First Bancorp, Inc /ME/ 10-Q

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations The First Bancorp, Inc. and Subsidiary Forward-Looking Statements This report contains statements that are "forward-looking statements." We may also make written or oral forward-looking statements in other documents we file with the Securities and Exchange Commission ("SEC"), in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume," "outlook," "will," "should," and other expressions that predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Company to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements. Some of the factors that might cause these differences include the following: changes in general national, regional or international economic conditions or conditions affecting the banking or financial services industries or financial capital markets, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, reductions in net interest income resulting from interest rate volatility as well as changes in the balance and mix of loans and deposits, reductions in the market value of wealth management assets under administration, changes in the value of securities and other assets, reductions in loan demand, changes in loan collectability, default and charge-off rates, changes in the size and nature of the Company's competition, changes in legislation or regulation and accounting principles, policies and guidelines, uncertainties with respect to the nature, the extent and the duration of the COVID-19 pandemic and its consequences (including in our market areas or affecting our customers such as protracted adverse effects on the tourism and hospitality industries), and changes in the assumptions used in making such forward-looking statements. In addition, the factors described under "Risk Factors" in Item 1A of this Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as filed with the SEC, may result in these differences, as well as the "Risk Factors" in Part II, Item 1A listed below. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this quarterly report, and we assume no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are also urged to carefully review and consider the various disclosures made by the Company, which attempt to advise interested parties of the factors that affect the Company's business. Critical Accounting Policies Management's discussion and analysis of the Company's financial condition is based on the consolidated financial statements which are prepared in accordance with GAAP. 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 fair value of securities, goodwill, the valuation of mortgage servicing rights, and other-than-temporary impairment on securities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from 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 regularly evaluates the allowance, typically monthly, to determine the appropriate level by taking into consideration factors such as the size and growth trajectory of the portfolio, quality trends as measured by key indicators, prior loan loss experience in major portfolio segments, local and national business and economic conditions, the results of any stress testing undertaken during the period, and Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses. Goodwill. Management utilizes numerous techniques to estimate the value of various assets held by the Company, including methods to determine the appropriate carrying value of goodwill as required under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 350 "Intangibles – Goodwill and Other." In addition, 48 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. Mortgage Servicing Rights. The valuation of mortgage servicing rights is a critical accounting policy which requires significant estimates and assumptions. The Bank often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 0.25% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized at fair value when they are acquired through the sale of loans, and are reported in other assets. They are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. The rights are subsequently carried at the lower of amortized cost or fair value. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value which is recorded on the balance sheet. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speed results in lower valuations of mortgage servicing rights. The valuation also includes an evaluation for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. The use of different assumptions could produce a different valuation. All of the assumptions are based on standards the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Fair Value of Securities. Determining a market price for securities carried at fair value is a critical accounting estimate in the Company's financial statements. Pricing of individual securities is subject to a number of factors including changes in market interest rates, changes in prepayment speeds and assumptions, changes in market tolerance for risk, and any changes in the risk profile of the security. The Company subscribes to a widely recognized, independent pricing service and updates carrying values no less frequently than monthly. It also validates the values provided by the pricing service no less frequently than quarterly by measuring against security prices provided by a secondary source. Results of the validation are reported to the Bank's Asset Liability Committee each quarter and any variances between the two sources above defined thresholds are investigated by management. Other-Than-Temporary Impairment on Securities. Another significant estimate related to investment securities is the evaluation of other-than-temporary impairment. The evaluation of securities for other-than-temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. Securities that are in an unrealized loss position are reviewed at least quarterly to determine if other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities' market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest when due. Derivative Financial Instruments Designated as Hedges. The Company recognizes all derivatives in the consolidated balance sheets at fair value. On the date a derivative contract is entered into, the derivative is designated as a hedge of either a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), or a held for trading instrument (“trading instrument”). The relationships between hedging instruments and hedged items is formally documented, as is the risk management objectives and strategy for undertaking various hedge transactions. Both at the hedge’s inception and on an ongoing basis, determination is made as to whether the derivatives that are used in hedging transactions are effective in offsetting changes in cash flows or fair values of hedged items. Changes in fair value of a derivative that is effective and that qualifies as a cash flow hedge are recorded in other comprehensive income (loss) and are reclassified into earnings when the forecasted transaction or related cash flows affect earnings. Changes in fair value of a derivative that qualifies as a fair value hedge and the change in fair value of the hedged item are both recorded in earnings and offset each other when the transaction is effective. Those derivatives that are classified as trading instruments, including customer loan swaps, are recorded at fair value with changes in fair value recorded in earnings. Hedge accounting is discontinued when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, that it is unlikely that the forecasted transaction will occur, or that the designation of the derivative as a hedging instrument is no longer appropriate. 49 Risks and Uncertainties. As of September 30, 2022, local and state governments in the US have eased or eliminated most restrictions imposed to curtail the spread of the global pandemic, COVID-19. There continues to be uncertainty surrounding the duration of the pandemic, its potential economic ramifications, and any further government actions to mitigate them. Accordingly, while management has considered the effect of the pandemic on collectability of loans receivable and other business impacts, it is possible that this matter may have a further financial impact on the Company's financial position and results of future operations, such potential impact of which cannot be reasonably estimated. Government economic programs intended to backstop and bolster the economy through the pandemic, such as the Payroll Protection Program (PPP) have ended, and the nation's economy has entered an inflationary phase. The Consumer Price Index has risen at levels not experienced since the 1980s while the labor market remains very tight, contributing additional inflationary pressure. To address the inflation problem, the Federal Reserve has removed accommodative monetary policies and aggressively increased short-term interest rates. These actions are intended to slow overall economic activity and risk entering the economy into a recession. The conflict between Russia and Ukraine has exacerbated pandemic-related supply chain issues, upset numerous global markets including energy and certain raw materials, and generally added to economic uncertainty and geopolitical instability. Any or all could have negative downstream effects on the Company's operating results, the extent of which is indeterminable at this time. Use of Non-GAAP Financial Measures Certain information in this release contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Management uses these “non-GAAP” measures in its analysis of the Company's performance (including for purposes of determining the compensation of certain executive officers and other Company employees) and believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods and with other financial institutions, as well as demonstrating the effects of significant gains and charges in the current period, in light of the disclosure practices employed by many other publicly-traded financial institutions. The Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. Management believes that investors may use these non-GAAP financial measures to analyze financial performance without the impact of unusual items that may obscure trends in the Company's underlying performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. In several places net interest income is calculated on a fully tax-equivalent basis. Specifically included in interest income was tax-exempt interest income from certain investment securities and loans. An amount equal to the tax benefit derived from this tax-exempt income has been added back to the interest income total which, as adjusted, increased net interest income accordingly. Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices . The following table provides a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements prepared in accordance with GAAP. A Federal Income Tax rate of 21.0% was used in 2022 and 2021. For the nine months ended September 30, For the quarter ended September 30, Dollars in thousands 2022 2021 2022 2021 Net interest income as presented $ 56,682 $ 48,607 $ 19,364 $ 17,011 Effect of tax-exempt income 1,719 1,762 592 574 Net interest income, tax equivalent $ 58,401 $ 50,369 $ 19,956 $ 17,585 The Company presents its efficiency ratio using non-GAAP information which is most commonly used by financial institutions. The GAAP-based efficiency ratio is non-interest expenses divided by net interest income plus non-interest income from the Consolidated Statements of Income. The non-GAAP efficiency ratio excludes securities losses and other-than-temporary impairment charges from non-interest expenses, excludes securities gains from non-interest income, and adds the tax-equivalent adjustment to net interest income. 50 The following table provides a reconciliation between the GAAP and non-GAAP efficiency ratio: For the nine months ended September 30, For the quarter ended September 30, Dollars in thousands 2022 2021 2022 2021 Non-interest expense, as presented $ 32,193 $ 29,302 $ 11,371 $ 9,932 Net interest income, as presented 56,682 48,607 19,364 17,011 Effect of tax-exempt interest income 1,719 1,762 592 574 Non-interest income, as presented 13,027 14,584 4,715 4,375 Effect of non-interest tax-exempt income 127 124 43 41 Net securities (gains) losses (7) (22) (6) 142 Adjusted net interest income plus non-interest income $ 71,548 $ 65,055 $ 24,708 $ 22,143 Non-GAAP efficiency ratio 44.99 % 45.04 % 46.02 % 44.85 % GAAP efficiency ratio 46.18 % 46.37 % 47.22 % 46.44 % The Company presents certain information based upon tangible common equity instead of total shareholders' equity. The difference between these two measures is the Company's intangible assets, specifically goodwill from prior acquisitions. Management, banking regulators and many stock analysts use the tangible common equity ratio and the tangible book value per common share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, typically stemming from the use of the purchase accounting method in accounting for mergers and acquisitions . The following table provides a reconciliation of average tangible common equity to the Company's consolidated financial statements, which have been prepared in accordance with U.S. GAAP: For the nine months ended September 30, For the quarter ended September 30, Dollars in thousands 2022 2021 2022 2021 Average shareholders' equity as presented $ 237,412 $ 233,763 $ 233,763 $ 239,672 Less average intangible assets (30,901) (30,971) (30,884) (30,994) Average tangible shareholders' common equity $ 206,511 $ 202,792 $ 202,879 $ 208,678 The following table provides a reconciliation of period ending tangible common equity to the Company's consolidated financial statements, adjusted to remove unrealized losses: Period Ending In thousands of dollars, except per share data September 30, 2022 September 30, 2021 Shareholders' Equity $ 219,917 $ 238,737 Intangible Assets (30,873) (30,942) Tangible Common Equity 189,044 207,795 Unrealized Losses on Available for Sale Securities, net of tax 47,661 627 Adjusted Tangible Common Equity $ 236,705 $ 208,422 Adjusted Tangible Book Value Per Share $21.44 $18.96 51 To provide period-to-period comparison of operating results prior to consideration of credit loss provision and income taxes, the non-GAAP measure of Pre-Tax, Pre-Provision Net Income is presented. The following table provides a reconciliation to Net Income: For the nine months ended September 30, For the quarter ended September 30, Dollars in thousands 2022 2021 2022 2021 Net Income, as presented $ 29,793 $ 26,723 $ 10,091 $ 9,014 Add: provision for loan losses 1,300 1,575 400 525 Add: income taxes expense 6,423 5,591 2,217 1,915 Pre-tax, pre-provision net income $ 37,516 $ 33,889 $ 12,708 $ 11,454 Executive Summary Net income for the nine months ended September 30, 2022 was $29.8 million, up $3.1 million or 11.5% from the same period in 2021. Earnings per common share on a fully diluted basis were $2.70 for the nine months ended September 30, 2022, up $0.27 or 11.1% from the $2.43 posted for the same period in 2021. For the quarter ended September 30, 2022, net income was $10.1 million, up $1.1 million or 11.9% from the same period in 2021. Earnings per common share on a fully diluted basis were $0.91 for the quarter ended September 30, 2022, up $0.09 or 11.0% from the $0.82 posted for the same period in 2021. The Company continues to perform very strongly in 2022, posting record earnings in each of the three quarters. Growth in net interest income, predominantly from a combination of strong earning asset growth and expanded net interest margin, has been a primary driver of performance year-to-date . Based upon the strength of the Company's earnings, dividends totaling $1.00 per share have been declared year-to-date, representing a payout to our shareholders of 36.63% of basic earnings per share for the period. Net interest income on a tax-equivalent basis was up $8.0 million or 15.9% in the nine months ended September 30, 2022 compared to the same period in 2021. This increase is attributable primarily to growth in earning assets and a wider net interest margin. The tax equivalent net interest margin for the nine months ended September 30, 2022, was 3.17%, up from 2.94% for the same period in 2021. For the quarter ended September 30, 2022, net interest income on a tax-equivalent basis increased $2.4 million or 13.5% compared to the same period in 2021, with the net interest margin at 3.14% compared to 2.96% for the same period in 2021. Non-interest income for the nine months ended September 30, 2022 was $13.0 million, down $1.6 million or 10.7%, from the nine months ended September 30, 2021. Revenue at First National Wealth Management increased $161,000 or 4.8% over the same period, debit card revenue was up $1.0 million or 26.0%, and service charge revenue increased $226,000 or 20.0%. Conversely, mortgage banking revenue decreased $3.1 million or 71.6%. Non-interest expense for the nine months ended September 30, 2022 was $32.2 million, up $2.9 million or 9.9% from the nine months ended September 30, 2021. Salaries and employee benefits year-to-date in 2022 have increased 9.6% from the same period in 2021. Other operating expense has increased 12.3% over the same period largely attributable to one-time charges associated with the sale of a block of residential mortgage loans. Asset quality has further improved year-to-date in 2022 and continues to be strong and stable. Non-performing assets stood at 0.07% of total assets as of September 30, 2022, down from 0.25% of total assets as of September 30, 2021 and 0.23% as of December 31, 2021. Total past-due loans were 0.08% of total loans as of September 30, 2022, down from 0.26% of total loans as of December 31, 2021 and 0.25% as of September 30, 2021. The provision for loan losses for the first nine months of 2022 was $1.3 million, down from the $1.6 million provisioned in the same period in 2021. The Company continues to view it prudent to consider the uncertainties brought about by COVID-19 and the potential impact to borrowers in its provision analysis. Net loan chargeoffs for the nine months ended September 30, 2022 were $434,000 or 0.03% of average loans on an annualized basis, unchanged in percentage terms to net charge-offs of $321,000 or 0.03% of total loans for the nine months ended September 30, 2021. The allowance for loan losses increased $866,000 between December 31, 2021 and September 30, 2022, and now stands at 0.88% of loans outstanding as of September 30, 2022, down from 0.94% at December 31, 2021 and 1.08% at September 30, 2021. The Company's balance sheet continued to expand in the first nine months of 2022 as total assets increased $208.0 million or 8.2% year-to-date. The loan portfolio increased $210.3 million or 12.8% in the nine months ended September 30, 2022 and $240.8 million or 14.9% from a year ago. Loan growth in the first nine months of 2022 was centered in commercial real estate and construction loans, up $112.2 million, and other commercial loans, up $45.5 million. Other commercial loans include PPP loan balances of $14,000, a decrease of $22.0 million since December 31, 2021. The investment portfolio decreased $26.3 million year-to-date and decreased $24.1 million from a year ago based upon changes in the carrying value of Available-for-Sale securities. On the liability side of the balance sheet, low-cost deposits have increased $44.9 million or 3.3% year-to-date, with growth centered in Demand and NOW account balances. Year-over-year, low-cost deposits have increased $66.8 million 52 or 5.0%. Local certificates of deposit ("CDs") increased $19.5 million and wholesale CDs increased $200.5 million year-to-date. Remaining well capitalized is a top priority for The First Bancorp, Inc. The Company's total risk-based capital ratio was 13.59% as of September 30, 2022, solidly above the well-capitalized threshold of 10.0% set by the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Office of the Comptroller of the Currency. The Company's operating ratios were strong in the first nine months of 2022, with a return on average tangible common equity of 19.29% for the nine months ended September 30, 2022 compared to 17.62% for the same period in 2021. Our non-GAAP efficiency ratio continues to be an important component in the Company's overall performance and stood at 44.99% for the nine months ended September 30, 2022 compared to 45.04% for the same period in 2021. Net Interest Income Total interest income of $66.0 million for the nine months ended September 30, 2022 was an increase of $8.9 million or 15.5% compared to total interest income of $57.1 million for the same period of 2021, with growth in earning assets primarily responsible for the increase. Total interest expense of $9.3 million for the nine months ended September 30, 2022 was an increase of $798,000 or 9.4% compared to total interest expense for the nine months ended September 30, 2021. As a result, net interest income of $56.7 million for the nine months ended September 30, 2022 was an increase of $8.1 million or 16.6% compared to net interest income of $48.6 million for the same period ended September 30, 2021. The Company's net interest margin on a tax-equivalent basis for the nine months ended September 30, 2022 was 3.17%, up from 2.94% for the first nine months of 2021. Tax-exempt interest income amounted to $6.5 million for the nine months ended September 30, 2022 compared to $6.6 million for the nine months ended September 30, 2021. The following tables present 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 nine months and quarters ended September 30, 2022 and 2021. Tax-exempt income is calculated on a tax-equivalent basis, using a 21.0% Federal Income Tax rate. For the nine months ended September 30, 2022 September 30, 2021 Dollars in thousands Amount of interest Average Yield/Rate Amount of interest Average Yield/Rate Interest on earning assets Interest-bearing deposits $ 163 0.93 % $ 45 0.11 % Investments 13,815 2.68 % 12,714 2.45 % Loans held for sale 11 2.53 % 22 1.16 % Loans 53,685 4.10 % 46,063 3.99 % Total interest income 67,674 3.67 % 58,844 3.43 % Interest expense Deposits 8,190 0.59 % 5,796 0.47 % Other borrowings 1,083 1.09 % 2,679 1.54 % Total interest expense 9,273 0.62 % 8,475 0.61 % Net interest income $ 58,401 $ 50,369 Interest rate spread 3.05 % 2.82 % Net interest margin 3.17 % 2.94 % 53 For the quarters ended September 30, 2022 September 30, 2021 Dollars in thousands Amount of interest Average Yield/Rate Amount of interest Average Yield/Rate Interest on earning assets Interest-bearing deposits $ 92 2.32 % $ 21 0.14 % Investments 4,849 2.80 % 4,168 2.37 % Loans held for sale 2 4.84 % 3 0.97 % Loans 19,640 4.29 % 15,970 3.96 % Total interest-earning assets 24,583 3.87 % 20,162 3.39 % Interest expense Deposits 4,164 0.86 % 1,650 0.40 % Other borrowings 463 1.40 % 927 1.57 % Total interest expense 4,627 0.89 % 2,577 0.54 % Net interest income $ 19,956 $ 17,585 Interest rate spread 2.97 % 2.85 % Net interest margin 3.14 % 2.96 % Interest income includes $137,000 in net origination fees recognized during the first six months of 2022, attributable to PPP loans; as of June 30, 2022, net unrecognized PPP origination fees were zero, therefore no fees were recognized during the third quarter 2022. Interest income in the first nine months of 2021 included $2.9 million in net origination fees recognized on PPP loans; as of September 30, 2021, net unrecognized PPP origination fees totaled $2.4 million. The following tables present changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and liabilities for the nine months and quarters ended September 30, 2022 compared to 2021. Tax-exempt income is calculated on a tax-equivalent basis, using a 21% Federal Income Tax rate. For the nine months ended September 30, 2022 compared to 2021 Dollars in thousands Volume Rate Rate/Volume 1 Total Interest on earning assets Interest-bearing deposits $ (25) $ 326 $ (183) $ 118 Investment securities (66) 1,173 (6) 1,101 Loans held for sale (17) 26 (20) (11) Loans 6,175 1,276 171 7,622 Change in interest income 6,067 2,801 (38) 8,830 Interest expense Deposits 839 1,358 197 2,394 Other borrowings (1,149) (783) 336 (1,596) Change in interest expense (310) 575 533 798 Change in net interest income $ 6,377 $ 2,226 $ (571) $ 8,032 1 Represents the change attributable to a combination of change in rate and change in volume. 54 For the quarter ended September 30, 2022 compared to 2021 Dollars in thousands Volume Rate Rate/Volume 1 Total Interest on earning assets Interest-bearing deposits $ (15) $ 329 $ (243) $ 71 Investment securities (61) 753 (11) 681 Loans held for sale (3) 12 (10) (1) Loans 2,183 1,308 179 3,670 Change in interest income 2,104 2,402 (85) 4,421 Interest expense Deposits 267 1,934 313 2,514 Other borrowings (408) (100) 44 (464) Change in interest expense (141) 1,834 357 2,050 Change in net interest income $ 2,245 $ 568 $ (442) $ 2,371 55 Average Daily Balance Sheets The following table shows the Company's average daily balance sheets for the nine months and quarters ended September 30, 2022 and 2021. For the nine months ended For the quarters ended Dollars in thousands September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Assets Cash and cash equivalents $ 23,926 $ 23,152 $ 27,062 $ 25,195 Interest-bearing deposits in other banks 23,405 53,251 15,711 59,939 Securities available for sale (includes tax exempt securities of $35,457 and $34,762 at September 30, 2022 and 2021, respectively) 308,297 306,007 302,428 311,212 Securities to be held to maturity (included tax exempt securities of $253,554 and $251,417 at September 30, 2022 and 2021, respectively) 377,163 378,526 380,512 377,879 Restricted equity securities, at cost 5,011 9,539 4,809 8,839 Loans held for sale 581 2,530 164 1,228 Loans 1,750,004 1,543,142 1,818,419 1,599,728 Allowance for loan losses (15,962) (16,788) (16,365) (17,180) Net loans 1,734,042 1,526,354 1,802,054 1,582,548 Accrued interest receivable 9,539 9,686 9,425 8,714 Premises and equipment 28,960 28,862 28,848 29,378 Other real estate owned 12 325 33 71 Goodwill 30,646 30,646 30,646 30,646 Other assets 51,225 46,040 54,953 45,463 Total Assets $ 2,592,807 $ 2,414,918 $ 2,656,645 $ 2,481,112 Liabilities & Shareholders' Equity Demand deposits $ 333,828 $ 291,641 $ 351,025 $ 331,546 NOW deposits 628,766 544,789 595,714 566,574 Money market deposits 210,145 176,767 193,257 185,745 Savings deposits 373,329 328,648 381,113 342,501 Certificates of deposit 659,083 584,470 750,935 558,563 Total deposits 2,205,151 1,926,315 2,272,044 1,984,929 Borrowed funds – short term 132,533 177,110 130,695 178,420 Borrowed funds – long term 85 55,092 85 55,094 Dividends payable 956 796 1,226 615 Other liabilities 16,670 21,842 18,832 22,382 Total Liabilities 2,355,395 2,181,155 2,422,882 2,241,440 Shareholders' Equity: Common stock 110 110 110 110 Additional paid-in capital 67,364 65,841 67,761 66,232 Retained earnings 192,666 168,593 198,897 174,123 Net unrealized gain (loss) on securities available for sale (22,823) 2,047 (33,249) 1,740 Net unrealized loss on securities transferred from available for sale to held to maturity (77) (120) (70) (108) Net unrealized gain (loss) on cash flow hedging derivative instruments 67 (2,736) 209 (2,453) Net unrealized gain on postretirement benefit costs 105 28 105 28 Total Shareholders' Equity 237,412 233,763 233,763 239,672 Total Liabilities & Shareholders' Equity $ 2,592,807 $ 2,414,918 $ 2,656,645 $ 2,481,112 56 Non-Interest Income Non-interest income of $13.0 million for the nine months ended September 30, 2022 is a decrease of $1.6 million compared to the same period in 2021. Revenue at First National Wealth Management increased $161,000 or 4.8% over the same period, debit card revenue was up $1.0 million or 26.0% due primarily to receipt of one-time program incentive payments, and service charge revenue was up 20.0%. As expected, mortgage banking revenues continued to trend down from the heights of the past two years, down $3.1 million, or 71.6%; the decrease is attributable to a significant year-to-year decrease in mortgage refinance activity and two marks against mortgage servicing rights. Non-interest income of $4.7 million for the quarter ended September 30, 2022 is an increase of $340,000 compared to the same period in 2021, due primarily to debit card revenue. Non-Interest Expense Non-interest expense of $32.2 million for the nine months ended September 30, 2022 is an increase of 9.9% or $2.9 million compared to non-interest expense of $29.3 million for the same period in 2021. Salaries and employee benefits increased as well as other operating expense, over the same period. Other Operating Expenses increased $906,000 or 12.3%, largely attributable to one-time charges totaling $681,000 incurred in a sale of residential mortgage loans in the third quarter of 2022 . Non-interest expense of $11.4 million for the quarter ended September 30, 2022 is an increase of 14.5% compared to non-interest expense of $9.9 million for the same period in 2021 due to the reasons mentioned. The Company's non-GAAP efficiency ratio stood at 44.99% for the nine months ended September 30, 2022, down from 45.04% for the same period in 2021. Income Taxes Income taxes on operating earnings were $6.4 million for the nine months ended September 30, 2022, up $832,000 from the same period in 2021. Investments The carrying value of the Company's investment portfolio decreased by $26.3 million between December 31, 2021 and September 30, 2022. As of September 30, 2022, mortgage-backed securities had a carrying value of $285.6 million and a fair value of $273.9 million. Of this total, securities with a fair value of $75.9 million or 27.7% of the mortgage-backed portfolio were issued by the Government National Mortgage Association and securities with a fair value of $197.9 million or 72.3% of the mortgage-backed portfolio were issued by the Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Federal National Mortgage Association ("Fannie Mae"). The Company's investment securities are classified into two categories: securities available for sale and securities to be held to maturity. Securities available for sale consist primarily of debt securities which Management intends to hold for indefinite periods of time. They may be used as part of the Company's funds management strategy, and may be sold in response to changes in interest rates, prepayment risk and liquidity needs, to increase capital ratios, or for other similar reasons. Securities to be held to maturity consist primarily of debt securities that the Company has acquired solely for long-term investment purposes, rather than potential future sale. For securities to be categorized as held to maturity, Management must have the intent and the Company must have the ability to hold such investments until their respective maturity dates. The Company does not hold trading account securities. All investment securities are managed in accordance with a written investment policy adopted by the Board of Directors. It is the Company's general policy that investments for either portfolio be limited to government debt obligations, time deposits, and corporate bonds or commercial paper with one of the three highest ratings given by a nationally recognized rating agency. The portfolio is currently invested primarily in U.S. Government agency securities, mortgage-backed securities and tax-exempt obligations of states and political subdivisions. The individual securities have been selected to enhance the portfolio's overall yield while not materially adding to the Company's level of interest rate risk. During the third quarter of 2014, the Company transferred securities with a total amortized cost of $89,780,000 and a corresponding fair value of $89,757,000 from available for sale to held to maturity. The net unrealized loss, net of taxes, on these securities at the date of the transfer was $15,000. The net unrealized holding loss at the time of transfer continues to be reported in accumulated other comprehensive income (loss), net of tax and is amortized over the remaining lives of the securities as an adjustment of the yield. The amortization of the net unrealized loss reported in accumulated other comprehensive income (loss) will offset the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the net unrealized losses for the securities transferred from available for sale to held to maturity was $67,000 at September 30, 2022. This compares to $87,000 and $99,000, net of taxes, at December 31, 2021 and September 30, 2021, respectively. These securities were transferred as a part of the Company's overall investment and balance sheet strategies. 57 The following table sets forth the Company's investment securities at their carrying amounts as of September 30, 2022 and 2021 and December 31, 2021. Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Securities available for sale U.S. Government-sponsored agencies $ 19,144 $ 21,899 $ 21,939 Mortgage-backed securities 229,178 254,900 247,253 State and political subdivisions 31,106 39,122 35,179 Asset-backed securities 3,840 4,645 4,853 $ 283,268 $ 320,566 $ 309,224 Securities to be held to maturity U.S. Government-sponsored agencies $ 38,100 $ 35,600 $ 35,600 Mortgage-backed securities 56,423 60,646 64,651 State and political subdivisions 257,633 250,544 254,198 Corporate securities 29,750 23,250 21,250 $ 381,906 $ 370,040 $ 375,699 Restricted equity securities Federal Home Loan Bank Stock $ 3,477 $ 4,328 $ 7,802 Federal Reserve Bank Stock 1,037 1,037 1,037 $ 4,514 $ 5,365 $ 8,839 Total securities $ 669,688 $ 695,971 $ 693,762 58 The following table sets forth yields and contractual maturities of the Company's investment securities as of September 30, 2022. Yields on tax-exempt securities have been computed on a tax-equivalent basis using a tax rate of 21%. Mortgage-backed securities are presented according to their final contractual maturity date, while the calculated yield takes into effect the intermediate cash flows from repayment of principal which results in a much shorter average life. Available For Sale Held to Maturity Dollars in thousands Fair Value Yield to maturity Amortized Cost Yield to maturity U.S. Government-Sponsored Agencies Due in 1 year or less $ — 0.00 % $ — 0.00 % Due in 1 to 5 years 2,776 1.83 % — 0.00 % Due in 5 to 10 years 7,720 1.17 % 11,500 1.02 % Due after 10 years 8,648 2.00 % 26,600 1.56 % Total 19,144 1.64 % 38,100 1.40 % Mortgage-Backed Securities Due in 1 year or less 4 4.24 % — 0.00 % Due in 1 to 5 years 286 2.64 % 8 8.43 % Due in 5 to 10 years 3,381 1.54 % 226 7.32 % Due after 10 years 225,507 2.04 % 56,189 1.36 % Total 229,178 2.03 % 56,423 1.39 % State & Political Subdivisions Due in 1 year or less — 0.00 % 1,346 4.05 % Due in 1 to 5 years 365 5.06 % 8,477 3.89 % Due in 5 to 10 years 3,335 2.51 % 40,766 3.40 % Due after 10 years 27,406 3.25 % 207,044 2.31 % Total 31,106 3.19 % 257,633 2.54 % Asset-Backed Securities Due in 1 year or less — 0.00 % — 0.00 % Due in 1 to 5 years — 0.00 % — 0.00 % Due in 5 to 10 years — 0.00 % — 0.00 % Due after 10 years 3,840 4.17 % — 0.00 % Total 3,840 4.17 % — 0.00 % Corporate Securities Due in 1 year or less — 0.00 % — 0.00 % Due in 1 to 5 years — 0.00 % 6,750 4.61 % Due in 5 to 10 years — 0.00 % 23,000 4.05 % Due after 10 years — 0.00 % — 0.00 % Total — 0.00 % 29,750 4.18 % $ 283,268 2.16 % $ 381,906 2.39 % Impaired Securities The securities portfolio contains certain securities where the amortized cost of which exceeds fair value, which at September 30, 2022 amounted to $128.5 million, or 18.24% of the amortized cost of the total securities portfolio. At December 31, 2021, this amount was $8.4 million, or 1.26% of the amortized cost of total securities portfolio. The position change since 2021 year-end is the result of the significant increase in market interest rates during the period. As a part of the Company's ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. If a decline in the fair value of a debt security is judged to be other-than-temporary, the decline related to credit loss is recorded in net realized securities losses while the decline attributable to other factors is recorded in other comprehensive income or loss. The Company's evaluation of securities for impairment is a quantitative and qualitative process intended to determine whether declines in the fair value of investment securities should be recognized in current period earnings. The primary factors considered in evaluating whether a decline in the fair value of securities is other-than-temporary include: (a) the length of time 59 and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity, and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred. The Company's best estimate of cash flows uses severe economic recession assumptions due to market uncertainty. The Company's assumptions include but are not limited to delinquencies, foreclosure levels and constant default rates on the underlying collateral, loss severity ratios, and constant prepayment rates. If the Company does not expect to receive 100% of future contractual principal and interest, an other-than-temporary impairment charge is recognized. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral. As of September 30, 2022, the Company had temporarily impaired securities with a fair value of $561.1 million and unrealized losses of $128.5 million, as identified in the table below. Securities in a continuous unrealized loss position more than twelve months amounted to $223.6 million as of September 30, 2022, compared with $55.9 million at December 31, 2021. The Company has concluded that these securities were not other-than-temporarily impaired. This conclusion was based on the issuer's continued satisfaction of the securities obligations in accordance with their contractual terms and the expectation that the issuer will continue to do so, Management's intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value which may be at maturity, the expectation that the Company will receive 100% of future contractual cash flows, as well as the evaluation of the fundamentals of the issuer's financial condition and other objective evidence. The following table summarizes temporarily impaired securities and their approximate fair values at September 30, 2022: Less than 12 months 12 months or more Total Dollars in thousands Fair Value (Estimated) Unrealized Losses Fair Value (Estimated) Unrealized Losses Fair Value (Estimated) Unrealized Losses U.S. Government-sponsored agencies $ 7,364 $ (1,264) $ 39,452 $ (16,043) $ 46,816 $ (17,307) Mortgage-backed securities 109,041 (13,868) 162,979 (41,957) 272,020 (55,825) State and political subdivisions 197,145 (44,277) 17,902 (9,005) 215,047 (53,282) Asset-backed securities 3,840 (32) — — 3,840 (32) Corporate Securities 20,186 (1,814) 3,229 (271) 23,415 (2,085) $ 337,576 $ (61,255) $ 223,562 $ (67,276) $ 561,138 $ (128,531) For securities with unrealized losses, the following information was considered in determining that the securities were not other-than-temporarily impaired: Securities issued by U.S. Government-sponsored agencies and enterprises. As of September 30, 2022, there were $17.3 million unrealized losses on these securities compared to $2.3 million unrealized losses as of December 31, 2021. All of these securities were credit rated "AAA" or "AA+" by the major credit rating agencies. Management believes that securities issued by U.S. Government-sponsored agencies and enterprises have minimal credit risk, as these agencies and enterprises play a vital role in the nation's financial markets and does not consider these securities to be other-than-temporarily impaired at September 30, 2022. Mortgage-backed securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises. As of September 30, 2022, there were $55.8 million of unrealized losses on these securities compared with $5.7 million at December 31, 2021. All of these securities were credit rated "AAA" or "AA+" by the major credit rating agencies. Management believes that securities issued by U.S. Government agencies bear no credit risk because they are backed by the full faith and credit of the United States and that securities issued by U.S. Government-sponsored enterprises have minimal credit risk, as these agencies and enterprises play a vital role in the nation's financial markets. Management believes that the unrealized losses at September 30, 2022 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at September 30, 2022. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity. Obligations of state and political subdivisions. As of September 30, 2022, there were $53.3 million of unrealized losses on these securities compared to $390,000 at December 31, 2021. Municipal securities are supported by the general taxing authority of the municipality or a dedicated revenue stream, and, in the case of school districts, are generally supported by state aid. At 60 September 30, 2022, all municipal bond issuers were current on contractually obligated interest and principal payments. The Company attributes the unrealized losses at September 30, 2022 to changes in prevailing market yields and pricing spreads since the date the underlying securities were purchased, combined with current market liquidity conditions and disruption in the financial markets in general. Accordingly, the Company does not consider these municipal securities to be other-than-temporarily impaired at September 30, 2022. Asset-backed securities. As of September 30, 2022, there were $32,000 of unrealized losses on these securities compared to none at December 31, 2021. These securities consist of U.S Government backed student loans along with other credit enhancements. Management believes that the unrealized losses at September 30, 2022 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at September 30, 2022. Corporate securities. As of September 30, 2022, there were $2.1 million of unrealized losses on these securities compared to $66,000 at December 31, 2021. Corporate securities are dependent on the operating performance of the issuers. At September 30, 2022, all corporate bond issuers were current on contractually obligated interest and principal payments. Management believes that the unrealized losses at September 30, 2022 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at September 30, 2022. Federal Home Loan Bank Stock The Bank is a member of the Federal Home Loan Bank ("FHLB") of Boston, a cooperatively owned wholesale bank for housing and finance in the six New England States. As a requirement of membership in the FHLB, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. The Bank uses the FHLB for much of its wholesale funding needs. As of September 30, 2022, the Bank's investment in FHLB stock totaled $3.5 million. This compares to $4.3 million as of December 31, 2021 and $7.8 million as of September 30, 2021. FHLB stock is a non-marketable equity security and therefore is reported at cost, subject to adjustments for any observable market transactions on the same or similar instruments of the investee. No impairment losses have been recorded through September 30, 2022. The Company will continue to monitor its investment in FHLB stock. Loans Held for Sale Loans held for sale are carried at the lower of cost or market value. As of September 30, 2022, the Bank had no loans held for sale. This compares to $835,000 loans held for sale at December 31, 2021 and $1.4 million loans held for sale at September 30, 2021. The Bank participates in FHLB's Mortgage Partnership Finance Program ("MPF"), selling loans with recourse. The volume of loans sold to date through the MPF program is de minimis; therefore, there was minimum impact on the reserve. Loans The loan portfolio increased during the first nine months of 2022, with total loans at $1.86 billion at September 30, 2022, up $210.3 million or 12.8% from total loans of $1.65 billion at December 31, 2021. Commercial loans increased $157.7 million or 17.1% between December 31, 2021 and September 30, 2022, municipal loans increased $340,000 or 0.7%, residential term loans increased $44.2 million, residential construction increased $9.9 million, and home equity lines of credit increased $306,000. Loans made under the U.S. Small Business Administration's PPP accounted for $14,000 of commercial loans as of September 30, 2022. Commercial loans are comprised of three major classes: commercial real estate loans, commercial construction loans and other commercial loans. Commercial real estate loans consist of mortgage loans to finance investments in real property such as multi-family residential, commercial/retail, office, industrial, hotels, educational and other specific or mixed use properties. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Commercial real estate loans typically have a loan-to-value ratio of up to 80% based upon current valuation information at the time the loan is made. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower. Commercial construction loans consist of loans to finance construction in a mix of owner- and non-owner occupied commercial real estate properties. Commercial construction loans typically have a construction phase of less than two years, followed by a repayment phase. Payment structures during the construction period are typically on an interest only basis, although principal payments may be established depending on the type of construction project being financed. During the construction phase, commercial construction loans are primarily paid by cash flow generated from the construction project or other operating cash flows from the borrower or guarantors, if applicable. At the end of the construction period, loan 61 repayment typically comes from a third party source in the event that the Company will not be providing permanent term financing. Collateral valuation and loan-to-value guidelines follow those for commercial real estate loans. Other commercial loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and or capital investment. Collateral generally consists of pledges of business assets including, but not limited to, accounts receivable, inventory, plant and equipment, and/or real estate, if applicable. Commercial loans are primarily paid by the operating cash flow of the borrower. Commercial loans may be secured or unsecured. Municipal loans are comprised of loans to municipalities in Maine for capitalized expenditures, construction projects or tax-anticipation notes. All municipal loans are considered general obligations of the municipality and are collateralized by the taxing ability of the municipality for repayment of debt. Residential loans are comprised of two classes: term loans and construction loans. Residential term loans consist of residential real estate loans held in the Company's loan portfolio made to borrowers who demonstrate the ability to make scheduled payments with full consideration to underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Residential loans typically have a loan-to-value ratio of up to 80% based on appraisal information at the time the loan is made. Collateral consists of mortgage liens on one- to four-family residential properties. Loans are offered with fixed or adjustable rates with amortization terms of up to thirty years. Residential construction loans typically consist of loans for the purpose of constructing single family residences to be owned and occupied by the borrower. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Residential construction loans normally have construction terms of one year or less and payment during the construction term is typically on an interest only basis from sources including interest reserves, borrower liquidity and/or income. Residential construction loans will typically convert to permanent financing from the Company or have another financing commitment in place from an acceptable mortgage lender. Collateral valuation and loan-to-value guidelines are consistent with those for residential term loans. Home equity lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity line of credit typically has a variable interest rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Loan maturities are normally 300 months. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios usually not exceeding 80% inclusive of priority liens. Collateral valuation guidelines follow those for residential real estate loans. Consumer loan products including personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto, recreational vehicles, debt consolidation, personal expenses or overdraft protection. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines. Consumer loans may be secured or unsecured. Construction loans, both commercial and residential, at 67.9% of total Bank capital are well under the regulatory guidance of 100.0% of capital at September 30, 2022. Construction loans and non-owner-occupied commercial real estate loans are at 221.4% of total Bank capital, well under the regulatory guidance of 300.0% of capital at September 30, 2022. The following table summarizes the loan portfolio, by class, at September 30, 2022 and 2021 and December 31, 2021. Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Commercial Real estate $ 638,708 34.5 % $ 576,198 35.0 % $ 550,077 34.0 % Construction 129,036 6.9 % 79,365 4.8 % 73,302 4.6 % Other 310,110 16.7 % 264,570 16.1 % 288,121 17.8 % Municipal 48,702 2.6 % 48,362 2.9 % 40,616 2.5 % Residential Term 595,031 32.0 % 550,783 33.4 % 537,811 33.3 % Construction 41,631 2.2 % 31,763 1.9 % 29,358 1.8 % Home equity line of credit 73,938 4.0 % 73,632 4.5 % 74,594 4.6 % Consumer 20,819 1.1 % 22,976 1.4 % 23,333 1.4 % Total loans $ 1,857,975 100.0 % $ 1,647,649 100.0 % $ 1,617,212 100.0 % 62 The following table sets forth certain information regarding the contractual maturities of the Bank's loan portfolio as of September 30, 2022. Dollars in thousands < 1 Year 1 - 5 Years 5 - 10 Years > 10 Years Total Commercial Real estate $ 221 $ 26,476 $ 67,436 $ 544,575 $ 638,708 Construction — 7,511 14,546 106,979 129,036 Other 453 118,861 79,473 111,323 310,110 Municipal — 26,070 7,929 14,703 48,702 Residential Term — 6,732 44,225 544,074 595,031 Construction — 1,560 — 40,071 41,631 Home equity line of credit 1,323 3,301 1,781 67,533 73,938 Consumer 5,325 7,468 2,996 5,030 20,819 Total loans $ 7,322 $ 197,979 $ 218,386 $ 1,434,288 $ 1,857,975 The following table provides a listing of loans by class, between variable and fixed rates as of September 30, 2022. Fixed-Rate Adjustable-Rate Total Dollars in thousands Amount % of total Amount % of total Amount % of total Commercial Real estate $ 86,567 4.7 % $ 552,141 29.8 % $ 638,708 34.5 % Construction 34,764 1.9 % 94,272 5.0 % 129,036 6.9 % Other 119,552 6.4 % 190,558 10.3 % 310,110 16.7 % Municipal 48,410 2.6 % 292 0.0 % 48,702 2.6 % Residential Term 428,941 23.1 % 166,090 8.9 % 595,031 32.0 % Construction 32,447 1.7 % 9,184 0.5 % 41,631 2.2 % Home equity line of credit 305 0.0 % 73,633 4.0 % 73,938 4.0 % Consumer 13,750 0.7 % 7,069 0.4 % 20,819 1.1 % Total loans $ 764,736 41.1 % $ 1,093,239 58.9 % $ 1,857,975 100.0 % Loan Concentrations As of September 30, 2022 and 2021, the Bank had one concentration of loans that exceeded 10% of its total loan portfolio. Loans to hotels (except Casino hotels) and motels totaled $201.5 million, or 10.84% of total loans and $165.6 million, or 10.23% of total loans, respectfully. Loan Sale In September 2022, the Bank sold a block of mixed-performing residential mortgage loans. The block consisted of 41 units with a total carrying value of $5.2 million, and included past-due, non-accrual, and Troubled Debt Restructure loans. One-time charges associated with the sale totaling $681,000 were recognized in the third quarter. Credit Risk Management and Allowance for Loan Losses Credit risk is the risk of loss arising from the inability of a borrower to meet its obligations. We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, Management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions. 63 We provide for loan losses through the establishment of an allowance for loan losses which represents an estimated reserve for existing losses in the loan portfolio. We deploy a systematic methodology for determining our allowance that includes a quarterly review process, risk rating, and adjustment to our allowance. We classify our portfolios as either commercial or residential and consumer and monitor credit risk separately as discussed below. We evaluate the appropriateness of our allowance continually based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that we believe require special attention. The allowance consists of four elements: (1) specific reserves for loans evaluated individually for impairment; (2) general reserves for types or portfolios of loans based on historical loan loss experience; (3) qualitative reserves judgmentally adjusted for local and national economic conditions, concentrations, portfolio composition, volume and severity of delinquencies and nonaccrual loans, trends of criticized and classified loans, changes in credit policies, and underwriting standards, credit administration practices, and other factors as applicable; and (4) unallocated reserves. All outstanding loans are considered in evaluating the appropriateness of the allowance. Appropriateness 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 appropriateness 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, economic trends, changes in credit policies, and experience, ability and depth of lending management. The appropriateness of the allowance for loan losses is assessed by an allocation process whereby specific reserve allocations are made against certain adversely classified loans, and general reserve allocations are made against segments of the loan portfolio which 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 appropriateness 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. Commercial Our commercial portfolio includes all secured and unsecured loans to borrowers for commercial purposes, including commercial lines of credit and commercial real estate. Our process for evaluating commercial loans includes performing updates on loans that we have rated for credit risk. Our non-performing commercial loans are generally reviewed individually to determine impairment, accrual status, and the need for specific reserves. Our methodology incorporates a variety of risk considerations, both qualitative and quantitative. Quantitative factors include our historical loss experience by loan type, collateral values, financial condition of borrowers, and other factors. Qualitative factors applied to the portfolio or segments of the portfolio may include judgments concerning general economic conditions that may affect credit quality, credit concentrations, the pace of portfolio growth, the direction of risk rating movements, policy exception levels, and delinquency levels; these qualitative factors are also considered in connection with the unallocated portion of our allowance for loan losses. The process of establishing the allowance with respect to the commercial loan portfolio begins when a Loan Officer or Senior Officer (or designate) initially assigns each loan a risk rating, using established credit criteria. Approximately 60% of commercial loan outstanding balances are subject to review and validation annually by an independent consulting firm. Additionally, commercial loan relationships with exposure greater than or equal to $500,000 are subject to review annually by the Company's internal credit review function. Our methodology employs Management's judgment as to the level of losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers' current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and or lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. We also evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors. Residential, Home Equity and Consumer Consumer, home equity and residential mortgage loans are generally segregated into homogeneous pools with similar risk characteristics. Trends and current conditions in these pools are analyzed and historical loss experience is adjusted accordingly. Quantitative and qualitative adjustment factors for the consumer, home equity and residential mortgage portfolios are consistent with those for the commercial portfolios. Certain loans in the consumer and residential portfolios identified as having the potential for further deterioration are analyzed individually to confirm the appropriate risk status and accrual status, and to determine the need for a specific reserve. Consumer loans that are greater than 120 days past due are generally charged off. 64 Residential loans and home equity lines of credit that are greater than 90 days past due are evaluated for collateral adequacy and if deficient are placed on non-accrual status. Unallocated The unallocated portion of the allowance is intended to provide for losses that are not identified when establishing the specific and general portions of the allowance and is based upon Management's evaluation of various conditions that are not directly measured in the determination of the portfolio and loan specific allowances. Such conditions may include general economic and business conditions affecting our lending area, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, duration of the current business cycle, bank regulatory examination results, findings of external loan review examiners, and Management's judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems. Management reviews these conditions quarterly. We have risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist inherently within the loan portfolio. In response to the consequences of COVID-19, we have increased the rigor and frequency of our loan portfolio monitoring and borrower contact, particularly within those industry groups thought to be most vulnerable, including the lodging, restaurant and hospitality sectors. As the economy has re-opened initial experience within these sectors has been generally favorable; our Allowance for Loan Losses will be evaluated as additional information continues to become available. The judgmental aspects involved in applying the risk grading criteria, analyzing the quality of individual loans, and assessing collateral values can also contribute to undetected, but probable, losses. Consequently, there may be underlying credit risks that have not yet surfaced in the loan-specific or qualitative metrics the Company uses to estimate its allowance for loan losses. The allowance for loan losses includes reserve amounts assigned 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 non-accrual and/or troubled debt restructure 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 September 30, 2022, impaired loans with specific reserves totaled $2.5 million and the amount of such reserves was $420,000. This compares to impaired loans with specific reserves of $3.1 million at December 31, 2021 and the amount of such reserves was $576,000. 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. Our total allowance at September 30, 2022 is considered by Management to be appropriate to address the credit losses inherent in the loan portfolio at that date. However, our determination of the appropriate allowance level is based upon a number of assumptions we make about future events, which we believe are reasonable, but which may or may not prove valid. Thus, there can be no assurance that our charge-offs in future periods will not exceed our allowance for loan losses or that we will not need to make additional increases in our allowance for loan losses. The following table summarizes our allocation of allowance by loan class as of September 30, 2022 and 2021 and December 31, 2021. The percentages are the portion of each loan class to total loans. Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Commercial Real estate $ 5,575 34.5 % $ 5,367 35.0 % $ 6,499 34.0 % Construction 1,121 6.9 % 746 4.8 % $ 879 4.6 % Other 3,014 16.7 % 2,830 16.1 % $ 3,727 17.8 % Municipal 160 2.6 % 157 2.9 % $ 189 2.5 % Residential Term 2,547 32.0 % 2,733 33.4 % $ 2,761 33.3 % Construction 168 2.2 % 148 1.9 % $ 142 1.8 % Home equity line of credit 993 4.0 % 925 4.5 % $ 956 4.6 % Consumer 872 1.1 % 833 1.4 % $ 867 1.4 % Unallocated 1,937 — % 1,782 — % $ 1,487 — % Total $ 16,387 100.0 % $ 15,521 100.0 % $ 17,507 100.0 % 65 The allowance for loan losses totaled $16.4 million at September 30, 2022, compared to $15.5 million as of December 31, 2021 and $17.5 million as of September 30, 2021. Management's ongoing application of methodologies to establish the allowance include an evaluation of impaired loans for specific reserves. These specific reserves decreased $156,000 in the first nine months of 2022 from $576,000 at December 31, 2021 to $420,000 at September 30, 2022. The specific loans that make up those categories change from period to period. Impairment on those loans, which would be reflected in the allowance for loan losses, might or might not exist, depending on the specific circumstances of each loan. The portion of the reserve based upon homogeneous pools of loans increased by $35,000 in the first nine months of 2022. The portion of the reserve based on qualitative factors increased $832,000 in the first nine months of 2022 due to a mix of factors. These included changes in various macroeconomic measures used in the qualitative model, updated analysis of the loan portfolio in multiple stress scenarios, and performance after exit of COVID-19 related loan modifications. Unallocated reserves of $1.8 million, or 11.5% of the total reserve at December 31, 2021, increased to $1.9 million, or 11.8% as of September 30, 2022. After consideration of the shifts in specific, pooled and qualitative reserves, Management determined that the unallocated portion of the reserve at September 30, 2022 adequately addresses general imprecision related to loan portfolio growth, along with other underlying credit risks not yet captured in loan specific or qualitative metrics the Company uses to estimate its allowance. A breakdown of the allowance for loan losses as of September 30, 2022, by loan class and allowance element, is presented in the following table: Dollars in thousands Specific Reserves on Loans Evaluated Individually for Impairment General Reserves on Loans Based on Historical Loss Experience Reserves for Qualitative Factors Unallocated Reserves Total Reserves Commercial Real estate $ — $ 867 $ 4,708 $ — $ 5,575 Construction 6 173 942 — 1,121 Other 315 420 2,279 — 3,014 Municipal — — 160 — 160 Residential Term 99 102 2,346 — 2,547 Construction — 7 161 — 168 Home equity line of credit — 106 887 — 993 Consumer — 216 656 — 872 Unallocated — — — 1,937 1,937 $ 420 $ 1,891 $ 12,139 $ 1,937 $ 16,387 Based upon Management's evaluation, provisions are made to maintain the allowance as a best estimate of inherent losses within the portfolio. The provision for loan losses to maintain the allowance was $1.3 million for the first nine months of 2022 and $1.6 million the first nine months of 2021. Net charge-offs were $434,000 in the first nine months of 2022, up from $321,000 in the first nine months of 2021. Our allowance as a percentage of outstanding loans was 0.88% as of September 30, 2022, down marginally from 0.94% as of December 31, 2021, and down from 1.08% as of September 30, 2021. 66 The following table summarizes the activities in our allowance for loan losses for the nine months ended September 30, 2022 and 2021 and for the year ended December 31, 2021: Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Balance at the beginning of period $ 15,521 $ 16,253 $ 16,253 Loans charged off: Commercial Real estate — 106 71 Construction — — — Other 272 288 286 Municipal — — — Residential Term — 42 41 Construction — — — Home equity line of credit 29 — — Consumer 318 312 239 Total 619 748 637 Recoveries on loans previously charged off Commercial Real estate 16 95 95 Construction — — — Other 11 84 83 Municipal — — — Residential Term 27 66 12 Construction — — — Home equity line of credit 3 61 60 Consumer 128 85 66 Total 185 391 316 Net loans charged off 434 357 321 Provision (credit) for loan losses 1,300 (375) 1,575 Balance at end of period $ 16,387 $ 15,521 $ 17,507 Ratio of net loans charged off to average loans outstanding 1 0.03 % 0.02 % 0.03 % Ratio of allowance for loan losses to total loans outstanding 0.88 % 0.94 % 1.08 % 1 Annualized using a 365-day basis for both 2022 and 2021. In Management's opinion, the level of the provision for loan losses is directionally consistent with the overall credit quality of our loan portfolio and corresponding levels of nonperforming loans, as well as with the performance of the national and local economies, including effects of the COVID-19 pandemic. COVID-19 Impact on Loan Portfolio First National Bank is a designated SBA preferred lender and has participated in both the 2020 (PPP1) and 2021 (PPP2) rounds of the PPP. Under PPP1, 1,718 loans were granted totaling $97.8 million in funds disbursed to qualified small businesses and under PPP2 there were 1,263 loans granted totaling $52.1 million. The Bank worked actively with borrowers to process applications for forgiveness per PPP guidelines. As of September 30, 2022, remaining PPP balances totaled $14,000. 67 The State of Maine, where most of the Bank's customers reside and/or operate businesses, has re-opened its economy. The emergence of COVID-19 variants virus has not resulted in new restrictions or curtailment of economic activity, but COVID-19 remains a threat to economic normalization and could ultimately have a negative impact on the Bank's borrowers. The Company regularly monitors activity on open credit lines and has not observed increased utilization related to COVID-19. Nonperforming Loans Nonperforming loans are comprised of loans, for which based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when principal and interest is 90 days or more past due unless the loan is both well secured and in the process of collection (in which case the loan may continue to accrue interest in spite of its past due status). A loan is "well secured" if it is secured (1) by collateral in the form of liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt including accrued interest) in full, or (2) by the guarantee of a financially responsible party. A loan is "in the process of collection" if collection of the loan is proceeding in due course either (1) through legal action, including judgment enforcement procedures, or (2) in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status in the near future. Generally, when a loan becomes 90 days past due it is evaluated for collateral dependency based upon the most recent appraisal or other evaluation method. If the collateral value is lower than the outstanding loan balance plus accrued interest and estimated selling costs, the loan is placed on non-accrual status, all accrued interest is reversed from interest income, and a specific reserve is established for the difference between the loan balance and the collateral value less selling costs, or, in certain situations, the difference between the loan balance and the collateral value less selling costs is written off. Concurrently, a new appraisal or valuation may be ordered, depending on collateral type, currency of the most recent valuation, the size of the loan, and other factors appropriate to the loan. Upon receipt and acceptance of the new valuation, the loan may have an additional specific reserve or write down based on the updated collateral value. On an ongoing basis, appraisals or valuations may be done periodically on collateral dependent nonperforming loans and an additional specific reserve or write down will be made, if appropriate, based on the new collateral value. Once a loan is placed on nonaccrual, it remains in nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current. All payments made on nonaccrual loans are applied to the principal balance of the loan. Nonperforming loans, expressed as a percentage of total loans, totaled 0.10% at September 30, 2022 compared to 0.35% at December 31, 2021 and 0.39% at September 30, 2021. The following table shows the distribution of nonperforming loans by class as of September 30, 2022 and 2021 and December 31, 2021: Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Commercial Real estate $ 195 $ 242 $ 604 Construction 25 27 23 Other 756 1,068 1,251 Municipal — — — Residential Term 637 3,808 3,785 Construction — — — Home equity line of credit 247 457 482 Consumer — — — Total nonperforming loans $ 1,860 $ 5,602 $ 6,145 Allowance for loan losses as a percentage of nonperforming loans 881.0 % 277.1 % 284.9 % The amounts shown for total nonperforming loans do not include loans 90 or more days past due and still accruing interest. These are loans for which we expect to collect all amounts due, including past-due interest. As of September 30, 2022, there were no loans 90 or more days past due and still accruing interest compared to $32,000 at December 31, 2021 and $229,000 at September 30, 2021. 68 Troubled Debt Restructured A TDR constitutes a restructuring of debt if the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. To determine whether or not a loan should be classified as a TDR, Management evaluates a loan based upon the following criteria: • The borrower demonstrates financial difficulty; common indicators include past due status with bank obligations, substandard credit bureau reports, or an inability to refinance with another lender, and • The Company has granted a concession; common concession types include maturity date extension, interest rate adjustments to below market pricing, and deferment of payments. As of September 30, 2022, we had 31 loans with a balance of $4.9 million that have been restructured. This compares to 60 loans with a balance of $8.3 million and 64 loans with a balance of $10.1 million classified as TDRs as of December 31, 2021 and September 30, 2021, respectively. The following table shows the activity in loans classified as TDRs between December 31, 2021 and September 30, 2022: Balance in Thousands of Dollars Number of Loans Aggregate Balance Total at December 31, 2021 60 $ 8,341 Added in 2022 1 38 Loans paid off in 2022 (30) (3,237) Repayments in 2022 — (216) Total at September 30, 2022 31 $ 4,926 As of September 30, 2022, 25 loans with an aggregate balance of $4.5 million were performing under the modified terms, six loans with an aggregate balance of $430,000 were on nonaccrual and no loans were more than 30 days past due and accruing. As a percentage of aggregate outstanding balance, 91.27% were performing under the modified terms, 8.73% were on nonaccrual and 0.00% were past due and still accruing. The performance status of all TDRs as of September 30, 2022, as well as the associated specific reserve in the allowance for loan losses, is summarized by type of loan in the following table. In thousands of dollars Performing As Modified 30+ Days Past Due and Accruing On Nonaccrual All TDRs Commercial Real estate $ 1,100 $ — $ — $ 1,100 Construction 661 — — 661 Other 196 — 265 461 Municipal — — — — Residential Term 2,539 — 165 2,704 Construction — — — — Home equity line of credit — — — — Consumer — — — — $ 4,496 $ — $ 430 $ 4,926 Percent of balance 91.3 % — % 8.7 % 100.0 % Number of loans 25 — 6 31 Associated specific reserve $ 106 $ — $ 83 $ 189 Residential and consumer TDRs as of September 30, 2022 included 20 loans with an aggregate balance of $2.7 million, and the modifications granted fell into four major categories. Loans totaling $1.5 million had an extension of term, allowing the borrower to repay over an extended number of years and lowering the monthly payment to a level the borrower can afford. Loans totaling $945,000 had interest capitalized, allowing the borrower to become current after unpaid interest was added to the balance of the loan and re-amortized over the remaining life of the loan. Rate concessions were granted on loans totaling $108,000. Loans with an aggregate balance of $538,000 were involved in bankruptcy. Certain residential TDRs had more than one modification. Commercial TDRs as of September 30, 2022 were comprised of 11 loans with a balance of $2.2 million. Of this total, four loans with an aggregate balance of $1.0 million had an extended period of interest-only payments, deferring the start of 69 principal repayment. Three loans with an aggregate balance of $249,000 had a deferral of payment. The remaining four loans with an aggregate balance of $1.0 million had several different modifications. In each case when a loan was modified, Management determined it was in the Bank's best interest to work with the borrower with modified terms rather than to proceed to foreclosure. Once a loan is classified as a TDR it generally remains classified as such until the balance is fully repaid, whether or not the loan is performing under the modified terms. As of September 30, 2022, Management is aware of four loans classified as TDRs that are involved in bankruptcy with an outstanding balance of $558,000. There were also 6 loans with an outstanding balance of $430,000 that were classified as TDRs and on non-accrual status, of which no loans were in the process of foreclosure. Impaired Loans Impaired loans include restructured loans and loans placed on non-accrual status. These loans are measured at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral less estimated selling costs if the loan is collateral dependent. If the measure of an impaired loan is lower than the recorded investment in the loan, a specific reserve is established for the difference. Impaired loans totaled $6.4 million at September 30, 2022, and have decreased $5.7 million from December 31, 2021. There were 59 impaired loans at September 30, 2022 down from 107 loans at December 31, 2021. Impaired commercial loans decreased $488,000 between December 31, 2021 and September 30, 2022. The specific allowance for impaired commercial loans decreased from $439,000 at December 31, 2021 to $321,000 as of September 30, 2022, which represented the fair value deficiencies for loans where the fair value of the collateral or net present value of expected cash flows was estimated at less than our carrying amount of the loan. From December 31, 2021 to September 30, 2022, impaired residential loans decreased $5.0 million and impaired home equity lines of credit decreased $210,000. The following table sets forth impaired loans as of September 30, 2022 and 2021 and December 31, 2021: Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Commercial Real estate $ 1,295 $ 1,428 $ 2,800 Construction 686 689 705 Other 951 1,303 1,755 Municipal — — — Residential Term 3,176 8,173 8,782 Construction — — — Home equity line of credit 247 457 503 Consumer — 2 4 Total $ 6,355 $ 12,052 $ 14,549 70 Past Due Loans The Bank's overall loan delinquency ratio was 0.08% at September 30, 2022 compared to 0.26% at December 31, 2021 and 0.25% at September 30, 2021. Loans 90 days delinquent and accruing decreased from $32,000 at December 31, 2021 to zero as of September 30, 2022. The following table sets forth loan delinquencies as of September 30, 2022 and 2021 and December 31, 2021: Dollars in thousands September 30, 2022 December 31, 2021 September 30, 2021 Commercial Real estate $ 195 $ 440 $ 259 Construction — 24 28 Other 271 157 676 Municipal — — — Residential Term 322 2,297 2,453 Construction — — — Home equity line of credit 502 1,035 407 Consumer 171 392 295 Total $ 1,461 $ 4,345 $ 4,118 Loans 30-89 days past due to total loans 0.055 % 0.130 % 0.160 % Loans 90+ days past due and accruing to total loans 0.000 % 0.002 % 0.010 % Loans 90+ days past due on non-accrual to total loans 0.024 % 0.130 % 0.080 % Total past due loans to total loans 0.079 % 0.262 % 0.250 % Potential Problem Loans and Loans in Process of Foreclosure Potential problem loans consist of classified, accruing commercial and commercial real estate loans that were between 30 and 89 days past due. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve due to improvements in the economy as well as changes in collateral values or the financial condition of the borrowers, while the credit quality of other loans may deteriorate, resulting in some amount of loss. At September 30, 2022, there were two potential problem loans with a balance of $111,000 or 0.006% of total loans. At December 31, 2021, there were no potential problem loans. As of September 30, 2022, there were three loans in the process of foreclosure with a total balance of $356,000. The Bank's residential foreclosure process begins when a loan becomes 75 days past due at which time a Demand/Breach Letter is sent to the borrower. If the loan becomes 120 days past due, copies of the promissory note and mortgage deed are forwarded to the Bank's attorney for review and a complaint for foreclosure is then prepared. An authorized Bank officer signs the affidavit certifying the validity of the documents and verification of the past due amount which is then forwarded to the court. Once a Motion for Summary Judgment is granted, a Period of Redemption (POR) begins which gives the customer 90 days to cure the default. A foreclosure auction date is then set 30 days from the POR expiration date if the default is not cured. The Bank's commercial foreclosure process begins when a loan becomes 60 days past due, at which time a default letter is issued. At expiration of the period to cure default, which lasts 12 days after the issuing of the default letter, copies of the promissory note and mortgage deed are forwarded to the Bank's attorney for review. A Notice of Statutory Power of Sale is then prepared. This notice must be published for three consecutive weeks in a newspaper located in the county in which the property is located. A notice also must be issued to the mortgagor and all parties of interest 21 days prior to the sale. The foreclosure auction occurs and the Affidavit of Sale is recorded within the appropriate county within 30 days of the sale. The Bank’s written policies and procedures for foreclosures, along with implementation of same, are subject to annual review by its internal audit provider. The scope of this review includes loans held in portfolio and loans serviced for others. There were no issues requiring management attention in the most recent review. Servicing for others includes loans sold to Freddie Mac, Fannie Mae, and the FHLB through its MPF program. The Bank follows the published guidelines of each investor. Loans serviced for Freddie Mac and Fannie Mae have been sold without recourse, and the Bank has no liability for these loans in the event of foreclosure. A de minimis volume of loans has been sold to and serviced for MPF to date. The Bank retains a second loss layer credit enhancement obligation; no losses have been recorded on this credit enhancement obligation since the Bank started selling loans to MPF in 2013. 71 Other Real Estate Owned Other real estate owned and repossessed assets ("OREO") are comprised of properties or other assets acquired through a foreclosure proceeding, or acceptance of a deed or title in lieu of foreclosure. Real estate acquired through foreclosure is carried at the lower of fair value less estimated cost to sell or the cost of the asset and is not included as part of the allowance for loan loss totals. At September 30, 2022, 2021 and December 31, 2021 there were no OREO properties owned and no allowance for OREO losses. Liquidity Management As of September 30, 2022, the Bank had primary sources of liquidity of $901.0 million. It is Management's opinion this is sufficient to meet liquidity needs under a broad range of scenarios. The Bank has $499.0 million in contingent sources of liquidity, including the Federal Reserve Borrower in Custody program, municipal and corporate securities, and correspondent bank lines of credit. The Asset/Liability Committee ("ALCO") establishes guidelines for liquidity in its Asset/Liability policy and monitors internal liquidity measures to manage liquidity exposure. Based on its assessment of the liquidity considerations described above, Management believes the Company's sources of funding will meet anticipated funding needs. Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Bank's primary source of liquidity is deposits, which funded 85.0% of total average assets in the first nine months of 2022, up from 79.8% a year ago. While the generally preferred funding strategy is to attract and retain low-cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from the securities portfolios and loan repayments. Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs although Management has no intention to do so at this time. The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. Management has developed quantitative models to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of "business as usual" cash flows. In Management's estimation, risks are concentrated in two major categories: runoff of in-market deposit balances and the inability to access or renew wholesale sources of funding. Of the two categories, potential runoff of deposit balances would have the most significant impact on contingent liquidity. Our modeling attempts to quantify deposits at risk over selected time horizons. In addition to these unexpected outflow risks, several other "business as usual" factors enter into the calculation of the adequacy of contingent liquidity including payment proceeds from loans and investment securities, maturing debt obligations and maturing time deposits. The Bank has established collateralized borrowing capacity with the FRB of Boston and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business as well as Fed Funds lines with two correspondent banks and availability through the FRB Borrower in Custody program. Deposits During the first nine months of 2022, total deposits increased by $246.7 million or 11.6% from December 31, 2021 levels. Low-cost deposits (demand, NOW, and savings accounts) increased by $44.9 million or 3.3% in the first nine months of 2022, money market deposits decreased $18.2 million or 8.8%, and certificates of deposit increased $220.0 million or 38.9%. Between September 30, 2021 and September 30, 2022, total deposits increased by $336.7 million or 16.6%. Low-cost deposits increased by $66.8 million or 5.0%, money market accounts decreased $1.7 million or 0.9%, and certificates of deposit increased $271.6 million or 52.8%. Estimated uninsured deposits totaled $194.0 million, $202.3 million and $228.4 million at September 30, 2022, 2021 and December 31, 2021, respectively. Borrowed Funds The Company uses funding from the FHLB, the FRB and repurchase agreements enabling it to grow its balance sheet and its revenues. This funding may also be used to balance seasonal deposit flows or to carry out interest rate risk management strategies, and may be used to replace or supplement other sources of funding, including core deposits and certificates of deposit. During the nine months ended September 30, 2022, borrowed funds decreased $18.0 million or 13.2% from December 31, 2021, primarily in customer repurchase agreements. Between September 30, 2021 and September 30, 2022, borrowed funds decreased by $114.9 million or 49.3%; this decrease resulted primarily from repayment of various FHLB borrowings. Shareholders' Equity Shareholders' equity as of September 30, 2022 was $219.9 million, compared to $245.7 million as of December 31, 2021 and $238.7 million as of September 30, 2021. The Company's earnings in the first nine months of 2022, net of dividends declared, added $18.8 million to shareholders' equity. The net unrealized loss on available-for-sale securities, net of tax, presented in accordance with FASB ASC Topic 320 "Investments – Debt and Equity Securities" stands at $47.7 million as of September 30, 2022 and was $1.7 million as of December 31, 2021. Additional information about the net unrealized loss on available-for-sale securities was provided in Note 2 of the Consolidated Financial Statements and in the Impaired Securities section of Management's Discussion and Analysis of Financial Condition and Results of Operations. 72 A cash dividend of $0.34 per share was declared in the third quarter of 2022. The dividend payout ratio, which is calculated by dividing dividends declared per share by basic earnings per share, was 36.63% for the first nine months of 2022 compared to 38.78% for the same period in 2021. 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 2022 is this year's net income plus $38.2 million. Financial institution regulators have established guidelines for minimum capital ratios for banks and bank holding companies. The net unrealized gain or loss on available for sale securities is generally not included in computing regulatory capital. During the first quarter of 2015, the Company adopted the new Basel III regulatory capital framework as approved by the federal banking agencies. In order to avoid limitations on capital distributions, including dividend payments, the Company must hold a capital conservation buffer of 2.5% above the adequately capitalized risk-based capital ratios. The Company met each of the well-capitalized ratio guidelines at September 30, 2022. The following tables indicate the capital ratios for the Bank and the Company at September 30, 2022 and December 31, 2021. As of September 30, 2022 Leverage Tier 1 Common Equity Tier 1 Total Risk-Based Bank 8.84 % 12.64 % 12.64 % 13.52 % Company 8.99 % 12.70 % 12.70 % 13.59 % Adequately capitalized ratio 4.00 % 6.00 % 4.50 % 8.00 % Adequately capitalized ratio plus capital conservation buffer 4.00 % 8.50 % 7.00 % 10.50 % Well capitalized ratio (Bank only) 5.00 % 8.00 % 6.50 % 10.00 % As of December 31, 2021 Leverage Tier 1 Common Equity Tier 1 Total Risk-Based Bank 8.56 % 13.21 % 13.21 % 14.17 % Company 8.63 % 13.31 % 13.31 % 14.27 % Adequately capitalized ratio 4.00 % 6.00 % 4.50 % 8.00 % Adequately capitalized ratio plus capital conservation buffer 4.00 % 8.50 % 7.00 % 10.50 % Well capitalized ratio (Bank only) 5.00 % 8.00 % 6.50 % 10.00 % The Bank maintains and annually updates a capital plan over a five year horizon; the capital plan was last updated in the second quarter of 2022. Based upon reasonable assumptions of growth and operating performance, the base capital plan model projects that the Bank will be well capitalized throughout the five year period. The base model is also stress tested for interest rate risk from increasing and decreasing rates, credit risk in normal, elevated and severe loss scenarios, and combinations of interest rate and credit risk. In each stress scenario, the Bank maintained well capitalized status. To further validate its internal results, the Bank engaged a third party consultant during the second quarter of 2022 to conduct credit stress tests on its loan portfolio under six scenarios. Three of the scenarios emulated the Federal Reserve's Dodd Frank Act Stress Tests (DFAST), and three were developed by a leading forecasting firm. The consultant's report applied projected credit losses over a thirteen quarter horizon to the Bank's capital position with immediate effect. In each of the six scenarios the Bank remained well capitalized. Off-Balance Sheet Financial Instruments and Contractual Obligations Derivative Financial Instruments Designated as Hedges As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and/or liabilities so that change in interest rates does not have a significant adverse effect on net interest income. Derivative instruments that Management periodically uses as part of its interest rate risk management strategy may include interest rate swap agreements, interest rate floor agreements, and interest rate cap agreements. 73 At September 30, 2022, the Bank had three outstanding off-balance sheet, derivative instruments designated as cash flow hedges. These derivative instruments were interest rate swap agreements, with notional principal amounts totaling $30.0 million and an unrealized gain of $500,000, net of taxes. The notional amounts and net unrealized gain (loss) of the financial derivative instruments do not represent exposure to credit loss. The Bank is exposed to credit loss only to the extent the counterparty defaults in its responsibility to pay interest under the terms of the agreements. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that Management believes to be creditworthy and by limiting the amount of exposure to each counter-party. At September 30, 2022, the Bank's derivative instrument counterparties had a composite credit rating of “A-” based upon the ratings of several major credit rating agencies. The interest rate swap agreements were entered into by the Bank to limit its exposure to rising interest rates. The Bank also enters into swap arrangements with qualified loan customers as a means to provide these customers with access to long-term fixed interest rates for borrowings, and simultaneously enters into a swap contract with an approved third- party financial institution. The terms of the contracts are designed to offset one another resulting in their being neither a net gain or a loss. The notional amounts of the financial derivative instruments do not represent exposure to credit loss. The Bank is exposed to credit loss only to the extent that either counter-party defaults in its responsibility to pay interest under the terms of the agreements. Credit risk is mitigated by prudent underwriting of the loan customer and financial institution counterparties. As of September 30, 2022, the Bank had six loan swap agreements in place with a total notional value of $77.3 million. Contractual Obligations The following table sets forth the contractual obligations of the Company as of September 30, 2022: Dollars in thousands Total Less than 1 year 1-3 years 3-5 years More than 5 years Borrowed funds $ 118,343 $ 118,258 $ 85 $ — $ — Operating leases 891 113 204 136 438 Certificates of deposit 786,176 480,369 222,424 83,383 — Total $ 905,410 $ 598,740 $ 222,713 $ 83,519 $ 438 Total loan commitments and unused lines of credit $ 360,292 $ 360,292 $ — $ — $ — 74