
Balance at September 30, 2009
  
$
753
    
$
(132
)
  
$
621
  

During the fourth quarter of 2008, the Company completed its annual impairment evaluation of goodwill and did not identify any impairment.

The following table reflects the expected amortization schedule for intangible assets at September 30, 2009:

   
Trust Relationship
    
Core Deposit
  
   
Intangible
    
Intangible
  
2009
  
$
18
    
$
126
  
2010
    
75
      
502
  
2011
    
75
      
502
  
2012
    
75
      
502
  
2013
    
75
      
502
  
Thereafter
    
303
      
2,008
  
Total unamortized intangible
  
$
621
    
$
4,142
  
 
 
Page 12
 
 
NOTE 6 – OTHER REAL ESTATE OWNED

Other real estate owned (“OREO”) properties acquired through foreclosure or deed-in-lieu of foreclosure are recorded at the fair value of the real estate, less costs to sell.  Any write-down of the recorded investment in the related loan is charged to the allowance for loan losses upon transfer to OREO.  Subsequent write-downs required for declines in value are recorded through a valuation allowance and a provision for losses charged to other non-interest expense.

Activity in other real estate owned was as follows:
 
   
Nine Months Ended September 30,
  
  
  
2009
    
 2008
  
Balance at beginning of year
  
$
4,024
    
$
400
  
Acquired from Union Trust
    
—
      
120
  
Additions
    
2,900
      
2,599
  
Increase in OREO valuation allowance
    
(1,011
) 
    
—
  
Properties sold
    
(448
) 
    
(420
)
Balance at end of period
  
$
5,465
    
$
2,699
  
 
NOTE 7 – MORTGAGE SERVICING

Residential real estate mortgages are originated by the Company both for portfolio and for sale into the secondary market. The Company may sell its loans to institutional investors such as Freddie Mac. Under loan sale and servicing agreements with the investor, the Company generally continues to service the residential real estate mortgages. The Company pays the investor an agreed-upon rate on the loan, which is less than the interest rate the Company receives from the borrower. The Company retains the difference as a fee for servicing the residential real estate mortgages. The Company capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment. The balance of capitalized mortgage servicing rights, net of a valuation allowance, included in other assets at September 30, 2009 and 2008 and December 31, 2008 was $852,000, $712,000, and $139,000, respectively. At these dates, the fair market value of the mortgage servicing rights approximated $932,600, $733,000, and $174,000, respectively. In evaluating the reasonableness of the carrying values of mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans. The model utilizes a variety of assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows. Prepayment assumptions, which are impacted by loan rates and terms, are calculated using a three-month moving average of weekly prepayment data published by the Public Securities Association and modeled against the serviced loan portfolio by the third party valuation specialist. The discount rate is the quarterly average 10-year US Treasury rate plus 5.1%. Other assumptions include delinquency rates, foreclosure rates, servicing cost inflation, and annual unit loan cost. All assumptions are adjusted periodically to reflect current circumstances. Amortization of the mortgage servicing rights, as well as write-offs of capitalized rights due to prepayments of the related mortgage loans, are recorded as a charge against mortgage servicing fee income.

Mortgage loans serviced for others are not included in the accompanying Consolidated Statements of Condition of the Company and amounted to $221.3 million and $194.7 million at September 30, 2009 and 2008, respectively.
 
 
Page 13
 
 
The following summarizes mortgage servicing rights capitalized and amortized, along with the activity in the related valuation allowance:

   
Nine Months Ended September 30,
  
  
  
2009
  
  
2008
  
Mortgage Servicing Rights:
    
  
      
  
  
Balance at beginning of year
  
$
139
    
$
142
  
Acquired from Union Bankshares
    
—
      
1,199
  
Capitalized mortgage servicing rights
    
796
      
—
  
Amortization charged against mortgage banking income
    
(515
)
    
(618
)
Valuation adjustment
    
432
      
(11
)
Balance at end of period
  
$
852
    
$
712
  
Valuation Allowance:
    
  
      
  
  
Balance at beginning of year
  
$
(469
)   
  
$
(1
)
Increase in impairment reserve
    
—
      
(11
)
Reduction of impairment reserve
    
432
      
—
  
Balance at end of period
  
$
(37
)
  
$
(12
)

NOTE 8 – EMPLOYEE BENEFIT PLANS

Pension Plan
The Company, through its acquisition of Union Bankshares, had a qualified noncontributory defined benefit pension plan covering substantially all permanent full-time employees of the former Union Bankshares. Effective May 15, 2005, benefits accrued under this defined benefit plan were frozen based on participants’ then current service and pay levels. During the fourth quarter of 2008 and the first quarter of 2009, the plan was liquidated.  On January 12, 2009, the Company paid out the remaining $735,000 liability related to this plan.

Supplemental Executive Retirement Plan
The Company maintains an unfunded, non-qualified supplemental executive retirement plan for certain officers.  The components of net period benefit cost for the periods ended September 30, 2009 and 2008 were as follows:
 
  
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
  
  
2009
    
2008
    
2009
    
2008
  
Net period benefit cost
                        
Service cost
  
$
51
    
$
46
    
$
153
    
$
238
  
Interest cost
    
104
      
65
      
312
      
195
  
Recognized net actuarial loss
    
19
      
—
      
57
      
—
  
Recognized prior service cost
    
4
      
5
      
13
      
15
  
Net period benefit cost
  
$
178
    
$
116
    
$
535
    
$
448
  
 
Other Postretirement Benefit Plan
The Company provides medical and life insurance to certain eligible retired employees.  The components of net period benefit cost for the periods ended September 30, 2009 and 2008 were as follows:
 
 
Page 14
 
 
  
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
  
  
2009
    
2008
    
2009
    
2008
  
Net period benefit cost
                        
Service cost
  
$
16
    
$
16
    
$
48
    
$
48
  
Interest cost
    
34
      
34
      
102
      
102
  
Recognized net actuarial loss
    
—
      
—
      
1
      
—
  
Net period benefit cost
  
$
50
    
$
50
    
$
151
    
$
150
  

NOTE 9 – SHAREHOLDERS’ EQUITY

Dividends
The primary source of funds available to the Company for payment of dividends to its shareholders is dividends paid to the Company by its subsidiaries. The Company’s subsidiaries are subject to certain requirements imposed by federal banking laws and regulations. These requirements, among other things, establish minimum levels of capital and restrict the amount of dividends that may be distributed by the subsidiaries to the Company. Under regulations prescribed by the Office of the Comptroller of the Currency (the “OCC”), without prior OCC approval a bank subsidiary may not declare dividends in any year in excess of the bank’s (i) net income for the current year, (ii) plus its retained net income for the prior two years. Due to the large dividends paid in the fourth quarter of 2007 to fund the Union Bankshares acquisition, the Bank sought and obtained OCC approval to pay dividends in the first three quarters of 2009 in excess of its current and retained net income for the period from January 1, 2007 through December 31, 2008. The Company expects this OCC approval to remain in place until the Bank’s retained net income meets the required regulatory levels and approval is no longer necessary. The Company paid $1.9 million and $1.9 million in dividends to shareholders for the three month periods ended September 30, 2009 and 2008, respectively.  For the nine months ended September 30, 2009 and 2008 dividends paid to shareholders totaled $5.7 million and $5.4 million, respectively.

Common Stock Repurchase
In June 2008, the Company’s Board of Directors approved the 2008 Common Stock Repurchase Program. Under the program, the Company was authorized to repurchase up to 750,000 shares of its outstanding common stock for a one-year period. Under the 2008 Plan, the Company repurchased 50,000 shares of common stock at an average price of $32.00 during the second half of 2008 and made no repurchases in the first half of 2009.  The authority, which expired on July 1, 2009, was not renewed for the coming year.

NOTE 10 – SHARE-BASED COMPENSATION PLANS

The 2003 Stock Option and Incentive Plan (the “Plan”) provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, deferred stock, unrestricted stock, performance share and dividend equivalent rights.

Compensation expense recognized in connection with the share-based arrangements is presented in the following table:

  
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
  
  
2009
    
2008
    
2009
    
2008
  
Stock options
  
$
43
    
$
24
    
$
147
    
$
66
  
Restricted stock awards
    
8
      
38
      
131
      
101
  
Management stock purchase plan
    
5
      
2
      
17
      
15
  
       Total share-based compensation expense
  
$
56
    
$
64
    
$
295
    
$
182
  

At September 30, 2009, there was $515,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements (including stock option and non-vested share awards) granted under the Plan.
 
 
Page 15
 

Option activity for the nine months ended September 30, 2009 is as follows:

  
  
Number of
Shares
    
Weighted-
Average
Exercise
Price
    
Weighted
Average
Remaining
Contractual
Term
    
Aggregate
Intrinsic
Value
($000)
  
Options outstanding at December 31, 2008
    
91,600
    
$
36.73
              
Granted
    
53,500
      
24.91
              
Forfeited
    
(11,300
)
    
35.56
              
Options outstanding at September 30, 2009
    
133,800
    
$
32.10
      
7.5
    
$
507
  
Options exercisable at September 30, 2009
    
49,400
    
$
35.76
      
5.8
    
$
59
  

During the first nine months of 2009, the Company awarded 2,000 shares of restricted stock with vesting occurring over a three-year period.  Under the Management Stock Purchase Plan, 3,339 shares were granted in lieu of management employees’ annual incentive bonus during the first nine months of 2009.

NOTE 11 – FAIR VALUE

Effective June 15, 2009, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Staff Position FAS 107-1, Interim Disclosures about Fair Value of Financial Instruments, now included in the FASB Accounting Standards CodificationTM (ASC or Codification) as part of FASB ASC 825-10-65, which requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements.  In accordance with FASB ASC 825-10-65, the Company has included the fair value of financial instruments at September 30, 2009.

The Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, now included in the Codification as part of FASB ASC 820-10, framework defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accordingly, FASB ASC 820-10 requires an “exit price” approach to value and establishes a fair value hierarchy which prioritizes the inputs used to measure fair value, requiring entities to maximize the use of market or observable inputs (as more reliable measures) and minimize the use of unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs generally require significant management judgment. The Company, in estimating its fair value disclosures, uses the following methods and assumptions:

Cash and Due from Banks:   The carrying amounts of cash and due from banks approximate their fair value.

Securities Available for Sale and Trading Account Assets: The fair value of securities available for sale and trading account assets is reported utilizing prices provided by an independent pricing service based on recent trading activity and other observable information including, but not limited to, dealer quotes, market spreads, cash flows, market interest rate curves, market consensus prepayment speeds, credit information, and the bond’s terms and conditions. The fair value of equity securities was calculated using a discounted cash flow analysis using observable information including, but not limited to, cash flows, risk-adjusted discount rates and market spreads.
 
Securities Held to Maturity:   Fair values of securities held to maturity are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
 
Federal Home Loan and Federal Reserve Bank Stock:   The carrying amount approximates fair value.
 
 
Page 16
 
 
Loans:   For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loan impairment is deemed to exist when full repayment of principal and interest according to the contractual terms of the loan is no longer probable. Impaired loans are reported based on one of three measures: the present value of expected future cash flows discounted at the loan’s effective interest rate; the loan’s observable market price; or the fair value of the collateral if the loan is collateral dependent. If the fair value measure is less than an impaired loan’s recorded investment, an impairment loss is recognized as part of the ALL. Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis. Management has estimated the fair values of these assets using Level 2 inputs, such as the fair value of collateral based on independent third-party appraisals for collateral-dependent loans.
 
Loans Held for Sale: The fair value of loans held for sale is based on secondary mortgage market prices.

Derivatives: Derivatives are reported at fair value utilizing Level 2 inputs obtained from third parties to value interest rate caps and swaps.

OREO: OREO property is recorded individually at net realizable value on the date of acquisition. Upon acquisition of a property, a current appraisal or broker’s opinion must substantiate market value for the property. At the acquisition date, if the net realizable value of the property is less than the book value of the loan, a charge to the ALL is recorded. If, after the initial acquisition, the value of the property becomes permanently impaired as determined by an appraisal or an evaluation in accordance with the Company’s appraisal policy, the Company records the decline by charging the impairment against current earnings.

Mortgage Servicing Rights: Mortgage servicing rights are evaluated regularly for impairment based upon the fair value of the servicing rights as compared to their amortized cost. The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The Company obtains a third-party valuation based upon loan level data including note rate, type and term of the underlying loans. The model utilizes a variety of observable inputs for its assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows. Other assumptions include delinquency rates, servicing cost inflation, and annual unit loan cost.

Interest Receivable and Payable:  The carrying amounts approximate their fair value.
 
Deposits:   The fair value of deposits, with no stated maturity, is equal to the carrying amount. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates and remaining maturities for currently offered certificates of deposit.
 
Borrowings:   The carrying amounts of short-term borrowings from the FHLBB, securities sold under repurchase agreements, note payable and other short-term borrowings approximate fair value. The fair value of long-term borrowings and commercial repurchase agreements is based on the discounted cash flows using current rates for advances of similar remaining maturities.
 
Junior Subordinated Debentures:   The fair value is estimated using a discounted cash flow calculation that applies current rates for debentures of similar maturity.
 
 
Page 17
 

The following table summarizes assets and liabilities measured at fair value on a recurring basis:

September 30, 2009
  
  
  
Level 1
  
Level 2
  
Level 3
  
Total
  
Assets:
    
  
    
  
    
  
    
  
  
Securities available for sale
  
$
—
  
$
525,966
  
$
—
  
$
525,966
  
Trading account assets
    
1,667
    
—
    
—
    
1,667
  
Derivative instruments
    
—
    
17
    
—
    
17
  

December 31, 2008
  
  
  
Level 1
  
Level 2
  
Level 3
  
Total
  
Assets:
    
  
    
  
    
  
    
  
  
Securities available for sale
  
$
—
  
$
606,031
  
$
—
  
$
606,031
  
Trading account assets
    
1,304
    
—
    
—
    
1,304
  
Derivative instruments (The fair value was less than $1)
    
—
    
—
    
—
    
—
  

The following table summarizes assets and liabilities measured at fair value on a nonrecurring basis:

September 30, 2009
  
  
  
Level 1
  
Level 2
  
Level 3
  
Total
  
Assets:
    
  
    
  
    
  
    
  
  
Impaired loans
  
$
—
  
$
15,286
  
$
—
  
$
15,286
  
Other real estate owned
    
—
    
—
    
5,465
    
5,465
  
Mortgage servicing rights
    
—
    
933
    
—
    
933
  

December 31, 2008
  
  
  
Level 1
  
Level 2
  
Level 3
  
Total
  
Assets:
    
  
    
  
    
  
    
  
  
Impaired loans
  
$
—
  
$
11,158
  
$
—
  
$
11,158
  
Other real estate owned
    
—
    
—
    
4,024
    
4,024
  
Mortgage servicing rights
    
—
    
174
    
—
    
174
  

The following is a summary of carrying amount and estimated fair value of the Company’s financial instruments:

  
  
September 30, 2009
  
December 31, 2008
  
  
  
Carrying
Amount
  
Fair Value
  
Carrying
Amount
  
Fair Value
  
Financial assets:
    
  
    
  
              
Cash and due from banks
  
$
30,081
  
$
30,081
  
$
35,195
  
$
35,195
  
Securities available for sale
    
525,966
    
525,966
    
606,031
    
606,031
  
Securities held to maturity
    
39,366
    
41,751
    
42,040
    
41,954
  
Federal Home Loan and Federal Reserve Bank stock
    
21,965
    
21,965
    
21,969
    
21,969
  
Trading account assets
    
1,667
    
1,667
    
1,304
    
1,304
  
Loans held for sale
    
1,298
    
1,308
    
—
    
—
  
Loans receivable, net of allowance
    
1,500,246
    
1,489,908
    
1,483,217
    
1,472,454
  
Interest receivable
    
7,649
    
7,649
    
8,325
    
8,325
  
Financial liabilities:
                          
Deposits
    
1,513,334
    
1,520,421
    
1,489,517
    
1,486,620
  
Advances from Federal Home Loan Bank
    
210,495
    
215,366
    
258,925
    
261,243
  
Commercial repurchase agreements
    
126,494
    
133,247
    
126,577
    
131,197
  
Other borrowed funds
    
163,933
    
163,933
    
232,893
    
232,893
  
Junior subordinated debentures
    
43,487
    
51,769
    
43,410
    
48,376
  
Interest payable
    
2,931
    
2,931
    
3,621
    
3,621
  
 
 
Page 18
 


NOTE 12 – COMMITMENTS AND CONTINGENCIES

Legal Contingencies
Various legal claims arise from time to time in the normal course of business, which in the opinion of management, are not expected to have a material effect on the Company’s consolidated financial statements.

Financial Instruments
In the normal course of business, the Company is a party to both on-balance sheet and off-balance sheet financial instruments involving, to varying degrees, elements of credit risk and interest rate risk in addition to the amounts recognized in the Consolidated Statements of Condition. For further information, refer to the Contractual Obligations and Commitments section within Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Lending-Related Instruments
The contractual amounts of the Company’s lending-related financial instruments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. These instruments are subject to the Company’s credit approval process, including an evaluation of the customer’s creditworthiness and related collateral requirements. Commitments generally have fixed expiration dates or other termination clauses.

Derivative Financial Instruments
The Company uses derivative financial instruments for risk management purposes and not for trading or speculative purposes. The Company controls the credit risk of these instruments through collateral, credit approvals and monitoring procedures.

The Company has an interest rate cap agreement with a cap rate of 5.50%, a notional amount of $20.0 million, and an expiration date of March 15, 2010. The fair value of the cap agreement at September 30, 2009 was less than $1,000 and was recorded in other assets. The Company considers this instrument to be an economic hedge; thus, changes in fair value are recorded in the Statement of Income.

The Company has a notional amount of $20.0 million in forward interest rate swap agreements on its junior subordinated debentures. As the interest on these debentures converts from fixed interest rate to variable rate on June 30, 2011, the Company swapped a portion of the variable cost for a fixed cost.  One $10.0 million notional amount forward interest rate swaps is for ten years with a fixed cost of 5.09% maturing on June 20, 2021, and a second $10.0 million notional amount forward interest rate swap is for 18 years with a fixed cost of 5.84% maturing on June 30, 2029. The fair value of the swap agreements at September 30, 2009 was $16,900 and, as this instrument qualifies as a highly effective cash flow hedge, the change in fair value was recorded in other comprehensive income, net of tax, and other liabilities.

As part of originating residential mortgage and commercial loans, the Company may enter into rate lock agreements with customers and may issue commitment letters to customers, which are considered interest rate lock or forward commitments. At September 30, 2009 and December 31, 2008, based upon the pipeline of mortgage loans with rate lock commitments and commercial loans with commitment letters, and the fair value of those commitments, the Company determined the impact was not material.

NOTE 13 – RECENT ACCOUNTING PRONOUNCEMENTS

 In June 2009, the FASB issued SFAS No. 166 (not incorporated into the Codification yet), Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140, to improve the reporting for the transfer of financial assets resulting from 1) practices that have developed since the issuance of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, that are not consistent with the original intent and key requirements of that Statement and 2) concerns of financial statement users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company will review the requirements of SFAS No. 166 and comply with its requirements. The Company does not expect that the adoption of this Statement will have a material impact on the Company’s consolidated financial statements.
 
 
Page 19
 

In June 2009, the FASB issued SFAS No. 167 (not incorporated into the Codification yet), Amendments to FASB Interpretation No. 46(R), to amend certain requirements of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. The Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company will review the requirements of SFAS No. 167 and comply with its requirements. The Company does not expect that the adoption of this Statement will have a material impact on the Company’s consolidated financial statements.
 
 In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162. This change initiated by this Statement is now included in the Codification as FASB ASC 105-10.  Under the Statement, the Codification became the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification became non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. In the FASB’s view, the issuance of this Statement and the Codification will not change GAAP, except for those nonpublic nongovernmental entities that must now apply the American Institute of Certified Public Accountants Technical Inquiry Service Section 5100, “Revenue Recognition,” paragraphs 38–76, now part of FASB ASC Topic 985.  Management adopted FASB ASC 105-10 in the third quarter of 2009 and there was no material impact on the financial statements of the Company.

In August, 2009, the FASB issued Accounting Standards Update (ASU) 2009-05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value,” which updates FASB ASC 820-10.  The update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques:

1. A valuation technique that uses a.) the quoted price of an identical liability when traded as an asset, or b.) quoted prices for similar liabilities or similar liabilities when traded as assets.
2. Another valuation technique that is consistent with the principles of FASB ASC 820, examples include an income approach, such as a present value technique, or a market approach, such as a technique that is based on the amount at measurement date that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability.

This standard is effective for financial statements issued for interim and annual periods beginning after August 2009.  The Company will adopt ASU 2009-05 effective for the quarter ending December 31, 2009.  The Company does not expect that the adoption will have a material impact on the Company’s consolidated financial statements.

NOTE 14 – SUBSEQUENT EVENTS

On October 16, 2009, the Company’s security group discovered that an employee of Camden National Bank, a subsidiary of the Company, engaged in a series of improper and unauthorized transactions. The Company is in discussions with its insurance carrier and aggressively taking steps to recover the funds, including cooperating with law enforcement authorities.  To date, transactions involving approximately $850,000 have been identified, but the investigation is still in its preliminary stages. Management does not believe that a material loss is probable and the amount of loss, if any, is not reasonably estimable at this time.

Subsequent events have been evaluated through October 30, 2009, the date financial statements are filed with the SEC. Through that date, except for the matter previously discussed, there were no additional events requiring disclosure.
 
 
Page 20
 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
FORWARD-LOOKING STATEMENTS
 
The discussions set forth below and in the documents we incorporate by reference herein contain certain statements that may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. The Company may make written or oral forward-looking statements in other documents we file with the Securities Exchange Commission, 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,” “will,” “should” and other expressions which 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, but are not limited to, the following:
 
 
•
continuing adverse general, national, regional or local economic conditions that could impact the performance of the Company’s investment portfolio, quality of credits or the overall demand for services;
 
•
changes in loan default and charge-off rates could affect the allowance for loan losses;
 
•
declines in the equity and financial markets which could result in impairment of goodwill;
 
•
reductions in deposit levels could necessitate increased and/or higher cost borrowing to fund loans and investments;
 
•
declines in mortgage loan refinancing, equity loan and line of credit activity which could reduce net interest and non-interest income;
 
•
changes in the domestic interest rate environment and inflation, as substantially all of the assets and virtually all of the liabilities are monetary in nature;
 
•
changes in the carrying value of investment securities and other assets;
 
•
further actions by the U.S. government and Treasury Department, similar to the Federal Home Loan Mortgage Corporation conservatorship, which could have a negative impact on the Company’s investment portfolio and earnings;
 
•
misalignment of the Company’s interest-bearing assets and liabilities;
 
•
increases in loan repayment rates affecting interest income and the value of mortgage servicing rights; and
 
•
changing business, banking, or regulatory conditions or policies, or new legislation affecting the financial services industry, that could lead to changes in the competitive balance among financial institutions, restrictions on bank activities, changes in costs (including deposit insurance premiums), increased regulatory scrutiny, declines in consumer confidence in depository institutions, or changes in the secondary market for bank loan and other products;
 
•
changes in accounting rules, Federal and State laws, Internal Revenue Service regulations, and other regulations and policies governing financial holding companies and their subsidiaries which may impact our ability to take appropriate action to protect our financial interests in certain loan situations.
 
You should carefully review all of these factors, and be aware that there may be other factors that could cause differences, including the risk factors listed in Item 1A. Risk Factors within our Annual Report on Form 10-K for the year ended December 31, 2008.  Readers should carefully review the risk factors described therein and should not place undue reliance on our forward-looking statements.

These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
 
 
Page 21
 
 
CRITICAL ACCOUNTING POLICIES

In preparing the Consolidated Financial Statements, management is required to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could 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 loan losses (“ALL”), accounting for acquisitions and review of goodwill and other identifiable intangible assets for impairment, valuation of other real estate owned, other than temporary impairment of investments, accounting for postretirement plans and income taxes. Our significant accounting policies and critical estimates are summarized in Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2008.

Allowance for Loan Losses. In preparing the Consolidated Financial Statements, the ALL requires the most significant amount of management estimates and assumptions. The ALL, which is established through a charge to the provision for loan losses, is based on our evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. We regularly evaluate the ALL for adequacy by taking into consideration, among other factors, local industry trends, management’s ongoing review of individual loans, trends in levels of watched or criticized assets, an evaluation of results of examinations by regulatory authorities and other third parties, analyses of historical trends in charge-offs and delinquencies, the character and size of the loan portfolio, business and economic conditions and our estimation of probable losses.

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 includes four elements: (1) identification of loss allocations for certain specific loans, (2) loss allocation factors for certain loan types based on credit grade and loss experience, (3) general loss allocations for other environmental factors, and (4) unallocated allowance. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The methodology is in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). 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 and flexibility, 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 contingencies, management strength, and the industry in which the obligor operates. These factors are based on an evaluation of historical information, as well as 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. 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 residential mortgages 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. We also consider the results of regulatory examinations, historical loss ranges, portfolio composition, and other changes in the portfolio. An additional allocation is determined based on a judgmental process whereby management considers qualitative and quantitative assessments of other environmental factors. For example, a significant portion of our loan portfolio is concentrated among borrowers in southern Maine and a substantial portion of the portfolio is collateralized by real estate in this area. Another portion of the commercial and commercial real estate loans are to borrowers in the hospitality, tourism and recreation industries. Finally, an unallocated portion of the total allowance is maintained to allow for shifts in portfolio composition.

Since 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 results of regulatory examinations. While management’s evaluation of the ALL as of September 30, 2009 determined the allowance to be appropriate, under adversely different conditions or assumptions, we may need to increase the allowance. The Corporate Risk Management group reviews the ALL with the Camden National Bank Board of Directors on a monthly basis. A more in-depth review of the ALL, including the methodology for calculating and allocating the ALL, is reviewed with the Company’s Board of Directors, as well as the Camden National Bank Board of Directors, on a quarterly basis.
 
Page 22

Accounting for Acquisitions and Review of Goodwill and Identifiable Intangible Assets for Impairment. We are required to record assets acquired and liabilities assumed at their fair value, which is an estimate determined by the use of internal or other valuation techniques. These valuation estimates result in goodwill and other intangible assets and are subject to ongoing periodic impairment tests and are evaluated using various fair value techniques. Impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exist. If we were to determine that our goodwill was impaired, the recognition of an impairment charge could have an adverse impact on our results of operations in the period that the impairment occurred or on our financial position. 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.

Valuation of Other Real Estate Owned (“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 net realizable value on the date of acquisition. At the acquisition date, if the net realizable value of the property 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, a current appraisal or broker’s opinion must substantiate market value for the property.

Other Than Temporary Impairment 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 other than temporary impairment 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 security 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.

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 eligible employees (and their related demographics) and to changes in the discount rate and other expected rates, such as medical cost trend rates. As with the computations of plan expense, cash contribution requirements are also sensitive to such changes.

Income Taxes. We account for income taxes by deferring income taxes based on estimated future tax effects of differences between the tax and book basis 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 Statement 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 recognizable. Although not currently under review, income tax returns for the years ended December 31, 2005 through 2008 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.

 
Page 23
 

RESULTS OF OPERATIONS

Executive Overview

For the nine months ended September 30, 2009:

Net income of $17.5 million for the nine-month period ended September 30, 2009 increased $12.3 million, compared to the nine-month period ended September 30, 2008.  Net income per diluted share increased to $2.29, compared to $0.69 per diluted share earned during the first nine months of 2008. The following were major factors contributing to the results of the first nine months of 2009 compared to the same period of 2008:
 
 
•  
Net interest income on a fully-taxable equivalent basis for the first nine months of 2009 increased 4.6% to $56.4 million due to lower funding costs and an improvement in the net interest margin.
 
•  
The provision for loan losses of $6.5 million increased $4.4 million in the first nine months of 2009 compared to the same period of 2008 as a result of an increase in net charge-offs and non-performing assets.
 
•  
For the nine months ended September 30, 2009, net charge-offs totaled $4.8 million, or an annualized rate of 0.42% of average loans, compared to $2.9 million, or 0.26%, for the same period of 2008. Non-performing assets as a percentage of total assets amounted to 1.04% and 0.69% at September 30, 2009 and 2008, respectively.
 
•  
Non-interest income before net investment securities gains/losses and securities impairment write-down for the first nine months of 2009 was $14.7 million, a 9.9% increase over the first nine months of 2008. The increase was driven by an increase in mortgage banking income, including mortgage-servicing income and gains on the sale of loans, in part offset by a decline in income from fiduciary services at Acadia Trust, N.A. (“Acadia Trust”).
 
•  
We recorded net losses on our investment securities portfolio totaling $14.6 million in the first nine months of 2008 primarily due to a $14.0 million write-down of other-than-temporarily-impaired securities (“OTTI write-down”) during the third quarter of 2008.  In accordance with Revenue Procedure 2008-64, the OTTI write-down was treated as an ordinary loss, and the Company was able to record a tax benefit of $4.9 million in the fourth quarter of 2008.
 
•  
Non-interest expense for the first nine months of 2009 was $37.9 million, an increase of $2.0 million, or 5.7%, over the first nine months of the prior year, which was primarily due to an increase in Federal Deposit Insurance Corporation (FDIC) insurance assessment rates as well as a special assessment of $1.1 million levied in the second quarter of 2009.  There were also increases in foreclosed properties and collection costs, in part offset by a 4.9% decline in salary and benefit costs and a decrease in the amortization of the core deposit intangible.
 
For the three months ended September 30, 2009:

Net income for the three-month period ended September 30, 2009 increased $14.4 million, compared to the three-month period ended September 30, 2008.  Net income per diluted share for the third quarter 2009 increased to $0.83, compared to a loss of $1.05 per diluted share earned in 2008. The following were major factors contributing to the results of the third quarter of 2009 compared to the same period of 2008:
 
 
•  
Net interest income on a fully-taxable equivalent basis for the third quarter of 2009 increased 3.9% to $18.6 million due to lower funding costs and an improvement in the net interest margin.
 
•  
The provision for loan losses of $2.0 million increased $830,000 in the third quarter of 2009 compared to the same period of 2008 as a result of an increase in net charge-offs and non-performing assets.
 
•  
Non-interest income before net investment securities gains/losses and securities impairment write-down for the third quarter of 2009 was $5.1 million, a 14.4% increase over the third quarter of 2008. The increase was driven by an increase in mortgage banking income, including mortgage-servicing income and gains on the sale of loans, in part offset by a decline in income from fiduciary services at the Company’s subsidiary Acadia Trust.
 
•  
Net losses on our investment securities portfolio for the third quarter 2008 totaling $14.8 million were recorded primarily due to a $14.0 million write-down of other-than-temporarily-impaired securities.  In accordance with Revenue Procedure 2008-64, the OTTI write-down was treated as an ordinary loss, and the Company was able to record a tax benefit of $4.9 million in the fourth quarter of 2008.
 
•  
Non-interest expense for the third quarter of 2009 was $12.2 million, an increase of $493,000, or 4.2%, over the third quarter of the prior year, which was primarily due to an increase in foreclosed properties and collection costs.

 
Page 24
 
 
  Financial condition at September 30, 2009 compared to December 31, 2008:
 
 
•  
Total loans at September 30, 2009 were $1.5 billion (including loans held for sale), an increase of $20.1 million (including loans held for sale) compared to December 31, 2008. The increase in loan balances was primarily in the commercial and residential real estate portfolios.
 
•  
Investment securities declined $82.7 million at September 30, 2009 compared to December 31, 2008 due to security prepayments.
 
•  
Total liabilities at September 30, 2009 of $2.1 billion decreased $89.1 million, or 4.1%, as borrowings decreased $117.4 million, primarily in Federal Home Loan Bank of Boston (“FHLBB”) borrowings, due to the decline in earning asset balances.
 
•  
Shareholders’ equity increased 12.2% due to current year earnings and other comprehensive income, in part offset by dividends declared.

Net Interest Income

Net interest income is our largest source of revenue and accounts for approximately 80% of total revenues. Net interest income reflects revenues generated through income from earning assets plus loan fees, less interest paid on interest-bearing deposits and borrowings. Net interest income is affected by changes in interest rates, by loan and deposit pricing strategies and competitive conditions, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets.

Net interest income was $56.4 million on a fully-taxable equivalent basis for the nine months ended September 30, 2009, compared to $53.9 million for the first nine months of 2008, an increase of $2.5 million or 4.6%. The increase in net interest income is largely due to an improvement of 19 basis points in the net interest margin, to 3.55%, for the first nine months of 2009. The increase in the net interest margin resulted from a decrease in the cost of funds, offset in part by a decrease in income on earning assets, both of which were caused by the decline in interest rates. Average interest-earning assets decreased by $12.8 million for the nine months ended September 30, 2009 compared the same period in 2008, primarily due to decreases in most loan categories, partially offset by increases in investment securities and consumer loans. The yield on earning assets for the first nine months of 2009 decreased 61 basis points, reflecting a decline in the interest rate environment impacting both the investment and loan yields. Average interest-bearing liabilities decreased $8.5 million for the nine months ended September 30, 2009 compared to the same period in 2008, primarily due to declines in wholesale funding, in part offset by an increase in retail deposits driven by increases in certificate of deposit accounts. Total cost of funds decreased 88 basis points due to the decline in short-term interest rates.

Net interest income, on a fully taxable equivalent basis, for the three months ended September 30, 2009 was $18.6 million, a 3.9%, or $696,000, increase compared to $17.9 million in net interest income for the same period in 2008.  The increase was primarily due to lower funding costs as the Company was able to improve pricing on deposits and borrowings and minimize the decline of interest rates on loans that resulted in an improved net interest margin.

The following table presents, for the periods noted, average balance sheets, interest income, interest expense, and the corresponding average yields earned and rates paid, as well as net interest income, net interest rate spread and net interest margin.

 
Page 25
 
 
Average Balance, Interest and Yield/Rate Analysis
 
   
Nine Months Ended
September 30, 2009
    
Nine Months Ended
September 30, 2008
  
(Dollars in Thousands)
  
Average
Balance
    
Interest
    
Yield/
Rate
    
Average
Balance
    
Interest
    
Yield/
Rate
  
ASSETS
                                    
Interest-earning assets:
                                    
Securities – taxable
  
$
555,525
    
$
20,344
      
4.88
%
  
$
544,416
    
$
20,665
      
5.05
%
Securities – nontaxable (1)
    
64,956
      
2,842
      
5.83
%
    
70,621
      
3,067
      
5.80
%
Trading account assets
    
1,413
      
16
      
1.51
%
    
1,561
      
35
      
2.99
%
Federal funds sold
    
—
      
—
      
—
%
    
451
      
10
      
2.96
%
Loans (1) (2) :
                                                
Residential real estate
    
621,407
      
27,089
      
5.81
%
    
627,896
      
28,367
      
6.03
%
Commercial real estate
    
408,622
      
18,803
      
6.15
%
    
416,533
      
22,159
      
7.11
%
Commercial
    
183,258
      
7,700
      
5.62
%
    
210,016
      
11,161
      
7.10
%
Municipal
    
23,756
      
880
      
4.95
%
    
22,422
      
889
      
5.30
%
Consumer
    
265,523
      
9,826
      
4.95
%
    
243,345
      
11,505
      
6.32
%
Total loans
    
1,502,566
      
64,298
      
5.71
%
    
1,520,212
      
74,081
      
6.50
%
Total interest-earning assets
    
2,124,460
      
87,500
      
5.50
%
    
2,137,261
      
97,858
      
6.11
%
Cash and due from banks
    
28,056
                      
37,534
                  
Other assets
    
155,118
                      
143,541
                  
Less: allowance for loan losses
    
(18,388
) 
                    
(17,343
) 
                
Total assets
  
$
2,289,246
                    
$
2,300,993
                  
LIABILITIES & SHAREHOLDERS’ EQUITY
                                                
Interest-bearing liabilities:
                                                
Interest checking accounts
  
$
199,795
      
692
      
0.46
%
  
$
185,142
      
1,226
      
0.88
%
Savings accounts
    
138,039
      
368
      
0.36
%
    
133,566
      
618
      
0.62
%
Money market accounts
    
305,860
      
2,474
      
1.08
%
    
348,652
      
6,126
      
2.35
%
Certificates of deposit
    
584,747
      
12,726
      
2.91
%
    
512,686
      
14,103
      
3.67
%
Total retail deposits
    
1,228,441
      
16,260
      
1.77
%
    
1,180,046
      
22,073
      
2.50
%
Broker deposits
    
80,973
      
1,483
      
2.45
%
    
67,453
      
2,239
      
4.43
%
Junior subordinated debentures
    
43,449
      
2,136
      
6.57
%
    
43,342
      
2,195
      
6.76
%
Borrowings
    
559,202
      
11,267
      
2.69
%
    
629,744
      
17,500
      
3.71
%
Total wholesale funding
    
683,624
      
14,886
      
2.91
%
    
740,539
      
21,934
      
3.96
%
Total interest-bearing liabilities
    
1,912,065
      
31,146
      
2.18
%
    
1,920,585
      
44,007
      
3.06
%
Demand deposits
    
180,702
                      
185,595
                  
Other liabilities
    
22,452
                      
25,180
                  
Shareholders’ equity
    
174,027
                      
169,633
                  
Total liabilities and shareholders’ equity
  
$
2,289,246
                    
$
2,300,993
                  
Net interest income (fully-taxable equivalent)
            
56,354
                      
53,851
          
Less: fully-taxable equivalent adjustment
            
(1,284
)
                    
(1,323
)
        
  
          
$
55,070
                    
$
52,528
          
Net interest rate spread (fully-taxable equivalent)
                    
3.32
%
                    
3.05
%
Net interest margin (fully-taxable equivalent)
                    
3.55
%
                    
3.36
%
 
 
(1)
Reported on tax-equivalent basis calculated using a rate of 35%.
 
(2)
Loans held for sale and non-accrual loans are included in total average loans.

Provision and Allowance for Loan Losses

The ALL is our best estimate of inherent risk of loss in the loan portfolio as of the balance sheet date. The ALL was $19.4 million, or 1.28% of total loans, at September 30, 2009, compared to $17.7 million, or 1.18% of total loans, at December 31, 2008. For the nine months ended September 30, 2009, our provision for loan losses charged to earnings amounted to $6.5 million, compared to $2.1 million for the same period in 2008. The increase in the provision was based on management’s assessment of various factors affecting the loan portfolio, including, among others, our ongoing evaluation of credit quality, with particular emphasis on the commercial and commercial real estate portfolio, and general economic conditions. For the first nine months of 2009, net charge-offs totaled $4.8 million, or an annualized rate of 0.42% of average loans, compared to $2.9 million, or 0.26%, for the same period of 2008. Year-to-date charge-off activity for 2009 is centered in commercial and commercial real estate loans. See additional ALL discussion under the caption “Asset Quality.”
 
Page 26

For the third quarter of 2009, our provision for loan losses charged to earnings amounted to $2.0 million, compared to $1.2 million for the same period in 2008.  The loan loss reserve analysis called for an increase in loan loss provision due to increased non-accrual loan levels resulting from a general weakening of the economy.  Net charge-offs were $1.2 million for the three months ended September 30, 2009 and $1.2 million for the three months ended September 30, 2008.

Non-Interest Income

Non-interest income totaled $14.7 million for the nine months ended September 30, 2009, compared to a loss of $1.2 million for the same period of 2008 primarily due to the OTTI write-down of $14.0 million and net losses on sales of securities of $624,000. There were increases in mortgage banking income of $1.4 million due to the loan sales in the first nine months of 2009 and $225,000 in earnings on bank-owned life insurance due to policy purchases in 2008. Income from fiduciary services at Acadia Trust decreased $699,000, or 13.9%, resulting from market value declines in assets under administration.

For the third quarter of 2009 non-interest income increased $15.4 million compared to the third quarter of 2008, primarily due to $14.8 million in net investment securities losses recorded in 2008 as a result of the $14.0 million OTTI write-down and net losses on sales of preferred equity securities. There were also increases in mortgage banking income of $352,000 and earnings on bank-owned life insurance of $63,000 due to policy purchases in 2008 recorded in 2009 compared to the same period in 2008.  Income from fiduciary services at Acadia Trust decreased $182,000, or 11.0%, for the three month period as a result of value declines in assets under administration.

Non-Interest Expenses

Non-interest expense increased $2.0 million, or 5.7%, for the nine months ended September 30, 2009 compared to the same period of 2008. The increase was primarily due to a $2.6 million increase in the FDIC insurance assessment rates which included a special assessment of $1.1 million levied in the second quarter of 2009 and the full utilization, in 2008, of assessment credits.  There was also a $1.4 million increase in foreclosed properties and collection costs related to the $1.0 million provision to increase the valuation allowance on other real estate owned. The increases were partially offset by a $935,000, or 4.9%, decline in salary and benefit costs as the first half of 2008 included higher staffing levels to facilitate the Union Bankshares merger. Also, the amortization of the core deposit intangible decreased $321,000 as the 1998 branch purchases were fully amortized in 2008.

For the third quarter of 2009, non-interest expense increased $493,000, or 4.2% compared to the third quarter of 2008, primarily due to the $660,000 increase in foreclosed properties and collection costs and the $276,000 increase in regulatory assessments related to an increase in the FDIC deposit insurance assessment rate.

FINANCIAL CONDITION
Overview

Total assets at September 30, 2009 were $2.3 billion, a decrease of $68.8 million, or 2.9%, from December 31, 2008. The change in assets consisted primarily of an $82.7 million decrease in investments and a $5.1 million decrease in cash and due from banks, partially offset by an $18.8 million increase in loans. Total liabilities decreased $89.1 million as borrowings decreased $117.4 million partially offset by an increase in total deposits (including brokered deposits) of $23.8 million. Total shareholders’ equity increased $20.4 million, which was a result of current year earnings and other comprehensive income, partially offset by dividends declared to shareholders.

During the first nine months of 2009, average assets of $2.3 billion decreased $11.7 million, compared to the same period in 2008.  This decrease was primarily the result of a decline in average loans of $17.6 million and cash and due from banks of $9.5 million, partially offset by a $5.4 million increase in the investment securities portfolio and a $10.0 million increase in bank-owned life insurance. Average liabilities decreased $16.1 million for the nine months ended September 30, 2009 compared to the same period of 2008, primarily due to a decrease in average borrowings of $70.4 million, partially offset by a $57.0 million increase in average deposits (including brokered deposits).
 
Assets
 
Investments. At September 30, 2009, investment security balances of $587.3 million decreased $82.7 million from December 31, 2008 primarily due to normal pay-downs, partially offset by purchases of mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises. Our portfolio is primarily comprised of obligations of U.S. government sponsored enterprises and mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises.  The approximately 20% remaining portfolio is invested as follows:

Page 27
 
 
·
$61.5 million of obligations of states and political subdivisions with 98% rated investment grade by at least one of the three rating agencies (Moody’s, Standard & Poor’s and Fitch);
 
·
$28.2 million of private issue collateralized mortgage obligations rated Triple-A by at least one of the three rating agencies, while $10.6 million currently carry ratings below investment grade;
 
·
$21.0 million of FHLBB stock which has suspended quarterly dividend payments. Given the extended time frame the FHLBB has to redeem the stock, and the Company’s ability and intent to hold the stock until redeemed, management believes that the stock is not impaired; and
 
·
$4.3 million of Duff & Phelps Select Income Fund Auction Preferred Stock which has failed at auction. We believe the failed auctions are a temporary liquidity event related to this asset class of securities. The security is rated Triple-A by Moody’s and Standard and Poor’s. We are currently collecting all amounts due according to contractual terms and have the ability and intent to hold the securities until they clear auction, are called, or mature; therefore, the securities are not considered other than temporarily impaired.

Loans. At September 30, 2009, loans of $1.5 billion (including loans held for sale) increased $20.1 million from December 31, 2008 primarily due to an increase in residential real estate, commercial real estate, and consumer loans of $6.7 million, $27.7 million and $4.1 million, respectively. These increases were partially offset by a decline in the commercial portfolio of $17.9 million as a result of normal pay-downs and decreased demand.  Residential real estate loan activity during the first nine months of 2009 has been strong due to low mortgage rates; as a result, $71.2 million in residential real estate production was sold year-to-date.

Asset Quality

Non-Performing Assets.  Non-performing assets include non-accrual loans, accruing loans 90 days or more past due, renegotiated loans and property acquired through foreclosure or repossession. The following table sets forth the amount of our non-performing assets as of the dates indicated:

   
September 30,
    
December 31,
  
(Dollars in Thousands)
  
2009
    
2008
  
Non-accrual loans
                
Residential real estate
  
$
5,779
    
$
4,048
  
Commercial real estate
    
5,322
      
4,957
  
Commercial
    
4,226
      
2,384
  
Consumer
    
1,271
      
1,112
  
Total non-accrual loans
    
16,598
      
12,501
  
Accruing loans past due 90 days
    
684
      
206
  
Renegotiated loans not included above
    
917
      
—
  
Total non-performing loans
    
18,199
      
12,707
  
Other real estate owned
    
5,465
      
4,024
  
Total non-performing assets
  
$
23,664
    
$
16,731
  
Non-performing loans to total loans
    
1.14
%
    
0.85
%
Allowance for loan losses to non-performing loans
    
112.45
%
    
139.22
%
Non-performing assets to total assets
    
1.04
%
    
0.71
%
Allowance for loan losses to non-performing assets
    
82.13
%
    
105.73
%

Non-performing loans have increased $5.5 million since December 31, 2008 due to the deterioration in economic conditions, resulting from a continued decrease in retail sales in our market area, rising unemployment, and an overall decline in real estate values. The portfolio of loans listed as non-performing are diversified by region, collateral, and loan size. Our largest single exposure is secured by a high-end residential property in the process of foreclosure. Until the economy improves, we expect that non-performing loans will remain at elevated levels.

The OREO balance at September 30, 2009 consisted of thirteen properties, including three residential properties, eight commercial/mixed use properties, and two parcels of raw land. During the first nine months of 2009, the Company recorded an OREO valuation allowance primarily related to two properties that were included in OREO at December 31, 2008. The first property is a parcel of raw land that the Company relied upon the appraised value and an offer to purchase the land at the time of acquisition. The sale of the property did not occur and due to the continued deterioration in the real estate market, the value of the property was reassessed during the first quarter of 2009, which resulted in a $666,000 increase in the valuation allowance.  The second property is a commercial property that was reassessed during the third quarter of 2009 and a new appraisal resulted in a $340,000 increase in the valuation allowance. The OREO balance is higher than we have historically experienced, and in light of the current economic environment and limited bid activity at the point of auction, we anticipate the level of OREO to continue to be at a higher than normal level.
 
Page 28
 
Potential Problem Loans. Potential problem loans consist of classified accruing commercial and commercial real estate loans that were between 30 and 89 days past due. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve due to changes in collateral values or the financial condition of the borrowers, while the credit quality of other loans may deteriorate, resulting in some amount of loss. These loans are not included in the analysis of non-accrual loans above. At September 30, 2009, potential problem loans amounted to approximately $3.2 million, or 0.21% of total loans, compared to $4.1 million, or 0.27% of total loans at December 31, 2008. The reduction was attributed in part to the migration of a portion of potential problem loans at December 31, 2008 to non-accrual status during the first nine months of 2009.

Past Due Loans. Past due loans consist of accruing loans that were between 30 and 89 days past due. The following table sets forth information concerning the past due loans at the date indicated.

   
September 30,
  
December 31,
  
(Dollars in Thousands)
  
2009
    
2008
  
Loans 30-89 days past due:
                
Residential real estate loans
  
$
2,397
    
$
2,880
  
Commercial real estate
    
1,852
      
2,314
  
Commercial loans
    
2,760
      
3,601
  
Consumer loans
    
531
      
829
  
Total loans 30-89 days past due
  
$
7,540
    
$
9,624
  
 
               
Loans 30-89 days past due to total loans
    
0.50
%
    
0.64
%

Allowance for Loan Losses. We use a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient ALL. Through the first nine months of 2009, there were no significant changes to the allowance assessment methodology. The ALL is management’s best estimate of the probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans.

The following table sets forth information concerning the activity in our ALL during the periods indicated.
 
   
Nine Months Ended September 30,
  
(Dollars in Thousands)
  
2009
    
2008
  
Allowance at the beginning of the period
  
$
17,691
    
$
13,653
  
Acquired from Union Trust
    
—
      
4,369
  
Provision for loan losses
    
6,514
      
2,120
  
Charge-offs:
                
Residential real estate loans
    
752
      
137
  
Commercial real estate
    
1,843
      
1,529
  
Commercial loans
    
1,865
      
1,221
  
Consumer loans
    
894
      
662
  
Total loan charge-offs
    
5,354
      
3,549
  
                 
Recoveries:
                
Residential real estate loans
    
9
      
1
  
Commercial real estate loans
    
41
      
55
  
Commercial loans
    
276
      
319
  
Consumer loans
    
258
      
244
  
Total loan recoveries
    
584
      
619
  
Net charge-offs
    
(4,770
)
    
(2,930
)
Allowance at the end of the period
  
$
19,435
    
$
17,212
  
Average loans outstanding
  
$
1,502,566
    
$
1,520,212
  
                 
Net charge-offs (annualized) to average loans outstanding
    
0.42
%
    
0.26
%
Provision for loan losses (annualized) to average loans outstanding
    
0.58
%
    
0.19
%
Allowance for loan losses to total loans
    
1.28
%
    
1.13
%
Allowance for loan losses to net charge-offs (annualized)
    
305.60
%
    
440.55
%
Allowance for loan losses to non-performing loans
    
112.45
%
    
130.85
%
Allowance for loan losses to non-performing assets
    
82.13
%
    
108.57
%

Page 29
 
During the first nine months of 2009, the Company provided $6.5 million of expense to the ALL compared to $2.1 million for the same period of 2008. The determination of an appropriate level of ALL, and subsequent provision for loan losses, which affects earnings, is based on our analysis of various economic factors and review of the loan portfolio, which may change due to numerous factors including loan growth, payoffs of lower quality loans, recoveries on previously charged-off loans, improvement in the financial condition of the borrowers, risk rating downgrades/upgrades and charge-offs. We utilize a comprehensive approach toward determining the ALL, which includes an expanded risk rating system to assist us in identifying the risks being undertaken, as well as migration within the overall loan portfolio. The increase in the provision for loan losses was primarily a result of an increase in net charge-offs mainly associated with commercial real estate and commercial loans. Non-performing assets as a percentage of total assets amounted to 1.04% at September 30, 2009, compared to 0.69% and 0.71% at September 30, 2008 and December 31, 2008, respectively, primarily resulting from an increase in non-accrual loans. Our local economy has continued to experience a decline in retail sales, rising unemployment, and an overall decline in real estate values.  We believe the ALL of $19.4 million, or 1.28% of total loans outstanding and 112.5% of total non-performing loans at September 30, 2009, was appropriate given the current economic conditions in our service area and the condition of the loan portfolio, although if conditions continue to deteriorate, more provision may be needed.  The ALL was 1.13% of total loans outstanding and 130.9% of total non-performing loans at September 30, 2008, and 1.18% of total loans outstanding and 139.2% of total non-performing loans at December 31, 2008.

Liabilities and Shareholders’ Equity

Total liabilities have decreased $89.1 million, or 4.1%, since December 31, 2008, to $2.1 billion at September 30, 2009.  Borrowings declined $117.5 million which was comprised primarily of a decrease of $48.4 million in advances from the FHLBB and a decrease in other borrowings of $69.0 million resulting from a decrease of $116.4 million in overnight funding at the FHLBB and an increase of $46.5 million in retail repurchase agreements. Total deposits including brokered deposits increased $23.8 million primarily due to increases in demand deposits of $21.0 million and interest checking, savings and money markets balances of $66.6 million, partially offset by declines in retail certificates of deposit and brokered deposits of $25.8 million and $38.0 million, respectively.

Total shareholders' equity at September 30, 2009 increased $20.4 million, or 12.2%, over the balance at December 31, 2008, as a result of current year net income of $17.5 million partially offset by $5.7 million in dividends declared to shareholders, and a $8.2 million increase in other comprehensive income primarily due to an increase in the unrealized gain position of the available for sale investment portfolio.
 
LIQUIDITY

Liquidity needs require the availability of cash to meet the withdrawal demands of depositors and credit commitments to borrowers. Liquidity is defined as our ability to maintain availability of funds to meet customer needs, as well as to support our asset base. The primary objective of liquidity management is to maintain a balance between sources and uses of funds to meet our cash flow needs in the most economical and expedient manner. Due to the potential for unexpected fluctuations in both deposits and loans, active management of liquidity is necessary. We maintain various sources of funding and levels of liquid assets in excess of regulatory guidelines in order to satisfy their varied liquidity demands. We monitor liquidity in accordance with internal guidelines and all applicable regulatory requirements. As of September 30, 2009 and 2008, our level of liquidity exceeded target levels. We believe that we currently have appropriate liquidity available to respond to liquidity demands. Sources of funds that we utilized consist of deposits, borrowings from the FHLBB and other sources, cash flows from operations, prepayments and maturities of outstanding loans, investments and mortgage-backed securities and the sales of mortgage loans.

Deposits continue to represent our primary source of funds. For the first nine months of 2009, average deposits (including brokered deposits) of $1.5 billion increased $57.0 million compared to the same period of 2008. Comparing average deposits for the first nine months of 2009 to the same period of 2008, declines were experienced in average money market account balances of $42.8 million and demand deposits of $4.9 million, while average interest checking, savings, and retail certificates of deposit increased $14.7 million, $4.5 million and $72.1 million, respectively.  Average brokered deposits increased $13.5 million. Included in the money market deposit category are deposits from Acadia Trust, representing client funds. The balance in the Acadia Trust client money market account, which was $105.0 million on September 30, 2009, could increase or decrease depending upon changes in the portfolios of the clients of Acadia Trust. The shift from money market accounts to retail certificates of deposit was the result of changes in market rates, while the decline in checking accounts reflects an increase in seasonal outflows due to the current economic environment.
 
Borrowings are used to supplement deposits as a source of liquidity. In addition to borrowings from the FHLBB, we purchase federal funds, sell securities under agreements to repurchase and utilize treasury tax and loan accounts. Average borrowings and long-term debt for the first nine months of 2009 was $602.7 million, a decrease of $70.4 million from the first nine months of 2008. We secure borrowings from the FHLBB, whose advances remain the largest non-deposit-related funding source, with qualified residential real estate loans, certain investment securities and certain other assets available to be pledged. The carrying value of loans pledged as collateral at the FHLBB was $705.3 million and $727.9 million at September 30, 2009 and 2008, respectively. The carrying value of securities pledged as collateral at the FHLBB was $40.7 million and $142.1 million at September 30, 2009 and 2008, respectively. Through our bank subsidiary, we have an available line of credit with the FHLBB of $9.9 million at September 30, 2009 and 2008. We had no outstanding balance on the line of credit with the FHLBB at September 30, 2009. The Company also has a $10.0 million line of credit through a correspondent bank available to us through December 28, 2009.  We had no outstanding balance on this line of credit at September 30, 2009. 
 
Page 30
 
We believe the investment portfolio and residential loan portfolio provide a significant amount of contingent liquidity that could be accessed in a reasonable time period through sales of those portfolios. We also believe that we have additional untapped access to the brokered deposit market, commercial reverse repurchase transaction market and the Federal Reserve Bank (“FRB”) discount window. These sources are considered as liquidity alternatives in our contingent liquidity plan. We believe that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer saving habits and availability or access to the national brokered deposit and commercial repurchase markets, could significantly impact our liquidity position.
 
CAPITAL RESOURCES

Under FRB guidelines, we are required to maintain capital based on risk-adjusted assets. These capital requirements represent quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital classification is also subject to qualitative judgments by our regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). These guidelines apply to us on a consolidated basis. Under the current guidelines, banking organizations must maintain a risk-based capital ratio of 8.0%, of which at least 4.0% must be in the form of core capital (as defined). Our risk-based ratios, and those of our bank subsidiary, exceeded regulatory guidelines at September 30, 2009 and 2008. Our Tier 1 capital to risk weighted assets was 11.89% and 11.01% at September 30, 2009 and 2008, respectively.  The Company’s total capital to risk weighted assets was 13.15% and 12.18% at September 30, 2009 and 2008, respectively. In addition to risk-based capital requirements, the FRB requires bank holding companies to maintain a minimum leverage capital ratio of core capital to total assets of 4.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted. Our leverage ratio was 7.87% and 7.11% at September 30, 2009 and 2008, respectively.

Although the junior subordinated debentures are recorded as a liability on our Statement of Condition, we are permitted, in accordance with regulatory guidelines, to include, subject to certain limits, the trust preferred securities in our calculation of risk-based capital. At September 30, 2009, $43.0 million of the trust preferred securities was included in Tier 1 and total risk-based capital.

As part of our goal to operate a safe, sound and profitable financial organization, we are committed to maintaining a strong capital base. Shareholders’ equity totaled $186.8 million and $158.7 million at September 30, 2009 and 2008, respectively, which amounted to 8.2% of total assets at September 30, 2009 and 6.9% of total assets at September 30, 2008.

Our principal cash requirement is the payment of dividends on our common stock, as and when declared by the Board of Directors. We paid dividends to shareholders in the aggregate amount of $5.7 million and $5.4 million for the nine months ended September 30, 2009 and 2008, respectively. Our Board of Directors approves cash dividends on a quarterly basis after careful analysis and consideration of various factors, including the following: a) capital position relative to total assets, b) risk-based assets, c) total classified assets, d) economic conditions, e) growth rates for total assets and total liabilities, f) earnings performance and projections and g) strategic initiatives and related capital requirements. All dividends declared and distributed by the Company will be in compliance with applicable state corporate law and regulatory requirements.

We are primarily dependent upon the payment of cash dividends by our subsidiaries to service our commitments. We, as the sole shareholder of our subsidiaries, are entitled to dividends, when and as declared by each subsidiary’s Board of Directors from legally available funds. Camden National Bank (“CNB”) declared dividends in the aggregate amount of $9.0 million for the first nine months of 2009 and $6.0 million for the first nine months of 2008. Under regulations prescribed by the Office of the Comptroller of the Currency (“OCC”), without prior OCC approval our bank subsidiary may not declare dividends in any year in excess of the each bank’s (i) net income for the current year, (ii) plus its retained net income for the prior two years. Due to the large dividends paid in the fourth quarter of 2007 to fund the Union Bankshares acquisition and a loss in the third quarter of 2008 related to the investment securities losses, CNB sought and obtained OCC approval to pay dividends in excess of its current and retained net income for the required period. We expect this OCC approval to remain in place until CNB’s net income meets the required levels and approval is no longer necessary. However, if we are required to use dividends from CNB to service unforeseen commitments in the future we may be required to reduce the dividends paid to our shareholders going forward.

In June 2008, the Board of Directors voted to authorize us to purchase up to 750,000 shares of outstanding common stock for a period of one year that expired on July 1, 2009, and was not renewed for the coming year. We repurchased 50,000 shares of common stock at an average price of $32.00 under the plan, all of which were purchased during 2008.
 
Page 31
 
CONTRACTUAL OBLIGATIONS AND COMMITMENTS

In the normal course of business, we are a party to credit related financial instruments with off-balance sheet risk, which are not reflected in the Consolidated Statements of Condition. These financial instruments include lending commitments and letters of credit. Those instruments involve varying degrees of credit risk in excess of the amount recognized in the Consolidated Statements of Condition. We follow the same credit policies in making commitments to extend credit and conditional obligations as we do for on-balance sheet instruments, including requiring similar collateral or other security to support financial instruments with credit risk. Our exposure to credit loss in the event of nonperformance by the customer is represented by the contractual amount of those instruments. Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements. At September 30, 2009, we had the following levels of commitments to extend credit.

   
Total Amount
Committed
  
Commitment Expires in:
  
(Dollars in Thousand)
      
<1 Year
    
1 – 3 Years
    
4 – 5 Years
    
>5 Years
  
Letters of Credit
  
$
1,157
    
$
1,157
    
$
—
    
$
—
    
$
—
  
Commercial Commitment Letters
    
15,946
      
15,946
      
—
      
—
      
—
  
Residential Loan Origination
    
13,114
      
13,114
      
—
      
—
      
—
  
Home Equity Line of Credit Commitments
    
149,850
      
—
      
6
      
—
      
149,844
  
Other Commitments to Extend Credit
    
124,593
      
74,582
      
6,223
      
18,858
      
24,930
  
Total
  
$
304,660
    
$
104,799
    
$
6,229
    
$
18,858
    
$
174,774
  

We are a party to several off-balance sheet contractual obligations through lease agreements on a number of branch facilities. We have an obligation and commitment to make future payments under these contracts. At September 30, 2009, we had the following levels of contractual obligations.

   
Total Amount
of Obligations
  
Payments Due per Period
(Dollars in Thousands)
      
<1 Year
    
1 – 3 Years
    
4 – 5 Years
    
>5 Years
  
Operating Leases
  
$
5,460
    
$
764
    
$
1,337
    
$
749
    
$
2,610
  
Capital Leases
    
1,220
      
40
      
91
      
97
      
992
  
FHLBB Borrowings – Overnight
    
43,960
      
43,960
      
—
      
—
      
—
  
FHLBB Borrowings – Advances
    
210,495
      
60,761
      
77,161
      
31,188
      
41,385
  
Commercial Repurchase Agreements
    
126,494
      
20,111
      
55,184
      
46,090
      
5,109
  
Other Borrowed Funds
    
119,021
      
119,021
      
—
      
—
      
—
  
Junior Subordinated Debentures
    
43,487
      
—
      
—
      
—
      
43,487
  
Note Payable
    
952
      
264
      
513
      
145
      
30
  
Other Contractual Obligations
    
736
      
379
      
357
      
—
      
—
  
Total
  
$
551,825
    
$
245,300
    
$
134,643
    
$
78,269
    
$
93,613
  

Borrowings from the FHLBB consist of short- and long-term fixed and variable rate borrowings and are collateralized by all stock in the FHLBB and a blanket lien on qualified collateral consisting primarily of loans with first mortgages secured by one-to-four family properties, certain pledged investment securities and other qualified assets. Other borrowed funds include treasury, tax and loan deposits and securities sold under repurchase agreements. We have an obligation and commitment to repay all borrowings and debentures. These commitments, borrowings, junior subordinated debentures and the related payments are made during the normal course of business.

We may use derivative instruments as partial hedges against large fluctuations in interest rates. We may also use fixed-rate interest rate swap and floor instruments to partially hedge against potentially lower yields on the variable prime rate loan category in a declining rate environment. If rates were to decline, resulting in reduced income on the adjustable rate loans, there would be an increased income flow from the interest rate swap and floor instruments. We may also use variable-rate interest rate swap and cap instruments to partially hedge against increases in short-term borrowing rates. If rates were to rise, resulting in an increased interest cost, there would be an increased income flow from the interest rate swap and cap instruments. These financial instruments are factored into our overall interest rate risk position. We regularly review the credit quality of the counterparty from which the instruments have been purchased. At September 30, 2009, the Company had an interest rate cap agreement with a notional amount of $20.0 million which expires on March 15, 2010, and two forward interest rate swaps, each with a notional amount of $10.0 million, related to the junior subordinated debentures, expiring on June 30, 2021 and June 30, 2029.

 
Page 32
 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK

MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of our asset/liability management process, which is governed by policies established by the CNB Board of Directors, and are reviewed and approved annually. The Board of Directors’ Asset/Liability Committee (“Board ALCO”) delegates responsibility for carrying out the asset/liability management policies to the Management Asset/Liability Committee (“Management ALCO”). In this capacity, Management ALCO develops guidelines and strategies impacting our asset/liability management-related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends. The Management ALCO and Board ALCO jointly meet on a quarterly basis to review strategies, policies, economic conditions and various activities as part of the management of these risks.

Interest Rate Risk

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with our financial instruments also change, thereby impacting net interest income (“NII”), the primary component of our earnings. Board and Management ALCO utilize the results of a detailed and dynamic simulation model to quantify the estimated exposure of NII to sustained interest rate changes. While Board and Management ALCO routinely monitor simulated NII sensitivity over a rolling 2-year horizon, they also utilize additional tools to monitor potential longer-term interest rate risk.

The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflected on our Statement of Condition, as well as for derivative financial instruments, if any. None of the assets used in the simulation were held for trading purposes. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 200 basis point (“bp”) upward and 200 bp downward shift in interest rates. Although our policy specifies a downward shift of 200 bp, this could result in negative rates as many benchmark rates are currently below 2.00%. A parallel and pro rata shift in rates over a 12-month period is assumed. Using this approach, we are able to produce reports that illustrate the effect that both a gradual change of rates (year-1) and a “rate shock” (year-2 and beyond) has on margin expectations.  In the down 100 bp scenario, Fed Funds and Treasury yields are floored at .01% while Prime is floored at 3.00%.  All other market rates are floored at 0.25%.  During the third quarter of 2009, our NII sensitivity analysis reflected the following changes to NII assuming no balance sheet growth and a parallel shift in interest rates over a 1-year horizon.

Rate Change
  
Estimated Change in NII
  
+200 bp
    
(0.1
 )%
-100 bp
    
(1.0
 )%

The preceding sensitivity analysis does not represent a 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, we cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

 
Page 33
 

 The most significant factors affecting the changes in market risk exposure during the first nine months of 2009 were the decrease in the investment balances, lower cost of retail deposits, and an increase in lower cost overnight borrowings that resulted in an overall reduction in the cost of funds that outpaced the drop in the yield on average assets.  If rates remain at or near current levels and the balance sheet mix remains similar, net interest income is projected to remain more or less unchanged over the first two years of the simulation period.  Beyond the second year, net interest income is projected to trend slightly downwards as funding cost reductions slow and the asset base continues to adjust lower. In a falling interest rate environment, net interest income is expected to trend in line with the base case scenarios before developing a downward trend thereafter.   Beyond the first year, opportunities to reduce funding costs become even more difficult while accelerated prepayments continue to drive asset yields lower; resulting in tighter spreads and a decrease in expected net interest income.  In the initial stages of a rising rate environment, net interest income is projected to trend in line with the base scenarios over the first year.  Thereafter, funding costs stabilize and the asset base continues to be reprice or replaced at higher levels, causing an upward trend to extend throughout the remaining simulation period.  If the yield curve were to flatten as rate rise, pressure on net interest income would be greater.  The risk in the various rate scenarios is within our policy limits.

Periodically, if deemed appropriate, we use interest rate swaps, floors and caps, which are common derivative financial instruments, to hedge interest rate risk position. The Board of Directors has approved hedging policy statements governing the use of these instruments. As of September 30, 2009, we had a notional principal amount of $20.0 million in an interest rate cap agreement and a notional principal amount of $20.0 million in interest rate swap agreements related to the junior subordinated debentures. Board and Management ALCO monitor derivative activities relative to its expectation and our hedging policies.

 
Page 34
 

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 (Principal Financial & Accounting Officer), regarding the effectiveness of the Company’s disclosure controls and procedures, as of the end of the last fiscal quarter covered by this report.  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 (Principal Financial & Accounting Officer) concluded that they believe the Company’s disclosure controls and procedures are 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.
 
There was no change in the 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, the Company's internal control over financial reporting.
 
Subsequent to the end of the fiscal quarter, on October 16, 2009, the Company’s security group discovered that an employee of Camden National Bank, a subsidiary of the Company, engaged in a series of improper and unauthorized transactions.  The Company, in conjunction with its independent registered public accountants, launched an investigation into this matter, including a review of the Company's disclosure controls and procedures and internal controls over financial reporting.  To date, transactions involving approximately $850,000 have been identified, but the investigation is still in its preliminary stages. Management does not believe that a material loss is probable and the amount of loss, if any, is not reasonably estimable at this time.  As part of the investigation, the Company intends to continue to review and document the disclosure controls and procedures, including the internal controls over financial reporting, and to make such changes to the disclosure controls and procedures as may be necessary to enhance their effectiveness.

 
Page 35
 
 
PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

No material litigation.

ITEM 1A.  RISK FACTORS

There has been no material changes in the Risk Factors described in Item 1A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) None
(b) None
(c) In June 2008, the Board of Directors of the Company voted to authorize the Company to purchase up to 750,000 shares of its authorized and issued common stock. The authority, which expired on July 1, 2009, was not renewed for the coming year.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None

ITEM 5.  OTHER INFORMATION

None

 
Page 36
 
 
ITEM 6.  EXHIBITS

 (a)  Exhibits
(3.i.1) The Articles of Incorporation of Camden National Corporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on August 10, 2001)

(3.i.2) Articles of Amendment to the Articles of Incorporation of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.3 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 9, 2003)

(3.i.3) Articles of Amendment to the Articles of Incorporation of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.i.3 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 4, 2007)

(3.ii) The Bylaws of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on March 10, 2008)

(11.1) Statement re computation of per share earnings (Data provided in Note 2 to the consolidated financial statements in this report)

(23.1) Consent of Berry, Dunn, McNeil & Parker relating to the financial statements of Camden National Corporation*

(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, Principal Financial & Accounting 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 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

(32.2) Certification of Chief Financial Officer, Principal Financial & Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

* Filed herewith

 
Page 37
 

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CAMDEN NATIONAL CORPORATION
(Registrant)
 
/s/ Gregory A. Dufour
  
October 30,  2009
Gregory A. Dufour
  
Date
President and Chief Executive Officer
    
     
/s/ Deborah A. Jordan
  
October 30, 2009
Deborah A. Jordan
  
Date
Chief Financial Officer and Principal
    
Financial & Accounting Officer
    

 
Page 38
 

Exhibit Index

(3.i.1)
The Articles of Incorporation of Camden National Corporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on August 10, 2001)

(3.i.2)
Articles of Amendment to the Articles of Incorporation of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.3 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 9, 2003)

(3.i.3)
Articles of Amendment to the Articles of Incorporation of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.i.3 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 4, 2007)

(3.ii)
The Bylaws of Camden National Corporation, as amended to date (incorporated by reference to Exhibit 3.ii to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 4, 2007)

(11.1)
Statement re computation of per share earnings (Data is provided in Note 2 to the consolidated financial statements in this report)

(23.1)
Consent of Berry, Dunn, McNeil & Parker relating to the financial statements of Camden National Corporation

(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, Principal Financial & Accounting 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 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(32.2)
Certification Chief Financial Officer, Principal Financial & Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 
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