NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the Company’s loan portfolio, excluding residential loans held for sale, at September 30, 2012 and December 31, 2011 was as follows:

	September 30, 2012			December 31, 2011
Residential real estate loans	$	571,712		$	578,757
Commercial real estate loans		501,283			470,061
Commercial loans		178,283			185,045
Home equity loans		274,176			268,782
Consumer loans		15,565			11,878
Deferred loan fees net of costs		(419	)		(495	)
Total loans	$	1,540,600		$	1,514,028

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. During the first nine months of 2012, the Company sold $18.8 million of fixed-rate residential mortgage loans on the secondary market that resulted in a net gain on the sale of loans of $268,000. For the year ended December 31, 2011, the Company sold $28.6 million of fixed-rate residential mortgage loans on the secondary market, which resulted in a net gain on the sale of loans of $292,000.

The allowance for loan losses (“ALL”) is management’s best estimate of the inherent risk of loss in the Company’s loan portfolio as of the statement of condition date. Management makes various assumptions and judgments about the collectability of the loan portfolio and provides an allowance for potential losses based on a number of factors 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: general real estate and economic conditions; regional credit concentration; industry concentration, for example in the hospitality, tourism and recreation industries; and a requirement by federal and state regulators to increase the provision for loan losses or recognize additional charge-offs.

The board of directors monitors credit risk management through the Directors’ Loan Committee and the Corporate Risk Management group. The Directors’ Loan Committee reviews large exposure credit requests, monitors asset quality on a regular basis and has approval authority for credit granting policies. The Corporate Risk Management group oversees management’s systems and procedures to monitor the credit quality of the loan portfolio, conduct a loan review program, maintain the integrity of the loan rating system and determine the adequacy of the ALL. The Company’s practice is to identify problem credits early and take charge-offs as promptly as practicable. In addition, management 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 portfolio loans into portfolio segments, which include residential real estate, commercial real estate, commercial, home equity, and consumer.

The following is a summary of activity in the ALL:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Balance at beginning of period	$	23,262		$	22,989		$	23,011		$	22,293
Loan charge-offs		(1,416	)		(1,400	)		(3,366	)		(3,417	)
Recoveries on loans previously charged off		146			235			530			865
Net charge-offs		(1,270	)		(1,165	)		(2,836	)		(2,552	)
Provision for loan losses		859			1,187			2,676			3,270
Balance at end of period	$	22,851		$	23,011		$	22,851		$	23,011

The following table presents activity in the ALL for the three months ended September 30, 2012:

	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL:
Beginning balance	$	6,352		$	4,837		$	6,368		$	2,319		$	164		$	3,222		$	23,262
Loans charged off		(578	)		—			(730	)		(70	)		(38	)		—			(1,416	)
Recoveries		5			53			85			1			2			—			146
Provision (reduction)		860			(215	)		73			108			34			(1	)		859
Ending balance	$	6,639		$	4,675		$	5,796		$	2,358		$	162		$	3,221		$	22,851

The following table presents activity in the ALL and select loan information for the nine months ended September 30, 2012:

	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated		Total
ALL:
Beginning balance	$	6,398		$	5,702		$	4,846		$	2,704		$	420		$	2,941	$	23,011
Loans charged off		(1,024	)		(209	)		(1,146	)		(921	)		(66	)		—		(3,366	)
Recoveries		73			219			205			21			12			—		530
Provision (reduction)		1,192			(1,037	)		1,891			554			(204	)		280		2,676
Ending balance	$	6,639		$	4,675		$	5,796		$	2,358		$	162		$	3,221	$	22,851
Ending Balance: Individually evaluated for impairment	$	2,071		$	343		$	376		$	265		$	39		$	—	$	3,094
Ending Balance: Collectively evaluated for impairment	$	4,568		$	4,332		$	5,420		$	2,093		$	123		$	3,221	$	19,757

Loans ending balance:
Ending Balance: Individually evaluated for impairment	$	12,554		$	7,121		$	3,829		$	1,668		$	263		$	—	$	25,435
Ending Balance: Collectively evaluated for impairment	$	558,739		$	494,162		$	174,454		$	272,508		$	15,302		$	—	$	1,515,165
Loans ending balance	$	571,293		$	501,283		$	178,283		$	274,176		$	15,565		$	—	$	1,540,600

The following table presents activity in the ALL for the three months ended September 30, 2011:

	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated		Total
ALL:
Beginning balance	$	6,109		$	6,324		$	4,473		$	2,478		$	453		$	3,152	$	22,989
Loans charged off		(239	)		(621	)		(325	)		(205	)		(10	)		—		(1,400	)
Recoveries		1			124			83			25			2			—		235
Provision (reduction)		75			179			633			188			(12	)		124		1,187
Ending balance	$	5,946		$	6,006		$	4,864		$	2,486		$	433		$	3,276	$	23,011

The following table presents activity in the ALL and select loan information for the nine months ended September 30, 2011:

	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated		Total
ALL:
Beginning balance	$	3,273		$	8,198		$	5,633		$	2,051		$	202		$	2,936	$	22,293
Loans charged off		(1,036	)		(946	)		(1,080	)		(325	)		(30	)		—		(3,417	)
Recoveries		114			307			239			195			10			—		865
Provision (reduction)		3,595			(1,553	)		72			565			251			340		3,270
Ending balance	$	5,946		$	6,006		$	4,864		$	2,486		$	433		$	3,276	$	23,011
Ending Balance: Individually evaluated for impairment	$	2,669		$	1,411		$	831		$	370		$	91		$	—	$	5,372
Ending Balance: Collectively evaluated for impairment	$	3,277		$	4,595		$	4,033		$	2,116		$	342		$	3,276	$	17,639

Loans ending balance:
Ending Balance: Individually evaluated for impairment	$	12,305		$	9,596		$	4,343		$	1,343		$	159		$	—	$	27,746
Ending Balance: Collectively evaluated for impairment	$	567,943		$	448,752		$	186,717		$	269,125		$	12,029		$	—	$	1,484,566
Loans ending balance	$	580,248		$	458,348		$	191,060		$	270,468		$	12,188		$	—	$	1,512,312

The following table presents the allowance for loan losses and select loan information for the year ended December 31, 2011:

	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated		Total
ALL:
Beginning balance	$	3,273		$	8,198		$	5,633		$	2,051		$	202		$	2,936	$	22,293
Loans charged off		(1,216	)		(1,633	)		(1,256	)		(861	)		(59	)		—		(5,025	)
Recoveries		120			374			296			196			16			—		1,002
Provision (reduction)		4,221			(1,237	)		173			1,318			261			5		4,741
Ending balance	$	6,398		$	5,702		$	4,846		$	2,704		$	420		$	2,941	$	23,011
Ending Balance: Individually evaluated for impairment	$	1,364		$	961		$	815		$	440		$	91		$	—	$	3,671
Ending Balance: Collectively evaluated for impairment	$	5,034		$	4,741		$	4,031		$	2,264		$	329		$	2,941	$	19,340
Loans ending balance:
Ending Balance: Individually evaluated for impairment	$	12,715		$	7,830		$	4,019		$	2,670		$	152		$	—	$	27,386
Ending Balance: Collectively evaluated for impairment	$	565,547		$	462,231		$	181,026		$	266,112		$	11,726		$	—	$	1,486,642
Loans ending balance	$	578,262		$	470,061		$	185,045		$	268,782		$	11,878		$	—	$	1,514,028

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 continuously monitored by the Company’s Corporate Risk Management group.

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 from lowest to highest risk rating. 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 — Substantially risk free loans. Loans to borrowers of unquestioned financial strength with stable earnings, cash flows and sufficient primary and secondary sources of repayment. These loans have no known or suspected shortcomings or weaknesses. Most loans in this category are secured by properly margined liquid collateral. Loan to value and loan to cost parameters are most conservative.

Grade 2 — Loans with minimal risk. Includes loans to borrowers with a solid financial condition and good liquidity, significant cash flows and interest coverage and well-defined repayment strength. Loan to value and loan to cost parameters are conservative.

Grade 3 — Loans with very modest risk. Borrowers in this category exhibit strong sources of repayment, consistent earnings and acceptable profitability growth. Working capital, debt to worth and coverage ratios are comparable with industry standards and there are no known negative trends. Collateral protection is adequate. Loan to value parameters do not exceed the maximum established by the Company’s loan policy.

Grade 4 — Loans with less than average risk. Loans to borrowers with adequate repayment source or a recently demonstrated ability to service debt with acceptable margins. Working capital, debt to worth and coverage ratios may be on the lower end of industry standards, but are not considered unsatisfactory. There may be minor negative trends but collateral position is adequate. Loan to value and debt coverage ratios meet the criteria in the Company’s loan policy.

Grade 5 — Average risk loans. Loans to borrowers with acceptable financial strength but possible vulnerability to changing economic conditions or inconsistent earnings history. Borrower evidences a reasonable ability to service debt in the normal course of business and has available and adequate secondary sources of repayment. Working capital, debt to worth and coverage ratios may be below industry standards, but are not considered unsatisfactory. Loan to value and debt coverage ratios meet the criteria outlined in the Company’s loan policy.

Grade 6 — Loans with maximum acceptable risk (Watch List). Loans in this grade exhibit the majority of the attributes associated with Grade 5, perform at that level, but have been recognized to possess characteristics or deficiencies that warrant monitoring. These loans have potential weaknesses which may, if not checked or corrected, weaken the assets or inadequately protect the Company’s credit position at some future date.

A Grade 6 Watch rating is assigned to a loan when one or more of the following circumstances exist:

	—	Lack of sufficient current information to properly assess the risk of the loan facility or value of pledged collateral.

	—	Adverse economic, market or other external conditions which may directly affect the obligor’s financial condition.

	—	Significant cost overruns occurred.

	—	Market share may exhibit some volatility. Sales and profits may be tied to business, credit or product cycles.

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 to 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. 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 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
September 30, 2012
Pass (Grades 1-6)	$	555,036	$	435,924	$	153,528	$	—	$	—
Performing		—		—		—		272,471		15,305
Special Mention (Grade 7)		1,143		15,524		7,204		—		—
Substandard (Grade 8)		15,114		49,835		17,551		—		—
Non-performing		—		—		—		1,705		260
Total	$	571,293	$	501,283	$	178,283	$	274,176	$	15,565
December 31, 2011
Pass (Grades 1-6)	$	560,926	$	413,489	$	157,141	$	—	$	—
Performing		—		—		—		266,112		11,726
Special Mention (Grade 7)		876		8,134		8,998		—		—
Substandard (Grade 8)		16,460		48,438		18,335		—		—
Non-performing		—		—		—		2,670		152
Doubtful (Grade 9)		—		—		571		—		—
Total	$	578,262	$	470,061	$	185,045	$	268,782	$	11,878

The Company closely monitors the performance of its loan portfolio. 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, 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. 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 troubled debt restructured loans (“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
September 30, 2012
Residential real estate	$	917	$	755	$	7,321	$	8,993	$	562,300	$	571,293	$	—	$	9,459
Commercial real estate		1,879		270		5,985		8,134		493,149		501,283		209		7,121
Commercial		645		541		2,468		3,654		174,629		178,283		—		3,765
Home equity		359		228		1,341		1,928		272,248		274,176		37		1,669
Consumer		11		8		260		279		15,286		15,565		—		260
Total	$	3,811	$	1,802	$	17,375	$	22,988	$	1,517,612	$	1,540,600	$	246	$	22,274
December 31, 2011
Residential real estate	$	2,207	$	575	$	7,373	$	10,155	$	568,107	$	578,262	$	99	$	9,503
Commercial real estate		2,105		739		5,009		7,853		462,208		470,061		—		7,830
Commercial		1,020		184		2,309		3,513		181,532		185,045		135		3,955
Home equity		1,208		962		1,927		4,097		264,685		268,782		2		2,670
Consumer		73		10		152		235		11,643		11,878		—		152
Total	$	6,613	$	2,470	$	16,770	$	25,853	$	1,488,175	$	1,514,028	$	236	$	24,110

The Company takes a conservative approach in credit risk management and remains focused on community lending and reinvesting. The Company’s Credit Administration group 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. Loans restructured due to credit difficulties that are now performing were $3.2 million at September 30, 2012 and $3.3 million at December 31, 2011. The Company did not have any TDR loans that subsequently defaulted during the first nine months of 2012.

At September 30, 2012 and December 31, 2011, the allowance related to TDRs was $395,000 and $357,000, 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 September 30, 2012, the Company did not have any commitments to lend additional funds to borrowers with loans classified as TDRs.

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
September 30, 2012
Troubled-Debt Restructurings
Residential real estate		18	$	3,124	$	3,227	$	3,095
Commercial real estate		2		1,178		1,178		1,013
Commercial		2		163		163		100
Consumer		1		3		3		3
Total		23	$	4,468	$	4,571	$	4,211
December 31, 2011
Troubled-Debt Restructurings
Residential real estate		19	$	3,221	$	3,426	$	3,330
Commercial real estate		3		1,708		1,708		1,249
Commercial		2		163		163		103
Total		24	$	5,092	$	5,297	$	4,682

Impaired loans consist of non-accrual and TDR loans. All impaired loans are allocated a portion of the allowance to cover potential losses.

The following is a summary of impaired loan balances and associated allowance by portfolio segment as of the following dates and for the periods then ended:

							Three Months Ended				Nine Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
September 30, 2012
With an allowance recorded:
Residential real estate	$	9,233	$	9,233	$	2,071	$	10,803	$	88	$	10,106	$	31
Commercial real estate		5,025		5,025		343		5,839		—		5,679		—
Commercial		3,435		3,435		376		4,062		—		3,862		—
Home equity		1,077		1,077		265		1,331		—		1,063		—
Consumer		257		257		39		234		—		257		—
Ending Balance	$	19,027	$	19,027	$	3,094	$	22,269	$	88	$	20,967	$	31
Without allowance recorded:
Residential real estate	$	3,321	$	4,324	$	—	$	2,324	$	20	$	2,923	$	7
Commercial real estate		2,096		2,341		—		1,723		—		1,860		—
Commercial		394		710		—		347		4		462		4
Home equity		591		1,462		—		726		—		591		—
Consumer		6		166		—		7		—		6		—
Ending Balance	$	6,408	$	9,003	$	—	$	5,127	$	24	$	5,842	$	11
Total impaired loans	$	25,435	$	28,030	$	3,094	$	27,396	$	112	$	26,809	$	42

							Twelve Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2011
With related allowance recorded:
Residential real estate	$	10,717	$	11,287	$	1,364	$	11,280	$	109
Commercial real estate		5,477		5,478		961		7,257		3
Commercial		3,636		3,636		815		3,963		7
Home equity		1,888		1,887		440		1,457		1
Consumer		136		136		91		106		—
Ending Balance	$	21,854	$	22,424	$	3,671	$	24,063	$	120
Without related allowance recorded:
Residential real estate	$	1,998	$	1,810	$	—	$	1,847	$	21
Commercial real estate		2,353		3,815		—		2,078		—
Commercial		383		665		—		393		—
Home equity		782		1,189		—		422		—
Consumer		16		176		—		18		—
Ending Balance	$	5,532	$	7,655	$	—	$	4,758	$	21
Total impaired loans	$	27,386	$	30,079	$	3,671	$	28,821	$	141