BHB US Equity☆

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Management’s discussion and analysis is intended to assist in understanding the financial condition and results of operations of the Company. The information in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes contained in report.

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SELECTED FINANCIAL DATA

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ At or For the Years Ended December 31,

Financial Condition Data: ​ ​ ​ ​ ​ ​ ​ ​ ​

Allowance for credit losses ​ 23 ​ 19 ​ 15

Total goodwill and intangible assets ​ 126 ​ 127 ​ 127

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Operating Data: ​ ​ ​

Total interest and dividend income ​ $ 111 ​ $ 126 ​ $ 135

Total interest expense ​ 15 ​ 27 ​ 46

Net interest income ​ 96 ​ 99 ​ 90

Non-interest income ​ 42 ​ 43 ​ 29

Provision for credit losses ​ (1) ​ 6 ​ 2

Total non-interest expense ​ 91 ​ 95 ​ 90

Income tax expense(3) ​ 9 ​ 8 ​ 4

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Ratios and Other Data: ​ ​ ​

Per Common Share Data ​ ​ ​

Common stock price: ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Weighted average common shares outstanding (in thousands): ​ ​ ​

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​ ​ ​ ​ ​ ​ ​ ​

​ ​ At or For the Years Ended December 31,

Performance Ratios:(4) ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​

Organic Growth Ratios: ​

Total commercial loans 7 % 17 % 6 %

Total loans (1) (3) 2 ​

Total deposits 5 8 (2) ​

​ ​ ​ ​ ​ ​ ​ ​

Asset Quality and Condition Ratios: ​

Non-accruing loans/total loans 0.40 % 0.48 % 0.44 %

Net charge-offs/average loans 0.01 0.07 0.03 ​

Allowance for credit losses/total loans 0.90 0.74 0.58 ​

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Capital Ratios: ​

Tier 1 capital to average assets - Company 8.66 % 8.12 % 8.13 %

Tier 1 capital to risk-weighted assets - Company 11.90 11.28 11.39 ​

Tier 1 capital to average assets - Bank 9.62 9.02 8.39 ​

(2) Net revenue is defined as net interest income plus non-interest income.

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AVERAGE BALANCES AND AVERAGE YIELDS/RATES

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The following table presents average balances and average rates and yields on a fully taxable equivalent basis for the periods included:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year Ended December 31,

Assets ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Loans: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Cash and due from banks ​ ​ 35 ​ ​ ​ ​ ​ ​ ​ ​ 27 ​ ​ ​ ​ ​ ​ ​ ​ 64 ​ ​ ​ ​ ​ ​

Other assets(5) ​ 333 ​ ​ ​ ​ ​ 351 ​ ​ ​ ​ ​ 277 ​ ​ ​ ​

Total assets(5) ​ $ 3,718 ​ ​ ​ ​ ​ $ 3,758 ​ ​ ​ ​ ​ $ 3,646 ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Liabilities ​ ​ ​ ​ ​ ​ ​ ​ ​

Non-interest bearing demand deposits ​ 668 ​ ​ ​ 481 ​ ​ ​ 394 ​ ​

Other liabilities(5) ​ 68 ​ ​ ​ 67 ​ ​ ​ 34 ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Total shareholders' equity(5) ​ 414 ​ ​ ​ 401 ​ ​ ​ 387 ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Net interest income ​ ​ $ 96 ​ ​ ​ ​ $ 105 ​ ​ ​ ​ $ 91 ​ ​

Net interest margin ​ ​ 2.88 ​ ​ ​ 2.97 ​ ​ ​ 2.77 ​

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(2) The average balance for securities is based on amortized cost.

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RATE/VOLUME ANALYSIS

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The following table presents the effects of rate and volume changes on the fully taxable equivalent net interest income. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison. For each category of interest- earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in rate (change in rate multiplied by prior year volume), (2) changes in volume (change in volume multiplied by prior year rate), and (3) changes in volume/rate (change in rate multiplied by change in volume) have been allocated proportionately based on the absolute value of the change due to the rate and the change due to volume.

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Increases (Decreases) due to ​ Increases (Decreases) due to

(in thousands) Rate Volume Net Rate Volume Net

Interest income: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Loans: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Interest expense: ​ ​ ​ ​ ​ ​

Deposits: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

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NON-GAAP FINANCIAL MEASURES

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This document contains certain non-GAAP financial measures in addition to results presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). These non-GAAP measures are intended to provide the reader with additional supplemental perspectives on operating results, performance trends, and financial condition. Non-GAAP financial measures are not a substitute for GAAP measures; they should be read and used in conjunction with the Company’s GAAP financial information. A reconciliation of non-GAAP financial measures to GAAP measures is provided below. In all cases, it should be understood that non-GAAP measures do not depict amounts that accrue directly to the benefit of shareholders. An item that management excludes when computing non- GAAP adjusted earnings can be of substantial importance to the Company’s results for any particular quarter or year. The Company’s non-GAAP adjusted earnings information set forth is not necessarily comparable to non- GAAP information that may be presented by other companies. Each non-GAAP measure used by the Company in this report as supplemental financial data should be considered in conjunction with the Company’s GAAP financial information.

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The Company utilizes the non-GAAP measure of adjusted earnings in evaluating operating trends, including components for adjusted revenue and expense. These measures exclude amounts that the Company views as unrelated to its normalized operations, including gains/losses on securities, premises, equipment and other real estate owned, acquisition costs, restructuring costs, legal settlements, and systems conversion costs. Non-GAAP adjustments are presented net of an adjustment for income tax expense.

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The Company also calculates adjusted earnings per share based on its measure of adjusted earnings. The Company views these amounts as important to understanding its operating trends, particularly due to the impact of accounting standards related to acquisition activity. Analysts also rely on these measures in estimating and evaluating the Company’s performance. Management also believes that the computation of non-GAAP adjusted earnings and adjusted earnings per share may facilitate the comparison of the Company to other companies in the financial services industry. The Company also adjusts certain equity related measures to exclude intangible assets due to the importance of these measures to the investment community.

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RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

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The following table summarizes the reconciliation of non-GAAP items for the time periods presented:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ At or For The Years Ended December 31,

Non-recurring items: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Gain on sale of securities, net ​ (2,870) ​ (5,445) ​ (237)

Loss (gain) on sale of premises and equipment, net ​ 378 ​ (32) ​ 18

Loss on other real estate owned ​ — ​ 355 ​ 166

Loss on debt extinguishment ​ ​ ​ ​ 2,851 ​ ​ 1,351 ​ ​ 1,096

Acquisition, conversion and other expenses ​ 1,667 ​ 5,801 ​ 8,317

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Gain on sale of securities, net ​ (2,870) ​ (5,445) ​ (237)

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Non-recurring expenses: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

(Loss) gain on sale of premises and equipment, net ​ (378) ​ 32 ​ (18)

Loss on other real estate owned ​ — ​ (355) ​ (166)

Loss on debt extinguishment ​ ​ ​ ​ (2,851) ​ ​ (1,351) ​ ​ (1,096)

Acquisition, conversion and other expenses ​ (1,667) ​ (5,801) ​ (8,317)

Total non-recurring expenses ​ ​ ​ ​ (4,896) ​ ​ (7,475) ​ ​ (9,597)

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(in millions) ​ ​ ​

Average paycheck protection program (PPP) loans ​ (R) ​ ​ 51 ​ ​ 109 ​ ​ —

Average interest-bearing deposits with other banks ​ (U) ​ ​ 219 ​ ​ 89 ​ ​ 17

Average shareholders' equity(8) (G) ​ 414 ​ 401 ​ 387

Average tangible shareholders' equity(2)(3)(8) (H) ​ 288 ​ 273 ​ 278

Tangible shareholders' equity, period-end(2)(3)(8) (I) ​ 298 ​ 284 ​ 269

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ At or For The Years Ended December 31, ​

(in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Common shares outstanding, period-end (K) ​ ​ 15,001 ​ ​ 14,916 ​ ​ 15,558 ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Adjusted earnings per share, diluted(2) (A/L) ​ $ 2.72 ​ $ 2.28 ​ $ 1.91 ​

Securities adjustment, net of tax(1)(4) (M) ​ ​ 1,985 ​ ​ 10,023 ​ ​ 5,549 ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Performance ratios(5) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Return on assets ​ ​ ​ 1.06 % ​ 0.88 % ​ 0.62 %

Adjusted return on assets(2) ​ (A/F) ​ ​ 1.10 ​ ​ 0.93 ​ ​ 0.82 ​

Pre-tax, pre-provision return on assets ​ ​ ​ ​ 1.27 ​ ​ 1.26 ​ ​ 0.80 ​

Adjusted return on equity(2)(8) ​ (A/G) ​ ​ 9.87 ​ ​ 8.68 ​ ​ 7.65 ​

Return on tangible equity(8) ​ ​ ​ ​ 13.92 ​ ​ 12.45 ​ ​ 8.32 ​

Net interest margin ​ (B+P)/E ​ ​ 2.88 ​ ​ 2.97 ​ ​ 2.77 ​

Adjusted net interest margin(2)(7) ​ (B+P-T-V)/S ​ ​ 2.93 ​ ​ 3.01 ​ ​ 2.77 ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Supplementary data (in thousands) ​ ​ ​ ​ ​ ​ ​ ​

Franchise taxes included in non-interest expense ​ (O) ​ ​ 528 ​ ​ 477 ​ ​ 469 ​

Intangible amortization ​ (Q) ​ ​ 940 ​ ​ 1,024 ​ ​ 861 ​

Interest and fees on PPP loans ​ (T) ​ ​ 6,039 ​ ​ 4,569 ​ ​ — ​

(2) Non-GAAP financial measure.

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EXECUTIVE OVERVIEW

Bar Harbor Bankshares recorded 2021 net income of $39 million, or $2.61 per diluted share, compared to $33 million, or $2.18 per diluted share, in 2020. Adjusted income (non-GAAP measure) in 2021 was $41 million, or $2.72 per diluted share, and $35 million, or $2.28 per diluted share, for the same period of 2020. The Company’s return on assets ratio was 1.06% for 2021, up from 0.88% in the prior year.

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Net interest margin (NIM) was 2.88% for 2021 compared with 2.97% in 2020. Excluding the effects of PPP fee acceleration, excess cash, and one-time items, adjusted NIM was 2.93% in 2021 compared to 3.01% in 2020. At year-end 2021, the Company had approximately $200 thousand of remaining PPP deferred fees which are expected to be amortized to the margin in 2022. The Company saw a leveling of NIM in the second quarter 2021, which was contributed growth in non-maturity deposits, and maturities of wholesale funding that were not replaced. NIM continued to stabilize in the second half of 2021 due to the execution of several delever and security remix strategies. Also as result, the Company’s cost of interest-bearing liabilities steadily dropped to 59 basis points in 2021 from 96 basis points during 2020.

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In 2021, the Company prepaid $159 million of FHLB borrowings and sold $63 million of securities to offset prepayment penalties, which were replaced with relatively short-lived securities with an average duration of approximately 4 years. The transactions took place in the second half of 2021 and the net result is expected to be fully accretive to NIM and earnings per share starting in 2022.

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Non-maturity deposits increased 19% during 2021 due to a significant amount of accounts were opened as new relationships were built and relationships with existing customers deepened. Wholesale funding has decreased to 4% of total funding, down from 18% at year-end 2020. Non-maturity deposit reliance continues to expand, funding earning asset growth with a much more stabilized cost if rates do go up. At year-end 2021, $114 million of wholesale funding remains, which represent longer durations or have associated hedges.

The Company continues to focus on profitability and fee-based revenue remains a priority. The growth seen during this past year has contributed to the expansion of the Company’s key performance metrics, while further enhancing the diversity and strength of revenue streams. Wealth management and customer service fees in 2021 increased 15% over the prior year, given a 13% increase in assets under management and significant increase in non-maturity deposits. The Wealth Management division continues to deliver a strong performance from both a customer and shareholder perspective. Customer service revenue benefits from the increase in non-maturity deposits along with adjustments made to product fee schedules based on peer review studies performed in late 2020. Mortgage banking income benefited from higher secondary market loan sales in 2021, which also accounts for the decrease in residential loans as production was selectively moved between on-balance sheet and held for sale throughout the year.

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Commercial real estate loans in 2021 grew 12% over the prior year driven by a balanced mix of new and existing customers that are proven operators and are strong relationships of the Bank. Similarly, the growth in commercial and industrial loans of 5%, excluding paycheck protection program (PPP) loans, came from new and existing customers and represented a variety of industries. Looking forward, the Company’s loan pipelines remain robust and it is seeing momentum continuing into the first quarter of 2022.

The Company adopted CECL effective January 1, 2021, which increased the allowance for credit losses (ACL) by $5.2 million and reserve for unfunded commitments by $1.6 million. Upon adoption, the coverage ratio of ACL to total loans increased to 0.94% from 0.76% in the fourth quarter of 2020, excluding PPP loans. The provision for credit losses for 2021 was a credit of $1.3 million compared with expense of $5.6 million in 2020. Steady improvements in macroeconomic expectations, lower specific reserves along with relative flat growth in total loans contributed to the benefit in 2021.

The Company continues to build long term shareholder value while providing a favorable dividend rate relative to other community banks. The Company’s return on equity for 2021 rose to 9.50% from 8.29% in 2020. Credit metrics remained strong and stable throughout 2021. Non-performing loans continue to decline across all categories on a quarterly and year-over- year basis. There was also noteworthy reduction of criticized loans, down to 3% from 4% at year-end 2020. Moving into 2022, all of these trends are positive and are expected to continue based on the Company’s credit discipline.

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In early 2021, the Company performed an intensive review of non-interest expense leveraging a strategic third-party partner. The goal of the review was to identify normalized expense run-rates that are optimal for the Company’s current size and footprint, and establish sustainable run-rates that allow for revenue growth in the future. Results of the study reduced salary and benefit expense by $2.3 million in 2021 and $3.0 million is expected to be fully realized in 2022.

The Company was named by Newsweek Magazine as one of "America's Best Banks." Best Bank winners were selected from over 2,500 financial institutions and assessed on more than 30 separate factors including the overall health of the bank, customer service performance and features, digital and branch presence, account and loan options, interest rate offerings, and fees.

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COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2021 AND 2020

Cash and cash equivalents

Total cash and cash equivalents at the end of 2021 were $250 million, compared to $226 million at December 31, 2020. Interest-earning cash held with other banks totaled $217 million compared to $198 million at year-end 2020 carrying a yield of 0.15% in both periods. The increase in cash balances reflects the growth in non-maturity deposits.

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Securities

Securities totaled $626 million at the end of 2021 and $599 million at year-end 2020 representing 17% and 16% of total assets, respectively. During 2021 security purchases totaled $250 million and were offset by $93 million of sales, $112 million of maturities, calls and pay-downs of amortizing securities and a $7 million reduction in FHLB stock. The majority of the sales were made in connection with the Company’s balance sheet delever and security remix strategies in the third and fourth quarters of 2021. Fair value adjustments decreased the security portfolio by $10 million in 2021 compared to an increase $5.8 million during 2020. Unrealized gains decreased in 2021 due to sales and changes in the long-term treasury yield curve. The weighted average yield of the Company's securities portfolio was 2.63% as of December 31, 2021 compared to 3.20% at year-end 2020. At the end of 2021 securities held by the Company had an average life of 5.3 years with an effective duration of 4.21 years compared to 4.8 years and 4.3 years at the end of 2020, respectively.

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Loans

In 2021 total loans decreased by $31 million from year-end 2020. The decrease was the net result of the Company’s strategy to grow its commercial portfolios and sell the majority of its residential loan originations in the secondary market. Commercial loans grew 10% in 2021 when excluding PPP loans, which was driven mostly from new relationships in commercial real estate products. Commercial real estate and commercial and industrial loans, excluding PPP, increased 12% and 5% in 2021, respectively PPP loans totaled $6.7 million at quarter-end, consisting of $6.6 million from 2021 and $104 thousand from 2020, and were $53.8 million at year-end 2020. COVID loan modifications were zero, down from $68.6 million at year-end 2020, as all modified loans have resumed normal payment schedules .Total residential loans decreased $103 million from year-end 2020, which includes $173 million of originations recorded on the balance sheet and $275 million of prepayments/amortization.

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Allowance for Credit Losses

The ACL was $22.7 million at the end of 2021 compared to $19.0 million at year-end 2020. The increase is primarily due to the Company’s adoption of CECL as of January 1, 2021, which increased the ACL by $5.2 million and for unfunded commitment reserves by $1.6 million. Unfunded commitment reserves are recorded in other liabilities. Since adoption the ACL has decreased due to improved economic forecasts and lower reserves on specific loans offset by changes in loan mix.

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Net charge-offs totaled $290 thousand in 2021, down from $1.9 million, or 0.07% of total average loans in 2020. Non-accruing loans improved to $10.2 million, or 0.40% of total loans at the end of 2021 from $12.2 million or 0.48% of total loans at year-end 2020. The allowance credit losses to total loans ratio was 0.90% at the end of 2021 compared to 0.74% at year-end 2021. The ratio of allowance for credit losses to non-accrual loans increased to 223% from 157% at year-end 2020. Increases in both credit quality ratios is primarily the result of the CECL implementation at the beginning of 2021 offset by improvement in economic forecasts throughout the year.

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Other Assets

Total other assets were $318 million at the end of 2021 compared to $331 million as of December 31, 2020. The decrease is primarily from a $15 million decrease in the fair value in customer loan and municipal security derivatives offset by $2.2 million increase in community limited partnership investments. Additionally, derivative balances and deferred taxes have been restated for prior periods as described in Note 1– Summary of Significant Accounting policies.

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Deposits and Borrowings

Total deposits were $3.0 billion at the end of 2021 compared to $2.9 billion at year-end 2020. Non-maturity deposits increased $415 million in 2021, or 19% due to growth in new accounts with over 4,884 new customer relationships added. Growth in non-maturity deposits in 2021 and the prepayment of $159 million in FHLB borrowings resulted in a reduction of wholesale funding as a percentage of total funding to 4% from 18% at year-end 2020. Time deposits decreased $273 million to $426 million at year-end 2021 as $178 million of brokered deposits matured in of 2021 and were not replaced due to excess liquidity. Retail time deposits decreased $63.1 million as customers moved funds to transactional accounts upon contractual maturity. Total borrowings decreased by $157 million primarily from the aforementioned delever strategy.

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Derivative Financial Instruments and Other Liabilities

The notional balance of derivative financial instruments increased to $944 million at year end 2021 from $877 million in the prior year. The increase is principally due to a $50.0 million new hedge on variable rate loans tied to one-month LIBOR. The net fair value of all derivatives was a liability of $1.1 million at the end of 2021 compared to $5.5 million at year-end 2020. The reduction in net derivative fair values reflects the rise in long-term interest rates. Additionally, derivative balances have been restated for prior periods as described in Note 1 – Summary of Significant Accounting Policies.

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Other liabilities totaled $58 million at the end of 2021 compared to $75 million as of December 31, 2020. The decrease primarily reflects a $12 million increase in the customer loan derivatives and a $2.5 million wholesale hedge valuations on higher interest rates compared to 2020.

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Equity

Total equity was $424 million, compared with $407 million at year-end 2020. The Company’s book value per share was $28.27 as of December 31, 2021 compared with $27.29 at December 31, 2020. Equity included net unrealized gains on securities, derivative and pension revaluations, net of tax, and totaling $2.3 million at the end of 2021 compared to $6.7 million at year-end 2020. Equity was reduced by $5.2 million due to the Company’s CECL adoption in the first quarter 2021. Additionally, accumulated other comprehensive income has been restated for prior periods as described in Note 1 – Summary of Significant Accounting Policies. The Company evaluates changes in tangible book value, a non-GAAP financial measure that is a commonly used valuation metric in the investment community, which parallels some regulatory capital measures. Tangible book value per share increased to $19.86 per share at year-end 2021, up from $18.77 per share at year-end 2020.

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During 2021 and 2020, the Company declared and distributed regular cash dividends on its common stock in the aggregate amounts of $14 million and $13 million, respectively. The Company’s 2021 dividend payout ratio amounted to 36%, compared with 40% in 2020. Total cash dividends paid in 2021 was $0.94 per common share of stock, compared with $0.88 in 2020.

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On April 20, 2021, the Company’s Board of Directors authorized a share repurchase plan (the “Plan”). Under the terms of the Plan, the Company is authorized to repurchase up to 5% of its outstanding common stock, representing approximately 747,000 shares. The Plan is authorized for twelve months expiring on March 31, 2022 and authorized based on the strength of the Company’s balance sheet and capital position, and the Company’s belief in the intrinsic value of the Company’s common stock. Given the current market for bank stock prices, the Company believes this program is another tool to enhance long-term shareholder value.

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The Company and the Bank remained well-capitalized under regulatory guidelines at period end as further described in Note 12 – Shareholders’ Equity and Earnings Per Common Share on the Consolidated Financial Statements.

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COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2021 AND 2020

Net Interest Income

Net interest income for 2021 was $96 million compared with $99 million in 2020. The net interest margin was 2.88% in 2021 compared to 2.97% in the prior year. The 2021 adjusted net interest margin (non-GAAP measure), which excludes PPP loans and excess cash was 2.93% compared to 3.01% for 2020. Acceleration of PPP loan fee amortization due to forgiveness contributed 14 basis points to NIM in 2021 and 4 basis points in the same period of 2020. Interest-bearing cash balances, held mostly at the Federal Reserve Bank, reduced NIM by 19 basis points in the year and 8 basis points in 2020. The yield on earning assets totaled 3.33% compared to 3.87% in 2020. Excluding the impact of PPP and excess cash, the yield on earning assets totaled 3.42% and 3.97% for the same periods. The decrease was primarily due to lower yields on loans which the Company feels are near-bottom at year-end 2021. The yield on loans was 3.78% in 2021 and 4.16% in 2020. Excluding PPP loans the yield on loans was 3.62% in 2021, and 4.15% in 2020. Costs of interest-bearing liabilities decreased to 0.59% from 0.96% in 2020 due to increased core deposit levels, lower deposit rates and reduced wholesale borrowings.

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Provision for Credit Losses

The provision in 2021 was a recapture of $1.3 million compared to and expense of $5.6 million in 2020. The benefit in 2021 is primarily due to the recapture of the day 1 CECL allowance that was established January 1, 2021 given steady improvements in most macroeconomic drivers to the ACL. The provision also benefited from lower net charge-offs of $209 thousand in 2021 compared to $1.9 million in 2020. Overall credit quality remains strong and credit quality metrics improved with decreases in non-accruing and past due loans.

Non-Interest Income

Non-interest income in 2021 was $42 million compared to $43 million in 2020. The net change reflects an increase in fee income from operations offset by decreased gains on sales of securities. Non-interest income excluding gains on sales of securities increased 5% over the prior year. Trust management fees were $15 million compared to $13 million in 2020 driven by higher assets under management of $2.5 billion compared to $2.3 billion in 2020. Customer service fees increased 17% to $13 million in 2021, with 3,374 net new core deposit accounts opened during the year. The Company sold securities resulting in gains of $2.9 million during 2021 as part of its delever and security remix strategies. Mortgage banking activities contributed $6.5 million in 2021 and $6.9 million in 2020. The Company took advantage of volatility in the yield curve in 2021 and put residential mortgages on the balance sheet when rates were higher and sold loans in the secondary market when rates were low.

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Non-Interest Expense

Non-interest expense was $91 million in 2021 compared to $95 million in 2020. The decrease is principally due to lower salary and benefit costs as well as decreased non-recurring expenses. Salaries and benefits expense decreased to $47 million compared to $49 million in 2020, the decrease is primarily due to the reduction from the aforementioned expense study in early 2021 offset by higher employee incentive accruals. The decrease also reflects full-time equivalents of 489 compared to 531 in 2020. Non-recurring expenses in 2021 totaled $4.9 million and were mostly made up of the $2.9 million prepayment penalty on debt extinguishment. In 2020 non-recurring expenses totaled $7.5 million and included a loss on debt extinguishment and costs to consolidate wealth management systems. The efficiency ratio for 2021was 61.29% compared to 61.71% in 2020.

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Income Tax Expense

Income tax expense was $9.3 million for the year ended December 31, 2021, compared with $8.4 million for the year ended December 31, 2020. The effective tax rate decreased to 19.2% in 2021 from 20.2% in 2020 primarily from a shift of business to the state of Maine, which has a lower tax rate compared with other jurisdictions.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019

Net Interest Income

Net interest income for 2020 was $99 million compared with $90 million in 2019 primarily due to a lower cost of funds resulting from increased liquidity from growth in non-maturity deposits. The net interest margin expanded to 2.97% in 2020 compared to 2.77% in the prior year. Purchase loan accretion contributed 11 and 10 basis points to the margin in 2020 and 2019, respectively. Cost of deposits and borrowings also benefited from the Federal Reserve rate cuts in 2020 and changes in other key indexes in response to the pandemic. In total cost of funds decreased 65 basis points to 0.96% compared to 1.61% in 2019 due to the shift in funding sources to core deposits. Total interest-bearing deposit rates improved to 0.78% compared to 1.27% in 2019 from growth in core deposits and reductions in time deposits during 2020. Borrowing costs improved to 1.75% from 2.61% in 2019, on reduced borrowing levels and interest rates.

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The yield on earning assets was 3.87% compared to 4.14% in 2019 reflecting loan originations and repricing of variable rate products in a lower interest rate environment. Both securities yields and loan yields dropped 22 basis points to 3.20% and 4.16%, respectively for 2020. The 2020 adjusted net interest margin (non-GAAP measure), which excludes PPP loans was 2.93% compared to 2.77% for 2019, which included a drag of 16 basis points and one basis point, respectively from excess liquidity reflected in interest-bearing deposits with other banks.

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Loan Loss Provision

The provision was $6 million in 2020 compared to $2 million in 2019. Credit quality metrics improved with decreases in non-accruing and past due loans. Overall credit quality remains strong, the increase in the provision is indicative of commercial loan growth and higher economic adjustments reflecting elevated risk from COVID-19.

Non-Interest Income

Non-interest income in 2020 increased to $43 million from $29 million in 2019 driven primarily by increases in mortgage banking income and gains on sold securities. The $5 million increase in mortgage banking income is associated with secondary market sales of $223 million compared to $63 million in 2019. The Company took advantage of unrealized gains in the securities portfolio in 2020 by selling certain investments for a net gain of $5 million. Customer loan derivative income also contributed to non-interest income as demand for these products remained strong within the commercial loan pipeline throughout the year. Customer services fees increased by over $1 million to $11 million resulting from expanded operations into Central Maine offset by impacts of the pandemic on these services. Wealth management income grew over $1 million to $13 million in 2020. The increase reflects a full year of having assets under management acquired in the fourth quarter of 2019 totaling $218 million.

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Non-Interest Expense

Non-interest expense was $95 million in 2020 compared to $90 million in 2019. The increase is primarily a result of a $4 million higher salary and benefit expense due to the expanded branch model and wealth management business. Salary and benefit expense was also impacted by larger accruals for incentives on improved performance metrics and post-retirement plan costs based on lower discount rates. Additionally, occupancy and equipment costs increased by $3 million based on the expanded footprint in central Maine. Operating expenses remained controlled as the efficiency ratio (non-GAAP) improved to 61.71% in 2020 from 64.95% in 2019. Non-recurring expenses in 2020 primarily consisted of a $4 million loss on termination of a $50.0 million swap on wholesale borrowings and a $1 million loss on extinguishment of debt on longer-term and higher cost FHLB borrowings. The remaining represents costs for profitability initiatives including trust system conversion and consolidation. Non-recurring expenses in 2019 included a $3 million loss on interest rate cap terminations, $3 million related to the branch acquisition, and $2 million related to branch optimization and other strategic initiatives.

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Income Tax Expense

Income tax expense was $8 million for the year ended December 31, 2020, compared with $4 million for the year ended December 31, 2019. The effective tax rate increased to 20.2% in 2020 from 15.7% in 2019, reflecting the higher level of taxable income and lower level of non-tax advantaged income in 2020. This reflects higher income in 2020 from the Company’s expanded customer base in the state of Maine along with higher core deposits that carry a lower cost of funds.

LIQUIDITY AND CASH FLOWS

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Bank actively manages its liquidity position through target ratios established under its Asset Liability Management Policy. Continual monitoring of these ratios, by using historical data and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. The Bank’s policy is to maintain a liquidity position of at least 8% of total assets. A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.

The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. Company management believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.

The Company believes the existing cash and cash equivalents (including an interest-bearing deposit at the FRB Boston), securities available for sale and cash flows from operating activities will be sufficient to meet anticipated cash needs for at least the next twelve months. Future working capital needs will depend on many factors, including the rate of business and revenue growth. To the extent cash and cash equivalents, securities available for sale and cash flows from operating activities are insufficient to fund future activities, the Company may need to raise additional funds through debt arrangements or public or private debt or equity financings. The Company also may need to raise additional funds in the event it is determined in the future to effect one or more acquisitions of banks or businesses. If additional funding is required, the Company may not be able to obtain debt arrangements or to effect an equity or debt financing on terms acceptable to the Company or at all.

Capital Resources

Consistent with its long-term goal of operating a sound and profitable organization, at December 31, 2021, the Company maintained its strong capital position and continued to be a “well-capitalized” financial institution according to applicable regulatory standards. Management believes this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth.

The Company’s liquidity position remains strong. At December 31, 2021, available same-day liquidity totaled approximately $1.2 billion, including cash, borrowing capacity at FHLB and the Federal Reserve Discount Window and various lines of credit. Additional sources of liquidity include cash flows from operations, wholesale deposits, cash flow from the Company's amortizing securities and loan portfolios. The Company had unused borrowing capacity at the FHLB of $472 million, unused borrowing capacity at the Federal Reserve of $65 million and unused lines of credit totaling $51 million, in addition to over $200 million in unencumbered, liquid investment portfolio assets. The Company has also utilized the Federal Reserve's Paycheck Protection Program Liquidity Facility to provide liquidity to fund PPP loans.

​

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Purchase Obligations

In the normal course of conducting its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third-party contracts for support services. Examples of such contractual agreements include, but are not limited to: services providing core banking systems, ATM and debit card processing, trust services software, accounting software and the leasing of T-1 telecommunication lines and other technology infrastructure supporting the Company’s network. These types of purchase obligations that will come due during 2022 totaled $4.4 million as of December 31, 2021 which is expected to be funded by cash flows generated from operations.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

Please refer to the notes on Recently Adopted Accounting Principles and Future Application of Accounting Pronouncements in Note 1 – Summary of Significant Accounting Policies of the Consolidated Financial Statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Note 1 – Summary of Significant Accounting Policies to the Company's Audited Consolidated Financial Statements for the year ended December 31, 2021 contains a summary of significant accounting policies. Various elements of these accounting policies, by their nature, are subject to estimation techniques, valuation assumptions and other subjective assessments. Certain assets are carried in the consolidated statements of financial condition at estimated fair value or the lower of cost or estimated fair value. Policies with respect to the methodology used to determine the allowance for credit losses is a critical accounting policy and estimate because of its importance to the presentation of the Company's financial condition and results of operations. The critical accounting policy involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions, and estimates could result in material differences in the results of operations or financial condition.

Allowance for credit losses on loans.

Effective January 1, 2021, the Company adopted CECL, which replaced the incurred loss allowance methodology with an expected loss allowance methodology. See Note 1– Summary of Significant Accounting Policies and Note 3 – Loans and Allowance for Credit Losses to the consolidated financial statements for information about CECL adoption, areas of judgment and methodologies used in establishing the allowance.

​

The allowance is sensitive to a number of internal factors, such as modifications in the mix and level of loan balances outstanding, portfolio performance and assigned risk ratings. The allowance is also sensitive to external factors such as the general health of the economy, as evidenced by changes in unemployment rates, home pricing index, gross domestic product, retail sales, multi-housing starts and changes in commercial real estate values. The Company considers these variables and all other available information when establishing the final level of the allowance. These variables and others have the ability to result in actual loan losses that differ from the originally estimated amounts.

​

Changes in the factors used by management to determine the appropriateness of the allowance or the availability of new information could cause the allowance to be increased or decreased in future periods. Additionally, changes in circumstances related to individually large credits, or certain macroeconomic forecast assumptions may result in volatility.

​

It is difficult to estimate how potential changes in any one economic factor might affect the overall allowance because a wide variety of factors and inputs are considered in the allowance estimate. Changes in the factors and inputs may not occur at the same rate and may not be consistent across all product types. Additionally, changes in factors and inputs may be directionally inconsistent, such that improvement in one factor may offset deterioration in others. However, to consider the impact of a hypothetical stressed forecast, the Company estimated the allowance using forecast inputs that were severely unfavorable to the expected scenario for each macroeconomic variable. This unfavorable scenario resulted in an allowance that is approximately $8.8 million higher than the allowance using the expected scenario.

​

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.

​

The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee (“ALCO”), chaired by the Chief Financial Officer and composed of various members of senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

​

Interest Rate Risk:

Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.

​

The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off-balance sheet instruments as each relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Company’s Board of Directors.

​

The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of the ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

​

Interest Rate Sensitivity Modeling:

The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense for all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

​

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with option provisions are examined on an individual basis in each rate environment to estimate the likelihood of exercise. Prepayment assumptions for mortgage loans are calibrated using specific Bank experience while mortgage-backed securities are developed from industry standard models of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions.

​

The simulation models a parallel and pro rata shift in rates over a 12-month period. Using this approach, we are able to produce simulation results that illustrate the effect that both a gradual “rate ramp” and a “rate shock” have on earnings

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expectations. Our net interest income sensitivity analysis reflects changes to net interest income assuming no balance sheet growth and a parallel shift in interest rates. All rate changes were “ramped” over the first 12-month period and then maintained at those levels over the remainder of the simulation horizon. Changes in net interest income based upon these simulations are measured against the flat interest rate scenario.

​

In 2020, behavioral assumptions regarding both core deposits and residential loans were modified to incorporate the results of a third party model to better reflect the Bank’s unique position and geographic footprint. As of December 31, 2021, interest rate sensitivity modeling results indicate that the Bank’s balance sheet was asset sensitive over the one- and two-year horizons.

​

The following table presents the changes in sensitivities on net interest income for the years ended December 31, 2021 and 2020:

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

(in thousands, except ratios) ​ $ Change ​ % Change ​ $ Change ​ % Change

​

Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will deteriorate over the one year horizon while deteriorating further from that level over the two-year horizon.

​

Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will improve over both the one and two-year horizons.

​

As compared to December 31, 2020, the down 100 basis points scenario is improved in both years 1 and 2. In the up 200 basis points scenario, results are also improved on a year-over-year basis.

​

The preceding 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: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

​

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate changes, caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s Senior Executive Team and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.

​

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors of Bar Harbor Bankshares and Subsidiaries

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Bar Harbor Bankshares and Subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.

​

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 14, 2022 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

​

Adoption of New Accounting Standard

As discussed in Note 1 and 3 to the financial statements, the Company has changed its method of accounting for credit losses on financial instruments in 2021 due to the adoption of Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments.

​

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

​

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

​

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

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Allowance for Credit Losses on Loans

As described in Notes 1 and 3 to the consolidated financial statements, the allowance for credit losses on loans is established through a provision for credit losses and represents an amount which, in management’s judgement, will be adequate to absorb losses on existing loans. The Company’s consolidated allowance for credit losses on loans balance was $22.7 million at December 31, 2021. The allowance for credit losses on loans is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and troubled debt restructurings.

​

The Company uses the discounted cash flow method to estimate expected credit losses for all loan portfolio segments measured on a pool basis wherein payment expectations are adjusted for estimated prepayment speeds, probability of default (PD), and loss given default (LGD). The Company uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime PD. This analysis also determines how expected PD and LGD will react to forecasted levels of the loss drivers. Management utilizes various economic indicators such as changes in unemployment rates, gross domestic product (GDP), property values and other relevant factors as loss drivers and has determined that, due to historical volatility in economic data, two quarters currently represents a reasonable and supportable forecast period, followed by a six-period reversion to historical mean levels for each of the various economic indicators. The allowance evaluation also considers various qualitative factors, such as: (i) changes to lending policies, underwriting standards and/or management personnel performing such functions, (ii) delinquency and other credit quality trends, (iii) credit risk concentrations, if any, (iv) changes to the nature of the Company’s business impacting the loan portfolio, (v) and other external factors, that may include, but are not limited to, results of internal loan reviews, stress testing, examinations by bank regulatory agencies, or other events such as a natural disaster. The development of the loan loss allocation for pools of loans with similar risk characteristics requires a significant amount of judgement by management and the assumptions utilized are subject to changing economic conditions.

​

We identified the Company’s allowance for credit losses on loans as a critical audit matter, specifically the economic forecasts and qualitative factors, because they involved complex auditor judgement in the evaluation of the Company’s methodology and assumptions. Specifically, complex auditor judgement was required to examine the methodology that underpins the allowance for credit losses on pools of loans with similar risk characteristics. This includes modeling of PD, LGD, economic forecasts, and qualitative factors.

​

Our audit procedures related to this critical audit matter included the following at implementation date and period end, among others:

•We obtained an understanding of the relevant controls related to the allowance for credit losses on loans and tested such controls for design and operating effectiveness, including those over model approval, validation and approval of key data inputs such as economic forecasts and qualitative factors.

​

•We tested the completeness and accuracy of data used by management in determining inputs to the PD and LGD, such as prepayment speed, by agreeing those inputs to internal or external information sources.

​

•We evaluated management’s forecasts of future economic indicators for reasonableness, which include unemployment, housing price index, retail sales, and national GDP growth, among others, by comparing these forecasts to external and internal information sources.

​

•We evaluated management’s judgments and assumptions used in the development of the qualitative factors for reasonableness, and tested the reliability of the underlying data on which these factors are based, by comparing information to source documents and external information sources.

​

/s/ RSM US LLP

We have served as the Company's auditor since 2015.

Boston, Massachusetts

March 14, 2022

​

​

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

​ ​ ​ ​ ​ ​ ​

(in thousands, except share data) December 31, 2021 December 31, 2020

Assets ​ ​

Cash and cash equivalents: ​ ​ ​ ​ ​ ​

Interest-earning deposits with other banks ​ 216,881 ​ 198,441

​ ​ ​ ​ ​ ​ ​

Securities: ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​

Less: Allowance for credit losses ​ (22,718) ​ (19,082)

​ ​ ​ ​ ​ ​ ​

Cash surrender value of bank-owned life insurance ​ 79,020 ​ 77,870

​ ​ ​ ​ ​ ​ ​

Liabilities ​ ​

Deposits: ​ ​

​ ​ ​ ​ ​ ​ ​

Borrowings: ​ ​

​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​

​

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​ ​ ​ ​ ​ ​ ​

(in thousands, except share data) December 31, 2021 December 31, 2020

Shareholders’ equity ​ ​ ​ ​

Accumulated other comprehensive income(1) ​ 2,303 ​ 6,740

​

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

​

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​

​ ​ Years Ended December 31,

(in thousands, except earnings per share data) 2021 2020 2019

Interest and dividend income ​ ​ ​ ​ ​ ​ ​ ​ ​

Interest expense ​ ​ ​

Net interest income after provision for credit losses ​ 96,875 ​ 93,555 ​ 87,493

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Non-interest income ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Non-interest expense ​ ​ ​

Loss (gain) on sales of premises and equipment, net ​ 378 ​ (32) ​ 18

Amortization of intangible assets ​ 940 ​ 1,024 ​ 861

Acquisition, conversion and other expenses ​ 1,667 ​ 5,801 ​ 8,317

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Earnings per share: ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Weighted average common shares outstanding: ​ ​ ​

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

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​

​ ​ Years Ended December 31,

Other comprehensive (loss) income, before tax: ​ ​ ​

Changes in unrealized gain (loss) on pension ​ 1,132 ​ (338) ​ (350)

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Income taxes related to other comprehensive income: ​ ​ ​ ​

Changes in unrealized (gain) loss on pension ​ (266) ​ 77 ​ 83

​

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

​

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​

​ ​ Common ​ Additional ​ ​ ​ ​ other ​ ​ ​ ​ ​ ​

​ ​ stock ​ paid-in ​ Retained ​ comprehensive ​ Treasury ​ ​ ​

Other comprehensive income ​ ​ — ​ — ​ — ​ 15,594 ​ — ​ ​ 15,594

Treasury stock purchased (9,195 shares) ​ — ​ — ​ — ​ — ​ (239) ​ (239)

Recognition of stock based compensation ​ — ​ 1,373 ​ — ​ — ​ — ​ 1,373

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Other comprehensive income ​ — ​ — ​ — ​ 2,948 ​ — ​ 2,948

Cash dividends declared ($0.88 per share) ​ — ​ — ​ (13,417) ​ — ​ — ​ (13,417)

Recognition of stock based compensation ​ — ​ 1,570 ​ — ​ — ​ — ​ 1,570

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Other comprehensive income ​ — ​ — ​ — ​ (4,437) ​ — ​ (4,437)

Cash dividends declared ($0.94 per share) ​ — ​ — ​ (14,072) ​ — ​ — ​ (14,072)

Recognition of stock based compensation ​ — ​ 2,149 ​ — ​ — ​ — ​ 2,149

​

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

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Cash flows from operating activities: ​ ​ ​ ​

Deferred tax expense (benefit) ​ ​ 427 ​ ​ (38) ​ ​ 1,020

Change in unamortized net loan costs and premiums ​ (1,354) ​ (122) ​ (555)

Accretion of purchase accounting entries, net ​ (2,274) ​ (749) ​ (3,806)

Amortization of other intangibles ​ 940 ​ 1,025 ​ 861

Gain on sales of securities, net ​ (2,870) ​ (5,445) ​ (237)

Decrease (increase) in right-of-use lease assets ​ ​ 1,064 ​ ​ (715) ​ ​ (632)

(Decrease) increase in lease liabilities ​ ​ (984) ​ ​ 976 ​ ​ 660

(Gain) loss on other real estate owned ​ — ​ (355) ​ 166

Loss (gain) on premises and equipment, net ​ 378 ​ (32) ​ 18

Net change in other assets and liabilities ​ (462) ​ (2,942) ​ 7,174

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Cash flows from investing activities: ​ ​ ​

Recoveries of previously charged off loans ​ ​ 608 ​ ​ 272 ​ ​ 321

Purchase of premises and equipment, net ​ (1,716) ​ (6,776) ​ (9,185)

Proceeds from premises held for sale ​ ​ 288 ​ ​ 903 ​ ​ —

Proceeds from death benefit of bank-owned life insurance policy ​ 1,029 ​ — ​ —

Acquisitions, net of cash acquired ​ ​ — ​ ​ (340) ​ ​ (18,383)

Proceeds from sale of other real estate owned ​ ​ — ​ ​ 2,205 ​ ​ —

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Cash flows from financing activities: ​ ​ ​

Proceeds from long-term senior borrowings ​ ​ — ​ ​ 148,199 ​ ​ 328,097

Net change in short-term other borrowings ​ (7,977) ​ (17,053) ​ 8,621

Proceeds from subordinated debt issuance ​ ​ — ​ ​ — ​ ​ 40,000

Repayments of subordinated debt ​ ​ — ​ ​ — ​ ​ (22,000)

Payment of subordinated debt issuance costs ​ ​ — ​ ​ — ​ ​ (700)

Exercise of stock options ​ ​ (615) ​ ​ 620 ​ ​ (273)

Purchase of treasury and common stock ​ ​ — ​ ​ (14,188) ​ ​ (239)

(continued)

​

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year Ended December 31,

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Supplemental cash flow information: ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Acquisition of non-cash assets and liabilities: ​ ​ ​ ​ ​ ​ ​ ​ ​

Liabilities acquired ​ ​ — ​ ​ (343) ​ ​ 261,814

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Other non-cash changes: ​ ​ ​

Real estate owned acquired in settlement of loans ​ — ​ — ​ 250

Initial recognition of operating lease right-of-use assets ​ ​ — ​ ​ — ​ ​ 8,991

Initial recognition of operating lease liabilities ​ — ​ — ​ 8,991

​

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

​

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BAR HARBOR BANKSHARES AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation: The consolidated financial statements (the “financial statements”) of Bar Harbor Bankshares and its subsidiaries (the “Company” or “Bar Harbor”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Bar Harbor Bankshares is a Maine Financial Institution Holding Company for the purposes of the laws of the state of Maine, and as such, is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. These financial statements include the accounts of the Company, its wholly-owned subsidiary Bar Harbor Bank & Trust (the "Bank") and the Bank’s consolidated subsidiaries. The results of operations of companies or assets acquired are included only from the dates of acquisition. All material wholly-owned and majority-owned subsidiaries are consolidated unless U.S. GAAP requires otherwise.

Consolidation: The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP. The consolidated financial statements include the accounts of Bar Harbor Bankshares and its wholly-owned subsidiaries, Bar Harbor Bank & Trust, Bar Harbor Trust Services, Charter Trust Company and Cottage Street Corporation. All significant inter-company balances and transactions have been eliminated in consolidation. Assets held in a fiduciary capacity are not assets of the Company, but assets of customers, and therefore, are not included in the consolidated balance sheets.

Reclassifications: Whenever necessary, amounts in the prior years’ financial statements are reclassified to conform to current presentation. The reclassifications had no impact on net income in the Company’s consolidated income statement.

Use of estimates: In preparing financial statements in conformity with U.S. GAAP, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the allowance for credit losses, off-balance sheet credit exposures, available for sale securities (effective for periods on or after January 1, 2021, upon adoption of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13")), the accounting for business combinations including subsequent impairment analyses for goodwill and other intangible assets, accounting for income taxes, postretirement benefits, and asset impairment assessments, including the assessment of OTTI of investment securities (for periods prior to January 1, 2021).

SubsequentEvents:TheCompanyhasevaluatedeventsandtransactionssubsequenttoDecember31,2021forpotentialrecognitionordisclosureasrequiredbyGAAP.

Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks, interest-bearing deposits with other banks, federal funds sold, and other short-term investments with maturities less than 90 days. The Federal Reserve Bank requires the Bank to maintain certain reserve requirements of vault cash and/or deposits. On March 15, 2020, the Federal Reserve Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirement for all depository institutions.

Securities: All securities held at December 31, 2021 and 2020 were classified as available-for-sale (“AFS”). Available for sale securities primarily consist of mortgage-backed securities, obligations of state and political subdivisions thereof, and corporate bonds and are carried at estimated fair value. Changes in estimated fair value of AFS securities, net of applicable income taxes, are reported in accumulated other comprehensive income (loss) as a separate component of shareholders’ equity unless deemed to have a credit loss as discussed below. The Company does not have any securities classified as trading or held-to-maturity.

Premiums and discounts on securities are amortized and accreted over the term of the securities using the interest method. Gains and losses on the sale of securities are recognized at the trade date using the specific-identification method and are shown separately in the Consolidated Statements of Income.

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Allowance for Credit Loss on AFS Debt Securities: Upon adoption of CECL, effective January 1, 2021, the Company monitors the credit quality of available for sale (AFS) debt securities through credit ratings from various rating agencies and substantial price changes. Credit ratings express opinions about the credit quality of a security and are utilized by the Company to make informed decisions. Securities are triggered for further review in the quarter if the security has significant fluctuations in ratings, drops below investment grade, or significant pricing changes. For securities without credit ratings, the Company utilizes other financial information indicating the financial health of the underlying municipality, agency, or organization associated with the underlying security. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance on AFS debt securities is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. When assessing an AFS debt security for credit loss, securities with identical CUSIPs are pooled together to assess for impairment using the average cost basis. Any impairment that has not been recorded through an allowance is recognized in other comprehensive income.

A change in the allowance on AFS debt securities may be in full or a portion thereof, is recorded as expense (credit) within provision for credit losses on the consolidated statements of income. Losses are charged against the allowance when management believes the uncollectibility of an AFS debt security is confirmed based on the above described analysis. As of December 31, 2021 and January 1, 2021 (i.e. ASU 2016-13 adoption), there was no allowance carried on the Company’s AFS debt securities. Refer to Note 2 – Securities Available for Sale of the consolidated financial statements for further discussion.

Federal Home Loan Bank Stock: The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). The Bank uses the FHLB for most of its wholesale funding needs. As a requirement of membership in the FHLB, the Bank must own a minimum required amount of FHLB stock, based primarily on its level of obligations with the FHLB. FHLB stock is a non-marketable equity security and therefore is reported at cost, which generally equals par value. Shares held in excess of the minimum required amount are generally redeemable at par value. Dividends from FHLB stock are reported in interest and dividend income.

The Company periodically evaluates FHLB stock for impairment based on the capital adequacy of the FHLB and its overall financial condition. Based on the capital adequacy, liquidity position and sustained profitability of the FHLB, management believes there is no impairment related to the carrying amount of the Bank’s FHLB stock as of December 31, 2021 and 2020.

Loans Held for Sale: Residential loans originated with the intent to be sold in the secondary market are accounted for at fair value. The Company elected the fair value option of accounting for its loans designated as held for sale as of December 31, 2021. Fair value is primarily determined based on quoted prices for similar loans in active markets. Residential loans held for sale are generally sold with servicing rights retained. The carrying value of loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of residential loans (sales proceeds minus carrying value) are recorded in non-interest income. Management consistently evaluates the Company's loan portfolio in conjunction with asset/liability management practices, and will opt to sell certain residential mortgage loans to manage the Company's interest rate exposure and for other business purposes, including generating fee income through mortgage sale gains.

Loans:Loans held for investment by the Company are reported at amortized cost. Amortized cost is the principal balance outstanding net of the unamortized balance of any deferred fees or costs and the unamortized balance of any premiums or discounts on loans purchased or acquired through mergers.

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For originated loans, loan fees and certain direct origination costs are deferred and amortized into interest income over the contractual term of the loan using the level-yield method over the estimated lives of the related loans. When a loan is paid off, the unamortized portion of deferred fees or costs are recognized in interest income. Interest income on originated loans is accrued based upon the daily principal amount outstanding except for loans on non-accrual status.

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For acquired loans, interest income is accrued based upon the daily principal amount outstanding and is then further adjusted by the accretion of any discount or amortization of any premium associated with the loan that was recognized

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based on the acquisition date fair value. When a loan is paid off, the unamortized portion of any premiums or discounts on loans are recognized in interest income.

Purchase Credit Deteriorated (PCD) Loans: Loans that the Company acquired in acquisitions include some loans that have experienced more than insignificant credit deterioration since origination. The initial allowance for credit losses is determined on a collective basis and allocated to the individual loans. The sum of the loan’s purchase price and allowance for credit losses becomes its initial amortized cost. The difference between the initial amortized cost and the par value of the loan is a discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision expense.

The Company adopted CECL using the prospective transition approach for financial assets purchased with credit deterioration that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30. In accordance with the standard, the Company did not reassess whether PCI assets met the definition of PCD assets as of the date of adoption. On January 1, 2021, the amortized cost basis of the PCD assets representing the noncredit discount will be accreted into interest income using the level-yield method over the estimated lives of the related loans. The converted PCD assets of $12.5 million were then pooled by call report coding and an additional allowance was calculated on the pooled assets separately from other loan pools totaling $524 thousand.

Non-performing loans: Residential real estate and home equity loans are generally placed on non-accrual status when reaching 90 days past due, or in process of foreclosure, or sooner if considered appropriate by management. Consumer loans are generally placed on non-accrual when reaching 90 days or more past due, or sooner if considered appropriate by management. Secured consumer loans are written down to net realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management.

When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on the loan. The interest on non-accrual loans is accounted for using the cash-basis or cost-recovery method depending on corresponding credit risk, until qualifying for return to accrual status. A loan can be returned to accrual status when collectability of principal is reasonably assured and the loan has performed for a period of time, generally six months.

Previously, acquired loans that met the criteria for non-accrual of interest prior to the acquisition were considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company could reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans and any change in performance would have impacted accretable yield. After adoption of ASC 326 on January 1, 2021 the Company now treats these non-performing acquired loans that meet the criteria for non-accrual consistent with originated loans.

Loans Modified in a Troubled Debt Restructuring: Loans are considered to have been modified in a troubled debt restructuring when, due to a borrower’s financial difficulties, the Company makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a troubled debt restructuring remains on non-accrual status for a period of at least 6 months to demonstrate that the borrower is able to meet the terms of the modified loan.

However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Loan Modifications under the CARES Act: The CARES Act provides that a financial institution may elect to suspend (1) the requirements under GAAP for certain loan modifications that may otherwise be categorized as a troubled debt

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restructuring (“TDR”) and (2) any determination that such loan modifications would be considered a TDR, including the related impairment for accounting purposes.

Allowance for Credit Losses: The allowance for credit losses (the “allowance”) is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The Allowance is comprised of the allowance for loan losses and the allowance for off-balance sheet credit exposures, which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the allowance represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.

Upon adoption of ASC 326 or CECL effective January 1, 2021, the Company replaced the incurred loss impairment model that recognized losses when it became probable that a credit loss will be incurred, with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged- off. The allowance is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and TDRs.

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The Company uses the discounted cash flow (DCF) method to estimate expected credit losses for all loan portfolio segments measured on a collective (pool) basis. For each loan segment, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, probability of default, and loss given default. The modeling of prepayment speeds is based on historical internal data.

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The Company uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime probability of default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. For all loan pools utilizing the DCF method, management utilizes various economic indicators such as changes in unemployment rates, gross domestic product, property values, housing starts, and other relevant factors as loss drivers. For all DCF models, management has determined that due to historic volatility in economic data, two quarters currently represents a reasonable and supportable forecast period, followed by a six-period reversion to historical mean levels for each of the various economic indicators.

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The combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. Specific instrument effective yields are calculated, net of the impacts of prepayment assumptions, and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level Net Present Value (NPV). An allowance is established for the difference between the instrument’s NPV and amortized cost basis.

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The allowance evaluation also considers various qualitative factors, such as: (i) changes to lending policies, underwriting standards and/or management personnel performing such functions, (ii) delinquency and other credit quality trends, (iii) credit risk concentrations, if any, (iv) changes to the nature of the Company's business impacting the loan portfolio, (v) and other external factors, that may include, but are not limited to, results of internal loan reviews, stress testing, examinations by bank regulatory agencies, or other events such as a natural disaster.

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Arriving at an appropriate level of allowance involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance.

Individually Evaluated Loans: Prior to the adoption of CECL effective January 1, 2021, a loan was individually evaluated when the loan was considered impaired. Impaired loans were based on current information and events, it is probable that the Company will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments.

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With the adoption of CECL, loans that do not share risk characteristics with existing pools are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, the specific credit loss reserve is calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV from the operation of the collateral. When repayment is expected to be from the sale of the collateral, the specific credit loss reserve is calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The allowance may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.

Accrued Interest. Upon adoption of CECL, effective January 1, 2021, the Company made the following elections regarding accrued interest receivable: (i) present accrued interest receivable balances within other assets on the consolidated statements of condition; (ii) exclude accrued interest from the measurement of the allowance for credit losses, including investments and loans; and (iii) continue to write-off accrued interest receivable by reversing interest income. The Company has a policy in place to write-off accrued interest when a loan is placed on non-accrual. Historically, the Company has not experienced uncollectible accrued interest receivable on investment debt securities.

Allowance for off-balance sheet credit exposures: The exposure is a component of other liabilities on the Company’s Consolidated Balance Sheet and represents the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit include unused portions of lines of credit and standby and commercial letters of credit. The process used to determine the allowance for these exposures is consistent with the process for determining the allowance for loans, as adjusted for estimated funding probabilities or loan equivalency factors. A charge (credit) to provision for credit losses on the consolidated statements of income is made to account for the change in the allowance on off-balance sheet exposures between reporting periods.

Premises and Equipment: Land is carried at cost. Premises and equipment and related improvements are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the lesser of the lease term or estimated useful lives of related assets; generally 5 to 39 years for premises and three to eight years for furniture and equipment. Software costs are stated at cost less accumulated depreciation within other assets on the Consolidated Statements of Condition. Amortization expense on software is calculated using the straight-line method over the estimated useful lives of the related assets.

Transfers of Financial Assets: Transfers of an entire financial asset, group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets.

Other Real Estate Owned: Other real estate owned consists of properties acquired through foreclosure proceedings or acceptance of a deed-in-lieu of foreclosure. These properties are recorded at fair value less estimated costs to sell the property. Initially at transfer if the recorded investment in the loan exceeds the property’s fair value at the time of acquisition, a charge-off is recorded against the allowance. If the fair value of the property initially at transfer exceeds the carrying amount of the loan, the excess is recorded either as a recovery to the allowance if a charge-off had previously been recorded, or as a gain on initial transfer in other non-interest income. Subsequent decreases in the property’s fair value and operating expenses of the property are recognized through charges to other non-interest expense. The fair value of the property acquired and ongoing valuation is based on third-party appraisals, broker price opinions, recent sales activity, or a combination thereof, subject to management judgment. Due to changing market conditions the amount ultimately realized on the other real estate owned may differ from the amounts reflected in the financial statements.

Goodwill: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and other intangible assets, such as core deposit and acquired customer relationship intangibles.

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Goodwill represents the excess of the purchase price over the fair value of net assets acquired in accordance with the purchase method of accounting for business combinations. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, or more frequently, if an event occurs or circumstances change that reduce the fair value of a reporting unit below its carrying amount. The impairment testing process is conducted by assigning assets and goodwill to each reporting unit. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. The Company, at our discretion, assesses certain qualitative factors to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. An impairment charge is recognized if the carrying fair value of goodwill exceeds the implied fair value of goodwill.

Other Intangible Assets: Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. The fair value of these assets are generally determined based on appraisals and management assesses the recoverability of these intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. These other intangible assets primarily consist of core deposit and acquired customer relationship intangible assets arising from the whole bank and branch acquisitions are amortized on an accelerated method over their estimated useful lives.

Bank-Owned Life Insurance: Bank-owned life insurance (“BOLI”) represents life insurance on the lives of certain current and retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes.

Capitalized Servicing Rights: Capitalized servicing rights are recognized as assets when residential loans are sold and the rights to service those loans are retained.

The Company’s capitalized servicing rights are initially recorded at fair value. Fair values are established by using a discounted cash flow model to calculate the present value of estimated future net servicing income. Changes in the fair value of capitalized servicing rights are primarily due to changes in valuation inputs, assumptions, and the collection and realization of expected cash flows. However, these capitalized servicing rights are amortized in proportion to and over the period of estimated net servicing income, which includes prepayment assumptions. An impairment analysis is prepared on a quarterly basis by estimating the fair value of the capitalized servicing rights and comparing that value to the carrying amount. A valuation allowance is established when the carrying amount of these capitalized servicing rights exceeds fair value. The capitalized servicing rights are included in other assets on the Company’s consolidated balance sheet.

Derivative Financial Instruments: The Company recognizes all derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items. The fair value of the derivative is reflected on the Consolidated Balance Sheet in either other assets or liabilities.

Changes in the fair value of derivative instruments that are highly effective and qualify as cash flow hedge are recorded in other comprehensive income (loss). Any ineffective portion is recorded in earnings. For fair value hedges that are highly effective, the gain or loss on the derivative and the loss or gain on the hedged item attributable to the hedged risk are both recognized in earnings, with the differences (if any) representing hedge ineffectiveness. The Company discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense based on the item being hedged. Net cash settlements on derivatives that do not quality for hedge accounting are reporting in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as cash flows of the items being hedged.

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The Company enters into commitments to fund mortgage loans with borrowers (interest rate locks) and forward commitments for the future delivery of these mortgage loans for sale on the secondary market. These mortgage banking derivatives are classified as free standing derivatives to hedge against inherent interest rate and pricing risk associated with selling loans. The commitments to lend generally terminate once the loan is funded, the lock period expires or the borrower decides not to contract for the loan. The forward commitments generally terminate once the loan is sold or the commitment period expires. These commitments are considered derivatives which are accounted for by recognizing their estimated fair value on the Consolidated Balance Sheets in either other assets or other liabilities.

Senior and Subordinated Borrowings: The Company’s senior borrowings include retail and wholesale repurchase agreements, FHLB overnight, FHLB short-term and long-term advances, federal funds purchased, credit facilities, and line of credit advances. Subordinated borrowings consist of subordinated notes issued to investors. The Company is required to post collateral for certain borrowings, for which it, generally, posts loans and/or investment securities as collateral.

Off-Balance Sheet Financial Instruments: In the ordinary course of business, the Company has entered into off- balance sheet financial instruments consisting of commitments to extend credit, unused or unadvanced loan funds and letters of credit. Such financial instruments are recorded in the consolidated financial statements when they are funded or related fees are incurred or received.

Stock Based Compensation: The Company has equity award plans that include stock options, restricted stock awards restricted stock units and performance stock units, which are described more fully in Note 13 – Stock Based Compensation Plans of the Consolidated Financial Statements. The Company recognizes expenses for stock options and restricted awards based on the fair value of these awards as of the grant date. For restricted stock units and performance stock units the expense is recognized over the vesting periods of the grants. The Company uses its treasury shares for issuing shares upon option exercises, restricted stock awards, restricted stock unit vesting and performance stock unit vesting.

Employee Stock Purchase Plan: The Company recognizes expense based difference between the market price of shares and the discounted price of the plan from participant enrollment over each six month enrollment period.

Employee Benefit Plans: The Company has non-qualified supplemental executive retirement agreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations. The Company also has a supplemental executive retirement agreement with a certain current executive officer. This agreement provides a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the participating executive leaves the Company following a change of control event. The Company recognizes the net present value of payments associated with these agreements over the service periods of the participating executive officers. Upon retirement, interest costs will continue to be recognized on the benefit obligation.

The Company recognizes the over-funded or under-funded status of post-retirement benefit plans as a liability or asset on the balance sheet in other liabilities or other assets and recognizes changes in that funded status through other comprehensive income (loss). Gains and losses, prior service costs and credits, and any remaining transition amounts that have not yet been recognized through net periodic benefit costs are recognized in accumulated other comprehensive income/(loss), net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, which is the date at which the benefit obligation and plan assets are measured, is the Company’s fiscal year end.

Employee 401(k) expenses are recognized for the amount of the Company’s matching contributions.

Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information indicates that it is more likely than not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in

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the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.