Note 6. 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 following table summarizes the composition of the allowance for loan losses, by class of financing receivable and allowance, as of December 31, 2012 and 2011:

As of December 31,	2012		2011
Allowance for Loans Evaluated Individually for Impairment
Commercial
Real estate	$	1,523,000	$	808,000
Construction		969,000		33,000
Other		652,000		402,000
Municipal		-		-
Residential
Term		395,000		478,000
Construction		-		235,000
Home equity line of credit		-		91,000
Consumer		-		11,000
Total	$	3,539,000	$	2,058,000
Allowance for Loans Evaluated Collectively for Impairment
Commercial
Real estate	$	4,342,000	$	4,851,000
Construction		390,000		625,000
Other		1,398,000		1,661,000
Municipal		18,000		19,000
Residential
Term		714,000		681,000
Construction		11,000		20,000
Home equity line of credit		654,000		504,000
Consumer		592,000		573,000
Unallocated		842,000		2,008,000
Total	$	8,961,000	$	10,942,000
Total Allowance for Loan Losses
Commercial
Real estate	$	5,865,000	$	5,659,000
Construction		1,359,000		658,000
Other		2,050,000		2,063,000
Municipal		18,000		19,000
Residential
Term		1,109,000		1,159,000
Construction		11,000		255,000
Home equity line of credit		654,000		595,000
Consumer		592,000		584,000
Unallocated		842,000		2,008,000
Total	$	12,500,000	$	13,000,000

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 December 31, 2012 and 2011, by class of financing receivable and allowance element, is presented in the following tables:

As of December 31, 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	$	1,523,000	$	2,369,000	$	1,973,000	$	-	$	5,865,000
Construction		969,000		213,000		177,000		-		1,359,000
Other		652,000		763,000		635,000		-		2,050,000
Municipal		-		-		18,000		-		18,000
Residential
Term		395,000		278,000		436,000		-		1,109,000
Construction		-		4,000		7,000		-		11,000
Home equity line of credit		-		315,000		339,000		-		654,000
Consumer		-		362,000		230,000		-		592,000
Unallocated		-		-		-		842,000		842,000
	$	3,539,000	$	4,304,000	$	3,815,000	$	842,000	$	12,500,000

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

The qualitative amount assigned to the substandard commercial loan segments declined between December 31, 2012, and December 31, 2011, to adjust historical loss averages for the impact of recent write downs taken on a large, atypical credit. Changes to qualitative adjustments for other major portfolio segments were not material in 2012. Qualitative adjustment factors are based upon Management's evaluation of various current conditions, including:

•	General economic conditions.

•	Credit quality trends with emphasis on loan delinquencies, nonaccrual levels and classified loans.

•	Recent loss experience in particular segments of the portfolio.

•	Loan volumes and concentrations, including changes in mix.

•	Other factors, including changes in quality of the loan origination; loan policy changes; changes in credit risk management processes; Bank regulatory and external loan review examination results.

The unallocated component is available to cover imprecision or uncertainties to incorporate the range of probable outcomes inherent in estimates used for the allowance, which may change from period to period. An example of this could be a delay in receiving an updated appraisal on a troubled credit. The unallocated component totaled $842,000 at December, 2012 compared to $2.0 million as of December 31, 2011. The decline in the unallocated amount was deemed appropriate due to the following:

•	Given more certainty in the status of several loans between December 31, 2011 and December 31, 2012, $666,000 was transferred from unallocated to specific reserves.

•

Credit quality improved significantly in 2012. Net loan chargeoffs were $8,335,000 or 0.95% of average loans, down $2,531,000 from net chargeoffs of $10,866,000 or 1.23% of average loans in 2011. Non-performing assets stood at 1.89% of total assets as of December 31, 2012 compared to 2.32% of total assets at December 31, 2011. Past-due loans were 2.67% of total loans as of December 31, 2012, the lowest year-end total in the past five years and well below 3.07% of total loans as of December 31, 2011. Management determined a lower level of unallocated was appropriate and reduced unallocated reserves by $500,000.

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 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 23.0% of capital are well under the regulatory guidance of 100.0% of capital at December 31, 2012. Construction loans and non-owner-occupied commercial real estate loans are at 81.0% of total capital, well under regulatory guidance of 300.0% of capital at December 31, 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 consultant, 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 paying capacity of the borrower or of the collateral, if any. These loans 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 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 construction, commercial real estate, commercial other and municipal loans as of December 31, 2012:

	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	19,000	$	-	$	271,000	$	1,731,000	$	2,021,000
2 Above average		13,871,000		1,274,000		4,084,000		7,061,000		26,290,000
3 Satisfactory		34,454,000		2,312,000		14,578,000		3,487,000		54,831,000
4 Average		99,712,000		12,322,000		28,618,000		2,425,000		143,077,000
5 Watch		43,369,000		1,721,000		19,524,000		-		64,614,000
6 OAEM		26,302,000		79,000		5,300,000		-		31,681,000
7 Substandard		33,153,000		4,709,000		8,806,000		-		46,668,000
8 Doubtful		455,000		-		2,000		-		457,000
Total	$	251,335,000	$	22,417,000	$	81,183,000	$	14,704,000	$	369,639,000

The following table summarizes the risk ratings for the Company's commercial construction, commercial real estate, 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

Commercial loans are generally charged off when all or a portion of the principal amount is determined to be uncollectible. 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 year ended December 31, 2012. Allowance for loan losses transactions for the years ended December 31, 2012, 2011 and 2010 were as follows:

For the year ended	Commercial						Municipal			Residential				Home Equity		Consumer		Unallocated			Total
December 31, 2012	Real Estate		Construction		Other					Term		Construction		Line of Credit
Allowance for loan losses:
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		1,394,000		928,000		3,215,000		-			1,911,000		389,000		688,000		555,000		-			9,080,000
Recoveries		13,000		246,000		113,000		-			110,000		54,000		1,000		208,000		-			745,000
Provision		1,587,000		1,383,000		3,089,000		(1,000	)		1,751,000		91,000		746,000		355,000		(1,166,000	)		7,835,000
Ending balance	$	5,865,000	$	1,359,000	$	2,050,000	$	18,000		$	1,109,000	$	11,000	$	654,000	$	592,000	$	842,000		$	12,500,000
Ending balance specifically evaluated for impairment	$	1,523,000	$	969,000	$	652,000	$	-		$	395,000	$	-	$	-	$	-	$	-		$	3,539,000
Ending balance collectively evaluated for impairment	$	4,342,000	$	390,000	$	1,398,000	$	18,000		$	714,000	$	11,000	$	654,000	$	592,000	$	842,000		$	8,961,000
Related loan balances:
Ending balance	$	251,335,000	$	22,417,000	$	81,183,000	$	14,704,000		$	379,447,000	$	6,459,000	$	99,082,000	$	14,657,000	$	-		$	869,284,000
Ending balance specifically evaluated for impairment	$	15,774,000	$	3,354,000	$	5,861,000	$	-		$	19,444,000	$	-	$	1,311,000	$	-	$	-		$	45,744,000
Ending balance collectively evaluated for impairment	$	235,561,000	$	19,063,000	$	75,322,000	$	14,704,000		$	360,003,000	$	6,459,000	$	97,771,000	$	14,657,000	$	-		$	823,540,000

For the year ended	Commercial							Municipal		Residential				Home Equity		Consumer		Unallocated		Total
December 31, 2011	Real Estate		Construction			Other				Term		Construction		Line of Credit
Allowance for loan losses:
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		1,619,000		346,000			6,492,000		-		1,421,000		505,000		415,000		381,000		-		11,179,000
Recoveries		23,000		-			60,000		-		7,000		-		1,000		222,000		-		313,000
Provision		1,995,000		(8,000	)		6,118,000		-		1,165,000		716,000		339,000		97,000		128,000		10,550,000
Ending 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
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:
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

For the year ended	Commercial						Municipal			Residential				Home Equity		Consumer		Unallocated		Total
December 31, 2010	Real Estate		Construction		Other					Term		Construction		Line of Credit
Allowance for loan losses:
Beginning balance	$	4,986,000	$	807,000	$	3,363,000	$	23,000		$	1,198,000	$	174,000	$	515,000	$	717,000	$	1,854,000	$	13,637,000
Charge offs		4,005,000		175,000		1,125,000		-			392,000		2,361,000		8,000		951,000		-		9,017,000
Recoveries		4,000		-		69,000		-			4,000		-		-		219,000		-		296,000
Provision		4,275,000		380,000		70,000		(4,000	)		598,000		2,231,000		163,000		661,000		26,000		8,400,000
Ending 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
Ending balance specifically evaluated for impairment	$	192,000	$	152,000	$	291,000	$	-		$	432,000	$	-	$	122,000	$	67,000	$	-	$	1,256,000
Ending balance collectively evaluated for impairment	$	5,068,000	$	860,000	$	2,086,000	$	19,000		$	976,000	$	44,000	$	548,000	$	579,000	$	1,880,000	$	12,060,000
Related loan balances:
Ending balance	$	245,540,000	$	41,869,000	$	101,462,000	$	21,833,000		$	337,927,000	$	15,512,000	$	105,297,000	$	18,156,000	$	-	$	887,596,000
Ending balance specifically evaluated for impairment	$	5,946,000	$	937,000	$	1,753,000	$	-		$	12,455,000	$	3,567,000	$	519,000	$	106,000	$	-	$	25,283,000
Ending balance collectively evaluated for impairment	$	239,594,000	$	40,932,000	$	99,709,000	$	21,833,000		$	325,472,000	$	11,945,000	$	104,778,000	$	18,050,000	$	-	$	862,313,000

Troubled Debt Restructured

A TDR constitutes a restructuring of debt if the Bank, 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 Bank has granted a concession; common concession types include maturity date extension, interest rate adjustments to below market pricing, and deferment of payments.

The Bank applies the same interest accrual policy to TDRs as it does for all classes of loans. As of December 31, 2012 we had 101 loans with a value of $29,955,000 that have been restructured. This compares to 59 loans with a value of $22,858,000 classified as TDRs as of December 31, 2011. 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 December 31, 2012:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		18	$	11,961,000	$	823,000
Construction		3		3,319,000		969,000
Other		23		3,074,000		574,000
Municipal		-		-		-
Residential
Term		53		10,945,000		224,000
Construction		-		-		-
Home equity line of credit		4		656,000		-
Consumer		-		-		-
		101	$	29,955,000	$	2,590,000

The following table shows TDRs by class and the specific reserve as of December 31, 2011:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		4	$	3,078,000	$	273,000
Construction		3		4,506,000		-
Other		9		5,350,000		97,000
Municipal		-		-		-
Residential
Term		43		9,924,000		363,000
Construction		-		-		-
Home equity line of credit		-		-		-
Consumer		-		-		-
		59	$	22,858,000	$	733,000

As of December 31, 2012, 12 of the loans classified as TDRs with a total balance of $2,413,000 were more than 30 days past due. Of these loans, six loans with an outstanding balance of $1,059,000 had been placed on TDR status in the previous 12 months. The following table shows past-due TDRs by class and the associated specific reserves included in the allowance for loan losses as of December 31, 2012:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		3	$	760,000	$	-
Construction		-		-		-
Other		-		-		-
Municipal		-		-		-
Residential
Term		8		1,624,000		67,000
Construction		-		-		-
Home equity line of credit		1		29,000		-
Consumer		-		-		-
		12	$	2,413,000	$	67,000

As of December 31, 2011, 14 of the loans classified as TDRs with a total balance of $2,841,000 were more than 30 days past due. Of these loans, six loans with an outstanding balance of $1,588,000 had been placed on TDR status in the previous 12 months. The following table shows past-due TDRs by class and the associated specific reserves included in the allowance for loan losses as of December 31, 2011:

	Number of Loans		Balance		Specific Reserves
Commercial
Real estate		-	$	-	$	-
Construction		1		1,154,000		-
Other		3		96,000		47,000
Municipal		-		-		-
Residential
Term		10		1,591,000		52,000
Construction		-		-		-
Home equity line of credit		-		-		-
Consumer		-		-		-
		14	$	2,841,000	$	99,000

During the year ended December 31, 2012, 52 loans were placed on TDR status with an outstanding balance of $14,657,000. 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 during the year ended December 31, 2012, by class of loan and the associated specific reserve included in the allowance for loan losses as of December 31, 2012:

	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserves
Commercial
Real estate		13	$	6,821,000	$	7,149,000	$	180,000
Construction		3		3,319,000		3,333,000		969,000
Other		19		1,887,000		1,903,000		543,000
Municipal		-		-		-		-
Residential
Term		13		1,974,000		1,989,000		77,000
Construction		-		-		-		-
Home equity line of credit		4		656,000		656,000		-
Consumer		-		-		-		-
		52	$	14,657,000	$	15,030,000	$	1,769,000

During the year ended December 31, 2011, 31 loans were placed on TDR status with an outstanding balance of $18,325,000. 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 2011 by type of loan and the associated specific reserve included in the allowance for loan losses as of December 31, 2011:

	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserves
Commercial
Real estate		4	$	3,078,000	$	3,078,000	$	273,000
Construction		3		4,506,000		4,506,000		-
Other		9		5,350,000		5,350,000		97,000
Municipal		-		-		-		-
Residential
Term		15		5,391,000		5,391,000		258,000
Construction		-		-		-		-
Home equity line of credit		-		-		-		-
Consumer		-		-		-		-
Unallocated		-		-		-		-
		31	$	18,325,000	$	18,325,000	$	628,000

As of December 31, 2012, Management is aware of 11 loans classified as TDRs that are involved in bankruptcy with an outstanding balance of $1,158,000. As of December 31, 2012, there were 24 loans with an outstanding balance of $3,363,000 that were classified as TDRs and were on non-accrual status, five of which, with an outstanding balance of $521,000, were in the process of foreclosure.