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, 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, 2022, 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 credit losses on loans, the fair value of securities and allowance for credit losses on securities, the allowance for credit losses on off balance sheet commitments, goodwill, and the valuation of mortgage servicing rights. 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 Credit Losses. Management believes the allowance for credit losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for credit losses is based on Management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan and investment portfolios. The allowance is comprised of the allowance for credit losses on loans, the allowance for credit losses on off balance sheet commitments, and the allowance for credit losses on held to maturity securities. 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 portfolios, quality trends as measured by key indicators, prior loan loss experience in each loan portfolio segment, local and national business and economic conditions, and other factors contributing to Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for credit 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, 47 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. Credit Loss Recognition on Securities. Another significant estimate related to investment securities is the evaluation of potential credit losses on investment securities. The evaluation of securities for potential credit losses 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 as a charge to the allowance for credit losses. 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 recognition of a loss is required. The primary factors considered in this evaluation (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, 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. Risks and Uncertainties. As of March 31, 2023, 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, it is possible that this matter may have a further financial impact on the Company's financial position and results 48 of future operations, such potential impact of which cannot be reasonably estimated. The U.S. Government has announced that the public health emergency declared in response to COVID-19 will end on May 11, 2023. 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. The recent failures of several regional banks have further roiled markets and introduced a new source of uncertainty. 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 2023 and 2022. For the three months ended March 31, Dollars in thousands 2023 2022 Net interest income as presented $ 17,475 $ 18,620 Effect of tax-exempt income 620 557 Net interest income, tax equivalent $ 18,095 $ 19,177 49 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 provision for credit losses on securities from non-interest expenses, excludes securities gains from non-interest income, and adds the tax-equivalent adjustment to net interest income. The following table provides a reconciliation between the GAAP and non-GAAP efficiency ratio: For the three months ended March 31, Dollars in thousands 2023 2022 Non-interest expense, as presented $ 10,850 $ 10,650 Net interest income, as presented 17,475 18,620 Effect of tax-exempt interest income 620 557 Non-interest income, as presented 3,569 4,232 Effect of non-interest tax-exempt income 44 42 Net securities gains — (2) Adjusted net interest income plus non-interest income $ 21,708 $ 23,449 Non-GAAP efficiency ratio 49.98 % 45.42 % GAAP efficiency ratio 51.56 % 46.60 % 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 three months ended March 31, Dollars in thousands 2023 2022 Average shareholders' equity as presented $ 237,518 $ 246,635 Less average intangible assets (30,853) (30,919) Average tangible shareholders' common equity $ 206,665 $ 215,716 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 March 31, 2023 March 31, 2022 Shareholders' Equity $ 228,461 $ 233,646 Intangible Assets (30,849) (30,856) Tangible Common Equity 197,612 202,790 Unrealized Losses on Available for Sale Securities, net of tax 40,537 20,061 Adjusted Tangible Common Equity $ 238,149 $ 222,851 Adjusted Tangible Book Value Per Share $21.50 $20.21 50 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 three months ended March 31, Dollars in thousands 2023 2022 Net Income, as presented $ 7,971 $ 9,705 Add: provision for loan losses 550 450 Add: income taxes expense 1,673 2,047 Pre-tax, pre-provision net income $ 10,194 $ 12,202 Executive Summary Net income for the three months ended March 31, 2023 was $8.0 million, down $1.7 million or 17.9% from the same period in 2022. Earnings per common share on a fully diluted basis were $0.72 for the three months ended March 31, 2023, down $0.16 or 18.2% from the $0.88 posted for the same period in 2022. Dividends totaling $0.34 per share have been declared year-to-date, representing a payout to our shareholders of 46.58% of basic earnings per share for the period. Net interest income on a tax-equivalent basis was down $1.1 million or 5.6% in the three months ended March 31, 2023 compared to the same period in 2022. The tax equivalent net interest margin for the three months ended March 31, 2023, was 2.78%, down from 3.24% for the same period in 2022. The period to period change in net interest margin is attributable to $1.1 million in PPP revenue earned in the first quarter of 2022 which was non-continuing, coupled with rising funding costs. Non-interest income for the three months ended March 31, 2023 was $3.6 million, down $663,000 or 15.7%, from the three months ended March 31, 2022. Revenue at First National Wealth Management decreased $51,000 or 4.3% over the same period, debit card revenue was down $245,000 or 17.1% due to timing of program incentive payments, and mortgage banking revenue decreased $306,000.0 or 61.4% on lower volume of mortgage sales and negative marks taken against mortgage servicing rights valuation. Non-interest expense for the three months ended March 31, 2023 was $10.9 million, up $200,000 or 1.9% from the three months ended March 31, 2022. Salaries and employee benefits decreased 3.7% from the same period in 2022, while other operating expense has increased 8.0% over the same period. Asset quality continues to be strong and stable. Non-performing assets stood at 0.06% of total assets as of March 31, 2023, down from 0.20% of total assets as of March 31, 2022 and even with December 31, 2022. Total past-due loans were 0.10% of total loans as of March 31, 2023, up slightly from 0.08% of total loans as of December 31, 2022 and down from 0.25% as of March 31, 2022. The provision for credit losses for the first three months of 2023 was $550,000, up from the $450,000 provisioned in the same period in 2022. Net loan chargeoffs for the three months ended March 31, 2023 were $25,000 or 0.01% of average loans on an annualized basis, down from net charge-offs of $205,000 or 0.05% of total loans for the three months ended March 31, 2022. Due to CECL adoption, the allowance for credit losses increased $6.7 million between December 31, 2022 and March 31, 2023, and now stands at 1.18% of loans outstanding as of March 31, 2023, up from 0.87% at December 31, 2022 and 0.92% at March 31, 2022. The Company has modeled its ACL using a discounted cash flow approach applied to each segment of the loan portfolio. The Company's balance sheet continued to expand in the first three months of 2023 as total assets increased $72.6 million or 2.7% year-to-date. The loan portfolio increased $68.2 million or 3.6% in the three months ended March 31, 2023 and $275.5 million or 16.1% from a year ago. Loan growth in the first three months of 2023 was centered in the commercial and residential portfolios. Commercial loans increased by $50.6 million during the period, led by increases in owner-occupied commercial real estate of $28.6 million, non-owner occupied commercial real estate of $20.8 million and commercial & industrial loans of $20.3 million; commercial construction balances decreased by $21.2 million as a number of projects converted to permanent financing. Residential term loans increased by $9.4 million in the first quarter while residential construction loans increased by $2.8 million. Commercial & industry loans include PPP loan balances of $11,000. The investment portfolio increased $1.7 million year-to-date and decreased $11.6 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 total deposits have increased $87.8 million, or 3.7%, year-to-date to $2.47 billion. The Company typically experiences a modest decline in local deposit balances in the first quarter of each year due to seasonal factors. In the three months ended March 31, 2023 total local deposits fell by $18.4 million, or 1.1%, well within a normal range. Low-cost deposits (Demand, NOW, Savings) decreased $55.7 million or 4.2% during the period, while Money Market balances increased $21.2 million and certificates of deposit ("CDs") increased $45.3 million as depositors shifted balances to higher cost product types. To balance the seasonal runoff and to support earning asset growth, wholesale CDs have increased $96.7 million year-to-date, while borrowings have decreased by $19.6 million. 51 Remaining well capitalized is a top priority for The First Bancorp, Inc. The Company's total risk-based capital ratio was 13.72% as of March 31, 2023, 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 remained favorable in the first three months of 2023, with a return on average tangible common equity of 15.64% for the three months ended March 31, 2023 compared to 18.25% for the same period in 2022. Our non-GAAP efficiency ratio continues to be an important component in the Company's overall performance and stood at 49.98% for the three months ended March 31, 2023 compared to 45.42% for the same period in 2022. Net Interest Income Total interest income of $28.9 million for the three months ended March 31, 2023 was an increase of $8.4 million or 40.8% compared to total interest income of $20.5 million for the same period of 2022, which included $1.1 million of non-recurring PPP revenue. Growth in earning assets coupled with higher interest rates resulted in the period to period increase. Higher interest rates coupled with changing customer product preferences to money market and CD accounts led to total interest expense of $11.4 million for the three months ended March 31, 2023, an increase of $9.5 million or 498.0% compared to total interest expense for the three months ended March 31, 2022. As a result, net interest income of $17.5 million for the three months ended March 31, 2023 was a decrease of $1.1 million or 6.1% compared to net interest income of $18.6 million for the same period ended March 31, 2022. The Company's net interest margin on a tax-equivalent basis for the three months ended March 31, 2023 was 2.78%, down from 3.24% for the first three months of 2022. Tax-exempt interest income amounted to $2.3 million for the three months ended March 31, 2023 compared to $2.1 million for the three months ended March 31, 2022. 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 three months ended March 31, 2023 and 2022. Tax-exempt income is calculated on a tax-equivalent basis, using a 21.0% Federal Income Tax rate. For the three months ended March 31, 2023 March 31, 2022 Dollars in thousands Amount of interest Average Yield/Rate Amount of interest Average Yield/Rate Interest on earning assets Interest-bearing deposits $ 40 4.83 % $ 9 0.15 % Investments 5,281 3.12 % 4,391 2.56 % Loans held for sale — 0.00 % 5 1.78 % Loans 24,213 5.04 % 16,685 4.04 % Total interest income 29,534 4.54 % 21,090 3.57 % Interest expense Deposits 10,917 2.10 % 1,625 0.37 % Other borrowings 522 1.94 % 288 0.86 % Total interest expense 11,439 2.09 % 1,913 0.40 % Net interest income $ 18,095 $ 19,177 Interest rate spread 2.45 % 3.17 % Net interest margin 2.78 % 3.24 % 52 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 three months ended March 31, 2023 compared to 2022. Tax-exempt income is calculated on a tax-equivalent basis, using a 21% Federal Income Tax rate. For the three months ended March 31, 2023 compared to 2022 Dollars in thousands Volume Rate Rate/Volume 1 Total Interest on earning assets Interest-bearing deposits $ (8) $ 273 $ (234) $ 31 Investment securities (73) 979 (16) 890 Loans held for sale (5) (5) 5 (5) Loans 2,720 4,134 674 7,528 Change in interest income 2,634 5,381 429 8,444 Interest expense Deposits 287 7,654 1,351 9,292 Other borrowings (56) 360 (70) 234 Change in interest expense 231 8,014 1,281 9,526 Change in net interest income $ 2,403 $ (2,633) $ (852) $ (1,082) 1 Represents the change attributable to a combination of change in rate and change in volume. 53 Average Daily Balance Sheets The following table shows the Company's average daily balance sheets for the three months ended March 31, 2023 and 2022. For the three months ended Dollars in thousands March 31, 2023 March 31, 2022 Assets Cash and cash equivalents $ 23,122 $ 22,285 Interest-bearing deposits in other banks 3,360 23,650 Securities available for sale (includes tax exempt securities of $36,636 and $34,879 at March 31, 2023 and 2022, respectively) 287,984 319,805 Securities to be held to maturity, net of allowance for credit losses of $438 at March 31, 2023 1 (included tax exempt securities of $257,279 and $250,145 at March 31, 2023 and 2022, respectively) 393,001 371,771 Restricted equity securities, at cost 4,451 5,385 Loans held for sale 28 1,140 Loans 1,948,353 1,675,245 Allowance for credit losses (17,026) (15,557) Net loans 1,931,327 1,659,688 Accrued interest receivable 11,812 8,857 Premises and equipment 28,204 28,948 Goodwill 30,646 30,646 Other assets 61,844 45,445 Total Assets $ 2,775,779 $ 2,517,620 Liabilities & Shareholders' Equity Demand deposits $ 300,948 $ 328,870 NOW deposits 606,145 657,007 Money market deposits 194,030 200,791 Savings deposits 359,361 366,628 Certificates of deposit 946,834 566,042 Total deposits 2,407,318 2,119,338 Borrowed funds – short term 109,209 80,722 Borrowed funds – long term 81 55,089 Dividends payable 876 782 Other liabilities 20,777 15,054 Total Liabilities 2,538,261 2,270,985 Shareholders' Equity: Common stock 111 110 Additional paid-in capital 68,573 66,959 Retained earnings 209,543 186,297 Net unrealized loss on securities available for sale (41,716) (6,749) Net unrealized loss on securities transferred from available for sale to held to maturity (62) (87) Net unrealized gain on cash flow hedging derivative instruments 796 — Net unrealized gain on postretirement benefit costs 273 105 Total Shareholders' Equity 237,518 246,635 Total Liabilities & Shareholders' Equity $ 2,775,779 $ 2,517,620 1 March 31, 2022 had no allowance for credit losses 54 Non-Interest Income Non-interest income of $3.6 million for the three months ended March 31, 2023 is a decrease of $663,000 compared to the same period in 2022. Revenue at First National Wealth Management decreased $51,000 or 4.3% over the same period, and debit card revenue was down $245,000 or 17.1%. Debit card interchange revenue has been reasonably steady, and revenue changes are mostly attributable to the timing of annual incentive payments. Mortgage banking revenue was down $306,000, or 61.4%; the decrease is attributable to a year-to-year decrease in mortgage refinance activity and marks against mortgage servicing rights. Non-Interest Expense Non-interest expense of $10.9 million for the three months ended March 31, 2023 is an increase of 1.9% or $200,000 compared to non-interest expense of $10.7 million for the same period in 2022. Salaries and employee benefits decreased $217,000 or 3.7%, while other operating expense increased $194,000 or 8.0%. Income Taxes Income taxes on operating earnings were $1.7 million for the three months ended March 31, 2023, down $374,000 from the same period in 2022. Investments The carrying value of the Company's investment portfolio increased by $1.7 million between December 31, 2022 and March 31, 2023. As of March 31, 2023, mortgage-backed securities had a carrying value of $290.6 million and a fair value of $280.2 million. Of this total, securities with a fair value of $82.1 million or 29.3% of the mortgage-backed portfolio were issued by the Government National Mortgage Association and securities with a fair value of $198.2 million or 70.7% 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 $60,000 at March 31, 2023. This compares to $64,000 and $78,000, net of taxes, at December 31, 2022 and March 31, 2022, respectively. These securities were transferred as a part of the Company's overall investment and balance sheet strategies. 55 The following table sets forth the Company's investment securities at their carrying amounts as of March 31, 2023 and 2022 and December 31, 2022. Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Securities available for sale U.S. Government-sponsored agencies $ 19,518 $ 19,147 $ 22,658 Mortgage-backed securities 231,091 228,676 252,184 State and political subdivisions 34,349 33,191 33,833 Asset-backed securities 3,284 3,495 4,340 $ 288,242 $ 284,509 $ 313,015 Securities to be held to maturity U.S. Government-sponsored agencies $ 40,100 $ 40,100 $ 38,100 Mortgage-backed securities 59,523 60,497 59,648 State and political subdivisions 257,910 258,549 252,185 Corporate securities 34,750 34,750 27,250 $ 392,283 $ 393,896 $ 377,183 Less allowance for credit losses (438) — — Net securities to be held to maturity $ 391,845 $ 393,896 $ 377,183 Restricted equity securities Federal Home Loan Bank Stock $ 2,837 $ 2,846 $ 4,365 Federal Reserve Bank Stock 1,037 1,037 1,037 $ 3,874 $ 3,883 $ 5,402 Total securities $ 683,961 $ 682,288 $ 695,600 The Company adopted ASC 326, the CECL standard in the current reporting period. In conjunction with adoption, holdings of AFS Securities and HTM securities were evaluated to determine the need to establish an allowance for credit losses, if any. The total ACL for HTM securities was $438,000 as of March 31, 2023; there was no reserve as of December 31, 2022 and March 31, 2022. Further details are included in Notes 2 and 16 of the accompanying financial statements. 56 The following table sets forth yields and contractual maturities of the Company's investment securities as of March 31, 2023. 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 2,832 1.83 % — 0.00 % Due in 5 to 10 years 7,967 1.17 % 13,500 1.80 % Due after 10 years 8,719 2.00 % 26,600 1.57 % Total 19,518 1.64 % 40,100 1.65 % Mortgage-Backed Securities Due in 1 year or less — 0.00 % 1 5.47 % Due in 1 to 5 years 223 2.67 % 5 8.24 % Due in 5 to 10 years 3,355 1.51 % 161 7.23 % Due after 10 years 227,513 2.24 % 59,356 1.78 % Total 231,091 2.23 % 59,523 1.80 % State & Political Subdivisions Due in 1 year or less — 0.00 % 1,788 3.97 % Due in 1 to 5 years 365 5.06 % 8,274 3.96 % Due in 5 to 10 years 4,673 2.49 % 48,818 3.52 % Due after 10 years 29,311 3.27 % 199,030 2.57 % Total 34,349 3.18 % 257,910 2.80 % 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 3,284 6.05 % — 0.00 % Total 3,284 6.05 % — 0.00 % Corporate Securities Due in 1 year or less — 0.00 % — 0.00 % Due in 1 to 5 years — 0.00 % 6,750 4.55 % Due in 5 to 10 years — 0.00 % 28,000 4.76 % Due after 10 years — 0.00 % — 0.00 % Total — 0.00 % 34,750 4.72 % $ 288,242 2.35 % $ 392,283 2.70 % Debt Securities in an Unrealized Loss Position The securities portfolio contains certain securities where the amortized cost of which exceeds fair value, which at March 31, 2023 amounted to $100.1 million, or 14.07% of the amortized cost of the total securities portfolio. At December 31, 2022, this amount was $111.7 million, or 15.65% of the amortized cost of total securities portfolio. 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 as a charge against the allowance for credit losses. The primary factors considered in evaluating whether a loss should be recognized 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 57 information and observable data considered relevant in determining whether full collection of amounts contractually due will be realized. 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, a charge against the allowance for credit losses 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 March 31, 2023, the Company had debt securities available-for-sale in an unrealized loss position with a fair value of $544.7 million and unrealized losses of $100.1 million, as identified in the table below. Securities in a continuous unrealized loss position more than twelve months amounted to $451.1 million as of March 31, 2023, compared with $310.2 million at December 31, 2022. The Company has concluded that these securities are fully collectible and that no charge against the allowance is required. 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 debt securities available-for-sale in an unrealized loss position for which an allowance for credit losses has not been recorded at March 31, 2023: 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 $ 1,998 $ (1) $ 47,521 $ (16,607) $ 49,519 $ (16,608) Mortgage-backed securities 32,434 (1,532) 240,750 (47,622) 273,184 (49,154) State and political subdivisions 47,700 (845) 148,282 (30,626) 195,982 (31,471) Asset-backed securities — — 3,284 (63) 3,284 (63) Corporate Securities 11,430 (1,570) 11,299 (1,201) 22,729 (2,771) $ 93,562 $ (3,948) $ 451,136 $ (96,119) $ 544,698 $ (100,067) For securities with unrealized losses, the following information was considered in determining that no charge against the allowance for decline in fair value was required in the current reporting period: Securities issued by U.S. Government-sponsored agencies and enterprises. As of March 31, 2023, there were $16.6 million unrealized losses on these securities compared to $17.4 million unrealized losses as of December 31, 2022. 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, and that 100% of the amounts contractually due will be collected. Mortgage-backed securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises. As of March 31, 2023, there were $49.2 million of unrealized losses on these securities compared with $53.8 million at December 31, 2022. 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 March 31, 2023 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and that 100% of the amounts contractually due will be realized. 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 March 31, 2023, there were $31.5 million of unrealized losses on these securities compared to $38.0 million at December 31, 2022. 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 March 31, 2023, all municipal bond issuers were current on contractually obligated interest and principal payments. The Company attributes the unrealized losses at March 31, 2023 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. The Company has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity, and believes that 100% of the amounts contractually due will be realized. 58 Asset-backed securities. As of March 31, 2023, there were $63,000 of unrealized losses on these securities compared to $53,000 at December 31, 2022. These securities consist of U.S Government backed student loans along with other credit enhancements. Management believes that the unrealized losses at March 31, 2023 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and that 100% of the amounts contractually due will be realized. Corporate securities. As of March 31, 2023, there were $2.8 million of unrealized losses on these securities compared to $2.5 million at December 31, 2022. Corporate securities are dependent on the operating performance of the issuers. At March 31, 2023, all corporate bond issuers were current on contractually obligated interest and principal payments. Management believes that the unrealized losses at March 31, 2023 were attributable to changes in current market yields and spreads since the date the underlying securities were purchased, and that 100% of the amounts contractually due will be realized. 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 March 31, 2023, the Bank's investment in FHLB stock totaled $2.8 million. This compares to $2.8 million as of December 31, 2022 and $4.4 million as of March 31, 2022. 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 March 31, 2023. 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 March 31, 2023, the Bank had no loans held for sale. This compares to $275,000 loans held for sale at December 31, 2022 and $400,000 loans held for sale at March 31, 2022. 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 Company provides loans to customers within our market area, the State of Maine, with very limited exposures outside of Maine. Loans are originated primarily via our network of branch offices, along with an online channel for residential mortgage loans. The loan portfolio increased during the first three months of 2023, with total loans at $1.98 billion at March 31, 2023, up $68.2 million or 3.6% from total loans of $1.91 billion at December 31, 2022. Commercial loans increased $50.6 million or 7.5% between December 31, 2022 and March 31, 2023, municipal loans increased $6.5 million or 16.1%, residential term loans increased $9.4 million, residential construction increased $2.8 million, and home equity lines of credit increased $447,000. Loans made under the U.S. Small Business Administration's PPP accounted for only $11,000 of commercial loans as of March 31, 2023. The loan portfolio is segmented into ten classes. Commercial loans comprise five of the classes: commercial real estate owner occupied, commercial real estate non-owner occupied, commercial construction, C&I and multifamily. Residential mortgage loans comprise two of the classes: residential real estate term and residential real estate construction. The remaining classes are municipal loans, home equity loans, and consumer loans. Further descriptions of each class, and the risk factors associated with each, are included in Note 4 of the accompanying financial statements. 59 The following table summarizes the loan portfolio, by class, at March 31, 2023 and 2022 and December 31, 2022. Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Commercial Real estate owner occupied $ 285,224 14.4 % $ 256,623 13.4 % $ 223,881 13.1 % Real estate non-owner occupied 384,457 19.4 % 363,660 19.0 % 292,727 17.2 % Construction 72,705 3.7 % 93,907 4.9 % 102,982 6.0 % C&I 339,688 17.1 % 319,359 16.7 % 267,666 15.7 % Multifamily 81,089 4.1 % 79,057 4.1 % 71,693 4.2 % Municipal 47,166 2.4 % 40,619 2.1 % 50,867 3.0 % Residential Term 606,849 30.5 % 597,404 31.2 % 556,681 32.6 % Construction 52,712 2.7 % 49,907 2.6 % 36,272 2.1 % Home Equity Revolving and term 93,522 4.7 % 93,075 4.9 % 82,502 4.8 % Consumer 19,435 1.0 % 21,063 1.1 % 22,077 1.3 % Total loans $ 1,982,847 100.0 % $ 1,914,674 100.0 % $ 1,707,348 100.0 % The following table sets forth certain information regarding the contractual maturities of the Bank's loan portfolio as of March 31, 2023. Dollars in thousands < 1 Year 1 - 5 Years 5 - 10 Years > 10 Years Total Commercial Real estate owner occupied $ 210 $ 12,297 $ 27,680 $ 245,037 $ 285,224 Real estate non-owner occupied — 16,866 50,856 316,735 384,457 Construction — 8,026 7,023 57,656 72,705 C&I 450 141,219 89,131 108,888 339,688 Multifamily — 1,078 410 79,601 81,089 Municipal 524 17,158 9,989 19,495 47,166 Residential Term — 6,323 39,306 561,220 606,849 Construction — 2,013 — 50,699 52,712 Home Equity Revolving and term 1,197 5,625 4,553 82,147 93,522 Consumer 5,167 7,332 2,847 4,089 19,435 Total loans $ 7,548 $ 217,937 $ 231,795 $ 1,525,567 $ 1,982,847 60 The following table provides a listing of loans by class, between variable and fixed rates as of March 31, 2023. Fixed-Rate Adjustable-Rate Total Dollars in thousands Amount % of total Amount % of total Amount % of total Commercial Real Estate Owner Occupied $ 17,249 0.9 % $ 267,975 13.5 % $ 285,224 14.4 % Real Estate Non-Owner Occupied 86,682 4.4 % 297,775 15.0 % 384,457 19.4 % Construction 23,077 1.2 % 49,628 2.5 % 72,705 3.7 % C&I 131,997 6.7 % 207,691 10.4 % 339,688 17.1 % Multifamily 726 0.0 % 80,363 4.1 % 81,089 4.1 % Municipal 46,905 2.4 % 261 0.0 % 47,166 2.4 % Residential Term 432,814 21.7 % 174,035 8.8 % 606,849 30.5 % Construction 38,790 2.0 % 13,922 0.7 % 52,712 2.7 % Home Equity Revolving and Term 9,160 0.5 % 84,362 4.2 % 93,522 4.7 % Consumer 13,307 0.7 % 6,128 0.3 % 19,435 1.0 % Total loans $ 800,707 40.5 % $ 1,182,140 59.5 % $ 1,982,847 100.0 % Loan Concentrations As of March 31, 2023 and 2022, the Bank had one concentration of loans that exceeded 10% of its total loan portfolio. Loans to hotels (except Casino hotels) and motels totaled $223.5 million, or 11.27% of total loans and $206.7 million, or 10.79% of total loans, respectfully. Credit Risk Management and Allowance for Credit Losses on Loans Upon adoption of the CECL standard, in the first quarter of 2023, the Company replaced the incurred loss model that recognized loan losses when it became probable that a credit loss would be incurred, with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The ACL is a valuation amount that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. The ACL consists of three elements: (1) specific reserves for loans individually analyzed; (2) general reserves for each portfolio segment; and, (3) qualitative reserves. All outstanding loans are considered in evaluating the appropriateness of the allowance with similar risk characteristics in the portfolio. Prior to adoption of ASC 326, under the incurred loss methodology, the Company evaluated portfolio risk characteristics largely on loan purpose. The Company provides for loan losses through the allowance for credit losses which represents an estimated reserve for losses in the loan portfolio. To determine an appropriate level for general reserves, a discounted cash flow approach is applied to each portfolio segment implementing a probability of default and loss given default estimate based upon a number of factors including historical losses over an economic cycle, economic forecasts, loan prepayment speeds and curtailment rates. To determine an appropriate level for qualitative reserves various factors are considered including underwriting policies, credit administration practices, experience, ability and depth of lending management, and economic factors not captured in the general reserve calculation. Adoption of ASC 326 added $6.2 million to the ACL on loans, recorded as a charge to retained earnings. The allowance for credit 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. The adequacy of the ACL is overseen by the ACL Committee whose membership includes senior level personnel from the Executive, Lending, Credit Administration, and Finance functions of the Bank. 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. 61 The allowance for credit losses includes reserve amounts assigned to individually analyzed loans. This includes loans that had been reported as TDR loans prior to adoption of ASU 2022-02 and loans placed on non-accrual. A specific reserve is allocated to an individual loan when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. At March 31, 2023, individually analyzed loans with specific reserves totaled $2.0 million and the amount of such reserves was $388,000. This compares to individually analyzed loans with specific reserves of $1.8 million at December 31, 2022 and the amount of such reserves was $398,000. Additional detail on individually analyzed loans may be found in Note 3 of the financial statements. The total ACL on loans at March 31, 2023 is considered by Management to be appropriate to address the credit losses inherent in the loan portfolio at that date. However, determination of the appropriate allowance level is based upon a number of assumptions made about future events, which we believe are reasonable, but which may or may not prove valid. Thus, there can be no assurance charge-offs in future periods will not exceed the ACL or that additional increases in the ACL will not be necessary. The following table summarizes the allocation of allowance by loan class as of March 31, 2023 and 2022 and December 31, 2022. The percentages are the portion of each loan class to total loans. Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Commercial Real estate owner occupied $ 4,470 14.4 % $ 6,116 36.5 % $ 5,369 34.5 % Real estate non-owner occupied 4,422 19.4 % — — % $ — — % Construction 1,784 3.7 % 821 4.9 % $ 939 6.0 % C&I 4,838 17.1 % 3,097 16.7 % $ 2,956 15.7 % Multifamily 1,206 4.1 % — — % $ — — % Municipal 307 2.4 % 162 2.1 % $ 156 3.0 % Residential Term 4,608 30.5 % 2,559 32.1 % $ 2,648 33.1 % Construction 949 2.7 % 199 2.6 % $ 161 2.1 % Home Equity Revolving and term 603 4.7 % 1,029 4.0 % $ 939 4.3 % Consumer 271 1.0 % 1,062 1.1 % $ 866 1.3 % Unallocated — — % 1,678 — % $ 1,732 — % Total $ 23,458 100.0 % $ 16,723 100.0 % $ 15,766 100.0 % The ACL totaled $23.5 million at March 31, 2023, compared to $16.7 million as of December 31, 2022 and $15.8 million as of March 31, 2022. The increase in the total allowance from December 31, 2022 to March 31, 2023 is attributable to the adoption of CECL. 62 A breakdown of the ACL on loans as of March 31, 2023, by loan class and allowance element, is presented in the following table: Dollars in thousands Specific Reserves on Loans Evaluated Individually General Reserves on Loans Based on Historical Loss Experience Reserves for Qualitative Factors Total Reserves Commercial Real estate owner occupied $ — $ 3,792 $ 678 $ 4,470 Real estate non-owner occupied — 3,914 508 4,422 Construction — 1,729 55 1,784 C&I 291 3,937 610 4,838 Multifamily — 1,146 60 1,206 Municipal — 272 35 307 Residential Term 94 3,786 728 4,608 Construction — 939 10 949 Home Equity Revolving and term 3 457 143 603 Consumer — 244 27 271 $ 388 $ 20,216 $ 2,854 $ 23,458 Based upon Management's evaluation, provisions are made to maintain the allowance as a best estimate of expected losses within the portfolio. The provision for credit losses to maintain the allowance was $550,000 for the first three months of 2023 and $450,000 the first three months of 2022. Net charge-offs were $25,000 in the first three months of 2023, down from $205,000 in the first three months of 2022. Our ACL as a percentage of outstanding loans was 1.18% as of March 31, 2023, up from 0.87% as of December 31, 2022, and up from 0.92% as of March 31, 2022. 63 The following table summarizes the activities in our allowance for credit losses for the three months ended March 31, 2023 and 2022 and for the year ended December 31, 2022: Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Balance at the beginning of period $ 16,723 $ 15,521 $ 15,521 Loans charged off: Commercial Real estate owner occupied 39 — — Real estate non-owner occupied — — — Construction — — — C&I — 309 1 Multifamily — — Municipal — — — Residential Term — 8 — Construction — — — Home Equity Revolving and term — 29 29 Consumer 37 412 217 Total 76 758 247 Recoveries on loans previously charged off Commercial Real estate owner occupied — 20 16 Real estate non-owner occupied — — — Construction — — — C&I 2 13 1 Multifamily — — Municipal — — — Residential Term 2 29 8 Construction — — — Home Equity Revolving and term 4 4 1 Consumer 43 144 16 Total 51 210 42 Net loans charged off 25 548 205 Provision for credit losses 550 1,750 450 Adoption of ASU No. 2016-13 $ 6,210 $ — $ — Balance at end of period $ 23,458 $ 16,723 $ 15,766 Ratio of net loans charged off to average loans outstanding 1 0.01 % 0.03 % 0.05 % Ratio of allowance for credit losses to total loans outstanding 1.18 % 0.87 % 0.92 % 1 Annualized using a 365-day basis for both 2023 and 2022. 64 ACL for Unfunded Commitments Adoption of CECL resulted in an increase in the Company's ACL for unfunded commitments. Our modeling methodology applies the same class level credit loss factors used in the ACL on loans model to applicable classes of unfunded commitments to determine an appropriate ACL level. Utilization assumptions are based upon an independent analysis of the Bank's historical data. The ACL for unfunded commitments is reported on the Company's balance within other liabilities and totaled $1.4 million as of March 31, 2023. 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. 65 Nonperforming loans, expressed as a percentage of total loans, totaled 0.09% at March 31, 2023 and December 31, 2022 compared to 0.30% at March 31, 2022. The following table shows the distribution of nonperforming loans by class as of March 31, 2023 and 2022 and December 31, 2022: Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Commercial Real estate owner occupied $ 152 $ 193 $ 604 Real estate non-owner occupied — — 27 Construction 23 23 — C&I 648 663 1,014 Multifamily — — — Municipal — — — Residential Term 443 572 3,113 Construction — — — Home Equity Revolving and term 534 304 291 Consumer — — — Total nonperforming loans $ 1,800 $ 1,755 $ 5,049 Allowance for credit losses as a percentage of nonperforming loans 1303.2 % 952.9 % 312.3 % 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 March 31, 2023, there were loans totaling $208,000 that were 90 or more days past due and still accruing interest compared to $241,000 at December 31, 2022 and $46,000 at March 31, 2022. Loan Modifications Made to Borrowers Experiencing Financial Difficulty The Company adopted ASU 2022-02 effective January 1, 2023. Reporting of loan modifications subject to ASU 2022-02 may be found in Note 3 of the financial statements. Troubled Debt Restructured Prior to adoption of ASU 2022-02 the Company evaluated loan modifications and other transactions to determine if classification as a TDR was necessary. A TDR constituted a restructuring of debt if the Company, for economic or legal reasons related to the borrower's financial difficulties, granted a concession to the borrower that it would not otherwise consider. To determine whether or not a loan was to be classified as a TDR, Management evaluated 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. The following table shows the activity in loans previously classified as TDRs between December 31, 2022 and March 31, 2023: Balance in Thousands of Dollars Number of Loans Aggregate Balance Total at December 31, 2022 29 $ 4,744 Loans paid off in 2023 (1) (661) Repayments in 2023 — (44) Total at March 31, 2023 28 $ 4,039 66 As of March 31, 2023, 23 loans with an aggregate balance of $3.7 million were performing under the modified terms, five loans with an aggregate balance of $334,000 were on nonaccrual and no loans were more than 30 days past due and accruing.As a percentage of aggregate outstanding balance, 91.73% were performing under the modified terms, 8.27% were on nonaccrual and 0.00% were past due and still accruing. The performance status of all loans previously classified as TDRs, as of March 31, 2023, 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 $ 1,031 $ — $ — $ 1,031 Construction — — — — Other 176 — 175 351 Municipal — — — — Residential Term 2,498 — 159 2,657 Construction — — — — Home equity line of credit — — — — Consumer — — — — $ 3,705 $ — $ 334 $ 4,039 Percent of balance 91.7 % — % 8.3 % 100.0 % Number of loans 23 — 5 28 Residential TDRs as of March 31, 2023 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 $1.0 million 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. Short-term rate concessions were granted on loans totaling $220,000. Loans with an aggregate balance of $521,000 were involved in bankruptcy. Certain residential TDRs had more than one modification. Commercial TDRs as of March 31, 2023 were comprised of eight loans with a balance of $1.4 million. Of this total, three loans with an aggregate balance of $929,000 had an extended period of interest-only payments, deferring the start of principal repayment. One loan with an aggregate balance of $46,000 had a deferral of payment. The remaining four loans with an aggregate balance of $406,000 had several different modifications. As of March 31, 2023, Management is aware of four loans previously classified as TDRs that are involved in bankruptcy proceedings with an aggregate outstanding balance of $545,000. There were also five loans with an outstanding balance of $334,000 that were previously classified as TDRs and on non-accrual status, of which no loans were in the process of foreclosure. 67 Past Due Loans The Bank's overall loan delinquency ratio was 0.10% at March 31, 2023 compared to 0.08% at December 31, 2022 and 0.25% at March 31, 2022. Loans 90 days delinquent and accruing decreased from $241,000 at December 31, 2022 to $208,000 as of March 31, 2023. The following table sets forth loan delinquencies as of March 31, 2023 and 2022 and December 31, 2022: Dollars in thousands March 31, 2023 December 31, 2022 March 31, 2022 Commercial Real estate owner occupied $ 152 $ 193 $ 563 Real estate non-owner occupied — — — Construction — — 12 C&I 300 226 269 Multifamily — — — Municipal — — — Residential Term 806 452 2,431 Construction — — — Home Equity Revolving and term 568 421 827 Consumer 120 167 136 Total $ 1,946 $ 1,459 $ 4,238 Loans 30-89 days past due to total loans 0.06 % 0.04 % 0.14 % Loans 90+ days past due and accruing to total loans 0.01 % 0.01 % 0.00 % Loans 90+ days past due on non-accrual to total loans 0.03 % 0.02 % 0.11 % Total past due loans to total loans 0.10 % 0.08 % 0.25 % 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 March 31, 2023, there was one potential problem loan with a balance of $12,000 or 0.001% of total loans. At December 31, 2022, there were no potential problem loans. As of March 31, 2023, there were two residential loans in the process of foreclosure with a total balance of $166,000. 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. As of March 31, 2023, there was one commercial loan in the process of foreclosure with a balance of $151,000. 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 68 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. 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 March 31, 2023, 2022 and December 31, 2022 there were no OREO properties owned and no allowance for OREO losses. Liquidity Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Bank's lead source of liquidity is deposits, including brokered deposits, which funded 86.7% of total average assets in the first three months of 2023, up from 84.2% a year ago. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term or overnight advances, and other borrowings), cash flows from the securities portfolio 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. While the generally preferred funding strategy is to attract and retain low cost deposits, our ability to do so is affected by competitive interest rates and terms in the marketplace. The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for prompt and comprehensive responses 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 amongst several major categories: runoff of in-market deposit balances, an inability to renew wholesale sources of funding, and materially increased utilization of available credit lines by borrowers. Of these, 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 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. Stress testing analysis of liquidity resources under various scenarios is conducted no less than quarterly and results are reported to the Bank's Asset/Liability Committee ("ALCO"). Borrowings supplement deposits as a source of liquidity; our borrowings typically consist of customer repurchase agreements and FHLB advances. The Bank tests its borrowing capacity with the Federal Reserve Bank of Boston, the FHLB and Fed Funds lines with other correspondent no less than annually. The Company defines its primary sources of contingent liquidity as cash & equivalents, unencumbered US Government or Agency bond collateral, available capacity at FHLB, and available authorized brokered deposit issuance capacity. As of March 31, 2023, the Bank had primary sources of contingent liquidity of $830.0 million or 29.9% of its total assets. It is Management's opinion that this is an appropriate level. In addition, the Bank has $180.0 in borrowing capacity under the Federal Reserve Borrower in Custody program, $51.0 million in credit lines with correspondent banks, and $177.0 million in other unencumbered securities available as collateral for borrowing. These bring the Bank's total sources of liquidity to $1.238 billion or 44.5% of its total assets. The Bank established borrowing capacity of an additional $47 million at the FRB of Boston under the Bank Term Funding Program ("BTFP") introduced in March 2023, which is included in the primary sources of contingent liquidity total above. To date, no advances have been made under BTFP. The 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. The Company is dependent upon the payment of cash dividends by the Bank to service its commitments. As the sole shareholder of the Bank, the Company is entitled to such dividends when and as declared by the Bank's Board of Directors from legally available funds. For the periods ended March 31, 2023, 2022 and December 31, 2022 the Bank declared dividends to the Company of $3.6 million, $3.4 million, and $3.4 million, respectively. The Bank's regulator, the OCC, may limit the amount of dividends declared and paid in a calendar year based upon certain factors. Further discussion may be found Shareholder's Equity below. Deposits During the first three months of 2023, total deposits increased by $87.8 million or 3.7% from December 31, 2022 levels. Low-cost deposits (demand, NOW, and savings accounts) decreased by $55.7 million or 4.2% in the first three months of 2023, money market deposits increased $1.6 million or 0.8%, and certificates of deposit increased $142.0 million or 16.4%. 69 Between March 31, 2022 and March 31, 2023, total deposits increased by $308.2 million or 14.3%. Low-cost deposits decreased by $88.6 million or 6.6%, money market accounts decreased $3.0 million or 1.5%, and certificates of deposit increased $399.7 million or 65.5%. Estimated uninsured deposits totaled $404.5 million or 16.4% of total deposits as of March 31, 2023, and $451.6 million or 19.0% of total deposits of December 31, 2022. The company has pledged assets as collateral covering certain deposits; these amounts were $324.7 million and $350.4 million as of March 31, 2023 and December 31, 2022, 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 three months ended March 31, 2023, borrowed funds decreased $19.6 million or 18.9% from December 31, 2022, primarily in customer repurchase agreements. Between March 31, 2022 and March 31, 2023, borrowed funds decreased by $49.8 million or 37.3%; the reduction was a combination of repayment of FHLB borrowings and lower balances in customer repurchase agreements. Capital Resources Shareholders' equity as of March 31, 2023 was $228.5 million, compared to $228.9 million as of December 31, 2022 and $233.6 million as of March 31, 2022. The Company's earnings in the first three months of 2023, net of dividends declared, added $4.2 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 $40.5 million as of March 31, 2023 and was $44.7 million as of December 31, 2022. 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 Debit Securities section of Management's Discussion and Analysis of Financial Condition and Results of Operations. A cash dividend of $0.34 per share was declared in the first quarter of 2023. The dividend payout ratio, which is calculated by dividing dividends declared per share by basic earnings per share, was 46.58% for the first three months of 2023 compared to 35.96% for the same period in 2022. 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 2023 is this year's net income plus $49.6 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 March 31, 2023. The following tables indicate the capital ratios for the Bank and the Company at March 31, 2023 and December 31, 2022. As of March 31, 2023 Leverage Common Equity Tier 1 Tier 1 Total Risk-Based Bank 8.58 % 12.38 % 12.38 % 13.64 % Company 8.75 % 12.43 % 12.43 % 13.72 % Adequately capitalized ratio 4.00 % 4.50 % 6.00 % 8.00 % Adequately capitalized ratio plus capital conservation buffer n/a % 7.00 % 8.50 % 10.50 % Well capitalized ratio (Bank only) 5.00 % 6.50 % 8.00 % 10.00 % 70 As of December 31, 2022 Leverage Common Equity Tier 1 Tier 1 Total Risk-Based Bank 8.81 % 12.64 % 12.64 % 13.52 % Company 9.01 % 12.70 % 12.70 % 13.58 % Adequately capitalized ratio 4.00 % 4.50 % 6.00 % 8.00 % Adequately capitalized ratio plus capital conservation buffer n/a % 7.00 % 8.50 % 10.50 % Well capitalized ratio (Bank only) 5.00 % 6.50 % 8.00 % 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 Credit Exposures 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. At March 31, 2023, the Bank had four outstanding off-balance sheet, derivative instruments, designated as cash flow hedges and three off-balance sheet, derivative instruments, designated as asset hedges. These derivative instruments were interest rate swap agreements, with notional principal amounts totaling $105.0 million and $100.0 million, respectively, and an unrealized loss of $2.2 million, 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 March 31, 2023, 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 March 31, 2023, the Bank had six loan swap agreements in place with a total notional value of $74.3 million. 71 Contractual Obligations The following table sets forth the contractual obligations of the Company as of March 31, 2023: Dollars in thousands Total Less than 1 year 1-3 years 3-5 years More than 5 years Borrowed funds $ 83,881 $ 83,800 $ 81 $ — $ — Operating leases 835 114 195 102 424 Certificates of deposit 1,009,667 636,793 287,367 85,507 — Total $ 1,094,383 $ 720,707 $ 287,643 $ 85,609 $ 424 Total loan commitments and unused lines of credit $ 337,239 $ 337,239 $ — $ — $ — 72