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 classes and credit risk is evaluated separately in each class. 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, 2014 and 2013:



As of December 31,	2014		2013
Allowance for Loans Evaluated Individually for Impairment
Commercial
Real estate	$	346,000	$	890,000
Construction	413,000		272,000
Other	129,000		841,000
Municipal	—		—
Residential
Term	519,000		404,000
Construction	—		—
Home equity line of credit	396,000		54,000
Consumer	—		—
Total	$	1,803,000	$	2,461,000
Allowance for Loans Evaluated Collectively for Impairment
Commercial
Real estate	$	3,186,000	$	3,712,000
Construction	410,000		303,000
Other	1,376,000		1,435,000
Municipal	15,000		15,000
Residential
Term	666,000		695,000
Construction	20,000		21,000
Home equity line of credit	664,000		621,000
Consumer	542,000		573,000
Unallocated	1,662,000		1,678,000
Total	$	8,541,000	$	9,053,000
Total Allowance for Loan Losses
Commercial
Real estate	$	3,532,000	$	4,602,000
Construction	823,000		575,000
Other	1,505,000		2,276,000
Municipal	15,000		15,000
Residential
Term	1,185,000		1,099,000
Construction	20,000		21,000
Home equity line of credit	1,060,000		675,000
Consumer	542,000		573,000
Unallocated	1,662,000		1,678,000
Total	$	10,344,000	$	11,514,000

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, 2014 and 2013, by class of financing receivable and allowance element, is presented in the following tables:



As of December 31, 2014	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	$	346,000	$	1,444,000	$	1,742,000	$	—	$	3,532,000
Construction	413,000		186,000		224,000		—		823,000
Other	129,000		624,000		752,000		—		1,505,000
Municipal	—		—		15,000		—		15,000
Residential
Term	519,000		297,000		369,000		—		1,185,000
Construction	—		9,000		11,000		—		20,000
Home equity line of credit	396,000		376,000		288,000		—		1,060,000
Consumer	—		346,000		196,000		—		542,000
Unallocated	—		—		—		1,662,000		1,662,000
	$	1,803,000	$	3,282,000	$	3,597,000	$	1,662,000	$	10,344,000



As of December 31, 2013	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	$	890,000	$	1,927,000	$	1,785,000	$	—	$	4,602,000
Construction	272,000		157,000		146,000		—		575,000
Other	841,000		745,000		690,000		—		2,276,000
Municipal	—		—		15,000		—		15,000
Residential
Term	404,000		342,000		353,000		—		1,099,000
Construction	—		10,000		11,000		—		21,000
Home equity line of credit	54,000		343,000		278,000		—		675,000
Consumer	—		382,000		191,000		—		573,000
Unallocated	—		—		—		1,678,000		1,678,000
	$	2,461,000	$	3,906,000	$	3,469,000	$	1,678,000	$	11,514,000

Qualitative adjustment factors are taken into consideration when determining reserve estimates. These adjustment factors are based upon our evaluation of various current conditions, including those listed below.


•	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 qualitative portion of the allowance for loan losses was 0.39% of related loans as of December 31, 2014, compared to 0.40% of related loans as of December 31, 2013. The qualitative portion increased $128,000 between December 31, 2013 and December 31, 2014.

The unallocated component totaled $1,662,000 at December 31, 2014, or 16.1% of the total reserve. This compares to $1,678,000 or 14.6% as of December 31, 2013. The level of unallocated reserve and period-to-period change is based on the following considerations:

•

The unallocated reserve at December 31, 2014 was $16,000 lower than the previous year, yet slightly higher as a percentage of the total allowance. The relative dollar reduction in the unallocated was less than the overall proportionate year-over-year decline in the total allowance. Management considers this appropriate to support loan growth in 2014. Between 2010 through 2013 average loans declined year-over-year, but grew 3.0% on average from 2013 to 2014. Growth in 2014 originated from the commercial loan and home equity line-of-credit portfolios.


•	External conditions, factors specific to individual credits and collateral values may bring rise to unforeseen variations in specific reserves on impaired loans in subsequent periods. There is a risk of uncertainty and imprecision in these estimates, thereby supporting some level of unallocated for unanticipated changes.

•

An internal analysis completed on OREO property sales through December 31, 2014, found that properties sold approximately 20% below the appraised value of the property at the time of take in. Based on current and prior analyses, Management applies a 20% additional discount factor, exclusive of the estimated cost to sell, to arrive at OREO take in amounts. Deterioration in distressed sales values will affect the allowance as these potential additional write downs would be taken against the allowance. The unallocated portion provides additional funds for these adjustments.

•

From 2009 through 2013, a period of historically high loan charge-offs for the Bank, the required reserve as a percent of total loans averaged 1.33%, ranging from a low of 0.88% to a high of 1.60%, or $8.7 million to $13.9 million. The current allowance, including the unallocated portion, is in the middle of the range. Federal Reserve officials remain optimistic about the U.S economic outlook but are concerned that the prospect of slower overseas growth could dampen the recovery. Caution remains appropriate at the evaluation date regarding the direction of the economy, the uncertain impact of a slowing of growth abroad on the U.S. economy and the potential collective impact on Bank loan portfolio quality. Such uncertainties support the unallocated position.


•	In more general terms, 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.

The allowance for loan losses as a percent of total loans stood at 1.13% as of December 31, 2014, compared to 1.31% of

total loans as of December 31, 2013.

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 31.3% of capital are well under the regulatory guidance of 100.0% of capital at December 31, 2014. Construction loans and non-owner-occupied commercial real estate loans are at 94.7% of total capital, well under regulatory guidance of 300.0% of capital at December 31, 2014.

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, 2014:



	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	12,000	$	—	$	330,000	$	—	$	342,000
2 Above average	12,668,000		771,000		7,210,000		18,789,000		39,438,000
3 Satisfactory	50,275,000		1,983,000		24,232,000		1,635,000		78,125,000
4 Average	108,719,000		23,345,000		44,895,000		—		176,959,000
5 Watch	36,974,000		1,567,000		18,171,000		—		56,712,000
6 OAEM	9,846,000		2,519,000		1,970,000		—		14,335,000
7 Substandard	23,817,000		747,000		7,723,000		—		32,287,000
8 Doubtful	—		—		—		—		—
Total	$	242,311,000	$	30,932,000	$	104,531,000	$	20,424,000	$	398,198,000

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, 2013:



	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	16,000	$	—	$	265,000	$	—	$	281,000
2 Above average	14,565,000		804,000		6,719,000		16,230,000		38,318,000
3 Satisfactory	45,213,000		871,000		14,852,000		2,887,000		63,823,000
4 Average	100,343,000		14,938,000		45,792,000		—		161,073,000
5 Watch	32,326,000		26,000		10,439,000		—		42,791,000
6 OAEM	26,102,000		2,948,000		3,238,000		—		32,288,000
7 Substandard	27,115,000		795,000		13,622,000		—		41,532,000
8 Doubtful	263,000		—		362,000		—		625,000
Total	$	245,943,000	$	20,382,000	$	95,289,000	$	19,117,000	$	380,731,000

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, 2014. Allowance for loan losses activity for the years ended December 31, 2014, 2013 and 2012 was as follows:



For the year ended December 31, 2014	Commercial										Residential					Home Equity Line of Credit
For the year ended December 31, 2014	Real Estate			Construction		Other			Municipal		Term		Construction			Home Equity Line of Credit		Consumer		Unallocated			Total
Allowance for loan losses:
Beginning balance	$	4,602,000		$	575,000	$	2,276,000		$	15,000	$	1,099,000	$	21,000		$	675,000	$	573,000	$	1,678,000		$	11,514,000
Chargeoffs	1,205,000			—		989,000			—		699,000		—			153,000		449,000		—			3,495,000
Recoveries	144,000			—		758,000			—		36,000		25,000			16,000		196,000		—			1,175,000
Provision (credit)	(9,000		)	248,000		(540,000		)	—		749,000		(26,000		)	522,000		222,000		(16,000		)	1,150,000
Ending balance	$	3,532,000		$	823,000	$	1,505,000		$	15,000	$	1,185,000	$	20,000		$	1,060,000	$	542,000	$	1,662,000		$	10,344,000
Ending balance specifically evaluated for impairment	$	346,000		$	413,000	$	129,000		$	—	$	519,000	$	—		$	396,000	$	—	$	—		$	1,803,000
Ending balance collectively evaluated for impairment	$	3,186,000		$	410,000	$	1,376,000		$	15,000	$	666,000	$	20,000		$	664,000	$	542,000	$	1,662,000		$	8,541,000
Related loan balances:
Ending balance	$	242,311,000		$	30,932,000	$	104,531,000		$	20,424,000	$	384,032,000	$	12,160,000		$	103,521,000	$	19,653,000	$	—		$	917,564,000
Ending balance specifically evaluated for impairment	$	13,304,000		$	1,380,000	$	2,942,000		$	—	$	16,123,000	$	—		$	2,087,000	$	26,000	$	—		$	35,862,000
Ending balance collectively evaluated for impairment	$	229,007,000		$	29,552,000	$	101,589,000		$	20,424,000	$	367,909,000	$	12,160,000		$	101,434,000	$	19,627,000	$	—		$	881,702,000



For the year ended December 31, 2013	Commercial										Residential				Home Equity Line of Credit
For the year ended December 31, 2013	Real Estate			Construction		Other		Municipal			Term		Construction		Home Equity Line of Credit		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning 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
Chargeoffs	150,000			963,000		2,583,000		—			1,118,000		—		611,000		430,000		—		5,855,000
Recoveries	—			—		359,000		—			103,000		—		24,000		183,000		—		669,000
Provision (credit)	(1,113,000		)	179,000		2,450,000		(3,000		)	1,005,000		10,000		608,000		228,000		836,000		4,200,000
Ending balance	$	4,602,000		$	575,000	$	2,276,000	$	15,000		$	1,099,000	$	21,000	$	675,000	$	573,000	$	1,678,000	$	11,514,000
Ending balance specifically evaluated for impairment	$	890,000		$	272,000	$	841,000	$	—		$	404,000	$	—	$	54,000	$	—	$	—	$	2,461,000
Ending balance collectively evaluated for impairment	$	3,712,000		$	303,000	$	1,435,000	$	15,000		$	695,000	$	21,000	$	621,000	$	573,000	$	1,678,000	$	9,053,000
Related loan balances:
Ending balance	$	245,943,000		$	20,382,000	$	95,289,000	$	19,117,000		$	377,218,000	$	11,803,000	$	91,549,000	$	15,066,000	$	—	$	876,367,000
Ending balance specifically evaluated for impairment	$	14,935,000		$	1,284,000	$	6,698,000	$	—		$	17,786,000	$	—	$	1,648,000	$	—	$	—	$	42,351,000
Ending balance collectively evaluated for impairment	$	231,008,000		$	19,098,000	$	88,591,000	$	19,117,000		$	359,432,000	$	11,803,000	$	89,901,000	$	15,066,000	$	—	$	834,016,000



For the year ended December 31, 2012	Commercial									Residential				Home Equity Line of Credit
For the year ended December 31, 2012	Real Estate		Construction		Other		Municipal			Term		Construction		Home Equity Line of Credit		Consumer		Unallocated			Total
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
Chargeoffs	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 (credit)	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