LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the Company’s loan portfolio, excluding residential loans held for sale, at March 31, 2014 and December 31, 2013 was as follows:



	March 31, 2014			December 31, 2013
Residential real estate loans	$	568,348		$	570,391
Commercial real estate loans	574,695			541,099
Commercial loans	191,071			179,203
Home equity loans	269,911			272,630
Consumer loans	16,766			17,651
Deferred loan fees, net of costs	(605		)	(572		)
Total loans	$	1,620,186		$	1,580,402

The Company’s lending activities are primarily conducted in Maine. The Company originates single family and multi-family residential loans, commercial real estate loans, business loans, municipal loans and a variety of consumer loans. In addition, the Company makes loans for the construction of residential homes, multi-family properties and commercial real estate properties. The ability and willingness of borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the geographic area and the general economy. For the three months ended March 31, 2014, the Company did not sell any loans on the secondary market. For the three months ended March 31, 2013, the Company sold $9.4 million, of fixed-rate residential mortgage loans on the secondary market that resulted in net gains on the sale of loans of $307,000.

The ALL is management’s best estimate of the inherent risk of loss in the Company’s loan portfolio as of the consolidated 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 including historical losses. If those assumptions are incorrect, 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 ALL in the future are: (i) financial condition of borrowers; (ii) real estate market changes; (iii) state, regional, and national economic conditions; and (iv) a requirement by federal and state regulators to increase the provision for loan losses or recognize additional charge-offs. There were no significant changes in the Company's ALL methodology during the first quarter of 2014.

The Company's Board of Directors monitors credit risk through the Directors' Loan Review Committee, which reviews large credit exposures, monitors the external loan review reports, reviews the lending authority for individual loan officers when required, and has approval authority and responsibility for all matters regarding the loan policy and other credit-related policies, including reviewing and monitoring asset quality trends, concentration levels, and the ALL methodology. The Corporate Risk Management Group and the Credit Risk Policy Committee oversee the Company's systems and procedures to monitor the credit quality of its loan portfolio, conduct a loan review program, maintain the integrity of the loan rating system, determine the adequacy of the ALL and support the oversight efforts of the Directors' Loan Review Committee and the Board of Directors. The Company's practice is to proactively manage the portfolio such that management can identify problem credits early, assess and implement effective work-out strategies, and take charge-offs as timely as practical. In addition, the Company continuously reassesses its underwriting standards in response to credit risk posed by changes in economic conditions. For purposes of determining the ALL, the Company disaggregates its loans into portfolio segments, which include residential real estate, commercial real estate, commercial, home equity, and consumer.

The following table presents the activity in the ALL and select loan information by portfolio segment for the three months ended March 31, 2014:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL:
Beginning balance	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671		$	21,590
Loans charged off	(183		)	(171		)	(219		)	(62		)	(14		)	—			(649		)
Recoveries	92			39			96			3			7			—			237
Provision (reduction)	(101		)	286			195			329			(2		)	(215		)	492
Ending balance	$	5,411		$	4,528		$	6,292		$	2,673		$	310		$	2,456		$	21,670
ALL balance attributable to loans:
Individually evaluated for impairment	$	1,628		$	557		$	177		$	754		$	141		$	—		$	3,257
Collectively evaluated for impairment	3,783			3,971			6,115			1,919			169			2,456			18,413
Total ending ALL	$	5,411		$	4,528		$	6,292		$	2,673		$	310		$	2,456		$	21,670
Loans:
Individually evaluated for impairment	$	13,041		$	9,339		$	2,372		$	2,011		$	446		$	—		$	27,209
Collectively evaluated for impairment	554,702			565,356			188,699			267,900			16,320			—			1,592,977
Total ending loans balance	$	567,743		$	574,695		$	191,071		$	269,911		$	16,766		$	—		$	1,620,186

The following table presents the activity in the ALL and select loan information by portfolio segment for the three months ended March 31, 2013:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL:
Beginning balance	$	6,996		$	4,549		$	5,933		$	2,520		$	184		$	2,862		$	23,044
Loans charged off	(145		)	(80		)	(277		)	(28		)	(57		)	—			(587		)
Recoveries	3			75			129			2			19			—			228
Provision (reduction)	415			(942		)	415			864			76			(144		)	684
Ending balance	$	7,269		$	3,602		$	6,200		$	3,358		$	222		$	2,718		$	23,369
ALL balance attributable to loans:
Individually evaluated for impairment	$	2,468		$	197		$	325		$	469		$	82		$	—		$	3,541
Collectively evaluated for impairment	4,801			3,405			5,875			2,889			140			2,718			19,828
Total ending ALL	$	7,269		$	3,602		$	6,200		$	3,358		$	222		$	2,718		$	23,369
Loans:
Individually evaluated for impairment	$	13,754		$	7,633		$	3,329		$	1,855		$	488		$	—		$	27,059
Collectively evaluated for impairment	558,180			498,359			187,963			289,835			16,771			—			1,551,108
Total ending loans balance	$	571,934		$	505,992		$	191,292		$	291,690		$	17,259		$	—		$	1,578,167

The following table presents the activity in the ALL and select loan information by portfolio segment for the year ended December 31, 2013:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL:
Beginning balance	$	6,996		$	4,549		$	5,933		$	2,520		$	184		$	2,862		$	23,044
Loans charged off	(1,059		)	(952		)	(1,426		)	(647		)	(190		)	—			(4,274		)
Recoveries	35			121			495			56			61			—			768
Provision (reduction)	(369		)	656			1,218			474			264			(191		)	2,052
Ending balance	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671		$	21,590
ALL balance attributable to loans:
Individually evaluated for impairment	$	1,750		$	526		$	132		$	433		$	140		$	—		$	2,981
Collectively evaluated for impairment	3,853			3,848			6,088			1,970			179			2,671			18,609
Total ending ALL	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671		$	21,590
Loans:
Individually evaluated for impairment	$	14,435		$	8,864		$	2,635		$	1,571		$	442		$	—		$	27,947
Collectively evaluated for impairment	555,384			532,235			176,568			271,059			17,209			—			1,552,455
Total ending loans balance	$	569,819		$	541,099		$	179,203		$	272,630		$	17,651		$	—		$	1,580,402

The ALL at March 31, 2014 increased $80,000 since December 31, 2013, primarily due to loan growth of $39.8 million driven by the commercial real estate and commercial portfolios.

The Company focuses on maintaining a well-balanced and diversified loan portfolio. Despite such efforts, it is recognized that credit concentrations may occasionally emerge as a result of economic conditions, changes in local demand, natural loan growth and runoff. To ensure that credit concentrations can be effectively identified, all commercial and commercial real estate loans are assigned Standard Industrial Classification codes, North American Industry Classification System codes, and state and county codes. Shifts in portfolio concentrations are monitored by the Corporate Risk Management Group. As of March 31, 2014 and December 31, 2013, the two most significant industry exposures within the commercial real estate loan portfolio were non-residential building operators (operators of commercial and industrial buildings, retail establishments, theaters, banks and insurance buildings) at 27% and 28%, respectively, and lodging (inns, bed & breakfasts, ski lodges, tourist cabins, hotels and motels) at 24% and 25%, respectively.

To further identify loans with similar risk profiles, the Company categorizes each portfolio segment into classes by credit risk characteristic and applies a credit quality indicator to each portfolio segment. The indicators for commercial, commercial real estate and residential real estate loans are represented by Grades 1 through 10 as outlined below. In general, risk ratings are adjusted periodically throughout the year as updated analysis and review warrants. This process may include, but is not limited to, annual credit and loan reviews, periodic reviews of loan performance metrics, such as delinquency rates, and quarterly reviews of adversely risk rated loans. The Company uses the following definitions when assessing grades for the purpose of evaluating the risk and adequacy of the ALL:

•

Grade 1 through 6 — Grades 1 through 6 represent groups of loans that are not subject to adverse criticism as defined in regulatory guidance. Loans in these groups exhibit characteristics that represent low to moderate risks, which is measured using a variety of credit risk criteria, such as cash flow coverage, debt service coverage, balance sheet leverage, liquidity, management experience, industry position, prevailing economic conditions, support from secondary sources of repayment and other credit factors that may be relevant to a specific loan. In general, these loans are supported by properly margined collateral and guarantees of principal parties.

•

Grade 7 — Loans with potential weakness (Special Mention). Loans in this category are currently protected based on collateral and repayment capacity and do not constitute undesirable credit risk, but have potential weakness that may result in deterioration of the repayment process at some future date. This classification is used if a negative trend is evident in the obligor’s financial situation. Special mention loans do not sufficiently expose the Company such that they warrant adverse classification.


•	Grade 8 — Loans with definite weakness (Substandard). Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or by collateral pledged. This classification is used if borrowers experience difficulty in meeting debt repayment requirements. Deterioration is sufficient to cause the Company to look to the sale of collateral.

•

Grade 9 — Loans with potential loss (Doubtful). Loans classified as doubtful have all the weaknesses inherent in the substandard grade with the added characteristic that the weaknesses make collection or liquidation of the loan in full highly questionable and improbable. The possibility of some loss is extremely high, but because of specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.


•	Grade 10 — Loans with definite loss (Loss). Loans classified as loss are considered uncollectible. The loss classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the asset because recovery and collection time may be protracted.

Asset quality indicators are periodically reassessed to appropriately reflect the risk composition of the Company’s loan portfolio. Home equity and consumer loans are not individually risk rated, but rather 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. Performing loans include loans that are current and loans that are past due less than 90 days. Loans that are past due over 90 days and non-accrual loans, including TDRs, are considered non-performing.

The following table summarizes credit risk exposure indicators by portfolio segment as of the following dates:



	Residential Real Estate		Commercial Real Estate		Commercial		Home Equity		Consumer		Total
March 31, 2014
Pass (Grades 1-6)	$	550,645	$	531,874	$	170,595	$	—	$	—	$	1,253,114
Performing	—		—		—		267,900		16,320		284,220
Special Mention (Grade 7)	3,171		6,471		11,585		—		—		21,227
Substandard (Grade 8)	13,927		36,350		8,891		—		—		59,168
Non-performing	—		—		—		2,011		446		2,457
Total	$	567,743	$	574,695	$	191,071	$	269,911	$	16,766	$	1,620,186
December 31, 2013
Pass (Grades 1-6)	$	551,035	$	496,257	$	155,851	$	—	$	—	$	1,203,143
Performing	—		—		—		271,059		17,210		288,269
Special Mention (Grade 7)	3,196		7,749		11,315		—		—		22,260
Substandard (Grade 8)	15,588		37,093		12,037		—		—		64,718
Non-performing	—		—		—		1,571		441		2,012
Total	$	569,819	$	541,099	$	179,203	$	272,630	$	17,651	$	1,580,402

The Company closely monitors the performance of its loan portfolio. Loans past due 30 days or more are considered delinquent. In general, consumer loans will be charged off if the loan is delinquent for 90 consecutive days. Commercial and real estate loans are charged off in part or in full if they appear uncollectible. A loan is placed on non-accrual status when the financial condition of the borrower is deteriorating, payment in full of both principal and interest is not expected as scheduled, or principal or interest has been in default for 90 days or more. Exceptions may be made if the asset is well-secured by collateral sufficient to satisfy both the principal and accrued interest in full and collection is assured by a specific event, such as the closing of a pending sale contract. When one loan to a borrower is placed on non-accrual status, generally all other loans to the borrower are re-evaluated to determine if they should also be placed on non-accrual status. All previously accrued and unpaid interest is reversed at this time. Interest payments received on non-accrual loans (including impaired loans) are applied as a reduction of principal. A loan remains on non-accrual status until all principal and interest amounts contractually due are brought current and future payments are reasonably assured. A loan may be returned to accrual status when collection of principal and interest is assured and the borrower has demonstrated timely payments of principal and interest for a reasonable period. Unsecured loans, however, are not normally placed on non-accrual status because they are charged-off once their collectability is in doubt.

The following is a loan aging analysis by portfolio segment (including loans past due over 90 days and non-accrual loans) and a summary of non-accrual loans, which include TDRs, and loans past due over 90 days and accruing as of the following dates:



	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans Outstanding		Loans > 90 Days Past Due and Accruing		Non-Accrual Loans
March 31, 2014
Residential real estate	$	2,352	$	532	$	6,426	$	9,310	$	558,433	$	567,743	$	—	$	9,125
Commercial real estate	1,413		643		6,108		8,164		566,531		574,695		—		8,278
Commercial	916		256		1,620		2,792		188,279		191,071		50		1,935
Home equity	635		206		1,529		2,370		267,541		269,911		—		2,011
Consumer	31		8		425		464		16,302		16,766		—		446
Total	$	5,347	$	1,645	$	16,108	$	23,100	$	1,597,086	$	1,620,186	$	50	$	21,795
December 31, 2013
Residential real estate	$	3,218	$	684	$	7,269	$	11,171	$	558,648	$	569,819	$	—	$	10,520
Commercial real estate	926		2,036		3,301		6,263		534,836		541,099		257		7,799
Commercial	159		237		1,980		2,376		176,827		179,203		198		2,146
Home equity	1,395		388		1,007		2,790		269,840		272,630		—		1,571
Consumer	63		21		418		502		17,149		17,651		—		441
Total	$	5,761	$	3,366	$	13,975	$	23,102	$	1,557,300	$	1,580,402	$	455	$	22,477

Interest income that would have been recognized if loans on non-accrual status had been current in accordance with their original terms was approximately $230,000 and $252,000 for the three months ended March 31, 2014 and 2013, respectively.

The Company takes a conservative approach in credit risk management and remains focused on community lending and reinvesting. The Company works closely with borrowers experiencing credit problems to assist in loan repayment or term modifications. TDR loans consist of loans where the Company, for economic or legal reasons related to the borrower’s financial difficulties, granted a concession to the borrower that it would not otherwise consider. TDRs involve term modifications or a reduction of either interest or principal. Once such an obligation has been restructured, it will continue to remain in a restructured status until paid in full.

At March 31, 2014 and December 31, 2013, the allowance related to TDRs was $707,000 and $656,000, respectively. The specific reserve component was determined by discounting the total expected future cash flows from the borrower, or if the loan is currently collateral-dependent, using the fair value of the underlying collateral, which was obtained through independent appraisals and internal evaluations. At March 31, 2014, the Company did not have any commitments to lend additional funds to borrowers with loans classified as TDRs.

During the first three months of 2014, the Company modified one loan qualifying as a TDR, which had a current balance of $149,000 at March 31, 2014. During the first three months of 2013, the Company modified four loans qualifying as TDRs with current balances of $638,000 at March 31, 2013. The modification of these loans as TDRs did not have a material financial effect on the Company. Loans restructured due to credit difficulties that are now performing were $5.4 million at March 31, 2014 and $5.5 million at March 31, 2013.

The following is a summary of accruing and non-accruing TDR loans by portfolio segment as of the following dates:



	Number of Contracts		Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment				Current Balance
	March 31, 2014	December 31, 2013	March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013
Residential real estate	27	26	$	4,276	$	4,140	$	4,461	$	4,311	4,186		$	4,089
Commercial real estate	9	10	2,471		3,031		2,509		3,074		1,999		2,558
Commercial	7	7	504		504		504		504		483		488
Consumer and home equity	1	1	3		3		3		3		—		1
Total	44	44	$	7,254	$	7,678	$	7,477	$	7,892	$	6,668	$	7,136

The following is a summary of loans by portfolio segment that were modified as a TDR within the previous 12 months and for which the borrower subsequently defaulted during the periods indicated:



	Three Months Ended March 31,
	2014			2013
	Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
Commercial	1	$	46	—	$	—
Total	1	$	46	—	$	—

Impaired loans consist of non-accrual loans and TDR loans. The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the three months ended March 31, 2014:



							Three Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	10,091	$	10,091	$	1,628	$	10,894	$	29
Commercial real estate	7,845		7,844		557		7,252		5
Commercial	1,980		1,980		177		1,963		5
Home equity	1,593		1,593		754		1,557		—
Consumer	429		430		141		427		—
Ending Balance	$	21,938	$	21,938	$	3,257	$	22,093	$	39
Without allowance recorded:
Residential real estate	$	2,950	$	3,371	$	—	$	2,345	$	5
Commercial real estate	1,494		2,088		—		1,735		10
Commercial	392		484		—		569		1
Home equity	418		594		—		418		—
Consumer	17		37		—		17		—
Ending Balance	$	5,271	$	6,574	$	—	$	5,084	$	16
Total impaired loans	$	27,209	$	28,512	$	3,257	$	27,177	$	55

The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the three months ended March 31, 2013:



							Three Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	10,904	$	10,904	$	2,468	$	8,689	$	29
Commercial real estate	3,680		3,680		197		4,343		3
Commercial	3,002		3,002		325		2,788		2
Home equity	1,319		1,319		469		1,528		—
Consumer	486		486		82		457		—
Ending Balance	$	19,391	$	19,391	$	3,541	$	17,805	$	34
Without allowance recorded:
Residential real estate	$	2,850	$	3,672	$	—	$	5,028	$	7
Commercial real estate	3,953		4,217		—		3,516		22
Commercial	327		421		—		558		1
Home equity	536		807		—		364		—
Consumer	2		2		—		2		—
Ending Balance	$	7,668	$	9,119	$	—	$	9,468	$	30
Total impaired loans	$	27,059	$	28,510	$	3,541	$	27,273	$	64

The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the year ended December 31, 2013:



							Year Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	11,902	$	11,902	$	1,750	$	10,411	$	118
Commercial real estate	6,805		6,805		526		5,517		20
Commercial	1,876		1,876		132		2,543		10
Home equity	1,228		1,228		433		1,291		—
Consumer	425		425		140		460		—
Ending Balance	$	22,236	$	22,236	$	2,981	$	20,222	$	148
Without allowance recorded:
Residential real estate	$	2,533	$	3,846	$	—	$	2,925	$	28
Commercial real estate	2,059		2,782		—		3,362		55
Commercial	759		871		—		765		8
Home equity	343		479		—		334		—
Consumer	17		37		—		11		—
Ending Balance	$	5,711	$	8,015	$	—	$	7,397	$	91
Total impaired loans	$	27,947	$	30,251	$	2,981	$	27,619	$	239

The Company records its properties obtained through foreclosure or deed-in-lieu of foreclosure as OREO properties on the consolidated statements of condition at fair value of the real estate, less the estimated cost to sell (i.e. net realizable value). If a write-down of the recorded investment at the time of transfer to OREO is necessary, the write-down is charged to the ALL. If a subsequent write-down of the property is necessary due to a further decline in the fair value of the property then the write-down is recorded through a valuation allowance on the OREO property and charged to other non-interest expense in the consolidated statements of income. At March 31, 2014, the Company had 10 residential real estate properties and 8 commercial properties with a carrying value of $1.0 million and $1.7 million, respectively, within OREO. At December 31, 2013, the Company had 10 residential real estate properties and 6 commercial properties with a carrying value of $1.0 million and $1.2 million, respectively, within OREO.

At March 31, 2014 and December 31, 2013, the Company had $5.9 million and $4.4 million, respectively, of consumer mortgage loans secured by residential real estate properties for which foreclosure proceedings are in process.