Note 4. Allowance for Loan Losses

The Company provides for loan losses through the establishment of an allowance for loan losses which represents an estimated reserve for existing losses in the loan portfolio. A systematic methodology is used for determining the allowance that includes a quarterly review process, risk rating changes, and adjustments to the allowance. The loan portfolio is classified in eight segments and credit risk is evaluated separately in each segment. The appropriate level of the allowance is evaluated continually based on a review of significant loans, with a particular emphasis on nonaccruing, past due, and other loans that may require special attention. Other factors include general conditions in local and national economies; loan portfolio composition and asset quality indicators; and internal factors such as changes in underwriting policies, credit administration practices, experience, ability and depth of lending management, among others. The allowance consists of four elements: (1) specific reserves for loans evaluated individually for impairment; (2) general reserves for each portfolio segment based on historical loan loss experience, (3) qualitative reserves judgmentally adjusted for local and national economic conditions, concentrations, portfolio composition, volume and severity of delinquencies and nonaccrual loans, trends of criticized and classified loans, changes in credit policies, and underwriting standards, credit administration practices, and other factors as applicable for each portfolio segment; and (4) unallocated reserves. All outstanding loans are considered in evaluating the appropriateness of the allowance.

A breakdown of the allowance for loan losses as of June 30, 2012, December 31, 2011, and June 30, 2011, by class of financing receivable and allowance element, is presented in the following tables:

As of June 30, 2012	Specific Reserves on Loans Evaluated Individually for Impairment		General Reserves on Loans Based on Historical Loss Experience		Reserves for Qualitative Factors		Unallocated Reserves		Total Reserves
Commercial
Real estate	$	1,133,000	$	2,685,000	$	1,746,000	$	-	$	5,564,000
Construction		787,000		355,000		231,000		-		1,373,000
Other		932,000		935,000		609,000		-		2,476,000
Municipal		-		-		19,000		-		19,000
Residential
Term		966,000		165,000		456,000		-		1,587,000
Construction		48,000		2,000		8,000		-		58,000
Home equity line of credit		300,000		155,000		354,000		-		809,000
Consumer		11,000		351,000		241,000		-		603,000
Unallocated		-		-		-		1,895,000		1,895,000
	$	4,177,000	$	4,648,000	$	3,664,000	$	1,895,000	$	14,384,000

As of December 31, 2011	Specific Reserves on Loans Evaluated Individually for Impairment		General Reserves on Loans Based on Historical Loss Experience		Reserves for Qualitative Factors		Unallocated Reserves		Total Reserves
Commercial
Real estate	$	808,000	$	2,578,000	$	2,273,000	$	-	$	5,659,000
Construction		33,000		332,000		293,000		-		658,000
Other		402,000		883,000		778,000		-		2,063,000
Municipal		-		-		19,000		-		19,000
Residential
Term		478,000		222,000		459,000		-		1,159,000
Construction		235,000		6,000		14,000		-		255,000
Home equity line of credit		91,000		149,000		355,000		-		595,000
Consumer		11,000		331,000		242,000		-		584,000
Unallocated		-		-		-		2,008,000		2,008,000
	$	2,058,000	$	4,501,000	$	4,433,000	$	2,008,000	$	13,000,000

As of June 30, 2011	Specific Reserves on Loans Evaluated Individually for Impairment		General Reserves on Loans Based on Historical Loss Experience		Reserves for Qualitative Factors		Unallocated Reserves		Total Reserves
Commercial
Real estate	$	613,000	$	2,463,000	$	3,851,000	$	-	$	6,927,000
Construction		-		274,000		428,000		-		702,000
Other		857,000		962,000		1,504,000		-		3,323,000
Municipal		-		-		19,000		-		19,000
Residential
Term		265,000		505,000		586,000		-		1,356,000
Construction		-		16,000		19,000		-		35,000
Home equity line of credit		165,000		85,000		402,000		-		652,000
Consumer		65,000		264,000		335,000		-		664,000
Unallocated		-		-		-		1,356,000		1,356,000
	$	1,965,000	$	4,569,000	$	7,144,000	$	1,356,000	$	15,034,000

Commercial loans are comprised of three major classes, commercial real estate loans, commercial construction loans and other commercial loans. Commercial real estate is primarily comprised of loans to small businesses collateralized by owner-occupied real estate, while other commercial is primarily comprised of loans to small businesses collateralized by plant and equipment, commercial fishing vessels and gear, and limited inventory-based

lending. Commercial real estate loans typically have a maximum loan-to-value of 75% based upon current appraisal information at the time the loan is made. Municipal loans are comprised of loans to municipalities in Maine for capitalized expenditures, construction projects or tax-anticipation notes. All municipal loans are considered general obligations of the municipality and as such are collateralized by the taxing ability of the municipality for repayment of debt.

Construction loans, both commercial and residential, comprise a very small portion of the portfolio, and at 30.3% of capital are well under the regulatory guidance of 100.0% of capital at June 30, 2012. Construction loans and non-owner-occupied commercial real estate loans are at 90.4% of total capital, well under regulatory guidance of 300.0% of capital at June 30, 2012.

The process of establishing the allowance with respect to the commercial loan portfolio begins when a loan officer initially assigns each loan a risk rating, using established credit criteria. Approximately 50% of the outstanding loans and commitments are subject to review and validation annually by an independent consulting firm, as well as periodically by the Company's internal credit review function. The methodology employs Management's judgment as to the level of losses on existing loans based on internal review of the loan portfolio, including an analysis of a borrower's current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and or lines of business. In determining the Company's ability to collect certain loans, Management also considers the fair value of underlying collateral.

The risk rating system has eight levels, defined as follows:

1 Strong

Credits rated "1" are characterized by borrowers fully responsible for the credit with excellent capacity to pay principal and interest. Loans rated "1" may be secured with acceptable forms of liquid collateral.

2 Above Average

Credits rated "2" are characterized by borrowers that have better than average liquidity, capitalization, earnings and/or cash flow with a consistent record of solid financial performance.

3 Satisfactory

Credits rated "3" are characterized by borrowers with favorable liquidity, profitability and financial condition with adequate cash flow to pay debt service.

4 Average

Credits rated "4" are characterized by borrowers that present risk more than 1, 2 and 3 rated loans and merit an ordinary level of ongoing monitoring. Financial condition is on par or somewhat below industry averages while cash flow is generally adequate to meet debt service requirements.

5 Watch

Credits rated "5" are characterized by borrowers that warrant greater monitoring due to financial condition or unresolved and identified risk factors.

6 Other Assets Especially Mentioned (OAEM)

Loans in this category are currently protected but are potentially weak and constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of substandard. OAEM have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the Bank's credit position at some future date.

7 Substandard

Loans in this category are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank may sustain some loss if the deficiencies are not corrected.

8 Doubtful

Loans classified "Doubtful" have the same weaknesses as those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.

The following table summarizes the risk ratings for the Company's commercial real estate, commercial construction, commercial other, and municipal loans as of June 30, 2012:

	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	21,000	$	-	$	284,000	$	1,822,000	$	2,127,000
2 Above Average		19,319,000		170,000		4,601,000		7,933,000		32,023,000
3 Satisfactory		36,207,000		1,751,000		13,541,000		3,770,000		55,269,000
4 Average		99,855,000		20,932,000		32,700,000		2,564,000		156,051,000
5 Watch		41,089,000		1,969,000		21,147,000		-		64,205,000
6 OAEM		21,135,000		1,649,000		4,357,000		-		27,141,000
7 Substandard		34,931,000		6,601,000		11,111,000		-		52,643,000
8 Doubtful		636,000		-		92,000		-		728,000
Total	$	253,193,000	$	33,072,000	$	87,833,000	$	16,089,000	$	390,187,000

The following table summarizes the risk ratings for the Company's commercial real estate, commercial construction, commercial other, and municipal loans as of December 31, 2011:

	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	23,000	$	-	$	465,000	$	2,158,000	$	2,646,000
2 Above Average		21,334,000		-		4,229,000		7,509,000		33,072,000
3 Satisfactory		33,119,000		1,365,000		10,981,000		3,861,000		49,326,000
4 Average		106,171,000		17,125,000		31,600,000		2,693,000		157,589,000
5 Watch		44,215,000		3,287,000		17,893,000		-		65,395,000
6 OAEM		18,309,000		2,320,000		5,303,000		-		25,932,000
7 Substandard		31,575,000		7,323,000		16,362,000		-		55,260,000
8 Doubtful		678,000		1,154,000		149,000		-		1,981,000
Total	$	255,424,000	$	32,574,000	$	86,982,000	$	16,221,000	$	391,201,000

The following table summarizes the risk ratings for the Company's commercial real estate, commercial construction, commercial other, and municipal loans as of June 30, 2011:

	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	29,000	$	-	$	467,000	$	2,341,000	$	2,837,000
2 Above Average		21,021,000		10,000		3,657,000		10,772,000		35,460,000
3 Satisfactory		40,346,000		1,616,000		15,714,000		3,985,000		61,661,000
4 Average		114,124,000		12,894,000		41,208,000		2,876,000		171,102,000
5 Watch		38,095,000		6,293,000		15,042,000		-		59,430,000
6 OAEM		19,572,000		4,015,000		6,338,000		-		29,925,000
7 Substandard		30,150,000		4,558,000		20,067,000		-		54,775,000
8 Doubtful		-		-		6,000		-		6,000
Total	$	263,337,000	$	29,386,000	$	102,499,000	$	19,974,000	$	415,196,000

Commercial loans are generally charged off when all or a portion of the principal amount is determined to be uncollectable. This determination is based on circumstances specific to a borrower including repayment ability, analysis of collateral and other factors as applicable.

Residential loans are comprised of two classes: term loans, which include traditional amortizing home mortgages, and construction loans, which include loans for owner-occupied residential construction. Residential loans typically have a 75% to 80% loan to value based upon current appraisal information at the time the loan is made. Home equity loans and lines of credit are typically written to the same underwriting standards. Consumer loans are primarily amortizing loans to individuals collateralized by automobiles, pleasure craft and recreation vehicles, typically with a maximum loan to value of 80% to 90% of the purchase price of the collateral. Consumer loans also include a small amount of unsecured short-term time notes to individuals.

Residential loans, consumer loans and home equity lines of credit are segregated into homogeneous pools with similar risk characteristics. Trends and current conditions are analyzed and historical loss experience is adjusted accordingly. Quantitative and qualitative adjustment factors for these segments are consistent with those for the commercial and municipal classes. Certain loans in the residential, home equity lines of credit and consumer classes identified as having the potential for further deterioration are analyzed individually to confirm impairment status, and to determine the need for a specific reserve, however there is no formal rating system used for these classes. Consumer loans greater than 120 days past due are generally charged off. Residential loans 90 days or more past due are placed on non-accrual status unless the loans are both well secured and in the process of collection.

There were no changes to the Company's accounting policies or methodology used to estimate the allowance for loan losses during the six months ended June 30, 2012.

The following table presents allowance for loan losses transactions by class for the six-months and quarters ended June 30, 2012, and allowance for loan loss balances by class and related loan balances by class as of June 30, 2012:

	Commercial						Municipal		Residential					Home Equity		Consumer		Unallocated			Total
	Real Estate		Construction		Other				Term		Construction			Line of Credit
For the six months ended June 30, 2012
Beginning balance	$	5,659,000	$	658,000	$	2,063,000	$	19,000	$	1,159,000	$	255,000		$	595,000	$	584,000	$	2,008,000		$	13,000,000
Charge offs		915,000		-		2,162,000		-		375,000		118,000			49,000		276,000		-			3,895,000
Recoveries		1,000		246,000		11,000		-		2,000		-			-		119,000		-			379,000
Provision		819,000		469,000		2,564,000		-		801,000		(79,000	)		263,000		176,000		(113,000	)		4,900,000
Ending balance	$	5,564,000	$	1,373,000	$	2,476,000	$	19,000	$	1,587,000	$	58,000		$	809,000	$	603,000	$	1,895,000		$	14,384,000
For the three months ended June 30, 2012
Beginning balance	$	5,862,000	$	704,000	$	2,125,000	$	19,000	$	1,236,000	$	59,000		$	682,000	$	568,000	$	1,699,000		$	12,954,000
Charge offs		915,000		-		160,000		-		136,000		118,000			-		96,000		-			1,425,000
Recoveries		1,000		-		9,000		-		1,000		-			-		44,000		-			55,000
Provision		616,000		669,000		502,000		-		486,000		117,000			127,000		87,000		196,000			2,800,000
Ending balance	$	5,564,000	$	1,373,000	$	2,476,000	$	19,000	$	1,587,000	$	58,000		$	809,000	$	603,000	$	1,895,000		$	14,384,000
Allowance for loan losses as of June 30, 2012
Ending balance specifically evaluated for impairment	$	1,133,000	$	787,000	$	932,000	$	-	$	966,000	$	48,000		$	300,000	$	11,000	$	-		$	4,177,000
Ending balance collectively evaluated for impairment	$	4,431,000	$	586,000	$	1,544,000	$	19,000	$	621,000	$	10,000		$	509,000	$	592,000	$	1,895,000		$	10,207,000
Related loan balances as of June 30, 2012
Ending balance	$	253,193,000	$	33,072,000	$	87,833,000	$	16,089,000	$	368,876,000	$	6,449,000		$	100,689,000	$	15,613,000	$	-		$	881,814,000
Ending balance specifically evaluated for impairment	$	13,795,000	$	3,619,000	$	4,100,000	$	-	$	19,052,000	$	1,336,000		$	1,456,000	$	16,000	$	-		$	43,374,000
Ending balance collectively evaluated for impairment	$	239,398,000	$	29,453,000	$	83,733,000	$	16,089,000	$	349,824,000	$	5,113,000		$	99,233,000	$	15,597,000	$	-		$	838,440,000

The following table presents allowance for loan loss balances by class and related loan balances by class as of December 31, 2011:

	Commercial						Municipal		Residential				Home Equity		Consumer		Unallocated		Total
	Real Estate		Construction		Other				Term		Construction		Line of Credit
Allowance for loan losses as of December 31, 2011
Ending balance specifically evaluated for impairment	$	808,000	$	33,000	$	402,000	$	-	$	478,000	$	235,000	$	91,000	$	11,000	$	-	$	2,058,000
Ending balance collectively evaluated for impairment	$	4,851,000	$	625,000	$	1,661,000	$	19,000	$	681,000	$	20,000	$	504,000	$	573,000	$	2,008,000	$	10,942,000
Related loan balances as of December 31, 2011
Ending balance	$	255,424,000	$	32,574,000	$	86,982,000	$	16,221,000	$	341,286,000	$	10,469,000	$	105,244,000	$	16,788,000	$	-	$	864,988,000
Ending balance specifically evaluated for impairment	$	10,141,000	$	5,702,000	$	7,042,000	$	-	$	16,821,000	$	1,198,000	$	1,163,000	$	53,000	$	-	$	42,120,000
Ending balance collectively evaluated for impairment	$	245,283,000	$	26,872,000	$	79,940,000	$	16,221,000	$	324,465,000	$	9,271,000	$	104,081,000	$	16,735,000	$	-	$	822,868,000

The following table presents allowance for loan losses transactions by class for the six-months and quarters ended June 30, 2011, and allowance for loan loss balances by class and related loan balances by class as of June 30, 2011:

	Commercial							Municipal		Residential					Home Equity		Consumer			Unallocated			Total
	Real Estate		Construction			Other				Term		Construction			Line of Credit
For the six months ended June 30, 2011
Beginning balance	$	5,260,000	$	1,012,000		$	2,377,000	$	19,000	$	1,408,000	$	44,000		$	670,000	$	646,000		$	1,880,000		$	13,316,000
Charge offs		835,000		-			319,000		-		697,000		505,000			45,000		169,000			-			2,570,000
Recoveries		5,000		-			20,000		-		4,000		-			1,000		158,000			-			188,000
Provision		2,497,000		(310,000	)		1,245,000		-		641,000		496,000			26,000		29,000			(524,000	)		4,100,000
Ending balance	$	6,927,000	$	702,000		$	3,323,000	$	19,000	$	1,356,000	$	35,000		$	652,000	$	664,000		$	1,356,000		$	15,034,000
For the three months ended June 30, 2011
Beginning balance	$	6,310,000	$	639,000		$	2,535,000	$	19,000	$	1,405,000	$	146,000		$	678,000	$	713,000		$	1,555,000		$	14,000,000
Charge offs		546,000		-			158,000		-		240,000		-			44,000		69,000			-			1,057,000
Recoveries		-		-			3,000		-		1,000		-			1,000		86,000			-			91,000
Provision		1,163,000		63,000			943,000		-		190,000		(111,000	)		17,000		(66,000	)		(199,000	)		2,000,000
Ending balance	$	6,927,000	$	702,000		$	3,323,000	$	19,000	$	1,356,000	$	35,000		$	652,000	$	664,000		$	1,356,000		$	15,034,000
Allowance for loan losses as of June 30, 2011
Ending balance specifically evaluated for impairment	$	613,000	$	-		$	857,000	$	-	$	265,000	$	-		$	165,000	$	65,000		$	-		$	1,965,000
Ending balance collectively evaluated for impairment	$	6,314,000	$	702,000		$	2,466,000	$	19,000	$	1,091,000	$	35,000		$	487,000	$	599,000		$	1,356,000		$	13,069,000
Related loan balances as of June 30, 2011
Ending balance	$	263,337,000	$	29,386,000		$	102,499,000	$	19,974,000	$	335,807,000	$	11,063,000		$	107,224,000	$	17,639,000		$	-		$	886,929,000
Ending balance specifically evaluated for impairment	$	6,746,000	$	772,000		$	2,095,000	$	-	$	16,191,000	$	334,000		$	740,000	$	103,000		$	-		$	26,981,000
Ending balance collectively evaluated for impairment	$	256,591,000	$	28,614,000		$	100,404,000	$	19,974,000	$	319,616,000	$	10,729,000		$	106,484,000	$	17,536,000		$	-		$	859,948,000

Troubled Debt Restructure

A troubled debt restructure ("TDR") constitutes a restructuring of debt if the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. To determine whether or not a loan should be classified as a TDR, Management evaluates a loan based upon the following criteria:

·	The borrower demonstrates financial difficulty; common indicators include past due status with bank obligations, substandard credit bureau reports, or an inability to refinance with another lender, and

·	The Company has granted a concession; common concession types include maturity date extension, interest rate adjustments to below market pricing, and deferment of payments.

As of June 30, 2012, the Company had 82 loans with a value of $24,980,000 that have been classified as TDRs. This compares to 59 loans with a value of $22,858,000 and 36 loans with a value of $6,663,000 classified as TDRs as of December 31, 2011 and June 30, 2011, respectively. The impairment carried as a specific reserve in the allowance for loan losses is calculated by present valuing the cashflow modification on the loan, or, for collateral-dependent loans, using the fair value of the collateral less costs to sell.

The following table shows TDRs by class and the specific reserve as of June 30, 2012:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		17	$	9,216,000	$	496,000
Construction		2		3,099,000		696,000
Other		15		1,984,000		590,000
Municipal		-		-		-
Residential
Term		48		10,681,000		327,000
Construction		-		-		-
Home equity line of credit		-		-		-
Consumer		-		-		-
		82	$	24,980,000	$	2,109,000

As of June 30, 2012, 13 of the loans classified as TDRs with a total balance of $2,487,000 were more than 30 days past due. Of these loans, 6 loans with an outstanding balance of $864,000 had been placed on TDR status in the previous 12 months.

The following table shows these TDRs by class and the associated specific reserves included in the allowance for loan losses as of June 30, 2012:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		1	$	269,000	$	111,000
Construction		-		-		-
Other		3		180,000		-
Municipal		-		-		-
Residential
Term		9		2,038,000		92,000
Construction		-		-		-
Home equity line of credit		-		-		-
Consumer		-		-		-
		13	$	2,487,000	$	203,000

For the six months ended June 30, 2012, 29 loans were placed on TDR status with an outstanding balance of $7,919,000. These were considered TDRs because concessions had been granted to borrowers experiencing financial difficulties. Concessions include reductions in interest rates, principal and/or interest forbearance, payment extensions, or combinations thereof.

The following table shows loans placed on TDR status in the six months ended June 30, 2012, by class of loan and the associated specific reserve included in the allowance for loan losses as of June 30, 2012:

	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserves
Commercial
Real estate		12	$	3,845,000	$	4,032,000	$	152,000
Construction		1		1,951,000		1,951,000		696,000
Other		9		712,000		713,000		544,000
Municipal		-		-		-		-
Residential
Term		7		1,411,000		1,411,000		76,000
Construction		-		-		-		-
Home equity line of credit		-		-		-		-
Consumer		-		-		-		-
		29	$	7,919,000	$	8,107,000	$	1,468,000

For the quarter ended June 30, 2012, 15 loans were placed on TDR status with an outstanding balance of $4,955,000. These were considered to be TDRs because concessions had been granted to borrowers experiencing financial difficulties. Concessions include reductions in interest rates, principal and/or interest forbearance, payment extensions, or combinations thereof.

The following table shows loans placed on TDR status in the quarter ended June 30, 2012, by class of loan and the associated specific reserve included in the allowance for loan losses as of June 30, 2012:

	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserves
Commercial
Real estate		5	$	1,449,000	$	1,598,000	$	152,000
Construction		1		1,951,000		1,951,000		696,000
Other		6		700,000		701,000		545,000
Municipal		-		-		-		-
Residential
Term		3		855,000		855,000		61,000
Construction		-		-		-		-
Home equity line of credit		-		-		-		-
Consumer		-		-		-		-
		15	$	4,955,000	$	5,105,000	$	1,454,000

As of June 30, 2012, Management is aware of five loans classified as TDRs that are involved in bankruptcy with an outstanding balance of $1,194,000. There were also 24 loans with an outstanding balance of $3,562,000 that were classified as TDRs and on non-accrual status, three of which, with an outstanding balance of $413,000, were in the process of foreclosure.