Camden National Earnings 2018-12-31
CAC 10K Annual Report
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the Fiscal Year Ended December 31, 2018
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
Commission File No. 0-28190
CAMDEN NATIONAL CORPORATION
(Exact Name of Registrant As Specified in Its Charter)
Maine | 01-0413282 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
2 Elm Street, Camden, ME | 04843 | |
(Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s Telephone Number, Including Area Code: (207) 236-8821
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Exchange on Which Registered | |
Common Stock, without par value | The NASDAQ Stock Market LLC | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. o
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 definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | o | Accelerated filer | x | ||
Non-accelerated filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | o | |
Emerging growth company | o | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial account standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter: $697,986,564. Shares of the Registrant’s common stock held by each executive officer, director and person who beneficially own 5% or more of the Registrant’s outstanding common stock have been excluded, in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of each of the registrant’s classes of common stock as of March 1, 2019 was 15,593,287.
Certain information required in response to Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K is incorporated by reference from Camden National Corporation’s Definitive Proxy Statement for the 2019 Annual Meeting of Shareholders pursuant to Regulation 14A of the General Rules and Regulations of the Commission.
CAMDEN NATIONAL CORPORATION
2018 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page | ||
PART I | ||
PART II | ||
PART III | ||
PART IV | ||
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FORWARD-LOOKING STATEMENTS
The discussions set forth below and in the documents we incorporate by reference herein contain certain statements that may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995, including certain plans, exceptions, goals, projections, and statements, which are subject to numerous risks, assumptions, and uncertainties. Forward-looking statements can be identified by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “plan,” “target,” or “goal” or future or conditional verbs such as “will,” “may,” “might,” “should,” “could” and other expressions which predict or indicate future events or trends and which do not relate to historical matters. Forward-looking statements should not be relied on, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of Camden National Corporation (the "Company"). These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Company to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.
The following factors, among others, could cause the Company’s financial performance to differ materially from the Company’s goals, plans, objectives, intentions, expectations and other forward-looking statements:
• | weakness in the United States economy in general and the regional and local economies within the New England region and Maine, which could result in a deterioration of credit quality, an increase in the allowance for loan losses or a reduced demand for the Company’s credit or fee-based products and services; |
• | changes in trade, monetary, and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; |
• | inflation, interest rate, market, and monetary fluctuations; |
• | competitive pressures, including continued industry consolidation and the increased financial services provided by non-banks; |
• | volatility in the securities markets that could adversely affect the value or credit quality of the Company’s assets, impairment of goodwill, or the availability and terms of funding necessary to meet the Company’s liquidity needs, and that could lead to impairment in the value of securities in the Company's investment portfolio; |
• | changes in information technology that require increased capital spending; |
• | changes in consumer spending and savings habits; |
• | changes in tax, banking, securities and insurance laws and regulations; and |
• | changes in accounting policies, practices and standards, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board ("FASB"), and other accounting standard setters. |
You should carefully review all of these factors, and be aware that there may be other factors that could cause the Company's actual results to differ materially from those anticipated, including the risk factors listed in Part I, Item 1A, “Risk Factors,” beginning on page 12. Readers should carefully review the risk factors described therein and should not place undue reliance on our forward-looking statements.
These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements for any reason, including to reflect changes in underlying assumptions or factors, new information, future events or other changes.
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PART I
Item 1. Business
Overview. Camden National Corporation (hereafter referred to as “we,” “our,” “us,” or the “Company”) is a publicly-held bank holding company, with $4.3 billion in assets at December 31, 2018, incorporated under the laws of the State of Maine and headquartered in Camden, Maine. Camden National Bank (the "Bank"), a wholly-owned subsidiary of the Company, was founded in 1875. The Company was founded in 1984, went public in 1997 and is now registered with NASDAQ Global Market (“NASDAQ”) under the ticker symbol "CAC."
The Company, as a diversified financial services provider, pursues the objective of achieving long-term sustainable growth by balancing growth opportunities against profit, while mitigating risks inherent in the financial services industry. The primary business of the Company and the Bank is to attract deposits from, and to extend loans to, consumer, institutional, municipal, non-profit and commercial customers. The Company, through the Bank, provides a broad array of banking and other financial services, including wealth management and trust services, brokerage, investment advisory and insurance services, to consumer, business, non-profit and municipal customers. For the year ended December 31, 2018, 2017 and 2016, net interest income was our primary revenue source, representing 76%, 75% and 74%, respectively, of our total revenues (sum of net interest income and non-interest income). Net interest income is the interest earned on our lending activities, investment securities and other interest-earning assets, less the interest paid on interest-bearing deposits and borrowings.
Our consolidated financial statements accompanying this Form 10-K include the accounts of the Company, the Bank and its subsidiaries and divisions. All inter-company accounts and transactions have been eliminated in consolidation.
We are committed to the philosophy of serving the financial needs of customers in our communities, as described in our core purpose: Through each interaction, we will enrich the lives of people, help businesses succeed and vitalize communities.
We have achieved a five-year compounded annual asset growth rate of 11%, resulting in $4.3 billion in total assets at December 31, 2018. The following is a chronological time-line of significant events and factors contributing to our asset growth over the past five years:
• | 2014 — We achieved loan growth of $192.2 million. We expanded our franchise outside of Maine by opening our first commercial loan office in Manchester, New Hampshire. This commercial loan office provided us with a wider reach across northern New England and access to new markets. |
• | 2015 — We completed the acquisition of SBM Financial, Inc. ("SBM"), the parent company of The Bank of Maine, on October 16, 2015. This was and continues to be the Company's largest acquisition to-date, with total acquired assets of $816.3 million, including loans of $628.0 million, and deposits and borrowings of $721.2 million. The acquisition provided us with an expanded presence in Southern and Central Maine, significant low-cost deposits (including interest and non-interest checking, savings and money market), and strengthened our mortgage banking platform. |
• | 2016 — We achieved loan growth of $104.4 million, or 4%, and deposits growth of $102.2 million, or 4%. |
• | 2017 — We achieved loan growth of $187.9 million, or 7% and deposits growth of $172.0 million, or 6%, driven by low-cost deposits growth of 11%. |
• | 2018 — We achieved loan growth of $243.8 million, or 9% and deposits growth of $464.0 million, or 15%, driven by low-cost deposits growth of 15%. |
The financial services industry continues to experience consolidations through mergers that could create opportunities for us to promote our value proposition to other financial institutions and financial service companies. We continue to evaluate the possibility of expansion into new markets through both de novo expansion and acquisitions. In addition, we are focused on maximizing growth across our current markets, and particularly those markets seen as growth markets where we currently have less of a presence and market share. Further details of our financial information can be found within the consolidated financial statements within Item 8. Financial Statements and Supplementary Data of this report.
Camden National Bank. The Bank is a national banking association chartered under the laws of the United States and headquartered in Camden, Maine. Originally founded in 1875, the Bank became a direct, wholly-owned subsidiary of the Company as a result of a corporate reorganization in 1984. The Bank provides a broad array of banking and other financial services to consumer, institutional, municipal, non-profit and commercial customers. As of December 31, 2018, the Bank had 60 branches spread across 13 of Maine's 16 counties, 71 ATMs, commercial loan production offices in Manchester and Portsmouth, New Hampshire, and a mortgage loan production office in Braintree, Massachusetts. The Bank optimizes its in-
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person professional financial guidance with state-of-the-art technology, delivered through sophisticated digital channels. These digital products empower customers to bank anywhere at any time, including, but not limited to, online and mobile banking; MortgageTouch®, our easy-to-use online platform for consumer borrowers; BusinessTouch™, our online loan application system with instant approval, making borrowing faster and easier for small businesses; and TreasuryLink™, our secure online platform designed to offer advanced cash management, monitoring capabilities and controls for commercial customers.
The Bank offers comprehensive wealth management and trust services, including investment advisory services, through our wealth management team, doing business as Camden National Wealth Management, and brokerage, investment advisory, insurance and financial planning services through our financial consulting team, doing business as Camden Financial Consultants.
• | Camden National Wealth Management provides a broad range of fiduciary and asset management services to both individual and institutional clients. The wealth management services provided by Camden National Wealth Management complement the services provided by the Bank, offering high net worth individuals and families, businesses and not-for profit customers investment management, financial planning and trustee services. |
• | Camden Financial Consultants is in the business of helping clients meet all of their financial needs. Camden Financial Consultants provides full-service brokerage and insurance and its financial offerings include college, retirement, and estate planning, mutual funds, strategic asset management accounts, and variable and fixed annuities. |
Securities are offered through LPL Financial, Member FINRA/SIPC. Camden Financial Consultants and the Bank are not registered broker/dealers and are not affiliated with LPL Financial. The investment products sold through LPL Financial are not insured by Bank deposits and are not insured by the Federal Deposit Insurance Corporation ("FDIC"). These products are not obligations of the Bank and are not endorsed, recommended or guaranteed by the Bank or any government agency. The value of the investment may fluctuate, the return on the investment is not guaranteed, and loss of principal is possible.
Customers may also access the Bank’s products and services using other channels, including on-line at CamdenNational.com.
Healthcare Professional Funding Corporation. Healthcare Professional Funding Corporation ("HPFC") is a wholly-owned subsidiary of the Bank that was acquired in connection with the acquisition of SBM on October 16, 2015. Prior to the closing of ongoing operations on February 19, 2016, it provided specialized lending to dentists, optometrists and veterinarians across the U.S. HPFC's website address is www.CamdenNational.com/healthprofunding.
Competition. We compete throughout Maine, and select areas of New Hampshire and Massachusetts. Our primary markets have historically and continue to be within Maine. Within Maine, we operate in 13 of the state's 16 counties, with our primary markets and presence being throughout coastal and central Maine. Many of these markets are characterized as rural areas. Major competitors in our primary market area include local branches of large regional and national banking organizations and brokerage houses, as well as local independent banks, financial advisors, thrift institutions and credit unions. Other competitors for deposits and loans within our primary market area include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers.
We have effectively competed with other financial institutions by emphasizing customer service, highlighted by local decision-making, establishing long-term customer relationships, building customer loyalty and providing products and services designed to meet the needs of customers. Through Camden National Wealth Management and Camden Financial Consultants, we compete for trust, trust-related, investment management, individual retirement, foundation and endowment management services and brokerage services with local banks and non-banks, as well as with a number of brokerage firms and investment advisors with offices in our market area. In addition, most of these services are widely available to our customers by telephone, online and mobile channels through firms located outside our market area.
Employees. The Company employed 634 people on a full- or part-time basis as of December 31, 2018.
Investor Relations. The Company’s Investor Relations information can be obtained through our internet address, CamdenNational.com. The Company makes available on or through its Investor Relations page, without charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. In addition, the Company makes available, free of
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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.
Information Security. Information security, including cybersecurity, is a high priority for the Company. Recent, highly publicized events have highlighted the importance of cybersecurity, including cyberattacks against financial institutions, government agencies and other organizations that resulted in the compromise of personal and/or confidential information, the theft or destruction of corporate information, and demands for ransom payments to release corporate information encrypted by so-called “ransomware.” A successful cyberattack could harm the Company’s reputation and/or impair its ability to provide services to its customers. The Company has developed policies and technology designed to protect our own and our customers’ information from cyberattacks or loss, allow for the continuity of our business in the event of disruptions to the Company’s or its vendors’ critical systems and comply with regulatory requirements related to the protection of customer data, but cannot assure that it will be able to anticipate, detect, or implement effective preventative measures against all potential threats. Refer to related risk factors in Item 1A. Risk Factors below for additional information.
Executive Officers of the Registrant
The following table sets forth certain information regarding the executive officers of the Company, as defined by Rule 3b-7 of the Securities and Exchange Act of 1934, as amended, as of December 31, 2018:
Executive Officer | Age | Position | ||
Gregory A. Dufour | 58 | President and Chief Executive Officer | ||
Joanne T. Campbell | 56 | Executive Vice President, Risk Management Officer | ||
Deborah A. Jordan | 53 | Executive Vice President, Chief Operating and Financial Officer | ||
Timothy P. Nightingale | 61 | Executive Vice President, Senior Loan Officer | ||
Patricia A. Rose | 55 | Executive Vice President, Retail and Mortgage Banking Officer | ||
Gregory A. Dufour has served as President and Chief Executive Officer ("CEO") of the Company since January 2009. Mr. Dufour joined the Company in April 2001 as Senior Vice President of Finance. In August of 2002, he assumed additional responsibility for Operations and Technology until December 2003. In January 2004, Mr. Dufour was named Chief Banking Officer for the Company and President and Chief Operating Officer for Camden National Bank, and in January 2006, he became President and CEO for Camden National Bank. He also serves on the Board of Directors of Camden National Bank. Prior to joining the Company, Mr. Dufour was Managing Director of Finance and a member of the Executive Operating Group for IBEX Capital Markets in Boston, Massachusetts. In addition to his experience at IBEX, Mr. Dufour held various financial management positions with FleetBoston Corporation and its affiliates, including Vice President and Controller of Debt Capital Markets, Controller of Investment Banking and Banking Group Controller. Mr. Dufour's extensive business and finance background, demonstrated ability to effectively manage growth, strong regulatory expertise and leadership capability contributes to his active support of the Board in his director capacity. Mr. Dufour has served in various volunteer capacities on numerous community-related organizations and currently serves as trustee of Coastal Healthcare Alliance system in Rockport, Maine and as trustee and vice chair of the board of Maine Health in Portland, Maine.
Joanne T. Campbell joined the Company in 1996 as Vice President, Manager of Residential Real Estate. She was promoted to Senior Vice President, Compliance, Audit & CRA in 2002, and then to Senior Vice President, Risk Management in 2005 and to Executive Vice President ("EVP") in January 2011. Ms. Campbell currently serves as a member of the ABA Risk Management Conference Advisory Board.
Deborah A. Jordan joined the Company in September 2008 as Senior Vice President, Chief Financial Officer ("CFO"), and Principal Financial and Accounting Officer and was promoted to EVP in January 2011. Effective January 1, 2015, Ms. Jordan was promoted to Chief Operating Officer ("COO"), and continues to serve as CFO, COO and Principal Financial and Accounting Officer. Ms. Jordan was previously EVP and CFO of Merrill Merchants Bancshares, Inc. in Bangor, Maine, from January 1993 to August 2008. Ms. Jordan worked at Arthur Andersen & Co. from 1987 to 1992. Ms. Jordan currently serves on the Board of Seven Islands Land Management Company.
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Timothy P. Nightingale joined the Company in March 2000 as Regional Vice President of UnitedKingfield Bank. In 2001, Mr. Nightingale was named Senior Lending Officer at UnitedKingfield Bank and was promoted to Senior Vice President in 2003. In September 2006, the Company merged UnitedKingfield Bank into Camden National Bank, at which time Mr. Nightingale was named Senior Vice President, Senior Lending Officer for Camden National Bank. In January 2011, he was promoted to EVP. Mr. Nightingale is a member of the board of directors for the Finance Authority of Maine, and was recently appointed to serve on the Maine Economic Growth Council.
Patricia A. Rose joined Camden National Bank in September 2017 as EVP of Retail & Mortgage Banking. Ms. Rose came to the Company from Citizens Bank where she served for two years as Head of Strategic Onboarding & Orientation, and, prior to that, Director level roles in Retail Network Sales & Strategy at Santander Bank for six years. Ms. Rose began her career in banking at Fleet Bank and Sovereign Bank where she held a variety of leadership roles and served as Market President of Retail Banking in Eastern Massachusetts and New Hampshire.
All of the executive officers hold office at the discretion of the Company’s Board of Directors. There are no arrangements or understandings between any of the directors, officers or any other persons pursuant to which any of the officers have been selected as officers. There are no “family relationships” among the directors and executive officers, as the Securities and Exchange Commission defines that term.
Supervision and Regulation
The following discussion addresses elements of the regulatory framework applicable to bank holding companies and their subsidiaries. This regulatory framework is intended primarily for the protection of depositors, the Federal Deposit Insurance Fund (“DIF”), and the banking system as a whole, rather than the protection of shareholders or non-depository creditors of a bank holding company such as the Company.
As a bank holding company, the Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (“FRB”) under the Bank Holding Company Act of 1956, as amended (“BHCA”). As a national bank, the Bank is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”).
The following is a summary of certain aspects of various statutes and regulations applicable to the Company and its direct and indirect subsidiaries. This summary is not a comprehensive analysis of all applicable laws, and you should refer to the applicable statutes and regulations for more information. Changes in applicable laws or regulations, and in their interpretation and application by regulatory agencies and other governmental authorities, cannot be predicted, but may have a material effect on our business, financial condition or results of operations.
Regulation of the Company
As a bank holding company, the Company is subject to regulation, supervision and examination by the FRB, which has the authority, among other things, to order bank holding companies to cease and desist from unsafe or unsound banking practices; to assess civil money penalties; and to order termination of non-banking activities or termination of ownership and control of a non-banking subsidiary by a bank holding company.
Source of Strength. Under long-standing FRB policy, now codified by Section 616 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), the Company is required to serve as a source of financial strength for the Bank. This support may be required at times when the Company may not have the resources to provide it. 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 a priority of payment.
Acquisitions and Activities. The BHCA prohibits a bank holding company, without prior approval of the FRB, from acquiring all or substantially all the assets of a bank, acquiring control of a bank, merging or consolidating with another bank holding company, or acquiring direct or indirect ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, the acquiring bank holding company would control more than 5% of any class of the voting shares of such other bank or bank holding company. The BHCA also prohibits a bank holding company from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks. However, a bank holding company may engage in and may own shares of companies engaged in activities that the FRB has determined, by order or regulation, to be so closely related to banking as to be a proper incident thereto.
Limitations on Acquisitions of Company Common Stock. The Change in Bank Control Act prohibits a person or group of persons acting in concert from acquiring “control” of a bank holding company unless the FRB has been notified and has not
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objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Exchange Act would generally constitute the acquisition of control of a bank holding company. In addition, the BHCA prohibits any company from acquiring control of a bank or bank holding company without first having obtained the approval of the FRB. Among other circumstances, under the BHCA, a company is deemed to control a bank or bank holding company if the company owns, controls or holds with power to vote 25% or more of a class of voting securities of the bank or bank holding company, controls in any manner the election of a majority of directors or trustees of the bank or bank holding company, or the FRB determines that the company has the power to exercise a controlling influence over the management or policies of the bank or bank holding company.
Regulation of the Bank
The Bank is subject to regulation, supervision, and examination by the OCC. Additionally, the Federal Deposit Insurance Corporation (“FDIC”) has secondary supervisory authority as the insurer of the Bank’s deposits. The Bank is also subject to regulations issued by the Consumer Financial Protection Bureau ("CFPB"), as enforced by the OCC. Pursuant to the Dodd-Frank Act, the FRB may directly examine the subsidiaries of the Company, including the Bank. The enforcement powers available to the federal banking regulators include, among other things, the ability to issue cease and desist or removal orders; to terminate insurance of deposits; to assess civil money penalties; to issue directives to increase capital; to place the Bank into receivership; and to initiate injunctive actions against banking organizations and institution-affiliated parties.
Deposit Insurance. The deposit obligations of the Bank are insured by the FDIC’s DIF up to the applicable limits. Under the Federal Deposit Insurance Act (“FDIA”), insurance of deposits may be terminated by the FDIC if the FDIC finds that the insured depository institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
The Bank’s deposits are subject to deposit insurance assessments to maintain the DIF. The Bank’s deposit insurance assessments are based on its assets. To determine its deposit insurance assessment, the Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier I capital) and the applicable assessment rate. On May 20, 2016, the FDIC’s Board of Directors adopted a final rule that changed the manner in which deposit insurance assessment rates are calculated for established small banks (generally those banks with less than $10 billion of assets that have been insured for at least five years). The rule utilizes the CAMELS rating system, which is a supervisory rating system designed to take into account and reflect all financial and operational risks that a bank may face, including capital adequacy, asset quality, management capability, earnings, liquidity and sensitivity to market risk. Each of the seven financial ratios and a weighted average of CAMELS component ratings is multiplied by a corresponding pricing multiplier. The sum of these products is added to a uniform amount, with the resulting sum being an institution’s initial base assessment rate (subject to minimum or maximum assessment rates based on a bank’s CAMELS composite rating). This method takes into account various measures, including an institution’s leverage ratio, brokered deposit ratio, one year asset growth, the ratio of net income before taxes to total assets and considerations related to asset quality. Assessments for established small banks with a CAMELS rating of 1 or 2 range from 1.5 to 16 basis points, after adjustments. Assessment rates for established small banks with a CAMELS rating of 3 range from 3 to 30 basis points, after adjustments. Assessment rates for established small banks with a CAMELS composite rating of 4 or 5 range from 11 to 30 basis points, after adjustments. The FDIC has the power to adjust deposit insurance assessment rates at any time, and the Company is not able to predict the amount or timing of any adjustment.
The FDIA, as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, establishes a minimum reserve ratio of the DIF to estimated insured deposits of 1.15% prior to September 2020 and 1.35% thereafter. Further, the Dodd-Frank Act required that, in setting assessments, the FDIC offset the effect of the increase in the minimum reserve ratio from 1.15% to 1.35% on banks with less than $10 billion in assets.
To satisfy these requirements, on March 15, 2016, the FDIC’s Board of Directors approved a final rule to increase the DIF’s reserve ratio to the statutorily required minimum ratio of 1.35% of estimated insured deposits. The final rule imposed a 4.5 basis points surcharge on the quarterly insurance assessments of large banks, which became effective on July 1, 2016. The surcharge continued through September 31, 2018, when the reserve ratio reached 1.36% of insured deposits, exceeding the statutorily required minimum reserve ratio of 1.35%. Small banks, such as the Bank, were not required to pay the surcharge. To offset the effect of the increase in the reserve ratio on small banks, those banks will receive credits for the portion of their assessments that helped to raise the reserve ratio from 1.15% to 1.35%. Credits will be applied automatically to reduce a small bank’s regular assessment in each quarter that the reserve ratio is at least 1.38%, up to the entire amount of the credit or assessment.
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Activities and Investments of National Banking Associations. National banking associations must comply with the National Bank Act and the regulations promulgated thereunder by the OCC, which limit the activities of national banking associations to those that are deemed to be part of, or incidental to, the “business of banking.” Activities that are part of, or incidental to, the business of banking include taking deposits, borrowing and lending money and discounting or negotiating promissory notes, drafts, bills of exchange, and other evidences of debt. Subsidiaries of national banking associations generally may only engage in activities permissible for the parent national bank.
Lending Restrictions. Federal law limits a bank’s authority to extend credit to its insiders, including its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital. The Dodd-Frank Act explicitly provides that an extension of credit to an insider includes credit exposure arising from a derivatives transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction. Additionally, the Dodd-Frank Act requires that asset sale transactions with insiders must be on market terms, and if the transaction represents more than 10% of the capital and surplus of the Bank, be approved by a majority of the disinterested directors of the Bank.
Brokered Deposits. Section 29 of the FDIA and FDIC regulations generally limit the ability of an insured depository institution to accept, renew or roll over any brokered deposit unless the institution’s capital category is “well capitalized” or, with a waiver from the FDIC, “adequately capitalized.” A bank that is “adequately capitalized” and that accepts or renews brokered deposits subject to a waiver from the FDIC is subject to additional restrictions on the interest rates it may offer. Depository institutions that have brokered deposits in excess of 10% of total assets will be subject to increased FDIC deposit insurance premium assessments. In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was enacted. Section 202 of the EGRRCPA amended Section 29 of the FDIA to exempt a capped amount of reciprocal deposits from treatment as brokered deposits. On December 18, 2018, the FDIC adopted a final rule to implement Section 202 of the EGRRCPA. Under the final rule, an institution that is “well capitalized” and has a CAMELS composite rating of 1 or 2 may exempt reciprocal deposits from treatment as brokered deposits up to $5 billion or 20% of the institution’s total liabilities. Institutions that are not well rated or well capitalized may treat reciprocal deposits as non-brokered up to an amount equal to a “special cap” set forth in the final rule. In addition, on December 18, 2018, the FDIC issued an advance notice of proposed rulemaking in connection with the FDIC’s comprehensive review of its regulatory approach to brokered deposits to solicit comment on all aspects of the FDIC’s brokered deposit regulations. The Company is not able to predict at this time whether any regulatory changes will be adopted as a result of the FDIC’s notice, or what impact, if any, such changes would have on the Bank.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the OCC to evaluate the Bank’s performance in helping to meet the credit needs of the entire communities it serves, including low and moderate-income neighborhoods, consistent with its safe and sound banking operations, and to take this record into consideration when evaluating certain applications. The OCC’s CRA regulations are generally based upon objective criteria of the performance of institutions under three key assessment tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low- or moderate-income individuals and businesses; and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs, and other offices. The OCC rates a national bank’s compliance with the CRA as “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” Failure of the Bank to receive at least a “Satisfactory” rating could inhibit the Bank or the Company from undertaking certain activities, including acquisitions of other financial institutions. The Bank currently has an “Outstanding” CRA rating.
Capital Adequacy and Safety and Soundness
Regulatory Capital Requirements. In July 2013, The FRB, the OCC and the FDIC approved final capital rules (“Capital Rules”) that are based on the Basel Committee on Banking Supervision’s (“Basel Committee”) framework for strengthening capital and liquidity regulation (referred to as Basel III). The Capital Rules are intended to reflect the relationship between the banking organization’s capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet items. The FRB and the OCC may from time to time require that a banking organization maintain capital above the minimum levels discussed below, due to the banking organization’s financial condition or actual or anticipated growth. The Company and the Bank became subject to the Capital Rules, applying the Standardized Approach, effective January 1, 2015.
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The Capital Rules define qualifying capital instruments and specify minimum amounts of capital as a percentage of assets that banking organizations are required to maintain. Common Equity Tier I (“CET1”) capital generally includes common stock and related surplus, retained earnings and, in certain cases and subject to certain limitations, minority interest in consolidated subsidiaries, less goodwill, other non-qualifying intangible assets and certain other deductions. Tier I capital for banks and bank holding companies generally consists of the sum of CET1 capital and “Additional Tier I capital” instruments, including non-cumulative perpetual preferred stock, related surplus and, in certain cases and subject to limitations, minority interest in consolidated subsidiaries that does not qualify as CET1 capital, less certain deductions. Tier II capital consists of other types of capital instruments, including subordinated debt and, for smaller banking organizations, legacy hybrid capital securities, and, subject to limitations, a banking organization’s allowances for loan and lease losses. The sum of Tier I and Tier II capital less certain required deductions represents qualifying total risk-based capital. Under the Dodd-Frank Act, bank holding companies are not permitted to include trust preferred securities and cumulative perpetual preferred stock in Tier I capital. However, the FRB’s capital rule applicable to bank holding companies permanently grandfathers non-qualifying capital instruments, including trust preferred securities, issued and included in Tier 1 capital before May 19, 2010, and permits bank holding companies with less than $15 billion in total assets as of December 31, 2009, to include such instruments in Additional Tier I capital, subject to a limit of 25% of Tier I capital. In addition, under the Capital Rules, accumulated other comprehensive income (positive or negative) must be reflected in Tier I capital; however, the Company was permitted to make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. The Company has made this election.
Under the Capital Rules, risk-based capital ratios are calculated by dividing CET1, Tier I and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned a risk weight based primarily on relative credit risk.
Under the Capital Rules, the Company and the Bank are each required to maintain a minimum CET1 capital to risk-weighted assets ratio of 4.5%, a minimum Tier I capital to risk-weighted assets ratio of 6%, a minimum total capital to risk-weighted assets ratio of 8% and a minimum leverage ratio of 4%. Additionally, subject to a transition schedule that was fully phased in on January 1, 2019, the Capital Rules require an institution to establish a capital conservation buffer of CET1 capital in an amount above the minimum risk-based capital requirements for “adequately capitalized” institutions equal to 2.5% of total risk weighted assets. Banking institutions with a ratio of CET1 capital to risk-weighted assets above the minimum requirement but below the capital conservation buffer face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases based on the amount of the shortfall and the institution’s “eligible retained income” (that is, four quarter trailing net income, net of distributions and tax effects not reflected in net income).
The EGRRCPA requires the federal bank regulators to adopt regulations to implement an exemption from the U.S. Basel III capital rules for smaller banking organizations, including the Company and the Bank, that maintain a “Community Bank Leverage Ratio” of at least 8% to 10%. Specifically, the legislation provides that if any depository institution or depository institution holding company with less than $10 billion in total consolidated assets maintains tangible equity in excess of this leverage ratio, as implemented by the federal bank regulators, it would be deemed to be in compliance with (i) the leverage and risk-based capital requirements promulgated by the federal banking agencies; (ii) in the case of a depository institution, the capital ratio requirements to be considered “well-capitalized” under the federal banking agencies’ “prompt corrective action” regime (see “—Prompt Corrective Action” below); and (iii) “any other capital or leverage requirements” to which the depository institution or holding company is subject, unless the appropriate federal banking agency determines otherwise based on the particular institution’s risk profile.
On November 21, 2018, the FRB, OCC and FDIC proposed a rule to implement the Community Bank Leverage Ratio. Under the proposal, a qualifying small banking organization, such as the Company, that has less than $10 billion in total consolidated assets and meets certain risk-based criteria can choose to apply the proposed Community Bank Leverage Ratio framework if its Community Bank Leverage Ratio is greater than 9%. The Company is evaluating the potential impact of this proposal.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee's standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain "unconditionally cancellable commitments," such as home equity lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company or Bank. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulators.
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Prompt Corrective Action. The FDIA requires the federal banking agencies to take prompt corrective action with respect to depository institutions that do not meet the minimum capital requirements described above. The FDIA establishes five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”). The federal banking regulators must take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions that are less than adequately capitalized, with supervisory actions progressively becoming more punitive as the institution’s capital category declines. Supervisory actions include: (i) restrictions on payment of capital distributions and management fees, (ii) requirements that a federal bank regulator monitor the condition of the institution and its efforts to restore its capital, (iii) submission of a capital restoration plan, (iv) restrictions on the growth of the institution’s assets and (v) requirements for prior regulatory approval of certain expansion proposals. A bank that is “critically undercapitalized” (i.e., has a ratio of tangible equity to total assets that is equal to or less than 2.0%) will be subject to further restrictions and generally will be placed in conservatorship or receivership within 90 days. An insured depository institution is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier I risk-based capital ratio of 8.0% or greater; (iii) a CET1 ratio of at least 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (v) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
The FDIA’s prompt corrective action provisions apply only to depository institutions such as the Bank, and not to bank holding companies. Under the FRB’s regulations, a bank holding company, such as the Company, is considered “well capitalized” if the bank holding company (i) has a total risk based capital ratio of at least 10%, (ii) has a Tier I risk-based capital ratio of at least 6%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Although prompt corrective action regulations apply only to depository institutions and not to bank holding companies, a bank that is required to submit a capital restoration plan generally must concurrently submit a performance guarantee by its parent holding company. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply.
Information concerning the Company and the Bank with respect to capital requirements is incorporated by reference
from Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital
Resources" and Note 13 of the consolidated financial statements included within this report.
The Bank and the Company meet all capital requirements under the Capital Rules, including the capital conservation buffer, and each meet the capital ratio requirements to be “well capitalized” for purposes of the prompt corrective action provisions of the FDIA and applicable FRB regulations, respectively.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe safety and soundness standards, by regulations or guidelines, as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, these guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the federal banking agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order restricting asset growth, requiring an institution to increase its ratio of tangible equity to assets or directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the FDIA. See “—Prompt Corrective Action” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
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Dividend and Share Repurchase Restrictions
The Company is a legal entity separate and distinct from its subsidiaries. The revenue of the Company (on a parent-only basis) is derived primarily from interest and dividends paid to it by the Bank. The right of the Company, and consequently the right of shareholders of the Company, to participate in any distribution of the assets or earnings of the Bank through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the Bank (including depositors), except to the extent that certain claims of the Company in a creditor capacity may be recognized. The Company and the Bank are subject to various federal and state restrictions on their ability to pay dividends as described below.
Restrictions on Bank Holding Company Dividends. The FRB has the authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. Further, the Company’s ability to pay dividends is restricted if it does not maintain the capital conservation buffer. See “—Capital Adequacy and Safety and Soundness—Regulatory Capital Requirements” above.
Under Maine law, a corporation’s Board of Directors may declare, and the corporation may pay, dividends on its outstanding shares, in cash or other property, generally only out of the corporation’s unreserved and unrestricted earned surplus, or out of the unreserved and unrestricted net earnings of the current fiscal year and the next preceding fiscal year taken as a single period, except under certain circumstances, including when the corporation is insolvent, or when the payment of the dividend would render the corporation insolvent or when the declaration would be contrary to the corporation’s charter.
Restrictions on Bank Dividends. Under OCC regulations, national banks generally may not declare a dividend in excess of the bank’s undivided profits and, absent OCC approval, if the total amount of dividends declared by the national bank in any calendar year exceeds the total of the national bank’s retained net income year-to-date combined with its retained net income for the preceding two years. National banks also are prohibited from declaring or paying any dividend if, after making the dividend, the national bank would be considered “undercapitalized” (as defined by reference to other OCC regulations). The OCC has the authority to use its enforcement powers to prohibit a national bank, such as the Bank, from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Further, the Bank’s ability to pay dividends is restricted if it does not maintain the capital conservation buffer. See “—Capital Adequacy and Safety and Soundness—Regulatory Capital Requirements” above.
Restrictions on Share Repurchases. Under the Capital Rules, any repurchase or redemption of a regulatory capital instrument is subject to approval by the FRB, in the case of the Company, or the OCC, in the case of the Bank. Accordingly, the Company may not repurchase its common stock without the prior approval of the FRB.
Certain Transactions by Banks with their Affiliates
Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W restrict transactions between a bank and its affiliates, including its parent bank holding company. The Bank is subject to these restrictions, which include quantitative and qualitative limits on the amounts and types of transactions that may occur, including extensions of credit to affiliates, investments in the stock or securities of affiliates, purchases of assets from affiliates and other “covered transactions.” Generally, a bank’s (including its subsidiaries) covered transactions with any affiliate are subject to the following limits: (i) the aggregate amount of covered transactions with any one affiliate cannot exceed 10% of the bank’s capital stock and surplus; and (ii) the aggregate amount of covered transactions with all affiliates cannot exceed 20% of the bank’s capital stock and surplus. For this purpose, “covered transactions” are defined by statute to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate unless exempted by the FRB, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate, securities borrowing or lending transactions with an affiliate that creates a credit exposure to such affiliate, or a derivatives transaction with an affiliate that creates a credit exposure to such affiliate. Covered transactions are also subject to certain collateral security requirements. Covered transactions as well as other types of transactions between a bank and its affiliates must be on market terms and not otherwise unduly favorable to an affiliate, including a parent holding company.
Anti-Tying Restrictions
Generally, a bank is prohibited from extending credit, leasing or selling property, furnishing any service or fixing or varying the consideration for any of the foregoing on the condition that (i) the customer obtains additional credit, property or
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services from the bank’s parent holding company or any subsidiary of the holding company, or (ii) the customer will not obtain credit, property or services from a competitor of the bank or its affiliates (except to the extent the restriction is a reasonable condition imposed to assure the soundness of the credit extended).
Consumer Protection Regulation
The Company and the Bank are subject to federal and state laws designed to protect consumers and prohibit unfair or deceptive business practices, including the Equal Credit Opportunity Act, the Fair Housing Act, the Home Ownership Protection Act, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”), the Gramm-Leach-Bliley Act of 1999 (“GLBA”), the Truth in Lending Act, the CRA, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act and various state law counterparts. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must interact with customers when taking deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The OCC examines the Bank for compliance with CFPB rules and enforces CFPB rules with respect to the Bank.
Mortgage Reform. The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage loan, including verifying a borrower’s ability to repay such mortgage loan, and allows borrowers to assert violations of certain provisions of the Truth in Lending Act as a defense to foreclosure proceedings. Under the Dodd-Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing insurance policies in connection with a residential mortgage loan or home equity line of credit. In addition, the Dodd-Frank Act prohibits mortgage originators from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage originator to be compensated by others if compensation is received from a consumer. The Dodd-Frank Act requires mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement and for negative amortization loans and hybrid adjustable rate mortgages.
Privacy and Customer Information Security. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the Bank must provide its customers with an initial and annual disclosure that explains its policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required or permitted by law, the Bank is prohibited from disclosing such information except as provided in such policies and procedures. However, an annual disclosure is not required to be provided by a financial institution if the financial institution only discloses information under exceptions from GLBA that do not require an opt out to be provided and if there has been no change in its privacy policies and practices since its most recent disclosure provided to consumers. The GLBA also requires that the Bank develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information (as defined under GLBA), to protect against anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank is also required to send a notice to customers whose sensitive information has been compromised if unauthorized use of this information is reasonably possible. Most states, including the states where the Bank operates, have enacted legislation concerning breaches of data security and Congress is considering federal legislation that would require consumer notice of data security breaches. Pursuant to the FACT Act, the Bank must develop and implement a written identity theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.
Anti-Money Laundering
The Bank Secrecy Act. Under the Bank Secrecy Act (“BSA”), a financial institution, is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report to the United States Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) any cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious activity reports for any transaction or series of transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The
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Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”), which amended the BSA, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, such as the Bank, to adopt and implement additional policies or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity, currency transaction reporting, customer identity verification and customer risk analysis. In evaluating an application under Section 3 of the BHCA to acquire a bank or an application under the Bank Merger Act to merge banks or affect a purchase of assets and assumption of deposits and other liabilities, the applicable federal banking regulator must consider the anti-money laundering compliance record of both the applicant and the target. In addition, under the USA PATRIOT Act, financial institutions are required to take steps to monitor their correspondent banking and private banking relationships as well as, if applicable, their relationships with “shell banks.”
OFAC. The U.S. has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These sanctions, which are administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”), 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 or other transactions relating to a sanctioned country or with certain designated persons and entities; (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); and (iii) restrictions on transactions with or involving certain persons or entities. Blocked assets (for example, property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences for the Company.
Regulation of Other Activities
Volcker Rule Restrictions on Proprietary Trading and Sponsorship of Hedge Funds and Private Equity Funds. Since its enactment, the Dodd-Frank Act has barred banking organizations, such as the Company and the Bank, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain circumstances, in a provision commonly referred to as the “Volcker Rule.”
The EGRRCPA amended the Volcker Rule to exclude certain banking organizations that do not have, and are not controlled by a company that has, more than $10 billion in total consolidated assets, and trading assets and liabilities that comprise more than 5% of total assets. This exclusion became effective immediately following enactment of the EGRRCPA. In July 2018, the FRB, FDIC and OCC issued an interagency statement in which the regulators stated they would not enforce the Volcker Rule in a manner inconsistent with the EGRRCPA and that the agencies intended to address the statutory changes to the Volcker Rule through a separate rulemaking process. On December 21, 2018, the OCC, FRB, FDIC, SEC and Commodity Futures Trading Commission jointly issued a notice of proposed rulemaking to implement the EGRRCPA’s exclusion with respect to small banking organizations. We are evaluating the proposed rule, and any potential impact on the Company or the Bank will depend on the final form of the agencies’ regulations and cannot be predicted at this time.
Item 1A. Risk Factors
An investment in the Company involves risk, some of which, including market, liquidity, credit, operational, legal, compliance, reputational and strategic risks, could be substantial and is inherent in our business. The material risks and uncertainties that management believes affect the Company are described below. Any of the following risks could affect the Company’s financial condition and results of operations and could be material and/or adverse in nature. You should consider all of the following risks together with all of the other information in this Annual Report on Form 10-K.
Risks Related to the Operation of Our Business
Our loans are concentrated in certain areas of Maine and adverse conditions in those markets could adversely affect our operations.
We primarily serve individuals and businesses located in the state of Maine, with 77% of our loan portfolio concentrated among borrowers in Maine as of December 31, 2018, with higher concentrations of exposure in Cumberland, Hancock, Kennebec, Knox, Penobscot and York counties. Further, because a substantial portion of the loan portfolio is secured by real estate in this area, the value of the associated collateral is also subject to regional real estate market conditions. Adverse economic, political or business developments or natural hazards may affect these areas and the ability of property owners in these areas to make payments of principal and interest on the underlying mortgages. If these regions experience adverse
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economic, political or business conditions, we would likely experience higher rates of loss and delinquency on these loans than if the loans were more geographically diverse.
We experience strong competition within our markets, which may impact our profitability.
Competition in the banking and financial services industry is strong. In our market areas, we compete for loans, deposits and other financial products and services with large financial companies, local independent banks, thrift institutions, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, and other financial intermediaries that offer similar services. Some of these competitors have substantially greater resources and lending limits than those of the Bank and may offer services that the Bank does not or cannot provide. Some of our non-bank competitors are not subject to the same extensive regulations we are, and, as a result, may be able to compete more effectively for business. In particular, the activity of marketplace lenders and other technological financial services companies have grown significantly over recent years and is expected to continue to grow, including through the possibility of being able to receive bank-like charters such as the Office of the Comptroller of the Currency’s “fintech” charter. There is also increased competition by out-of-market competitors through online and mobile channels. Our long-term success depends on our ability to compete successfully with other financial institutions in their service areas. Because we maintain a smaller staff and have fewer financial and other resources than larger institutions with which we compete, we may be limited in our ability to attract customers. If we are unable to attract and retain customers, we may be unable to achieve growth in the loan and core deposit portfolios, and our results of operations and financial condition may be negatively impacted.
Our loan portfolio includes commercial real estate and commercial loans, which are generally riskier than other types of loans.
At December 31, 2018, our commercial real estate and commercial loan portfolios comprised 56% of our total loan balances. Commercial loans generally carry larger loan balances and involve a higher risk of nonpayment or late payment than residential mortgage loans. Commercial loans may lack standardized terms and may include a balloon payment feature. The ability of a borrower to make or refinance a balloon payment may be affected by a number of factors, including the financial condition of the borrower, prevailing economic conditions and prevailing interest rates. Repayment of these loans is generally more dependent on the economy and the successful operation of a business. Because of the risks associated with commercial loans, we may experience higher rates of default than if the portfolio were more heavily weighted toward residential mortgage loans. Higher rates of default could have an adverse effect on our financial condition and results of operations.
As of December 31, 2018, the most significant industry concentration within our loan portfolio was non-residential building operators (operators of commercial and industrial buildings, retail establishments, theaters, banks and insurance buildings), which was 11% of our total loans and 26% of our total commercial real estate portfolio. As of December 31, 2018, we had no other industry concentrations in excess of 10% of total loans.
If our allowance for loan losses is not adequate to cover actual loan losses, our earnings could decrease.
We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for probable loan losses based on a number of factors. On a monthly basis, management reviews the allowance for loan losses to assess recent asset quality trends and impact on the Company's financial condition. On a quarterly basis, the allowance for loan losses is reviewed and approved at the Bank's Board of Directors meeting. If our assumptions are incorrect, the allowance for loan losses may not be sufficient to cover the losses we could experience, which would have an adverse effect on operating results, and may also cause us to increase the allowance for loan losses in the future. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provisions for credit losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by regulatory authorities could have a material adverse effect on our consolidated results of operations and financial condition. If additional amounts are provided to the allowance for loan losses, our earnings could decrease.
Fluctuations in market interest rates may adversely affect our performance.
Our profitability depends to a large extent upon our net interest income, which is the difference between interest income earned from loans and investments and the interest expense paid on deposits and borrowings. Net interest income is our largest source of revenue and can be affected significantly by changes in market interest rates. In particular, changes in relative interest rates may reduce our net interest income as the difference between interest income and interest expense decreases. As a result, we have adopted asset and liability management policies to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources.
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As of December 31, 2018, our balance sheet composition supported an asset sensitive interest rate risk position over a one- and two-year period. This would suggest that if interest rates were to decrease, then net interest income would decrease, reducing revenue and net income, while an increase in interest rates would increase net interest income, increasing revenue and net income. However, there can be no assurance that a change in interest rates will not negatively impact our results of operations or financial condition. Because market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. An increase in interest rates could also have a negative impact on our results of operations by slowing loan production, and specifically, loan refinance activity, and/or reducing the ability of borrowers to repay their current loan obligations, which could not only result in increased loan defaults, foreclosures and write-offs, but also necessitate further increases to our allowance for loan losses.
A downgrade or potential downgrade of the U.S. Government's sovereign credit rating by one or more credit ratings agencies could adversely affect our business.
Future uncertainty over U.S. fiscal policy could result in a downgrade or a reduction in the outlook of the U.S. long-term sovereign credit rating by one or more credit ratings agencies. Any downgrade, or perceived future downgrade, in the U.S. sovereign credit rating or outlook could adversely affect global financial markets and economic conditions and may result in, among other things, increased volatility and illiquidity in the capital markets, declines in consumer confidence, increased unemployment levels and declines in the value of U.S. Treasury securities and securities guaranteed by the U.S. government. As a result, our business, liquidity, results of operations and financial conditions may be adversely affected. Additionally, the economic conditions resulting from any such downgrade or perceived future downgrade may significantly exacerbate the other risks we face.
Our cost of funds may increase as a result of loss of deposits or a change in deposit mix.
Deposits are a low cost, stable source of funding. We compete with banks and other financial institutions for deposits. Funding costs may increase if we lose deposits and are forced to replace them with more expensive sources of funding, if clients shift their deposits into higher cost products or if we need to raise interest rates to avoid losing deposits. Higher funding costs reduce our net interest margin, net interest income and net income.
As of December 31, 2018, brokered deposits made up 10% of our total deposits. We have and will continue to utilize brokered deposits when it is a more cost effective source of funding compared to alternative funding sources. As a “well-capitalized” financial institution under the prompt corrective action regime, we are not currently subject to any FDIC restrictions for the acceptance of brokered deposits or interest rates that may be offered on such deposits. Should we become less than well-capitalized, our use of brokered deposits may be limited, which could result in the use of more costly funding source that would reduce our net interest margin, net interest income and net income.
Wholesale funding sources may prove insufficient to replace deposits and support our operations and future growth.
We and our bank subsidiary must maintain sufficient funds to respond to the needs of depositors and borrowers. To manage liquidity, we draw upon a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered deposits, borrowings through the Federal Home Loan Bank and correspondent banks, proceeds from the sale of investments and loans, and liquidity resources at the holding company. Our ability to manage liquidity will be severely constrained if we are unable to maintain access to funding or if adequate financing is not available to accommodate future growth at acceptable costs. In addition, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, operating margins and profitability would be adversely affected. Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.
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We could be adversely affected by the actions and commercial soundness of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We maintain a diversified securities portfolio and have exposure to many different counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, other commercial banks, investment banks, mutual and hedge funds, and other financial institutions. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and losses or defaults by us or by other institutions and organizations. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. Furthermore, our credit risk may be exacerbated when the collateral held by us cannot be liquidated or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
We believe that we have adequately reviewed our investment securities for impairment and we did not recognize any other-than-temporary impairments on our investment securities portfolio in 2018. However, over time, the economic and market environment may provide additional insight regarding the fair value of certain securities, which could change our judgment regarding impairment. In addition, if a counterparty should default, become insolvent, declare bankruptcy, or otherwise cease to exist, the value of our investment may be impaired. This could result in realized losses relating to other-than-temporary declines being charged against future income. Given the significant judgments involved, there is risk that material other-than-temporary impairments may be charged to income in future periods, resulting in realized losses.
Market changes may adversely affect demand for our services and impact results of operations.
Channels for servicing our customers are evolving rapidly, with less reliance on traditional branches, more use of online and mobile banking, and increased demand for universal bankers and other relationship managers who can service multiples product lines. We compete with larger providers that are rapidly evolving their service offerings and escalating the costs of evolving the Bank’s efforts to keep pace. We have a process for evaluating the profitability of our branches and other office and operational facilities. The identification of unprofitable operations and facilities can lead to restructuring charges and introduce the risk of disruptions to revenues and customer relationships.
Our financial condition and results of operations have been adversely affected, and may continue to be adversely affected, by the U.S. and international financial market and economic conditions.
We have been, and continue to be, impacted by general business and economic conditions in the United States and, to a lesser extent, abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, unemployment and investor confidence, all of which are beyond our control. While in recent years there has been gradual improvement in the U.S. economy, deterioration in any of these conditions could result in increases in loan delinquencies and non-performing assets, decreases in loan collateral values, the value of our investment portfolio and demand for our products and services. Higher credit or collateral related losses, or decreases in the value of our investment portfolio or demand for our products and services, could negatively impact our financial condition or results of operations.
Prepayments of loans may negatively impact our business.
Generally, our customers may prepay the principal amount of their outstanding loans at any time, frequently without financial penalty to the borrower. The speeds at which such prepayments occur, as well as the size of such prepayments, are within our customers’ discretion. Fluctuations in interest rates, in certain circumstances, may also lead to high levels of loan prepayments. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, interest income will be reduced. A significant reduction in interest income could have a negative impact on our results of operations and financial condition.
We may become involved in lawsuits and legal proceedings that may lead to adverse consequences.
As a participant in the financial services industry, many aspects of the Company’s business involve substantial risk of legal liability. From time to time, we are named or threatened to be named as defendants in various lawsuits arising from our business activities. There is no assurance that litigation with private parties will not increase in the future. Future actions against us may result in judgments, settlements, fines, penalties or other results adverse to us, which could materially adversely affect our business, financial condition or results of operations, or cause serious reputational harm to us. Although we maintain
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insurance, the scope of this coverage may not provide us with full, or even partial, coverage in any particular case. As a result, a judgment against us in any such litigation and/or legal costs incurred in defending us against such litigation could have a material adverse effect on our financial condition and results of operation.
We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations.
The financial services industry is subject to intense scrutiny from bank supervisors in the examination process and aggressive enforcement of federal and state regulations, particularly with respect to mortgage-related practices and other consumer compliance matters, and compliance with anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control regulations, and economic sanctions against certain foreign countries and nationals. Enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Although we maintain systems and procedures designed to manage and monitor our compliance with applicable laws and regulations, our systems and controls can provide only reasonable, not absolute, assurances that their objectives are being met. In addition, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there were systems and procedures designed to ensure compliance in place at the time. There have been a number of significant enforcement actions in recent years by regulators, state attorneys general and the Department of Justice against banks and other non-bank financial institutions with respect to anti-money laundering and sanctions laws, and some have resulted in substantial penalties including criminal pleas. Although the Company and the Bank have adopted policies and procedures designed to comply with these laws, any failure to comply with these laws and other regulations, or to maintain an adequate compliance program, could result in significant fines, penalties, lawsuits, regulatory sanctions, reputation damage, or restrictions on our business.
We are subject to numerous laws designed to meet the credit needs of low- and moderate-income communities and to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose community investment and nondiscriminatory lending requirements on financial institutions. The FRB, OCC, CFPB, the Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act or other fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions, restrictions on expansion and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
Damage to our reputation could significantly harm our business.
We are dependent on our reputation within our market area, as a trusted and responsible financial company, for all aspects of our relationships with customers, employees, vendors, third-party service providers and others with whom we conduct business or potential future business, particularly because our business is primarily concentrated in certain areas of Maine. Our actual or perceived failure to (a) identify and address potential conflicts of interest, ethical issues, money-laundering, or privacy issues; (b) meet legal and regulatory requirements applicable to the Bank and to the Company; (c) maintain the privacy of customer and accompanying personal information; (d) maintain adequate record keeping; (e) engage in proper sales and trading practices; and (f) identify the legal, reputational, credit, liquidity and market risks inherent in our products; or any action of one of our employees that results in actual or perceived misconduct or error, among other things, could give rise to reputational risk that could cause harm to the Bank and our business prospects. If we fail to address any of these issues in an appropriate manner, we could be subject to additional legal risks, which, in turn, could increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause us to incur related costs and expenses. Because we primarily serve individuals and businesses located in Maine, any negative impact resulting from reputational harm, including any impact on our ability to attract and retain customers and employees, likely would be greater than if our business were more geographically diverse.
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We may incur significant losses as a result of ineffective risk management processes and strategies.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application may not be effective and may not anticipate every economic and financial outcome in all market environments or the specifics and timing of such outcomes. Market conditions over the last several years have involved unprecedented dislocations and highlight the limitations inherent in using historical data to manage risk. If our risk and control framework, or the assumptions underlying our framework, prove ineffective, we may not be able to mitigate our risk exposures effectively, and, as a result, we could incur litigation, negative regulatory consequences, reputational damage or other adverse consequences, and we could suffer unexpected losses that may affect our business, financial condition or results of operations.
Our business may be adversely affected if we are unable to attract and retain qualified employees.
The Company’s employees are its most important resource, and in many areas of the financial services industry, competition for qualified personnel is intense. If the Company provides inadequate succession planning, or is unable to continue to retain and attract qualified employees, the Company’s performance, including its competitive position, could have a materially adverse effect.
We could be held responsible for environmental liabilities of properties we acquired through foreclosure.
In the course of business, we may acquire, through foreclosure, properties securing loans originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that material environmental violations could be discovered on these properties. In this event, we might be required to remedy these violations at the affected properties at our sole cost and expense. The cost of remedial action could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our financial condition and results of operations.
Systems failures, interruptions or breaches of security concerning our information base, including the information we maintain relating to our customers, could have an adverse effect on our financial condition and results of operations.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our business and to store sensitive data, including financial information regarding customers. We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud, cyberattacks, hacking, identity theft and catastrophic failures resulting from terrorist acts or natural disasters. We depend upon data processing, software, communication, and information exchange on a variety of computing platforms and networks and over the internet, and we rely on the services of a variety of vendors to meet our data processing and communication needs. Despite instituted safeguards, we cannot be certain that all of our systems are entirely free from vulnerability to attack or other technological difficulties or failures. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and we could be exposed to claims from customers. While we maintain a system of internal controls and procedures, any of these results could have a material adverse effect on our reputation, business, financial condition, results of operations or liquidity.
We regularly assess and test our security systems and disaster preparedness, including back-up systems, but the risks are substantially escalating. As a result, cybersecurity and the continued enhancement of our controls and processes to protect our systems, data and networks from attacks, unauthorized access or significant damage remain a priority. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures in our computer systems and networks, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through insurance maintained by us. Any such losses, which may be difficult to detect, could adversely affect our financial condition or results of operations. In addition, the occurrence of such a loss could expose the Company and the Bank to reputational risk, the loss of customers and additional regulatory scrutiny.
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We are subject to a variety of cybersecurity risks that, if realized, could adversely affect our business, financial condition and results of operations.
Information security risks for financial institutions such as the Company and the Bank have increased significantly in recent years due to the use of online, telephone and mobile banking channels by customers and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Third parties with whom we or our customers do business also present operational and information security risks to us, including security breaches or failures of their own systems. Our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. Our businesses rely on our digital technologies, computer and email systems, software, and networks to conduct their operations. Our technologies, systems, networks and our customers’ devices may be the target of cyber-attacks, computer viruses, malicious code, phishing attacks or information security breaches. Malicious actors may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information, including passwords and other identifying information, in order to gain access to data or our systems.
In recent years, there have been several well-publicized attacks on various companies, including in the financial services industry, and personal, proprietary, and public e-mail systems in which the perpetrators gained unauthorized access to confidential information and customer data, often through the introduction of computer viruses or malware, cyber-attacks, phishing, or other means. Even if not directed at the Company or the Bank specifically, attacks on other entities with whom we do business or on whom we otherwise rely or attacks on financial or other institutions important to the overall functioning of the financial system could adversely affect, directly or indirectly, aspects of our business.
Furthermore, as cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our systems or to investigate and remediate vulnerabilities. System enhancements and updates may also create risks associated with implementing and integrating new systems. Due to the complexity and interconnectedness of information technology systems, the process of enhancing our systems can itself create a risk of systems disruptions and security issues.
Although we believe we have appropriate information security controls and procedures, we may not be able to anticipate, detect, or implement effective preventative measures against all potential threats, particularly because the techniques used by cyber criminals change frequently, often are not recognized until launched and can be initiated from a variety of sources. In the event one or more of the events described above occurs, this could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, the theft of customer assets through fraudulent transactions or disruption of our or our customers’ or other third parties’ business operations, which could result in legal or regulatory action, significant losses, increased compliance costs or reputational damage, any of which could adversely affect our business, financial condition or results of operations.
We must adapt to information technology changes in the financial services industry, which could present operational issues, require significant capital spending, or impact our reputation.
The financial services industry is constantly undergoing technological changes, with frequent introductions of new technology-driven products and services. We invest significant resources in information technology system enhancements in order to provide functionality and security at an appropriate level. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully implement and integrate future system enhancements could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in our stock, among others. In addition, future system enhancements could have higher than expected costs and/or result in operating inefficiencies, which could increase the costs associated with the implementation as well as ongoing operations.
Failure to properly utilize system enhancements that are implemented in the future could result in impairment charges that adversely impact our financial condition and results of operations and could result in significant costs to remediate or replace the defective components. In addition, we may incur significant training, licensing, maintenance, consulting and amortization expenses during and after systems implementations, and any such costs may continue for an extended period of time.
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We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.
Third parties with which we do business could also be sources of information security risk to us, including from breakdowns, systems failures or cyber threats through their systems to our systems. Any of these occurrences could impact our ability to operate our business, or cause financial loss, potential liability to clients, reputational damage or regulatory consequences, any of which could have a material adverse effect on our financial condition or results of operations.
Natural disasters, acts of terrorism and other external events could harm our business.
Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. A significant natural disaster, such as a tornado, hurricane, earthquake, fire or flood, could have a material adverse impact on our ability to conduct business, and our insurance coverage may be insufficient to compensate for losses that may occur. Because we primarily serve individuals and businesses located in Maine, a natural disaster likely would have a greater impact on our business, operations and financial condition than if our business were more geographically diverse. Acts of terrorism, war, civil unrest, violence or human error could cause disruptions to our business or the economy as a whole. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
Camden National Wealth Management may be negatively affected by changes in economic and market conditions.
A substantial portion of income from fiduciary services is dependent on the market value of wealth management assets under administration, which are primarily marketable securities. Changes in domestic and foreign economic conditions, volatility in financial markets, and general trends in business and finance, all of which are beyond our control, could adversely impact the market value of these assets and the fee revenues derived from the management of these assets.
Due to strong competition, Camden National Wealth Management may not be able to attract and retain clients at current levels. Competition is strong as there are numerous well-established and successful investment management and wealth advisory firms including commercial banks and trust companies, investment advisory firms, mutual fund companies, stock brokerage firms, and other financial companies. Our ability to attract and retain wealth management clients is dependent upon our ability to compete with competitors’ investment products, level of investment performance, client services, and marketing and distribution capabilities. If we are not successful, our results of operations and financial condition may be negatively impacted.
If we do not maintain net income growth, the market price of our common stock could be adversely affected.
Return on shareholders’ equity and other measures of profitability, which affect the market price of our common stock, depend in part on continued growth and expansion. Our growth strategy has two principal components: internal growth and external growth. The ability to generate internal growth is affected by the competitive factors described herein as well as by the primarily rural characteristics and related demographic features of the markets we serve. The ability to continue to identify and invest in suitable acquisition candidates on acceptable terms is an important component of our external growth strategy. In pursuing acquisition opportunities, we may be in competition with other companies having similar growth strategies. As a result, we may not be able to identify or acquire promising acquisition candidates on acceptable terms. Competition for these acquisitions could result in increased acquisition prices and a diminished pool of acquisition opportunities. An inability to find suitable acquisition candidates at reasonable prices could slow our growth rate and have a negative effect on the market price of our common stock.
Our financial statements are based in part on assumptions and estimates, which, if wrong, could cause unexpected losses in the future.
Pursuant to U.S. generally accepted accounting principles, we are required to use certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value
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of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses. For additional information, see Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies."
We may be required to write down goodwill and other identifiable intangible assets.
When we acquire a business, a portion of the purchase price of the acquisition may be allocated to goodwill and other identifiable intangible assets. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired determines the amount of the purchase price that is allocated to goodwill acquired. At December 31, 2018, our goodwill and other identifiable intangible assets totaled $98.9 million, which included goodwill and core deposit intangible assets created in connection with the SBM acquisition on October 16, 2015 of $49.9 million and $6.6 million, respectively. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we would be required to write down the value of these assets to fair value. We conduct an annual review, or more frequently if events or circumstances warrant such additional review, to determine whether goodwill is impaired. We recently completed our goodwill impairment analysis as of November 30, 2018 and concluded goodwill was not impaired. We conduct a review of our other intangible assets for impairment should events or circumstances warrant such review. There were no triggers for such review for impairment for other intangible assets for the year ended December 31, 2018. We cannot provide assurance that we will not be required to take an impairment charge in the future. Any impairment charge would have a negative effect on our shareholders’ equity and financial results and may cause a decline in our stock price.
Continued market volatility may impact our business and the value of our common stock.
Our business performance and the trading price of shares of our common stock may be affected by many factors affecting financial institutions, including volatility in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and the value of debt and mortgage-backed and other securities that we hold in our investment portfolio. Government action and legislation may also impact us and the value of our common stock. We cannot predict what impact, if any, volatility will have on our business or share price and for these and other reasons our shares of common stock may trade at a price lower than that at which they were purchased.
We are a holding company and dependent upon our subsidiary for dividends, distributions and other payments.
We are a legal entity separate and distinct from our direct and indirect subsidiaries. Our revenue (on a parent-only basis) is derived primarily from interest and dividends paid to us by the Bank. Our right, and consequently the right of our shareholders, to participate in any distribution of the assets or earnings of the Bank through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the Bank (including depositors), except to the extent that certain claims of us in a creditor capacity may be recognized.
Holders of our common stock are entitled to receive dividends only when, and if declared by our Board of Directors. Although we have historically declared cash dividends on our common stock, we are not required to do so and our Board of Directors may reduce or eliminate our common stock dividend in the future. The FRB has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. Additionally, the OCC 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. Further, our ability to pay dividends would be restricted under current regulatory capital rules if we do not maintain a capital conservation buffer. A reduction or elimination of dividends could adversely affect the market price of our common stock. See Item 1. “Business—Supervision and Regulation—Dividend Restrictions” and “Business—Supervision and Regulation—Regulatory Capital Requirements.”
Reforms to London Interbank Offered Rate ("LIBOR") and other indices, and related uncertainty, may adversely affect our business, financial condition or results of operations.
In July 2017, the U.K. Financial Conduct Authority announced that after 2021 it will no longer persuade or require banks to submit rates for LIBOR. This announcement, and, more generally, financial benchmark reforms and changes in the interbank lending markets, have resulted in uncertainty about the future of LIBOR and certain other rates or indices that are used as interest rate benchmarks. These actions may result in future changes in the rules or methodologies used to calculate benchmarks or in the discontinuance or unavailability of certain benchmarks. The possible impact of these actions is uncertain and cannot be predicted at this time, and the potential or actual discontinuance of benchmark quotes may have a material, adverse effect on the value of, return on and trading market for our financial assets and liabilities that are based on or are linked to benchmarks, including our hedge contracts, or our financial condition or results of operations. In addition, we cannot assure that we and other market participants will adequately be prepared for a discontinuation of LIBOR or other benchmarks, and
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such discontinuation may have an unpredictable impact on our contracts and/or cause significant disruption to financial markets that are relevant to our business, which may have a material, adverse effect on our financial condition or results of operations.
Risks Arising From the Legal and Regulatory Framework in which Our Business Operates
Our banking business is highly regulated, and we may be adversely affected by changes in law and regulation.
We are subject to regulation and supervision by the FRB, and the Bank is subject to regulation and supervision by the OCC and the FDIC, as well as regulations issued by the CFPB. Federal laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible nonbanking activities, the level of reserves against deposits and restrictions on dividend payments. The OCC possesses the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we may conduct business and obtain financing.
Our business is highly regulated and the laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change. These changes could adversely and materially impact us. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of the performance of and government intervention in the financial services sector. There have been significant revisions to the laws and regulations applicable to banks and bank holding companies that have been enacted or proposed in recent months. Banking regulators have yet to adopt final rules to implement many of these changes, and the final timing, scope and impact to financial institutions generally, and to us in particular, remain uncertain. These and other changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties, and/or reputational damage, which could have a material adverse effect on our business, financial condition, and results of operations. See Item 1. “Business—Supervision and Regulation.”
We are subject to capital and liquidity standards that require banks and bank holding companies to maintain more and higher quality capital and greater liquidity that has historically been the case.
We became subject to new capital requirements in 2015. These standards require bank holding companies and their bank subsidiaries to maintain substantially higher levels of capital as a percentage of their assets, with a greater emphasis on common equity as opposed to other components of capital. See Item 1. “Business—Supervision and Regulation—Regulatory Capital Requirements.” The need to maintain more and higher quality capital, as well as greater liquidity, and generally increased regulatory scrutiny with respect to capital levels, may at some point limit our business activities, including lending, and our ability to expand. It could also result in our being required to take steps to increase our regulatory capital and may dilute shareholder value or limit our ability to pay dividends or otherwise return capital to our investors through stock repurchases. In addition, if we fail to maintain appropriate levels of capital or liquidity, we could become subject to formal or informal enforcement actions that may impose restrictions on our business, including limiting our lending activities or our ability to expand, requiring us to raise additional capital (which may be dilutive to shareholders) or requiring regulatory approval to pay dividends or otherwise return capital to shareholders.
Changes in accounting standards can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to anticipate and implement and can materially impact how we record and report our financial condition and results of operations. For example, the FASB’s recently issued financial instruments standard will, among other things, significantly change how loan loss provisions are determined once effective from an “incurred loss” model to an “expected loss” model, which may result in an increase in our allowance for loan and lease losses upon adoption. We continue to assess the impact of the financial instruments standard on our consolidated financial statements.
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Changes in tax laws and regulations and differences in interpretation of tax laws and regulations may adversely impact our financial statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than we do and challenge tax positions that we have taken on tax returns. This may result in differences in the treatment of revenues, deductions, credits and/or differences in the timing of these items. The differences in treatment may result in payment of additional taxes, interest or penalties that could have a material adverse effect on our results. In addition, there may be future changes to tax laws, administrative rulings or court decisions that could adversely affect our financial condition, including an increased provision for income taxes and/or reduced net income. We are not able to predict the timing or impact of any changes in local, state or federal tax laws.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
At December 31, 2018, the Company owns or leases a total of 66 facilities, excluding any properties designated as other real estate owned. All facilities are fully utilized and considered suitable and adequate for the purposes intended. The Company owns 44 of its facilities, none of which are subject to a mortgage, and the remaining branches and loan offices are leased by the Company. The Company has 60 branches located throughout Maine, a commercial loan production office in Manchester and Portsmouth, New Hampshire, and a mortgage loan production office in Braintree, Massachusetts.
The following table presents the Company's materially important locations and properties as of December 31, 2018:
Facility Name | Location | General Character of the Physical Property | Primary Business Segment | Property Status | Property Square Feet(1) | |||||||
Main Office | Camden, Maine | 3 story building | Branch and principal executive office | Owned | 15,500 | |||||||
Canal Plaza | Portland, Maine | 2 floors | Branch and executive office | Leased | 16,355 | |||||||
Hanley Center | Rockport, Maine | 2 story building | Service center | Owned | 32,360 | |||||||
Gardiner | Gardiner, Maine | 3 story building | Branch and service center | Owned | 17,497 | |||||||
Kennebunk | Kennebunk, Maine | 2 story building | Branch and service center | Owned | 9,982 | |||||||
Auburn | Auburn, Maine | 3 story building | Branch | Owned | 13,000 | |||||||
Bangor | Bangor, Maine | 1 floor | Branch | Leased | 17,432 | |||||||
Ellsworth | Ellsworth, Maine | 3 story building | Branch | Owned | 44,000 | (2) | ||||||
Rockland | Rockland, Maine | 3 story building | Branch | Owned | 21,600 | |||||||
Waterville | Waterville, Maine | 1 floor | Branch | Leased | 3,500 | |||||||
(1) | Total square footage for leased locations represents the amount of space the Company occupies. |
(2) | Includes space leased to third parties. |
For additional information regarding the Company's premises and equipment and lease obligations see Note 6 of the consolidated financial statements within Item 8. Financial Statements and Supplementary Data.
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Item 3. Legal Proceedings
The Company is currently involved, and from time to time in the future may become involved, in various legal claims that arise in the normal course of the Company’s business. The Company may also in the future become involved in other regulatory, judicial and/or arbitration proceedings relating to matters that arise in connection with the conduct of the Company’s business. Because of the difficulty in predicting the outcome of these matters, particularly when they are in their early stages, the Company cannot predict what the final outcome of each legal proceeding may be, or what the eventual loss, fine or penalty related to each proceeding may be, if any. Based on currently available information, in our opinion the results of legal proceedings that are currently pending are not expected to have a material effect on our consolidated financial statements.
Reserves are established for legal claims only when losses associated with the claims are judged to be probable, and the loss can be reasonably estimated. In many lawsuits and arbitrations, it is not possible to determine whether a liability has been incurred or to estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case a reserve will not be recognized until that time. As of December 31, 2018 and 2017, the Company did not maintain material reserves against legal claims.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is currently traded on the NASDAQ Global Market (“NASDAQ”) under the ticker symbol “CAC.” The Company has paid quarterly dividends since its foundation in 1984. The high and low closing sales prices (as quoted by NASDAQ for 2018 and 2017) and cash dividends declared per share of the Company’s common stock, by calendar quarter for the past two years, were as follows:
2018 | 2017 | ||||||||||||||||||||||
Market Price | Dividends Declared per Share | Market Price | Dividends Declared per Share | ||||||||||||||||||||
High | Low | High | Low | ||||||||||||||||||||
First Quarter | $ | 45.74 | $ | 41.91 | $ | 0.25 | $ | 44.82 | $ | 40.14 | $ | 0.23 | |||||||||||
Second Quarter | 47.43 | 43.54 | 0.30 | 44.12 | 40.20 | 0.23 | |||||||||||||||||
Third Quarter | 47.05 | 42.58 | 0.30 | 44.40 | 37.33 | 0.23 | |||||||||||||||||
Fourth Quarter | 42.23 | 34.05 | 0.30 | 47.00 | 41.70 | 0.25 | |||||||||||||||||
As of March 1, 2019, there were 15,593,287 shares of the Company’s common stock outstanding by approximately 1,200 shareholders, as obtained through our transfer agent. Such number of shareholders does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms and other nominees.
Although the Company has historically paid quarterly dividends on its common stock, the Company’s ability to pay such dividends depends on a number of factors, including restrictions under federal laws and regulations on the Company’s ability to pay dividends, and as a result, there can be no assurance that dividends will be paid in the future. For further information on dividend restrictions, refer to Item 1. "Business—Supervision and Regulation" and Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources."
The following graph illustrates the annual percentage change in the cumulative total shareholder return of the Company’s common stock for the period December 31, 2013 through December 31, 2018. For purposes of comparison, the graph illustrates comparable shareholder returns of the SNL $1B – $5B Bank Index and the Russell 2000 Stock Index. The graph assumes a $100 investment on December 31, 2013 in each case and measures the amount by which the market value, assuming reinvestment of dividends, has changed as of December 31, 2018.
Stock Performance Graph
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On September 24, 2013, the Board of Directors authorized a common stock repurchase program that had no set expiration date and was to terminate upon the earlier of (i) reaching the authorized share repurchase amount or (ii) vote by the Board of Directors to terminate the share repurchase program. As of December 31, 2018, the Company had repurchased all 375,000 shares eligible for repurchase at an average price of $26.57, representing 2.4% of total outstanding shares, and the plan terminated.
Issuer's Purchases of Equity Securities | |||||||||||||
Period | Total number of shares (or units) purchased | Average price paid per share (or unit) | Total number of shares (or units) purchased as part of publicly announced plans or programs | Maximum number (or appropriate dollar value) of shares (or units) that may yet be purchased under the plans or programs | |||||||||
October 1-31, 2018 | — | $ | — | — | 750 | ||||||||
November 1-30, 2018 | — | — | — | 750 | |||||||||
December 1-31, 2018 | 750 | 36.19 | 750 | — | |||||||||
Total | 750 | $ | 36.19 | 750 | — | ||||||||
On January 22, 2019, the Board of Directors authorized a common stock repurchase program authorizing management to repurchase up to 775,000 shares of the Company's outstanding common stock. The repurchase program will terminate upon the earlier of (i) reaching the authorized share repurchase amount, (ii) vote by the Board of Directors to terminate the plan, or (iii) one year.
Other information required by this item is incorporated by reference to Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
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Item 6. Selected Financial Data
The selected consolidated financial and other data of the Company set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information, including the consolidated financial statements and related notes, appearing elsewhere herein.
At or For The Year Ended December 31, | ||||||||||||||||||||
(In Thousands, Except per Share Data) | 2018 | 2017(1) | 2016 | 2015(2) | 2014 | |||||||||||||||
Financial Condition Data | ||||||||||||||||||||
Investments | $ | 926,678 | $ | 907,642 | $ | 897,679 | $ | 855,995 | $ | 803,633 | ||||||||||
Loans and loans held for sale | 3,030,625 | 2,790,542 | 2,609,400 | 2,501,164 | 1,772,610 | |||||||||||||||
Allowance for loan losses | (24,712 | ) | (24,171 | ) | (23,116 | ) | (21,166 | ) | (21,116 | ) | ||||||||||
Total assets | 4,297,435 | 4,065,398 | 3,864,230 | 3,709,344 | 2,789,853 | |||||||||||||||
Deposits | 3,464,474 | 3,000,491 | 2,828,529 | 2,726,379 | 1,932,097 | |||||||||||||||
Borrowings | 341,515 | 611,498 | 599,675 | 572,362 | 577,002 | |||||||||||||||
Shareholders’ equity | 435,825 | 403,413 | 391,547 | 363,190 | 245,109 | |||||||||||||||
Operating Data | ||||||||||||||||||||
Net interest income | $ | 120,393 | $ | 115,300 | $ | 113,072 | $ | 86,452 | $ | 76,257 | ||||||||||
Provision for credit losses | 847 | 3,035 | 5,258 | 1,936 | 2,220 | |||||||||||||||
Non-interest income | 38,176 | 38,599 | 39,621 | 27,482 | 24,370 | |||||||||||||||
Non-interest expense | 91,945 | 88,510 | 89,896 | 81,139 | 62,397 | |||||||||||||||
Income before income tax expense | 65,777 | 62,354 | 57,539 | 30,859 | 36,010 | |||||||||||||||
Income tax expense | 12,706 | 33,878 | 17,472 | 9,907 | 11,440 | |||||||||||||||
Net income | $ | 53,071 | $ | 28,476 | $ | 40,067 | $ | 20,952 | $ | 24,570 | ||||||||||
Ratios | ||||||||||||||||||||
Return on average assets | 1.28 | % | 0.71 | % | 1.04 | % | 0.70 | % | 0.92 | % | ||||||||||
Return on average equity | 12.92 | % | 7.00 | % | 10.47 | % | 7.54 | % | 10.37 | % | ||||||||||
Dividend payout ratio | 33.85 | % | 51.43 | % | 32.22 | % | 50.60 | % | 33.73 | % | ||||||||||
Per common share data | ||||||||||||||||||||
Basic earnings per share | $ | 3.40 | $ | 1.83 | $ | 2.59 | $ | 1.73 | $ | 2.19 | ||||||||||
Diluted earnings per share | 3.39 | 1.82 | 2.57 | 1.73 | 2.19 | |||||||||||||||
Cash dividends declared per share | 1.15 | 0.94 | 0.83 | 0.80 | 0.74 | |||||||||||||||
Book value per share | 27.95 | 25.99 | 25.30 | 23.69 | 22.00 | |||||||||||||||
Non-GAAP measures(3) | ||||||||||||||||||||
Adjusted net income | $ | 53,071 | $ | 42,739 | $ | 40,630 | $ | 28,189 | $ | 24,570 | ||||||||||
Adjusted diluted earnings per share | 3.39 | 2.73 | 2.61 | 2.33 | 2.19 | |||||||||||||||
Adjusted return on average assets | 1.28 | % | 1.07 | % | 1.06 | % | 0.94 | % | 0.92 | % | ||||||||||
Adjusted return on average tangible equity | 17.22 | % | 14.35 | % | 14.95 | % | 13.20 | % | 13.30 | % | ||||||||||
(1) | In December 2017, the Tax Cuts and Jobs Act of 2017 was enacted, and the Company recognized a $14.3 million income tax charge upon the revaluation of its deferred tax assets and liabilities using the lower federal corporate income tax rate of 21.0%. Refer to Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Income Tax Expense" and Note 17 of the consolidated financial statements for further details. |
(2) | On October 16, 2015, the Company completed its acquisition of SBM Financial, Inc., the parent company of The Bank of Maine. The impact of the acquisition was included within the presented financial data and results as of and for the year ended December 31, 2015. |
(3) | Refer to Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures and Reconciliation to GAAP" for discussion and reconciliations of non-GAAP measures. |
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollar Amounts in Tables Expressed in Thousands, Except Per Share Data)
The discussion below focuses on the factors affecting our consolidated results of operations for the year ended
December 31, 2018, 2017 and 2016 and financial condition at December 31, 2018 and 2017 and, where appropriate, factors that may affect our future financial performance, unless stated otherwise. This discussion should be read in conjunction with the consolidated financial statements, notes to the consolidated financial statements and selected consolidated financial data.
ACRONYMS AND ABBREVIATIONS
The acronyms and abbreviations identified below are used throughout Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." The following is provided to aid the reader and provide a reference page when reviewing this section of the Form 10-K.
AFS: | Available-for-sale | HPFC: | Healthcare Professional Funding Corporation, a wholly-owned subsidiary of Camden National Bank | |
ALCO: | Asset/Liability Committee | HTM: | Held-to-maturity | |
ALL: | Allowance for loan losses | IRS: | Internal Revenue Service | |
AOCI: | Accumulated other comprehensive income (loss) | LIBOR: | London Interbank Offered Rate | |
ASC: | Accounting Standards Codification | LTIP: | Long-Term Performance Share Plan | |
ASU: | Accounting Standards Update | Management ALCO: | Management Asset/Liability Committee | |
Bank: | Camden National Bank, a wholly-owned subsidiary of Camden National Corporation | MBS: | Mortgage-backed security | |
BOLI: | Bank-owned life insurance | MSPP: | Management Stock Purchase Plan | |
Board ALCO: | Board of Directors' Asset/Liability Committee | N/A: | Not applicable | |
CCTA: | Camden Capital Trust A, an unconsolidated entity formed by Camden National Corporation | N.M.: | Not meaningful | |
CDs: | Certificate of deposits | OCC: | Office of the Comptroller of the Currency | |
Company: | Camden National Corporation | OCI: | Other comprehensive income (loss) | |
CMO: | Collateralized mortgage obligation | OREO: | Other real estate owned | |
DCRP: | Defined Contribution Retirement Plan | OTTI: | Other-than-temporary impairment | |
EPS: | Earnings per share | SBM: | SBM Financial, Inc., the parent company of The Bank of Maine, that was acquired by Camden National Corporation | |
FASB: | Financial Accounting Standards Board | SERP: | Supplemental executive retirement plans | |
FDIC: | Federal Deposit Insurance Corporation | Tax Act: | Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017 | |
FHLB: | Federal Home Loan Bank | TDR: | Troubled-debt restructured loan | |
FHLBB: | Federal Home Loan Bank of Boston | UBCT: | Union Bankshares Capital Trust I, an unconsolidated entity formed by Union Bankshares Company that was subsequently acquired by Camden National Corporation | |
FRB: | Federal Reserve System Board of Governors | U.S.: | United States of America | |
FRBB: | Federal Reserve Bank of Boston | 2003 Plan: | 2003 Stock Option and Incentive Plan | |
GAAP: | Generally accepted accounting principles in the United States | 2012 Plan: | 2012 Equity and Incentive Plan | |
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NON-GAAP FINANCIAL MEASURES AND RECONCILIATION TO GAAP
In addition to evaluating the Company’s results of operations in accordance with GAAP, management supplements this evaluation with an analysis of certain non-GAAP financial measures, such as adjusted net income, diluted EPS, return on average assets, return on average equity and average tangible equity; the efficiency ratio; tax equivalent net interest income; tangible book value per share; and tangible common equity ratio. We utilize these non-GAAP financial measures for purposes of measuring our performance against our peer group and other financial institutions and analyzing our internal performance. We also believe these non-GAAP financial measures help investors better understand the Company’s operating performance and trends and allow for better performance comparisons to other banks. In addition, these non-GAAP financial measures remove the impact of unusual items that may obscure trends in the Company’s underlying performance. These disclosures should not be viewed as a substitute for GAAP operating results, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other financial institutions.
Adjusted Net Income, Adjusted Diluted EPS and Adjusted Return on Average Assets. The following tables provide a reconciliation of net income, diluted EPS, and return on average assets to adjusted net income, adjusted diluted EPS and adjusted return on average assets. Certain transactions have been excluded to calculate adjusted net income, adjusted diluted EPS and adjusted return on average assets. We believe the following adjusted financial metrics assist users of our financial statements with their financial analysis period-over-period as it adjusts for certain non-recurring items.
For The Year Ended December 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Adjusted Net Income: | ||||||||||||||||||||
Net income, as presented | $ | 53,071 | $ | 28,476 | $ | 40,067 | $ | 20,952 | $ | 24,570 | ||||||||||
Add: impact of the revaluation of deferred tax assets and liabilities due to the Tax Act | — | 14,263 | — | — | — | |||||||||||||||
Add: merger and acquisition costs and divestiture costs, net of tax(1) | — | — | 563 | 7,237 | — | |||||||||||||||
Adjusted net income | $ | 53,071 | $ | 42,739 | $ | 40,630 | $ | 28,189 | $ | 24,570 | ||||||||||
Adjusted Diluted EPS: | ||||||||||||||||||||
Diluted EPS, as presented | $ | 3.39 | $ | 1.82 | $ | 2.57 | $ | 1.73 | $ | 2.19 | ||||||||||
Impact of adjustments to arrive at adjusted net income | — | 0.91 | 0.04 | 0.60 | — | |||||||||||||||
Adjusted diluted EPS | $ | 3.39 | $ | 2.73 | $ | 2.61 | $ | 2.33 | $ | 2.19 | ||||||||||
Adjusted Return on Average Assets: | ||||||||||||||||||||
Return on average assets, as presented | 1.28 | % | 0.71 | % | 1.04 | % | 0.70 | % | 0.92 | % | ||||||||||
Impact of adjustments to arrive at adjusted net income | — | % | 0.36 | % | 0.02 | % | 0.24 | % | — | % | ||||||||||
Adjusted return on average assets | 1.28 | % | 1.07 | % | 1.06 | % | 0.94 | % | 0.92 | % | ||||||||||
(1) | Reported on a tax-equivalent basis using the corporate federal income tax rate in effect for the respective period. |
Adjusted Return on Average Equity and Adjusted Return on Average Tangible Equity. The following tables provide a reconciliation of return on average equity to adjusted return on average equity and adjusted return on average tangible equity. Return on average equity and return on average tangible equity represent a shareholders' return on capital and tangible capital, respectively, deployed in our business and is a common measure by financial institutions.
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Certain transactions have been excluded to calculate adjusted return on average equity and tangible equity. We believe the following adjusted financial metrics assist users of our financial statements with their financial analysis period-over-period as it adjusts for certain non-recurring items.
For The Year Ended December 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Net income, as presented | $ | 53,071 | $ | 28,476 | $ | 40,067 | $ | 20,952 | $ | 24,570 | ||||||||||
Add: impact of the revaluation of deferred tax assets and liabilities due to the Tax Act | — | 14,263 | — | — | — | |||||||||||||||
Add: merger and acquisition costs and divestiture costs, net of tax(1) | — | — | 563 | 7,237 | — | |||||||||||||||
Adjusted net income | $ | 53,071 | $ | 42,739 | $ | 40,630 | $ | 28,189 | $ | 24,570 | ||||||||||
Add: amortization of intangible assets, net of tax(1) | 573 | 1,176 | 1,237 | 849 | 746 | |||||||||||||||
Adjusted tangible net income | $ | 53,644 | $ | 43,915 | $ | 41,867 | $ | 29,038 | $ | 25,316 | ||||||||||
Average equity, as presented | $ | 410,755 | $ | 406,628 | $ | 382,507 | $ | 277,716 | $ | 236,849 | ||||||||||
Less: average goodwill and other intangible assets | (99,287 | ) | (100,513 | ) | (102,711 | ) | (57,833 | ) | (48,735 | ) | ||||||||||
Average tangible equity | $ | 311,468 | $ | 306,115 | $ | 279,796 | $ | 219,883 | $ | 188,114 | ||||||||||
Return on average equity | 12.92 | % | 7.00 | % | 10.47 | % | 7.54 | % | 10.37 | % | ||||||||||
Adjusted return on average equity | 12.92 | % | 10.51 | % | 10.62 | % | 10.15 | % | 10.37 | % | ||||||||||
Adjusted return on average tangible equity | 17.22 | % | 14.35 | % | 14.96 | % | 13.21 | % | 13.46 | % | ||||||||||
(1) | Reported on a tax-equivalent basis using the corporate federal income tax rate in effect for the respective period. |
Efficiency Ratio. The efficiency ratio represents an approximate measure of the cost required for the Company to generate a dollar of revenue. This is a common measure used by financial institutions and is a key ratio for evaluating Company performance. The efficiency ratio is calculated as the ratio of (i) total non-interest expense, adjusted for certain operating expenses to (ii) net interest income on a tax equivalent basis plus total non-interest income, adjusted for certain other income items.
For The Year Ended December 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Non-interest expense, as presented | $ | 91,945 | $ | 88,510 | $ | 89,896 | $ | 81,139 | $ | 62,397 | ||||||||||
Less: merger and acquisition costs, and divestiture cost | — | — | (866 | ) | (10,415 | ) | — | |||||||||||||
Adjusted non-interest expense | $ | 91,945 | $ | 88,510 | $ | 89,030 | $ | 70,724 | $ | 62,397 | ||||||||||
Net interest income, as presented | $ | 120,393 | $ | 115,300 | $ | 113,072 | $ | 86,452 | $ | 76,257 | ||||||||||
Add: effect of tax-exempt income(1) | 1,022 | 2,105 | 2,121 | 1,763 | 1,157 | |||||||||||||||
Non-interest income, as presented | 38,176 | 38,599 | 39,621 | 27,482 | 24,370 | |||||||||||||||
Less: net gains on sale of securities | (275 | ) | (855 | ) | (51 | ) | (4 | ) | (451 | ) | ||||||||||
Adjusted net interest income plus non-interest income | $ | 159,316 | $ | 155,149 | $ | 154,763 | $ | 115,693 | $ | 101,333 | ||||||||||
GAAP efficiency ratio | 57.98 | % | 57.51 | % | 58.87 | % | 71.22 | % | 62.01 | % | ||||||||||
Non-GAAP efficiency ratio | 57.71 | % | 57.05 | % | 57.53 | % | 61.13 | % | 61.58 | % | ||||||||||
(1) | Reported on a tax-equivalent basis using the corporate federal income tax rate in effect for the respective period. |
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Tax Equivalent Net Interest Income. Tax-equivalent net interest income is net interest income plus the taxes that would have been paid had tax-exempt securities been taxable. This number attempts to enhance the comparability of the performance of assets that have different tax liabilities.
For The Year Ended December 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Net interest income, as presented | $ | 120,393 | $ | 115,300 | $ | 113,072 | $ | 86,452 | $ | 76,257 | ||||||||||
Effect of tax-exempt income(1) | 1,022 | 2,105 | 2,121 | 1,763 | 1,157 | |||||||||||||||
Net interest income, tax equivalent | $ | 121,415 | $ | 117,405 | $ | 115,193 | $ | 88,215 | $ | 77,414 | ||||||||||
(1) | Reported on a tax-equivalent basis using the corporate federal income tax rate in effect for the respective period. |
Tangible Book Value per Share and Tangible Common Equity Ratio. Tangible book value per share is the ratio of (i) shareholders’ equity less goodwill, premium on deposits and other acquisition-related intangibles (the numerator) to (ii) total common shares outstanding at period end. Tangible book value per share is a common measure within our industry when assessing the value of a company as it removes goodwill and other intangible assets generated within purchase accounting upon a business combination.
Tangible common equity is the ratio of (i) shareholders’ equity less goodwill and other intangible assets (the numerator) to (ii) total assets less goodwill and other intangible assets. This ratio is a measure used within our industry to assess whether or not a company is highly leveraged.
December 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Tangible Book Value Per Share: | ||||||||||||||||||||
Shareholders' equity, as presented | $ | 435,825 | $ | 403,413 | $ | 391,547 | $ | 363,190 | $ | 245,109 | ||||||||||
Less: goodwill and other intangible assets | (98,927 | ) | (99,652 | ) | (101,461 | ) | (104,324 | ) | (48,171 | ) | ||||||||||
Tangible shareholders' equity | $ | 336,898 | $ | 303,761 | $ | 290,086 | $ | 258,866 | $ | 196,938 | ||||||||||
Shares outstanding at period end | 15,591,914 | 15,524,704 | 15,476,379 | 15,330,717 | 11,139,333 | |||||||||||||||
Tangible book value per share | $ | 21.61 | $ | 19.57 | $ | 18.74 | $ | 16.89 | $ | 17.68 | ||||||||||
Book value per share | $ | 27.95 | $ | 25.99 | $ | 25.30 | $ | 23.69 | $ | 22.00 | ||||||||||
Tangible Common Equity Ratio: | ||||||||||||||||||||
Total assets | $ | 4,297,435 | $ | 4,065,398 | $ | 3,864,230 | $ | 3,709,344 | $ | 2,789,853 | ||||||||||
Less: goodwill and other intangibles | (98,927 | ) | (99,652 | ) | (101,461 | ) | (104,324 | ) | (48,171 | ) | ||||||||||
Tangible assets | $ | 4,198,508 | $ | 3,965,746 | $ | 3,762,769 | $ | 3,605,020 | $ | 2,741,682 | ||||||||||
Common equity ratio | 10.14 | % | 9.92 | % | 10.13 | % | 9.79 | % | 8.79 | % | ||||||||||
Tangible common equity ratio | 8.02 | % | 7.66 | % | 7.71 | % | 7.18 | % | 7.18 | % | ||||||||||
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. In preparing the Company’s consolidated financial statements, management is required to make significant estimates and assumptions that affect assets, liabilities, revenues, and expenses reported. Actual results could materially differ from our current estimates, as a result of changing conditions and future events. Several estimates are particularly critical and are susceptible to significant near-term change, including (i) the allowance for loan losses; (ii) accounting for acquisitions and the subsequent review of goodwill and core deposit intangible assets generated in an acquisition for impairment; (iii) OTTI of investments; and (iv) income taxes.
Allowance for Loan Losses. Management is committed to maintaining an ALL that is appropriate to absorb likely loss exposure in the loan portfolio. Evaluating the appropriateness of the ALL is a key management function and one that requires the most significant amount of management estimates and assumptions. The ALL, which is established through a charge to the provision for credit losses, consists of two components: (i) a reduction to total gross loans in the asset section of the consolidated statements of condition, and (ii) the reserve for unfunded commitments included in other liabilities on the consolidated statements of condition. We regularly evaluate the ALL for adequacy by taking into consideration, among other
30
factors, historical trends in charge-offs and delinquencies, overall risk characteristics and size of the portfolios, ongoing review of significant individual loans, trends in levels of watched or criticized assets, business and economic conditions, regulatory guidance, and other relevant factors.
In determining the appropriate level of ALL, we use a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio. The methodology focuses on three key elements: (i) identification of loss allocations for specific loans, (ii) loss allocation factors for certain loan types based on credit grade and loss experience, and (iii) general loss allocations for other qualitative and environmental factors.
Loans for which a specific loss allocation may be required are identified and assessed at least quarterly by reviewing individual loans with a principal balance of $500,000 or more that are risk rated as substandard or doubtful and are on non-accrual status in accordance with the Bank's policy. We believe loans that meet the above criteria most often demonstrate the qualities and characteristics of an impaired loan and are individually significant enough to the Company to warrant individual assessment. Once a loan is deemed to be impaired, an allowance may be established to reduce its net carrying value to its estimated value, if the estimated value of an impaired loan is lower than its recorded investment. The estimated value of an impaired loan is determined using one of three methods: (i) calculating the present value of expected future cash flows discounted at the loan's effective interest rate (i.e. discounted cash flow method); (ii) the loan's observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent and repayment of the loan is expected to be provided solely by the underlying collateral.
The remaining loan portfolio is separated into risk pools by portfolio segment and subject to a general reserve factor. At least annually, we reassess and revise the loss allocation factor used in constructing the reserve for each risk pool. The factors we consider in constructing each risk pool include: (i) risk rating; (ii) historical losses; (iii) market conditions; and (iv) other economic factors.
In assessing the risk rating of a particular loan, we consider, among other factors, the obligor’s debt capacity, financial condition, the level of the obligor’s earnings, the amount and sources of repayment, the performance with respect to loan terms, the adequacy of collateral, the level and nature of contingent liabilities, management strength, and the industry in which the obligor operates. These factors are based on an evaluation of historical information, as well as a subjective assessment and interpretation of current conditions. Emphasizing one factor over another, or considering additional factors that may be relevant in determining the risk rating of a particular loan but which are not currently an explicit part of our methodology, could impact the risk rating assigned to that loan.
Three times a year, management conducts a thorough review of adversely risk rated commercial and commercial real estate exposures exceeding certain thresholds to re-evaluate the risk rating and identify impaired loans. This extensive review takes into account the obligor’s repayment history and financial condition, collateral value, guarantor support, local economic and industry trends, and other factors relevant to the particular loan relationship.
Because the methodology is based upon historical experience and trends as well as management’s judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in our market area, concentration of risk, declines in local property values, and the results of regulatory examinations. While management’s evaluation of the ALL as of December 31, 2018 determined it to be appropriate, under adversely different conditions or assumptions, we may need to increase the ALL. Management reviews the ALL on a monthly basis to assess recent asset quality trends and impact on the Company's financial condition. The ALL is reviewed and approved on a quarterly basis at each of the Bank's Board of Directors meetings.
The adequacy of the reserve for unfunded commitments is determined in a similar manner as the ALL, with the exception that management must also estimate the likelihood of these commitments being funded and becoming loans. This is accomplished by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the historical utilization rates could change in the future.
Purchase Price Allocation and Impairment of Goodwill and Identifiable Intangible Assets. We record all acquired assets and liabilities at fair value, which is an estimate determined by the use of internal valuation techniques. We also may engage external valuation services to assist with the valuation of material assets and liabilities acquired, including, but not limited to, loans, core deposit intangibles and/or other intangible assets, real estate and time deposits. As part of purchase accounting, we typically acquire goodwill and other intangible assets as part of the purchase price. These assets are subject to ongoing periodic impairment tests under differing accounting models. We did not acquire any other company or assets for the year ended December 31, 2018 or 2017.
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Goodwill impairment evaluations are required to be performed at least annually, but may be required more frequently if certain conditions indicate a potential impairment may exist. Our policy is to perform the goodwill impairment analysis annually as of November 30th, or more frequently as warranted. The goodwill impairment evaluation is required to be performed at the reporting unit level and is performed using the two-step process outlined in ASC 350-20, Goodwill ("ASC 350-20").
As of November 30, 2018, we assessed goodwill for impairment at the consolidated Company-level as the Company's operating segment was also its only reporting unit. We used the qualitative analysis (i.e. "step zero") outlined in ASC 350-20 to test goodwill for impairment, and considered such factors as the macroeconomic environment; overall industry environment and performance; company specific factors, including, but not limited to, competition, performance and personnel. Through completion of our analysis, we concluded it was not more-likely-than-not that the Company's carrying value exceeded its fair value. Thus, no further goodwill impairment analysis was warranted and we concluded that goodwill was not impaired as of November 30, 2018. Furthermore, we are not aware of any indications and/or triggers subsequent to our goodwill impairment analysis performed as of November 30, 2018 that would lead us to believe there may be subsequent impairment of goodwill.
For the year ended December 31, 2017 and 2016, we assessed goodwill for impairment and concluded goodwill was not impaired.
Core deposit intangible assets have a finite life and are amortized over their estimated useful lives. Core deposit intangible assets are subject to impairment tests if events or circumstances indicate a possible inability to realize the carrying amount. Core deposit intangible assets are measured for impairment utilizing a cost recovery model. We did not identify any events or circumstances that occurred for the year ended December 31, 2018 or 2017 that would indicate that our core deposit intangible assets may be impaired and should be evaluated for such.
OTTI of Investments. On January 1, 2018, we adopted ASU No. 2016-01, Income Statement- Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities ("ASU 2016-01"), which changed the accounting for equity investments with readily determinable fair values. Effective January 1, 2018, equity investments with readily determinable fair values are no longer able to be designated as AFS, rather the change in fair value for these investments must now be accounted for within the consolidated statements of income as an increase or decrease to net income. As of December 31, 2018, the fair value of equity investments with a readily determinable fair value recorded on the consolidated statements of condition was $746,000 and an unrealized loss of $50,000 was recorded within other income on the consolidated statements of income for the year ended December 31, 2018. Effective January 1, 2018, upon adoption of ASU 2016-01, we no longer assess equity investments with a readily determinable fair value for OTTI as the change in fair value is now recorded within net income. For those equity investments without a readily determinable fair value within the scope of ASC 2016-01, a company must make an accounting policy election at the investment-level to account for the equity investment either (i) at fair value and record the change in fair value through net income or (ii) at cost, less any impairment, adjusted for any observable price changes in orderly transactions for an identical or similar investment the same issuer. As of December 31, 2018, we did not have any equity securities without a readily determinable fair value within the scope of ASU 2016-01.
For those investments we assess for OTTI, including debt securities and equity securities with a readily determinable fair value prior to adoption of ASU 2016-01, we will record an impairment charge at the point we believe an investment has experienced a decline in value that is other-than-temporary. In determining whether an OTTI has occurred, we review information about the underlying investment that is publicly available, analysts’ reports, applicable industry data and other pertinent information, and assess our intent and ability to hold the security for the foreseeable future until recovered. The investment is written down to its current fair value at the time the impairment is deemed to have occurred. Future adverse changes in market conditions, continued poor operating results of underlying investments or other factors could result in further losses that may not be reflected in an investment’s current carrying value, possibly requiring an additional impairment charge in the future.
For the year ended December 31, 2018 and 2017, we did not record OTTI on any equity or debt investments. As of December 31, 2018 and 2017, we did not have any equity or debt investments designated as level 3 in accordance with ASC 820, Fair Value Measurement ("ASC 820"), rather the fair value all investments were measured using level 2 techniques. Refer to Note 19 of the consolidated financial statements for further details.
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Income Taxes. We account for income taxes by deferring income taxes based on the estimated future tax effects of differences between the book and tax bases of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in the consolidated statements of condition. We must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined not likely to be recoverable. Judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. Although we have determined a valuation allowance is not required for our deferred tax assets, there is no guarantee that these assets will be realized.
On December 22, 2017, the Tax Act was enacted reducing the federal corporate income tax rate from 35.0% to 21.0%, effective January 1, 2018. In accordance with ASC 740, Income Taxes, we revalued our deferred tax assets and liabilities as of the enactment date, and, as a result, we recorded additional income tax expense for the year ended December 31, 2017 of $14.3 million. Refer to "—Results of Operations—Income Tax Expense" for further discussion.
As of December 31, 2018, our federal and state income tax returns for the year ended December 31, 2017, 2016 and 2015 were open to audit by federal and various state authorities. If, as a result of an audit, we were to be assessed interest and penalties, the amounts would be recorded through other non-interest expense on the consolidated statements of income.
EXECUTIVE OVERVIEW
The Company reported net income for 2018 of $53.1 million, an increase of $24.6 million, or 86%, over 2017. Over the same period, diluted EPS increased $1.57, or 86%, to $3.39 per share for 2018. Our strong operating results for 2018 translated into improved performance metrics, including return on average assets of 1.28% for 2018, compared to 0.71% for 2017; and return on average equity of 12.92% for 2018, compared to 7.00% for 2017.
Our strong financial performance in 2018 was driven by:
• | Lower income taxes — Our effective tax rate for 2018 was 19.3%, compared to 54.3% for 2017. Effective January 1, 2018, the federal income tax rate was reduced from 35.0% to 21.0%, and the income tax benefit was $9.2 million for 2018. Our effective tax rate for 2017 was unusually high due to the $14.3 million income tax charge recorded after the Tax Act was enacted. |
• | Low cost deposit growth of 15% — Our total deposit base grew $464.0 million, or 15%, to $3.5 billion at December 31, 2018, which included checking account growth of $185.9 million, or 14%, and savings and money market growth of $151.8 million, or 15%. |
• | Loan growth of 9% — Our loan portfolio grew $243.8 million, or 9%, in 2018 to $3.0 billion at December 31, 2018, led by residential and commercial real estate growth of $134.5 million and $105.5 million, respectively. |
• | Superior asset quality — Improved asset quality metrics in 2018, including the favorable resolution of two large commercial credit relationships that contributed to a net charge-offs to average loans ratio of 0.01% for 2018, resulted in a provision for credit losses of $847,000 for 2018. Provision for credit losses for 2018 decreased $2.2 million, compared to 2017. |
Adjusted net income (non-GAAP) for 2018 increased $10.3 million, or 24%, over 2017, adjusted for a $14.3 million income tax charge in 2017. Adjusted diluted EPS (non-GAAP) for 2018 increased $0.66 per share over 2017. Our operating metrics, on an adjusted basis, improved over the same period as well, including adjusted return on average assets (non-GAAP) of 1.28% for 2018, compared to 1.07% for 2017; adjusted return on average equity (non-GAAP) of 12.92% for 2018, compared to 10.51% for 2017; and adjusted return on average tangible equity (non-GAAP) of 17.22% for 2018, compared to 14.35% for 2017.
For 2018, we declared aggregate cash dividends to our shareholders of $1.15 per share, a 22% increase over 2017. The increase in dividends paid to shareholders reflects our overall earnings and financial strength. Our fourth quarter 2018 annualized dividend yield at December 31, 2018 was 3.34%.
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Operating Results
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Financial Condition
35
RESULTS OF OPERATIONS
Net Interest Income and Net Interest Margin
Net interest income is the interest earned on loans, securities, and other interest-earning assets, plus net loan fees, origination costs and fair value marks on loans and/or time deposits created in purchase accounting, less the interest paid on interest-bearing deposits and borrowings. Net interest income, which is our largest source of revenue, accounted for 76% and 75% of total revenues (sum of net interest income and non-interest income) for 2018 and 2017, respectively. Net interest income is affected by factors including, but not limited to, changes in interest rates, loan and deposit pricing strategies and competitive conditions, loan prepayment speeds, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. Net interest margin is calculated as net interest income, on a fully-taxable equivalent basis, as a percentage of average interest-earning assets. Our net interest margin on a fully-taxable equivalent basis for 2018 and 2017 was 3.16% and 3.19%, respectively.
Net interest income on a fully-taxable equivalent basis for 2018 was $121.4 million, an increase of $4.0 million, or 3%, over 2017. The increase was driven by average loan growth of $155.9 million, or 6%, but was partially offset by a decline in the net interest margin on a fully-taxable equivalent basis of 3 basis points to 3.16% for 2018. The decrease in net margin on a fully-taxable equivalent basis was primarily driven by the decrease in fair value mark accretion and recoveries from charged-off acquired loans of $902,000. Adjusted for fair value mark accretion and recoveries from charged-off acquired loans, net interest margin on a fully-taxable equivalent basis was 3.10% for 2018 and 2017.
In 2018, the Federal Open Market Committee raised the federal funds rate four times for a total of 100 basis points and was indicative of the overall interest rate environment for 2018. Our average asset yield for 2018 increased 21 basis points to 3.97%, while our average funding rate for 2018 increased 26 basis points to 0.85%, compared to 2017. Strong average deposits growth in 2018 of $222.4 million, or 8%, was led by average interest and non-interest checking growth of $192.2 million, or 16%, and average money market growth of $35.5 million, or 7%. Low-cost deposits (interest and non-interest checking, savings and money market) growth in the current interest rate environment allows for a more efficient means of funding continued asset growth and maintain net interest margin on a fully-taxable equivalent basis at or near current levels. For 2018, our average low-cost deposits rate was 0.40%, compared to our average CD rate of 1.13% and an average borrowings rate of 1.96% for the same period.
The following table presents, for the periods noted, average balances, interest income, interest expense, and the corresponding average yields earned and rates paid, as well as net interest income, net interest rate spread and net interest margin:
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Average Balance, Interest and Yield/Rate Analysis | |||||||||||||||||||||||||||||||||
For The Year Ended December 31, | |||||||||||||||||||||||||||||||||
2018 | 2017 | 2016 | |||||||||||||||||||||||||||||||
Average Balance | Interest | Yield/Rate | Average Balance | Interest | Yield/Rate | Average Balance | Interest | Yield/Rate | |||||||||||||||||||||||||
ASSETS | |||||||||||||||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||||||||||||||
Interest-bearing deposits in other banks(1) | $ | 45,155 | $ | 732 | 1.62 | % | $ | 40,611 | $ | 429 | 1.06 | % | $ | 46,199 | $ | 204 | 0.44 | % | |||||||||||||||
Securities – taxable | 829,462 | 19,451 | 2.35 | % | 826,749 | 18,348 | 2.22 | % | 796,423 | 17,362 | 2.18 | % | |||||||||||||||||||||
Securities – nontaxable(2) | 98,128 | 3,352 | 3.42 | % | 101,898 | 4,253 | 4.17 | % | 103,086 | 4,363 | 4.23 | % | |||||||||||||||||||||
Loans(3): | |||||||||||||||||||||||||||||||||
Residential real estate | 913,593 | 38,293 | 4.19 | % | 838,781 | 34,517 | 4.12 | % | 822,690 | 34,366 | 4.18 | % | |||||||||||||||||||||
Commercial real estate | 1,195,544 | 53,420 | 4.47 | % | 1,120,591 | 46,080 | 4.11 | % | 1,004,169 | 41,228 | 4.11 | % | |||||||||||||||||||||
Commercial(2) | 354,508 | 15,956 | 4.50 | % | 336,685 | 14,180 | 4.21 | % | 292,709 | 12,350 | 4.22 | % | |||||||||||||||||||||
Municipal(2) | 20,361 | 648 | 3.18 | % | 19,428 | 667 | 3.43 | % | 19,238 | 572 | 2.97 | % | |||||||||||||||||||||
Consumer and home equity | 343,292 | 17,424 | 5.08 | % | 343,457 | 15,294 | 4.45 | % | 358,098 | 15,111 | 4.22 | % | |||||||||||||||||||||
HPFC | 39,588 | 3,123 | 7.89 | % | 52,031 | 4,441 | 8.53 | % | 70,188 | 6,191 | 8.82 | % | |||||||||||||||||||||
Total loans | 2,866,886 | 128,864 | 4.49 | % | 2,710,973 | 115,179 | 4.25 | % | 2,567,092 | 109,818 | 4.28 | % | |||||||||||||||||||||
Total interest-earning assets(1) | 3,839,631 | 152,399 | 3.97 | % | 3,680,231 | 138,209 | 3.76 | % | 3,512,800 | 131,747 | 3.75 | % | |||||||||||||||||||||
Cash and due from banks | 45,503 | 44,678 | 41,120 | ||||||||||||||||||||||||||||||
Other assets | 274,293 | 287,765 | 305,440 | ||||||||||||||||||||||||||||||
Less: ALL | (23,959 | ) | (24,068 | ) | (22,663 | ) | |||||||||||||||||||||||||||
Total assets | $ | 4,135,468 | $ | 3,988,606 | $ | 3,836,697 | |||||||||||||||||||||||||||
LIABILITIES & SHAREHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||
Deposits: | |||||||||||||||||||||||||||||||||
Non-interest checking | $ | 503,287 | $ | — | — | % | $ | 430,706 | $ | — | — | % | $ | 386,189 | $ | — | — | % | |||||||||||||||
Interest checking | 870,125 | 4,826 | 0.55 | % | 750,543 | 1,541 | 0.21 | % | 724,222 | 921 | 0.13 | % | |||||||||||||||||||||
Savings | 485,986 | 308 | 0.06 | % | 492,483 | 310 | 0.06 | % | 461,794 | 278 | 0.06 | % | |||||||||||||||||||||
Money market | 515,590 | 4,467 | 0.87 | % | 480,119 | 2,475 | 0.52 | % | 490,155 | 2,053 | 0.42 | % | |||||||||||||||||||||
Certificates of deposit | 467,631 | 5,267 | 1.13 | % | 466,418 | 4,124 | 0.88 | % | 489,040 | 3,793 | 0.78 | % | |||||||||||||||||||||
Total deposits | 2,842,619 | 14,868 | 0.52 | % | 2,620,269 | 8,450 | 0.32 | % | 2,551,400 | 7,045 | 0.28 | % | |||||||||||||||||||||
Borrowings: | |||||||||||||||||||||||||||||||||
Brokered deposits | 264,711 | 5,245 | 1.98 | % | 296,261 | 3,361 | 1.13 | % | 231,610 | 1,588 | 0.69 | % | |||||||||||||||||||||
Customer repurchase agreements | 248,743 | 2,547 | 1.02 | % | 232,762 | 1,070 | 0.46 | % | 198,403 | 555 | 0.28 | % | |||||||||||||||||||||
Subordinated debentures | 58,990 | 3,415 | 5.79 | % | 58,834 | 3,408 | 5.79 | % | 58,718 | 3,415 | 5.82 | % | |||||||||||||||||||||
Other borrowings | 249,544 | 4,909 | 1.97 | % | 329,988 | 4,515 | 1.37 | % | 359,281 | 3,951 | 1.10 | % | |||||||||||||||||||||
Total borrowings | 821,988 | 16,116 | 1.96 | % | 917,845 | 12,354 | 1.35 | % | 848,012 | 9,509 | 1.12 | % | |||||||||||||||||||||
Total funding liabilities | 3,664,607 | 30,984 | 0.85 | % | 3,538,114 | 20,804 | 0.59 | % | 3,399,412 | 16,554 | 0.49 | % | |||||||||||||||||||||
Other liabilities | 60,106 | 43,864 | 54,778 | ||||||||||||||||||||||||||||||
Shareholders’ equity | 410,755 | 406,628 | 382,507 | ||||||||||||||||||||||||||||||
Total liabilities & shareholders’ equity | $ | 4,135,468 | $ | 3,988,606 | $ | ||||||||||||||||||||||||||||