First Bancorp, Inc /ME/ (FNLC) FY 2021 MD&A

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The First Bancorp, Inc. (the "Company" or "The First Bancorp") was incorporated in the State of Maine on January 15, 1985, and is the parent holding company of First National Bank (the "Bank"). On January 28, 2016, the Board of Directors voted to change the Bank's name to First National Bank from The First, N.A.

The Company generates almost all of its revenues from the Bank, which was chartered as a national bank under the laws of the United States on May 30, 1864. The Bank, which has eighteen offices along coastal and eastern Maine, emphasizes personal service to the communities it serves, concentrating primarily on small businesses and individuals.

The Bank offers a wide variety of traditional banking services and derives the majority of its revenues from net interest income – the spread between what it earns on loans and investments and what it pays for deposits and borrowed funds. While net interest income typically increases as earning assets grow, the spread can vary up or down depending on the level and direction of movements in interest rates. Management believes the Bank has modest exposure to changes in interest rates, as discussed in "Interest Rate Risk Management" elsewhere in Management's Discussion.

Non-interest income is the Bank's secondary source of revenue and includes fees and service charges on deposit accounts and services, interchange from debit cards, income from the sale and servicing of mortgage loans, and income from investment management and private banking services through First National Wealth Management (previously First Advisors), a division of the Bank.

Forward-Looking Statements

This report contains statements that are "forward-looking statements." We may also make written or oral forward-looking statements in other documents we file with the Securities and Exchange Commission ("SEC"), in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume," "outlook," "will," "should," and other expressions that predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of 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.

Some of the factors that might cause these differences include the following: changes in general national, regional or international economic conditions or conditions affecting the banking or financial services industries or financial capital markets, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, reductions in net interest income resulting from interest rate volatility as well as changes in the balance and mix of loans and deposits, reductions in the market value of wealth management assets under administration, changes in the value of securities and other assets, reductions in loan demand, changes in loan collectability, default and charge-off rates, changes in the size and nature of the Company's competition, changes in legislation or regulation and accounting principles, policies and guidelines, uncertainties with respect to the nature, the extent and the duration of the COVID-19 pandemic and its consequences (including in our market areas or affecting our customers such as protracted adverse effects on the tourism and hospitality industries), and changes in the assumptions used in making such forward-looking statements. In addition, the factors described under "Risk Factors" in Item 1A of this Annual Report on Form 10-K may result in these differences. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this annual report, and we assume no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are also urged to carefully review and consider the various disclosures made by the Company, which attempt to advise interested parties of the factors that affect the Company's business.

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Critical Accounting Policies

Management's discussion and analysis of the Company's financial condition and results of operations is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, Management evaluates its estimates, including those related to the allowance for loan losses, fair value of securities, goodwill, the valuation of mortgage servicing rights, derivative financial instruments, and other-than-temporary impairment on securities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amounts derived from Management's estimates and assumptions under different assumptions or conditions.

Allowance for Loan Losses. Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on Management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management regularly evaluates the allowance, typically monthly, to determine the appropriate level by taking into consideration factors such as the size and growth trajectory of the portfolio, quality trends as measured by key indicators, prior loan loss experience in major portfolio segments, local and national business and economic conditions, the results of any stress testing undertaken during the period, and Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses.

Fair Value of Securities. Determining a market price for securities carried at fair value is a critical accounting estimate in the Company's financial statements. Pricing of individual securities is subject to a number of factors including changes in market interest rates, changes in prepayment speeds and assumptions, changes in market tolerance for risk, and any changes in the risk profile of the security. The Company subscribes to a widely recognized, independent pricing service and updates carrying values no less frequently than monthly. It also validates the values provided by the pricing service no less frequently than quarterly by measuring against security prices provided by a secondary source. Results of the validation are reported to the Bank's Asset Liability Committee each quarter and any variances between the two sources above defined thresholds are investigated by management.

Other-Than-Temporary Impairment on Securities. Another significant estimate related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than-temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. Securities that are in an unrealized loss position are reviewed at least quarterly to determine if other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities' market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity, and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest when due.

Goodwill. Management utilizes numerous techniques to estimate the value of various assets held by the Company, including methods to determine the appropriate carrying value of goodwill as required under FASB ASC Topic 350 "Intangibles – Goodwill and Other." In addition, goodwill from a purchase acquisition is subject to ongoing periodic impairment tests, which include an evaluation of the ongoing assets, liabilities and revenues from the acquisition and an estimation of the impact of business conditions.

Mortgage Servicing Rights. The valuation of mortgage servicing rights is a critical accounting policy which requires significant estimates and assumptions. The Bank often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 0.25% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized at fair value when they are acquired through the sale of loans, and are reported in other assets. They are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. The rights are subsequently carried at the lower of amortized cost or fair value. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speed and amount result in lower valuations of mortgage servicing rights. The valuation also includes an evaluation for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. The use of different assumptions could produce a different valuation. All of the assumptions are based on standards the Company believes

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would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources.

Derivative Financial Instruments Designated as Hedges. The Company recognizes all derivatives in the consolidated balance sheets at fair value. On the date a derivative contract is entered into, the derivative is designated as a hedge of either a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), or a held for trading instrument (“trading instrument”). The relationships between hedging instruments and hedged items is formally documented, as is the risk management objectives and strategy for undertaking various hedge transactions. Both at the hedge’s inception and on an ongoing basis, determination is made as to whether the derivatives that are used in hedging transactions are effective in offsetting changes in cash flows or fair values of hedged items. Changes in fair value of a derivative that is effective and that qualifies as a cash flow hedge are recorded in other comprehensive income (loss) and are reclassified into earnings when the forecasted transaction or related cash flows affect earnings. Changes in fair value of a derivative that qualifies as a fair value hedge and the change in fair value of the hedged item are both recorded in earnings and offset each other when the transaction is effective. Those derivatives that are classified as trading instruments, including customer loan swaps, are recorded at fair value with changes in fair value recorded in earnings. Hedge accounting is discontinued when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, that it is unlikely that the forecasted transaction will occur, or that the designation of the derivative as a hedging instrument is no longer appropriate.

Use of Non-GAAP Financial Measures

Certain information in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Management uses these "non-GAAP" measures in its analysis of the Company's performance and believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrating the effects of significant gains and charges in the current period. The Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. Management believes that investors may use these non-GAAP financial measures to analyze financial performance without 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 operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

In several places in this report, net interest income is presented on a fully taxable equivalent basis. Specifically included in interest income was tax-exempt interest income from certain investment securities and loans. An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income total, which adjustments increased net interest income accordingly. Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices. The following table provides a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with GAAP. A Federal income tax rate of 21.0% was used in 2021 and 2020.

The Company presents its efficiency ratio using non-GAAP information which is most commonly used by financial institutions. The GAAP-based efficiency ratio is noninterest expenses divided by net interest income plus noninterest income from the Consolidated Statements of Income and Comprehensive Income. The non-GAAP efficiency ratio excludes securities losses from noninterest expenses, excludes securities gains from noninterest income, and adds the tax-equivalent adjustment to net interest income.

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The following table provides a reconciliation between the GAAP and non-GAAP efficiency ratio:

The Company presents certain information based upon average tangible common shareholders' equity instead of total average shareholders' equity. The difference between these two measures is the Company's intangible assets, specifically goodwill from prior acquisitions. Management, banking regulators and many stock analysts use the tangible common equity ratio and the tangible book value per common share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, typically stemming from the use of the purchase accounting method in accounting for mergers and acquisitions. The following table provides a reconciliation of average tangible common shareholders' equity to the Company's consolidated financial statements, which have been prepared in accordance with GAAP:

To provide period-to-period comparison of operating results prior to consideration of credit loss provision and income taxes, the non-GAAP measure of Pre-Tax, Pre-Provision Net Income is presented. The following table provided a reconciliation to Net Income:

Executive Summary

The Company posted record annual earnings in 2021, driven primarily by earning asset growth, which, combined with reduced funding costs from strong local deposit growth, led to increased net interest income. The lift in net interest income was supplemented by growth in non-interest income, stemming primarily from year-over-year increases in debit card revenue and wealth management revenue. Earnings growth was achieved while at the same time realizing year-over-year improvements in asset quality.

Net income for the year ended December 31, 2021 was $36.3 million, up $9.1 million or 33.7% from the $27.1 million posted for the year ended December 31, 2020. Earnings per common share on a fully diluted basis were $3.30 for the year ended December 31, 2021, up $0.82 or 33.1% from the $2.48 posted for the year ended December 31, 2020. Net interest income on a tax-equivalent basis increased $6.5 million or 10.4% for the year ended December 31, 2021 compared to the year ended December 31, 2020, with growth in earning assets primarily responsible for the increase. The Company's net interest margin was 2.95% in 2021, compared to 2.94% in 2020.

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Non-interest income in 2021 was $19.4 million, an increase of $1.3 million or 7.0% from the $18.1 million reported in 2020. This increase was due to year-over-year gains in debit card income and wealth management income; mortgage banking income was essentially flat year-over-year.

Non-interest expense in 2021 was $42.1 million, an increase of $2.5 million or 6.3% from the $39.7 million reported in 2020. This increase was attributable primarily to the recognition of a $2.2 million loss on sales of commercial loans which

occurred in the fourth quarter of 2021; increases in salaries and employee benefit benefits also contributed to the year-to-year change.

Income taxes on operating earnings were $7.6 million for the year ended December 31, 2021, up $2.5 million from the year ended December 31, 2020.

During 2021, total assets increased $165.9 million or 7.0%, ending the year at $2.527 billion. The loan portfolio increased $170.9 million or 11.6% in 2021, ending the year at $1.648 billion. The investment portfolio was up $6.4 million or 0.9% for the year. On the liability side of the balance sheet, low-cost deposits increased $275.0 million or 25.6%, totaling $1.350 billion as of December 31, 2021. Certificates of deposit decreased $39.4 million or 6.5% from the end of 2020.  Local certificates of deposit (CDs) decreased $17.6 million and wholesale CDs decreased $21.8 million at December 31, 2021 compared to December 31, 2020.

Asset quality continues to be strong and stable. Non-performing loans stood at 0.35% of total loans as of December 31, 2021, improving from the 0.46% level of non-performing loans a year ago. Net chargeoffs were $357,000, or 0.02% of average loans in 2021, down $1.1 million or 0.10% from the year ended December 31, 2020. Past due loans were 0.26% of total loans as of December 31, 2021, down from 0.66% of total loans at December 31, 2020. The allowance for loan losses as a percentage of total loans outstanding stood at 0.94% in 2021, down from 1.10% at December 31, 2020, and above the pre-pandemic level of 0.90% at December 31, 2019. In the fourth quarter of 2021, a block of $14.5 million in commercial loans was sold without recourse to reduce exposures in certain portfolio segments. This reduction, along with continued strong asset quality metrics and improving macro-economic factors, led management to release $2.3 million from the allowance for loan losses in December 2021.

Remaining well capitalized remains a top priority for The First Bancorp, Inc. The Company's total risk-based capital ratio was 14.27% as of December 31, 2021, solidly above the well-capitalized threshold of 10.0% set by the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Office of the Comptroller of the Currency.

The Company's operating ratios remain favorable, with a return on average tangible common equity of 17.64% for the year ended December 31, 2021 compared to 14.29% for the year ended December 31, 2020. Our non-GAAP efficiency ratio continues to be an important component in our overall performance and stood at 47.81% in 2021, improved from the 50.00% posted for 2020.

Results of Operations

Net Interest Income

Net interest income on a tax-equivalent basis increased 10.4% or $6.5 million to $68.6 million for the year ended December 31, 2021 from the $62.2 million reported for the year ended December 31, 2020, with growth in earning assets responsible for the increase. The Company's net interest margin was 2.95% in 2021, compared to 2.94% in 2020.

Total interest income on a tax-equivalent basis in 2021 was $79.4 million, a decrease of $49,000 or 0.1% from the $79.5 million posted by the Company in 2020. Total interest expense in 2021 was $10.8 million, a decrease of $6.5 million or 37.6% from the $17.3 million posted by the Company in 2020. Tax-exempt interest income amounted to $8.7 million for the year ended December 31, 2021, and $8.8 million for the year ended December 31, 2020.

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The following tables present changes in interest income and expense attributable to changes in interest rates, volume, and rate/volume1 for interest-earning assets and interest-bearing liabilities. Tax-exempt income is calculated on a tax-equivalent basis, using a 21.0% Federal income tax rate in 2021 and 2020.

1 Represents the change attributable to a combination of change in rate and change in volume.

The following table presents the interest earned on or paid for each major asset and liability category, respectively, for the years ended December 31, 2021 and 2020, as well as the average yield for each major asset and liability category, and the net yield between assets and liabilities. Tax-exempt income has been calculated on a tax-equivalent basis using a 21% Federal income tax rate in 2021 and 2020. Unrecognized interest on non-accrual loans is not included in the amount presented, but the average balance of non-accrual loans is included in the denominator when calculating yields.

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Average Daily Balance Sheets

The following table shows the Company's average daily balance sheets for the years ended December 31, 2021 and 2020:

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Non-Interest Income

Non-interest income in 2021 was $19.4 million, an increase of $1.3 million or 7.0% from the $18.1 million reported in 2020. Revenue at First National Wealth Management increased $869,000, debit card income increased $1.1 million, while net gains on securities decreased $1.1 million. Mortgage banking revenue continued to benefit from strong purchase and refinance volume throughout 2021, and was level year-over-year.

Non-Interest Expense

Non-interest expense in 2021 was $42.1 million, an increase of $2.5 million or 6.3% from the $39.7 million reported in 2020. Employee salary and benefit expense increased 3.7% from the prior year and other recurring expense items saw modest year year-over-year changes. Non-recurring items were primarily responsible for the year-to-year change, and included the recognition in 2021 of a $2.2 million loss from commercial loan sales recognized in other operating expenses.

Provision to the Allowance for Loan Losses

The Company's provision to the allowance for loan losses was $(375,000) in 2021 compared to $6.1 million in 2020. The sale of $14.5 million in commercial loans substantially reduced risk exposure in certain segments, which, combined with strong and stable asset quality, led management to release $2.3 million from the allowance for loan losses in December 2021. The allowance for loan losses stood at 0.94% of total loans as of December 31, 2021, compared to 1.10% as of December 31, 2020.

Net loan charge-offs in 2021 were $357,000 or 0.02% of average loans, down $1.1 million from 2020. Non-performing assets stood at 0.23% of total assets as of December 31, 2021 compared to 0.32% of total assets at December 31, 2020. Past-due loans were 0.26% of total loans as of December 31, 2021, down from 0.66% of total loans as of December 31, 2020.

Income Taxes

Income taxes on operating earnings were $7.6 million for the year ended December 31, 2021, up $2.5 million from 2020.

Net Income

Net income for 2021 was $36.3 million, up 33.7% or $9.1 million from net income of $27.1 million that was posted in 2020. Earnings per share on a fully diluted basis for 2021 were $3.30, up $0.82 or 33.1% from the $2.48 reported for the year ended December 31, 2020.

Key Ratios

Return on average assets in 2021 was 1.48%, up from the 1.21% posted in 2020. Return on average tangible common equity was 17.64% in 2021, compared to 14.29% in 2020. In 2021, the Company's dividend payout ratio (dividends declared per share divided by earnings per share) was 38.14%, compared to 49.20% in 2020. The Company's non-GAAP efficiency ratio – a benchmark measure of the amount spent to generate a dollar of income – was 47.81% in 2021, improved from 50.00% in 2020.

Investment Management and Fiduciary Activities

As of December 31, 2021, First National Wealth Management, the Bank's trust and investment management division, had assets under management or custody with a market value of $1.310 billion, consisting of 1,282 trust accounts, estate accounts, agency accounts, and self-directed individual retirement accounts. This compares to December 31, 2020, when 1,216 accounts with a market value of $1.227 billion were under management or custody.

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Assets and Asset Quality

Total assets of $2.527 billion at December 31, 2021 increased 7.0% or $165.9 million from $2.361 billion at December 31, 2020. The investment portfolio, including restricted equity securities, increased $6.4 million or 0.9% over December 31, 2020, and the loan portfolio increased $170.9 million or 11.6%. Year-over-year, average assets were up $212.9 million in 2021 over 2020. Average loans in 2021 were $157.2 million higher than in 2020, and average investments in 2021 were $27.6 million higher than in 2020.

Non-performing assets to total assets stood at 0.23% at December 31, 2021, below the 0.32% of total assets at December 31, 2020.  In general terms, the Company's long-standing approach to working with borrowers and ethical loan underwriting standards helps alleviate some of the payment problems on customers' loans and minimizes actual loan losses, in Management's opinion.

Net chargeoffs in 2021 were $357,000 or 0.02% of average loans outstanding, down $1.1 million from 2020. Residential real estate term loans represent 33.4% of the total loan portfolio, and this loan category generally has a lower level of losses in comparison to other loan types. In 2021, residential mortgages had a recovery ratio of 0.01% compared to a loss ratio of 0.02% for the entire loan portfolio. The Company does not have a credit card portfolio or offer dealer consumer loans, which generally carry more risk and potentially higher losses than other types of consumer credit.

The allowance for loan losses ended 2021 at $15.5 million and stood at 0.94% of total loans outstanding, compared to $16.3 million and 1.10% of total loans outstanding at December 31, 2020. Through eleven months of 2021 a $1.9 million provision for losses had been made. Subsequent to the above mentioned commercial loan sale, $2.3 million was released from the allowance for loan losses in December 2021. This provision and release, coupled with net charge off activity, resulted in the allowance for loan losses decreasing $732,000 or 4.5% from December 31, 2020.

Investment Activities

During 2021, the investment portfolio increased 0.9% to end the year at $696.0 million, compared to $689.5 million at December 31, 2020. Average investments in 2021 were $27.6 million higher than in 2020. As of December 31, 2021, mortgage-backed securities had a carrying value of $315.5 million and a fair value of $314.0 million. Of this total, securities with a fair value of $64.2 million or 20.4% of the mortgage-backed portfolio were issued by the Government National Mortgage Association and securities with a fair value of $249.8 million or 79.6% of the mortgage-backed portfolio were issued by the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association.

The Company's investment securities are classified into three categories: securities available for sale, securities to be held to maturity and restricted equity securities. Securities available for sale consist primarily of debt securities which Management intends to hold for indefinite periods of time. They may be used as part of the Company's funds management strategy, and may be sold in response to changes in interest rates, prepayment risk and liquidity needs, to increase capital ratios, or for other similar reasons. Securities to be held to maturity consist primarily of debt securities that the Company has acquired solely for long-term investment purposes, rather than for trading or future sale. For securities to be categorized as held to maturity, Management must have the intent and the Company must have the ability to hold such investments until their respective maturity dates. Restricted equity securities consist of investments in the stock of the Federal Reserve Bank of Boston and the Federal Home Loan Bank of Boston; ownership of these securities is required as a condition of the Bank's membership in the respective banks and these shares are not able to be pledged or sold. The Company does not hold trading account securities.

All investment securities are managed in accordance with a written investment policy adopted by the Board of Directors. It is the Company's general policy that investments for either portfolio be limited to government debt obligations, time deposits, and corporate bonds or commercial paper with one of the three highest ratings given by a nationally recognized rating agency. The portfolio is currently invested primarily in U.S. Government sponsored agency securities, mortgage-backed securities, collateralized mortgage obligations, and tax-exempt obligations of states and political subdivisions. The individual securities have been selected to enhance the portfolio's overall yield while not materially adding to the Company's level of interest rate risk.

During the third quarter of 2014, the Company transferred securities with a total amortized cost of $89,780,000 with a corresponding fair value of $89,757,000 from available for sale to held to maturity. The net unrealized loss, net of taxes, on these securities at the date of the transfer was $15,000. The net unrealized holding loss at the time of transfer continues to be reported in accumulated other comprehensive income (loss), net of tax and is amortized over the remaining lives of the securities as an adjustment of the yield. The amortization of the net unrealized loss reported in accumulated other comprehensive income (loss) will offset the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the net unrealized losses for the securities transferred from available for sale to held to maturity was $87,000, net of taxes, at December 31, 2021. This compares to $133,000, net of taxes at December 31, 2020. These securities were transferred as a part of the Company's overall investment and balance sheet strategies.

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The following table sets forth the Company's investment securities at their carrying amounts as of December 31, 2021 and 2020:

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The following table sets forth information on the yields and expected maturities of the Company's investment securities as of December 31, 2021. Yields on tax-exempt securities have been computed on a tax-equivalent basis using a tax rate of 21%. Mortgage-backed securities are presented according to their contractual maturity date, while the yield takes into effect intermediate cashflows from repayment of principal which results in a much shorter average life.

Impaired Securities

The securities portfolio contains certain securities, the amortized cost of which exceeds fair value, which at December 31, 2021 amounted to an unrealized loss of $8.4 million, or 1.26% of the amortized cost of the total securities portfolio. At December 31, 2020 this amount represented an unrealized loss of $1.2 million, or 0.18% of the total securities portfolio. As a part of the Company's ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. If a decline in the fair value of a debt security is judged to be other-than-temporary, the decline related to credit loss is recorded in net realized securities losses while the decline attributable to other factors is recorded in other comprehensive income or loss.

The Company's evaluation of securities for impairment is a quantitative and qualitative process intended to determine whether declines in the fair value of investment securities should be recognized in current period earnings. The primary factors considered in evaluating whether a decline in the fair value of securities is other-than-temporary include: (a) the length of time

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and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the security's market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity, and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred.

The Company's best estimate of cash flows uses severe economic recession assumptions to quantify potential market uncertainty. The Company's assumptions include but are not limited to delinquencies, foreclosure levels and constant default rates on the underlying collateral, loss severity ratios, and constant prepayment rates. If the Company does not expect to receive 100% of future contractual principal and interest, an other-than-temporary impairment charge is recognized. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral.

As of December 31, 2021, the Company had temporarily impaired securities with a fair value of $329.4 million and unrealized losses of $8.4 million, as identified in the table below. Securities in a continuous unrealized loss position of twelve months or more amounted to $55.9 million as of December 31, 2021, compared with $3.9 million at December 31, 2020. The Company has concluded that these securities were not other-than-temporarily impaired. This conclusion was based on the issuers' continued satisfaction of their obligations in accordance with their contractual terms and the expectation that the issuers will continue to do so, Management's intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value (which may be at maturity), the expectation that the Company will receive 100% of future contractual cash flows, as well as the evaluation of the fundamentals of the issuers' financial condition and other objective evidence. The following table summarizes temporarily impaired securities and their approximate fair values at December 31, 2021.

For securities with unrealized losses, the following information was considered in determining that the securities were not other-than-temporarily impaired:

Securities issued by U.S. Government-sponsored agencies. As of December 31, 2021, the total unrealized losses on these securities amounted to $2.3 million, compared with $333,000 at December 31, 2020. All of these securities were credit rated "AAA" or "AA+" by the major credit rating agencies. Management believes that securities issued by U.S. Government-sponsored agencies and enterprises have minimal credit risk, as these agencies and enterprises play a vital role in the nation's financial markets, and does not consider these securities to be other-than-temporarily impaired at December 31, 2021.

Mortgage-backed securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises. As of December 31, 2021, the total unrealized losses on these securities amounted to $5.7 million, compared with $812,000 at December 31, 2020. All of these securities were credit rated "AAA" by the major credit rating agencies. Management believes that securities issued by U.S. Government agencies bear no credit risk because they are backed by the full faith and credit of the United States and that securities issued by U.S. Government-sponsored enterprises have minimal credit risk, as these agencies enterprises play a vital role in the nation's financial markets. Management believes that the unrealized losses at December 31, 2021 were attributable to changes in current market yields and spreads since the dates the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at December 31, 2021. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.

Obligations of state and political subdivisions. As of December 31, 2021, the total unrealized losses on municipal securities amounted to $390,000, compared with $3,000 at December 31, 2020. Municipal securities are supported by the general taxing authority of the municipality and, in the cases of school districts, are supported by state aid. At December 31, 2021, all municipal bond issuers were current on contractually obligated interest and principal payments. The Company monitors price changes and changes in credit quality of municipal issuers on a regular basis as a potential indicator of temporary impairment. The Company attributes the unrealized losses at December 31, 2021, however, to changes in prevailing market yields and pricing spreads since the dates the underlying securities were purchased, combined with current market liquidity conditions and

The First Bancorp - 2021 Form 10-K - Page 33

the disruption in the financial markets in general. Accordingly, the Company does not consider these municipal securities to be other-than-temporarily impaired at December 31, 2021. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.

Corporate securities. As of December 31, 2021, the total unrealized losses on corporate securities amounted to $66,000, compared with $2,000 at December 31, 2020. Corporate securities are dependent on the operating performance of the issuers. At December 31, 2021, all corporate bond issuers were current on contractually obligated interest and principal payments.

Federal Home Loan Bank Stock

The Bank is a member of the Federal Home Loan Bank ("FHLB") of Boston, a cooperatively owned wholesale bank for housing and finance in the six New England States. As a requirement of membership in the FHLB, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. The Bank uses the FHLB for much of its wholesale funding needs. As of December 31, 2021 and 2020, the Bank's investment in FHLB stock totaled $4.3 million and $9.5 million, respectively. The year-to-year change was based upon the Bank's level of borrowings from the FHLB, and by a change in FHLB's minimum ownership requirements. FHLB stock is a non-marketable equity security and therefore is reported at cost, which equals par value. The Company periodically evaluates its investment in FHLB stock for impairment based on, among other factors, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through December 31, 2021. The Bank will continue to monitor its investment in FHLB stock.

Lending Activities

The loan portfolio increased $170.9 million or 11.6% in 2021, with total loans at $1.65 billion at December 31, 2021, compared to $1.48 billion at December 31, 2020. Commercial loans increased $136.4 million or 17.4% between December 31, 2020 and December 31, 2021. Residential term loans increased by $28.7 million or 5.5% and municipal loans decreased by $4.6 million or 10.5% over the same period.

Commercial loans are comprised of three major classes: commercial real estate loans, commercial construction loans and other commercial loans.

Commercial real estate loans consist of mortgage loans to finance investments in real property such as multi-family residential, commercial/retail, office, industrial, hotels, educational and other specific or mixed use properties. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Commercial real estate loans typically have a loan-to-value ratio of up to 80% based upon current valuation information at the time the loan is made. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.

Commercial construction loans consist of loans to finance construction in a mix of owner- and non-owner occupied commercial real estate properties. Commercial construction loans typically have maturities of less than two years. Payment structures during the construction period are typically on an interest only basis, although principal payments may be established depending on the type of construction project being financed. During the construction phase, commercial construction loans are primarily paid by cash reserves or other operating cash flows of the borrower or guarantors, if applicable. At the end of the construction period, loan repayment typically comes from a third party source in the event that the Bank will not be providing permanent term financing. Collateral valuation and loan-to-value guidelines follow those for commercial real estate loans.

Other commercial loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital or capital investment. Collateral generally consists of pledges of business assets including, but not limited to, accounts receivable, inventory, plant and equipment, and/or real estate, if applicable. Commercial loans are primarily paid from the operating cash flow of the borrower. Other commercial loans may be secured or unsecured. Loans granted under the Paycheck Protection Program ("PPP") are considered other commercial loans.

Municipal loans are comprised of loans to municipalities in Maine for capitalized expenditures, construction projects or tax-anticipation notes. All municipal loans are considered general obligations of the municipality and are collateralized by the taxing ability of the municipality for repayment of debt.

Residential loans are comprised of two classes: term loans and construction loans.

Residential term loans consist of residential real estate loans held in the Company's loan portfolio made to borrowers who demonstrate the ability to make scheduled payments with full consideration of applicable underwriting factors comprising the Bank's credit policies. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Residential loans typically have a loan-to-value ratio of up to 80% based on appraisal information at the time the loan is made. Collateral consists of mortgage liens on one- to four-family residential properties. Loans are offered with fixed or adjustable rates with amortization terms of up to thirty years.

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Residential construction loans typically consist of loans for the purpose of constructing single family residences to be owned and occupied by the borrower. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Residential construction loans normally have construction terms of one year or less and payment during the construction term is typically on an interest only basis from sources including interest reserves, borrower liquidity and/or income. Residential construction loans will typically convert to permanent financing from the Bank or have another financing commitment in place from an acceptable mortgage lender. Collateral valuation and loan-to-value guidelines are consistent with those for residential term loans.

Home equity lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity line of credit typically has a variable interest rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Loan maturities are normally 25 years. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios usually not exceeding 80% inclusive of priority liens. Collateral valuation guidelines follow those for residential real estate loans.

Consumer loan products including personal lines of credit and amortizing loans are made to qualified individuals for various purposes such as automobiles, recreational vehicles, debt consolidation, personal expenses or overdraft protection. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines. Consumer loans may be secured or unsecured.

Construction loans, both commercial and residential, at 48.2% of capital are well under the regulatory guidance of 100.0% of capital at December 31, 2021. Construction loans and non-owner-occupied commercial real estate loans are at 203.0% of total capital at December 31, 2021, well below the regulatory limit of 300.0% of capital.

The following table summarizes the loan portfolio, by class, as of December 31, 2021 and 2020:

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The following table sets forth certain information regarding the contractual maturities of the Bank's loan portfolio as of December 31, 2021:

The following table provides a listing of loans, by class, between variable and fixed rates as of December 31, 2021:

Loan Concentrations

As of December 31, 2021, the Bank had one concentration of loans in one particular industry that exceeded 10% of its total

loan portfolio. Loans to hotels (except Casino hotels) and motels totaled $183.4 million, or 11.13% of total loans. As of December 31, 2020, the industry category Lessors of Nonresidential Properties accounted for 10.0% of the Bank's total

loan portfolio, and stood at 9.7% as of December 31, 2021.

Loans Held for Sale

As of December 31, 2021, the Bank had $835,000 in loans held for sale.  This compares to $5.9 million loans held for sale at December 31, 2020.

Credit Risk Management and Allowance for Loan Losses

Credit risk is the risk of loss arising from the inability of a borrower to meet its obligations. We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, Management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

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We provide for loan losses through the establishment of an allowance for loan losses which represents an estimated reserve for existing losses in the loan portfolio. The allowance for loan losses is a critical accounting estimate inherent in the Company's financial statements. We deploy a systematic methodology for determining our allowance that includes a quarterly review process, risk rating, and, where appropriate, adjustment to our allowance. We classify our portfolios as either commercial or residential and consumer and monitor credit risk separately as discussed below. We evaluate the appropriateness of our allowance continually based on a review of all significant loans, with a particular emphasis on non-accruing, past due, and other loans that we believe require special attention.

The allowance consists of four elements: (1) specific reserves for loans evaluated individually for impairment; (2) general reserves for types or portfolios of loans based on historical loan loss experience; (3) qualitative reserves judgmentally adjusted for local and national economic conditions, concentrations, portfolio composition, volume and severity of delinquencies and nonaccrual loans, trends of criticized and classified loans, changes in credit policies, and underwriting standards, credit administration practices, and other factors as applicable; and (4) unallocated reserves. All outstanding loans are considered in evaluating the appropriateness of the allowance.

Appropriateness of the allowance for loan losses is determined using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectability of specific loans when determining the appropriateness of the allowance for loan losses, Management also takes into consideration other factors such as changes in the mix and size of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, economic trends, changes in credit policies, and experience, ability and depth of lending management. The appropriateness of the allowance for loan losses is assessed through an allocation process whereby specific reserve allocations are made against certain impaired loans, and general reserve allocations are made against segments of the loan portfolio which have similar attributes. The Company's historical loss experience, industry trends, and the impact of the local and regional economy on the Company's borrowers are considered by Management in determining the appropriateness of the allowance for loan losses.

The allowance for loan losses is increased by provisions charged against current earnings. Loan losses are charged against the allowance when Management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. While Management uses available information to assess possible losses on loans, future additions to the allowance may be necessary based on increases in non-performing loans, changes in economic conditions, growth in loan portfolios, or for other reasons. Any future additions to the allowance would be recognized in the period in which they were determined to be necessary. In addition, various regulatory agencies periodically review the Company's allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to record additions to the allowance based on judgments different from those of Management. No such addition has been required by any agency in over twenty years.

Commercial

Our commercial portfolio includes all secured and unsecured loans to borrowers for commercial purposes, including commercial lines of credit and commercial real estate. Our process for evaluating commercial loans includes performing updates on loans that we have rated for risk. Our non-performing commercial loans are generally reviewed individually to determine impairment, accrual status, and the need for specific reserves. Our methodology incorporates a variety of risk considerations, both qualitative and quantitative. Quantitative factors include our historical loss experience by loan type, collateral values, financial condition of borrowers, and other factors. Qualitative factors include judgments concerning general economic conditions that may affect credit quality, credit concentrations, the pace of portfolio growth, and delinquency levels; these qualitative factors are also considered in connection with the unallocated portion of our allowance for loan losses.

The process of establishing the allowance with respect to our commercial loan portfolio begins when a loan officer initially assigns each loan a risk rating, using established credit criteria. Approximately 60% of a trailing four quarter average gross commercial portfolio is subject to review and validation annually by an independent consulting firm, as well as periodically by our internal credit review function. Our methodology employs Management's judgment as to the level of losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers' current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. We also evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors.

Residential, Home Equity and Consumer

Consumer, home equity and residential mortgage loans are generally segregated into homogeneous pools with similar risk characteristics. Trends and current conditions in these pools are analyzed and historical loss experience is adjusted accordingly. Quantitative and qualitative adjustment factors for the consumer, home equity and residential mortgage portfolios are consistent with those for the commercial portfolios. Certain loans in the consumer and residential portfolios identified as having the potential for further deterioration are analyzed individually to confirm the appropriate risk status and accrual status, and to determine the need for a specific reserve. Consumer loans that are greater than 120 days past due are generally charged off. Residential loans and home equity lines of credit that are greater than 90 days past due are evaluated for collateral adequacy and if deficient are placed on non-accrual status. The Bank sells residential loans through the Federal Home Loan Bank of Boston

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Mortgage Partnership Finance program ("MPF") with limited recourse. Volume sold to MPF continues to be de minimis; therefore, the impact on the Allowance is minimal.

Specific Reserves

The allowance for loan losses includes reserve amounts assigned to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when Management believes it is probable that the Company will not collect all of the contractual interest and principal payments as scheduled in the loan agreement. Impaired loans include troubled debt restructured loans ("TDRs") and loans placed on non-accrual status. A specific reserve is allocated to an individual loan when that loan has been deemed impaired and when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. At December 31, 2021, impaired loans with specific reserves totaled $3.1 million and the amount of such reserves was $576,000. This compares to impaired loans with specific reserves of $3.9 million at December 31, 2020, at which date the amount of such reserves was $462,000.

Unallocated

The unallocated portion of the allowance is intended to provide for losses that are not identified when establishing the specific and general portions of the allowance and is based upon Management's evaluation of various conditions that are not directly measured in the determination of the portfolio and loan specific allowances. Such conditions may include general economic and business conditions affecting our lending area, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, duration of the current business cycle, bank regulatory examination results, findings of external loan review examiners, and Management's judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems. Management reviews these conditions quarterly. We have risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist inherently within the loan portfolio. The judgmental aspects involved in applying the risk grading criteria, analyzing the quality of individual loans, and assessing collateral values can also contribute to undetected, but probable, losses. Consequently, there maybe underlying credit risks that have not yet surfaced in the loan- specific or qualitative metrics the Company uses to estimate its allowance for loan losses.

All of these analyses are reviewed and discussed by the Directors' Loan Committee, and recommendations from these processes provide Management and the Board of Directors with independent information on loan portfolio condition. Our total allowance at December 31, 2021 is considered by Management to be appropriate to address the credit losses inherent in the loan portfolio at that date. However, our determination of the appropriate allowance level is based upon a number of assumptions we make about future events, which we believe are reasonable, but which may or may not prove valid. Thus, there can be no assurance that our charge-offs in future periods will not exceed our allowance for loan losses or that we will not need to make additional increases in our allowance for loan losses.

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The following table summarizes our allocation of allowance by loan class as of December 31, 2021 and 2020. The percentages are the portion of each loan type to total loans:

The allowance for loan losses totaled $15.5 million at December 31, 2021, compared to $16.3 million at December 31, 2020. Management's ongoing application of methodologies to establish the allowance include an evaluation of non-accrual loans and troubled debt restructured loans for specific reserves. These specific reserves increased $114,000 in 2021 from $462,000 at December 31, 2020 to $576,000 at December 31, 2021. The specific loans that make up those categories change from period to period. Impairment on those loans, which would be reflected in the allowance for loan losses, might or might not exist, depending on the specific circumstances of each loan. The portion of the reserve based on historical loss experience of homogeneous pools of loans decreased by $6,000 in 2021. The portion of the reserve based on qualitative factors decreased by $488,000 during 2021 due to a mix of factors. These factors included changes in various macroeconomic measures used in the qualitative model, volume changes in certain portfolio segments, ongoing analysis of the loan portfolio in multiple stress scenarios, and performance of COVID-19 related loan modifications. Unallocated reserves, which were $2.1 million, or 13.1% of the total reserve at December 31, 2020, decreased to $1.8 million or 11.5% of the total reserve at December 31, 2021. Management considers these levels appropriate as they support general imprecision related to portfolio growth and include considerations of general economic and business conditions affecting our lending area, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, duration of the current business cycle, duration of the pandemic, bank regulatory examination results, findings of external loan review examiners, and Management's judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems. Consequently, there may be underlying credit risks that have not yet surfaced in the loan specific or qualitative metrics the Company uses to estimate its allowance for loan losses that are reflected in the unallocated component.

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A breakdown of the allowance for loan losses as of December 31, 2021, by loan class, and allowance element, is presented in the following table:

Based upon Management's evaluation, provisions are made to maintain the allowance as a best estimate of inherent losses within the portfolio. The net provision for loan losses was $(375,000) in 2021 compared to $6.1 million in 2020. Through November 2021 provision of $1.9 million had been recorded year-to-date; a reversal of $2.3 million was recorded in December 2021 reflecting reductions in certain risk categories resulting from the sale of commercial loans that month. Net charge offs were $357,000 in 2021 compared to net charge offs of $1.4 million in 2020. The allowance as a percentage of loans outstanding stood at 0.94% at December 31, 2021 compared to 1.10% at December 31, 2020 and 0.90% at December 31, 2019.

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The following table summarizes the activities in our allowance for loan losses as of December 31, 2021 and 2020:

Management believes the allowance for loan losses is appropriate as of December 31, 2021. The level of the provision for loan losses in 2020 was elevated in response to uncertainties brought about by the COVID-19 pandemic. Credit quality metrics remained favorable throughout 2021, and, when coupled with risk reduction brought about by the sale of $14.5 million in commercial loans, led to a net reduction in the allowance from the level at December 31, 2020.

COVID-19 Impact on Loan Portfolio

The Company has continued to work with borrowers impacted by the COVID-19 outbreak. As of December 31, 2021, a total of 1,053 loan modification requests for interest-only payments or deferred payments have been completed in conformance with the Interagency Statement on Loan Modifications and Reporting ("Interagency Guidance") issued March 23, 2020, Section 4013 of the CARES Act passed March 2020, or the Supplemental Appropriations Act passed December 2020, representing $284.8 million in loan balances, or approximately 17.3% of the overall loan portfolio. One of these modifications of a de minimis amount has been classified as a TDR since being modified. So long as modified terms are met, qualified loans in an active COVID-19 related modification are not classified as TDRs, are not included past due loan totals, and continue to accrue interest.

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As of December 31, 2021, 18 loans totaling $2.9 million remained in their original modification or had had a subsequent modification, representing 0.17% of the overall portfolio. Refer to Note 5 of the consolidated financial statements for further detail.

First National Bank is a designated SBA preferred lender and has participated in both the 2020 (PPP1) and 2021 (PPP2) rounds of the Payroll Protection Program. Under PPP1, 1,718 loans were granted totaling $97.8 million in funds disbursed to qualified small businesses. The Bank has actively worked with these borrowers to process applications for forgiveness per PPP guidelines; as of December 31, 2021, PPP1 balances had been reduced to $7,500. Under PPP2, 1,263 loans totaling 52.1million had been granted as of December 31, 2021, and the outstanding balances had been reduced to $22.0 million. It is expected that most of the remaining PPP1 and PPP2 balances will be forgiven or otherwise paid in the first half of 2022.

The State of Maine, where most of the Bank's customers reside and/or operate businesses, has largely re-opened its economy; quarantines for out of state visitors and limits on the size of public gatherings have been lifted. The emergence of the Delta and Omicron variants of the COVID-19 virus did not result in new restrictions or curtailment of economic activity, but COVID-19 remains a threat to economic normalization and could ultimately have a negative impact on the Bank's borrowers.

The Company regularly monitors activity on open credit lines and has not observed increased utilization related to COVID-19.

Nonperforming Loans

Nonperforming loans are comprised of loans for which, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when principal and interest is 90 days or more past due unless the loan is both well secured and in the process of collection (in which case the loan may continue to accrue interest in spite of its past due status). A loan is "well secured" if it is secured (1) by collateral in the form of liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt (including accrued interest) in full, or (2) by the guarantee of a financially responsible party. A loan is "in the process of collection" if collection of the loan is proceeding in due course either (1) through legal action, including judgment enforcement procedures, or, (2) in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to current status in the near future.

When a loan becomes nonperforming (generally 90 days past due), it is evaluated for collateral dependency based upon the most recent appraisal or other evaluation method. If the collateral value is lower than the outstanding loan balance plus accrued interest and estimated selling costs, the loan is placed on non-accrual status, all accrued interest is reversed from interest income, and a specific reserve is established for the difference between the loan balance and the collateral value less selling costs or, in certain situations, the difference between the loan balance and the collateral value less selling costs is written off. Concurrently, a new appraisal or valuation may be ordered, depending on collateral type, currency of the most recent valuation, the size of the loan, and other factors appropriate to the loan. Upon receipt and acceptance of the new valuation, the loan may have an additional specific reserve or write down based on the updated collateral value. On an ongoing basis, appraisals or valuations may be obtained periodically on collateral dependent non-performing loans and an additional specific reserve or write down will be made, if appropriate, based on the new collateral value.

Once a loan is placed on nonaccrual, it remains in nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current. All payments made on non-accrual loans are applied to the principal balance of the loan.

Nonperforming loans, expressed as a percentage of total loans, totaled 0.35% at December 31, 2021 compared to 0.46% at December 31, 2020.

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The following table shows the distribution of nonperforming loans by class as of December 31, 2021 and 2020:

Total nonperforming loans do not include loans 90 or more days past due and still accruing interest. These are loans in which we expect to collect all amounts due, including past-due interest. As of December 31, 2021, loans 90 or more days past due and still accruing interest totaled $32,000, compared to $1.5 million at December 31, 2020.

As of December 31, 2021, 20 loans with a balance of $1.9 million were non-performing and also classified as TDR. This compares to 22 loans with a balance of $2.2 million as of December 31, 2020.

Troubled Debt Restructured

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

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

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

Interagency regulatory guidance issued in March 2020 in response to the consequences of the COVID-19 pandemic, the CARES Act passed in March 2020, and the Supplemental Appropriations Act passed in December 2020 granted exemption to TDR classification for certain qualified loan modification actions that normally would have been classified as TDRs.

As of December 31, 2021 there were 60 loans with an aggregate outstanding balance of $8.3 million that have been restructured. This compares to 74 loans with amounts totaling $11.5 million that had been restructured as of December 31, 2020. The following table shows the activity in loans classified as TDRs between December 31, 2020 and December 31, 2021. As noted above, this data does not include loans with modified terms granted under the Interagency Guidance, CARES Act or Supplemental Appropriations Act:

As of December 31, 2021, 39 loans with an aggregate balance of $6.4 million were performing under the modified terms, one loan with an aggregate balance of $3,000 was more than 30 days past due and accruing, and 20 loans with an aggregate balance of $1.9 million were on nonaccrual. As a percentage of aggregate outstanding balance, 77.25% were performing under

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the modified terms, 0.04% were more than 30 days past due and accruing and 22.71% were on nonaccrual. The performance status of all TDRs as of December 31, 2021, as well as the associated specific reserve in the allowance for loan losses, is summarized by class of loan in the following table.

Residential and consumer TDRs as of December 31, 2021 included 46 loans with an aggregate balance of $5.7 million and the modifications granted fell into five major categories. Loans totaling $3.6 million had an extension of term, allowing the borrower to repay over an extended number of years and lowering the monthly payment to a level the borrower can afford. Loans totaling $2.0 million had interest capitalized, allowing the borrower to become current after unpaid interest was added to the balance of the loan and re-amortized over the remaining life of the loan. Short-term rate concessions were granted on loans totaling $376,000. Certain residential TDRs had more than one modification.

Commercial TDRs as of December 31, 2021 were comprised of 14 loans with a balance of $2.7 million. Of this total, four loans with an aggregate balance of $1.1 million had an extended period of interest-only payments, deferring the start of principal repayment. Three loans with an aggregate balance of $289,000 had an extension of term, allowing the borrower to repay over an extended number of years and lowering the monthly payment to a level the borrower can afford. Three loans with an aggregate balance of $257,000 had a deferral of payment. The remaining four loans with an aggregate balance of $1.0 million had several different modifications.

In each case when a loan was modified, Management determined it was in the Bank's best interest to work with the borrower with modified terms rather than to proceed to foreclosure. Once a loan is classified as a TDR, however, it remains classified as such until the balance is fully repaid, despite whether the loan is performing under the modified terms. As of December 31, 2021, Management is aware of eight loans classified as TDRs that are involved in bankruptcy proceedings with an aggregate outstanding balance of $950,000. There were also 20 loans with an outstanding balance of $1.9 million that were classified as TDRs and on non-accrual status, of which no loans were in the process of foreclosure.

Impaired Loans

Impaired loans include TDRs and loans placed on non-accrual status when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. These loans are measured at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral less estimated selling costs if the loan is collateral dependent. If the measure of an impaired loan is lower than the recorded investment in the loan, a specific reserve is established for the difference. Impaired loans totaled $12.1 million at December 31, 2021, and have decreased $4.0 million from December 31, 2020. The number of impaired loans decreased by 33 loans from 140 to 107 during the same period. Impaired commercial loans decreased $2.2 million from December 31, 2020 to December 31, 2021. The specific allowance for impaired commercial loans increased from $299,000 at December 31, 2020 to $439,000 as of December 31, 2021, which represented the fair value deficiencies for those loans for which the net fair value of the collateral was estimated at less than our carrying amount of the loan. From December 31, 2020 to December 31, 2021, impaired residential loans decreased $1.2 million and impaired home equity lines of credit decreased $582,000.

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The following table sets forth impaired loans as of December 31, 2021 and 2020:

Past Due Loans

The Bank's overall loan delinquency ratio was 0.26% at December 31, 2021, versus 0.66% at December 31, 2020. Loans 90 days delinquent and accruing decreased from $1.5 million at December 31, 2020 to $32,000 as of December 31, 2021, the year-to-year reduction being the result of resolution of one credit that comprised most of the year-end 2020 balance. The year-end 2021 total is made up of two units, one of which is a checking account overdraft; we expect to collect all amounts due on each, including interest.

The following table sets forth loan delinquencies as of December 31, 2021 and 2020:

Potential Problem Loans and Loans in Process of Foreclosure

Potential problem loans consist of classified accruing commercial and commercial real estate loans that were between 30 and 89 days past due. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve due to changes in collateral values or the financial condition of the borrowers, while the credit quality of other loans may deteriorate, resulting in some amount of loss. At December 31, 2021, there were no potential problem loans, compared to five loans with a balance of $195,000 or 0.01% of total loans at December 31, 2020.

As of December 31, 2021, there were seven loans in the process of foreclosure with a total balance of $667,000. The Bank's residential foreclosure process begins when a loan becomes 75 days past due at which time a Demand/Breach Letter is sent to the borrower. If the loan becomes 120 days past due, copies of the promissory note and mortgage deed are forwarded to the

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Bank's attorney for review and a complaint for foreclosure is then prepared. An authorized Bank officer signs the affidavit certifying the validity of the documents and verification of the past due amount which is then forwarded to the court. Once a Motion for Summary Judgment is granted, a Period of Redemption ("POR") begins which gives the customer 90 days to cure the default. A foreclosure auction date is then set 30 days from the POR expiration date if the default is not cured. The Bank's commercial foreclosure process begins when a loan becomes 60 days past due, at which time a default letter is issued. At expiration of the period to cure default, which lasts 12 days after the issuing of the default letter, copies of the promissory note and mortgage deed are forwarded to the Bank's attorney for review. A Notice of Statutory Power of Sale is then prepared. This notice must be published for three consecutive weeks in a newspaper located in the county in which the property is located. A notice also must be issued to the mortgagor and all parties of interest 21 days prior to the sale. The foreclosure auction occurs and the Affidavit of Sale is recorded within the appropriate county within 30 days of the sale.

The Bank’s written policies and procedures for foreclosures, along with implementation of same, are subject to annual review by its internal audit provider. The scope of this review includes loans held in portfolio and loans serviced for others. There were no issues requiring management attention in the most recent review. Servicing for others includes loans sold to Freddie Mac, Fannie Mae, and the Federal Home Loan Bank of Boston through its MPF program. The Bank follows the published guidelines of each investor. Loans serviced for Freddie Mac and Fannie Mae have been sold without recourse, and the Bank has no liability for these loans in the event of foreclosure. A de minimis volume of loans has been sold to and serviced for MPF to date. The Bank retains a second loss layer credit enhancement obligation; no losses have been recorded on this credit enhancement obligation since the Bank started selling loans to MPF in 2013.

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Other Real Estate Owned

Other real estate owned and repossessed assets ("OREO") are comprised of properties or other assets acquired through a foreclosure proceeding, or acceptance of a deed or title in lieu of foreclosure. Real estate acquired through foreclosure is carried at the lower of cost or fair value less estimated cost to sell. At December 31, 2021, there were no OREO properties, compared to December 31, 2020 when there were four properties owned with an OREO balance of $908,000, net of an allowance for losses of $45,000. The following table presents the composition of other real estate owned as of December 31, 2021 and 2020.

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Funding, Liquidity and Capital Resources

As of December 31, 2021, the Bank had primary sources of liquidity of $1.010 billion or 40.4% of its total assets. It is Management's opinion that this is an appropriate level. In addition, the Bank has $139.0 million in borrowing capacity under the Federal Reserve Bank of Boston's Borrower in Custody program, $76.0 million in credit lines with correspondent banks, and $281.8 million in unencumbered securities available as collateral for borrowing. These bring the Bank's primary sources of liquidity to $1.507 billion or 60.3% of its total assets. The Asset/Liability Committee ("ALCO") establishes guidelines for liquidity in its Asset/Liability policy and monitors internal liquidity measures to manage liquidity exposure. Based on its assessment of the liquidity considerations described above, Management believes the Bank's and the Company's sources of funding will meet anticipated funding needs.

Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Bank's primary source of liquidity is deposits, which funded 80.1% of total average assets in 2021. While the generally preferred funding strategy is to attract and retain low cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from the securities portfolios and loan repayments. Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs, although Management has no intention to do so at this time.

The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for prompt and comprehensive responses to unexpected demands for liquidity. Management has developed quantitative models to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of "business as usual" cash flows. In Management's estimation, risks are concentrated in two major categories: runoff of in-market deposit balances and the inability to renew wholesale sources of funding. Of the two categories, potential runoff of deposit balances would have the most significant impact on contingent liquidity. Our modeling attempts to quantify deposits at risk over selected time horizons. In addition to these unexpected outflow risks, several other "business as usual" factors enter into the calculation of the adequacy of contingent liquidity, including payment proceeds from loans and investment securities, maturing debt obligations and maturing time deposits. The Bank has established collateralized borrowing capacity with the Federal Reserve Bank of Boston and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business, as well as Fed Funds lines with three correspondent banks.

Deposits

During 2021, total deposits increased by $278.7 million, ending the year at $2.123 billion compared to $1.845 billion at December 31, 2020. Low-cost deposits (demand, NOW, and savings accounts) increased by $275.0 million or 25.6% during the year, money market deposits increased $43.1 million or 26.3%, and certificates of deposit decreased $39.4 million or 6.5%. The increase in low-cost deposits provided funding for earning asset growth, and enabled a reduction in certificates of deposit obtained from wholesale sources. Estimated uninsured deposits totaled $228.4 million and $205.0 million at December 31, 2021 and 2020, respectively.

Average deposits increased $229.5 million in 2021, as shown in the following table, which sets forth the average daily balance for the Bank's principal deposit categories for each period:

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The average cost of deposits (including non-interest-bearing accounts) was 0.37% for the year ended December 31, 2021, compared to 0.82% for the year ended December 31, 2020. The following table sets forth the average cost of each category of interest-bearing deposits for the periods indicated.

Of all certificates of deposit, $323.8 million or 79.26% will mature by December 31, 2022. As of December 31, 2021 and 2020, the Bank held a total of $55.4 million and $63.0 million, respectively, in certificate of deposit accounts with balances in excess of $250,000. The following table summarizes the time remaining to maturity for these certificates of deposit.

Borrowed Funds

Borrowed funds consists of advances from the FHLB, advances from the FRB Discount Window, and securities repurchase agreements with customers. Advances from the FHLB are secured with pledged collateral consisting of FHLB stock, funds on deposit with FHLB, U.S. Agency notes, mortgage-backed securities, and qualifying first mortgage loans. FRB Discount Window advances are similarly secured with collateral consisting of FRB stock, funds on deposit at FRB, and qualifying commercial, home equity and construction loans. As of December 31, 2021, advances from FHLB totaled $55.1 million, with a weighted average interest rate of 1.38% per annum and remaining maturities ranging from 2.5 to 4 years. This compares to advances from FHLB and FRB totaling $192.7 million, with a weighted average interest rate of 0.69% per annum and remaining maturities ranging from 7 days to 5 years, as of December 31, 2020. The increase in low-cost deposits in 2021, described above in Deposits, enabled a reduction in the level of FHLB and FRB advances in addition to providing funding for earning asset growth. The change in the weighted average rate paid on borrowed funds in 2021 compared to 2020 is rooted in the underlying mix of advance terms. Advances as of December 31, 2020 were primarily short term and at lower rates than the longer term, higher rate, non-prepayable advances outstanding as of December 31, 2021.

The Bank offers securities repurchase agreements to municipal and corporate customers as an alternative to deposits. The balance of these agreements as of December 31, 2021 was $81.3 million, compared to $69.3 million on December 31, 2020. The weighted average interest rates payable under these agreements were 0.47% per annum as of December 31, 2021, compared to 0.74% per annum as of December 31, 2020.

The maximum amount of borrowed funds outstanding at any month-end during each of the last two years was $238.5 million at the end of August in 2021 and $324.2 million at the end of May in 2020. The average amount outstanding during 2021 was $228.8 million with a weighted average interest rate of 1.51% per annum. This compares to an average outstanding amount of $259.8 million with a weighted average interest rate of 1.21% per annum in 2020.

Capital Resources

Shareholders' equity as of December 31, 2021 was $245.7 million, compared to $223.7 million as of December 31, 2020.

During 2021, the Company declared cash dividends of $0.31 per share in the first quarter and $0.32 per share in the remaining three quarters, or $1.27 per share for the year. The dividend payout ratio, which is calculated by dividing dividends declared per share by diluted earnings per share, was 38.14% for the year ended December 31, 2021 compared to 49.20% for the year ended December 31, 2020. In determining future dividend payout levels, the Board of Directors carefully analyzes capital requirements and earnings retention, as set forth in the Company's Dividend Policy. The ability of the Company to pay cash dividends to its shareholders depends on receipt of dividends from its subsidiary, the Bank. The subsidiary may pay

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dividends to its parent out of so much of its net profits as the Bank's directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. The amount available for dividends in 2022 is this year's net income plus $38.2 million.

In 2021, 58,228 shares were issued via employee stock programs, the dividend reinvestment plan, and restricted stock grants. The Company received consideration totaling $689,000.  The following table summarizes the Company's 2021 stock issuances.

Financial institution regulators have established guidelines for minimum capital ratios for banks and bank holding companies. The net unrealized gain or loss on available for sale securities is generally not included in computing regulatory capital. During the first quarter of 2015, the Company adopted the new Basel III regulatory capital framework as approved by the federal banking agencies. In order to avoid limitations on capital distributions, including dividend payments, the Company must hold a capital conservation buffer of 2.5% above the adequately capitalized risk-based capital ratios.

Capital at December 31, 2021 was sufficient to meet the requirements of regulatory authorities. Leverage capital of the Company, or total shareholders' equity divided by average total assets for the current quarter less goodwill and any net unrealized gain or loss on securities available for sale and postretirement benefits, stood at 8.63% on December 31, 2021 and 8.49% at December 31, 2020. To be rated "well-capitalized", regulatory requirements call for a minimum leverage capital ratio of 5.00%. At December 31, 2021, the Company had tier-one risk-based capital of 13.31% and tier-two risk-based capital of 14.27%, versus 13.66% and 14.82%, respectively, at December 31, 2020. To be rated "well-capitalized", regulatory requirements call for minimum tier-one and tier-two risk-based capital ratios of 8.00% and 10.00%, respectively. The Company's actual levels of capitalization were comfortably above the standards to be rated "well-capitalized" by regulatory authorities.

The Company met each of the well-capitalized ratio guidelines at December 31, 2021. The following tables indicate the capital ratios for the Bank and the Company at December 31, 2021 and December 31, 2020.

Except as identified in Item 1A, "Risk Factors", Management knows of no present trends, events or uncertainties that will have, or are reasonably likely to have, a material effect on the Company's capital resources, liquidity, or results of operations.

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Contractual Obligations

The following table sets forth the contractual obligations of the Company as of December 31, 2021:

Capital Purchases

In 2021, the Company made capital purchases totaling $3.8 million for real estate improvements for branch or operations premises and equipment related to technology. This cost, along with the cost of other assets placed into service in 2020, will be amortized over an average of 23 years, adding approximately $165,000 to pre-tax operating costs per year.

Goodwill

On December 11, 2020, the Bank completed the purchase of a branch at 1B Belmont Avenue in Belfast, Maine, from Bangor Savings Bank ("Bangor Savings"). The branch is one of six branches Bangor Savings acquired from Damariscotta Bank & Trust Company ("DB&T"), and this branch was divested by Bangor Savings to resolve competitive concerns in that market raised by the U.S. Department of Justice's Antitrust Division. The transaction value was approximately $25.2 million consisting of loans, the building, equipment, core deposit intangible and goodwill. Goodwill totaled $841,000; this amount is not amortizable under GAAP but is amortizable for tax purposes.

On October 26, 2012, the Bank completed the purchase of a branch at 63 Union Street in Rockland, Maine, from Camden National Bank that was formerly operated by Bank of America. As part of the transaction, the Bank acquired approximately $32.3 million in deposits as well as a small volume of loans. The excess of the purchase price over the fair value of the assets acquired, liabilities assumed, and the amount allocated for core deposit intangible totaled $2.1 million and was recorded as goodwill. The goodwill is not amortizable under GAAP but is amortizable for tax purposes.

On January 14, 2005, the Company acquired FNB Bankshares (“FNB”) of Bar Harbor, Maine, and its subsidiary, The First National Bank of Bar Harbor. The total value of the transaction was $48.0 million, and all of the voting equity interest of FNB was acquired in the transaction. The transaction was accounted for as a purchase and the excess of purchase price over the fair value of net identifiable assets acquired equaled $27.6 million and was recorded as goodwill, none of which was deductible for tax purposes. The portion of the purchase price related to the core deposit intangible was amortized over its expected economic life.

Goodwill is evaluated annually for possible impairment under the provisions of FASB ASC Topic 350, “Intangibles – Goodwill and Other”. As of December 31, 2021, in accordance with Topic 350, the Company completed its annual review of goodwill and determined there has been no impairment. The Bank also carries $125,000 in goodwill for a de minimis transaction in 2001.

Effect of Future Interest Rates on Post-retirement Benefit Liabilities

In evaluating the Company's post-retirement benefit liabilities, Management believes changes in discount rates which have occurred pursuant to recently enacted Federal legislation will not have a significant impact on the Company's future operating results or financial condition.