Camden National Corporation and Subsidiaries 27 26 Camden National Corporation and Subsidiaries impact of the existing stock market performance has benefited the CompanyGLYPH<213>s banking subsidiaries as disenchanted stock market investors searched for safer investment opportunities such as certificates of deposit, money market funds and other bank products. interest rate swap agreements that were a component of the CompanyGLYPH<213>s strategy to protect a portion of its interest income revenue stream against a changing interest rate environment. These instruments contributed $597,000 to interest income in 2002 and $422,000 in 2001. Interest rate swap agreements involve risks associated with counterparties to the agreements and their abilities to meet the contractual terms of the agreements, as well as risks associated with a changing interest rate environment. Notional principal amounts are used to reflect the volume of these transactions, but credit risks associated with these agreements are limited to the forecasted payment stream expected from counterparties. The CompanyGLYPH<213>s counterparties to these agreements had an investment grade rating by MoodyGLYPH<213>s and Standard and PoorGLYPH<213>s rating agencies. These instruments involve only the exchange of fixed- and variable-rate interest payments based upon a notional principal amount and maturity date. At December 31, 2002, the CompanyGLYPH<213>s notional value of derivative financial instruments was $30.0 million, compared to $90.0 million on December 31, 2001. Note 22, GLYPH<210>Financial Instruments,GLYPH<211> of the Notes to Consolidated Financial Statements, on page 59, should be reviewed for further discussion of derivative instruments. Non-interest income was $14.5 million and $13.1 million for the years ended December 31, 2002 and 2001, respectively. This includes the $1.3 million gain from the sale of the CompanyGLYPH<213>s merchant business credit card product to NOVA Information Systems during November 2002 (recorded in GLYPH<210>Other incomeGLYPH<211>) and a gain of $932,000 realized from the  sale of derivative instruments during 2001. Income from deposit services increased $228,000 primarily due to volume and fee increases related to transaction accounts. Other service charges and fees declined $425,000 due to the acceleration of the amortization of the capitalized mortgage servicing rights asset, that is netted against servicing rights income, associated with increased prepayments on previously sold residential real estate loans that the Company services. Trust fees increased $1.1 million, or 44.8%, during 2002 primarily due to the acquisition of Acadia Trust, N.A. on July 19, 2001. Brokerage and insurance commissions increased $222,000 as a result  of the addition of Acadia Financial Consultants, the banksGLYPH<213>  full-service brokerage and insurance sales division, during  the fourth quarter of 2001. Although increases were recorded in non-interest income related to the CompanyGLYPH<213>s financial services business lines, the general stock market environment negatively impacted revenue. Decreased market values of clientsGLYPH<213> assets under management resulted in lower management fees. In addition, it is the CompanyGLYPH<213>s belief that an overall negative investor sentiment toward the stock market affected the CompanyGLYPH<213>s ability to attract and retain clients who use the CompanyGLYPH<213>s investment management services. Conversely, the Company believes the The Company reported $3.7 million of provision for  loan losses in 2001 compared to $2.9 million in 2000. The allowance for loan losses increased from 1.54% of total loans at the end of 2000 to 1.87% at the end of 2001. The reserve was increased in response to managementGLYPH<213>s view of probable economic deterioration in its central, eastern and western Maine geographic markets. Net interest income on a fully-taxable equivalent basis  was $44.7 million in 2001 compared to $40.0 million in 2000. During 2001, the Company benefited from the declining interest rate environment as expenses on interest-bearing liabilities decreased faster than income received on interest-earning assets. The Company reported net income of $15.4 million or $1.89 per diluted share in 2001 compared to $13.9 million or $1.69 per diluted share in 2000. Return on average assets was 1.47% in 2001 compared to 1.40% in 2000, while return on average shareholdersGLYPH<213> equity was 15.55% in 2001 compared  to 16.43% in 2000. This performance primarily reflected  loan growth from the CompanyGLYPH<213>s Portland, Maine location, expansion of fee based revenues from its banking subsidiaries, revenues from its acquired investment management subsidiary, and control of its operating expenses. On February 4, 2000, Kingfield Savings Bank and the CompanyGLYPH<213>s United Bank subsidiary were merged to create UnitedKingfield Bank. Non-interest expenses increased to $32.3 million for the year ended December 31, 2002 from $31.0 million in 2001, approximately $1.3 million, or 4.2%. Salaries and employee benefits increased by $2.2 million, or 15.6%, during this same period reflecting, in part, increased salaries and employee benefits of $1.3 million associated with the Acadia Trust, N.A. acquisition in July 2001 and establishment of Acadia Financial Consultants in October 2001. In addition to this amount, there was an increase of $821,000, or 6.5%, due to annual salary increases and higher employee benefit costs. Occupancy expenses increased $224,000, or 10.8%, due in part to the  full year of Acadia Trust, N.A. and a new branch facility in Kennebunk, Maine. Expenses associated with the processing  of merchant business credit card transactions decreased $183,000, or 9.2%, during 2002 compared to 2001 reflecting the sale of the CompanyGLYPH<213>s merchant program to NOVA Information Systems effective in November 2002. Other expenses decreased by $683,000, or 7.4%, in 2002 compared to 2001 primarily due to a legal settlement of $1.0 million paid in 2001. Non-interest income increased $4.2 million from $8.9 million in 2000 to $13.1 million in 2001. The increase of 46.9%, in total non-interest income reflected the effects of various balance sheet management activities which included the securitization of $57.0 million of the CompanyGLYPH<213>s residential mortgages (i.e. the sale of residential mortgages purchased back by the Company as mortgage-backed securities) and  sales of various investments which resulted in $1.2 million of non-interest income. In 2001, the Company also recognized $932,000 from the sale of interest rate derivatives and increased trust fees of $1.2 million due to the acquisition  of Acadia Trust, N.A. on July 19, 2001.  Non-interest expenses were $31.0 million in 2001, compared to $25.4 million in 2000. Salaries and employee benefits increased by $2.7 million, reflecting, in part, increased salaries and employee benefits of $855,000 associated with the Acadia Trust, N.A. acquisition. Occupancy expenses increased $409,000 during 2001 compared to 2000 due to the renovation and expansion of several of the CompanyGLYPH<213>s branch facilities and expansion of its operations center. Other expenses increased  by $2.3 million due to expenses related to the CompanyGLYPH<213>s new subsidiaries, courier costs, legal settlement and debit card processing costs. Total assets at December 31, 2002 were $1.2 billion, an increase of $129.1 million, or 11.8%, from December 31, 2001. The change in assets consisted primarily of a $51.0 million increase in investment securities, an increase in net loans of $83.1 million, a decrease of $5.3 million in cash and due from banks, a decrease in net premises and equipment of $700,000, and an increase in other assets of $1.0 million. The asset growth was supported by an increase of $28.0 million in total borrowings, an $86.6 million increase in deposits, a $700,000 increase in other liabilities, and an increase of $13.8 million in total shareholdersGLYPH<213> equity.  The Company maintains an investment portfolio of various securities to diversify its revenues, as well as provide interest rate risk and credit risk diversification and to provide for its liquidity and funding needs. Total investment securities increased $51.0 million, or 19.3%, to $314.8 million at December 31, 2002. The Company has investment securities in both the available-for-sale and held-to-maturity categories. During 2002, the Company sold fixed rate residential mortgages which were converted into mortgage-backed securities and purchased back by the Company and are classified as securities available for sale (also known as GLYPH<210>securitization.GLYPH<211>) These transactions resulted in the CompanyGLYPH<213>s loan balances decreasing, as those assets shifted to investment securities. Converting residential Residential real estate mortgage loans increased by  $39.9 million, or 19.5%, in 2002. During 2002, the Company securitized $16.7 million of fixed-rate residential mortgage The CompanyGLYPH<213>s bank subsidiaries provide loans to customers primarily located within the banksGLYPH<213> geographic market area. Loans, including loans held for sale, totaled $808.9 million at December 31, 2002, an 11.7% increase  from total loans of $724.0 million at December 31, 2001. This reflects the continuation of strong loan growth experienced in the commercial, residential real estate and consumer loan portfolios, less the $52.1 million of fixed-rate residential mortgage loans that were either sold on the secondary market or converted to securities available for sale by the Company during 2002. The Company conforms to SFAS No. 115, which requires all investments to be categorized as GLYPH<210>trading securities,GLYPH<211> GLYPH<210>available for saleGLYPH<211> or GLYPH<210>held to maturity.GLYPH<211> All realized gains or losses from investments in any category are recorded as an effect to net income in the period incurred. Unrealized gains or losses from investments are recorded based on its respective classification. Unrealized gains or losses from investments categorized as GLYPH<210>trading securitiesGLYPH<211> are immediately recorded in the CompanyGLYPH<213>s income statement. During 2002, the Company did not hold any securities in this category. Unrealized gains or losses from investments categorized as GLYPH<210>held to maturityGLYPH<211> are only recorded when and if the gain or loss is recognized. In most cases, due to the strict interpretation of this classification, these securities are not sold. Unrealized gains or losses on securities classified as GLYPH<210>available for saleGLYPH<211> are recorded as adjustments to shareholdersGLYPH<213> equity, net of related deferred income taxes, and are a component of the CompanyGLYPH<213>s other comprehensive income contained in the Consolidated Statement of Changes in ShareholdersGLYPH<213> Equity. At December 31, 2002, the Company had $6.8 million of unrealized gains on securities available for sale, net of the deferred taxes, compared to $4.5 million of unrealized gains, net of deferred taxes at December 31, 2001. The increase in unrealized appreciation was attributed to a decrease in market interest rates. mortgages into mortgage-backed securities provides flexibility and liquidity in the CompanyGLYPH<213>s balance sheet. As a result of  the securitization activity in 2002 and 2001, the Company generated and maintained $73.7 million of mortgage-backed securities through this program. This strategy reflects the fact that mortgage backed securities are a more liquid investment alternative to residential mortgages, thus allowing the Company to provide its customers competitive residential mortgages while maintaining adequate liquidity on its balance sheet. The Company also purchases mortgage-backed securities and  other investment securities as part of its overall investment portfolio strategy. Loans Investment Securities Overview FINANCIAL CONDITION Non-interest Expenses Non-interest Income Comparison of 2001 to 2000