UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

**FORM 10-Q**

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the Quarter Period:Commission File No.

September 30, 2005      0-26589

 

**FIRST NATIONAL LINCOLN CORPORATION**

(Exact name of registrant as specified in its charter)

 

 

|   | MAINE | 01-0404322 |  
 

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No)

 

 

 

MAIN STREET, DAMARISCOTTA, MAINE

04543

 
 

(Address of principal executive offices)

(Zip Code)

 

Registrant's telephone number, including area code:

 (207) 563 - 3195

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes x    Noo

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes x   Noo

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock,

as of the latest practicable date.

 

 

Class

Outstanding at November 4, 2005

 

Common Stock, Par One Cent

9,830,621

 
 

 

 

 

 

**Table of Contents**

 

 

**Part I. Financial Information**

1

 

**Selected Financial Data (Unaudited)**

1

 

**Item 1 – Financial Statements**

2

 

*Report of Independent Registered Public Accounting Firm*

2

 

*Consolidated Balance Sheets (Unaudited)*

3

 

*Consolidated Statements of Income (Unaudited)*

4

 

*Consolidated Statements of Changes in Shareholders' Equity (Unaudited)*

5

 

*Consolidated Statements of Cash Flows (Unaudited)*

6

 

**Notes to Consolidated Financials Statements**

7

 

*Note 1 – Basis of Presentation*

7

 

*Note 2 – Common Stock*

7

 

*Note 3 – Stock Options*

7

 

*Note 4 – Earnings Per Share*

8

 

*Note 5 – Postretirement Benefit Plans*

9

 

*Note 6 – Pro-Forma Financial Information*

10

 

**Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations**

12

 

*Critical Accounting Policies*

12

 

*GAAP vs. Pro-Forma Results*

12

 

*Executive Summary*

13

 

*Net Interest Income*

13

 

*Provision for Loan Losses*

16

 

*Non-Interest Income*

16

 

*Non-Interest Expense*

16

 

*Income Taxes*

16

 

*Average Daily Balance Sheets*

16

 

*Value of Assets Acquired*

18

 

*Investments*

19

 

*Loans*

19

 

*Allowance for Loan Losses*

19

 

*Deposits*

20

 

*Borrowed Funds*

21

 

*Shareholders' Equity*

21

 

*Non-Performing Assets*

22

 

*Off-Balance Sheet Financial Instruments*

22

 

*Sale of Loans*

22

 

*Contractual Obligations*

22

 

*Liquidity Management*

22

 

*Forward-Looking Statements*

22

 

**Item 3 – Quantitative and Qualitative Disclosures About Market Risk**

23

 

*Market-Risk Management*

23

 

*Asset/Liability Management*

23

 

*Interest Rate Risk Management*

24

 

**Item 4: Controls and Procedures**

25

 

**Part II – Other Information**

26

 

**Item 1 – Legal Proceedings**

26

 

**Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds**

26

 

**Item 3 – Default Upon Senior Securities**

26

 

**Item 4 – Other Information**

26

 

**Item 5 – Exhibits**

27

 

**Signatures**

28

 

 

 

 

**Part I. Financial Information**

 

**Selected Financial Data (Unaudited)**

First National Lincoln Corporation and Subsidiary

 

 

**For the nine months ended**

**For the quarters ended**

*Dollars in thousands,***

**September 30**

**September 30**

*except for per share amounts***

**2005**

2004

**2005**

2004

 

 

 

 

 

***Summary of Operations*****

 

 

 

 

Operating Income

**$43,174**

$25,937 

**$16,092**

$9,175 

Operating Expense

**29,927**

17,270 

**11,403**

$6,079 

Net Interest Income

**23,398**

15,798 

**7,989**

5,612 

Provision for Loan Losses

**100**

720 

**0**

240 

Net Income

**9,477**

6,197 

**3,347**

2,216 

***Per Common Share Data*****

 

 

 

 

Basic Earnings per Share

**$0.98**

$0.85 

**$0.34**

$0.30 

Diluted Earnings per Share

**0.96**

0.83 

**0.34**

0.30 

Cash Dividends Declared

**0.390**

0.328 

**0.135**

0.115 

Book Value

**10.36**

7.02 

**10.36**

7.02 

Market Value

**19.25**

19.25 

**19.25**

19.25 

***Financial Ratios*****

 

 

 

 

Return on Average Equity1

**12.97%**

16.85%

**13.14%**

17.78%

Return on Average Tangible Equity1

**17.79%**

16.97%

**18.16%**

17.82%

Return on Average Assets1

**1.37%**

1.40%

**1.37%**

1.44%

Average Equity to Average Assets

**10.55%**

8.29%

**10.42%**

8.12%

Average Tangible Equity to Average Assets

**7.69%**

8.45%

**7.54%**

8.10%

Net Interest Margin Tax-Equivalent1

**3.88%**

3.95%

**3.76%**

4.06%

Dividend Payout Ratio

**39.80%**

38.59%

**39.71%**

38.33%

Allowance for Loan Losses/Total Loans

**0.88%**

1.02%

**0.88%**

1.02%

Non-Performing Loans to Total Loans

**0.40%**

0.37%

**0.40%**

0.37%

Non-Performing Assets to Total Assets

**0.30%**

0.28%

**0.30%**

0.28%

Efficiency Ratio2

**53.31%**

49.07%

**54.64%**

49.18%

***At Period End*****

 

 

 

 

Total Assets

**$ 993,321**

$ 630,202 

**$ 993,321**

$ 630,202 

Total Loans

**739,597**

461,504 

**739,597**

461,504 

Total Investment Securities

**163,439**

137,210 

**163,439**

137,210 

Total Deposits

**755,324**

401,479 

**755,324**

401,479 

Total Shareholders’ Equity

**101,844**

51,532 

**101,844**

51,532 

*Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a*

*200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.***

1Annualized using a 365-day basis

2The Company uses the following formula in calculating its efficiency ratio:

Non-Interest Expense  -  Loss on Securities Sales 

Tax-Equivalent Net Interest Income + Non-Interest Income – Gains on Securities Sales

 

Page 1

 

 

 

**Item 1 – Financial Statements**

 

 

 

 

 

 

 

***Report of Independent Registered Public Accounting Firm***

 

The Board of Directors and Shareholders

First National Lincoln Corporation

 

We have reviewed the accompanying interim consolidated financial information of First National Lincoln Corporation and Subsidiary as of September 30, 2005 and 2004, and for the three-month and nine-month periods then ended. These financial statements are the responsibility of the Company's management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is to express an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying  interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Berry, Dunn, McNeil & Parker

 

Portland, Maine

November 4, 2005

 

 

Page 2

 

 

 

***Consolidated Balance Sheets (Unaudited)***

First National Lincoln Corporation and Subsidiary

 

**September 30,**

December 31,

September 30,

*In thousands of dollars***

**2005**

2004

2004

**Assets**

 

 

 

Cash and due from banks

**$29,507**

$14,770

$16,659

Overnight funds sold

**2,500**

-

-

Investments:

 

 

 

Available for sale

**49,171**

51,892

52,900

Held to maturity (market values $114,098 at 9/30/2005, 

$75,600 at 12/31/2004, and $85,316 at 9/30/2004)

**114,268**

74,935

84,310

Loans held for sale (fair value approximates cost)

**40**

-

-

Loans

**739,597**

478,332

461,504

Less: allowance for loan losses

**6,474**

4,714

4,727

Net loans

**733,123**

473,618

456,777

Accrued interest receivable

**4,759**

2,791

3,026

Bank premises and equipment

**16,987**

9,061

9,149

Other real estate owned

**-**

-

-

Goodwill

**27,960**

125

125

Other assets

**15,006**

7,046

7,256

**Total Assets**

**$993,321**

$634,238

$630,202

**Liabilities**

 

 

 

Demand deposits

**$66,792**

$31,181

$33,734

NOW deposits

**127,312**

60,550

60,088

Money market deposits

**119,419**

76,411

85,651

Savings deposits

**116,440**

68,673

67,182

Certificates of deposit

**140,450**

63,900

75,423

Certificates $100,000 and over

**184,911**

69,129

79,401

Total deposits

**755,324**

369,844

401,479

Borrowed funds

**126,647**

207,206

172,442

Other liabilities

**9,506**

4,373

4,749

Total Liabilities

**891,477**

581,423

578,670

**Shareholders' Equity**

 

 

 

Common stock

**99**

74

74

Additional paid-in capital

**47,806**

3,973

3,851

Retained earnings

**52,798**

46,809

45,378

Accumulated other comprehensive income

 

 

 

Net unrealized gains on available-for-sale securities

**1,141**

1,959

2,229

Total Shareholders' Equity

**101,844**

52,815

51,532

**Total Liabilities & Shareholders' Equity**

**$993,321**

$634,238

$630,202

**Common Stock**

 

 

 

Number of shares authorized

**18,000,000**

18,000,000 

18,000,000 

Number of shares issued and outstanding

**9,827,356**

7,356,836 

7,350,040 

Book value per share

**$10.36**

$7.18 

$7.01 

*Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a 200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.*

See Report of Independent Registered Public Accounting Firm. 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 3

 

 

 

***Consolidated Statements of Income (Unaudited)***

First National Lincoln Corporation and Subsidiary

 

**For the nine months**

 

**For the quarters**

 

  **ended September 30,**

 

  **ended September 30,**

*In thousands of dollars***

**2005**

2004

 

**2005**

2004

**Interest income**

 

 

 

 

 

Interest and fees on loans

**$30,619**

$17,470

 

**$11,157**

$6,172

Interest on deposits with other banks

**9**

4

 

**5**

1

Interest and dividends on investments

**5,701**

4,940

 

**1,976**

1,702

Total interest income

**36,329**

22,414

 

**13,138**

7,875

**Interest expense**

 

 

 

 

 

Interest on deposits

**8,978**

3,868

 

**3,911**

1,342

Interest on borrowed funds

**3,953**

2,748

 

**1,238**

921

Total interest expense

**12,931**

6,616

 

**5,149**

2,263

Net interest income

**23,398**

15,798

 

**7,989**

5,612

Provision for loan losses

**100**

720

 

**-**

240

Net interest income after provision for loan losses

**23,298**

15,078

 

**7,989**

5,372

**Non-interest income**

 

 

 

 

 

Investment management and fiduciary income

**1,245**

644

 

**426**

214

Service charges on deposit accounts

**1,779**

881

 

**628**

301

Net securities gains

**-**

-

 

**-**

-

Mortgage origination and servicing income

**481**

310

 

**106**

59

Other operating income

**3,340**

1,688

 

**1,794**

726

Total non-interest income

**6,845**

3,523

 

**2,954**

1,300

**Non-interest expense**

 

 

 

 

 

Salaries and employee benefits

**8,349**

5,138

 

**2,875**

1,835

Occupancy expense

**1,016**

655

 

**319**

227

Furniture and equipment expense

**1,564**

1,094

 

**529**

340

Amortization of identified intangibles

**200**

-

 

**71**

-

Other operating expense

**5,767**

3,047

 

**2,460**

1,174

Total non-interest expense

**16,896**

9,934

 

**6,254**

3,576

Income before income taxes

**13,247**

8,667

 

**4,689**

3,096

Applicable income taxes

**3,770**

2,470

 

**1,342**

880

**NET INCOME**

**$9,477**

$6,197

 

**$3,347**

$2,216

**Earnings per common share:**

 

 

 

 

 

Basic earnings per share

**$0.98**

$0.85

 

**$0.34**

$0.30

Diluted earnings per share

**$0.96**

$0.83

 

**$0.34**

$0.30

Cash dividends declared per share

**$0.390**

$0.328

 

**$0.135**

$0.115

Weighted average number of shares outstanding

**9,717,011**

7,322,255

 

**9,823,370**

7,347,208

Incremental Shares

**124,417**

149,414

 

**128,621**

152,290

*Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a 200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.*

See Report of Independent Registered Public Accounting Firm. 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 4

 

 

 

***Consolidated Statements of Changes in Shareholders' Equity (Unaudited)***

First National Lincoln Corporation and Subsidiary

 

*In thousands of dollars except number of shares and per share amounts***

Number of common shares

Common stock

Additional paid-in capital

Retained earnings

Net unrealized gain on securities available for sale

Treasury stock

Total 

shareholders’

equity

 
**Balance at December 31, 2003**

**7,264,140**

**$74**

**$4,650**

**$42,988**

**$2,497**

**($2,491)**

**$47,718**

 
Net income

-

-

-

6,197

-

-

6,197

 
Net unrealized loss on securities available for sale, net of tax benefit of $138

-

-

-

-

(268)

-

(268)

 
Comprehensive Income

-

-

-

6,197

(268)

-

5,929

 
Cash dividends declared

-

-

-

(2,411)

-

-

(2,411)

 
Treasury stock purchases

(24,394)

-

-

-

-

(404)

(404)

 
Treasury stock sold

110,294

-

(747)

-

-

1,447

700

 
Retirement of Treasury Stock

-

-

(52)

(1,396)

-

1,448

-

 
**Balance at September 30, 2004**

**7,350,040**

**$74**

**$3,851**

**$45,378**

**$2,229**

**-**

**$51,532**

 
 

 

 

 

 

 

 

 

 
**Balance at December 31, 2004**

**7,356,836**

**$74**

**$3,973**

**$46,809**

**$1,959**

**-**

**$52,815**

 
Net income

-

-

-

9,477

-

-

9,477

 
Net unrealized loss on securities available for sale, net of tax benefit of $421

-

-

-

-

(818)

-

(818)

 
Comprehensive Income

-

-

-

9,477

(818)

-

8,659

 
Cash dividends declared

-

-

-

(3,835)

-

-

(3,835)

 
Payment to repurchase common stock

(162,199)

(1)

(2,773)

-

-

-

(2,774)

 
Proceeds from sale of common stock

168,121

1

1,245

-

-

-

1,246

 
Tax benefit of disqualifying disposition of incentive stock option shares

-

-

-

347

-

-

347

 
Acquisition of FNB Bankshares

2,464,598

25

45,361

-

-

-

45,386

 
**Balance at September 30, 2005**

**9,827,356**

**$99**

**$47,806**

**$52,798**

**$1,141**

**-**

**$101,844**

 

*Share and per share data have been adjusted to reflect the three-for-one stock split, in the form of a 200% stock dividend, paid June 1, 2004, to shareholders of record on May 12, 2004.*

See Report of Independent Registered Public Accounting Firm. 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 5

 

 

 

***Consolidated Statements of Cash Flows (Unaudited)***

First National Lincoln Corporation and Subsidiary

 

 
**Nine months ended September 30****

**2005**

2004

 
*In thousands of dollars*

 

 

 
**Cash flows from operating activities**

 

 

 
Net income

**$9,477**

$6,197

 
**Adjustments to reconcile net income to net cash provided by operating activities**

 

 

 
Depreciation

**958**

773

 
Provision for loan losses

**100**

720

 
Loans originated for resale

**(19,222)**

(10,774)

 
Proceeds from sales and transfers of loans

**19,773**

11,756

 
Net gain on sale of other real estate owned

**-**

4

 
Net increase in other assets and accrued interest

**(817)**

(267)

 
Net increase in other liabilities

**2,001**

692

 
Net amortization of premiums on investments

**95**

90

 
Net amortization of acquisition costs

**245**

-

 
Net cash provided by operating activities

**12,610**

9,191

 
**Cash flows from investing activities**

 

 

 
Proceeds from maturities, payments and calls of securities available for sale

**4,153**

4,934

 
Proceeds from maturities, payments and calls of securities to be held to maturity

**20,234**

35,951

 
Proceeds from sales of other real estate owned

**-**

47

 
Purchases of securities available for sale

**(683)**

(824)

 
Purchases of securities to be held to maturity

**(35,087)**

(41,078)

 
Net increase in loans

**(76,656)**

(62,802)

 
Capital expenditures

**(1,117)**

(874)

 
Cash for acquisition, net of cash acquired

**3,493**

-

 
Net cash used in investing activities

**(85,663)**

(64,646)

 
**Cash flows from financing activities**

 

 

 
Net increase in demand deposits, savings, money market and club accounts

**51,587**

21,678

 
Net increase in certificates of deposit

**141,208**

20,724

 
Advances on long-term borrowings

**-**

8,216

 
Repayment on long-term borrowings

**(37,118)**

(25,331)

 
Net increase (decrease) in short-term borrowings

**(60,459)**

31,735

 
Payments to repurchase common stock

**(2,774)**

(404)

 
Proceeds from sale of common stock

**1,246**

700

 
Dividends paid

**(3,400)**

(2,291)

 
Net cash provided by financing activities

**90,290**

55,027

 
Net increase (decrease) in cash and cash equivalents

**17,237**

(428)

 
Cash and cash equivalents at beginning of period

**14,770**

17,087

 
**Cash and cash equivalents at end of period**

**$32,007**

$16,659

 
Interest paid

**$12,285**

$6,622

 
Income taxes paid

**$3,490**

$2,532

 
**Non-cash transactions**

 

 

 
Change in unrealized gain on available for sale securities

**$(1,239)**

$(406)

Non-cash assets acquired with common stock

**$258,631**

$-

Less liabilities assumed

**$214,266**

$-

 

See Report of Independent Registered Public Accounting Firm. 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 6

 

 

 

**Notes to Consolidated Financials Statements**

First National Lincoln Corporation and Subsidiary

 

***Note 1 – Basis of Presentation***

 

First National Lincoln Corporation (the Company) is a financial holding company that owns all of the common stock of The First, N.A. (the Bank). The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of Management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions and balances are eliminated in consolidation. On January 14, 2005, the Company completed the acquisition of FNB Bankshares (FNB) of Bar Harbor,Maine, and operating results include the effect of the FNB acquisition only after the closing date (see Note 6 --  Pro-Forma Financial Information).

The income reported for the 2005 period is not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2004.

 

***Note 2 – Common Stock***

 

On April 27, 2004, the Company's Board of Directors declared a three-for-one split of the Company's common stock payable in the form of a 200% stock dividend to shareholders of record on May 12, 2004, with a payment date of June 1, 2004. All share and per share data included in the consolidated financial statements and elsewhere in this report have been restated to reflect the stock split.

On January 20, 2005, the Company announced that its Board of Directors had authorized the repurchase of up to 250,000 shares of the Company's common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company's stock and the level of stock issuances under the Company's employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated.

As of September 30, 2005, the Company had repurchased 162,188 shares under the new repurchase plan at an average price of $17.09.

 

***Note 3 – Stock Options***

 

The Company established a stock option plan in 1995. Under the plan, the Company may grant options to its employees for up to 600,000 shares of common stock. Only incentive stock options may be granted under the plan. The option price of each option grant is determined by the Options Committee of the Board of Directors, and in no instance shall be less than the fair market value on the date of the grant. An option's maximum term is ten years from the date of grant. As a result of the FNB acquisition, options to acquire 40,630 FNB shares were converted into options to acquire an aggregate of 95,479 common shares of the Company at a purchase price of $3.80 per share.

A summary of the status of the Company's Stock Option Plan as of September 30, 2005, and changes during the nine months then ended, is presented below.

 

 

**Number of**

**Weighted Average**

 

**Shares**

**Exercise Price**

Balance at December 31, 2004

205,500

$  4.81

Granted in 2005

42,000

18.00

Assumed in 2005 

95,479

3.80

Exercised in 2005 

(125,229)

4.05

**Balance at September 30, 2005**

**217,750**

**$  7.34**

 

 

Page 7

 

 

 

The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for the stock option plan. Accordingly, no compensation cost has been recognized. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation. Share and per share data have been adjusted to reflect the three-for-one stock split in the form of a 200% stock dividend paid June 1, 2004, to shareholders of record on May 12, 2004.

 

 

**For the nine months**

**For the quarters**

 

**ended September 30,**

**ended September 30,**

*In thousands of dollars***

**2005**

2004 

2005 

2004 

Net income               

 

 

 

 

As reported

**$9,477**

6,197

**$3,347**

2,216

Value of option grants, net of tax

**136**

-

**-**

-

Pro forma

**$9,341**

6,197

**$3,347**

2,216

Basic earnings per share               

 

 

 

 

As reported

**$0.98**

$0.85

**$0.34**

$0.30

Value of option grants, net of tax

**0.01**

-

**-**

-

Pro forma

**$0.97**

0.85

**$0.34**

0.30

Diluted earnings per share               

 

 

 

 

As reported

**$0.96**

0.83

**$0.34**

0.30

Value of option grants, net of tax

**0.01**

-

**-**

-

Pro forma

**$0.95**

0.83

**$0.34**

0.30

 

The fair market value of options granted, net of tax, was $136,000 in 2005. No options were granted in 2004. The weighted average fair market value of options granted was $3.24 in 2005. The fair market value in 2005 is estimated using the Black-Scholes option pricing model and the following assumptions: quarterly dividends of $0.12, risk-free interest rate of 4.20%, volatility of 17.80%, and an expected life of 10 years.

 

***Note 4 – Earnings Per Share***

 

The following table sets forth the computation of basic and diluted earnings per share for the nine months ended September 30, 2005 and 2004:

 

 **

Income

Shares

Per-Share

*In thousands, except for number of shares and per share data***

(Numerator)

(Denominator)

Amount

**For the nine months ended September 30, 2005**

 

 

 

Net income as reported

$9,477 

 

 

Basic EPS: Income available to common shareholders

$9,477 

9,717,011

$0.98 

Effect of dilutive securities: incentive stock options

 

124,417

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$9,477 

9,841,428

$0.96 

**For the nine months ended September 30, 2004**

 

 

 

Net income as reported

$6,197 

 

 

Basic EPS: Income available to common shareholders

$6,197 

7,322,255

$0.85 

Effect of dilutive securities: incentive stock options

 

149,414

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$6,197 

7,471,669

$0.83 

 

 

Page 8

 

 

 

The following table sets forth the computation of basic and diluted earnings per share for the quarter ended September 30, 2005 and 2004:

 

 **

Income

Shares

Per-Share

*In thousands, except for number of shares and per share data***

(Numerator)

(Denominator)

Amount

**For the quarter ended September 30, 2005**

 

 

 

Net income as reported

$3,347 

 

 

Basic EPS: Income available to common shareholders

$3,347 

9,823,370

$0.34 

Effect of dilutive securities: incentive stock options

 

128,621

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$3,347 

9,951,991

$0.34 

**For the quarter ended September 30, 2004**

 

 

 

Net income as reported

$2,216 

 

 

Basic EPS: Income available to common shareholders

$2,216 

7,347,208

$0.30 

Effect of dilutive securities: incentive stock options

 

152,290

 

Diluted EPS: Income available to common shareholders plus assumed conversions

$2,216 

7,499,498

$0.30 

 

All earnings per share calculations have been made using the weighted average number of shares outstanding during the period. All of the dilutive securities are incentive stock options granted to certain key members of Management. The dilutive number of shares has been calculated using the treasury method, assuming that all granted options were exercisable at the end of each period.

 

***Note 5 – Postretirement Benefit Plans***

 

The Bank sponsors postretirement benefit plans which provide certain life insurance and health insurance benefits for certain retired employees and health insurance for retired directors. None of these plans are pre-funded. The following table sets forth the accumulated post-retirement benefit obligation and funded status:

 

 

**At September 30,**

*In thousands of dollars***

**2005**

2004

**Change in benefit obligations**

 

 

Benefit obligation at beginning of year

**$531**

$542

Plan assumed in FNB acquisition

**1,189**

**-**

Service cost

**8**

4

Interest cost

**89**

26

Benefits paid

**(81)**

(21)

Actuarial gain

**(18)**

**-**

Benefit obligation at end of period

**1,718**

551

**Funded status**

 

 

Benefit obligation at end of period

**(1,718)**

(551)

Unamortized prior service cost

**(11)**

(11)

Unamortized net actuarial loss

**42**

48

Unrecognized transition obligation

**215**

251

Accrued benefit cost

**$(1,472)**

$(263)

 

The following table sets forth the net periodic pension cost:

 

 

 

Page 9

 

 

 

 

 

**For nine months ended September 30,**

**For the quarters ended September 30,**

*In thousands of dollars***

**2005**

2004

**2005**

2004

**Components of net periodic benefit cost**

 

 

 

 

Service cost

**$8**

$4

**$1**

$2

Interest cost

**89**

26

**27**

8

Amortization of unrecognized transition obligation

**22**

22

**(1)**

7

Amortization of prior service cost

**(2)**

2

**(4)**

1

Amortization of accumulated losses

**5**

3

**2**

1

Net periodic benefit cost

**$122**

$57

**$25**

$19

 

A weighted average discount rate of 7.0% was used in determining both the accumulated benefit obligation and the net benefit cost. The measurement date for benefit obligations was as of year-end for both years presented. The estimated amount of related benefit expense in 2005 is $162,000, and the estimated amount of benefits to be paid is $121,000.

 

***Note 6 – Pro-Forma Financial Information***

 

On August 25, 2004, the Company entered into an agreement to acquire FNB Bankshares (FNB) of Bar Harbor, Maine, and its subsidiary, The First National Bank of Bar Harbor. This acquisition was completed on January 14, 2005. In its 2004 Strategic Plan, the Company identified certain markets in which it would consider future growth opportunities, including the area served by FNB Bankshares. Management expects that the products and services available in the FNB Bankshares market area will be enhanced as a result of the combination of the two companies, and this will also provide a larger capacity to lend money and a stronger overall funding base. It is expected that the combined entity will realize cost savings from redundant expenses, such as regulatory fees, audit costs, legal costs, and outsourced costs.

As part of the acquisition, the Company issued 2.35 shares of its common stock to the shareholders of FNB in exchange for each of the 1,048,814 shares of the common stock outstanding of FNB. Cash in lieu of fractional shares of the Company's stock was paid at the rate of $17.87 per share, which was the average high/low price of the Company's stock for the 30-day period ending January 9, 2005, under terms specified in the Merger Agreement. At the time of the acquisition, there were outstanding options to purchase 126,208 shares of FNB common stock under the FNB Bankshares Stock Option Plan. Of these, options to acquire 40,630 FNB shares were converted into options to acquire an aggregate of 95,479 common shares of the Company at a purchase price of $3.80 per share. Holders of unexercised options to purchase FNB shares that were not converted were paid cash to retire their options at the rateof $42.00 for each share subject to the option, less the option exercise price per share. The total amount paid to retire the remaining options was approximately $2.6 million. 

The total value of the transaction was $47,955,000, and all of the voting equity interest of FNB was acquired in the transaction. The Company assumed all outstanding liabilities of FNB, including liabilities under certain Employment Continuity Agreements and Split Dollar Agreements with executive officers of FNB. The acquisition was intended to qualify as a reorganization for federal income tax purposes and provide for a tax-free exchange of shares.

The transaction was accounted for as a purchase and, accordingly, the operations of FNB are included in the Company’s consolidated financial statements from the date of acquisition. The purchase price was allocated to assets acquired and liabilities assumed at the date of acquisition. The excess of purchase price over the fair value of net tangible assets acquired was recorded as goodwill, none of which is expected to be deductible for tax purposes. Goodwill related to the core deposit intangible is being amortized over its expected economic life, and remaining goodwill is evaluated annually for possible impairment under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. In the tables which follow, pro forma financial information is presented. 

The pro forma balance sheets in the following table show how the financial position of the Company would have been presented if the transaction had closed prior to September 30, 2004. The adjustments show the effect of recording all assets and liabilities acquired to current fair value as well as the amount of identified intangibles (core deposit intangible). The excess of purchase price over the fair value of net tangible and intangible assets acquired is recorded as goodwill.

 

Page 10

 

 

 

 

*In thousands of dollars***

**September 30, 2005**

December 31, 2004

September 30, 2004

**Assets**

 

 

 

Cash and cash equivalents

**$ 32,007**

$ 22,777 

$ 36,838 

Investments

**163,439**

154,081 

165,255 

Loans held for sale (fair value approximates cost)

**40**

179 

316 

Loans

**739,597**

664,466 

645,213 

Less: allowance for loan losses

**6,474**

6,719 

6,870 

Net loans

**733,123**

657,747 

638,343 

Bank premises and equipment

**16,987**

16,861 

16,934 

Goodwill

**27,960**

27,960 

27,960 

Other assets

**19,765**

18,573 

18,972 

**Total Assets**

**$ 993,321**

$ 898,178 

$ 904,618 

**Liabilities & Shareholders' Equity**

 

 

 

Deposits

**$ 755,324**

$ 559,500 

$ 609,075 

Borrowed funds

**126,647**

228,241 

186,559 

Other liabilities

**9,506**

9,193 

9,387 

Total Liabilities

**891,477**

796,934 

805,021 

Shareholders' Equity

**101,844**

101,244 

99,597 

**Total Liabilities & Shareholders' Equity**

**$ 993,321**

$ 898,178 

$ 904,618 

 

The pro forma statements of income in the following table show how the Company's results of operations would have been presented if the Company and FNB had operated as one entity for the entire periods presented. Management has made adjustments to reflect the amortization of the premium on loans acquired, increased depreciation on premises, and amortization of the core deposit intangible. Average shares outstanding and incremental shares used in earnings per share calculations are based upon the exchange ratio of 2.35 shares of the Company for each share of FNB.

 

 

For nine months ended September 30,

 

For quarters ended September 30,

*In thousands of dollars, except share and per share information***

**2005**

2004

 

**2005**

2004

Interest Income:

**$36,710**

$30,374

 

**$13,138**

$10,628

Interest expense:

**13,040**

8,455

 

**5,149**

2,851

Net interest income

**23,670**

21,919

 

**7,989**

7,777

Provision for loan losses

**100**

900

 

**-**

300

Net interest income after provision for loan losses

**23,570**

21,019

 

**7,989**

7,477

Other operating income:

**6,990**

6,551

 

**2,954**

2,551

Other operating expenses:

**17,590**

16,701

 

**6,254**

6,130

Income before income taxes

**12,970**

10,869

 

**4,689**

3,897

Applicable income taxes

**3,668**

3,013

 

**1,342**

1,077

Net Income

**$9,302**

$7,856

 

**$3,347**

$2,821

**Operating Statistics**

 

 

 

 

 

Basic earnings per share

**$0.96**

$0.80 

 

**$0.34**

$0.29 

Diluted earnings per share

**$0.95**

$0.79 

 

**$0.34**

$0.28 

Cash dividends declared per share

**$0.390**

$0.328 

 

**$0.125**

$0.103 

Dividend payout ratio

**40.63%**

41.00%

 

**36.76%**

35.63%

Return on average assets

**1.34%**

1.29%

 

**1.39%**

1.33%

Return on average equity

**12.74%**

16.19%

 

**13.31%**

17.20%

Return on average tangible equity

**17.46%**

16.22%

 

**18.49%**

17.23%

Efficiency ratio (tax equivalent)

**54.75%**

56.50%

 

**54.03%**

57.65%

 

 

Page 11

 

 

 

**Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations**

First National Lincoln Corporation and Subsidiary

 

***Critical Accounting Policies***

 

Management's discussion and analysis of the Company's financial condition 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 and the valuation of mortgage servicing rights. 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 in making judgments about the carrying values of assets that are not readily apparent from othersources. Actual results could differ from the amount 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 believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses.

**Mortgage Servicing Rights.** The valuation of mortgage servicing rights also 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 when they are acquired through 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. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value which is recorded on the balance sheet. This includes an evaluation for impairment based upon the fair value of the rights, which can varydepending 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 for both mortgage servicing rights and impairment.

**Acquired Assets and Liabilities.**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 SFAS No. 142. 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 an acquisition and an estimation of the impact of business conditions. Different estimates or assumptions are also utilized to determine the appropriate carrying value of other assets including, but not limited to, property, plant and equipment, overall collectibility of loans and receivables. The use of different estimates or assumptions could produce different estimates of carrying value. Management prepares the valuation analyses, which are thenreviewed by the Board of Directors of the Company. 

 

***GAAP vs. Pro-Forma Results***

 

Operating results for the Company are prepared using accounting principles generally accepted in the United States of America (GAAP) which, under the purchase methods of accounting, exclude FNB Bankshares results prior to the closing date of the acquisition on January 14, 2005. This discussion also includes pro-forma information which shows how the Company's results of operations would have been presented if the Company and FNB had operated as one entity for the entire periods presented (for a presentation of pro-forma results, see Note 6 to the Consolidated Financial Statements -- Pro-Forma Financial Information).

 

 

Page 12

 

 

 

***Executive Summary***

 

Net income for the nine months ended September 30, 2005 was $9,477,000, an increase of 52.9% over net income of $6,197,000 for the comparable period of 2004. The Company's increase in net income for the nine months ended September 30, 2005 in comparison to the same period in 2004 was the result of a 62.1% increase in net interest income driven by the FNB Bankshares acquisition and organic growth. In addition, non-interest income increased 94.3% in comparison to 2004. The level of increase in operating expenses was lower than growth in revenues and assets as a result of economies realized from the FNB acquisition. Fully diluted earnings per share for the nine months ended September 30, 2005 were $0.96, a 15.7% increase over the $0.83 reported for the third quarter of 2004.

Net income for the three months ended September 30, 2005 was $3,347,000, an increase of 51.0% over net income of $2,216,000 in the comparable period of 2004. The increase in net income for the three months ended September 30, 2005 in comparison to 2004 included a 42.4% increase in net interest income driven by the FNB Bankshares acquisition and organic growth. In addition, non-interest income increased 127.2% in comparison to 2004. The level of increase in operating expenses was lower than growth in revenues and assets as a result of economies realized from the FNB acquisition.  Fully diluted earnings per share for the three months ended September 30, 2005 were $0.34, a 13.3% increase over the $0.30 reported for the third quarter of 2004.

On a pro-forma basis, net income for the nine months ended September 30, 2005, was $9,302,000, an increase of $1,445,000 or 18.4% over pro-forma net income of $7,856,000 for the first nine months of 2004. Pro-forma fully diluted earnings per share for the first nine months of 2005 were $0.95, an increase of $0.16 or 20.3% over the $0.79 calculated for the first nine months of 2004.

On a pro-forma basis, net income for the three months ended September 30, 2005, was $3,347,000, an increase over pro-forma net income of $2,821,000 for the three months ended September 30, 2004. Pro-forma fully diluted earnings per share for the three months ended September 30, 2005 were $0.34, and increase of $0.06 or 21.4% over the $0.28 calculated for the three months ended September 30, 2004.

 

***Net Interest Income***

 

Total interest income of $36,329,000 for the nine months ended September 30, 2005 is a 62.1% increase from total interest income of $22,414,000 in the comparable period of 2004. In addition to the interest income related to the FNB acquisition, rising interest rates resulted in higher asset yields in 2005 compared to 2004. Total interest expense of $12,931,000 for the first nine months of 2005 is a 95.5% increase from total interest expense of $6,616,000 for the first nine months of 2004. This was a direct result of the rising interest rate climate and the FNB acquisition.

The combination of higher interest rates, asset growth and the FNB acquisition resulted in net interest income of $23,398,000 for the nine months ended September 30, 2005, which represents a 48.1% increase from the $15,798,000 reported for the same period in 2004.

The Company's net interest margin on a tax-equivalent basis decreased from 3.95% in the first nine months of 2004 to 3.88% for the nine months ended September 30, 2005 due to liability costs accruing at a faster rate than the yield on assets.  Tax-exempt interest income amounted to $2,485,000 and $1,580,000 for the nine months ended September 30, 2005 and 2004, respectively. Tax equivalency is calculated using a 35% effective tax rate. These results are consistent with the Company's expectations for changes in its net interest margin in the current rate environment.

Total interest income of $13,138,000 for the three months ended September 30, 2005 is a 66.8% increase from total interest income of $7,875,000 in the comparable period of 2004. In addition to the interest income related to the FNB acquisition, rising interest rates resulted in higher asset yields in 2005 compared to 2004. At the same time, total interest expense of $5,149,000 for the three months ended September 30, 2005 is a 127.5% increase from total interest expense of $2,263,000 for the third quarter of 2004. This was a direct result of the rising interest rate climate and the FNB acquisition.

The combination of higher interest rates, asset growth and the FNB acquisition resulted in net interest income of $7,989,000 for the three months ended September 30, 2005, a 42.4% increase from the $5,612,000 reported for the same period in 2004.

The Company's net interest margin on a tax-equivalent basis decreased from 4.06% for the three months ended September 30, 2004 to 3.76% for the three months ended September 30, 2005 due to liability costs increasing at a faster rate than yield on assets. Tax-exempt interest income amounted to $869,000 and $571,000 for the three months ended September 30, 2005 and 2004, respectively. Tax equivalency is calculated using a 35% effective tax rate. 

 

 

Page 13

 

 

 

The following table presents the effect of tax-exempt income on the calculation of the net interest margin, using a 35.0% tax rate in 2005 and 2004:

 

**For the nine months**

**For the quarter ended**

 

**ended September 30,**

**September 30,**

 

**2005**

2004

**2005**

2004

Net interest income as presented

**$23,398**

$15,798

**$7,989**

$5,612

Effect of tax-exempt income

**1,338**

851

**468**

308

Net interest income, tax equivalent

**$24,736**

$16,649

**$8,457**

$5,920

 

The following table presents the amount of interest earned or paid, as well as the average yield or rate on an annualized basis, for each major category of assets or liabilities for the nine months ended September 30, 2005 and 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.

 

**Nine months ended September 30,**

**2005**

2004

*Dollars in thousands***

**Amount of interest**

**Average Yield/Rate**

Amount of interest

Average Yield/Rate

**Interest on earning assets**

 

 

 

 

Interest-bearing deposits

**$9**

**2.62%**

$4

0.89%

Investments

**6,684**

**5.64%**

5,660

5.51%

Loans held for sale

**24**

**5.70%**

4

5.62%

Loans  

**30,950**

**5.97%**

17,597

5.52%

Total interest-earning assets

**37,667**

**5.91%**

23,265

5.51%

**Interest-bearing liabilities**

 

 

 

 

Deposits

**8,978**

**1.89%**

3,868

1.33%

Other borrowings

**3,953**

**2.82%**

2,748

2.47%

Total interest-bearing liabilities

**12,931**

**2.11%**

6,616

1.65%

**Net interest income**

**$24,736**

 

$16,649

 

Interest rate spread

 

**3.81%**

 

3.87%

Net interest margin

 

**3.88%**

 

3.95%

 

The following table presents changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and interest-bearing liabilities for the nine months ended September 30, 2005 compared to 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.

 

**Nine months ended September 30, 2005 compared to 2004**

 

 

*Dollars in thousands***

Volume

Rate

Rate/Volume1

Total

**Interest on earning assets**

 

 

 

 

Interest-bearing deposits

$(1)

$8

$(2)

$5

Investment securities

879

125

20

1,024

Loans held for sale

13

1

6

20

Loans  

11,023

1,432

898

13,353

Total interest income

11,914

1,566

922

14,402

**Interest expense**

 

 

 

 

Deposits

2,445

1,633

1,032

5,110

Other borrowings2

714

390

101

1,205

Total interest expense

3,159

2,023

1,133

6,315

Change in net interest income

$8,755

$(457)

$(211)

$8,087

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

2 Includes federal funds purchased.

 

Page 14

 

 

 

The following table presents the amount of interest earned or paid, as well as the average yield or rate on an annualized basis, for each major category of assets or liabilities for the quarters ended September 30, 2005 and 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.

 

**Quarter ended September 30,**

**2005**

2004

*Dollars in thousands***

**Amount of interest**

**Average Yield/Rate**

Amount of interest

Average Yield/Rate

**Interest on earning assets**

 

 

 

 

Interest-bearing deposits

**$5**

**3.02%**

$1

0.98%

Investments

**2,324**

**5.64%**

1,948

5.62%

Loans held for sale

**7**

**5.71%**

1

5.58%

Loans  

**11,270**

**6.15%**

6,233

5.61%

Total interest-earning assets

**13,606**

**6.05%**

8,183

5.60%

**Interest-bearing liabilities**

 

 

 

 

Deposits

**3,911**

**2.17%**

1,342

1.33%

Other borrowings

**1,238**

**3.25%**

921

2.38%

Total interest-bearing liabilities

**5,149**

**2.36%**

2,263

1.62%

**Net interest income**

**$8,457**

 

$5,920

 

Interest rate spread

 

**3.69%**

 

3.98%

Net interest margin

 

**3.76%**

 

4.06%

 

The following table presents changes in interest income and expense attributable to changes in interest rates and volume for interest-earning assets and interest-bearing liabilities for the quarter ended September 30, 2005 compared to 2004. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2005 and 2004.

 

**Quarter ended September 30, 2005 compared to 2004**

*Dollars in thousands***

Volume

Rate

Rate/Volume1

Total

**Interest on earning assets**

 

 

 

 

Interest-bearing deposits

$1

$2

$1

$4

Investment securities

360

14

2

376

Loans held for sale

6

-

-

6

Loans  

4,013

623

401

5,037

Total interest income

4,380

639

404

5,423

**Interest expense**

 

 

 

 

Deposits

1,049

853

667

2,569

Other borrowings2

(17)

340

(6)

317

Total interest expense

1,032

1,193

661

2,886

Change in net interest income

$3,348

$(554)

$(257)

$2,537

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

2 Includes federal funds purchased.

 

On a pro-forma basis, net interest income for the first nine months of 2005 was $23,670,000, an increase of $1,751,000 or 8.0% over net interest income of $21,919,000 for the first nine months of 2004. This increase was the result of asset growth, primarily in the loan portfolio.

On a pro-forma basis, net interest income for the three months ended September 30, 2005 was $7,989,000, an increase of $212,000 or 2.7% over net interest income of $7,777,000 for the three months ended September 30, 2004. This increase was the result of asset growth, primarily in the loan portfolio.

 

 

Page 15

 

 

 

***Provision for Loan Losses***

 

A $100,000 provision to the allowance for loan losses was made during the first nine months of 2005, compared to a $720,000 provision made for the same period of 2004. The decrease in provision is a result of the analysis of credit quality in the loan portfolio and the level of net chargeoffs experienced by the Company.

 

***Non-Interest Income***

 

Non-interest income was $6,845,000 for the nine months ended September 30, 2005, an increase of 94.3% from the $3,523,000 reported for the first nine months of 2004. The increase in non-interest income was primarily due to the acquisition of FNB Bankshares. On a pro-forma basis, non-interest income increased by $439,000 or 6.7% from $6,551,000 in 2004 to $6,990,000 in 2005. Although investment management and fiduciary income increased by 10.8%, income from mortgage origination declined due to higher interest rates and lower levels of loans sold to the secondary market.

Non-interest income was $2,954,000 for the three months ended September 30, 2005, an increase of 127.2% from the $1,300,000 reported for the three months ended September 30, 2004. The increase in non-interest income was due to the acquisition of FNB Bankshares. On a pro-forma basis, non-interest income increased by $403,000 or 15.8% from $2,551,000 in 2004 to $2,954,000 in 2005, with increases in deposit account income and fiduciary fees.

 

***Non-Interest Expense***

 

Non-interest expense of $16,896,000 for the nine months ended September 30, 2005, is an increase of 70.1% over non-interest expense of $9,934,000 for the first nine months of 2004. In addition to a higher expense base as a result of the FNB acquisition, this increase is due to higher personnel and premises costs to provide more comprehensive and competitive services for customers, as well as increased costs for marketing, supplies and professional fees, in line with the Company's revenue and asset growth. On a pro-forma basis, non-interest expense increased by $889,000 or 5.3% during the first nine months of 2005 compared to the first nine months of 2004, with the largest increase in furniture and equipment expense, which were up by 10.7%.

Non-interest expense of $6,254,000 for the three months ended September 30, 2005, is an increase of 74.9% over non-interest expense of $3,576,000 for the three months ended September 30, 2004. This level of increase in non-interest expense for the quarter was for the same reasons cited above. On a pro-forma basis, non-interest expense increased by $124,000 or 2.0% during the three months ended September 30, 2005 compared to the three months ended September 30, 2004, with the largest increase in furniture and equipment expense, which was up by 14.0%. In Management's opinion, this low rate of increase in non-interest expense on a pro-forma basis is indicative of the cost savings which the Company is realizing as a result of the FNB Bankshares acquisition.

 

***Income Taxes***

 

Income taxes on operating earnings increased to $3,770,000 for the first nine months of 2005 from $2,470,000 for the same period a year ago. The increase is in line with the increase in pre-tax income.

 

 

Page 16

 

 

 

***Average Daily Balance Sheets***

 

The following table shows the Company's average daily balance sheets for the nine-month periods ended September 30, 2005 and 2004.

 

 

**For nine months ended**

**For quarters ended**

**September 30,**

**September 30,**

*In thousands of dollars***

**2005**

2004

**2005**

2004

**Assets**

 

 

 

 

Cash and due from banks

**$20,904**

$12,140

**$25,586**

$13,123

Interest-bearing deposits

**459**

599

**656**

405

**Investments**

 

 

 

 

U.S. Treasury securities & government agency securities

**64,771**

60,781

**66,390**

61,750

Obligations of states and political subdivisions

**51,254**

34,288

**55,004**

35,406

Other securities

**42,376**

42,043

**42,073**

40,836

Total investments

**158,401**

137,112

**163,467**

137,992

Loans held for sale

**420**

100

**520**

100

**Loans**

 

 

 

 

Commercial

**280,383**

146,206

**297,901**

149,751

Consumer

**34,745**

26,042

**35,432**

26,082

State and municipal

**22,226**

10,767

**21,508**

13,928

Real estate

**355,336**

242,884

**372,307**

252,611

Total loans

**692,690**

425,899

**727,148**

442,372

Allowance for loan losses

**(6,525)**

(4,417)

**(6,529)**

(4,520)

Net loans

**686,165**

421,482

**720,619**

437,852

Fixed assets

**16,501**

8,950

**16,849**

8,877

Other assets

**18,397**

10,416

**19,662**

10,588

Goodwill

**26,430**

125

**27,961**

125

**Total assets**

**$927,677**

$590,924

**$975,320**

$609,062

**Liabilities and shareholders' equity**

 

 

 

 

**Deposits**

 

 

 

 

Demand

**$57,802**

$28,277

**$64,869**

$30,180

NOW

**105,713**

54,932

**113,018**

57,795

Money market

**112,502**

81,107

**115,752**

81,786

Savings

**111,832**

64,412

**117,229**

65,890

Certificates of deposit

**115,686**

76,279

**131,687**

77,755

Certificates of deposit over $100,000

**130,297**

83,331

**171,654**

87,464

Total deposits

**633,832**

388,338

**714,209**

400,870

Borrowed funds

**187,342**

148,718

**151,067**

153,889

Other liabilities

**8,848**

4,868

**8,966**

4,853

**Total liabilities**

**830,022**

541,924

**874,242**

559,612

Common stock

**98**

74

**98**

77

Additional paid-in capital

**46,208**

2,750

**47,912**

3,777

Retained earnings

**49,687**

43,762

**51,588**

43,651

Unrealized gain/loss on AFS

**1,662**

2,414

**1,480**

1,945

**Total shareholders' equity**

**97,655**

49,000

**101,078**

49,450

**Total liabilities and shareholders' equity**

**$927,677**

$590,924

**$975,320**

$609,062

 

 

Page 17

 

 

 

***Value of Assets Acquired***

 

On January 14, 2005, the Company completed the FNB acquisition. In its 2004 Strategic Plan, the Company identified certain markets in which it would consider future growth opportunities, including the area served by FNB Bankshares. Management expects that the products and services available in the FNB Bankshares market area will be enhanced as a result of the combination of the two companies, and this will also provide a larger capacity to lend money and a stronger overall funding base. It is expected that the combined entity will realize cost savings from redundant expenses, such as regulatory fees, audit costs, legal costs, and outsourced costs which the company has experienced in the period since the transaction closed.

The total value of the transaction was $47,955,000, and all of the voting equity interest of FNB was acquired in the transaction. As required under GAAP, the purchase price was allocated to assets acquired and liabilities assumed at the date of acquisition. The excess of purchase price over the fair value of net tangible and identified intangible assets acquired was recorded as goodwill, which totaled $27,835,000 and included $972,000 for direct expenses to consummate the transaction. The majority of the $1,830,000 difference between actual goodwill booked and the $26,005,000 of goodwill which Management estimated in the Company's December 31, 2004 financial statements was due to deferred income taxes.

There have been no changes in the opening balance sheet since the end of the first quarter.  The following table shows the fair value of assets and liabilities recorded on the Company's balance sheet from the FNB acquisition, including the associated goodwill in the transaction:

 

*In thousands of dollars***

**January 14, 2005**

**Assets**

 

Cash and due from banks

**$6,963**

Investments

**26,562**

Loans held for sale (fair value approximates cost)

**591**

Loans

**185,357**

Less: allowance for loan losses

**(2,164)**

Net loans

**183,193**

Bank premises and equipment

**7,767**

Goodwill

**27,835**

Other assets

**9,311**

**Total Assets**

**$262,222**

**Liabilities & Shareholders' Equity**

 

Deposits

**$192,860**

Borrowed funds

**17,044**

Other liabilities

**4,362**

Total liabilities

**214,266**

Shareholders' equity

**47,956**

**Total Liabilities & Shareholders' Equity**

**$262,222**

 

 

Page 18

 

 

 

***Investments***

 

The Company's investment portfolio increased by $36.6 million or 28.9% to $163.4 million between December 31, 2004, and September 30, 2005. At September 30, 2005, the Company's available-for-sale portfolio had an unrealized gain, net of taxes, of $1.1 million. Between September 30, 2004 and September 30, 2005, the Company's investment portfolio increased by $26.2 million or 19.1%. This growth was the result of the FNB acquisition.

On a pro-forma basis, the Company's investment portfolio increased by $9.4 million or 6.1% during the first nine months of 2005. Year-over-year, the investment portfolio declined by $1.8 million or 1.1% on a pro-forma basis, the result of the decline in investments on the FNB balance sheet to fund loan growth.

 

***Loans***

 

Loans grew by $261.3 million or 54.6% during the first nine months of 2005. The growth in commercial loans was $137.8 million or 87.3% and municipal loans increased $7.2 million or 52.7%. The residential mortgage portfolio increased by $85.2 million or 39.7%, and home equity lines of credit grew $20.3 million or 31.3% year-to-date. The majority of this growth was due to the FNB acquisition. Between September 30, 2004 and September 30, 2005, the loan portfolio increased $278.1 million or 60.5%, as a result of strong customer demand and the FNB acquisition

On a pro-forma basis, the loan portfolio increased by $75.1 million or 11.3% during the nine months ended September 30, 2005. Year-over-year, the loan portfolio increased by $94.4 million or 14.6% on a pro-forma basis, the result of strong loan growth seen by the Company in both the Mid-Coast and Down East Maine regions.

 

***Allowance for Loan Losses***

 

The allowance for loan losses represents the amount available for credit losses inherent in the Company's loan portfolio. Loans are charged off when they are deemed uncollectible, after giving consideration to factors such as the customer's financial condition, underlying collateral and guarantees, as well as general and industry economic conditions.

Adequacy 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 collectibility of specific loans when determining the adequacy 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, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss 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 theCompany’s borrowers, were considered by Management in determining the adequacy 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 collectibility 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 allowancebased on judgments different from those of Management. 

Credit quality of the commercial portfolios is quantified by a corporate credit rating system designed to parallel regulatory criteria and categories of loan risk. Individual loan officers monitor their loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of the commercial loan portfolio are also assessed on a regular basis by an independent loan review consulting firm. An ongoing portfolio trend analyses and individual credit reviews to evaluate loan risk and compliance with corporate lending policies are also performed. The level of allowance allocable to each group of risk-rated loans is then determined by applying a loss factor that estimates the amount of probable loss in each category. The assigned loss factor for each risk rating is based upon Management’s assessment of historical loss data, portfolio characteristics, economictrends, overall market conditions and past experience. 

 

Page 19

 

 

 

Consumer loans, which include residential mortgages, home equity loans/lines, and direct/indirect loans, are generally evaluated as a group based on product type and on the basis of delinquency data and other credit data available due to the large number of such loans and the relatively small size of individual credits. Allocations for these loan categories are principally determined by applying loss factors that represent Management’s estimate of inherent losses. In each category, inherent losses are estimated based upon Management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience. In addition, certain loans in these categories may be individually risk-rated if considered necessary by Management. 

The other method used to allocate the allowance for loan losses entails the assignment of reserve amounts 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. Under this method, loans are selected for evaluation based on internal risk ratings or 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 September 30, 2005, impaired loans with specific reserves totaled $1,707,000 (all of these loans were on non-accrual status) and theamount of such reserves were $598,000.

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. As a result of these analyses, the Company has concluded that the level of the allowance for loan losses was adequate as of September 30, 2005. As of that date, the balance of $6,474,000 was 0.88% of total loans, compared to 0.99% at December 31, 2004 and 1.02% at September 30, 2004. Loans considered to be impaired according to SFAS 114/118 totaled $2,996,000 at September 30, 2005, compared to $1,601,000 at December 31, 2004. The portion of the allowance for loan losses allocated to impaired loans at September 30, 2005, was $598,000 compared to $228,000 at December 31, 2004.

In Management's opinion, the level of the Company's allowance for loan losses is adequate. Although the allowance is lower as a percentage of loans than many peers, the Bank's loan portfolio has a higher percentage of residential mortgage loans than peers, and the overall credit quality of the portfolio and historically low level of chargeoffs support this.

On a pro-forma basis, the allowance for loan losses decreased by $245,000 or 3.6% in the first nine months of 2005. This was the result of limited additional provision to the allowance due to the analysis of credit quality in the loan portfolio and the level of loan chargeoffs during the period.

 

***Deposits***

 

During the first nine months of 2005, deposits increased by $385.5 million or 104.2% over December 31, 2004. Core deposits (demand, NOW, savings and money market accounts) increased by $192.8 million or 80.9% in the first nine months of 2005. During the same period, certificates of deposit increased $192.3 million or 144.6%. Between September 30, 2004, and September 30, 2005, deposits grew by 88.1%, or $353.8 million. Demand deposits grew $32.8 million, NOW accounts $67.2 million, savings $49.3 million, and money market accounts $33.8 million, while certificates of deposit increased $170.5 million. The majority of the growth, both year-to-date and year-over-year, was due to the FNB acquisition and in certificates of deposit, primarily from wholesale and brokered sources. The Company also saw good growth in core deposits in the first nine month of 2005, although this growth was at lower levels than withwholesale and brokered sources of funding.

On a pro-forma basis, deposits grew by $195.8 million or 35.0% during the first nine months of 2005. This growth was in certificate of deposits, primarily from wholesale and brokered sources.

 

 

Page 20

 

 

 

***Borrowed Funds***

 

The Company's funding includes borrowings from the Federal Home Loan Bank of Boston, the Federal Reserve System, and repurchase agreements, enabling it to grow its balance sheet and, in turn, grow its revenues. They may also be used to carry out interest rate risk management stategies, and are increased to replace or supplement other sources of funding, including core deposits and certificates of deposit. During the nine months ended September 30, 2005, borrowed funds decreased by $80.6 million or 38.9% from December 31, 2004. Between September 30, 2004 and September 30, 2005, borrowed funds decreased $45.8 million or 26.6%. 

On a pro-forma basis, borrowed funds decreased by $101.6 million or 44.5% during the first nine months of 2005. This was the result of growth in wholesale and brokered sources, as noted above. Year-over-year, borrowed funds decreased $59.9 million or 32.1%.

 

***Shareholders' Equity***

 

Shareholders' equity as of September 30, 2005 was $101.8 million, compared to $52.8 million as of December 31, 2004. The Company's strong earnings performance in the first nine months of 2005, net of dividends paid, added to shareholders' equity, in addition to the significant increase from the FNB acquisition. The net unrealized gain on available-for-sale securities, presented in accordance with SFAS 115, decreased by $0.8 million from December 31, 2004, as a result of a recent rise in interest rates and by maturing securities replaced at lower yields.

On April 27, 2004, the Company's Board of Directors declared a three-for-one split of the Company's common stock payable in the form of a 200% stock dividend to shareholders of record on May 12, 2004, with a payment date of June 1, 2004. All share and per share data included in the consolidated financial statements and elsewhere in this report have been restated to reflect the stock split.

In 2005, a cash dividend of 13.5 cents per share was declared in the third quarter compared to 11.5 cents in the third quarter of 2004. The dividend payout ratio was 39.71% in the third quarter of 2005 compared to 38.33% in the third quarter of 2004.

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 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 2005 is this year's net income plus $9.7 million.

Regulatory leverage capital ratios for the Company were 7.67% and 8.03% at September 30, 2005 and December 31, 2004, respectively. The Company had a tier one risk-based capital ratio of 10.81% and tier two risk-based capital ratio of 11.78% at September 30, 2005, compared to 11.62% and 12.71%, respectively, at December 31, 2004. These are comfortably above the standards to be rated "well-capitalized" by regulatory authorities -- qualifying the Company for lower deposit-insurance premiums.

On January 20, 2005, the Company announced that its Board of Directors had authorized the repurchase of up to 250,000 shares of the Company's common stock or approximately 2.5% of the outstanding shares. The Company expects such repurchases to be effected from time to time, in the open market, in private transactions or otherwise, during a period of up to 24 months. The amount and timing of shares to be purchased will be subject to market conditions and will be based on several factors, including the price of the Company's stock and the level of stock issuances under the Company's employee stock plans. No assurance can be given as to the specific timing of the share repurchases or as to whether and to what extent the share repurchase will be consummated.

As of September 30, 2005, the Company had repurchased 162,188 shares under the new repurchase plan at an average price of $17.09.

 

 

Page 21

 

 

 

***Non-Performing Assets***

 

At September 30, 2005, loans on non-accrual status totaled $2.9 million, which compares to non-accrual loans of $1.6 million as of December 31, 2004. In addition to loans on non-accrual status at September 30, 2005, loans past due 90 days or more and accruing (calculated on a constant 30-day month basis) totaled $408,000 which compares to $281,000 as of December 31, 2004. The Company continues to accrue interest on these loans because it believes collection of the interest is reasonably assured. The majority of the increase in non-performing assets in the third quarter of 2005 was the result of the FNB acquisition.

 

***Off-Balance Sheet Financial Instruments***

 

No material off-balance sheet risk exists that requires a separate liability presentation.

 

***Sale of Loans***

 

No recourse obligations have been incurred in connection with the sale of loans.

 

***Contractual Obligations***

 

The following table sets forth the contractual obligations of the Company as of September 30, 2005:

 

*In thousands of dollars***

**Total**

**Less than 1 year**

**1-3 years**

**3-5 years**

**More than 5 years**

Borrowed funds 

$126,647

$84,938

$14,000

$15,000

$12,709

Operating leases 

686

119

338

171

58

Certificates of deposit 

325,361

260,038

51,692

13,508

123

Total 

$452,694

$345,095

$66,030

$28,679

$12,890

Commitments to extend credit and unused lines of credit 

$159,917

$159,917

$-

$-

$-

 

 

***Liquidity Management***

 

As of September 30, 2005 the Bank had primary sources of liquidity of $182.2 million. It is Management's opinion this is adequate. In its Asset/Liability policy, the Bank has guidelines for liquidity. The Company is not aware of any recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on the Company's liquidity, capital resources or results of operations.

 

***Forward-Looking Statements***

 

Certain disclosures in Management's Discussion and Analysis of Financial Condition and Results of Operations contain certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In preparing these disclosures, Management must make assumptions, including, but not limited to, the level of future interest rates, prepayments on loans and investment securities, required levels of capital, needs for liquidity, and the adequacy of the allowance for loan losses. These forward-looking statements may be subject to significant known and unknown risks uncertainties, and other factors, including, but not limited to, those matters referred to in the preceding sentence. 

Although First National Lincoln Corporation 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 cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company which attempt to advise interested parties of the facts which affect the Company's business.

 

Page 22

 

 

 

**Item 3 – Quantitative and Qualitative Disclosures About Market Risk**

 

***Market-Risk Management***

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. First National Lincoln Corporation's market risk is composed primarily of interest rate risk. The Bank's Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. All guidelines and policies established by ALCO have been approved by the Board of Directors.

 

***Asset/Liability Management***

 

The primary goal of asset/liability management is to maximize net interest income within the interest rate risk limits set by ALCO. Interest rate risk is monitored through the use of two complementary measures: static gap analysis and earnings simulation modeling. While each measurement has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. 

Static gap analysis measures the amount of repricing risk embedded in the balance sheet at a point in time. It does so by comparing the differences in the repricing characteristics of assets and liabilities. A gap is defined as the difference between the principal amount of assets and liabilities which reprice within a specified time period. The Bank's cumulative one-year gap, at September 30, 2005, 1.59% of total assets. ALCO's policy limit for the one-year gap is plus or minus 20% of total assets. Core deposits with non-contractual maturities are presented based upon historical patterns of balance attrition and pricing behavior which are reviewed at least annually.

The gap repricing distributions include principal cash flows from residential mortgage loans and mortgage-backed securities in the time frames in which they are expected to be received. Mortgage prepayments are estimated by applying industry median projections of prepayment speeds to portfolio segments based on coupon range and loan age.

A summary of the Bank's static gap, as of September 30, 2005 is presented in the following table:

 

 

**0-90**

**90-365**

**1-5**

**5+**

 

**Days**

**Days**

**Years**

**Years**

Investment securities at amortized cost

$17,643

$24,487

$87,016

$33,839

Loans held for sale

-

-

-

40

Loans

297,581

106,082

274,574

60,305

Other interest-earning assets

2,500

-

-

8,144

Non-rate-sensitive assets

71

213

1,134

49,631

Total assets

317,795

130,782

362,724

151,959

Interest-bearing deposits

250,257

92,955

65,204

347,958

Borrowed funds

79,464

5,428

14,101

27,654

Non-rate-sensitive liabilities and equity

1,281

3,843

20,496

54,619

Total liabilities and equity

331,002

102,226

99,801

430,231

Period gap

$(13,207)

$28,556

$262,923

$(278,272)

Percent of total assets

-1.37%

2.96%

27.30%

-28.89%

Cumulative gap (current)

(13,207)

15,349

278,272

-

Percent of total assets

-1.37%

1.59%

28.89%

0.00%

 

The earnings simulation model forecasts capture the impact of changing interest rates on one-year and two-year net interest income. The modeling process calculates changes in interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflected on the Company's balance sheet. None of the assets used in the simulation are held for trading purposes. The modeling is done for a variety of scenarios that incorporate changes in the absolute level of interest rates as well as basis risk, as represented by changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effects on income of alternative interest rate scenarios 

 

Page 23

 

 

against earnings in a stable interest rate environment. This analysis is also most useful in determining the short-run earnings exposures to changes in customer behavior involving loan payments and deposit additions and withdrawals.

The Bank's most recent simulation model projects net interest income would increase by approximately 4.90% of stable-rate net interest income if short-term rates affected by Federal Open Market Committee actions fall gradually by two percentage points over the next year, and decrease by approximately 5.92% if rates rise gradually by two percentage points. Both scenarios are well within ALCO's policy limit of a decrease in net interest income of no more than 10.0% given a 2.0% move in interest rates, up or down. Management believes this reflects a reasonable interest rate risk position. In year two, and assuming no additional movement in rates, the model forecasts that net interest income would be higher than that earned in a stable rate environment by 11.66% in a falling-rate scenario and decrease by 9.16% in a rising rate scenario when compared to the year-one base scenario.

A summary of the Bank's interest rate risk simulation modeling, as of September 30, 2005 is presented in the following table:

 

 

**Changes in Net Interest Income**

**2005**

**Year 1**

 

Projected change if rates decrease by 2.0%

+4.90%

 

Projected change if rates increase by 2.0%

-5.92%

**Year 2**

 

Projected change if rates decrease by 2.0%

+11.66%

 

Projected change if rates increase by 2.0%

-9.16%

 

This dynamic simulation model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. Loans and deposits are projected to maintain stable balances. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in similar assets. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Non-contractual deposit volatility and pricing are assumed to follow historical patterns. The sensitivities of key assumptions are analyzed annually and reviewed by ALCO.

The information for static gap and changes in net interest income presented in this section pertains to the Bank only and does not include goodwill and a small volume of assets and liabilities owned by the Company and included in its consolidated financial statements as of September 30, 2005. This sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/ replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to thepredictive nature of these assumptions, including how customer preferences or competitor influences might change.

 

***Interest Rate Risk Management***

 

A variety of financial instruments can be used to manage interest rate sensitivity. These may include investment securities, interest rate swaps, and interest rate caps and floors. Frequently called interest rate derivatives, interest rate swaps, caps and floors have characteristics similar to securities but possess the advantages of customization of the risk-reward profile of the instrument, minimization of balance sheet leverage and improvement of liquidity. As of September 30, 2005, the Company was not using any derivative instruments for interest rate risk management.

The Company engages an independent consultant to periodically review its interest rate risk position, as well as the effectiveness of simulation modeling and reasonableness of assumptions used. As of September 30, 2005, there were no significant differences between the views of the independent consultant and Management regarding the Company's interest rate risk exposure. Management expects interest rates will continue to rise in the near term and believes that the current level of interest rate risk is acceptable.

 

Page 24

 

 

 

**Item 4: Controls and Procedures**

 

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2005, the end of the quarter covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal controls over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve withits business. 

 

 

Page 25

 

 

 

**Part II – Other Information**

 

**Item 1 – Legal Proceedings**

 

The Company was not involved in any legal proceedings requiring disclosure under Item 103 of Regulation S-K during the reporting period.

 

**Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds** 

 

The Company issues shares to the Bank's 401k Investment and Savings Plan pursuant to an exemption from registration under the Securities Act of 1933, as amended (the "Securities Act"), contained in Section 3(a)(11) thereof and Rule 147 promulgated thereunder. During the first nine months of 2005, 24,514 shares were issued pursuant to this Plan, as presented in the following table:

 

**Month**

**Shares**

January 2005

6,088

February 2005

1,514

March 2005

560

April 2005

1,417

May 2005

11,292

June 2005

1,099

July 2005

1,534

August 2005

457

September 2005

552

 

24,514

 

 

**Item 3 – Default Upon Senior Securities**

 

None.

 

**Item 4 – Other Information**

 

 

A.  

None.

 

 

B.  

None.

 

 

Page 26

 

 

 

**Item 5 – Exhibits**

 

Exhibit 2.1 Agreement and Plan of Merger With FNB Bankshares Dated August 25, 2004, incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K dated August 25, 2004, filed under item 1.01 on August 27, 2004.

 

Exhibit 3.1 Conformed Copy of the Registrants Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 3.2 Conformed Copy of the Registrant's Bylaws, incorporated by reference to Exhibit 3.2 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 10.1(a) FNB Bankshares' Stock Option Plan. incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed under item 5.03 on October 7, 2004.

 

Exhibit 10.1(b) Specimen FNB Bankshares Non-Qualified Stock Option Agreement entered into with Messrs. Rosborough, McKim, Wrobel, Dalrymple and Lay, whose FNB Bankshares options have been converted into options to purchase 5,287, 34,086, 15,275, 11,750 and 21,150 shares of the Registrant's stock, respectively, all at $3.80 per share, incorporated by reference to Exhibit 10.1(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.2(a) Specimen Employment Continuity Agreement entered into with Messrs. McKim, Wroble, Dalrymple and Lay, incorporated by reference to Exhibit 10.2(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.2(b) Specimen Amendment to Employment Continuity Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay, incorporated by reference to Exhibit 10.2(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.3(a) Specimen Split Dollar Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay. For Mr. McKim, the amount of the death benefit is $250,000; for Messrs. Lay, Dalrymple and Wrobel, the death benefit is $150,000. Incorporated by reference to Exhibit 10.3(a) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 10.3(b) Specimen Amendment to Split Dollar Agreement entered into with Messrs. McKim, Wrobel, Dalrymple and Lay, incorporated by reference to Exhibit 10.3(b) to the Company’s Form 8-K filed under item 1.01 on January 14, 2005.

 

Exhibit 31.1 Certification of Chief Executive Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934

 

Exhibit 31.2 Certification of Chief Financial Officer Persuant to Rule 13A-14(A) of The Securities Exchange Act of 1934

 

Exhibit 32.1 Certification of Chief Executive Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

Exhibit 32.2 Certification of Chief Financial Officer Persuant to 18 U.S.C. Section 1350, As Adopted Persuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

 

Page 27

 

 

 

**Signatures**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

FIRST NATIONAL LINCOLN CORPORATION

 

 

/s/ Daniel R. Daigneault

Daniel R. Daigneault

President & Chief Executive Officer

 

Date: November 9, 2005

 

 

/s/ F. Stephen Ward

F. Stephen Ward

Executive Vice President & Chief Financial Officer

 

Date: November 9, 2005

 

 

Page 28

 

 

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