UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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 March 31, 2007

 

Commission File Number 0-26589

 

 

FIRST NATIONAL LINCOLN CORPORATION

(Exact name of Registrant as specified in its charter)

 

MAINE 01-0404322

(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)

 

MAIN STREET, DAMARISCOTTA, MAINE 04543

(Address of principal executive offices) (Zip code)

 

(207) 563-3195

Registrant’s telephone number, including area code

 

 

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 period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No[_]

 

 

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

Large accelerated filer [_] Accelerated filer x Non-accelerated filer [_]

 

 

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

Yes [_] No x

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of May 9, 2007

Common Stock: 9,784,070 shares

 

 

Table of Contents

 

 

Part I. Financial Information

1

 

 

Selected Financial Data (Unaudited)

1

 

 

Item 1 – Financial Statements

2

 

 

Report of Independent Registered Public Accounting Firm

2

 

 

Consolidated Balance Sheets (Unaudited)

3

 

 

Consolidated Statements of Income (Unaudited)

4

 

 

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

5

 

 

Consolidated Statements of Cash Flows (Unaudited)

6

 

 

Notes to Consolidated Financials Statements

7

 

 

Note 1 – Basis of Presentation

7

 

 

Note 2 – Common Stock

7

 

 

Note 3 – Stock Options

7

 

 

Note 4 – Earnings Per Share

8

 

 

Note 5 – Postretirement Benefit Plans

9

 

 

Note 6 – Goodwill

10

 

 

Note 7 –L oan Servicing

10

 

 

Note 8 – Derivative Financial Instruments

10

 

 

Note 9 – Income Taxes

11

 

 

Note10 – Reclassifications

11

 

 

Note11 – Impact of Recently Issued Accounting Standards

11

 

 

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

12

 

 

Critical Accounting Policies

12

 

 

Executive Summary

12

 

 

Net Interest Income

13

 

 

Provision for Loan Losses

14

 

 

Non-Interest Income

14

 

 

Non-Interest Expense

14

 

 

Income Taxes

14

 

 

Investments

15

 

 

Loans

15

 

 

Allowance for Loan Losses

15

 

 

Non-Performing Assets

16

 

 

Goodwill

16

 

 

Deposits

16

 

 

Borrowed Funds

16

 

 

Shareholders’ Equity

17

 

 

Average Daily Balance Sheets

18

 

 

Off-Balance Sheet Financial Instruments

19

 

 

Sale of Loans

19

 

 

Contractual Obligations

19

 

 

Liquidity Management

19

 

 

Forward-Looking Statements

19

 

 

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

20

 

 

Market-Risk Management

20

 

 

Asset/Liability Management

20

 

 

Interest Rate Risk Management

21

 

 

Item 4: Controls and Procedures

22

 

 

Part II – Other Information

23

 

 

Item 1 – Legal Proceedings

23

 

 

Item 1a –Risk Factors

23

 

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

23

 

 

Item 3 – Default Upon Senior Securities

23

 

 

Item 4 – Submission of Matters to a Vote of Security Holders

24

 

 

Item 5 – Other Information

24

 

 

Item 6 – Exhibits

25

 

 

Signatures

26

Part I. Financial Information

 

Selected Financial Data (Unaudited)

First National Lincoln Corporation and Subsidiary

 

 

For the three months ended

Dollars in thousands,

March 31

except for per share amounts

2007

2006

 

 

 

Summary of Operations

 

 

Interest Income

$16,948

$14,812

Interest Expense

9,383

7,064

Net Interest Income

7,565

7,748

Provision for Loan Losses

300

250

Non-Interest Income

2,148

2,073

Non-Interest Expense

5,250

5,434

Net Income

3,003

2,978

Per Common Share Data

 

 

Basic Earnings per Share

$0.31

$0.30

Diluted Earnings per Share

0.31

0.30

Cash Dividends Declared

0.165

0.145

Book Value

11.12

10.62

Market Value

15.92

17.59

Financial Ratios

 

 

Return on Average Equity (1)

11.25%

11.56%

Return on Average Tangible Equity (1)

15.12%

15.74%

Return on Average Assets (1)

1.10%

1.15%

Average Equity to Average Assets

9.77%

9.92%

Average Tangible Equity to Average Assets

7.27%

7.29%

Net Interest Margin Tax-Equivalent (1)

3.16%

3.46%

Dividend Payout Ratio

53.23%

48.33%

Allowance for Loan Losses/Total Loans

0.77%

0.77%

Non-Performing Loans to Total Loans

0.26%

0.51%

Non-Performing Assets to Total Assets

0.20%

0.38%

Efficiency Ratio (2)

51.16%

52.60%

At Period End

 

 

Total Assets

$1,108,621

$1,060,373

Total Loans

846,190

791,315

Total Investment Securities

178,390

187,930

Total Deposits

824,761

750,714

Total Shareholders’ Equity

108,800

104,579

1Annualized using a 365-day basis

2The Company uses the following formula in calculating its efficiency ratio:

 

Non-Interest Expense - Loss on Securities Sales

Tax-Equivalent Net Interest Income + Non-Interest Income – Gains on Securities Sales

 

Page 1

Item 1 – Financial Statements

 

 

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders

First National Lincoln Corporation

 

We have reviewed the accompanying interim consolidated financial information of First National Lincoln Corporation and Subsidiary as of March 31, 2007 and 2006 and for the three-month periods then ended. These financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is to express an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Berry, Dunn, McNeil & Parker

 

Portland, Maine

May 9, 2007

 

Page 2

Consolidated Balance Sheets (Unaudited)

First National Lincoln Corporation and Subsidiary

 

 

March 31,

December 31,

March 31,

In thousands of dollars

2007

2006

2006

Assets

 

 

 

Cash and due from banks

$ 21,103

$ 24,188

$ 21,052

Overnight funds sold

-

-

-

Securities available for sale

43,924

44,815

54,369

Securities to be held to maturity (fair value $133,474 at March 31, 2007, $134,649 at December 31, 2006,

and $131,610 at March 31, 2006)

134,466

135,734

133,561

Loans held for sale (fair value approximates cost)

584

460

-

Loans

846,190

838,145

791,315

Less: allowance for loan losses

6,495

6,364

6,131

Net loans

839,695

831,781

785,184

Accrued interest receivable

7,202

6,140

6,096

Premises and equipment

15,670

15,845

16,516

Other real estate owned

1,144

1,144

498

Goodwill

27,684

27,684

27,684

Other assets

17,149

17,078

15,413

Total Assets

$1,108,621

$1,104,869

$1,060,373

Liabilities

 

 

 

Demand deposits

$ 53,128

$ 62,157

$ 58,526

NOW deposits

96,685

99,612

100,432

Money market deposits

140,465

137,163

118,670

Savings deposits

93,472

98,131

103,267

Certificates of deposit

182,890

164,770

154,068

Certificates $100,000 and over

258,121

243,402

215,751

Total deposits

824,761

805,235

750,714

Borrowed funds

162,512

179,862

194,172

Other liabilities

12,548

12,445

10,908

Total Liabilities

999,821

997,542

955,794

Shareholders’ Equity

 

 

 

Common stock

98

98

100

Additional paid-in capital

45,693

45,587

47,430

Retained earnings

62,685

61,298

56,505

Net unrealized gains on securities available-for-sale

672

696

544

Net unrealized loss on postretirement benefit costs

(348)

(352)

-

Total Shareholders’ Equity

108,800

107,327

104,579

Total Liabilities & Shareholders’ Equity

$1,108,621

$1,104,869

$1,060,373

 

 

 

 

Common Stock

 

 

 

Number of shares authorized

18,000,000

18,000,000

18,000,000

Number of shares issued and outstanding

9,783,515

9,770,792

9,849,166

Book value per share

$11.12

$10.98

$10.62

See Report of Independent Registered Public Accounting Firm.

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 3

Consolidated Statements of Income (Unaudited)

First National Lincoln Corporation and Subsidiary

 

 

For the three months

 

ended March 31,

In thousands of dollars

2007

2006

Interest income

 

 

Interest and fees on loans

$14,462

$12,507

Interest on deposits with other banks

-

-

Interest and dividends on investments

2,486

2,305

Total interest income

16,948

14,812

Interest expense

 

 

Interest on deposits

7,229

5,119

Interest on borrowed funds

2,154

1,945

Total interest expense

9,383

7,064

Net interest income

7,565

7,748

Provision for loan losses

300

250

Net interest income after provision for loan losses

7,265

7,498

Non-interest income

 

 

Investment management and fiduciary income

503

496

Service charges on deposit accounts

659

622

Net securities gains

-

-

Mortgage origination and servicing income

100

84

Other operating income

886

871

Total non-interest income

2,148

2,073

Non-interest expense

 

 

Salaries and employee benefits

2,712

2,662

Occupancy expense

379

374

Furniture and equipment expense

474

505

Amortization of identified intangibles

71

71

Other operating expense

1,614

1,822

Total non-interest expense

5,250

5,434

Income before income taxes

4,163

4,137

Applicable income taxes

1,160

1,159

NET INCOME

$3,003

$2,978

Earnings per common share:

 

 

Basic earnings per share

$0.31

$0.30

Diluted earnings per share

$0.31

$0.30

Cash dividends declared per share

$0.165

$0.145

Weighted average number of shares outstanding

9,780,352

9,857,326

Incremental Shares

40,945

84,829

See Report of Independent Registered Public Accounting Firm.

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 4

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

First National Lincoln Corporation and Subsidiary

 

 

In thousands of dollars except number of shares

Number of common shares

Common stock

Additional paid-in capital

Retained earnings

Net unrealized gains on securities available for sale

Net unrealized loss on post-retirement benefit costs

Total

share-holders’ equity

Balance at December 31, 2005

9,832,777

$ 99

$47,718

$54,901

$734

$ -

$103,452

Net income

-

-

-

2,978

-

-

2,978

Net unrealized loss on securities available for sale, net of tax benefit of $102

-

-

-

-

(190)

-

(190)

Comprehensive income

-

-

-

2,978

(190)

-

2,788

Cash dividends declared

-

-

-

(1,429)

-

-

(1,429)

Payment to repurchase common stock

(32,887)

-

(578)

-

-

-

(578)

Proceeds from sale of common stock

49,276

1

290

-

-

-

291

Tax benefit of disqualifying disposition of incentive stock option shares

-

-

-

55

-

-

55

Balance at March 31, 2006

9,849,166

$100

$47,430

$56,505

$544

$ -

$104,579

 

 

 

 

 

 

 

 

Balance at December 31, 2006

9,770,792

$ 98

$45,587

$61,298

$696

$(352)

$107,327

Net income

-

-

-

3,003

-

-

3,003

Net unrealized loss on securities available for sale, net of tax benefit of $13

-

-

-

-

(24)

-

(24)

Net change in unrecognized transition obligation for postretirement benefits, net of tax of $3

-

-

-

-

-

4

4

Comprehensive income

-

-

-

3,003

(24)

4

2,983

Cash dividends declared

-

-

-

(1,616)

-

-

(1,616)

Equity compensation expense

-

-

15

-

-

-

15

Payment to repurchase common stock

(6,668)

-

(111)

-

-

-

(111)

Proceeds from sale of common stock

19,391

-

202

-

-

-

202

Balance at March 31, 2007

9,783,515

$ 98

$45,693

$62,685

$672

$(348)

$108,800

 

See Report of Independent Registered Public Accounting Firm.

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 5

Consolidated Statements of Cash Flows (Unaudited)

First National Lincoln Corporation and Subsidiary

 

For three months ended March 31,

In thousands of dollars

2007

2006

Cash flows from operating activities

 

 

Net income

$ 3,003

$ 2,978

Adjustments to reconcile net income to net cash provided by operating activities

 

 

Depreciation

307

344

Provision for loan losses

300

250

Loans originated for resale

(5,663)

(4,198)

Proceeds from sales and transfers of loans

5,539

4,198

Equity compensation expense

15

-

Net increase (decrease) in other assets and accrued interest

(1,194)

18

Net increase in other liabilities

68

1,354

Net accretion of discounts on investments

(355)

(21)

Net acquisition amortization

57

67

Provision for losses on other real estate owned

17

-

Net cash provided by operating activities

2,094

4,990

Cash flows from investing activities

 

 

Proceeds from maturities, payments and calls of securities available for sale

1,226

97

Proceeds from maturities, payments and calls of securities to be held to maturity

51,777

2,817

Proceeds from sales of other real estate owned

518

-

Purchases of securities available for sale

(343)

-

Purchases of securities to be held to maturity

(50,183)

(7,134)

Net increase in loans

(8,768)

(19,727)

Capital expenditures

(132)

(148)

Net cash used in investing activities

(5,905)

(24,095)

Cash flows from financing activities

 

 

Net decrease in demand deposits, savings, money market and club accounts

(13,313)

(27,583)

Net increase in certificates of deposit

32,868

64,378

Advances on long-term borrowings

10,000

-

Repayment on long-term borrowings

(5,000)

-

Net decrease in short-term borrowings

(22,356)

(21,011)

Payments to repurchase common stock

(111)

(578)

Proceeds from sale of common stock

202

291

Tax benefit from disqualifying disposition of stock options

 

55

Dividends paid

(1,564)

(1,377)

Net cash provided by financing activities

726

14,175

Net decrease in cash and cash equivalents

(3,085)

(4,930)

Cash and cash equivalents at beginning of year

24,188

25,982

Cash and cash equivalents at end of period

$ 21,103

$ 21,052

Interest paid

$ 9,001

$ 6,292

Income taxes paid

$ 273

$ 8

Non-cash transactions

 

 

Change in unrealized gain on available for sale securities, net of tax

$ (24)

$ (190)

Net transfer from loans to other real estate owned

$ 535

$ -

See Report of Independent Registered Public Accounting Firm.

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 6

Notes to Consolidated Financial Statements

First National Lincoln Corporation and Subsidiary

 

Note 1 – Basis of Presentation

 

First National Lincoln Corporation (the Company) is a financial holding company that owns all of the common stock of The First, N.A. (the Bank). The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of Management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions and balances are eliminated in consolidation. The income reported for the 2007 period is not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the consolidated financial statements and notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

 

Note 2 – Common Stock

 

On July 21, 2006, the Company announced that its Board of Directors had authorized a new program for the repurchase of up to 250,000 shares of the Company’s common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company’s stock and the level of stock issuances under the Company’s employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated. As of March 31, 2007, the Company had repurchased 113,704 shares under the new repurchase plan at an average price of $17.02 and at a total cost of $1.9 million.

 

Note 3 – Stock Options

 

The Company established a shareholder-approved stock option plan in 1995, under which the Company may grant options to its employees for up to 600,000 shares of common stock. The Company believes that such awards align the interests of its employees with those of its shareholders. Only incentive stock options may be granted under the plan. The option price of each option grant is determined by the Options Committee of the Board of Directors, and in no instance shall be less than the fair market value on the date of the grant. An option’s maximum term is ten years from the date of grant, with 50% of the options granted vesting two years from the date of grant and the remaining 50% vesting five years from date of grant. As of January 16, 2005, all options under this plan had been granted.

The Company applies the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payment”, to stock-based employee compensation for fiscal years beginning on or after January 1, 2006. As a result, $15,000 in compensation cost is included in the Company’s financial statements for the current year. The unrecognized compensation cost to be amortized over a weighted average remaining vesting period of 2.9 years is $156,000, which is comprised of $17,000 for 16,500 options granted in 2002 and $139,000 for 42,000 options granted in 2005.

The weighted average fair market value per share was $2.77 for options granted in 2002 and $4.41 for options granted in 2005. The fair market value was estimated using the Black-Scholes option pricing model and the following assumptions: quarterly dividends of $0.07 in 2002 and $0.12 in 2005, risk-free interest rate of 1.58% in 2002 and 4.20% in 2005, volatility of 37.73% in 2002 and 25.81% in 2005, and an expected life of 10 years for both years, the options’ maximum term. Volatility is based on the actual volatility of the Company’s stock during the quarter in which the options were granted. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of the option grant.

The following table summarizes the status of the Company’s non-vested options as of March 31, 2007.

 

 

Page 7

 

 

Number of Shares

Weighted Average Grant Date Fair Value

Non-vested at December 31, 2006

58,500

$3.95

Granted in 2007

-

-

Vested in 2007

-

-

Forfeited in 2007

-

-

Non-vested at March 31, 2007

58,500

$3.95

 

During 2007, 9,000 options were exercised, with proceeds paid to the Company of $31,000. The excess of the fair value of the stock issued upon option exercise over the exercise price was $120,000. A summary of the status of the Company’s Stock Option Plan as of March 31, 2007 and changes during the three months then ended, is presented below.

 

 

Number of Shares

Weighted Average Exercise Price

Weighted Average Remaining Contractual Term

Aggregate Intrinsic Value

(In thousands)

Outstanding at December 31, 2006

123,000

$10.53

 

 

Granted in 2007

-

-

 

 

Vested in 2007

-

-

 

 

Exercised in 2007

(9,000)

3.42

 

 

Forfeited in 2007

-

-

 

 

Outstanding at March 31, 2007

114,000

$11.09

4.9

$695

Exercisable at March 31, 2007

55,500

$ 6.39

2.6

$574

 

Note 4 – Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share (EPS) for the three months ended March 31, 2007 and 2006:

 

 

Income

Shares

Per-Share

In thousands, except number of shares and per share data

(Numerator)

(Denominator)

Amount

For the three months ended March 31, 2007

 

 

 

Net income as reported

$3,003

 

 

Basic EPS: Income available to common shareholders

$3,003

9,780,352

$0.31

Effect of dilutive securities: incentive stock options

 

40,945

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$3,003

9,821,297

$0.31

For the three months ended March 31, 2006

 

 

 

Net income as reported

$2,978

 

 

Basic EPS: Income available to common shareholders

$2,978

9,857,326

$0.30

Effect of dilutive securities: incentive stock options

 

84,829

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$2,978

9,942,155

$0.30

 

All earnings per share calculations have been made using the weighted average number of shares outstanding during the period. All of the dilutive securities are incentive stock options granted to certain key members of Management. The dilutive number of shares has been calculated using the treasury method, assuming that all granted options were exercisable at the end of each period.

 

Page 8

Note 5 – Postretirement Benefit Plans

 

In December 2006, the Company implemented SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” – an amendment of FASB Statements No. 87, 88, 106, and 132(R). This Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income of a business entity. The Bank sponsors postretirement benefit plans which provide certain life insurance and health insurance benefits for certain retired employees and health insurance for retired directors. None of these plans are pre-funded. The following table sets forth the accumulated postretirement benefit obligation and funded status:

 

 

At March 31,

In thousands of dollars

2007

2006

Change in benefit obligation

 

 

Benefit obligation at beginning of year

$ 2,005

$1,705

Service cost

3

3

Interest cost

31

30

Benefits paid

(38)

(32)

Benefit obligation at end of period

2,001

1,706

Funded status

 

 

Benefit obligation at end of period

(2,001)

(1,706)

Unamortized prior service cost

-

(11)

Unamortized net actuarial loss

-

56

Unrecognized transition obligation

-

201

Accrued benefit cost

$(2,001)

$(1,460)

 

The following table sets forth the net periodic pension cost:

 

 

For three months ended March 31,

In thousands of dollars

2007

2006

Components of net periodic benefit cost

 

 

Service cost

$ 3

$ 3

Interest cost

31

30

Amortization of unrecognized transition obligation

7

7

Amortization of prior service credit

(1)

(1)

Amortization of accumulated losses

1

2

Net periodic benefit cost

$41

$41

 

Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive loss are as follows:

 

 

At March 31,

In thousands of dollars

2007

2006

Unamortized prior service credit

$ 7

$ -

Unamortized net actuarial loss

(370)

-

Unrecognized transition obligation

(172)

-

 

(535)

-

Deferred tax benefit at 35%

(187)

-

Net unrecognized postretirement benefits included in accumulated other comprehensive income

$ (348)

$ -

 

 

Page 9

A weighted average discount rate of 7.0% was used in determining both the accumulated benefit obligation and the net periodic benefit cost. The measurement date for benefit obligations was as of year-end for prior years presented. The Company’s expected benefit payments for the second quarter of 2007 are $38,000 and the expected benefit payments for all of 2007 are $153,000. There is no expected contribution for 2007. Plan expense for 2007 is estimated to be $168,000.

 

Note 6 – Goodwill and Other Intangible Assets

 

As of December 31, 2006, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company completed its annual review of goodwill and determined there has been no impairment.

 

Note 7 – Loan Servicing

 

The Company implemented SFAS No. 156, “Accounting for Servicing of Financial Assets,” in the first quarter of 2007. An amendment to SFAS No. 140, SFAS No. 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. Servicing assets and servicing liabilities will subsequently be reported using the amortization method or the fair value measurement method.

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 ten-year U.S. Treasury rate plus 5.0%. 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.

For the three months ended March 31, 2007, mortgage servicing rights of $178,000 were capitalized and amortization for the period totaled $111,000. At March 31, 2007 and 2006, the Bank serviced loans for others totaling $163.7 million and $163.0 million, respectively. Mortgage servicing rights are included in other assets and are detailed in the following table:

        

 

At March 31

In thousands of dollars

2007

2006

Mortgage servicing rights

$ 3,494

$ 2,893

Accumulated amortization

(2,550)

(1,845)

Impairment reserve

(9)

(8)

 

$ 935

$ 1,040

 

Note 8 – Derivative Financial Instruments

 

The Bank uses an interest rate protection agreement (cap) as a cash flow hedge to eliminate the cash flow exposure of interest rate movements on money-market deposits. The premium paid for the cap is amortized over its life. Any cash payments received are recorded as an adjustment to net interest income. The Bank documents its risk management strategy and hedge effectiveness at the inception of and during the term of the hedge. The cap is designated and qualifies as a cash flow hedge, and thus is recorded at fair value. SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, provides that a cash flow hedge is effective to the extent the variability in its cash flows offsets the variability in the cash flows of the hedged item, in this case the increase in cost of money market deposits.

Management has determined that the hedge relationship is 100 percent effective. The fair value of the derivative, $72,000 at March 31, 2007, is recorded on the balance sheet. This approximates the amortized cost of the cap, and as a result, no unrealized gain or loss, net of applicable income taxes, is recorded in other comprehensive income in the statement of changes in shareholders’ equity for the period ended March 31, 2007.

 

Page 10

Note 9 – Income Taxes

 

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company has adopted the provisions of FIN 48 and there was no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2004 through 2006.

 

Note 10 – Reclassifications

 

Certain items from the prior year were reclassified in the financial statements to conform with the current year presentation. These do not have a material impact on the balance sheet or statement of income presentations.

 

Note 11 – Impact of Recently Issued Accounting Standards

 

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and early application is encouraged. This Statement does not require any new fair value measurements and the Company does not expect application of this Statement to change current practice.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which permits companies to choose to measure many financial instruments and certain other items at fair value. The objective of the new pronouncement is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for the Company in 2008. The Company has not yet made a determination if it will elect to apply the options available in SFAS No. 159.

 

Page 11

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

First National Lincoln Corporation and Subsidiary

 

Critical Accounting Policies

 

Management’s discussion and analysis of the Company’s financial condition is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, Management evaluates its estimates, including those related to the allowance for loan losses, the valuation of mortgage servicing rights, and goodwill. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from Management’s estimates and assumptions under different assumptions or conditions.

Allowance for Loan Losses. Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on Management’s evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and Management’s estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses.

Goodwill. Management utilizes numerous techniques to estimate the value of various assets held by the Company, including methods to determine the appropriate carrying value of goodwill as required under SFAS No. 142. In addition, goodwill from a purchase acquisition is subject to ongoing periodic impairment tests, which include an evaluation of the ongoing assets, liabilities and revenues from the acquisition and an estimation of the impact of business conditions.

 

Executive Summary

 

The current challenges faced by the banking industry were summed up very well by Don Johnson and Jeff Kaplan in the March issue of the NASDAQ Regional Banking Monitor, in which they noted that investors should ‘not expect much improvement from the flat earnings reported (by banks) during the fourth quarter of 2006. While the first quarter is generally weaker than the fourth quarter ... the anticipated weakness also reflects the challenges facing the industry. First quarter earnings growth is expected to be hurt by the deterioration of asset quality in the form of higher nonperforming assets, net charge-offs and loan loss provisions as well as a moderation of loan growth, (and) stiff competition on loan and deposit pricing.”

The Company’s first-quarter results were better than those Kaplan and Johnson predicted for the banking industry. Net income and earnings per share were higher than the first quarter of 2006 as well as above those posted for the previous quarter. Net income for the three months ended March 31, 2007, was $3,003,000, an increase of 0.8% from net income of $2,978,000 for the comparable period of 2006 and up $33,000 or 1.1% from the previous quarter. Fully diluted earnings per share for the three months ended March 31, 2007 were $0.31, a 3.3% increase from the $0.30 reported for the first quarter of 2006. Although the Company had modest growth in earning assets this quarter, it experienced margin compression due to the flat-to-inverted yield curve, with liability costs increasing more rapidly than yield on assets. The net interest margin on a tax-equivalent basis declined to 3.16% for the first three months of 2007 from 3.46% for the same period in 2006, which, in turn, has resulted in a modest decline in net interest income.

Asset quality remains strong, with first quarter net chargeoffs of $169,000 significantly lower than the $243,000 average quarterly net chargeoffs during the past two years. Past-due and problem loans remain low and improved, with non-performing loans to total loans at 0.26% as of March 31, 2007, compared to 0.51% a year ago.

 

Page 12

Net Interest Income

 

Total interest income of $16.9 million for the three months ended March 31, 2007 is a 14.4% increase from total interest income of $14.8 million for the comparable period of 2006. Rising interest rates resulted in higher asset yields in 2007 compared to 2006. Total interest expense of $9.4 million for the first three months of 2007 is a 32.8% increase from total interest expense of $7.1 million for the first three months of 2006. This was a direct result of the rising interest rate climate and increased volume of higher cost sources of funding. Net interest income decreased 2.4% to $7.6 million for the three months ended March 31, 2007, from $7.7 million reported for the same period in 2006.

The Company’s net interest margin on a tax-equivalent basis decreased from 3.46% in the first three months of 2006 to 3.16% for the three months ended March 31, 2007. This is due to the current flat yield curve and liability costs increasing at a faster rate than the yield on assets. These results are consistent with the Company’s expectations for changes in its net interest income in the current rate environment.

Tax-exempt interest income amounted to $947,000 and $879,000 for the three months ended March 31, 2007 and 2006, respectively. Tax equivalency is calculated using a 35.0% effective tax rate. The following table presents the effect of tax-exempt income on the calculation of the net interest margin, using a 35.0% tax rate in 2007 and 2006:

 

 

For the three months

 

ended March 31,

 

2007

2006

Net interest income as presented

$ 7,565

$ 7,748

Effect of tax-exempt income

510

474

Net interest income, tax equivalent

$ 8,075

$ 8,222

 

The following table presents the amount of interest earned or paid, as well as the average yield or rate on an annualized basis, for each major category of assets or liabilities for the three months ended March 31, 2007 and 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2007 and 2006.

 

Three months ended March 31,

2007

2006

Dollars in thousands

Amount of interest

Average yield/rate

Amount of interest

Average yield/rate

Interest-earning assets

 

 

 

 

Investments

$ 2,855

5.98%

$ 2,659

5.84%

Loans held for sale

4

7.95%

8

5.96%

Loans

14,599

7.03%

12,619

6.56%

Total interest-earning assets

17,458

6.84%

15,286

6.42%

Interest-bearing liabilities

 

 

 

 

Deposits

7,229

3.91%

5,119

3.04%

Other borrowings

2,154

4.81%

1,945

4.10%

Total interest-bearing liabilities

9,383

4.08%

7,064

3.27%

Net interest income

$ 8,075

 

$ 8,222

 

Interest rate spread

 

2.75%

 

3.15%

Net interest margin

 

3.16%

 

3.46%

 

The following table presents changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2007 compared to 2006. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in both years.

 

 

 

 

Page 13

 

Three months ended March 31, 2007 compared to 2006

 

 

Dollars in thousands

Volume

Rate

Rate/Volume1

Total

Interest on earning assets

 

 

 

 

Interest-bearing deposits

$ -

$ -

$ -

$ -

Investment securities

129

64

3

196

Loans held for sale

-

2

1

3

Loans

999

903

71

1,973

Total interest income

1,128

969

75

2,172

Interest expense

 

 

 

 

Deposits

497

1,470

143

2,110

Other borrowings2

(108)

336

(19)

209

Total interest expense

389

1,806

124

2,319

Change in net interest income

$ 739

$ (837)

$ (49)

$ (147)

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

2 Includes federal funds purchased.

 

Provision for Loan Losses

 

A $300,000 provision to the allowance for loan losses was made during the first three months of 2007, compared to a $250,000 provision made for the same period of 2006. This additional provision is not indicative of a significant decline in loan quality – it was to maintain the allowance for loan losses at an adequate level given continued growth in our loan portfolio and our level of chargeoffs.

 

Non-Interest Income

 

Non-interest income was $2,148,000 for the three months ended March 31, 2007, an increase of 3.6% from $2,073,000 reported for the first three months of 2006. This rise in non-interest income was primarily due to increases in mortgage origination and servicing income as well as increased levels of revenue on deposit accounts.

 

Non-Interest Expense

 

Non-interest expense of $5,250,000 for the three months ended March 31, 2007, is a decrease of 3.4% compared to non-interest expense of $5,434,000 for the same period in 2006. This decline was attributable to minimal increases in employee costs as well as lower other operating expense. Due to the challenges produced by the interest rate environment established by the FOMC, the Company aggressively sought to control operating expense in the first quarter of 2007.

 

Income Taxes

 

Income taxes on operating earnings were $4,163,000 for the three months ended March 31, 2007, up from $4,137,000 in the same period a year ago. This is in line with the Company’s level of income before taxes.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company has adopted the provisions of FIN 48 and there was no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48. However, certain amounts have been reclassified in the statement of financial position in order to comply with the requirements of the statement. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2004 through 2006.

 

Page 14

 

Investments

 

The Company’s investment portfolio decreased by $2.2 million or 1.2% to $178.4 million between December 31, 2006, and March 31, 2007. At March 31, 2007, the Company’s available-for-sale portfolio had an unrealized gain, net of taxes, of $0.7 million. Between March 31, 2006, and March 31, 2007, the Company’s investment portfolio decreased by $9.5 million or 5.1%.

 

Loans

 

Loans grew by $8.0 million or 1.0% during the first three months of 2007. The growth in commercial loans was $8.0 million or 2.4% while municipal loans decreased $0.1 million or 0.5%. The residential mortgage portfolio increased by $2.4 million or 0.7%, and home equity lines of credit decreased $1.8 million or 2.5% year-to-date. Between March 31, 2006 and March 31, 2007 the loan portfolio increased $54.9 million or 6.9%, as a result of modest customer demand.

 

Allowance for Loan Losses

 

The allowance for loan losses represents the amount available for credit losses inherent in the Company’s loan portfolio. Loans are charged off when deemed uncollectible, after giving consideration to factors such as the customer’s financial condition, underlying collateral and guarantees, as well as general and industry economic conditions.

Adequacy of the allowance for loan losses is determined using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for loan losses, Management also takes into consideration other factors such as changes in the mix and size of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio that have similar attributes. The Company’s historical loss experience, industry trends, and the impact of the local and regional economy on the Company’s borrowers, are considered by Management in determining the adequacy of the allowance for loan losses.

The allowance for loan losses is increased by provisions charged against current earnings. Loan losses are charged against the allowance when Management believes that the collectibility of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. While Management uses available information to assess possible losses on loans, future additions to the allowance may be necessary based on increases in non-performing loans, changes in economic conditions, growth in loan portfolios, or for other reasons. Any future additions to the allowance would be recognized in the period in which they were determined to be necessary. In addition, various regulatory agencies periodically review the Company’s allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to record additions to the allowance based on judgments different from those of Management.

Credit quality of the commercial portfolios is quantified by a credit rating system designed to parallel regulatory criteria and categories of loan risk. Individual loan officers monitor their loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of the commercial loan portfolio are also assessed on a regular basis by an independent loan review consulting firm. Ongoing portfolio trend analyses and individual credit reviews to evaluate loan risk and compliance with corporate lending policies are also performed. The level of allowance allocable to each group of risk-rated loans is then determined by applying a loss factor that estimates the amount of probable loss in each category. The assigned loss factor for each risk rating is based upon Management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience.

Consumer loans, which include residential mortgages, home equity loans/lines, and direct/indirect loans, are generally evaluated as a group based on product type and on the basis of delinquency data and other credit data available due to the large number of such loans and the relatively small size of individual credits. Allocations for these loan categories are principally determined by applying loss factors that represent Management’s estimate of inherent losses. In each category, inherent losses are estimated based upon Management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience. In addition, certain loans in these categories may be individually risk-rated if considered necessary by Management.

 

Page 15

The other method used to allocate the allowance for loan losses entails the assignment of reserve amounts to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when Management believes it is probable that the Company will not collect all of the contractual interest and principal payments as scheduled in the loan agreement. Under this method, loans are selected for evaluation based on internal risk ratings or non-accrual status. A specific reserve is allocated to an individual loan when that loan has been deemed impaired and when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. At March 31, 2007, impaired loans with specific reserves totaled $1.3 million (all of these loans were on non-accrual status) and the amount of such reserves were $0.5 million.

All of these analyses are reviewed and discussed by the Directors’ Loan Committee, and recommendations from these processes provide Management and the Board of Directors with independent information on loan portfolio condition. As a result of these analyses, the Company has concluded that the level of the allowance for loan losses was adequate as March 31, 2007. As of that date, the balance of $6,495,000 was 0.77% of total loans, compared to 0.76% at December 31, 2006 and 0.77% at March 31, 2006. Loans considered to be impaired according to SFAS 114/118 totaled $2.5 million at March 31, 2007 compared to $3.5 million at December 31, 2006. The portion of the allowance for loan losses allocated to impaired loans at March 31, 2007, was $0.5 million compared to $0.2 million at December 31, 2006.

In Management’s opinion, the level of the Company’s allowance for loan losses is adequate. Although the allowance is lower as a percentage of loans than many peers, the Bank’s loan portfolio has a higher percentage of residential mortgage loans than peers, which typically reflects a much lower level of credit risk. The Company’s actual historical experience supports this by the overall credit quality of the portfolio and historically low level of chargeoffs.

 

Non-Performing Assets

 

At March 31, 2007, loans on non-accrual status totaled $2.2 million, which compares to non-accrual loans of $3.5 million as of December 31, 2006. In addition to loans on non-accrual status March 31, 2007, loans past due 90 days or more and accruing (calculated on a constant 30-day month basis) totaled $0.8 million which compares to $0.7 million as of December 31, 2006. The Company continues to accrue interest on these loans because it believes collection of the interest is reasonably assured.

 

Goodwill

 

On January 14, 2005, the Company completed the acquisition of FNB Bankshares (“FNB”) of Bar Harbor, Maine, and its subsidiary, The First National Bank of Bar Harbor, which was merged into the Bank. The total value of the transaction was $48.0 million, and all of the voting equity interest of FNB was acquired in the transaction. As of December 31, 2006, in accordance with SFAS No. 142, the Company completed its annual review of goodwill and determined there has been no impairment.

 

Deposits

 

During the first three months of 2007, total deposits increased by $19.5 million or 2.4% over December 31, 2006. Core deposits (demand, NOW, savings and money market accounts) decreased by $13.3 million or 3.4% in the first three months of 2007, and during the same period, certificates of deposit increased $32.8 million or 8.0%. Between March 31, 2006, and March 31, 2007, deposits grew by 9.9%, or $74.0 million. Certificates of deposit grew by $71.2 million, while money market accounts also grew by $21.8 million. Demand deposits decreased by $5.4 million, while NOW accounts also decreased by $3.7 million, and savings decreased by $9.8 million. The majority of the growth in certificates of deposit, both year-to-date and year-over-year, was primarily from wholesale and brokered sources. The Company saw a decline in core deposits year-over-year due to transfers to higher-yielding certificates of deposit due to higher interest rates.

 

Borrowed Funds

 

The Company’s funding includes borrowings from the Federal Home Loan Bank of Boston, the Federal Reserve System, and repurchase agreements, enabling it to grow its balance sheet and its revenues. They may also be used to carry out interest rate risk management stategies, and are increased to replace or supplement other sources of funding, including core deposits and certificates of deposit. During the three months ended March 31, 2007, borrowed funds

 

Page 16

decreased $17.4 million or 9.6% from December 31, 2006, as a result of the deposit growth previously noted. Between March 31, 2006 and March 31, 2007, borrowed funds also decreased by $31.7 million or 16.3%.

Shareholders’ Equity

 

Shareholders’ equity as of March 31, 2007 was $108.8 million, compared to $107.3 million as of December 31, 2006. The Company’s earnings in the first three months of 2007, net of dividends paid, added to shareholders’ equity. The net unrealized loss on available-for-sale securities, presented in accordance with SFAS 115, remained relatively the same at $0.7 million for quarter ended March 31, 2007.

In 2007, a cash dividend of 16.5 cents per share was declared in the first quarter compared to 14.5 cents in the first quarter of 2006. The dividend payout ratio was 53.23% in the first quarter of 2007 compared to 48.33% in the first quarter of 2006. In determining future dividend payout levels, the Board of Directors carefully analyzes capital requirements and earnings retention, as set forth in the Company’s Dividend Policy. The ability of the Company to pay cash dividends to its shareholders depends on receipt of dividends from its subsidiary, the Bank. The subsidiary may pay dividends to its parent out of so much of its net profits as the Bank’s directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. The amount available for dividends in 2007 is this year’s net income plus retained earnings of $10.2 million from 2006 and 2005.

Regulatory leverage capital ratios for the Company were 7.46% and 7.22% at March 31, 2007 and December 31, 2006, respectively. The Company had a tier one risk-based capital ratio of 10.47% and tier two risk-based capital ratio of 11.34% at March 31, 2007, compared to 10.40% and 11.26%, respectively, at December 31, 2006. These are comfortably above the standards to be rated “well-capitalized” by regulatory authorities – qualifying the Company for lower deposit-insurance premiums.

On July 21, 2006, the Company announced that its Board of Directors had authorized a new program for the repurchase of up to 250,000 shares of the Company’s common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company’s stock and the level of stock issuances under the Company’s employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated. As of March 31, 2007, the Company had repurchased 113,704 shares under the new repurchase plan at an average price of $17.02 and at a total cost of $1.9 million.

 

Page 17

Average Daily Balance Sheets

 

The following table shows the Company’s average daily balance sheets for the three month periods ended March 31, 2007 and 2006.

 

 

For the Three months

ended March 31,

In thousands of dollars

2007

2006

Assets

 

 

Cash and due from banks

$ 20,001

$ 20,401

Interest-bearing deposits

-

-

Investments

 

 

U.S. Treasury securities & government agency securities

92,576

87,597

Obligations of states and political subdivisions

58,535

56,048

Other securities

42,366

40,881

Total investments

193,477

184,526

Loans held for sale

202

133

Loans

 

 

Commercial

337,433

317,830

Consumer

54,930

40,323

State and municipal

23,667

20,509

Real estate

425,934

401,569

Total loans

841,964

780,231

Allowance for loan losses

(6,382)

(6,168)

Net loans

835,582

774,063

Premises and equipment

15,795

16,629

Goodwill

27,684

27,684

Other assets

14,523

29,712

Total assets

$1,107,264

$1,053,148

Liabilities and shareholders’ equity

 

 

Deposits

 

 

Demand

$ 56,974

$ 58,668

NOW

96,220

101,578

Money market

141,189

127,002

Savings

95,313

106,711

Certificates of deposit

186,595

143,978

Certificates of deposit over $100,000

230,751

204,419

Total deposits

807,042

742,356

Borrowed funds

181,678

192,375

Other liabilities

10,328

13,983

Total liabilities

999,048

948,714

Common stock

98

100

Additional paid-in capital

45,637

47,686

Retained earnings

61,785

55,915

Unrealized gain/loss on available-for-sale securities

696

733

Total shareholders’ equity

108,216

104,434

Total liabilities and shareholders’ equity

$ 1,107,264

$1,053,148

 

 

Page 18

Off-Balance Sheet Financial Instruments

 

No material off-balance sheet risk exists that requires a separate liability presentation.

 

Sale of Loans

 

No recourse obligations have been incurred in connection with the sale of loans.

 

Contractual Obligations

 

The following table sets forth the contractual obligations of the Company as of March 31, 2007:

 

In thousands of dollars

Total

Less than 1 year

1-3 years

3-5 years

More than 5 years

Borrowed funds

$ 162,512

$ 105,315

$ 42,000

$ 15,000

$ 197

Operating leases

474

179

191

80

24

Certificates of deposit

441,011

359,256

76,309

5,446

-

Total

$ 603,997

$ 464,750

$ 118,500

$ 20,526

$ 221

Unused line, collateralized by residential real estate

$ 78,083

78,083

-

-

-

Other unused commitments

$ 50,126

50,126

-

-

-

Standby letters of credit

$ 1,466

1,466

-

-

-

Commitments to extend credit

$ 20,869

20,869

-

-

-

Total loan commitments and unused lines of credit

$ 137,505

$ 137,505

$ -

$ -

$ -

 

Liquidity Management

 

As of March 31, 2007 the Bank had primary sources of liquidity of $247.1 million. It is Management’s opinion this is adequate. In its Asset/Liability policy, the Bank has guidelines for liquidity. The Company is not aware of any recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on the Company’s liquidity, capital resources or results of operations.

 

Forward-Looking Statements

 

Certain disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations contain certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In preparing these disclosures, Management must make assumptions, including, but not limited to, the level of future interest rates, prepayments on loans and investment securities, required levels of capital, needs for liquidity, and the adequacy of the allowance for loan losses. These forward-looking statements may be subject to significant known and unknown risks uncertainties, and other factors, including, but not limited to, those matters referred to in the preceding sentence.

Although First National Lincoln Corporation believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company, which attempt to advise interested parties of the facts that affect the Company’s business.

 

Page 19

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

 

Market-Risk Management

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. First National Lincoln Corporation’s market risk is composed primarily of interest rate risk. The Bank’s Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. All guidelines and policies established by ALCO have been approved by the Board of Directors.

 

Asset/Liability Management

 

The primary goal of asset/liability management is to maximize net interest income within the interest rate risk limits set by ALCO. Interest rate risk is monitored through the use of two complementary measures: static gap analysis and earnings simulation modeling. While each measurement has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships.

Static gap analysis measures the amount of repricing risk embedded in the balance sheet at a point in time. It does so by comparing the differences in the repricing characteristics of assets and liabilities. A gap is defined as the difference between the principal amount of assets and liabilities that reprice within a specified time period. The Bank’s cumulative one-year gap, March 31, 2007, was -13.73% of total assets. Core deposits with non-contractual maturities are presented based upon historical patterns of balance attrition and pricing behavior, which are reviewed at least annually.

The gap repricing distributions include principal cash flows from residential mortgage loans and mortgage-backed securities in the time frames in which they are expected to be received. Mortgage prepayments are estimated by applying industry median projections of prepayment speeds to portfolio segments based on coupon range and loan age.

A summary of the Bank’s static gap, as of March 31, 2007 is presented in the following table:

 

 

0-90

90-365

1-5

5+

 

Days

Days

Years

Years

Investment securities at amortized cost

$23,139

$20,860

$79,698

$53,279

Loans held for sale

2

9

52

521

Loans

303,296

114,846

336,104

91,912

Other interest-earning assets

-

8,569

-

-

Non-rate-sensitive assets

87

233

1,089

46,489

Total assets

326,524

144,517

416,943

192,201

Interest-bearing deposits

291,634

215,552

81,789

182,527

Borrowed funds

75,278

30,027

57,074

133

Non-rate-sensitive liabilities and equity

1,650

5,249

31,687

107,585

Total liabilities and equity

368,562

250,828

170,550

290,245

Period gap

$(42,038)

$(106,311)

$246,393

$(98,044)

Percent of total assets

-3.89%

-9.84%

22.81%

-9.08%

Cumulative gap (current)

(42,038)

(148,349)

98,044

-

Percent of total assets

-3.89%

-13.73%

9.08%

0.00%

 

The earnings simulation model forecasts capture the impact of changing interest rates on one-year and two-year net interest income. The modeling process calculates changes in interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflected on the Company’s balance sheet. None of the assets used in the simulation are held for trading purposes. The modeling is done for a variety of scenarios that incorporate changes in the absolute level of interest rates as well as basis risk, as represented by changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effects on income of alternative interest rate scenarios

 

Page 20

against earnings in a stable interest rate environment. This analysis is also most useful in determining the short-run earnings exposures to changes in customer behavior involving loan payments and deposit additions and withdrawals.

The Bank’s most recent simulation model projects net interest income would increase by approximately 6.47% of stable-rate net interest income if short-term rates affected by Federal Open Market Committee actions fall gradually by two percentage points over the next year, and decrease by approximately 6.86% if rates rise gradually by two percentage points. Both scenarios are well within ALCO’s policy limit of a decrease in net interest income of no more than 10.0% given a 2.0% move in interest rates, up or down. Management believes this reflects a reasonable interest rate risk position. In year two, and assuming no additional movement in rates, the model forecasts that net interest income would be higher than that earned in a stable rate environment by 15.69% in a falling-rate scenario, and lower than that earned in a stable rate environment by 17.42% in a rising rate scenario, when compared to the year-one base scenario. A summary of the Bank’s interest rate risk simulation modeling, as of March 31, 2007 is presented in the following table:

 

 

Changes in Net Interest Income

2007

Year 1

 

Projected change if rates decrease by 2.0%

+6.47%

 

Projected change if rates increase by 2.0%

-6.86%

Year 2

 

Projected change if rates decrease by 2.0%

+15.69%

 

Projected change if rates increase by 2.0%

-17.42%

 

This dynamic simulation model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. Loans and deposits are projected to maintain stable balances. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in similar assets. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Non-contractual deposit volatility and pricing are assumed to follow historical patterns. The sensitivities of key assumptions are analyzed annually and reviewed by ALCO.

The information for static gap and changes in net interest income presented in this section pertains to the Bank only and does not include goodwill and a small volume of assets and liabilities owned by the Company and included in its consolidated financial statements as of March 31, 2007. This sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/ replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

 

Interest Rate Risk Management

 

A variety of financial instruments can be used to manage interest rate sensitivity. These may include investment securities, interest rate swaps, and interest rate caps and floors. Frequently called interest rate derivatives, interest rate swaps, caps and floors have characteristics similar to securities but possess the advantages of customization of the risk-reward profile of the instrument, minimization of balance sheet leverage and improvement of liquidity. As of March 31, 2007, the Company was using interest rate caps for interest rate risk management.

The Company engages an independent consultant to periodically review its interest rate risk position, as well as the effectiveness of simulation modeling and reasonableness of assumptions used. As of March 31, 2007, there were no significant differences between the views of the independent consultant and Management regarding the Company’s interest rate risk exposure. Management expects interest rates will remain stable for the next two quarters and believes that the current level of interest rate risk is acceptable.

 

Page 21

Item 4: Controls and Procedures

 

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of March 31, 2007, the end of the quarter covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level 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 Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal controls over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page 22

Part II – Other Information

 

Item 1 – Legal Proceedings

 

The Company was not involved in any legal proceedings requiring disclosure under Item 103 of Regulation S-K during the reporting period.

 

Item 1A – Risk Factors

 

There have been no material changes to the Risk Factors previously disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds  

 

a. The Company issues shares to the Bank’s 401k Investment and Savings Plan pursuant to an exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”), contained in Section 3(a)(11) thereof and Rule 147 promulgated thereunder, as presented in the following table:

 

Month

Shares

Average Price

Proceeds

January 2007

1,191

$16.61

$20,000

February 2007

1,381

16.54

22,000

March 2007

776

16.19

13,000

Total

3,348

$16.48

$55,000

 

b. None

 

c. On July 21, 2006, the Company announced that its Board of Directors had authorized a new program for the repurchase of up to 250,000 shares of the Company’s common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company’s stock and the level of stock issuances under the Company’s employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated. As of March 31, 2007, the Company had repurchased 113,704 shares under the new repurchase plan at an average price of $17.02 and at a total cost of $1,936,000. The following table details repurchases under this program during the three months ended March 31, 2007:

 

Month

Total

Number of

Shares Purchased

Average Price Paid Per Share

Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program

Maximum Number of Shares that may yet be Purchased under the Plan or Program

January 2007

5,210

$16.49

5,210

137,753

February 2007

808

16.50

808

136,945

March 2007

650

16.31

650

136,295

Total

6,668

$16.47

6,668

136,295

 

 

Item 3 – Default Upon Senior Securities

 

None.

 

Page 23

 

Item 4 – Submission of Matters to a Vote of Security Holders

 

None

 

Item 5 – Other Information

 

 

A.

None.

 

 

B.

None.

 

Page 24

Item 6 – Exhibits

 

Exhibit 2.1 Agreement and Plan of Merger With FNB Bankshares Dated August 25, 2004, incorporated by reference to Exhibit 2.1 to the Registrant’s Form 8-K dated August 25, 2004, filed under item 1.01 on August 27, 2004.

 

Exhibit 3.1 Conformed Copy of the Registrants Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 3.2 Conformed Copy of the Registrant’s Bylaws, incorporated by reference to Exhibit 3.2 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 10.1(a) FNB Bankshares’ Stock Option Plan. incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 10.2(a) Specimen Employment Continuity Agreement entered into with Messrs. McKim, Wroble and Dalrymple, incorporated by reference to Exhibit 10.2(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.2(b) Specimen Amendment to Employment Continuity Agreement entered into with Messrs. McKim, Wrobel and Dalrymple, incorporated by reference to Exhibit 10.2(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.3(a) Specimen Split Dollar Agreement entered into with Messrs. McKim, Wrobel and Dalrymple. For Mr. McKim, the amount of the death benefit is $250,000; for Messrs. Dalrymple and Wrobel, the death benefit is $150,000. Incorporated by reference to Exhibit 10.3(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.3(b) Specimen Amendment to Split Dollar Agreement entered into with Messrs. McKim, Wrobel and Dalrymple, incorporated by reference to Exhibit 10.3(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.4 Specimen Amendment to Employment Continuity Agreement entered into with Messrs. McKim and Wrobel, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 1.01 on January 31, 2005.

 

Exhibit 10.4 Specimen Amendment to Employment Continuity Agreement entered into with Mr. Dalrymple, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 1.01 on September 27, 2005.

 

Exhibit 31.1 Certification of Chief Executive Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934

 

Exhibit 31.2 Certification of Chief Financial Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934

 

Exhibit 32.1 Certification of Chief Executive Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

Exhibit 32.2 Certification of Chief Financial Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

Page 25

Signatures

 

 

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

 

 

FIRST NATIONAL LINCOLN CORPORATION

 

 

/s/ Daniel R. Daigneault

Daniel R. Daigneault

President & Chief Executive Officer

 

Date: May 10, 2007

 

 

/s/ F. Stephen Ward

F. Stephen Ward

Executive Vice President & Chief Financial Officer

 

Date: May 10, 2007

 

 

Page 26