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, 2015 and 2014:



As of December 31,	2015		2014
Allowance for Loans Evaluated Individually for Impairment
Commercial
Real estate	$	89,000	$	346,000
Construction	302,000		413,000
Other	8,000		129,000
Municipal	—		—
Residential
Term	326,000		519,000
Construction	—		—
Home equity line of credit	29,000		396,000
Consumer	—		—
Total	$	754,000	$	1,803,000
Allowance for Loans Evaluated Collectively for Impairment
Commercial
Real estate	$	3,031,000	$	3,186,000
Construction	278,000		410,000
Other	1,444,000		1,376,000
Municipal	17,000		15,000
Residential
Term	1,065,000		666,000
Construction	24,000		20,000
Home equity line of credit	864,000		664,000
Consumer	566,000		542,000
Unallocated	1,873,000		1,662,000
Total	$	9,162,000	$	8,541,000
Total Allowance for Loan Losses
Commercial
Real estate	$	3,120,000	$	3,532,000
Construction	580,000		823,000
Other	1,452,000		1,505,000
Municipal	17,000		15,000
Residential
Term	1,391,000		1,185,000
Construction	24,000		20,000
Home equity line of credit	893,000		1,060,000
Consumer	566,000		542,000
Unallocated	1,873,000		1,662,000
Total	$	9,916,000	$	10,344,000

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, 2015 and 2014, by class of financing receivable and allowance element, is presented in the following tables:



As of December 31, 2015	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	$	89,000	$	893,000	$	2,138,000	$	—	$	3,120,000
Construction	302,000		82,000		196,000		—		580,000
Other	8,000		425,000		1,019,000		—		1,452,000
Municipal	—		—		17,000		—		17,000
Residential
Term	326,000		613,000		452,000		—		1,391,000
Construction	—		14,000		10,000		—		24,000
Home equity line of credit	29,000		500,000		364,000		—		893,000
Consumer	—		331,000		235,000		—		566,000
Unallocated	—		—		—		1,873,000		1,873,000
	$	754,000	$	2,858,000	$	4,431,000	$	1,873,000	$	9,916,000



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

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 0.45% of related loans as of December 31, 2015, compared to 0.39% of related loans as of December 31, 2014. The qualitative portion increased $834,000 between December 31, 2014 and December 31, 2015.

The unallocated component totaled $1,873,000 at December 31, 2015, or 18.9% of the total reserve. This compares to $1,662,000 or 16.1% as of December 31, 2014. The increase in the unallocated portion is due to increased loan demand in comparison to previous years. Management feels the increase in the unallocated portion is directionally consistent with this change in demand.

The allowance for loan losses as a percent of total loans stood at 1.00% as of December 31, 2015, compared to 1.13% of total loans as of December 31, 2014.

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 80% 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, at 23.1% of capital are well under the regulatory guidance of 100.0% of capital at December 31, 2015. Construction loans and non-owner-occupied commercial real estate loans are at 104.2% of total capital, are below the regulatory limit of 300.0% of capital at December 31, 2015.

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, 2015:



	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	6,000	$	—	$	1,256,000	$	—	$	1,262,000
2 Above average	29,176,000		56,000		7,506,000		18,321,000		55,059,000
3 Satisfactory	52,821,000		2,057,000		28,787,000		1,430,000		85,095,000
4 Average	122,071,000		18,070,000		67,301,000		—		207,442,000
5 Watch	36,075,000		4,490,000		18,135,000		—		58,700,000
6 OAEM	9,742,000		—		2,410,000		—		12,152,000
7 Substandard	19,571,000		208,000		2,946,000		—		22,725,000
8 Doubtful	—		—		—		—		—
Total	$	269,462,000	$	24,881,000	$	128,341,000	$	19,751,000	$	442,435,000

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, 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

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. One-to four-family residential real estate loans and home equity loans are written down or charged-off no later than 180 days past due, or for residential real estate secured loans having a borrower in bankruptcy, within 60 days of receipt of notification of filing from the bankruptcy court, whichever is sooner. This is subject to completion of a current assessment of the value of the collateral with any outstanding loan balance in excess of the fair value of the property, less costs to sell, written down or charged-off.

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, 2015. Allowance for loan losses activity for the years ended December 31, 2015, 2014 and 2013 was as follows:



For the year ended December 31, 2015	Commercial										Residential				Home Equity Line of Credit
For the year ended December 31, 2015	Real Estate			Construction			Other		Municipal		Term		Construction		Home Equity Line of Credit		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning 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
Chargeoffs	280,000			9,000			732,000		—		420,000		—		582,000		350,000		—		2,373,000
Recoveries	2,000			1,000			88,000		—		152,000		—		31,000		121,000		—		395,000
Provision (credit)	(134,000		)	(235,000		)	591,000		2,000		474,000		4,000		384,000		253,000		211,000		1,550,000
Ending balance	$	3,120,000		$	580,000		$	1,452,000	$	17,000	$	1,391,000	$	24,000	$	893,000	$	566,000	$	1,873,000	$	9,916,000
Ending balance specifically evaluated for impairment	$	89,000		$	302,000		$	8,000	$	—	$	326,000	$	—	$	29,000	$	—	$	—	$	754,000
Ending balance collectively evaluated for impairment	$	3,031,000		$	278,000		$	1,444,000	$	17,000	$	1,065,000	$	24,000	$	864,000	$	566,000	$	1,873,000	$	9,162,000
Related loan balances:
Ending balance	$	269,462,000		$	24,881,000		$	128,341,000	$	19,751,000	$	403,030,000	$	8,451,000	$	110,202,000	$	24,520,000	$	—	$	988,638,000
Ending balance specifically evaluated for impairment	$	10,717,000		$	1,026,000		$	1,234,000	$	—	$	15,088,000	$	—	$	1,466,000	$	—	$	—	$	29,531,000
Ending balance collectively evaluated for impairment	$	258,745,000		$	23,855,000		$	127,107,000	$	19,751,000	$	387,942,000	$	8,451,000	$	108,736,000	$	24,520,000	$	—	$	959,107,000



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