FIRST NATIONAL LINCOLN CORP /ME/ - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: Commission File No.
September 30, 2003 0-26589

FIRST NATIONAL LINCOLN CORPORATION
(Exact name of registrant as specified in its charter)

MAINE 01-0404322
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No)

MAIN STREET, DAMARISCOTTA, MAINE 04543
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (207) 563 - 3195

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

Yes [X] No[ ]

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [X] No[ ]

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

Class Outstanding at November 13, 2003
Common Stock, Par One Cent 2,420,219

FIRST NATIONAL LINCOLN CORPORATION

INDEX

PART 1 Financial Information (Unaudited)
Page No.

Item 1:

Selected Financial Data .......................................... 1

Independent Accountants' Review Report ........................... 2

Financial Statements

Consolidated Balance Sheets -
September 30,2003, September 30,2002 and December 31, 2002 3 - 4

Consolidated Statements of Income - for the Three and Nine
Months ended September 30,2003 and September 30,2002 ........... 5 - 6

Consolidated Statements of Changes in Shareholders' Equity -
for the Nine Months ended September 30,2003 and September 30,2002 7 - 8

Consolidated Statements of Cash Flows - for the Nine Months
Ended September 30,2003 and September 30,2002 .................. 9 - 10

Notes to Financial Statements - for the Nine Months
Ended September 30,2003 and September 30,2002 .................. 11 - 16

Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations ................. 17 - 24

Item 3: Quantitative and Qualitative Disclosures
About Market Risk ........................................ 25 - 27

Item 4: Controls and Procedures .................................... 28

PART II Other Information

Item 1: Legal Proceedings .......................................... 29

Item 2: Changes in Securities ...................................... 30

Item 3: Defaults Upon Senior Securities ............................ 31

Item 4: Submission of Matters to a Vote of Security Holders ........ 32

Item 5: Other Information .......................................... 33

Item 6: Exhibits and Reports on Form 8-K ........................... 34

Signatures ........................................................... 35

PART I.

ITEM 1. FINANCIAL STATEMENTS

FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY
SELECTED FINANCIAL DATA (Unaudited)

- -----------------------------------------------------------------------------
For the nine months For the quarters
Dollars in thousands, ended September 30, ended September 30,
except for per share amounts 2003 2002 2003 2002
- -----------------------------------------------------------------------------
Summary of Operations
Operating Income $24,463 $25,374 $8,358 $8,881
Operating Expense 16,903 18,557 5,530 6,470
Net Interest Income 12,850 12,828 4,586 4,339
Provision for Loan Losses 675 945 225 255
Net Income 5,420 4,808 2,012 1,689
- -----------------------------------------------------------------------------
Per Common Share Data
Basic Earnings per Share $2.24 $2.00 $0.83 $0.70
Diluted Earnings per Share 2.18 1.95 0.81 0.68
Cash Dividends Declared 0.84 0.72 0.29 0.25
Book Value 19.26 17.42 19.26 17.42
Market Value 43.00 28.80 43.00 28.80
- -----------------------------------------------------------------------------
Financial Ratios
Return on Average Equity (a) 16.23% 16.49% 17.24% 16.56%
Return on Average Assets (a) 1.40% 1.40% 1.49% 1.38%
Average Equity to Average Assets 8.63% 8.47% 8.64% 8.35%
Net Interest Margin Tax-Equivalent (a) 3.69% 4.08% 3.78% 3.92%
Dividend Payout Ratio 37.50% 35.96% 34.94% 35.78%
Allowance for Loan
Losses to Total Loans 1.09% 1.10% 1.09% 1.10%
Non-Performing Loans
to Total Loans 0.32% 0.52% 0.32% 0.52%
Non-Performing Assets
to Total Assets 0.23% 0.39% 0.23% 0.39%
Efficiency Ratio (b) 48.66% 50.06% 47.95% 51.45%
- -----------------------------------------------------------------------------
At Period End
Total Assets 551,818 497,248 551,818 497,248
Total Loans 383,032 331,142 383,032 331,142
Total Investment Securities 139,196 124,104 139,196 124,104
Total Deposits 370,952 336,800 370,952 336,800
Total Shareholders' Equity 46,733 42,114 46,733 42,114
- -----------------------------------------------------------------------------

(a) Annualized using a 365-day basis

(b) The Company uses the following formula in calculating its efficiency ratio

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

Page 1

INDEPENDENT ACCOUNTANTS' REVIEW REPORT

The Board of Directors and Shareholders
First National Lincoln Corporation

We have reviewed the accompanying interim consolidated financial information of
First National Lincoln Corporation and Subsidiary as of September 30, 2003 and
2002, and for the three- and nine-month periods then ended. These financial
statements are the responsibility of the Company's management.

We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit in
accordance with U.S. generally accepted auditing standards, the objective of
which is to express an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.

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

/s/ Berry, Dunn, McNeil & Parker

Berry, Dunn, McNeil & Parker

Portland, Maine
November 11, 2003

Page 2
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (Unaudited)

- ------------------------------------------------------------------------------
(000 OMITTED except per share data September 30, September 30, December 31,
and number of shares) 2003 2002 2002
- ------------------------------------------------------------------------------
Assets
Cash and due from banks $ 13,758 $ 19,904 $ 14,181
Overnight funds sold - 6,400 9,325
------- ------- -------
Cash and cash equivalents 13,758 26,304 23,506
------- ------- -------

Investments:
Available for sale 62,815 57,115 56,410
Held to maturity (market values $78,174
at 9/30/03, $68,556 at 9/30/02 and
$67,421 at 12/31/02) 76,381 66,989 65,663
Loans held for sale
(fair value approximates cost) 1,884 1,983 2,613
Loans 383,032 331,142 332,074
Less: allowance for loan losses 4,177 3,628 3,700
------- ------- -------
Net loans 378,855 327,514 328,374
------- ------- -------
Accrued interest receivable 2,814 2,852 2,642
Bank premises and equipment,
net of accumulated depreciation 7,466 7,851 7,833
Other real estate owned 51 192 255
Other assets 7,794 6,448 6,772
------- ------- -------
Total Assets $ 551,818 $ 497,248 $ 494,068
======= ======= =======

Page 3
CONSOLIDATED BALANCE SHEETS, CONTINUED

- ------------------------------------------------------------------------------
September 30, September 30, December 31,
2003 2002 2002
- ------------------------------------------------------------------------------
Liabilities
Demand deposits $ 33,425 $ 29,885 $ 25,484
NOW deposits 55,593 49,078 46,989
Money market deposits 86,366 76,632 80,805
Savings deposits 65,093 58,986 59,521
Certificates of deposit 69,522 72,096 71,169
Certificates $100,000 and over 60,953 50,123 50,256
------- ------- -------
Total deposits 370,952 336,800 334,224
------- ------- -------
Borrowed funds 129,583 113,975 113,365
Other liabilities 4,550 4,359 3,784
------- ------- -------
Total Liabilities 505,085 455,134 451,373
------- ------- -------

Shareholders' Equity
Common stock 25 25 25
Additional paid-in capital 4,687 4,687 4,687
Retained earnings 41,707 37,103 38,322
Net unrealized gains on
securities available for sale 2,558 2,356 2,170
Treasury stock (2,244) (2,057) (2,509)
------- ------- -------
Total Shareholders' Equity 46,733 42,114 42,695
------- ------- -------
Total Liabilities
& Shareholders' Equity $ 551,818 $ 497,248 $ 494,068
======= ======= =======
- ------------------------------------------------------------------------------
Number of shares authorized 6,000,000 6,000,000 6,000,000
Number of shares issued 2,481,270 2,481,270 2,481,270
Number of shares outstanding 2,426,575 2,417,637 2,414,693
Book value per share $19.26 $17.42 $17.68
- ------------------------------------------------------------------------------

See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.

Page 4
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

- ------------------------------------------------------------------------------

(000 OMITTED except per share data For the nine months ended September 30,
and number of shares) 2003 2002
- ------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $ 15,949 $ 16,652
Interest on deposits with other banks 52 26
Interest and dividends on investments 4,486 5,392
-------- --------
Total interest and dividend income 20,487 22,070
-------- --------
Interest expense
Interest on deposits 4,600 5,809
Interest on borrowed funds 3,037 3,433
-------- --------
Total interest expense 7,637 9,242
-------- --------
Net interest income 12,850 12,828
Provision for loan losses 675 945
-------- --------
Net interest income after
provision for loan losses 12,175 11,883
-------- --------
Non-interest income
Fiduciary income 577 555
Service charges on deposit accounts 833 719
Mortgage origination and servicing income 794 377
Other operating income 1,772 1,653
-------- --------
Total non-interest income 3,976 3,304
-------- --------
Non-interest expenses
Salaries and employee benefits 4,377 4,113
Occupancy expense 569 532
Furniture and equipment expense 1,039 958
Other 2,606 2,767
-------- --------
Total non-interest expenses 8,591 8,370
-------- --------
Income before income taxes 7,560 6,817
Applicable income taxes 2,140 2,009
-------- --------
NET INCOME $ 5,420 $ 4,808
======== ========
- -----------------------------------------------------------------------------
Earnings per common share
Basic earnings per share $2.24 $2.00
Diluted earnings per share $2.18 $1.95
Cash dividends declared per share $0.84 $0.72
Weighted average number of shares outstanding 2,421,594 2,401,365
Incremental shares 63,498 67,499
- -----------------------------------------------------------------------------
See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.

Page 5
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME, CONTINUED

- ------------------------------------------------------------------------------
(000 OMITTED except per share data For the quarters ended September 30,
and number of shares) 2003 2002
- ------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $ 5,358 $ 5,623
Interest on deposits with other banks 4 21
Interest and dividends on investments 1,453 1,869
------- -------
Total interest and dividend income 6,815 7,513
------- -------
Interest expense
Interest on deposits 1,318 2,034
Interest on borrowed funds 911 1,140
------- -------
Total interest expense 2,229 3,174
------- -------
Net interest income 4,586 4,339
Provision for loan losses 225 255
------- -------
Net interest income after provision for loan losses 4,361 4,084
------- -------
Non-interest income
Fiduciary income 203 172
Service charges on deposit accounts 268 249
Mortgage origination and servicing income 304 153
Other operating income 768 794
------- -------
Total non-interest income 1,543 1,368
------- -------
Non-interest expenses
Salaries and employee benefits 1,546 1,451
Occupancy expense 176 174
Furniture and equipment expense 338 334
Other 1,016 1,082
------- -------
Total non-interest expenses 3,076 3,041
------- -------
Income before income taxes 2,828 2,411
Applicable income taxes 816 722
------- -------
NET INCOME $ 2,012 $ 1,689
======= =======
- ------------------------------------------------------------------------------
Earnings per common share
Basic earnings per share $0.83 $0.70
Diluted earnings per share $0.81 $0.68
Cash dividends declared per share $0.29 $0.25
Weighted average number of shares outstanding 2,424,694 2,417,235
Incremental shares 66,754 69,904
- ------------------------------------------------------------------------------
See Accountants' Review Report. The accompanying notes are an integral part of
these consolidated financial statements.

Page 6
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)

Page 8
FIRST NATIONAL LINCOLN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

- -------------------------------------------------------------------------------
For the nine months ended September 30,
(000 omitted) 2003 2002
- -------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 5,420 4,808
Adjustments to reconcile net income to
net cash provided(used) by operating activities:
Depreciation 737 708
Provision for loan losses 675 945
Loans originated for resale (50,569) (22,527)
Proceeds from sales and transfers of loans 51,298 21,010
Net gain on sale of other real estate owned (24) -
Net increase (decrease) in other assets
and accrued interest 428 (449)
Net increase (decrease) in other liabilities (76) 384
Net amortization (accretion) of
premiums (discounts) on investments 927 (544)
------ ------
Net cash provided by operating activities 8,816 4,335
------ ------
Cash flows from investing activities
Proceeds from maturities, payments and calls of
securities available for sale 9,430 1,822
Proceeds from maturities, payments and calls of
securities to be held to maturity 24,555 24,974
Proceeds from sales of other real estate owned 228 10
Purchases of securities available for sale (15,311) (5,582)
Purchases of securities to be held to maturity (35,570) (34,206)
Net increase in loans (51,156) (30,155)
Capital expenditures (1,992) (996)
------ ------
Net cash used in investing activities (69,816) (44,133)
------ ------
Cash flows from financing activities
Net increase in demand deposits, savings,
money market and club accounts 27,678 85,708
Net increase (decrease) in
certificates of deposit 9,050 (11,597)
Advances on long-term borrowings 25,000 17,000
Repayment on long-term borrowings (28,000) -
Net decrease in short-term borrowings 19,218 (34,382)
Payment to repurchase common stock (209) (304)
Proceeds from sale of treasury stock 474 439
Dividends paid (1,959) (1,656)
------ ------
Net cash provided by financing activities 51,252 55,208
------ ------

Page 9
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

- -------------------------------------------------------------------------------
For the nine months ended September 30,
2003 2002
- -------------------------------------------------------------------------------

Net increase (decrease) in cash and cash equivalents (9,748) 15,410
Cash and cash equivalents at beginning of period 23,506 10,894
------ ------
Cash and cash equivalents at end of period $13,758 26,304
====== ======
- -------------------------------------------------------------------------------
Interest paid $ 8,019 $ 9,347
Income taxes paid 1,874 1,970
Non-cash transactions
Change in net unrealized gain on
available for sale securities 588 1,572
- ------------------------------------------------------------------------------

See Independent Accountants' Review Report. The accompanying notes are an
integral part of these consolidated financial statements.

Page 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - STOCK OPTIONS

First National Lincoln Corporation (the Company) established a stock option
plan in 1995. Under the plan, the Company may grant options to its employees
for up to 200,000 shares of common stock. Only incentive stock options may be
granted under the plan. The option price of each option grant is determined by
the Options Committee of the Board of Directors, and in no instance shall be
less than the fair market value of the stock on the date of the grant. An
option's maximum term is ten years from the date of grant.
The Company applies Accounting Principles Board Opinion No.25 and related
interpretations in accounting for the stock option plan. Accordingly, no
compensation cost has been recognized. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation", to stock-based employee
compensation.

- -------------------------------------------------------------------------------
For the nine months For the three months
In thousands, ended September 30, ended September 30,
except for per share data 2003 2002 2003 2002
- -------------------------------------------------------------------------------
Net income
As reported $ 5,420 4,808 $ 2,012 1,689
Value of option grants, net of tax - 60 - -
----- ----- ----- -----
Pro forma 5,420 4,748 2,012 1,689
===== ===== ===== =====
Basic earnings per share
As reported 2.24 2.00 0.83 0.70
Value of option grants, net of tax - 0.03 - -
----- ----- ----- -----
Pro forma 2.24 1.97 0.83 0.70
===== ===== ===== =====
Diluted earnings per share
As reported 2.18 1.95 0.81 0.68
Value of option grants, net of tax - 0.02 - -
----- ----- ----- -----
Pro forma 2.18 1.93 0.81 0.68
===== ===== ===== =====
- -------------------------------------------------------------------------------

No options were granted in 2003. The fair market value of options granted
in 2002, net of tax, was $60,000, with a weighted average fair market value of
options granted of $8.32. The fair market value is estimated using the Black-
Scholes option pricing model and the following assumptions: quarterly dividends
of $0.22, risk-free interest rate of 1.59%, volatility of 37.73%, and an
expected life of 10 years.

Page 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

A summary of the status of the Company's Stock Option Plan as of September
30, 2003, and changes during the nine months then ended, is presented below.

- -------------------------------------------------------------------------------
Number of Weighted Average
Shares Exercise Price
- -------------------------------------------------------------------------------
Balance at December 31, 2002 104,800 $12.88
Granted during the period 0 0
Exercised during the period (6,500) 7.42
------- ------
Balance at September 30, 2003 98,300 $13.24
======= ======
- -------------------------------------------------------------------------------

NOTE 2 - BASIS OF PRESENTATION

First National Lincoln Corporation is a financial holding company that owns all
of the common stock of The First National Bank of Damariscotta (the Bank). The
accompanying unaudited consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of Management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. All significant intercompany transactions and balances are
eliminated in consolidation. The income reported for the 2003 periods is not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on
Form 10-K for the year ended December 31, 2002.

Page 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

NOTE 3 - EARNINGS PER SHARE

The following tables set forth the computation of basic and diluted earnings
per share for the nine months ended September 30, 2003 and 2002:

- ----------------------------------------------------------------------------
For the nine months ended September 30, 2003
- ----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- ----------------------------------------------------------------------------
Net income as reported $ 5,420
-------
Basic EPS: Income available
to common shareholders $ 5,420 2,421,594 $ 2.24
Effect of dilutive securities:
incentive stock options 63,498
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 5,420 2,485,092 $ 2.18
======= ========= ======
- ----------------------------------------------------------------------------

- ----------------------------------------------------------------------------
For the nine months ended September 30, 2002
- ----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- ----------------------------------------------------------------------------
Net income as reported $ 4,808
-------
Basic EPS: Income available
to common shareholders $ 4,808 2,401,363 $ 2.00
Effect of dilutive securities:
incentive stock options 67,499
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 4,808 2,468,862 $ 1.95
======= ========= ======
- ----------------------------------------------------------------------------

Page 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

The following tables set forth the computation of basic and diluted earnings
per share for the three months ended September 30, 2003 and 2002:

- ----------------------------------------------------------------------------
For the three months ended September 30, 2003
- ----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- ----------------------------------------------------------------------------
Net income as reported $ 2,012
-------
Basic EPS: Income available
to common shareholders $ 2,012 2,424,694 $ 0.83
Effect of dilutive securities:
incentive stock options 66,754
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 2,012 2,491,448 $ 0.81
======= ========= ======
- ----------------------------------------------------------------------------

- ----------------------------------------------------------------------------
For the three months ended September 30, 2002
- ----------------------------------------------------------------------------
In thousands, except for number of Income Shares Per-Share
shares and per share data (Numerator) (Denominator) Amount
- ----------------------------------------------------------------------------
Net income as reported $ 1,689
-------
Basic EPS: Income available
to common shareholders $ 1,689 2,417,233 $ 0.70
Effect of dilutive securities:
incentive stock options 69,904
------- --------- ------
Diluted EPS: Income available
to common shareholders plus
assumed conversions $ 1,689 2,487,137 $ 0.68
======= ========= ======
- ----------------------------------------------------------------------------

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

Page 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

NOTE 4 - COMPREHENSIVE INCOME

Total comprehensive income for the three months ended September 30, 2003 and
2002 is as follows:

- -----------------------------------------------------------------------------
For the three months ended
September 30,
Dollars in thousands 2003 2002
- -----------------------------------------------------------------------------
Net income 2,012 1,689
Net unrealized gain on securities available
for sale, net of tax benefit of $186 in 2003
and taxes of $512 in 2002 (361) 993
------- ------
Comprehensive income 1,651 2,682
======= ======
- -----------------------------------------------------------------------------

NOTE 5 - RECENT ACCOUNTING DEVELOPMENTS

Financial Accounting Standards Board (FASB) Interpretation Number 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", an interpretation of FASB
Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34
(FIN 45), was issued in November 2002.
The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's fiscal year-
end. The disclosure requirements in this Interpretation are effective for
financial statements of interim or annual periods ending after December 15,
2002.
Financial and standby letters of credit are included in the scope of FIN
45, while commercial letters of credit are not. A guarantor of financial and
standby letters of credit is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee.
This Interpretation contains disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. This interpretation does not have a material
effect on the Company's consolidated financial statements.
In 2003, FASB issued Statement of Financial Accounting Standards (SFAS)
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." The Statement amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement 133.
The amendment requires contracts with comparable characteristics be
accounted for similarly. This Statement clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a
derivative as discussed in Statement 133. In addition, it clarifies when a
derivative contains a financing component that warrants special reporting in
the statement of cash flows and amends certain other existing pronouncements.

Page 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

SFAS 149 is effective for contracts entered into or modified after June
30, 2003, except as stated below and for hedging relationships designated after
June 30, 2003. The guidance should be applied prospectively. The provisions of
this Statement that relate to Statement 133 Implementation Issues that have
been effective for fiscal quarters that began prior to June 15, 2003, should
continue to be applied in accordance with their respective effective dates. In
addition, certain provisions relating to forward purchases or sales of when-
issued securities or other securities that do not yet exist, should be applied
to existing contracts as well as new contracts entered into after June 30,
2003. SFAS No. 149 does not affect the Company's consolidated financial
condition and results of operations.
In May 2003, FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
This Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances).
The requirements of this Statement apply to issuers' classification and
measurement of freestanding financial instruments, including those that
comprise more than one option or forward contract.
This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities. It is to be implemented
by reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of the Statement and
still existing at the beginning of the interim period of adoption. This
Statement is not expected to have a material effect on the Company's
consolidated financial statements.

Page 16
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

Management's discussion and analysis of the Company's financial condition is
based on the consolidated financial statements which are prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of such financial statements requires Management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosure of contingent assets and
liabilities. On an ongoing basis, Management evaluates its estimates, including
those related to the allowance for loan losses. Management bases its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis in
making judgments about the carrying values of assets that are not readily
apparent from other sources. Actual results could differ from the amount
derived from Management's estimates and assumptions under different assumptions
or conditions.
Management believes the allowance for loan losses is a critical accounting
policy that requires significant estimates and assumptions in the preparation
of the consolidated financial statements. The allowance for loan losses is
based on Management's evaluation of the level of the allowance required in
relation to the estimated loss exposure in the loan portfolio. Management
regularly evaluates the allowance for loan losses for adequacy by taking into
consideration factors such as prior loan loss experience, the character and
size of the loan portfolio, business and economic conditions and Management's
estimation of potential losses. The use of different estimates or assumptions
could produce different provisions for loan losses.

EARNINGS SUMMARY

Net income for the nine months ended September 30, 2003 was $5,420,000, an
increase of 12.7% over net income of $4,808,000 in the comparable period of
2002.
Increased non-interest income coupled with controlled operating expenses
were the primary factors in the Company's increased earnings. During the period
assets grew, and while assets showed substantial growth, interest margins
decreased, resulting in an increase in net interest income of only $22,000 or
0.2% for the first nine months of 2003 when compared to the first nine months
of 2002. Between December 31, 2002 and September 30, 2003, the loan and
investment portfolios increased by a combined $68.1 million, which Management
views as an excellent rate of growth.
Fully diluted earnings per share for the first nine months of 2003 were
$2.18, an 11.8% increase over the $1.95 reported for the first nine months of
2002.
Net income for the three months ended September 30, 2003 set a new single-
quarter record at $2,012,000, an increase of 19.1% over net income of
$1,689,000 for the comparable period of 2002.
A combination of higher net interest income, increased non-interest income
coupled with controlled operating expenses were the primary factors in the
Company's increased earnings for the quarter. Net interest income grew by
$247,000, or 5.7% over the comparable three-month period in 2002, while
continued strong mortgage origination volume resulted in an increase of
$175,000 in non-interest income when compared to the same quarter in 2002.
Fully diluted earnings per share for the third quarter of 2003 were $0.81,
a 19.1% increase over the $0.68 reported for the third quarter of 2002.

Page 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

NET INTEREST INCOME

Total interest income of $20,487,000 for the nine months ended September 30,
2003 was a 7.2% decrease from total interest income of $22,070,000 in the
comparable period of 2002. Total interest expense of $7,637,000 for the first
nine months of 2003 was a 17.4% decrease from total interest expense of
$9,242,000 for the first nine months of 2002. The decreases in both interest
income and interest expense were due to significantly lower interest rates
resulting from current economic conditions, despite significantly higher
balances for both assets and liabilities. At the same time, the low interest
rate climate brought on by recent Federal Reserve Board actions resulted in a
high level of residential mortgage refinance activity during the period, during
which the Bank sold an increased amount of its secondary-market-qualifying
mortgage production. This, along with higher than usual levels of liquidity,
invested in low-rate overnight deposits, caused compression of the net interest
margin.
The combination of lower interest rates and sale of mortgage loans resulted
in net interest income of $12,850,000 for the nine months ended September 30,
2003, a 0.2% increase from the $12,828,000 reported for the same period in
2002.
Total interest income of $6,815,000 for the three months ended September
30, 2003 was an 9.3% decrease from total interest income of $7,513,000 in the
comparable period of 2002. Total interest expense of $2,229,000 for the three
months ended September 30, 2003, was a 29.8% decrease from total interest
expense of $3,174,000 for the third quarter of 2002. The decreases in both
interest income and interest expense for the third quarter of 2003 occurred for
the same reasons cited above for the first nine months of 2003 and resulted in
net interest income of $4,586,000 for the three months ended September 30,
2003, a 5.7% increase from the $4,339,000 reported for the same period in 2002.
This, was complemented by income recognized from the sale of mortgage loans,
which was recorded in non-interest income, which increased $175,000 or 12.8%
when compared to the same quarter of 2002.
The Company's net interest margin on a tax-equivalent basis decreased from
4.08% in the first nine months of 2002 to 3.69% in the first nine months of
2003, and from 3.92% in the third quarter of 2002 to 3.78% in the third quarter
of 2003. Tax equivalency is calculated using a 35% effective tax rate. These
results are indicative of the widening which occurred in the Company's net
interest margin beginning in the third quarter of 2003 after repricing a
significant amount of liabilities in the second and third quarters of 2003.
The following table presents the effect of tax-exempt income on the
calculation of the net interest margin:

- ------------------------------------------------------------------------------
For the nine months For the three months
ended September 30, ended September 30,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------
Net interest income as presented $ 12,850 $ 12,828 $ 4,586 $ 4,339
Effect of tax-exempt income 751 510 262 174
----- ----- ----- -----
Net interest income, tax equivalent $ 13,601 $ 13,338 $ 4,848 $ 4,513
===== ===== ===== =====
- ------------------------------------------------------------------------------

Page 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

PROVISION FOR LOAN LOSSES

A $675,000 provision to the allowance for loan losses was made during the first
nine months of 2003, a $270,000 decrease from the $945,000 provision made for
the same period of 2002. While commercial loan growth has been substantial in
the first nine months of 2003, the lower level of provision in 2003 was the
result of several factors, including lower levels of past-due loans and lower
levels of net charge-offs. The Company's net loss ratio as a percentage of
average loans for the first nine months of 2003 was 0.06% in comparison to
0.10% for the first nine months of 2002. In additon, the deterioration of one
large credit due to weakness in the commercial fishing industry led to a higher
level of provision for the first nine months of 2002.

NON-INTEREST INCOME

Non-interest income was $3,976,000 for the nine months ended September 30,
2003, an increase of 20.3% from the $3,304,000 reported for the first nine
months of 2002. The increase in non-interest income was due primarily to
mortgage origination and servicing income increasing by $417,000 or 110.7% as
well as higher merchant credit card processing income. Demand for residential
mortgages was strong in the first nine months of 2003. The Bank sold $51.3
million of residential loans in the first nine months of 2003 compared to $21.0
million in the first nine months of 2002, resulting in increased gains on sales
of loans. In addition, the balances of loans serviced for others increased by
$15.6 million during the period.
Non-interest income was $1,543,000 for the three months ended September
30, 2003, an increase of 12.8% over the $1,368,000 reported for the three
months ended September 30, 2002. The increase in non-interest income was due
primarily to mortgage origination and servicing income which was $151,000 or
98.8% higher than the same period in 2002. There were also increases in
merchant credit card processing income and service charge income.

NON-INTEREST EXPENSE

Non-interest expense of $8,591,000 for the nine months ended September 30,
2003, is an increase of only 2.6% from non-interest expense of $8,370,000 for
the first nine months of 2002. Higher personnel costs related to the strong
asset and income growth experienced by the Company, as well as higher health
care insurance premiums, were offset by reductions in cardholder processing as
a result of the sale of the Bank's credit card portfolio in the fourth quarter
of 2002. Included in 2002's other operating expense was a $75,000 one-time
expense representing the write-down of a repossessed asset as well as the
associated carrying costs for maintaining this repossessed asset. In addition,
there were increases in merchant credit card processing costs which were offset
by an increase in merchant credit card processing income.
Non-interest expense of $3,076,000 for the three months ended September
30, 2003, is an increase of 1.2% over non-interest expense of $3,041,000 for
the three months ended September 30, 2002. This low level of increase in non-
interest expense for the quarter was for the same reasons cited above.

INCOME TAXES

Income taxes on operating earnings increased to $2,140,000 for the first nine
months of 2003 from $2,009,000 for the same period a year ago. The increase is
in line with the increase in pre-tax income.

Page 19
AVERAGE DAILY BALANCE SHEET
The following table shows the Company's average daily balance sheets for the
nine-month periods ended September 30, 2003 and 2002
- --------------------------------------------------------------------------
Nine-month periods ended September 30,
Dollars in thousands 2003 2002
- --------------------------------------------------------------------------
Cash and due from banks $ 10,222 9,101
Overnight funds sold 7,224 2,240
Investments
U.S. Treasury securities & government agencies 49,415 61,117
Obligations of states & political subdivisions 28,361 21,003
Other securities 48,580 36,041
--------- ---------
Total investments 126,356 118,161
--------- ---------
Loans held for sale 1,957 1,849
--------- ---------
Loans
Commercial 131,136 109,977
Consumer 26,572 29,934
State and municipal 12,258 8,022
Real estate 187,226 167,071
--------- ---------
Total loans 357,192 315,004
Allowance for loan losses (3,889) (3,303)
--------- ---------
Net loans 353,303 311,701
--------- ---------
Bank premises and equipment, net 7,755 7,777
Other assets 10,439 9,545
--------- ---------
Total assets $ 517,256 460,374
========= =========
Deposits
Demand $ 26,469 23,116
NOW 50,086 44,949
Money market 87,194 40,507
Savings 61,816 51,042
Certificates of deposit 70,083 77,636
Certificates of deposit over $100,000 54,003 53,979
--------- ---------
Total deposits 349,651 291,229
--------- ---------
Borrowed funds 118,480 126,742
Other liabilities 4,470 3,424
--------- ---------
Total liabilities 472,601 421,395
--------- ---------
Common stock 25 25
Additional paid in capital 4,687 4,687
Retained earnings 39,877 35,468
Net unrealized gain on
securities available for sale 2,476 935
Treasury stock (2,410) (2,136)
--------- ---------
Total capital 44,655 38,979
--------- ---------
Total liabilities and capital $ 517,256 460,374
========= =========
Page 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

INVESTMENTS

The Company's investment portfolio increased by $17.1 million or 14.0% between
December 31, 2002, and September 30, 2003. A portion of the portfolio consists
of callable securities, some of which were called by issuers and replaced at
lower yields. At September 30, 2003, the Company's available-for-sale portfolio
had an unrealized gain, net of taxes, of $2.6 million, which is in line with
the interest rate climate seen in the first nine months of 2003.

LOANS

Loans grew by $51.0 million or 15.3% during the first nine months of 2003. The
growth in commercial loans was $18.5 million or 15.5% and municipal loans
increased $3.5 million or 37.0%. The residential mortgage portfolio increased
by $14.8 million or 10.3% and home equity lines of credit grew $15.5 million or
50.3% -- the result of a new product with competitive pricing and marketing.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses represents the amount available for credit losses
inherent in the Company's loan portfolio. Loans are charged off when they are
deemed uncollectible, after giving consideration to factors such as the
customer's financial condition, underlying collateral and guarantees, as well
as general and industry economic conditions.
In general, the Company determines the appropriate overall reserve for
loan losses based upon periodic, systematic reviews of its portfolio to
identify inherent losses and Management's judgment about various qualitative
factors. These reviews result in the identification and quantification of loss
factors, which are used in determining the amount of the allowance for loan
losses. The Company periodically evaluates prevailing economic and business
conditions, industry concentrations, changes in the size and characteristics of
the portfolio and other pertinent factors. Portions of the allowance for loan
losses are quantified to cover the estimated losses inherent in each loan
category based on the results of this detailed review process.
Commercial loans are individually reviewed and assigned a credit risk
rating from "1" (low risk of loss) to "8" (high risk of loss). For non-impaired
loans with a credit risk rating of "1" to "7", estimated loss factors based on
historical loss experience (ranging from two to five years) are used to
calculate a loan loss reserve for each credit risk rating classification.
Qualitative adjustments are also made based upon Management's assessment of
prevailing economic conditions, trends in volumes and terms of loans, levels
and trends in delinquencies and non-accruals, and the effect of changes in
lending policies. A specific allocation is made for impaired loans (loans on
non-accrual status, as well as loans with a credit risk rating of "8"), which
are measured at the net present value of future cash flows, discounted at the
loan's effective interest rate, or at fair market value of collateral if the
loan is collateral dependent. The combination of these analyses is the basis
for the determination of the commercial loan portion of the allowance for loan
losses.
Consumer loans, which includes residential mortgages, home equity
loans/lines, and direct/indirect loans, are generally evaluated as a group
based on product type. The determination of the consumer loan portion of
the allowance for loan losses is based on a five-year average of annual
historical losses, adjusted for the qualitative factors noted above.

Page 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

The results of all analyses are reviewed and discussed by the Directors'
Loan Committee. An integral component of the Company's risk management process
is to ensure the proper quantification of the reserve for loan losses based
upon an analysis of risk characteristics, demonstrated losses, loan
segmentations, and other factors. Reserve methodology is reviewed on a periodic
basis and modified as appropriate. The unallocated component of the allowance
for loan losses represents Management's view that, given the complexities of
the loan portfolio, there are estimable losses that have been incurred within
the portfolio but not yet specifically identified.
Based on this analysis, including the aforementioned assumptions, the
Company believes that the allowance for loan losses is adequate as of September
30, 2003. As of that date, the balance of $4,177,000 was 1.09% of total loans,
compared to 1.11% at December 31, 2002 and 1.10% at September 30, 2002. Loans
considered to be impaired according to SFAS 114/118 totalled $1,229,000 at
September 30, 2003, compared to $1,070,000 at December 31, 2002. The portion of
the allowance for loan losses allocated to impaired loans at September 30,
2003, was $337,000 compared to $297,000 at December 31, 2002.

DEPOSITS

During the first nine months of 2003, deposits increased by $36.7 million or
11.0% over December 31, 2002. Core deposits (demand, NOW, savings and money
market accounts) grew by $27.7 million or 13.0% in the first nine months of
2003. During the same period, certificates of deposit increased $9.1 million as
a result of restructuring the liability side of the Company's balance sheets.
As of September 30, 2003, deposits grew year-over-year by 10.1%, or $34.2
million. Demand deposits grew $3.5 million, NOW accounts $6.5 million, savings
$6.1 million, money market accounts $9.7 million and certificates of deposit by
$8.2 million. The increase in deposit balances is the result of generating
addition deposit funding in the Bank's primary market area.

BORROWED FUNDS

The Company's funding includes borrowings from the Federal Home Loan Bank, the
Federal Reserve Bank of Boston, and repurchase agreements. The Company utilizes
borrowings as an additional source of funding for both loans and investments,
enabling it to grow its balance sheet and, in turn, grow its revenues. They may
also be used to carry out interest rate risk management stategies, and are
increased as other sources of funding decrease, including core deposits and
certificates of deposit. During the nine months ended September 30, 2003,
borrowed funds increased by $16.2 million or 14.3% from December 31, 2002.
Between September 30, 2002 and September 30, 2003, borrowed funds
increased $15.6 million or 13.7% during this period.

Page 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

SHAREHOLDERS' EQUITY AND CAPITAL RESOURCES

Shareholders' equity as of September 30, 2003 was $46,733,000, compared to
$42,695,000 as of December 31, 2002. The Company's strong earnings performance
in the first nine months months of 2003 provided a significant addition to
retained earnings. In addition, the net unrealized gain on available-for-sale
securities, as required under SFAS 115, has increased by $388,000 since
December 31, 2002.
During 2002, the Company increased its dividend each quarter to end the
year at a quarterly rate of 26 cents per share. In 2003, a cash dividend of 27
cents per share was declared in the first quarter of 2003 compared to 23 cents
in the first quarter of 2002 and a cash dividend of 28 cents per share was
declared in the second quarter of 2003 compared to 24 cents in the second
quarter of 2002 and a cash dividend of 29 cents per share was declared in the
third quarter of 2003 compared to 25 cents in the third quarter of 2002.
Regulatory leverage capital ratios for the Company were 8.22% and 8.19% at
September 30, 2003 and December 31, 2002, respectively. The Company had a tier
one risk-based capital ratio of 11.69% and tier two risk-based capital ratio of
12.80% at September 30, 2003, compared to 12.32% and 13.45%, respectively, at
December 31, 2002. These are comfortably above the standards to be rated "well-
capitalized" by regulatory authorities -- qualifying the Company for lower
deposit-insurance premiums.
On September 23, 2002, the Company announced that its Board of Directors
authorized the repurchase of up to 5.0% of the outstanding shares of the
Company's common stock, or slightly more than 120,000 shares. The Company
expects such repurchases to be effected from time to time, in the open market,
in private transactions or otherwise, during a period of up to 24 months. The
amount and timing of shares to be purchased will be subject to market
conditions and will be based on several factors, including the price of the
Company's stock and the level of stock issuances under the Company's employee
stock plans. No assurance can be given as to the specific timing of the share
repurchases or as to whether and to what extent the share repurchase will be
consummated. In Management's opinion, the Company has adequate capital
resources to undertake this repurchase plan. As of September 30, 2003, the
Company had repurchased 26,981 shares under the 2002 repurchase plan -
including 21,054 shares in the fourth quarter of 2002 and 5,927 shares in the
first three quarters of 2003.

CONTRACTUAL OBLIGATIONS

The following table sets forth the contractual obligations of the Company as of
September 30, 2003:
- -------------------------------------------------------------------------------
Less than 1-3 4-5 More than
Dollars in thousands Total 1 Year Years Years 5 Years
- -------------------------------------------------------------------------------
Borrowed funds $ 129,583 58,083 32,000 12,000 27,500
Operating leases 262 79 119 64 -
Certificates of deposit 130,475 64,476 53,882 12,117 -
------- ------- ------ ------ ------
Total $ 260,320 122,638 86,001 24,181 27,500
======= ======= ====== ====== ======
Commitments to extend
credit and
unused lines of credit $ 79,069 79,069 - - -
- -------------------------------------------------------------------------------

Page 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED

LIQUIDITY MANAGEMENT

As of September 30, 2003 the Bank had primary sources of liquidity of $40.9
million and an additional $129.2 million of secondary sources. It is
Management's opinion that this is adequate. In its Asset/Liability policy, the
Bank has adopted guidelines for liquidity. The Company is not aware of any
recommendations by the regulatory authorities which, if they were to be
implemented, would have a material effect on the Corporation's liquidity,
capital resources or results of operations.

NON-PERFORMING ASSETS

At September 30, 2003, loans on non-accrual status totaled $1,229,000, which
compares to non-accrual loans of $1,070,000 as of December 31, 2002. In
addition to loans on non-accrual status at September 30, 2003, loans past due
90 days or more and accruing (calculated on a constant 30-day month basis)
totaled $475,000, which compares to $406,000 as of December 31, 2002. The
Company continues to accrue interest on these loans because it believes
collection of the interest and principal is reasonably assured.

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

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

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

FORWARD-LOOKING STATEMENTS

Certain disclosures in Management's Discussion and Analysis of Financial
Condition and Results of Operations contain certain forward-looking statements
(as defined in the Private Securities Litigation Reform Act of 1995). In
preparing these disclosures, Management must make assumptions, including, but
not limited to, the level of future interest rates, prepayments on loans and
investment securities, required levels of capital, needs for liquidity, and the
adequacy of the allowance for loan losses. These forward-looking statements may
be subject to significant known and unknown risks uncertainties, and other
factors, including, but not limited to, those matters referred to in the
preceding sentence.
Although First National Lincoln Corporation believes that the expectations
reflected in such forward-looking statements are reasonable, actual results may
differ materially from the results discussed in these forward-looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to republish revised forward-looking statements to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Readers are also urged to carefully review
and consider the various disclosures made by the Company which attempt to
advise interested parties of the facts which affect the Company's business.

Page 24
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK MANAGEMENT

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

ASSET/LIABILITY MANAGEMENT

The primary goal of asset/liability management is to maximize net interest
income within the interest rate risk limits set by ALCO. Interest rate risk is
monitored through the use of two complementary measures: static gap analysis
and earnings simulation modeling. While each measurement has limitations, taken
together they represent a reasonably comprehensive view of the magnitude of
interest rate risk in the Company, the level of risk through time, and the
amount of exposure to changes in certain interest rate relationships.
Static gap analysis measures the amount of repricing risk embedded in the
balance sheet at a point in time. It does so by comparing the differences in
the repricing characteristics of assets and liabilities. A gap is defined as
the difference between the principal amount of assets and liabilities which
reprice within a specified time period. The Bank's cumulative one-year gap, at
September 30, 2003, was +11.8% of total assets. ALCO's policy limit for the
one-year gap is plus or minus 20% of total assets. Core deposits with non-
contractual maturities are presented based upon historical patterns of balance
attrition and pricing behavior which are reviewed at least annually.
The gap repricing distributions include principal cash flows from
residential mortgage loans and mortgage-backed securities in the time frames in
which they are expected to be received. Mortgage prepayments are estimated by
applying industry median projections of prepayment speeds to portfolio segments
based on coupon range and loan age.

Page 25
MARKET RISK MANAGEMENT, CONTINUED

A summary of the Bank's static gap, as of September 30, 2003, is presented in
the following table:

- -------------------------------------------------------------------------------
0-90 91-365 1-5 5+
Dollars in thousands days days years years
- -------------------------------------------------------------------------------
Investment securities at
amortized cost $ 26,659 22,961 45,118 43,570
Loans held for sale 17 78 626 1,163
Loans 153,954 70,540 128,092 30,446
Other interest-earning assets 4,702 - - -
Non-rate-sensitive assets - - - 22,611
-------- -------- -------- --------
Total assets $ 185,332 93,579 173,836 97,790
-------- -------- -------- --------
Interest-bearing deposits 111,669 41,004 66,002 118,852
Borrowed funds 36,865 21,218 44,000 27,500
Non-rate-sensitive
liabilities and equity 727 2,324 12,673 67,703
-------- -------- -------- --------
Total liabilities and equity $ 149,261 64,546 122,675 214,055
-------- -------- -------- --------
Period gap $ 36,071 29,033 51,161 (116,265)
========= ======== ======== ========
Percent of total assets 6.55% 5.27% 9.29% -21.12%
Cumulative gap (current) $ 36,071 65,104 116,265 -
Percent of total assets 6.55% 11.83% 21.12% 0.0%
- -------------------------------------------------------------------------------

The earnings simulation model forecasts captures the impact of changing
interest rates on one-year and two-year net interest income. The modeling
process calculates changes in interest income received and interest expense
paid on all interest-earning assets and interest-bearing liabilities reflected
on the Company's balance sheet. None of the assets used in the simulation are
held for trading purposes. The modeling is done for a variety of scenarios that
incorporate changes in the absolute level of interest rates as well as basis
risk, as represented by changes in the shape of the yield curve and changes in
interest rate relationships. Management evaluates the effects on income of
alternative interest rate scenarios against earnings in a stable interest rate
environment. This analysis is also most useful in determining the short-run
earnings exposures to changes in customer behavior involving loan payments and
deposit additions and withdrawals.
The Bank's most recent simulation model projects net interest income would
decrease by approximately 0.58% of stable-rate net interest income if rates
fall gradually by one percentage point over the next year, and decrease by
approximately 0.40% if rates rise gradually by two percentage points. Both
scenarios are well within ALCO's policy limit of a decrease in net interest
income of no more than 10.0% given a 2.0% move in interest rates, up or down.
Management believes this reflects a reasonable interest rate risk position. In
year two, and assuming no additional movement in rates, the model forecasts
that net interest income would be lower than that earned in a stable rate
environment by 1.80% in a falling-rate scenario and decrease by 5.44% in a
rising rate scenario when compared to the year-one base scenario.

Page 26
MARKET RISK MANAGEMENT, CONTINUED

This dynamic simulation model includes assumptions about how the balance
sheet is likely to evolve through time and in different interest rate
environments. Loans and deposits are projected to maintain stable balances. All
maturities, calls and prepayments in the securities portfolio are assumed to be
reinvested in similar assets. Mortgage loan prepayment assumptions are
developed from industry median estimates of prepayment speeds for portfolios
with similar coupon ranges and seasoning. Non-contractual deposit volatility
and pricing are assumed to follow historical patterns. The sensitivities of key
assumptions are analyzed annually and reviewed by ALCO.
A summary of the Bank's interest rate risk simulation modeling, as of
September 30, 2003 is presented in the following table:

- -------------------------------------------------------------
Changes in Net Interest Income 2003
- -------------------------------------------------------------
Year 1
Projected change if rates decrease by 1.0% -0.58%
Projected change if rates increase by 2.0% -0.40%
- -------------------------------------------------------------
Year 2
Projected change if rates decrease by 1.0% -1.80%
Projected change if rates increase by 2.0% -5.44%
- -------------------------------------------------------------

The information for static gap and changes in net interest income
presented in this section pertains to the Bank only and does not include a
small volume of assets and liabilities owned by the Company and included in its
consolidated financial statements as of September 30, 2003. In Management's
opinion, the Bank-only information would not be materially different than that
for the Company's consolidated balances. This sensitivity analysis does not
represent a Company forecast and should not be relied upon as being indicative
of expected operating results. These hypothetical estimates are based upon
numerous assumptions including, among others, the nature and timing of interest
rate levels, yield curve shape, prepayments on loans and securities, deposit
decay rates, pricing decisions on loans and deposits, and reinvestment/
replacement of asset and liability cash flows. While assumptions are developed
based upon current economic and local market conditions, the Company cannot
make any assurances as to the predictive nature of these assumptions, including
how customer preferences or competitor influences might change.

INTEREST RATE RISK MANAGEMENT

A variety of financial instruments can be used to manage interest rate
sensitivity. These may include investment securities, interest rate swaps, and
interest rate caps and floors. Frequently called interest rate derivatives,
interest rate swaps, caps and floors have characteristics similar to securities
but possess the advantages of customization of the risk-reward profile of the
instrument, minimization of balance sheet leverage and improvement of
liquidity. As of September 30, 2003, the Company was not using any derivative
instruments for interest rate risk management.
The Company engages an independent consultant to periodically review its
interest rate risk position, as well as the effectiveness of simulation
modeling and reasonableness of assumptions used. As of September 30, 2003,
there were no significant differences between the views of the independent
consultant and Management regarding the Company's interest rate risk exposure.
Management expects interest rates will remain relatively stable in the near-
term and believes that the current level of interest rate risk is acceptable.

Page 27
Item 4: Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

As required by new Rule 13a-15 under the Securities Exchange Act of 1934, as of
the end of the period covered by this report, the Company carried out an
evaluation under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules
and forms. In connection with the new rules, the Company is currently in the
process of further reviewing and documenting disclosure controls and
procedures, including internal controls and procedures for financial reporting,
and may from time to time make changes aimed at enhancing their effectiveness
and to ensure that these systems evolve with the Company's business.

(b) Changes in internal controls.

None.

Page 28
PART II

ITEM 1. LEGAL PROCEEDINGS

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

Page 29
ITEM 2. CHANGES IN SECURITIES

None

Page 30
ITEM 3. DEFAULT UPON SENIOR SECURITIES

None.

Page 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

Page 32
ITEM 5: OTHER INFORMATION

None.

Page 33
ITEM 6: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

A. EXHIBITS

14.1 CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS UNDER
SECTION 406 OF THE SARBANES-OXLEY ACT OF 2002

31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 REGARDING THE
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003

31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 REGARDING THE
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003

32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER UNDER
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 REGARDING THE
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003

32.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER UNDER
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 REGARDING THE
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003

B. REPORTS ON FORM 8-K

The Company's press release announcing the second quarter 2003 earnings was
filed on Form 8-K under item 5 on July 16, 2003.

The Company's press release announcing the third quarter 2003 dividend
declaration was filed on Form 8-K under item 5 on September 25, 2003.

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SIGNATURES

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

FIRST NATIONAL LINCOLN CORPORATION

November 14, 2003 /s/ Daniel R. Daigneault
Date Daniel R. Daigneault
President & Chief Executive Officer

November 14, 2003 /s/ F. Stephen Ward
Date F. Stephen Ward
Treasurer & Chief Financial Officer

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