CAMDEN NATIONAL CORP quarterly report, Q3 FY2016

Business Context and Reporting Period

Camden National Corporation is a Maine-based bank holding company with lending operations primarily in Maine and an expanding New England footprint. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods, and the balance sheet compared with December 31, 2015. Results include the impact of the SBM Financial acquisition completed October 16, 2015.

On September 30, 2016, the Company completed a three-for-two stock split; prior-period share and per-share data were retrospectively adjusted. Management also announced a proposed merger of Acadia Trust into Camden National Bank, subject to regulatory approval and expected in the fourth quarter of 2016.

Financial Performance and Position

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Net interest income	$28.4 million	$20.0 million	$84.8 million	$60.1 million
Non-interest income	$11.0 million	$6.6 million	$29.5 million	$19.0 million
Net income	$10.9 million	$6.5 million	$29.2 million	$19.3 million
Diluted EPS	$0.70	$0.57	$1.88	$1.71
Net interest margin, fully taxable equivalent	3.24%	3.08%	3.31%	3.12%
Return on average assets	1.11%	0.90%	1.02%	0.91%
Return on average equity	11.18%	9.99%	10.29%	10.19%

Q3 net income increased approximately 69%, while nine-month net income increased approximately 51%. Diluted EPS increased 23% and 10%, respectively.
Q3 total revenue, defined as net interest income plus non-interest income, was approximately $39.4 million; nine-month total revenue was approximately $114.3 million.
Non-interest income growth was led by mortgage banking income, debit card income, service charges, customer loan swap income and other income. Mortgage banking income was $2.4 million in Q3 and $4.9 million for nine months.
Total non-interest expense increased to $22.1 million in Q3 and $67.4 million for nine months, primarily because of the larger organization following the SBM acquisition. The non-GAAP efficiency ratio improved to 56.29% in Q3 and 57.92% for nine months, from 58.94% and 59.80%, respectively.
The effective tax rate was 31.6% in Q3 and 30.4% for nine months, compared with 32.6% and 32.3% in the prior-year periods.

Balance Sheet, Liquidity and Capital

Total assets were $3.904 billion at September 30, 2016, up $194.6 million, or 7%, from year-end. Total loans were $2.592 billion, up $101.8 million, or 4%; commercial loans increased $141.5 million, while retail loans declined $39.7 million.
Commercial real estate loans increased 14% to $1.054 billion and commercial loans increased 9% to $324.4 million. Management identified non-residential building operators as 13% of total loans and 33% of commercial real estate loans.
Total deposits were $2.889 billion, up $162.8 million from year-end. Core deposits increased $159.7 million, or 11% annualized. Total borrowings were $559.3 million, approximately $13.1 million below year-end.
Cash and due from banks were $99.5 million. Nine-month operating cash flow was $33.0 million, investing cash flow was negative $154.7 million, and financing cash flow was $141.7 million, producing a $20.0 million increase in cash and cash equivalents.
Shareholders’ equity was $393.2 million, or 10.07% of assets. Tangible book value per share increased to $18.87 from $16.89 at year-end, and the tangible common equity ratio increased to 7.66% from 7.18%.
The Company and Bank exceeded regulatory capital requirements. The Bank’s September 30, 2016 ratios included total risk-based capital of 12.34%, common equity Tier 1 capital of 11.46% and Tier 1 leverage capital of 8.06%; the Bank remained well capitalized.

Material Changes Versus Prior Comparable Period

The SBM acquisition materially increased average loans, deposits, interest-earning assets, employees, banking centers and operating expenses. Management attributed much of the year-over-year growth to the acquisition and related organic growth.
Mortgage loan sales increased to $71.4 million in Q3 and $166.6 million for nine months, compared with $11.9 million and $24.5 million, respectively, in 2015. Related gains increased to $2.0 million and $4.2 million.
The provision for credit losses increased to $1.3 million in Q3 and $5.0 million for nine months, from $279,000 and $979,000. The increase reflected loan growth, a higher commercial loan mix and deterioration in one commercial real estate credit and one commercial credit.
The allowance for loan losses increased to $23.3 million, but declined to 0.90% of total loans from 1.25% at September 30, 2015 because of the acquired and expanded loan base.
Net unrealized gains on available-for-sale securities were $6.6 million at September 30, 2016, compared with net unrealized losses of $3.8 million at year-end 2015, primarily reflecting changes in interest rates rather than credit deterioration.
HPFC ceased originating loans on February 19, 2016. Its portfolio declined 15% from year-end to $65.7 million and is expected to continue declining through amortization and payoffs.

Outlook, Risks, Contingencies and Unusual Items

The filing provides no formal earnings or revenue guidance. Management expects the Acadia Trust merger, subject to regulatory approval, to occur in the fourth quarter of 2016.
Normalized fully taxable equivalent net interest margin was 3.10% in Q3 and 3.11% for nine months, excluding purchase-accounting accretion and collections of previously charged-off acquired loans. These items contributed $1.0 million and $4.2 million of accretion, respectively, and are not expected to recur at the same level.
Q3 other income included $638,000 of legal settlement proceeds related to a previously charged-off acquired loan. Nine-month bank-owned life insurance income included $394,000 of non-taxable death-benefit income.
Non-accrual loans were $21.0 million, non-performing loans were $25.5 million and non-performing assets were $26.3 million, or 0.67% of total assets. Management stated that credit deterioration in two commercial relationships was specific to those borrowers and not systemic, but acknowledged that worsening economic conditions could require higher provisions.
Commercial real estate and commercial lending represented 56% of the loan portfolio, increasing exposure to regional economic conditions, real estate values and borrower cash flows. The allowance may prove insufficient if borrower, collateral or economic conditions deteriorate.
Interest-rate risk is the principal market risk. The Company uses interest-rate swaps and customer loan swaps; the filing’s modeled results indicate sensitivity of net interest income to both rising and falling rates. Cash flow hedge liabilities totaled $13.5 million at September 30, 2016.
Liquidity exceeded internal targets, with unused lines of credit of $9.9 million from the FHLB, $50.0 million from PNC Bank and $74.6 million from the Federal Reserve Discount Window. However, access to brokered deposits and wholesale repurchase markets could be affected by market conditions.
Management reported no material legal loss contingencies, no material changes to previously disclosed risk factors, and effective disclosure controls. The Company expects recently issued credit-loss and lease accounting standards to have a material effect, but the filing does not provide a quantified estimate.

Investor Verification Priorities

Verify the sustainability of earnings growth after removing SBM acquisition effects, purchase-accounting accretion, legal settlement proceeds and BOLI death-benefit income.
Monitor commercial real estate concentrations, the two identified deteriorated credits, net charge-offs and future provision requirements.
Assess the sustainability of mortgage banking gains and the expected runoff of the higher-yielding HPFC portfolio.
Review deposit mix, brokered deposits, borrowing maturities and available liquidity facilities.
Confirm regulatory approval and timing of the proposed Acadia Trust merger and assess related integration or restructuring costs.
Evaluate the future impact of ASU 2016-13 on the allowance for credit losses and capital.