UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

Commission File Number: 001-13349

BAR HARBOR BANKSHARES

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

          Title of class                                                Name of exchange on which registered        

  Common Stock, $2.00 par value per share

     NYSE MKT, LLC

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: YES ¨ NO þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act: YES ¨ NO þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES þ NO ¨

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act: Large accelerated filer ¨ Accelerated filer þ Non-accelerated filer (do not check if a smaller reporting company) ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES ¨ NO þ

The aggregate market value of the common stock held by non-affiliates of Bar Harbor Bankshares was $208,645,716 based on the closing sale price of the common stock on the NYSE MKT on June 30, 2016, the last trading day of the registrant’s most recently completed second quarter.

Number of shares of Common Stock par value $2.00 outstanding as of March 10, 2017:  10,256,441

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 16, 2017 are incorporated by reference into Part III, Items 10-14 of this Annual Report on Form 10-K.

FORWARD-LOOKING STATEMENTS DISCLAIMER

Certain statements, as well as certain other discussions contained in this Annual Report on Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operations, financial condition, and the business of Bar Harbor Bankshares (the “Company”) which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

(i)		The Company's success is dependent to a significant extent upon general economic conditions in our market areas in Maine, New Hampshire and Vermont and the ability to attract new business, as well as factors that affect tourism, a major source of economic activity in the Company’s market areas;
(ii)		The Company's earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Company’s wholly-owned banking subsidiary, Bar Harbor Bank & Trust (the “Bank”), and thus the Company’s results of operations may be adversely affected by increases or decreases in interest rates;
(iii)		The banking business is highly competitive and the profitability of the Company depends on the Bank's ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and non-traditional institutions, such as credit unions and finance companies;
(iv)		A significant portion of the Bank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;
(v)		Adverse changes in repayment performance and fair value of underlying residential mortgage loan collateral, that differ from the Company’s current estimates, could change the Company’s expectations that it will recover the amortized cost of its private label mortgage backed securities portfolio and/or its conclusion that such securities were not other-than temporarily impaired as of the date of this report;
(vi)		The Company’s allowance for loan losses may be adversely impacted by a variety of factors, including, but not limited to, the performance of the Company’s loan portfolio, the economy, changes in interest rates, and the view of regulatory authorities toward loan classifications;

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(vii)		Significant changes in the Company’s internal controls, or internal control failures;
(viii)		Acts or threats of terrorism and actions taken by the United States or other governments as a result of such threats, including military action and cyber security, could further adversely affect business and economic conditions in the United States generally and in the Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s common stock;
(ix)		Significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company's business environment or affect its operations;
(x)		Changes in general, national, international, regional or local economic conditions and credit markets which are less favorable than those anticipated by Company management that could impact the Company's securities portfolio, quality of credits, or the overall demand for the Company's products or services;
(xi)		The integrity of information systems are under significant threat from cyber-attacks by third parties, including thorough coordinated attacks sponsored by foreign nations and criminal organizations to disrupt business operations and other compromises to data and systems for political or criminal purposes; and
(xii)		The Company’s success in managing the risks involved in all of the foregoing matters.

Readers  should carefully review all of these factors as well as the risk factors set forth in Item 1A, Risk Factors of this Annual Report on Form 10-K. There may be other risk factors that could cause differences from those anticipated by management.

When we say “we,” “us,” “our,” or the “Company,” we mean the Company on a consolidated basis with the Bank and Trust Services.

The forward-looking statements contained herein represent the Company's judgment as of the date of this Annual Report on Form 10-K, and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the succeeding discussion, or elsewhere in this Annual Report on Form 10-K, except to the extent required by federal securities laws.

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TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

Organization

Bar Harbor Bankshares (the “Company”) (“BHB”) was incorporated under the laws of the state of Maine on January 19, 1984. At December 31, 2016, the Company had total consolidated assets of $1.76 billion and total shareholders’ equity of $156.7 million.

The Company has one, wholly-owned first tier operating subsidiary, Bar Harbor Bank & Trust (the “Bank”), a community bank, which offers a wide range of deposit, loan, and related banking products, as well as brokerage services provided through a third-party brokerage arrangement. In addition, the Company offers trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services (“Trust Services”), a Maine chartered non-depository trust company. These products and services are offered to individuals, businesses, not-for-profit organizations and municipalities.

The Company is a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the state of Maine, and as such is subject to the jurisdiction of the Superintendent (the “Superintendent”) of the Maine Bureau of Financial Institutions (“BFI”).

Recent Acquisition

On January 13, 2017, the Company completed the previously announced acquisition of Lake Sunapee Bank Group (“LSBG”). In connection with the acquisition, Lake Sunapee Bank, a wholly owned subsidiary of LSBG, merged with and into the Bank, with the Bank continuing as the surviving entity.  

Bar Harbor Bank & Trust

The Bank, originally founded in 1887, is a Maine financial institution, and its deposits are insured by the Deposit Insurance Fund (the “DIF”) of the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum extent permitted by law. The Bank is subject to the supervision, regulation, and examination of the FDIC and the BFI. It is not a member of the Federal Reserve System.

As of December 31, 2016, the Bank had 14 branch offices located throughout downeast, midcoast and central Maine, including its principal office located at 82 Main Street, Bar Harbor. The Bank’s branch offices are located in Hancock, Washington, Knox, Kennebec, and Sagadahoc Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Blue Hill, Deer Isle, Ellsworth, Northeast Harbor, Somesville, Southwest Harbor, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Knox, Kennebec and Sagadahoc County offices are located in Rockland, South China, and Topsham. The Bank delivers its operations and technology support services from its operations centers located in Ellsworth and Hampden, Maine.  Following the completion of the acquisition of LSBG, the Bank has 35 additional branch offices located throughout New Hampshire and central Vermont.

The Bank is a retail bank serving individual and business customers, retail establishments and restaurants, seasonal lodging, biological research laboratories, and a large contingent of retirees. With significant operations in coastal Maine, it serves the tourism, hospitality, lobstering, fishing, boat building and marine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. The Bank operates in a competitive market that includes other community banks, savings institutions, credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area.

The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a material adverse effect on its business. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and autumn. These seasonal swings have been fairly predictable and have historically not had a materially adverse impact on the Bank or its liquidity position. Approximately 90.6% of the Bank’s

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deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on all of the deposit account products it offers and does not anticipate any material loss of these deposits.

The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses to which the Bank offers a wide variety of products and services.

Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include checking accounts, interest bearing NOW accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, Health Savings Accounts, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, credit cards, installment loans, and overdraft protection services. The Bank provides secured and unsecured installment loans for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rentals, wire transfers, check collection services, foreign currency exchange, money orders, and U.S. Savings Bonds redemptions.

The Bank staffs a call center, providing customers with telephone and e-mail responses to their questions and needs. The Bank also offers free banking-by-mail services.

Retail Brokerage Services: The Bank retains Infinex Investments, Inc., (“Infinex”) as a full service third-party broker-dealer, conducting business under the assumed business name “Bar Harbor Financial Services.”  Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other government agency, are not guaranteed by the Bank or any affiliate, and may be subject to investment risk, including possible loss of value.

Bar Harbor Financial Services principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. Infinex was formed by a group of member banks, and is one of the largest providers of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.

Electronic Banking Services: The Bank continues to offer free Internet banking services, including consumer remote deposit capture, e-statements, free check images, and electronic bill payment, through its dedicated website at www.bhbt.com. Additionally, the Bank offers telephone banking, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Customers can also monitor their accounts with free mobile banking access via text messaging, browser or “Apps”, and they can receive alerts, view accounts, transfer funds and pay bills. The Bank also offers Popmoney®, an innovative personal payment service that eliminates the need for checks and cash by allowing customers to send and receive money as easily as they send and receive e-mail and text messages.

The Bank has 54 Automated Teller Machines (ATMs) are located throughout downeast, midcoast and central, Maine, as well as south, central and western New Hampshire and Central Vermont. The Bank is also a member of Maine Cash Access, providing customers with surcharge-free access to over 225 ATMs throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.

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Commercial Products and Services:  The Bank serves the small business market throughout downeast, midcoast and central Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate and equipment financing, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and sole proprietors in the tourism, hospitality, healthcare, blueberry, boatbuilding, biological research, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities.

The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. The Bank also offers Business On-Line Direct (“BOLD”) an Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, and transmit Automated Clearing House (ACH) files. The Bank also offers remote deposit capture, enabling its business customers to deposit checks remotely. Other commercial banking services include merchant credit card processing provided through a third party vendor, night depository, and coin and currency handling.

Bar Harbor Trust Services

Trust Services is a Maine chartered non-depository trust company and a wholly-owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities.

Trust Services serves as trustee of both living trusts and trusts under wills, including revocable, irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Trust Services offers custody, estate settlement, and fiduciary tax services.

The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2016, Trust Services served 702 client accounts, with assets under management and assets held in custody amounting to $402.8 million and $21.9 million, respectively.

Market Competition

Maine

The Company competes principally in downeast, midcoast and central Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be Hancock, Knox, Washington, Kennebec and Sagadahoc counties, each in the state of Maine. According to the 2015 Census Bureau Report estimate, the population of these five counties was 54,659, 39,855, 31,625, 119,980 and 35,149, respectively, representing a combined population of approximately 281,268. The economies in these counties are based primarily on tourism, healthcare, fishing and lobstering, agriculture, state government, and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions, savings and loan institutions, mortgage companies, and credit unions. Other competitors in the Company’s primary market area include financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.

New Hampshire and Vermont

With the acquisition of Lake Sunapee Bank Group, our market area now extends into certain regions of New Hampshire and Vermont.  The New Hampshire market extends from the southern New Hampshire/Massachusetts border-city of Nashua to the north through central and western New Hampshire and central Vermont. It is concentrated in the counties of Hillsborough, Grafton, Merrimack, Sullivan and Cheshire in south, central and western New Hampshire, and the counties of Rutland, Windsor and Orange in central Vermont.

There are several distinct regions within our market area. The first region is centered in Nashua, New Hampshire, the second largest city in the three northern New England states of New Hampshire, Maine and Vermont. Nashua’s downtown is a regional commercial, entertainment and dining destination. The city, bordering Massachusetts to the south, enjoys a vibrant high-tech industry and a robust retail industry due in part to New Hampshire’s absence of a sales tax. The Upper Valley region is located in the west-central area of New Hampshire, and includes the towns of Lebanon, a commerce and manufacturing center, home to Dartmouth-Hitchcock Medical Center, New Hampshire’s only academic medical center, and Hanover, home of Dartmouth College. The Lake Sunapee region is a popular year-round recreation and resort area that includes both Lake Sunapee and Mount Sunapee.

The Monadnock region, in southwestern New Hampshire, is named after Mount Monadnock, the major geographic landmark in the region, and consists of Cheshire, southern Sullivan and western Hillsborough counties. Rutland, Windsor and Orange counties are located in central Vermont. This region is home to many attractions, including Killington Mountain, Okemo Resort, and the city of Rutland. Popular vacation destinations in this region include Woodstock, Brandon, Ludlow and Quechee.

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Like most financial institutions in the United States, the Company competes with an ever-increasing array of financial service providers. As the national economy moves further towards a concentration of service companies, competitive pressures will mount.

The Company has generally been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers; however, no assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future.

No part of the Company’s business is materially dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.

Management and Employees

The Company has two principal executive officers: Curtis C. Simard, President and Chief Executive Officer, and Josephine Iannelli, Executive Vice President, Chief Financial Officer and Treasurer.

 

For the quarter ended December 31, 2016, the Bank employed 172 full-time equivalent employees, Trust Services employed 11 full-time equivalent employees, and the Company employed 3 full-time equivalent employees, representing a full-time equivalent complement of 186 employees of the Company. None of the employees are represented by collective bargaining agreements.

The Company’s management believes employee relations are good.

Supervision and Regulation

General

Banking is a complex, highly regulated industry. Consequently, the performance of the Company and the Bank can be affected not only by management decisions and general and local economic conditions, but also by the statutes enacted by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Federal Reserve Board, the Maine Bureau of Financial Institutions ("BFI"), the Internal Revenue Service, the Consumer Financial Protection Bureau (the “CFPB”) and state taxing authorities. The effect of these statutes, regulations and policies and any changes to any of them can be significant and cannot be predicted.

 

The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, the U.S. Congress and the State of Maine have created several largely autonomous regulatory agencies that oversee, and have enacted numerous laws that govern banks, bank holding companies and the banking industry. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for the entities’ respective operations and is intended primarily for the protection of the Bank’s depositors and the public, rather than the stockholders and creditors. The following summarizes some of the materially relevant laws, rules and regulations governing banks and bank holding companies, including the Company and the Bank, but does not purport to be a complete summary of all applicable laws, rules and regulations governing banks and bank holding companies or the Company or the Bank. The descriptions are qualified in their entirety by reference to the specific statutes, regulations and policies discussed. Any change in applicable laws, regulations or regulatory policies may have a material effect on our businesses, operations and prospects. We are unable to predict the nature or extent of the

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effects that economic controls or new federal or state legislation may have on our business and earnings in the future.

Regulatory Agencies

 

Bar Harbor Bankshares is a legal entity separate and distinct from its first tier bank subsidiary, Bar Harbor Bank & Trust and its second tier subsidiary, Bar Harbor Trust Services. As a bank holding company, the Company is regulated under the Bank Holding Company Act (“BHC”) and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System, or the Federal Reserve Board. The Company is also under the jurisdiction of the SEC and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (“Exchange Act”). The Company’s common stock is listed on The NYSE MKT (“NYSE”) under the trading symbol “BHB,” and is subject to the rules of NYSE for listed companies.

 

As a Maine chartered financial institution, Bar Harbor Bank & Trust is subject to supervision, periodic examination, and regulation by the BFI as its chartering authority and the FDIC as its primary federal regulator. The prior approval of the Bureau and the FDIC is required, among other things, for the Bank to establish or relocate an additional branch office, assume deposits, or engage in any merger, consolidation, purchase or sale of all or substantially all of the assets of any bank.

 

Bank Holding Company Regulations Applicable to the Company

 

The BHC Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

Permitted Activities: Generally, bank holding companies are prohibited under the BHC Act from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in any activity other than (i) banking or managing or controlling banks or (ii) an activity that the Federal Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking. The Federal Reserve Board has the authority to require a bank holding company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries.

 

A bank holding company that qualifies and elects to become a financial holding company is permitted to engage in additional activities that are financial in nature or incidental or complementary to financial activity. We currently have no plans to make a financial holding company election.

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Sound Banking Practices: Bank holding companies and their non-banking subsidiaries are prohibited from engaging in activities that represent unsafe and unsound banking practices. For example, under certain circumstances the Federal Reserve Board’s Regulation Y requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate a regulation. As another example, a holding company is prohibited from impairing its subsidiary bank’s soundness by causing the bank to make funds available to non-banking subsidiaries or their customers if the Federal Reserve Board believes it not prudent to do so. The Federal Reserve Board has the power to assess civil money penalties for knowing or reckless violations, if the activities leading to a violation caused a substantial loss to a depository institution. Potential penalties are as high as $1,000,000 for each day the activity continues.

 

Source of Strength: In accordance with Federal Reserve Board policy, the holding company is expected to act as a source of financial and managerial strength to the Bank. Section 616 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) codifies the requirement that bank holding companies serve as a source of financial strength to their subsidiary depository institutions.   Under this policy, the holding company is expected to commit resources to support its bank subsidiary, including at times when the holding company may not be in a financial position to provide it. As discussed below, the holding company could be required to guarantee the capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations. Any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. The BHC Act provides that, in the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Regulatory agencies have promulgated regulations to increase the capital requirements for bank holding companies to a level that matches those of banking institutions. See Capital Adequacy and Prompt Corrective Action.

 

Anti-tying Restrictions: Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Mergers & Acquisitions: The BHC Act, the Bank Merger Act, the laws of the State of Maine applicable to financial institutions and other federal and state statutes regulate acquisitions of banks and their holding companies. The BHC Act generally limits acquisitions by bank holding companies to banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring more than 5% of the voting stock of any bank or other bank holding company, (ii) acquiring all or substantially all of the assets of any bank or bank holding company, or (iii) merging or consolidating with any other bank holding company.

 

In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities generally consider, among other things, the competitive effect and public benefits of the transactions, the financial and managerial resources and future prospects of the combined organization (including the capital position of the combined organization), the applicant’s performance record under the Community Reinvestment Act (see the section captioned “Community Reinvestment Act” included elsewhere in this item), fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

Dividends:  Dividends from the Bank are the Company's principal source of cash revenues. Our earnings and activities are affected by legislation, by regulations and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which we conduct business. These include limitations on the ability of the Bank to pay dividends to the holding company and our ability to pay dividends to our

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stockholders. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiary. Consistent with such policy, a banking organization should have comprehensive policies on dividend payments that clearly articulate the organization’s objectives and approaches for maintaining a strong capital position and achieving the objectives of the policy statement.

The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Maine law requires the approval of the Bureau for any dividend that would reduce a bank's capital below prescribed limits.

 

Annual Reporting; Examinations: The Company is required to file an annual report with the Federal Reserve Board, and such additional information as the Federal Reserve Board may require. The Federal Reserve Board may examine a bank holding company and any of its subsidiaries, and charge the company for the cost of such an examination.

 

Imposition of Liability for Undercapitalized Subsidiaries: Pursuant to Section 38 of the Federal Deposit Insurance Act (“FDIA”) federal banking agencies are required to take “prompt corrective action”  (“PCA”) should an insured depository institution fail to meet certain capital adequacy standards. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the holding company has control of the Bank. Under FDIA, the aggregate liability of all companies controlling a particular institution is limited to the lesser of five percent of the depository institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically”  undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed distributions, or might be required to consent to a merger or to divest the troubled institution or other affiliates. See Capital Adequacy and Prompt Corrective Action.

 

Transactions with Affiliates:  The holding company and the Bank are considered “affiliates” of each other under the Federal Reserve Act, and transactions between a bank and its affiliates are subject to certain restrictions, under Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve Baord’s implementing Regulation W. Generally, Sections 23A and 23B: (1) limit the extent to which an insured depository or its subsidiaries may engage in covered transactions (a) with an affiliate (as defined in such sections) to an amount equal to 10% of such institution’s capital and surplus, and (b) with all affiliates, in the aggregate to an amount equal to 20% of such capital and surplus; and (2) require all transactions with an affiliate, whether or not covered transactions, to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as the terms provided or that would be provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.

State Law Restrictions: As a Maine corporation, the holding company is subject to certain limitations and restrictions under applicable Maine corporate law. For example, state law restrictions in Maine include limitations and restrictions relating to indemnification of directors, distributions and dividends to

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stockholders, transactions involving directors, officers or interested stockholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.

 

Capital Adequacy and Prompt Corrective Action  

In July 2013, the Federal Reserve Board, the FDIC and the Office of the Comptroller of the Currency (the “OCC”) issued final rules (the “Capital Rules”) that established a new capital framework for U.S. banking organizations. The Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards.  In addition, the Capital Rules implement certain provisions of the Dodd-Frank Act, including the requirements of Section 939A to remove references to credit ratings from the federal banking agencies’ rules.  The Capital Rules substantially revised the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries. The risk-based capital guidelines are designed to make regulatory capital requirements sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposures and to minimize disincentives for holding liquid, low-risk assets.

The Capital Rules: (i) require a capital measure called “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. The Capital Rules revised the definitions and the components of regulatory capital and impacted the calculation of the numerator in banking institutions’ regulatory capital ratios.  The Capital Rules became effective for the Company and the Bank on January 1, 2015, subject to phase-in periods for certain components and other provisions.  Under the Capital Rules, for most banking organizations, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock and the most common forms of Tier 2 capital are subordinated notes and a portion of the allocation for loan losses, in each case, subject to the Capital Rules’ specific requirements.

Pursuant to the Capital Rules, the minimum capital ratios are as follows:

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4.5% CET1 to risk-weighted assets;

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6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets;

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8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and

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4.0% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (the “leverage ratio”).

The Capital Rules also require a “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking organizations with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity and other capital instrument repurchases and compensation based on the amount of the shortfall.  When fully phased-in on January 1, 2019, the capital standards applicable to the Company and the Bank will include an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios inclusive of the capital conservation buffer of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.

The Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.

In addition, under the prior general risk-based capital rules, the effects of accumulated other comprehensive income or loss (“AOCI”) items included in shareholders’ equity (for example, mark-to-market of securities held in the available-for-sale portfolio) under U.S. GAAP are reversed for the purposes of determining regulatory capital ratios.  Under the Capital Rules, the effects of certain AOCI items are not excluded; however, banking organizations not using the advanced approaches, including the Company and the Bank, were permitted to make a one-time permanent election to continue to exclude these items in January 2015. The Capital Rules also preclude certain hybrid securities, such as trust preferred securities issued after May 19, 2010, from inclusion in bank holding companies’ Tier 1 capital.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer began on January 1, 2016, at the 0.625% level and increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019.

The Capital Rules prescribe a standardized approach for risk weightings, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset classes.

Pursuant to Section 38 of the FDIA, federal banking agencies are required to take “prompt corrective action” should an insured depository institutions fail to meet certain capital adequacy standards.  At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits. Furthermore, if an insured depository institution is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the appropriate federal banking agency, and the holding company must guarantee the performance of that plan. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

For purposes of PCA, to be: (i) well-capitalized, an insured depository institution must have a total risk based capital ratio of at least 10%, a Tier 1 risk based capital ratio of at least 8%, a CET1 risk based capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%; (ii) adequately capitalized, an insured depository institution must have a total risk based capital ratio of at least 8%, a Tier 1 risk based capital ratio of at least 6%, a CET1 risk based capital ratio of at least 4.5%, and a Tier 1 leverage ratio of at least 4%; (iii)  undercapitalized, an insured depository institution would have a total risk based capital ratio of less than 8%, a Tier 1 risk based capital ratio of less than 6%, a CET1 risk based capital ratio of less than 4.5%, and a Tier 1 leverage ratio of less than 4%; (iv) significantly undercapitalized, an insured depository institution would have a total risk based capital ratio of less than 6%, a Tier 1 risk based capital ratio of less than 4%, a CET1 risk based capital ratio of less than 3%, and a Tier 1 leverage ratio of less than 3%.; (v) critically undercapitalized, an insured depository institution would have a ratio of tangible equity to total assets that is less than or equal to 2%.  

Both the Company and the Bank have always maintained the capital ratios and leverage ratio above the levels to be considered quantitatively well-capitalized. For information regarding the capital ratios and leverage ratio of the Company and the Bank as of December 31, 2016, and December 31, 2015, see the discussion under the section captioned “Capital Resources” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14, in the “Notes to Consolidated Financial Statements” included in Item 8, “Financial Statements and Supplementary Data”, elsewhere in this report.

The Volker Rule

Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, restricts the ability of banking entities, such as the Company, from: (i) engaging in “proprietary trading” and (ii) investing in or sponsoring certain types of funds (“Covered Funds”), subject to certain limited exceptions. Under the Volcker Rule, a Covered Fund is any issuer that would be an investment company under the Investment Company Act (the “ICA”) but for the exemptions in section 3(c)(1) and 3(c)(7) of the ICA, which includes collateralized loan obligation (“CLO”) and collateralized debt obligation securities. The regulation also provides, among other exemptions, an exemption for CLOs meeting certain requirements.  Compliance with the Volcker Rule is generally required by July 21, 2017.  The Company expects to be fully compliant with the Volcker Rule by July 21, 2017.

Significant Banking Regulations Applicable to the Bank

Deposit Insurance: The Bank’s deposit accounts are fully insured by the DIF of the FDIC up to the deposit insurance limit of $250,000 per depositor, per insured institution, in accordance with applicable laws and regulations.

The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a risk matrix that accounts for a bank's capital level and supervisory rating (CAMELS rating). The risk matrix uses different risk categories distinguished by capital levels and supervisory ratings. The base for deposit insurance assessments is consolidated average assets less average tangible equity.  Assessment rates are calculated using formulas that take into account the risk of the institution being assessed.  The FDIC may increase or decrease the assessment rate schedule in order to manage the DIF to prescribed statutory target levels. An increase in the risk category for the Bank or in the assessment rates could have an adverse effect on the Bank’s and consequently the Company’s earnings. The FDIC may terminate deposit insurance if it determines the institution involved has engaged in or is engaging in unsafe or unsound banking practices, is in an unsafe or unsound condition, or has violated applicable laws, regulations or orders.  

In addition to deposit insurance assessments, the FDIA provides for additional assessments to be imposed on insured depository institutions to pay for the cost of Financing Corporation (“FICO”) funding.  The FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987, whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation.  The FICO assessments are adjusted quarterly to reflect changes in the assessment base of the DIF and do not vary depending upon a depository institution’s capitalization or supervisory evaluation. The current annualized assessment rate is approximately six basis points and the rate is adjusted quarterly. These assessments will continue until the FICO bonds mature in 2019.  

Depositor Preference: The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Reserve Requirements:  Federal Reserve Board regulations require insured depository institutions to maintain non-interest earning reserves against their transaction accounts (primary interest-bearing and regular checking accounts).  The Bank’s required reserves can be in the form of vault cash.  If vault cash does not fully satisfy the required reserves, in the form of a balance maintained with the Federal Reserve Bank of Boston (the “FRB Boston”).  Federal Reserve Board regulations required for 2016 that reserves be maintained against aggregate transaction accounts, except for transaction accounts which are exempt up to $15.2 million. Transaction accounts greater than $15.2 million up to and including $110.2 million have a reserve requirement of 3%.  A 10% reserve ratio will be assessed on transaction accounts in excess of $110.2 million. The Federal Reserve Board makes annual adjustments to the tiered reserves. The Bank is in compliance with these reserve requirements.

 

Consumer Financial Protection: The Company is subject to a number of federal and state consumer protection laws that govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, restrict the Bank's ability to raise interest rates and subject the Bank to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees.

Further, the CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s: (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests.

Neither the Dodd-Frank Act nor the individual consumer financial protection laws prevent states from adopting stricter consumer protection standards.

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Brokered Deposit Restrictions:  Under FDICIA, banks may be restricted in their ability to accept brokered deposits, depending on their classification. “Well-capitalized” institutions are permitted to accept brokered deposits, but all banks that are not well-capitalized could be restricted from accepting such deposits.  The Bank is currently well-capitalized ad not restricted from accepting brokered deposits.

 

Community Reinvestment Act: The Community Reinvestment Act of 1977 (“CRA”), requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The applicable federal regulators regularly conduct CRA examinations to assess the performance of financial institutions and assign one of four ratings to the institution’s records of meeting the credit needs of its community. During its last examination, a rating of “satisfactory” was received by the Bank.

 

Insider Credit Transactions: Section 22(h) of the FRA and its implementing Regulation O restricts loans to directors, executive officers, and principal stockholders (“insiders”). Under Section 22(h), loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, under Section 22(h) of the FRA, loans to directors, executive officers and principal stockholders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the bank’s employees and does not give preference to the insider over the employees. Section 22(g) of the FRA places additional limitations on loans to executive officers.  A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order, and other regulatory sanctions.

 

SAFETY AND SOUNDESS: Under FDIA, each federal banking agency has prescribed, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards cover internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions.

  

Examinations: The Bank is examined from time-to-time by its primary federal banking regulator, the FDIC, and the Maine Bureau of Financial Institutions (“BFI”).

Financial Privacy:  Section V of the Gramm-Leach-Bliley Act and its implementing regulations require all financial institutions, including the Company and the Bank, to adopt privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer’s request, limit the reuse of certain consumer information received from nonaffiliated financial institutions, and establish procedures and practices to protect customer data from unauthorized access.  In addition, the Fair Credit Reporting Act (“FCRA”), as amended by the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”), includes many provisions affecting the Company, Bank, and/or their affiliates, including provisions concerning obtaining consumer reports, furnishing information to consumer reporting agencies, maintaining a program to prevent identity theft, sharing of certain information among affiliated companies, and other provisions. The FACT Act requires persons subject to FCRA to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available. The CFPB and the Federal Trade Commission (“FTC”) have extensive rulemaking authority under the FACT Act, and the Company and the Bank are subject to the rules that have been promulgated under the FACT Act, including rules requiring financial institutions with covered accounts (e.g. consumer bank accounts and loans) to develop, implement, and administer an identity theft protection program, as well as rules regarding limitations on affiliate marketing and implementation of programs to identify, detect and mitigate certain identity theft red flags.  The Company has developed policies and procedures for itself and its subsidiaries, including the Bank, and believes it is in compliance with all privacy, information sharing, and notification provisions of the GLB Act and the FACT Act.  The Bank is also subject to data security standards, privacy and data breach notice requirements, primarily those issued by the FDIC.  

Anti-Money Laundering Initiatives and the USA Patriot Act: A major focus of governmental policy on financial institutions over the last decade has been combating money laundering and terrorist financing. The USA PATRIOT Act of 2001  (“USA Patriot Act”), substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial

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jurisdiction of the United States. The U.S. Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as the Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identities of their customers. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must use enhanced due diligence procedures in their dealings with certain types of high-risk customers and implement a written customer identification program. Financial institutions must take certain steps to assist government agencies in detecting and preventing money laundering and report certain types of suspicious transactions. Regulatory authorities routinely examine financial institutions for compliance with these obligations, and failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, can have serious legal and reputational consequences for the institution.

Office of Foreign Assets Control Regulation: The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. The Company is responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences.

 

Other Laws and Regulations:  The Company is not only subject to federal laws applicable to it, it is also subject to the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

Guidance on Sound Compensation Policies

 

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions.

The Dodd-Frank Act also requires the federal banking agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities with at least $1 billion in total consolidated assets that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits that could lead to material financial loss to the entity. The federal banking agencies and the SEC most recently proposed such regulations in 2016, but the regulations have not yet been finalized. If the regulations are adopted in the form initially proposed, they will restrict the manner in which executive compensation is structured.

Changing Regulatory Structure and Future Legislation and Regulation

 

Congress may enact further legislation that affects the regulation of the financial services industry, and the Maine legislature may enact further legislation affecting the regulation of financial institutions chartered by the State of Maine. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The Company cannot predict the substance or impact of pending or future legislation or regulations, or the application thereof, although enactment of the proposed legislation could impact the regulatory structure under which the Company operates and may significantly increase costs, impede the efficiency of internal business processes, require an increase in regulatory capital, require modifications to the Company’s business strategy, and limit the Company’s ability to pursue business opportunities in an efficient manner. A change in statutes, regulations or regulatory policies applicable to the Company or any of its subsidiaries could have a material effect on its business.

Monetary Policy and Economic Environment  

The earnings of the Company are significantly affected by the monetary and fiscal policies of governmental authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. Government securities and federal funds, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments, and deposits, and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently used these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation, or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect which they may have on the Company’s business and earnings.

Financial Information About Industry Segments

The information required under this item is included in the Company’s financial statements, which appear in Part II, Item 8, Note 1 of this Annual Report on Form 10-K, and is incorporated herein by cross reference thereto.

Availability of Information – Company Website

The Company maintains an Internet website at www.bhbt.com. At this website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statement on Schedule 14A and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at

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1-800-SEC-0330. The SEC also maintains an Internet website at www.sec.gov that contains reports, proxy, and information statements, and other information regarding issuers that file electronically with the SEC. In addition, the Company makes available, free of charge, its press releases and Code of Ethics through the Company’s Investor Relations page. Information on our website is not incorporated by reference into this document and should not be considered part of this Report.

ITEM 1A. RISK FACTORS

An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This Report is qualified in its entirety by these risk factors.

If any of the following risks actually occurs, our financial condition, results of operations, or cash flow could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

Changes in the general economy or the financial markets could adversely affect our financial performance.

We provide traditional commercial, retail and mortgage banking services, as well as other financial services including wealth management and insurance brokerage services.  Downturns in the United States or global economies or financial markets could adversely affect the demand for, or the availability of, loans and other products and services offered by us.  The business environment in the U.S. has experienced volatility in recent years and may continue to do so for the foreseeable future. There can be no assurance that economic conditions will not worsen.  Difficult economic conditions could adversely affect our business, results of operations and financial condition.

Changes in economic conditions of local markets where conduct business could adversely affect our operations.

Maine

The Company’s success is dependent on the local economies of downeast, midcoast and central Maine as a significant portion of our loan portfolio is concentrated among borrowers in these markets.  Furthermore, because a substantial portion of our loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions.

A number of our hospitality and other customers rely upon a high number of visits from tourists and vacationers to Acadia National Park as a significant part of their businesses. Prolonged interruptions or shutdowns in the operation of tourist destination sites within our market areas could have a material adverse effect on our business and results of operations.

New Hampshire and Vermont

With the acquisition of Lake Sunapee Bank Group, we are now exposed to the local market conditions and economies of Cheshire, Grafton, Hillsborough, Merrimack and Sullivan counties in central and western New Hampshire and in Rutland, Windsor and Orange counties in central Vermont. Future growth

opportunities depend on the growth and stability of the regional economy and our ability to expand our market area. A downturn in the local economy may limit funds available for deposit and may negatively affect borrowers’ ability to repay their loans on a timely basis, both of which could have an impact on our profitability and business.

Unsuccessful acquisition and geographic expansion could negatively impact earnings

The Company recently expanded into the New Hampshire and Vermont markets with the acquisition of Lake Sunapee Bank Group.  Success of the acquisition is dependent on the integration of the combined company infrastructure, culture, and acceptance of customer within these new markets.  Profitability is dependent on management’s ability to maintain employee and customer relationships, improve operational efficiencies and grow profits at a rate that exceeds the growth of expenses.  To the extent that the Company acquires other companies, its business may be negatively impacted by certain risks inherent with such acquisitions.

Interest rate volatility could significantly reduce the Company’s profitability.

The Bank’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-bearing assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions, demand for loans, securities and deposits, and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our loans and securities that are collateralized by mortgages. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore

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earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. If interest rates decline, the Bank’s higher-rate loans and investments may be subject to prepayment risk, which could negatively impact its net interest margin. Conversely, if interest rates increase, the Bank’s loans and investment securities may be subject to extension risk, which could negatively impact its net interest margin as well.

High concentrations of commercial loans may increase exposure to credit loss upon borrower default  

As of December 31, 2016, approximately 49% of the Banks’s loan portfolio consisted of commercial real estate, commercial and industrial, construction and agricultural loans. Commercial loan portfolio concentration generally exposes lenders to greater risk of delinquency and loss than residential real estate loans because repayment of the loans often depends on the successful operation and income streams from the property.  Additionally, commercial loans typically involve larger balances to single borrowers or groups of related borrowers compared to residential real estate loans. Because the Bank’s loan portfolio contains a significant number of large commercial loans, the deterioration of one or a few of these loans could cause a significant increase in nonperforming loans, provision for loan losses,  and/or an increase in loan charge-offs, all of which could adversely affect the financial condition and results of operations of the Company.

Greater than anticipated credit losses in the loan portfolios may adversely affect earnings.

Credit losses are inherent in the business of making loans and could have a material adverse effect on our operating results.  We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for loan losses based on a number of factors. We evaluate the allowance for loan losses on a periodic basis using current information, including the quality of the loan portfolio, economic conditions, and the value of the underlying collateral and the level of non-accrual loans.  Although we believe the allowance for loan losses is appropriate to absorb probable losses in our loan portfolio, this allowance may not be adequate. Increases in the allowance will result in an expense for the period, thereby reducing our reported net income.   

Strong competition within our markets may significantly impact the Company’s profitability.

The Company competes with an ever-increasing array of financial service providers. See the section entitled “Competition” of Item 1 of this Form 10-K for additional information about our competitors. Competition from nationwide banks, as well as local institutions, continues to mount in our markets.

Regional, national and international competitors have far greater assets and capitalization than we do and have greater access to capital markets and can offer a broader array of financial services than we can. For example, consumers can maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. Further, many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

To compete, the Company focuses on quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers. Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect the Company’s growth and profitability.

New regulations could restrict residential lending activities.

The Consumer Financial Protection Bureau ("CFPB") issued a rule designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. The CFPB’s rule on qualified mortgages could limit the Banks's ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could limit growth or profitability. CFPB rules on other types of consumer lending could similarly affect the cost and profitability of those lending activities.

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The Company is subject to extensive government regulation and supervision, which may interfere with  our ability to conduct our business and may negatively impact our financial results.

The Company is subject to extensive government regulation and supervision, which may interfere with our ability to conduct our business and may negatively impact our financial results.  The Bank and certain non-bank subsidiaries, are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, the Federal Deposit Insurance Fund and the safety and soundness of the banking system as a whole, not stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer, and/or limit the pricing the Company may charge on certain banking services, among other things. Compliance personnel and resources may increase our costs of operations and adversely impact our earnings.

Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.   

The Company may elect or be compelled to seek additional capital in the future, but capital may not be available when it is needed.

The Company is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. In addition, the Company may elect to raise additional capital to support its business or to finance acquisitions, if any, or the Company may otherwise elect to raise additional capital.

The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions, and a number of other factors, many of which are outside the Company’s control, and on its financial performance. Accordingly, we cannot be assured of our Company’s ability to raise additional capital if needed or on terms acceptable to us.  If the Company cannot raise additional capital when needed, or on reasonable terms, it may have a material adverse effect on its financial condition and results of operations.

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The Bank may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates, and competitive pressures.

Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and standing in the marketplace, and general economic conditions.

The Bank’s primary source of funding is retail deposits, gathered throughout its network of banking offices. Wholesale funding sources principally consist of secured borrowing lines from the Federal Home Loan Bank of Boston (the “FHLB”) of which it is a member, secured borrowing lines from the FRB of Boston, and certificates of deposit obtained from the national market. The Bank’s securities and loan portfolios provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.

Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Bank’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows.

The Company is subject to a variety of operational risks, including reputational risk, legal risk, and compliance risk, and the risk of fraud or theft by employees or outsiders, which may adversely affect the Company’s business and results of operations.

The Company is exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.

If personal, non-public, confidential, or proprietary information of customers in our possession were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage, and financial loss.

Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process transactions and its large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Company may also be subject to disruptions

19

of its operating systems arising from events that are wholly or partially beyond its control (i.e., computer viruses or electrical or telecommunications outages, natural disaster, disease pandemics, or other damage to property or physical assets), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as we are) and to the risk that our (or our vendors’) business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in a diminished ability to operate our business (i.e., by requiring us to expend significant resources to correct the defect), as well as potential liability to clients, reputational damage, and regulatory intervention.

Disruptions to the Company’s information systems and security breaches could adversely affect its business and reputation.

In the ordinary course of business, the Company relies on electronic communications and information systems to conduct its businesses and to store sensitive data, including financial information regarding its customers. The integrity of information systems are under significant threat from cyber-attacks by third parties, including through coordinated attacks sponsored by foreign nations and criminal organizations to disrupt business operations and other compromises to data and systems for political or criminal purposes. The Company employs an in-depth, layered, defense approach that leverages people, processes and technology to manage and maintain cyber security controls. Notwithstanding the strength of our defensive measures, the threat from cyberattacks is severe, attacks are sophisticated and attackers respond rapidly to changes in defensive measures. Cyber security risks may also occur with the Company’s third-party service providers, and may interfere with their ability to fulfill their contractual obligations to us, with additional potential for financial loss or liability that could adversely affect the Company’s financial condition or results of operations. The Company offers its customers the ability to bank remotely and provide other technology based products and services, which services include the secure transmission of confidential information over the Internet and other remote channels. To the extent that the Company’s customers’ systems are not secure or are otherwise compromised, its network could be vulnerable to unauthorized access, malicious software, phishing schemes and other security breaches. To the extent that the Company’ activities or the activities of its clients or third-party service providers involve the storage and transmission of confidential information, security breaches and malicious software could expose the Company to claims, regulatory scrutiny, litigation and other possible liabilities.

While to date the Company has not experienced a significant compromise, significant data loss or material financial losses related to cyber security attacks, the Company’s systems and those of its clients and third-party service providers are under constant threat and we may experience a significant event in the future. The Company may suffer material financial losses related to these risks in the future or it may be subject to liability for compromises to its client or third-party service provider systems. Any such losses or liabilities could adversely affect the Company’s financial condition or results of operations, and could expose us to reputation risk, the loss of client business, increased operational costs, as well as additional regulatory scrutiny, possible litigation, and related financial liability. These risks also include possible business interruption, including the inability to access critical information and systems.

The Company continually encounters technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in

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technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.

The Company is subject to possible claims and litigation pertaining to fiduciary responsibilities.

From time to time, customers make claims and take legal action pertaining to the Company’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of our Company and our products and services as well as impact customer demand for our products and services.

Tax law changes may adversely affect the Company’s net income, effective tax rate, and its overall results of operations and financial condition.

The Company’s financial performance is impacted by federal and state tax laws.  The enactment of proposed U.S. tax reforms could materially adversely affect us, including as a result of a reduction in the value of our DTAs upon a reduction in the U.S. corporate income tax rate. We cannot predict if any such proposals will ultimately become law, or, if enacted, what its provisions or that of the regulations promulgated thereunder will be, but they could materially adversely affect our financial position and our results of operations.

The Company’s controls and procedures may fail or be circumvented.

The Company regularly reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met.

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The Company’s access to funds from subsidiaries may be restricted.

Bar Harbor Bankshares is a separate and distinct legal entity from our Bank and nonbanking subsidiaries. Bar Harbor Bankshares depends on dividends, distributions and other payments from its banking and nonbanking subsidiaries to fund dividend payments on its common stock and to fund all payments on its other obligations. The Company’s subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to Bar Harbor Bankshares, which could impede access to funds it needs to make payments on its obligations or dividend payments.

The Company may be unable to attract and retain key personnel.

The Company’s success depends, in large part, on its ability to attract and retain key personnel. Competition for qualified personnel in the financial services industry can be intense and the Company and its subsidiaries may not be able to hire or retain the key personnel that it depends upon for success. In addition, the Bank’s rural geographic marketplace, combined with relatively expensive real estate purchase prices within the area of the Bank’s principal office location in Bar Harbor, Maine, create additional risks for the Company and the Bank’s ability to attract and retain key personnel. The unexpected loss of services of one or more of the our key personnel could have a material adverse impact on our business because of their skills, knowledge of the markets in which we operate, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

The Bank is exposed to risk of environmental liabilities with respect to properties to which it takes title.

In the course of our business, the Bank may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a

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governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The cost associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.

Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact the Company’s business and the business of its customers.

Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our Company’s ability to conduct business. Such events could affect the stability of our borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. In particular, such events may have a particularly negative impact upon the business of our customers who are engaged in the hospitality and natural resource dependent industries in our market area, which could have a direct negative impact on our Company’s business and results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

ITEM 2. PROPERTIES

The Company’s headquarters are located at 82 Main Street, Bar Harbor, Maine, which also serves as the main office for the Bank. The Bank completed a substantial renovation of its Bar Harbor facility to better meet its business needs at that location in 2016.  

The Bank operates 49 full-service banking offices throughout Maine, New Hampshire and Vermont. Locations in Maine include: Bar Harbor, Northeast Harbor, Southwest Harbor, Somesville, Deer Isle, Blue Hill, Ellsworth, Rockland, Topsham, South China, Winter Harbor, Milbridge, Machias, and Lubec. Locations in New Hampshire include: Andover, Bradford, Claremont, Concord, Enfield, Grantham, Guild, Hanover, Hillsboro, Lebanon, Milford, Nashua, Newbury, New London, Newport, Peterborough, Sunapee and West Lebanon.  Locations in Vermont include: Brandon, Pittsford, Quechee, Randolph, Rochester, Royalton, Rutland, South Royalton, West Rutland, Williamstown and Woodstock.  The Bank owns 33 of these banking offices and leases 16 at prevailing rates.

An Operations Center located in Ellsworth, Maine, that houses the Company’s operations and data processing centers. The Bank also leases space in Hampden, Maine, which serves as a back office support for multiple lines of business and related functions.  

In the opinion of management, the physical properties of the Company and the Bank are considered adequate to meet the needs of customers in the communities served. Additional information relating to the Company’s properties is provided in Part II, Item 8, Note 17 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.

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ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The common stock of the Company is traded on the NYSE MKT, LLC (“NYSE MKT”), under the trading symbol BHB.

On April 22, 2014, the Company’s Board of Directors declared a three-for-two split of its common stock, payable as a large stock dividend, which was paid on May 19, 2014 (the “payment date”) to all stockholders of record at the close of business on May 5, 2014 (the “2014 Stock Split”).  All previously reported share and per share data included in public filings subsequent to the payment date have been adjusted to reflect the retroactive effect of this three-for-two stock split.  Refer to Note 2 Three-for-two Common Stock Split, of the Consolidated Financial Statements, in this Annual Report on Form 10-K, for further information concerning the 2014 stock split.

On February 21, 2017, the Company announced that its Board of Directors declared a three-for-two split of its common stock payable in the form of a large stock dividend (the “2017 Stock Split”). The 2017 Stock Split is payable March 21, 2017, to the Company’s common stockholders of record at the close of business on March 7, 2017. Refer to Note 23 Subsequent Events, of the Consolidated Financial Statements in this Annual Report on Form 10-K, for further information concerning the 2017 Stock Split.

The following table sets forth the high and low market prices per share of BHB Common Stock as reported by NYSE MKT by calendar quarter for each of the last two years:

	1st Quarter		2nd Quarter		3rd Quarter		4th Quarter
	High	Low	High	Low	High	Low	High	Low
2016	$34.70	$29.53	$36.10	$30.80	$37.69	$34.05	$49.87	$36.19
2015	33.98	30.03	37.98	32.50	36.35	28.97	36.08	30.00

As of March 10, 2017, there were 10,256,441 shares of Company common stock, par value $2.00 per share, outstanding and approximately 1,576 Registered Shareholders of record, as obtained through the Company’s transfer agent.  These share totals are not adjusted for the 2017 Stock Split.  

Performance Graph

The following graph illustrates the estimated yearly change in value of the Company's cumulative total stockholder return on its common stock for each of the last five years. Total shareholder return is computed by taking the difference between the ending price of the common stock at the end of the previous year and the current year, plus any dividends paid divided by the ending price of the common stock at the end of the previous year. For purposes of comparison, the graph also matches Bar Harbor Bankshares' cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the NYSE MKT Composite index, the S&P 500 index, and the ABA NASDAQ Community Bank index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2011 to December 31, 2016.

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Dividends

Common stock dividends paid by the Company in 2016 and 2015 are summarized below:

	1st Quarter	2nd Quarter	3rd Quarter	4th Quarter	Total
2016	$0.265	$0.270	$0.275	$0.280	$1.090
2015	0.245	0.250	0.255	0.260	1.010

During 2016, the Company declared and distributed regular cash dividends on its common stock in the aggregate amount of $6,577 compared with $6,040 in 2015. The Company’s 2016 dividend payout ratio amounted to 44.0% compared with 39.9% in 2015. The total regular cash dividends paid in 2016 amounted to $1.09 per share of common stock, compared with $1.01 in 2015, representing an increase of $0.08 per share, or 7.9%.

In the first quarter of 2017, the Company’s Board of Directors declared a regular cash dividend of $0.28 per share of common stock, representing an increase of $0.015 or 5.7% compared with the first quarter of 2016.

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The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including the Company’s financial condition, earnings, its need for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.

For further information, refer to Item 6, Selected Consolidated Financial Data for dividend related ratios and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, (specifically the “Capital Resources” section).

Recent Sale of Unregistered Securities; Use of Proceeds from Registered Securities

No unregistered securities were sold by the Company during the years ended December 31, 2016, and 2015.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

There were no purchases of shares of the Company’s common stock made by or on behalf of the Company or any “affiliated purchaser” for the quarter ended December 31, 2016.

Information relating to the Company’s stock repurchase program is provided in Part II, Item 7, Stock Repurchase Plan, contained in this Annual Report on Form 10-K and incorporated herein by reference.

Stock Based Compensation Plans

Information regarding stock-based compensation awards both outstanding and available for future grants as of December 31, 2016, represents stock-based compensation plans approved by shareholders and is presented in the table below. There are no compensation plans under which equity securities of the Company may be issued that have not been approved by shareholders. Additional information is presented in Note 15, Stock-Based Compensation Plans, in the Notes to the Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, within this Annual Report on Form 10-K.

Transfer Agent Services

American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15^th Avenue, 3^rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: www.amstock.com.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The supplementary financial data presented in the following table contains information highlighting certain significant trends in the Company’s financial condition and results of operations over the past five years.

The following information should be analyzed in conjunction with Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and with the audited consolidated financial statements included in this Annual Report on Form 10-K. Unless otherwise noted, all dollars are expressed in thousands except share and per share data.

FIVE-YEAR SUMMARY OF FINANCIAL DATA

As of and For the Years Ended December 31,

Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully tax-equivalent basis. 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 their earning asset portfolios. 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 tables below provide a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.

Average Balances, Interest and Average Yields/Cost: The following tables present an analysis of average rates and yields on a fully taxable equivalent basis for the years presented. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison.

For The Year Ended December 31, 2016

			Weighted
	Average		Average
	Balance	Interest	Rate
Interest Earning Assets:
Loans (1,3)	$1,054,687	$41,889	3.97%
Securities (2,3)	521,760	16,823	3.22%
Federal Home Loan Bank stock	24,985	868	3.47%
Total Earning Assets	1,601,432	59,580	3.72%
Non-Interest Earning Assets:
Cash and due from banks	5,485
Allowance for loan losses	(10,061)
Other assets (2)	80,085
Total Assets	$1,676,941
Interest Bearing Liabilities:
Deposits	$   888,823	$  6,699	0.75%
Borrowings	524,859	5,414	1.03%
Total Interest Bearing Liabilities	1,413,682	12,113	0.86%
Rate Spread			2.86%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits	93,757
Other liabilities	7,375
Total Liabilities	1,514,814
Shareholders' equity	162,127
Total Liabilities and Shareholders' Equity	$1,676,941
Net interest income and net interest margin (3)		47,467	2.96%
Less:  Tax Equivalent adjustment		(2,093)
Net Interest Income		$45,374	2.83%

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For The Year Ended December 31, 2015

	Average Balance	Interest	Weighted Average Rate
Interest Earning Assets:
Loans (1,3)	$   962,240	$39,545	4.11%
Securities (2,3)	484,527	17,059	3.52%
Federal Home Loan Bank stock	22,320	578	2.59%
Total Earning Assets	1,469,087	57,182	3.89%
Non-Interest Earning Assets:
Cash and due from banks	4,899
Allowance for loan losses	(9,239)
Other assets (2)	76,580
Total Assets	$1,541,327
Interest Bearing Liabilities:
Deposits	$  843,596	$  6,097	0.72%
Borrowings	456,669	4,293	0.94%
Total Interest Bearing Liabilities	1,300,265	10,390	0.80%
Rate Spread			3.09%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits	82,741
Other liabilities	6,930
Total Liabilities	1,389,936
Shareholders' equity	151,391
Total Liabilities and Shareholders' Equity	$1,541,327
Net interest income and net interest margin (3)		46,792	3.19%
Less:  Tax Equivalent adjustment		(1,958)
Net Interest Income		$44,834	3.05%

For The Year Ended December 31, 2014

	Average Balance	Interest	Weighted Average Rate
Interest Earning Assets:
Loans (1,3)	$   881,389	$37,982	4.31%
Securities (2,3)	470,192	17,331	3.69%
Federal Home Loan Bank stock	20,219	290	1.43%
Total Earning Assets	1,371,800	55,603	4.05%
Non-Interest Earning Assets:
Cash and due from banks	4,204
Allowance for loan losses	(8,753)
Other assets (2)	56,958
Total Assets	$1,424,209
Interest Bearing Liabilities:
Deposits	$   801,224	$  5,894	0.74%
Borrowings	406,744	4,011	0.99%
Total Interest Bearing Liabilities	1,207,968	9,905	0.82%
Rate Spread			3.23%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits	72,706
Other liabilities	6,863
Total Liabilities	1,287,537
Shareholders' equity	136,672
Total Liabilities and Shareholders' Equity	$1,424,209
Net interest income and net interest margin (3)		45,698	3.33%
Less:  Tax Equivalent adjustment		(1,885)
Net Interest Income		$43,813	3.19%

(1) For purposes of these computations, non-accrual loans are included in average loans.

(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.

(3) For purposes of these computations, net interest income and net interest margin are reported on a tax-equivalent basis.

Net Interest Margin Analysis: The following table summarizes the net interest margin components, on a quarterly basis, over the past two years.

 (1) For purposes of these computations, non-accrual loans are included in average loans.

(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.

(3) For purposes of these computations, net interest income and net interest margin are reported on a tax-equivalent basis.

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Rate/Volume Analysis: The following table presents the effects of rate and volume changes on the fully taxable equivalent net interest income. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in rate (change in rate multiplied by prior year volume), (2) changes in volume (change in volume multiplied by prior year rate), and (3) changes in volume/rate (change in rate multiplied by change in volume) have been allocated proportionately based on the absolute value of the change due to the rate and the change due to volume.

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FOR THE YEAR ENDED DECEMBER 31, 2016 VERSUS 2015

INCREASES (DECREASES) DUE TO:

	Average Volume	Average Rate	Total Change
Loans (1,3)	$3,797	$(1,453)	$2,344
Securities (2,3)	1,322	(1,558)	(236)
Federal Home Loan Bank stock	69	221	290
TOTAL EARNING ASSETS	$5,188	$(2,790)	$2,398
Interest bearing deposits	327	275	602
Borrowings	641	480	1,121
TOTAL INTEREST BEARING LIABILITIES	$   968	$    755	$1,723
NET CHANGE IN NET INTEREST INCOME	$4,220	$(3,545)	$   675

(

FOR THE YEAR ENDED DECEMBER 31, 2015 VERSUS 2014

INCREASES (DECREASES) DUE TO:

	Average Volume	Average Rate	Total Change
Loans (1,3)	$3,481	$(1,918)	$1,563
Securities (2,3)	529	(801)	(272)
Federal Home Loan Bank stock	30	258	288
TOTAL EARNING ASSETS	$4,040	$(2,461)	$1,579
Interest bearing deposits	312	(109)	203
Borrowings	492	(210)	282
TOTAL INTEREST BEARING LIABILITIES	$   804	$   (319)	$   485
NET CHANGE IN NET INTEREST INCOME	$3,236	$(2,142)	$1,094

(1) For purposes of these computations, non-accrual loans are included in average loans.

(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.

(3) For purposes of these computations, net interest income and net interest margin are reported on a tax-equivalent basis.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis, which follows, focuses on factors affecting the Company’s consolidated results of operations for the years ended December 31, 2016, 2015, and 2014, and financial condition at December 31, 2016, and 2015, and where appropriate, factors that may affect future financial performance. The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on Form 10-K.

Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.  Unless otherwise noted, all dollars are expressed in thousands except share and per share data.

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of the Company’s financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. 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. Management evaluates its estimates, including those related to the allowance for loan losses, on an ongoing basis. Management bases its estimates on historical experience and 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.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s

32

financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements:

Allowance for Loan Losses: The allowance for loan losses (“allowance”) is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of probable loss in the loan portfolio. Management regularly evaluates the allowance for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current general economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when a greater amount of provision for loan losses is necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, and Part II, Item 8, Notes 1 and 4 of the Consolidated Financial Statements, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.

Other-Than-Temporary Impairments on Securities: The Company evaluates debt and equity securities within the Company’s available for sale portfolio for other-than-temporary impairment (“OTTI”), at least quarterly. The evaluation of securities for other-than-temporary impairments 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.

Refer to Part II, Item 7, Impaired Securities, and Part II, Item 8, Notes 1 and 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K, for further discussion and analysis concerning other-than-temporary impairments.

Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2016, and 2015, there were no valuation allowances for deferred tax assets, which are included in other assets on the consolidated balance sheet.

Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and identifiable intangible assets, such as core deposit intangibles.

The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event using certain fair value techniques. Goodwill impairment testing is performed at the segment (or “reporting unit”) level. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to the reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or organically grown, are available to support the value of the goodwill.  

Identifiable intangible assets, included in other assets on the consolidated balance sheet, consist of core deposit intangibles amortized over their estimated useful lives on a straight-line method, which approximates the economic benefits to the Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset

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may not be recoverable. The determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.

Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s consolidated results of operations.

Refer to Notes 1 and 8 of the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill.

FINANCIAL HIGHLIGHTS

·

Total assets in 2016 increased 11.1% to $1,755,349 from $1,580,055 in 2015

·

Total loans in 2016 increased 14.0% to $1,129,064 from $990,070 in 2015

·

2016 diluted earnings per share totaled $2.45 and were net of acquisition and system conversion costs totaling $0.28 per share

·

2016 net interest income, on a tax-equivalent basis, was $47,467 compared $46,792 in 2015

·

Total non-interest income for 2016 was up $3,370 or 38% from 2015.  Excluding securities gains, non-interest income was up $206 compared to 2015   

·

Non-performing assets decreased $512, or 7.3% compared to 2015

Lake Sunapee Bank Group Acquisition

On January 13, 2017, the Company completed the previously announced acquisition of Lake Sunapee Bank Group (“LSBG”) was completed. The Company issued 4,163,853 common shares using a fixed exchange ratio of 0.4970 which was based on a stock price of $34.55. Total consideration paid at closing was $182.2 million which reflected the increase in the Company’s stock at the time of closing plus an additional $28 thousand in cash paid for fractional shares.  At completion of the acquisition, LSBG had approximately $1.5 billion in total assets.  Final allocation of the purchase price to the fair value of assets and liabilities acquired is expected to be reported as part of the first quarter of 2017 earnings release and Form 10-Q as of March 31, 2017.  

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2016 AND 2015

Summary:  In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Net interest income from these products is the Company’s primary source of revenue.  Funding of the Company’s earning assets is achieved through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. The Company’s objective is to optimize its balance sheet position and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company maintains adequate liquidity, under prevailing and forecasted economic conditions, with an efficient and appropriate mix of core deposits, brokered deposits, and borrowed funds.

Securities: The Company maintains a relatively high quality and liquid security portfolio consisting of mortgage-backed securities (“MBS”) issued by U.S. government agencies, U.S. Government-sponsored enterprises and, to a much lesser extent, other non-agency, private-label issuers.  The securities portfolio also includes obligations of state and political subdivisions thereof.  Each investment is evaluated from a return on equity and interest rate risk perspective under the policy guidelines established by the Company’s Board of Directors.  The yield and duration of each security are given careful consideration given the current rising interest rate environment.  Overall, management has positioned the portfolio to provide flexibility in reacting to asset and liability changes as they arise.     

Total Securities: At December 31, 2016, total securities amounted to $528,856 compared with $504,969 at December 31, 2015, representing an increase of $23,887, or 4.7%. Securities purchased during 2016 consisted of MBS securities issued and guaranteed by U.S. Government agencies and sponsored enterprises and, to a lesser extent, obligations of state and political subdivisions.  All of the Company’s securities were classified as available for sale as of December 31, 2016 and 2015.

The following table summarizes the securities available for sale portfolio as of December 31, 2016, and 2015:

	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses
				Estimated Fair Value
December 31, 2016
Mortgage-backed securities:
US Government-sponsored enterprises	$330,635	$2,682	$4,865	$328,452
US Government agency	76,722	797	613	76,906
Private label	936	207	11	1,132
Obligations of states and political       subdivisions thereof	123,832	1,941	3,407	122,366
Total	$532,125	$5,627	$8,896	$528,856

	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
December 31, 2015
Mortgage-backed securities:
US Government-sponsored enterprises	$304,106	$  5,042	$2,155	$306,993
US Government agency	78,408	1,269	547	79,130
Private label	2,713	762	11	3,464
Obligations of states and political      subdivisions thereof	110,952	4,758	328	115,382
Total	$496,179	$11,831	$3,041	$504,969

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Mortgage-backed Securities Issued by U.S. Government-sponsored Enterprises: This category of securities represents MBS issued and guaranteed by U.S. Government-sponsored enterprises, specifically, Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”). These Government-sponsored enterprises were placed under the conservatorship of the U.S. Government on September 7, 2008. In August of 2011, Standard and Poor’s, a major credit rating agency, downgraded all debt issued and guaranteed by the United States from “AAA” to “AA+”. Accordingly, all of these securities were credit rated “AA+” at December 31, 2016 and 2015. At December 31, 2016, the amortized cost of MBS issued by U.S. Government enterprises comprised 62.1% of the securities portfolio, compared with 61.3% at December 31, 2015.  At December 31, 2016, the Bank’s weighted average yield on MBS issued by U.S. Government-sponsored enterprises amounted to 2.69% compared with 2.81% at December 31, 2015.

Mortgage-backed Securities Issued by U.S. Government Agencies: This category of securities represents MBS backed by the full faith and credit of the U.S. Government, such as the Government National Mortgage Association (“GNMA”). All of these securities were credit rated “AA+” at December 31, 2016 and 2015.  At December 31, 2016, the amortized cost of mortgage-backed securities issued by U.S. Government agencies comprised 14.4% of the Bank’s securities portfolio, compared with 15.8% at December 31, 2015.  At December 31, 2016, the weighted average yield on mortgage-backed securities issued by U.S. Government agencies amounted to 2.64%, compared with 2.95% at December 31, 2015.

Mortgage-backed Securities Issued by Private-label Issuers: This category of securities represents MBS issued by banks, investment banks, and thrift institutions. Typically, these securities are largely based on mortgages which exceed the conforming loan sizes required by agency securities. While private-label MBS are not guaranteed by any U.S. Government agency, they are credit rated by the major rating agencies (Moody’s, Standard & Poor’s and FITCH).

Most of the Bank’s MBS issued by private-label issuers carry various amounts of credit enhancement, and none are classified as sub-prime MBS pools. All of these securities were purchased prior to 2008 based on the underlying loan characteristics such as loan to value ratios, borrower credit scores, property type and location, and the level of credit enhancement.  At December 31, 2016, the amortized cost of mortgage-backed securities issued by private-label issuers comprised 0.2% of the Bank’s securities portfolio, compared with 0.5% at December 31, 2015.  At December 31, 2016, the weighted average yield on the Bank’s private-label MBS portfolio amounted to 20.78%, compared with 11.59% at December 31, 2015. The unusually high yields were largely attributed to interest received on certain other-than-temporarily impaired securities where the book value was significantly lower than the contractual par value.

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At December 31, 2016, $632 of the total amortized cost of the Bank’s private-label MBS portfolio was rated below investment grade by at least one of the major credit rating agencies, compared with $2,032 at December 31, 2015. All of these below investment grade securities had been rated “AAA” by the credit rating agencies at the date of purchase and continued to be rated “AAA” through December 31, 2007. Beginning in 2008, unprecedented market stresses began affecting all MBS (Government agency and private-label) as the economy, in general, and the housing market, in particular, seriously deteriorated. As a result, the Bank revised its assessments as to the full recoverability of its private-label MBS, which necessitated OTTI write-downs under existing accounting standards each year from 2008 through 2013. Refer to Part II, item 8, Notes to Consolidated Financial Statements, Notes 1 and 4 in this Annual Report on Form 10-K for further information on OTTI.

Obligations of States and Political Subdivisions Thereof: Obligations of states and political subdivisions thereof (“municipal bonds”) are issued by city, county and state governments, as well as by enterprises with a public purpose, such as certain electric utilities, universities and hospitals. One of the primary attractions of municipal bonds is that “Bank Qualified” issues are federally tax exempt. The Bank’s municipal securities primarily consist of general obligation bonds and, to a lesser extent, revenue bonds. General obligation bonds carry less risk, as they are supported by the full faith, credit and taxing authority of the issuing government and in the cases of school districts, are supported with state aid.  Revenue bonds are generally backed by municipal revenue streams generated through user fees or lease payments associated with specific municipal projects that have been financed. The Bank’s municipal bond portfolio is generally concentrated in school districts across the U.S.A., which have historically been considered among the safer municipal bond investments.

Municipal bonds are frequently supported with insurance, which guarantees that in the event the issuer experiences financial problems, the insurer will step in and assume payment of both principal and interest. Historically, insurance support has strengthened an issuer’s underlying credit rating to AAA or AA status. Starting in 2008, many of the insurance companies providing municipal bond insurance experienced financial difficulties and, accordingly, were downgraded by at least one of the major credit rating agencies. Consequently, since 2008 a portion of the Bank’s municipal bond portfolio was downgraded by at least one of the major credit rating agencies. Notwithstanding the credit rating downgrades, at December 31, 2016 and 2015, the Bank’s municipal bond portfolio did not contain any below investment grade securities as reported by major credit rating agencies. In addition, at December 31, 2016 and 2015 all municipal bond issuers were current on contractually obligated interest and principal payments.

At December 31, 2016, the amortized cost of municipal bonds comprised 23.3% of the Bank’s securities portfolio, compared with 22.4% at December 31, 2015. At December 31, 2016, the fully tax-equivalent yield on the Bank’s municipal bond portfolio amounted to 5.49%, compared with 5.57% at December 31, 2015.

Securities Maturity Distribution and Weighted Average Yields:  The following table summarizes the maturity distribution of the amortized cost of the Bank’s securities portfolio and weighted average yields of such securities on a fully tax-equivalent basis as of December 31, 2016. The maturity distribution is based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers have the right to prepay.

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Securities Concentrations: At December 31, 2016 and 2015, the Bank did not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceeded 2% of the Company’s shareholders’ equity.

Impaired Securities: The securities portfolio contains certain securities where amortized cost exceeds fair value, which at December 31, 2016, amounted to an excess of $8,896 or 1.7% of the total amortized cost of the securities portfolio. At December 31, 2015, this amount represented an excess of $3,041 or 0.6% of the total amortized cost of the securities portfolio. As of December 31, 2016, unrealized losses on securities in a continuous unrealized loss position more than twelve months amounted to $803, compared with $1,161 at December 31, 2015. The decrease in net unrealized losses was attributed to changes in long-term interest rates and pricing spreads at December 31, 2016, compared with December 31, 2015, which unfavorably impacted the fair value of the Bank’s fixed income portfolio.

Further information regarding impaired securities, other-than-temporarily impaired securities and evaluation of securities for impairment is incorporated by reference to Part II, Item 8, Notes 1 and 4 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

Federal Home Loan Bank Stock

The Bank is a member of the FHLB, which is a cooperatively owned wholesale bank for housing and finance in the six New England states. Its mission is to support the residential mortgage and community-development lending activities of its members, which include over 440 financial institutions across New England. 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 most of its wholesale funding needs.

At December 31, 2016, the Bank’s investment in FHLB stock totaled $25,331, compared with $21,479 at December 31, 2015, representing an increase of $3,852, or 17.9%. The foregoing increase was attributed to increased FHLB borrowing levels during 2016. Additionally, during 2016 shares held in excess of the minimum required amount were redeemed at par value.

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FHLB stock is a non-marketable equity security and therefore is reported at cost, which generally equals par value. The ratio of the FHLB’s market value of equity to its par value of capital stock was 148% at December 31, 2016, compared with 143% at December 31, 2015.

The Company periodically evaluates its investment in FHLB stock for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. The FHLB recently reported that it remained in compliance with all regulatory capital ratios as of December 31, 2016, and was classified as adequately capitalized by its regulator, the Federal Housing Finance Agency, based on the FHLB’s financial information at September 30, 2016.  Based on the capital adequacy, liquidity position and sustained profitability of the FHLB, management believes there is no impairment related to the carrying amount of the Bank’s FHLB stock as of December 31, 2016. The Bank will continue to monitor its investment in FHLB stock.

Loans

Total Loans: The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington, Knox, Kennebec and Sagadahoc, Maine. The following table summarizes the major components of the Bank’s loan portfolio, net of deferred loan fees and costs, as of December 31 over the past five years.

	2016	2015	2014	2013	2012
Commercial real estate mortgages	$   403,594	$371,002	$325,949	$336,542	$324,493
Commercial and industrial	103,586	79,911	73,893	73,972	59,373
Commercial construction and       land development	14,695	24,926	25,421	18,129	22,120
Agricultural and other loans to farmers	31,808	31,003	30,471	26,929	24,922
Total commercial loans	553,683	506,842	455,734	455,572	430,908
Residential real estate mortgages	506,612	408,401	382,678	317,115	297,103
Home equity loans	46,921	51,530	51,795	49,565	53,303
Other consumer loans	6,172	7,949	12,140	14,523	19,001
Total consumer loans	559,705	467,880	446,613	381,203	369,407
Tax exempt loans	15,846	15,244	16,693	16,355	15,244
Net deferred loan costs and fees	(170)	104	(16)	(273)	(555)
Total loans	1,129,064	990,070	919,024	852,857	815,004
Allowance for loan losses	(10,419)	(9,439)	(8,969)	(8,475)	(8,097)
Total loans net of allowance for loan losses	$1,118,645	$980,631	$910,055	$844,382	$806,907

At December 31, 2016, commercial loans comprised 49.0% of the total loan portfolio, compared with 51.2% at December 31, 2015. Consumer loans, which principally consisted of residential real estate mortgage loans, comprised 49.6% of total loans at December 31, 2016, compared with 47.3% at December 31, 2015.

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Commercial Loans: The Bank offers a variety of commercial lending products including term loans and lines of credit. The Bank offers a broad range of commercial loans, primarily collateralized, to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure. Commercial loans are provided primarily to organizations and sole proprietors in the tourism, hospitality, healthcare, blueberry, boatbuilding, biological research, insurance, and fishing industries, as well as to other small and mid-size businesses associated with the coastal communities of Maine.

At December 31, 2016, total commercial loans amounted to $553,683, compared with $506,842 at December 31, 2015, representing an increase of $46,841, or 9.2%.

Commercial loan growth has generally been challenged by continued economic uncertainty, diminished demand, and strong competition for quality loans. Bank management attributes the growth of commercial loans to an effective business banking team, deep local market knowledge, sustained new business development efforts, and a resilient local economy that has been faring better than the nation as a whole.

Reflecting the Bank’s business region, at December 31, 2016, approximately $127,676 or 31.6% of the commercial real estate mortgage portfolio was represented by loans to the lodging industry, compared with $95,330 or 25.7% at December 31, 2015. The Bank underwrites lodging industry loans as operating businesses, lending primarily to seasonal establishments with stabilized cash flows.

The proportion of commercial and industrial loans to total commercial loans is generally reflective of the Bank’s market area demographics, which have historically limited the opportunity and growth potential in this particular category of loans. Similarly, the communities served by the Bank generally offer limited opportunities for agricultural and other loans to farmers.  This category of loans principally includes loans related to Maine’s wild blueberry industry.

Consumer Loans: At December 31, 2016, total consumer loans stood at $559,705 compared with $467,880 at December 31, 2015, representing an increase of $91,825, or 19.6%. At December 31, 2016, residential real estate mortgage loans represented 90.5% of total consumer loans, compared with 87.3% at December 31, 2015.

Residential real estate mortgage loans totaled $506,612 as of December 31, 2016, compared with $408,401 at December 31, 2015, representing an increase of $98,211, or 24.0%.  The increase in residential real estate mortgage loans was aided by the purchased loans. Loans originated and closed by the Bank during 2016 were largely offset by loan re-financings and scheduled principal amortization from the existing residential real estate loan portfolio.

Home equity loans totaled $46,921 at December 31, 2016, compared with $51,530 at December 31, 2015, representing a decline of $4,069, or 8.9%. The Bank did not aggressively campaign for home equity loans during 2016.

Loans to individuals for household, family and other personal expenditures (“other consumer loans”) totaled $6,172 at December 31, 2016, compared with $7,949 at December 31, 2015, representing a decline of $1,777, or 22.4%. Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank does not campaign aggressively for consumer installment loans.

Tax Exempt Loans: Tax-exempt loans totaled $15,846 at December 31, 2016, compared with $15,244 at December 31, 2015, representing an increase of $602, or 3.9%. Tax-exempt loans include loans to local government municipalities, not-for-profit organizations, and other organizations that qualify for tax-

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exempt treatment. Government municipality loans typically have short maturities (e.g., tax anticipation notes, etc.). Government municipality loans are normally originated through a bid process among local financial institutions and are typically priced aggressively, thus generating relatively narrow net interest margins.

Loan Concentrations: Because of the Bank’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31, 2016, approximately $128,680 or 11.4% of the Bank’s loan portfolio was represented by loans to the lodging industry, compared with $98,231 or 9.9% at December 31, 2015. Loan concentrations continued to principally reflect the Bank’s business region.

Mortgage Loan Servicing: The Bank, from time to time, will sell residential mortgage loans to other institutions and investors such as the FHLMC. In prior years, the Bank has generally sold fixed rate, long term residential mortgage loans, as a means of managing interest rate risk. The sale of loans also allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2016, the unpaid balance of mortgage loans serviced for others totaled $9,501 compared with $11,175 at December 31, 2015, representing a decline of $1,674 or 15.0%.

Loan Portfolio Interest Rate Composition:  The following table summarizes the commercial, tax-exempt and consumer components of the loan portfolio by fixed and variable interest rate composition, as of December 31, 2016 and 2015:

	2016	2015
Commercial:
Fixed	$     88,428	$  87,347
Variable	465,405	419,560
Total	$   553,833	$506,907
Tax exempt:
Fixed	$      7,585	$    6,939
Variable	8,026	8,293
Total	$     15,611	$  15,232
Consumer:
Fixed	$   453,744	$352,687
Variable	105,876	115,245
Total	$   559,620	$467,932
Total loans:
Fixed	$   549,757	$446,972
Variable	579,307	543,098
Total	$1,129,064	$990,070

At December 31, 2016, fixed and variable rate loans comprised 48.7% and 51.3% of the loan portfolio, respectively, compared with 45.1% and 54.9% at December 31, 2015.

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Loan Maturities and Re-pricing Distribution:  The following table summarizes fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31, 2016 and 2015. Actual maturity dates may differ from contractual maturity dates due to prepayments, modifications and re-financings.

Maturities	2016	2015
One year or less	$   289,786	$306,977
Over 1 - 5 years	231,606	196,431
Over 5 years	607,672	486,662
Total loans	$1,129,064	$990,070

Credit Risk: Credit risk is managed through loan officer authorities, loan policies, and oversight from the Bank’s Chief Credit Officer, the Bank's Management Loan Committee, the Directors’ Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to management's review, of individual credits is performed by an independent loan review consulting firm, which reports to the Audit Committee of the Board of Directors.

Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses and maximize earnings. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Closed-end non-residential mortgage loan losses are recognized no later than the point at which a loan is 120 days past due, and open-end retail loan losses are recognized no later than the point at which a loan is 180 days past due. Residential mortgage loan losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans, the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlate with regulatory definitions of “Pass,” “Other Assets Especially Mentioned,” “Substandard,” “Doubtful,” and “Loss.”

As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and or interest is 90 days overdue, or sooner if judged appropriate by management. Consumer loans are generally charged-off when principal and or interest payments are 120 days overdue, or sooner if judged appropriate by management.

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Non-performing Loans: Non-performing loans include loans on non-accrual status and loans past due 90 days or more and still accruing interest. The following table sets forth the details of non-performing loans over the past five years.

At December 31, 2016, total non-performing loans amounted to $6,496, compared with $7,008 at December 31, 2015, representing a decline of $512, or 7.3%.

Non-performing commercial real estate mortgages totaled $2,564 at December 31, 2016, representing an increase of $1,285, or 100.5%, compared with December 31, 2015. The increase was due to the reclassification of a non-performing commercial construction and land development loan that was completed in 2016. At December 31, 2016, non-performing commercial real estate mortgages were represented by 15 business relationships, with outstanding balances ranging from $31 to $637.

Non-performing commercial and industrial loans totaled $284 at December 31, 2016, representing a decline of $8, or 2.7%, compared with December 31, 2015.  At December 31, 2016, non-performing commercial and industrial loans were represented by four business relationships, with outstanding balances ranging from $11 to $170.

Non-performing commercial construction and land development loans totaled zero at December 31, 2016, representing a decline of $1,111, or 100%, compared with December 31, 2015. At December 31, 2015, non-performing commercial construction and land development loans were entirely represented by a commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project. This loan is principally secured by the housing units from the project. The project is fully constructed and there is no construction risk associated with the loan. The primary source of repayment is the sale of the existing housing units. This loan is impaired and was put on non-accrual status in late 2010. This loan was reclassified to non-performing commercial real estate mortgages during 2016.

Non-performing agricultural and other loans to farmers totaled $31 at December 31, 2016, representing an increase of $15, or 93.8%, compared with December 31, 2015. At December 31, 2016, non-performing agricultural and other loans to farmers were represented by one loan, with an outstanding balance of $31.

Non-performing residential real estate mortgage loans totaled $3,419 at December 31, 2016, representing a decline of $33, or 1.0%, compared with December 31, 2015. At December 31, 2016, non-performing residential real estate mortgage loans were represented by 40 conventional 1-4 family mortgage loans, with outstanding balances ranging from $9 to $472.

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Non-performing home equity loans totaled $90 at December 31, 2016, representing a decline of $730, or 89.0%, compared with December 31, 2015. At December 31, 2016, non-performing home equity loans were represented by five relationships with outstanding balances ranging from $7 to $44.

Non-performing other consumer  loans totaled $108 at December 31, 2016, representing an increase of $98, or 980.0%, compared with December 31, 2015. At December 31, 2016, non-performing other consumer loans were represented by six relationships with outstanding balances ranging from $1 to $83.

While the level and mix of non-performing loans continued to reflect favorably on the overall quality of the loan portfolio as of December 31, 2016, Bank management is cognizant of the still-recovering real estate market and soft economic conditions overall. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank’s customers, including debt service levels, collateral values, tourism activity, consumer confidence and other factors existing at the time.  Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.

Delinquencies and Potential Problem Loans: In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent. These loans amounted to $6,103 and $1,857 at December 31, 2016, and 2015, or 0.54% and 0.19% of total loans, respectively, net of any loans classified as non-performing that are within these delinquency categories. These loans and delinquency trends in general are considered in the evaluation of the allowance for loan losses and the related determination of the provision for loan losses.

On an ongoing basis, the Bank reviews the commercial loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the borrower causes doubt about the ability of the borrower to comply with the loan payment terms and may result in disclosure of such loans as non-performing at some time in the future.

In addition the non-performing and delinquent loans discussed above, at December 31, 2016, the Bank identified 34 commercial relationships totaling $20,299, or 1.8% of total loans, as other potential problem loans (i.e. loans classified as sub-standard that were not delinquent or non-performing). At December 31, 2015, the Bank identified 32 commercial relationships totaling $19,774 as potential problem loans, or 2.0% of total loans. Factors such as payment history, value of supporting collateral, and personal or government guarantees led the Bank to conclude that the current risk exposure on these potential problem loans did not warrant accounting for the loans as non-performing. Although in a performing status as of year-end, these loans exhibited certain risk factors, which have the potential to cause them to become non-performing at some point in the future.

Allowance for Loan Losses: At December 31, 2016, the allowance for loan losses (the “allowance”) stood at $10,419, compared with $9,439 at December 31, 2015, representing an increase of $980, or 10.4%. The increase in the allowance from December 31, 2015 was largely attributed to loan growth combined with changes in the overall mix of non-performing and other potential problem loans.

Specific allowances for impaired loans are determined based upon a discounted cash flows analysis, or as appropriate, a collateral shortfall analysis. The amount of collateral dependent impaired loans totaled $3,268 as of December 31, 2016, compared with $1,999 as of December 31, 2015, representing an increase of $1,269 or 63.5%. The related allowances for loan losses on these impaired loans amounted to $369 and $312 as of December 31, 2016 and 2015, respectively.

Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $286, $117, and $58 for the years ended December 31, 2016, 2015 and 2014, respectively.

General allowances for loan losses account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no material changes in loan concentrations during 2016 compared with 2015.

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, management believes the allowance for loan losses at December 31, 2016, is appropriate for the risks inherent in the loan portfolio.

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

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The following table details changes in the allowance for loan losses and summarizes loan loss experience by loan type over the past five years.

	2016	2015	2014	2013	2012
Balance at beginning of period	$      9,439	$    8,969	$    8,475	$    8,097	$    8,221
Charge-offs:
Commercial real estate mortgages	133	667	238	214	474
Commercial and industrial	90	323	475	405	102
Commercial construction and      land development	---	---	---	---	344
Agricultural and other loans to farmers	---	72	14	81	160
Residential real estate mortgages	141	70	650	406	568
Other consumer loans	37	111	191	120	294
Home equity loans	10	376	52	29	92
Tax exempt loans	---	---	---	---	---
Total charge-offs	411	1,619	1,620	1,255	2,034
Recoveries:
Commercial real estate mortgages	40	$         98	$         85	$       105	$           9
Commercial and industrial loans	242	36	16	23	25
Commercial construction and      land development	---	---	---	---	---
Agricultural and other loans to farmers	47	18	130	37	82
Residential real estate mortgages	44	129	12	7	104
Other consumer loans	29	22	37	23	38
Home equity loans	10	1	1	20	---
Tax exempt loans	---	---	---	---	---
Total recoveries	412	304	281	215	258
Net (recoveries) charge-offs	(1)	1,315	1,339	1,040	1,776
Provision charged to operations	979	1,785	1,833	1,418	1,652
Balance at end of period	$    10,419	$    9,439	$    8,969	$    8,475	$    8,097
Average loans outstanding during period	$1,054,687	$962,240	$881,389	$839,010	$779,800
Annualized net charge-offs to      average loans outstanding	0.00%	0.14%	0.15%	0.12%	0.23%

For the year ended December 31, 2016, total net loan recoveries amounted to $1, compared to net charge-offs of $1,315 in 2015, representing a decline of $1,316 or 100.1%. Total net charge-offs to average loans outstanding amounted to 0.00% in 2016, compared with 0.14% in 2015.

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The following table presents the five-year summary of the allowance by loan type at each respective year-end.

Bank Owned Life Insurance

Bank owned life insurance (“BOLI”) represents life insurance on the lives of certain current and retired employees who have provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value of the BOLI is included on the Company’s consolidated balance sheet.

The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and quarterly thereafter.  At December 31, 2016, the Bank had four BOLI carriers which were credit rated by Standard & Poor’s as “AA-” or higher (i.e., “high grade investments”).

At December 31, 2016, the cash surrender value of BOLI amounted to $24,450, compared with $23,747 at December 31, 2015, representing an increase of $703, or 3.0%. The increase in BOLI was attributed to increases in the cash surrender value of the BOLI policies.

Other Assets

The Company’s other assets are principally comprised of accrued interest receivable, deferred income taxes and other real estate owned. At December 31, 2016, total other assets amounted to $21,274, compared with $13,900 at December 31, 2015, representing an increase of $7,374 or 53.1%.  The increase was principally due to an increase in deferred tax assets reflecting lower unrealized security gains in 2016 as compared to 2015.

Funding Sources

The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of retail deposits and, to a lesser extent, certificates of deposit obtained from the national market, borrowings from the FHLB, of which it is a member, Fed funds purchased and borrowing from the Federal Reserve Bank of Boston, subordinated debt and securities sold under agreements to repurchase.

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Deposits

Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in the summer and autumn. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing capacity from the FHLB, brokered certificates of deposit obtained from the national market and cash flows from its securities portfolio.

Total Deposits: At December 31, 2016, total deposits amounted to $1,050,300 compared with $942,787 at December 31, 2015, representing an increase of $107,513, or 11.4%. Total demand deposit and other interest bearing deposit, NOW accounts, and savings and money market accounts increased $87,805 or 16.1%, while time deposits increased $19,708, or 5.0%, compared with December 31, 2015.

Demand Deposits: The Bank’s demand deposits are principally business accounts. At December 31, 2016, total demand deposits amounted to $98,856, compared with $86,577 at December 31, 2015, representing an increase of $12,279, or 14.2%. As discussed above, the Bank’s deposits are seasonal in nature and the timing and extent of seasonal swings vary from year to year. This is particularly the case with demand deposits. For the year ended December 31, 2016, total average demand deposits amounted to $93,757 compared with $82,741 in 2015, representing an increase of $11,016, or 13.3%. The increase in average demand deposits was largely attributed to a relatively strong tourist season in the local communities served by the Bank combined with new customer relationships.

The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include Easy Business Checking, Small Business Checking, Business Checking with Interest, Business Plus Checking, and Non-Profit Business Plus Checking, each designed to help business owners manage the varying financial aspects of their business. The Bank also offers Remote Deposit Capture, enabling its business customers to deposit checks remotely. Business demand deposits are also generated by way of the Bank’s Merchant Credit Card Processing Program.

NOW Accounts: The Bank offers interest bearing NOW accounts to individuals and not-for-profit organizations. At December 31, 2016, total NOW accounts amounted to $175,150, compared with $160,394 at December 31, 2015, representing an increase of $14,756, or 9.2%. For the year ended December 31, 2016, average NOW accounts amounted to $161,494, compared with $149,117 in 2015, representing an increase of $12,377, or 8.3%.  

Savings and Money Market Deposits:  At December 31, 2016, total savings and money market accounts amounted to $359,857, compared with $299,087 at December 31, 2015, representing an increase of $60,770, or 20.3%.  For the year ended December 31, 2016, average savings and money market accounts amounted to $312,982, compared with $266,929 in 2015, representing an increase of $46,053 or 17.3%. This increase was principally attributed to both new and existing customer relationships.

Time Deposits: At December 31, 2016, total time deposits amounted to $416,437, compared with $396,729 at December 31, 2015, representing an increase of $19,708, or 5.0%. The increase in time deposits was primarily due to an increase in jumbo time deposits, compared with December 31, 2015. A portion of the Bank’s time deposits include certificates of deposit obtained from the national market. This source of funds is generally utilized to help support the Bank’s earning asset growth, while maintaining its strong on-balance-sheet liquidity position via secured borrowing lines of credit with the FHLB and the Federal Reserve Bank of Boston.

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The following table summarizes the changes in the average balances of deposits during the periods indicated, including the weighted average interest rates paid for each category of deposits:

	2016		2015
	Average Balance	Average Rate	Average Balance	Average Rate
Demand deposits	$  93,757	---%	$  82,741	---%
NOW accounts	161,494	0.20	149,117	0.20
Savings and money market deposits	312,982	0.33	266,929	0.29
Time deposits	414,347	1.29	427,550	1.18
Total deposits	$982,580		$926,337

The following table summarizes the maturity distribution of time deposits of $100 or greater as of December 31 2016:

	Amount
Less than 3 months	$  32,540
Over three to six months	9,863
Over six to twelve months	30,279
Over twelve months	39,362
	$112,044

Time deposits in denominations of $100 or greater totaled $112,044 at December 31, 2016, compared with $93,481 at December 31, 2015, representing an increase of $18,563, or 19.9%.

Borrowed Funds

The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Bank’s ability to select desired amounts, terms and maturities on a daily basis.

Borrowed funds principally consist of advances from the FHLB and, to a lesser extent, securities sold under agreements to repurchase, Fed funds purchased and borrowings from the Federal Reserve Bank of Boston.  Advances from the FHLB are secured by stock in the FHLB, investment securities, certain commercial real estate loans, and blanket liens on qualifying mortgage loans and home equity loans.  

Refer to Part II, Item 7, Contractual Obligations, and Notes 11 and 12, Short-term Borrowings and Long-term Debt, of the consolidated financial statements in this annual report on form 10-K for further information on borrowed funds.

Junior Subordinated Debentures: In the second quarter of 2008, the Bank issued $5,000 aggregate principal amount of subordinated debt securities. These securities qualify as Tier 2 capital for the Bank and the Company and were issued to help support future earning asset growth without jeopardizing the

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Bank’s historically strong capital position. The subordinated debt securities are due in 2023, but are callable quarterly by the Bank after five years without penalty. The rate of interest on these securities is three month Libor plus 345 basis points. The subordinated debt securities are classified as borrowings on the Company’s consolidated balance sheet.

Total Borrowings: At December 31, 2016, total borrowings amounted to $536,596, compared with $474,791 at December 31, 2015, representing an increase of $61,805, or 13.0%. The increase in borrowings was principally utilized to help fund the Bank’s earning asset growth.

Capital Resources

Consistent with its long-term goal of operating a sound and profitable organization, at December 31, 2016 the Company maintained its strong capital position and continued to be a “well-capitalized” financial institution according to applicable regulatory standards. Management believes this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth.

During 2015 the Company amended its Articles of Incorporation to increase the number of shares of common stock authorized for issuance from 10,000,000 shares to 20,000,000 shares. The $2.00 par value of the Company’s common stock, as well as the authorized issuance of up to 1,000,000 shares of preferred stock, remained unchanged from prior periods.

In October 2009, the Company filed a shelf registration statement on Form S-3 with the SEC to register an indeterminate number of shares of common stock and preferred stock, which together have an aggregate initial offering price not to exceed $35,000 (the “Shelf Registration”). The SEC declared the Company’s Shelf Registration effective on November 3, 2009.  In December of 2009 the Company announced that it had completed its offering of 800,000 shares of its common stock to the public at $27.50 per share. The principal use of the net proceeds from that offering were used to repurchase all the Company’s Series A preferred shares previously sold to the U.S. Department of the Treasury under its Capital Purchase Program.

The Company’s Shelf Registration expired on November 3, 2012. The Company has not decided whether to file a new shelf registration statement and does not have any current plans to raise additional capital; however, the Company does recognize that financial flexibility is important and that a shelf registration filed with the SEC can be a prudent capital management tool should the need or opportunity to raise capital on attractive terms arise and, therefore, the Company may consider the filing of a new shelf registration with the SEC on terms similar to the Shelf Registration or other terms during 2017 or in other future years.

Capital Ratios: The Company and the Bank are subject to the risk-based capital guidelines administered by the Company’s and the Bank's principal regulators. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk-weighted assets and off-balance sheet items. Effective January 1, 2015, the Company and the Bank adopted the Basel III capital adequacy rules which, among other changes added a new risk-weighted capital measure Common Equity Tier 1 (“CET1”).  The new Basel III capital adequacy guidelines require all banks and bank holding companies to maintain minimum capital ratios of:

·

Common Equity Tier 1 of 4.5%

·

Total risk-based capital to risk-weighted assets of 8.0%

·

Tier 1 capital to total risk-weighted assets of 6.0%

·

Tier 1 capital to average assets (“Leverage Ratio”) of 4.0%

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Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company's financial statements.

As of December 31, 2016, the Company and the Bank were considered well-capitalized under the regulatory framework for prompt corrective action. Under the Basel III capital adequacy guidelines, a well-capitalized institution must maintain the following capital ratios:

·

Common Equity Tier 1 of 6.5%

·

Total risk-based capital to risk-weighted assets of 10.0%

·

Tier 1 capital to total risk-weighted assets of 8.0%

·

Tier 1 capital to average assets  (“Leverage Ratio”) of 5.0%

The following table sets forth the Company's regulatory capital at December 31, 2016 and 2015, under the rules applicable at that date.

	2016		2015
	Amount	Ratio	Amount	Ratio
Common Equity Tier 1 to Risk Weighted Assets	$155,905	15.01%	$145,400	15.55%
Regulatory Requirement	46,742	4.50	42,071	4.50
Excess over "adequately capitalized"	$109,163	10.51%	$103,329	11.05%
Tier 1 Capital to Risk Weighted Assets	$155,905	15.01%	$145,400	15.55%
Regulatory Requirement	62,323	6.00	56,095	6.00
Excess over "adequately capitalized"	$  93,582	9.01%	$  89,305	9.55%
Tier 1 Capital to Average Assets	$171,558	16.52%	$160,042	17.12%
Regulatory Requirement	83,097	8.00	74,793	8.00
Excess over "adequately capitalized"	$  88,461	8.52%	$  85,249	9.12%
Tier 1 Capital to Average Assets (Leverage)	$155,905	8.94%	$145,400	9.37%
Regulatory Requirement	69,722	4.00	62,087	4.00
Excess over "adequately capitalized"	$  86,183	4.94%	$  83,313	5.37%

As more fully disclosed in Note 14 of the Consolidated Financial Statements in this Annual Report on Form 10-K, the Bank also maintained its standing as a well-capitalized institution as defined by applicable regulatory standards.

Shareholders’ Equity: At December 31, 2016, total shareholders’ equity amounted to $156,740, compared with $154,152 at December 31, 2015, representing an increase of $2,588, or 1.7%. The increase in shareholder’s equity was attributed to an $8,299 increase in retained earnings offset by a $7,955 decline in accumulated other comprehensive income. This decline was principally the result of a reduction in unrealized gains in the Bank’s securities portfolio, which changed from a tax effected unrealized gain of $5,713 at December 31, 2015 to a tax effected unrealized loss of $2,125 at December 31, 2016, largely resulting from interest rate movements between reporting periods.

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Trends, Events or Uncertainties: There are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Company’s capital resources, liquidity, or financial condition.

Stock Repurchase Plan: In August 2008, the Company’s Board of Directors approved a 24 month program to repurchase up to 450,000 shares of the Company’s common stock, or approximately 10.2% of the shares then currently outstanding.  The Company’s Board of Directors authorized the continuance of this program for additional 24 month periods in August 2010, 2012 and 2014.  On August 16, 2016, the Company’s Board of Directors authorized the continuance of this program through August 17, 2018.

Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time to time, without prior notice and may be made in the open market or through privately negotiated transactions.

As of December 31, 2016, the Company had repurchased 173,794 shares of stock under this plan, at a total cost of $3,465 and an average price of $19.94 per share. During 2016, the Company repurchased 15,381 shares under the plan, at a total cost of $497 and an average price of $32.30. The Company records repurchased shares as treasury stock.

Cash Dividends:  The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter, the Board of Directors may declare the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of its balance sheet, its need for funds, and other relevant factors. There can be no assurance that dividends on the Company’s common stock will be paid in the future.

The Company’s principal source of funds to pay cash dividends and support its commitments is derived from Bank operations. During 2016, the Company declared and distributed regular cash dividends on its common stock in the aggregate amount of $6,577 compared with $6,040 in 2015. The Company’s 2016 dividend payout ratio amounted to 44.0%, compared with 39.9% in 2015. The total regular cash dividends paid in 2016 amounted to $1.09 per common share of common stock, compared with $1.01 in 2015, representing an increase of $0.08 per share, or 7.9%.

In the first quarter of 2017, the Company declared a regular cash dividend of $0.28 per share of common stock, representing an increase of $0.015 or 5.7%, compared with the first quarter of 2016. Based on the December 31, 2016 price of the Company’s common stock of $47.33 per share, the dividend yield amounted to 2.37%.

Contractual Obligations

The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first and second mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.

The Company is also obligated to make payments on operating leases for its retail branch offices in Somesville and Topsham, Maine, as well as office space in Hampden and Rockland, Maine.

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Borrowings are stated at their contractual maturity due dates and do not reflect call features, or principal amortization features, on certain borrowings. The following table summarizes the Company’s contractual obligations at December 31, 2016.

All FHLB advances are fixed-rate instruments. Advances are payable at their call dates or final maturity dates. At December 31, 2016, the Bank had $17,000 in callable advances.

In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATMs, Visa Debit Card processing, trust services accounting support, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.

The majority of the Company’s core operating systems and software applications are maintained “in-house” with traditional third party maintenance agreements of one year.

Off-Balance Sheet Arrangements

The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.

At December 31, 2016 and 2015, the Company’s off-balance sheet arrangements were limited to standby letters of credit.

Standby Letters of Credit: The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third-party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.

At December 31, 2016 and 2015, commitments under existing standby letters of credit totaled $385. The fair value of the standby letters of credit was not significant as of the foregoing dates.

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Off-Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and certain financial derivative instruments.

Commitments to Extend Credit: Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments, such as loans. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.

The following table summarizes the Bank’s commitments to extend credit as of December 31:

	2016	2015
Commitments to originate loans	$  41,731	$  41,529
Unused lines of credit	98,823	97,283
Un-advanced portions of construction loans	20,330	12,719
Total	$160,884	$151,531

Financial Derivative Instruments: 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 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 include interest rate swap agreements, interest rate floor agreements and interest rate cap agreements.

At December 31, 2016 and 2015, the Bank had four outstanding, off balance sheet, derivative instruments. These derivative instruments were interest rate cap agreements, with notional principal amounts totaling $90,000. 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 the counter-party defaults in its responsibility to pay interest under the terms of the agreements. The interest rate cap agreements were purchased by the Bank to limit its exposure to rising interest rates and were designated as cash flow hedges.

Further information covering the Bank’s derivative instruments is incorporated by reference to Part II, Item 8, Notes 1 and 12 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

Liquidity

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for

52

maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Bank actively manages its liquidity position through target ratios established under its Asset Liability Management Policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.

The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Bank’s policy is to maintain a liquidity position of at least 4% of total assets. At December 31, 2016, liquidity, as measured by the basic surplus model, was 9.2% over the 30-day horizon and 8.7% over the 90-day horizon.

At December 31, 2016, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB approximating $221,440. The Bank also had capacity to borrow funds on a secured basis utilizing the Borrower in Custody (“BIC”) program and the Discount Window at the Federal Reserve Bank of Boston (the “FRB”). At December 31, 2016, the Bank’s available secured line of credit at the FRB stood at $130,979 or 7.5% of the Bank’s total assets. The Bank also has access to the national brokered deposit market, and has used this funding source to bolster its on balance sheet liquidity position.

The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. Company management believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.

AVERAGE BALANCES, INTEREST, AVERAGE YIELDS/COST AND RATE/VOLUME ANALYSIS

Tables with the above information are presented in Item 6 of this report.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the principal component of the Company’s income stream and represents the difference or spread between interest generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.

Total Net Interest Income: For the year ended December 31, 2016, net interest income on a tax-equivalent basis amounted to $47,467 compared with $46,792 in 2015, representing an increase of $675, or 1.4%.  The increase in 2016 tax-equivalent net interest income was attributed to average earning asset growth of $132,345 or 9.0%, as the net interest margin declined 23 basis points compared with 2015.

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For the year ended December 31, 2015, net interest income on a tax-equivalent basis amounted to $46,792 compared with $45,698 in 2015, representing an increase of $1,094, or 2.4%. The increase in 2016 tax-equivalent net interest income was attributed to average earning asset growth of $97,287 or 7.1%, as the net interest margin declined 14 basis points compared with 2014.

For the year ended December 31, 2016, the tax equivalent net interest margin amounted to 2.96%, compared with 3.19% in 2015, representing a decline of 23 basis points. The decline in the net interest margin was principally attributed to a 17 basis point decline in the weighted average earning asset yield, as well as a six basis point increase in the weighted average cost of interest bearing liabilities.

For the year ended December 31, 2015, the tax equivalent net interest margin amounted to 3.19%, compared with 3.33% in 2014, representing a decline of fourteen basis points. The decline in the net interest margin was principally attributed to a 16 basis point decline in the weighted average earning asset yield, partially offset by a two basis point decline in the weighted average cost of interest bearing liabilities.

Interest and Dividend Income: For the year ended December 31, 2016, total interest and dividend income on a tax-equivalent basis amounted to $59,580, compared with $57,182 in 2015, representing an increase of $2,398, or 4.2%. The increase in interest and dividend income was attributed to average interest earning asset growth of $132,345 or 9.0%, partially offset by a decline in the weighted average earning asset yield of 17 basis points to 3.72%.

For the year ended December 31, 2015, total interest and dividend income on a tax-equivalent basis amounted to $57,182, compared with $55,603 in 2014, representing an increase of $1,579, or 2.8%. The increase in interest and dividend income was attributed to average earning growth of $97,287 or 7.1%, as the weighted average earning asset yield remained unchanged at 3.89%.

For the year ended December 31, 2016, tax-equivalent interest income from the securities portfolio amounted to $16,823, compared with $17,059 in 2015, representing a decline of $236, or 1.4%. This decline was principally attributed to a 30 basis point decline in the weighted average securities yield to 3.22%, but was largely offset by a $37,233 or 7.7% increase in total average securities, compared with 2015.

For the year ended December 31, 2015, tax-equivalent interest income from the securities portfolio amounted to $17,059, compared with $17,331 in 2014, representing an increase of $272 or 1.6%. This increase was principally attributed to a 17 basis point increase in the weighted average securities yield to 3.52%, but was largely offset by a $14,335 or 3.0% increase in total average securities, compared with 2014.  The decline in the weighted average securities yield was largely attributed to the replacement of MBS cash flows in a still-historically low interest rate environment, combined with management’s 2015 efforts to lower the duration of the securities portfolio.

For the year ended December 31, 2016, tax-equivalent interest income from the loan portfolio amounted to $41,889, compared with $39,545 in 2015, representing an increase of $2,344, or 5.9%. This increase was attributed to average loan portfolio growth of $92.447 or 9.6%, partially offset by a decline in the weighted average loan yield of 14 basis points to 3.97%.

For the year ended December 31, 2015, tax-equivalent interest income from the loan portfolio amounted to $39,545, compared with $37,982 in 2014, representing an increase of $1,563, or 4.1%. This increase was attributed to average loan portfolio growth of $80,851 or 9.2%, partially offset by a decline in the previously discussed weighted average loan yield of 20 basis points to 4.11%.

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Interest Expense: For the year ended December 31, 2016, total interest expense amounted to $12,113, compared with $10,390 in 2015, representing an increase of $1,723, or 16.6%. This increase was principally attributed to a $113,417 or 8.7% increase in average interest bearing liabilities, and to a lesser extent a six basis point increase in the weighted average cost of interest bearing liabilities to 0.86%, compared with 2015.

The 2016 increase in the average cost of interest bearing liabilities was principally attributed to increases in the weighted average cost borrowings, which increased nine basis points to 1.03%, principally reflecting the maturity of higher cost, long-term borrowings that were replaced in a historically low interest rate environment.

For the year ended December 31, 2015, total interest expense amounted to $10,390, compared with $9,905 in 2014, representing an increase of $485, or 4.9%. This increase was principally attributed to a $92,297 or 7.6% increase in average interest bearing liabilities, partially offset by a two basis point decline in the weighted average cost of interest bearing liabilities to 0.80%, compared with 2014.

The 2015 decline in the average cost of interest bearing liabilities was principally attributed to prevailing, historically low short-term and long-term market interest rates, with maturing time deposits and borrowings being added or replaced at a lower cost and other interest bearing deposits re-pricing into the lower interest rate environment. The weighted average cost of interest bearing deposits declined two basis points in 2015 to 0.72%, while the weighted average cost of borrowings declined five basis points to 0.94%, principally reflecting the maturity of higher cost, long-term borrowings that were replaced in a historically low interest rate environment.  

Provision for Loan Losses

The provision for loan losses (the “provision”) reflects the amount necessary to maintain the allowance for loan losses (the “allowance”) at a level that, in management’s judgment, is appropriate for the amount of inherent risk of probable loss in the Bank’s current loan portfolio.

For the year ended December 31, 2016, the Bank recorded a provision of $979, compared with $1,785 in 2015, representing a decline of $806 or 45.2%. The decline in the provision was largely attributed to lower levels of non-performing loans and loan charge-off experience, combined with relatively stable credit quality metrics.

For the year ended December 31, 2015, the Bank recorded a provision of $1,785, compared with $1,833 in 2014, representing a decline of $48, or 2.6%. The moderate decline in the provision was attributed to lower levels of non-performing loans and loan charge-off experience, combined with relatively stable credit quality metrics.

Refer to Part II, Item 7, Non-performing Loans, Potential Problem Loans and the Allowance for Loan Losses, in this Annual Report on Form 10-K for further discussion and analysis related to the provision for loan losses.

Non-interest Income

In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. In 2016, non-interest income represented 21.5% of total net interest income and non-interest income, compared with 16.7% and 15.0% in 2015 and 2014, respectively.

For the year ended December 31, 2016, total non-interest income amounted to $12,349, compared with $8,979 in 2015, representing an increase of $3,370, or 37.5%.

For the year ended December 31, 2015, total non-interest income amounted to $8,979, compared with $7,758 in 2014, representing an increase of $1,221, or 15.7%.

Trust and Financial Services Income: Income from trust and financial services represented 31.0% of the Company’s total non-interest income in 2016, compared with 43.3% and 51.3% in 2015 and 2014, respectively. Income from trust and financial services is principally derived from fee income based on a percentage of the fair market value of client assets under management and held in custody and, to a lesser extent, revenue from retail brokerage services conducted through Bar Harbor Financial Services, an independent third-party broker.

For the year ended December 31, 2016, income from trust and other financial services amounted to $3,829, compared with $3,888, in 2015, representing a decline of $59, or 1.5%. This decline was attributed to lower levels of revenue from retail brokerage activities.

For the year ended December 31, 2015, income from trust and other financial services amounted to $3,888, compared with $3,976, in 2014, representing a decline of $88, or 2.2%. This decline was attributed to lower levels of revenue from retail brokerage activities.

At December 31, 2016, total assets under management stood at $402,759, compared with $377,533 at December 31, 2015, representing an increase of $25,226, or 6.7%. The increase in assets under management was principally reflective of the broad increases experienced by the equity markets during 2016, as well as new managed asset accounts.

Service Charges on Deposit Accounts: This income is principally derived from overdraft fees, monthly deposit account maintenance and activity fees, automated teller machine (“ATM”) fees and a variety of other deposit account related fees. Income from service charges on deposit accounts represented 7.0% of total 2016 non-interest income, compared with 9.9% and 12.5% in 2015 and 2014, respectively.

For the year ended December 31, 2016, income generated from service charges on deposit accounts amounted to $866, compared with $892 and $971 in 2015 and 2014, representing declines of $26 and $79, or 2.9% and 8.1%, respectively. The Bank has not been aggressive in selling its fee based overdraft

55

products as a cautionary measure in light of continued regulatory pressure on the banking industry including the Consumer Financial Protection Bureau, which was established by the Wall Street Reform and Consumer Protection Act (the “Dodd – Frank Act”).

Debit Card Service Charges and Fees: This income is principally derived from the Bank’s Visa debit card product and merchant credit and debit card processing fees. Income from debit card service charges and fees represented 14.4% of total 2016 non-interest income, compared with 18.9% and 20.4% in 2015 and 2014, respectively.

For the year ended December 31, 2016, credit and debit card service charges and fees amounted to $1,782, compared with $1,694 in 2015, representing an increase of $88, or 5.2%. This increase was principally attributed to continued growth of the Bank’s retail deposit base and continued success with a program that offers rewards for certain debit card transactions.

For the year ended December 31, 2015, debit card service charges and fees amounted to $1,694, compared with $1,584 in 2014, representing an increase of $110, or 6.9%. This increase was principally attributed to continued growth of the Bank’s retail deposit base and continued success with a program that offers rewards for certain debit card transactions.

Net Securities Gains: For the year ended December 31, 2016, total realized securities gains amounted to $4,498, compared with $1,334 in 2015, representing an increase of $3,164, or 237.2%. The realized securities gains largely reflected Bank management’s strategy of lowering the duration of the securities portfolio and its overall interest rate risk profile, while simultaneously generating income.

For the year ended December 31, 2015, total realized securities gains amounted to $1,334, compared with $403 in 2014, representing an increase of $931, or 231.0%. The realized securities gains largely reflected Bank management’s strategy of lowering the duration of the securities portfolio and its overall interest rate risk profile, while simultaneously generating income.

Further information regarding securities gains and losses is incorporated by reference to Part II, Item 8, Notes 1 and 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

Other Operating Income: Other operating income principally includes income from bank-owned life insurance, representing increases in the cash surrender value of life insurance policies on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Other operating income also includes a variety of miscellaneous service charges and fees including fees for non-customer ATM transactions. Other operating income represented 11.1% of total 2016 non-interest income, compared with 13.0% and 10.6% in 2015 and 2014, respectively.

For the year ended December 31, 2016, total other operating income amounted to $1,374, compared with $1,171 in 2015, representing an increase of $203, or 17.3%.

For the year ended December 31, 2015, total other operating income amounted to $1,171, compared with $824 in 2014, representing an increase of $347, or 42.1%. The 2015 increase in other operating income was principally attributed to income relating to the Bank’s purchase of Bank Owned Life Insurance (“BOLI”) during the first quarter of 2015.

Non-interest Expense

For the year ended December 31, 2016, total non-interest expense amounted to $35,935, compared with $30,908 and $29,211 in 2015 and 2014, representing increases of $5,027 and $1,697, or 16.3% and 5.8%, respectively.

Salaries and Employee Benefits: For the year ended December 31, 2016, total salaries and employee benefits expense amounted to $19,775, compared with $17,884 and $16,836 in 2015 and 2014, representing increases of $1,891 and $1,048, or 10.6% and 6.2%, respectively.  The increase in 2016 was due to strategic hires at the executive and senior level positions within the risk management and information technology departments, along with normal increases in base salaries and employee health insurance costs.  The increase in 2015 was due to normal increases in base salaries and higher levels of employee health insurance costs, higher levels of employee incentive and equity compensation, as well as increases in staffing levels.

Occupancy Expense: For the year ended December 31, 2016, total occupancy expense amounted to $2,334, compared with $2,248 and $2,143 in 2015 and 2014, representing increases of $86 and $105, or 3.8% and 4.9%, respectively. The increases were largely attributed to higher levels of building improvement expenses, as well as higher levels of utilities expense and grounds maintenance.

 

Furniture and Equipment Expense: For the year ended December 31, 2016, total furniture and equipment expense amounted to $2,276, compared with $2,321 and $2,166 in 2015 and 2014, representing a decrease of $45 or 1.9% and an increase of $155, or 7.2%, respectively.

Debit Card Expenses: These expenses relate to the Bank’s Visa debit card processing activities. For the year ended December 31, 2016, total debit card expense amounted to $495 compared with $452 and

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$429 in 2015 and 2014, representing increases of $43 and $23, or 9.5% and 5.4%, respectively. These increases were principally attributed to higher transaction volumes and were more than offset with higher revenues from debit card activity.

Other Operating Expense: For the year ended December 31, 2016, total other operating expenses amounted to $10,250, compared with $7,170 in 2015, representing an increase of $3,080, or 43.0%.  The increase was principally due to $2,650 of merger related and system conversion costs in 2016 associated with the Lake Sunapee Bank Group acquisition.

For the year ended December 31, 2015, total other operating expenses amounted to $7,170, compared with $6,938 in 2014, representing an increase of $232, or 3.3%. The increase was principally due to higher professional services and shareholder related expenses in 2015.

Income Taxes

The effective tax rate was 28.2%, 28.3%, and 28.8% in 2016, 2015, and 2014, respectively.  The effective tax rate remained relative flat in 2016 as compared to 2015, which reflected the impact of 2016 security gains offset by merger-related expenses.  The slightly higher effective tax rate in 2014 was reflective of a lower proportion of tax advantaged-income.  

Impact of New Accounting Pronouncements

See Note 1 to the Consolidated Financial Statements for the recently adopted accounting standards and accounting standards pending adoption.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.

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The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee (“ALCO”), chaired by the Chief Financial Officer and composed of various members of senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

Interest Rate Risk: Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.

The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off-balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Company’s Board of Directors.

The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of the ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

Interest Rate Sensitivity Modeling: The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense for all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage-backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:

·

A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption;

58

·

A 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month horizon together with a dynamic balance sheet anticipated to be consistent with such interest rate changes;

·

Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes; and

·

An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products will continue to change the balance sheet profile for each of the interest rate conditions.

Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.

The following table summarizes the Bank's net interest income sensitivity analysis as of December 31, 2016, over one and two-year horizons and under different interest rate scenarios. In light of the prevailing Federal Funds rate of 0.25% to 0.50%, and the two-year U.S. Treasury note of 1.05% at December 31, 2015, the analysis incorporates a declining interest rate scenario of 100 basis points, rather than the 200 basis points as would traditionally be the case.

	-100 Basis Points  Parallel Yield Curve Shift	+200 Basis Points  Parallel Yield Curve Shift
Year 1
Net interest income ($)	$    (86)	$(982)
Net interest income (%)	-0.18%	-2.06%
Year 2
Net interest income ($)	$(1,530)	$(3,624)
Net interest income (%)	-3.22%	-7.63%

As more fully discussed below, the December 31, 2016, interest rate sensitivity modeling results indicate that the Bank’s balance sheet was moderately liability sensitive over the one and two-year horizons (i.e., moderately exposed to rising interest rates).

Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will remain relatively stable over the one year horizon and then decline moderately over the two-year horizon as declining earning assets yields outpace reductions in funding costs. Should the yield curve steepen as rates fall, the model suggests that accelerated earning asset prepayments will slow, resulting in a more stabilized level of net interest income. Management anticipates that moderate to strong earning asset growth will be needed to meaningfully increase the Bank’s current level of net interest income should both long-term and short-term interest rates decline in parallel.

Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in

59

parallel with these increases, management believes net interest income will remain relatively stable over the one year horizon and then decline moderately over the two year horizon as increased funding costs outpace increases in earning asset yields. The interest rate sensitivity simulation model suggests that as interest rates rise, the Bank’s funding costs will initially re-price disproportionately with earning asset yields to a moderate degree. As funding costs begin to stabilize early in the third year of the simulation, the model suggests that the earning asset portfolios will continue to re-price at prevailing interest rate levels and cash flows from the Bank’s earning asset portfolios will be reinvested into higher yielding earning assets, resulting in a widening of spreads and a stabilization of net interest income over the three year horizon and beyond. Management believes moderate to strong earning asset growth will be necessary to meaningfully increase the current level of net interest income over the one-year and two-year horizons should short-term and long-term interest rates rise in parallel.

Interest rates plummeted during 2008 and have remained historically low ever since, as the global economy slowed at unprecedented levels, unemployment levels soared, delinquencies on all types of loans increased along with decreased consumer confidence and dramatic declines in housing prices. Management believes the most significant ongoing factor affecting market risk exposure and the impact on net interest income continues to be the slow and extended recovery from the severe nationwide recession and the U.S. Government’s extraordinary responses, including the continued impact of a variety of government stimulus programs and quantitative easing strategies.

The Federal Reserve has maintained short-term interest rates at historically low levels for an extended period of time, threatening net interest income. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curve, and changes in the size and composition of the Bank’s loan, investment and deposit portfolios.

The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results.  These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables.  The sensitivity analysis also does not reflect additional actions that the Bank’s SET and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.

The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31, 2016, there were no significant differences between the views of the independent consultant and management regarding the Bank’s interest rate risk exposure.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Bar Harbor Bankshares

We have audited the accompanying consolidated balance sheet of Bar Harbor Bankshares and subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the two years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 14, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

/s/ RSM US LLP

Boston, Massachusetts

March 14, 2017

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Bar Harbor Bankshares:

We have audited the accompanying consolidated balance sheet of Bar Harbor Bankshares and subsidiaries as of December 31, 2014, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year in the period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31, and the results of their operations and their cash flows for the year in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Bar Harbor Bankshares’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2015, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Boston, Massachusetts
March 16, 2015

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2016 AND 2015

(in thousands, except share and per share data)

	2016		2015
Assets
Cash and cash equivalents	$      8,439		$       9,720
Securities available for sale, at fair value	528,856		504,969
Federal Home Loan Bank stock	25,331		21,479
Loans	1,129,064		990,070
Allowance for loan losses	(10,419)		(9,439)
Loans, net of allowance for loan losses	1,118,645		980,631
Premises and equipment, net	23,419		20,674
Goodwill	4,935		4,935
Bank owned life insurance	24,450		23,747
Other assets	21,274		13,900
TOTAL ASSETS	$1,755,349		$1,580,055
Liabilities
Deposits:
Demand and other non-interest bearing deposits	$      98,856		$     86,577
NOW accounts	175,150		160,394
Savings and money market deposits	359,857		299,087
Time deposits	416,437		396,729
Total deposits	1,050,300		942,787
Short-term borrowings	394,480		333,909
Long-term advances from Federal Home Loan Bank	137,116		135,882
Junior subordinated debentures	5,000		5,000
Other liabilities	11,713		8,325
TOTAL LIABILITIES	1,598,609		1,425,903
Commitments and Contingencies (Note 17)
Shareholders' equity
Capital stock, par value $2.00; authorized 20,000,000 shares; issued 6,788,407 shares
at December 31, 2016 and December 31, 2015	13,577		13,577
Surplus	23,027		21,624
Retained earnings	130,489		122,260
Accumulated other comprehensive (loss) income:
Prior service cost and unamortized net actuarial losses on employee
benefit plans, net of tax of ($217) and ($249), at December 31, 2016
and December 31, 2015,respectively	(403)		(463)
Net unrealized (depreciation) appreciation on securities available for sale, net of tax
of ($1,214) and $2,828, at December 31, 2016 and December 31, 2015 respectively	(2,255)		5,251
Portion of OTTI attributable to non-credit gains, net of tax of $70 and $249, at
December 31, 2016 and December 31, 2015, respectively	130		462
Net unrealized depreciation on derivative instruments, net of tax
of $968 and $873, at December 31, 2016 and December 31, 2015, respectively	(1,798)		(1,621)
Total accumulated other comprehensive income	(4,326)		3,629
Less: cost of 711,344 and 778,196 shares of treasury stock at December 31, 2016 and
December 31, 2015, respectively	(6,027)		(6,938)
TOTAL SHAREHOLDERS' EQUITY	156,740		154,152
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$1,755,349		$1,580,055

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

63

BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 2016, 2015 AND 2014

(in thousands, except share and per share data)

 

	2016	2015	2014
Interest and dividend income:
Interest and fees on loans	$41,653	$39,303	$37,739
Interest on securities	14,966	15,343	15,689
Dividends on FHLB stock	868	578	290
Total interest and dividend income	57,487	55,224	53,718
Interest expense:
Deposits	6,699	6,097	5,894
Short-term borrowings	1,942	983	667
Long-term debt	3,472	3,310	3,344
Total interest expense	12,113	10,390	9,905
Net interest income	45,374	44,834	43,813
Provision for loan losses	979	1,785	1,833
Net interest income after provision for loan losses	44,395	43,049	41,980
Non-interest income:
Trust and other financial services	3,829	3,888	3,976
Service charges on deposit accounts	866	892	971
Debit card service charges and fees	1,782	1,694	1,584
Net securities gains	4,498	1,334	403
Other operating income	1,374	1,171	824
Total non-interest income	12,349	8,979	7,758
Non-interest expense:
Salaries and employee benefits	19,775	17,884	16,836
Occupancy expense	2,334	2,248	2,143
Furniture and equipment expense	2,276	2,321	2,166
Credit and debit card expenses	495	452	429
FDIC insurance assessments	805	833	699
Other operating expense	10,250	7,170	6,938
Total non-interest expense	35,935	30,908	29,211
Income before income taxes	20,809	21,120	20,527
Income taxes	5,876	5,967	5,914
Net income	$14,933	$15,153	$14,613
Per Common Share Data:
Basic Earnings Per Share	$    2.47	$    2.53	$    2.47
Diluted Earnings Per Share	$    2.45	$    2.50	$    2.45

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

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2016, 2015 AND 2014

(in thousands)

	2016	2015	2014
Net income	$14,933	$15,153	$14,613
Other comprehensive (loss) income:
Net unrealized (depreciation) appreciation on securities available for sale,            net of tax of ($2,646), ($708) and $8,291, respectively	(4,914)	(1,321)	15,730
Less reclassification adjustment for net gains related to securities            available for sale included in net income,
net of tax of ($1,575), ($467) and ($138), respectively	(2,924)	(867)	(262)
Net unrealized depreciation on interest rate derivatives,            net of tax of ($95), ($484) and ($389), respectively	(177)	(899)	(722)
Net amortization of prior service cost and actuarial loss for           supplemental executive retirement plan,
net of related tax of $10, $13 and $0, respectively	18	25	---
Actuarial gains on supplemental executive retirement plan,            net of related tax of $23, $0 and ($59), respectively	42	---	(115)
Total other comprehensive loss	(7,955)	(3,062)	14,631
Total comprehensive income	$  6,978	$12,091	$29,244

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

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 2016, 2015 AND 2014

(in thousands, except share and per share data)