NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

Business

Optima Bank & Trust Company (the Bank) provides a full range of banking services to individual and corporate customers in southern and coastal areas of New Hampshire.  The Bank is subject to the regulations of certain state and federal agencies and undergoes periodic examinations by those regulatory authorities.

On December 5, 2018, Cambridge Bancorp (Cambridge), its wholly owned subsidiary, Cambridge Trust Company (Cambridge Trust) and the Bank entered into an Agreement and Plan of Merger (the Merger Agreement), pursuant to which the Bank will merge with and into Cambridge Trust, in a stock and cash transaction.  Under the terms of the merger agreement, each share of the Bank’s common stock will be exchanged for either 0.3468 shares of Cambridge common stock, or $32.00 in cash, subject to customary pro-ration procedures which will result in an aggregate stock / cash consideration mix of 95% / 5%.  Consummation of the merger is subject to certain conditions, and is expected to occur in the second quarter of 2019.  See note 14 for further information.

Basis of Financial Statement Presentation

The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period.  Actual results could differ significantly from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses.  A substantial portion of the Bank’s loans are in the southern and coastal areas of New Hampshire.  Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio is susceptible to changes in economic conditions in those areas.  In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

Investment Securities

Available for sale securities (AFS) consist of debt securities that the Bank anticipates could be made available for sale in response to changes in market interest rates, liquidity needs, funding sources and other similar factors.  These assets are specifically identified and are carried at fair value.  Unrealized holding gains and losses on these assets, net of related income taxes, are excluded from earnings and are included in accumulated other comprehensive loss and reported as a separate component of stockholders’ equity.  Gains and losses on the sale of available for sale securities are computed on the specific identification of the adjusted costs of each security sold, are recognized upon realization and are shown separately in the statements of income.  Premiums and discounts on investment securities are amortized using methods that approximate the effective yield method.

9

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

Management of the Bank, in addition to considering current trends and economic conditions that may affect the quality of individual securities within the Bank’s investment portfolio, also considers the Bank’s ability and intent to hold available for sale debt securities or whether it is more likely than not it will be required to sell debt securities before recovery of the amortized cost basis.  When a decline in fair value of AFS is considered other than temporary and there is intent to hold the debt security, the credit loss portion is recognized in the statements of income, resulting in the establishment of a new cost basis for the security.  If the Bank intends to sell the security, the entire unrealized loss for the security is recognized in the statements of income.  There were no other-than-temporary declines in fair value as of December 31, 2018 and 2017.

Loans and Interest Income on Loans

Loans are stated at the principal amounts outstanding, plus net deferred loan origination costs.  Interest is recognized on loans using the accrual method, unless it is no longer probable of collection or the loan is 90 days or more past due, at which time interest ceases to accrue and is recognized on the cash basis.  Loans are restored to accrual status when there has been a period of sustained positive performance on the loans, the borrower has demonstrated the ability to make future payments of principal and interest, and management believes outstanding principal and interest receivable are collectible.  Interest received on an impaired loan for which the Bank does not expect full collection of principal will generally be recorded as a reduction in the recorded investment in the loan.  When the recorded carrying value in the impaired loan has been reduced to a point at which ultimate collection is probable, then interest income may be recognized.

Allowance for Loan Losses

The allowance for loan losses is established by management to absorb probable future charge-offs of loans deemed uncollectible.  This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off.  Loan losses are charged against the allowance when management believes that the collectibility of the loan principal is unlikely.  Management, considering current information and events regarding the borrowers’ ability to repay their obligations, considers loans to be impaired when it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the note agreement.  When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the note’s effective interest rate, or the fair value of collateral if the loan is collateral dependent.  Impairment losses are included in the allowance for loan losses through a charge to provision for loan losses.

Management believes that the allowance for loan losses is adequate.  Arriving at an appropriate level of allowance for loan loss involves judgment; the primary considerations are the level of delinquencies (based on contractual terms), the nature of the loan portfolio, prior loan loss experience by loan category, and qualitative factors including the local economic conditions and current real estate market trends.  While management uses available information to recognize losses on loans, future additions to the allowance may be necessary.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses.  Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management.

10

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

The qualitative factors are determined based on the various risk characteristics of each portfolio segment. Risk characteristics relevant to each portfolio segment are as follows:

Residential real estate and home equity lines of credit:  The Bank generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans.  Loans with loan-to-value ratios greater than 85 percent require the purchase of private mortgage insurance unless strong mitigating factors are identified.  Loans in these segments are collateralized primarily by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower.  The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in these segments.

Commercial real estate and multi-family residential:  Loans in these segments are primarily income-producing properties throughout southern and coastal areas of New Hampshire.  The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates which, in turn, may have an effect on the credit quality in these segments.  Management periodically obtains rent rolls and continually monitors the cash flows of these loans.

Construction loans:  The loans in this segment are primarily residential and commercial construction-to-permanent loans collateralized by owner-occupied residential and commercial real estate, and repayment is dependent on the credit quality of the individual borrower.  The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in this segment.

Commercial loans:  Loans in this segment are made to businesses and are generally secured by assets of the business.  Repayment is expected from the cash flows of the business.  A weakened economy, and resultant decreased consumer spending, may have an effect on the credit quality in this segment.

Consumer loans:  Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.

A substantial portion of the loan portfolio consists of loans to borrowers in southern and coastal areas of New Hampshire.  The ability of the Bank’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in these areas.

Origination Fees and Costs

Loan origination fees and direct origination costs are deferred and amortized over the life of the related loan on the level yield method.  Amortization ceases while loans are on nonaccrual status.  The Bank does not anticipate prepayments in determining the amortization but recognizes the amortization at the time of prepayment.

11

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

Loan Servicing

The Bank recognizes as separate assets the rights to service mortgage loans for others, and performs an assessment of capitalized mortgage servicing rights for impairment, based on the current fair value of those rights.  The Bank capitalizes mortgage servicing rights at their fair values upon the sale of the related loans.  Capitalized mortgage servicing rights are amortized in proportion to, and over the period of, estimated future net servicing income.  Fair values are estimated using bid quotations received from dealers for similar instruments.  For purposes of measuring impairment, the rights are stratified, as necessary, based on interest rates and the expected maturities of the underlying loans.

Federal Home Loan Bank Stock

Stock in the Federal Home Loan Bank (FHLB) is a required investment due to membership in FHLB, and is carried at cost and can be redeemed at the FHLB subject to current redemption policies.

Other Real Estate Owned (OREO)

Collateral acquired through foreclosure is recorded at fair value, less estimated costs to sell, at the time of acquisition.  The excess, if any, of the loan balance over the fair value of the property at the time of transfer from loans to OREO, is charged to the allowance for loan losses.  Subsequent declines in the fair value of the properties are recorded as noninterest expense.  Net operating income or expense related to foreclosed property is included in noninterest expense in the accompanying statements of income.  There are inherent uncertainties in the assumptions with respect to the estimated fair value of other real estate owned, and the amounts ultimately realized on other real estate owned may differ from the amounts reflected in the accompanying financial statements.  There was no OREO at December 31, 2018 and 2017.

Bank Premises and Equipment

Bank premises and equipment are stated at cost less accumulated depreciation.  Depreciation is computed by the straight-line method over the estimated useful lives of the assets.  Leasehold improvements are amortized over the shorter of the expected lease term or the estimated useful life.  Maintenance and repairs are charged to current expense as incurred and the cost of major renewals and betterments are capitalized.

Income Taxes

The Bank follows the asset and liability method of accounting for income taxes, whereby 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.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  If it is not determined that realization of the deferred tax assets is more likely than not to occur, then a valuation allowance is established.  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.  See note 9 for additional information.

12

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

Assets and liabilities are established for certain tax positions taken or positions expected to be taken in income tax returns when such positions are judged to not meet the “more-likely-than-not” threshold, based upon the technical merits of the position.  Estimated interest and penalties, if applicable, related to uncertain tax positions are included as a component of income tax expense.  Management has determined that the Bank has not taken, nor does it expect to take, any uncertain tax positions in any income tax return.

Advertising and Marketing Expense

Advertising and marketing costs are expensed as incurred.  Advertising and marketing expense was approximately $305,000 and $393,800 in 2018 and 2017, respectively.

Stock-Based Compensation

Stock-based compensation represents the cost related to stock-based awards to employees and directors.  The Bank measures stock-based compensation cost at the grant date based upon the estimated fair value of the award, and recognizes the cost as expense on a straight-line basis over the employee requisite service period.  Forfeitures are recognized as they occur.  The Bank estimates the fair value of stock options using the Black-Scholes valuation method.

Statement of Cash Flows

For the purpose of reporting cash flows, cash and cash equivalents includes cash and due from banks, interest-bearing deposits in other banks with an original maturity of three months or less and federal funds sold.

Comprehensive Income

The only component of other comprehensive income reported in the accompanying statements of comprehensive income and of accumulated other comprehensive loss on the balance sheets is the unrealized net holding gains or losses on securities available-for-sale, net of tax.  Components of accumulated other comprehensive loss are presented net of taxes, which are determined using a 27.5% tax rate.

Transfers of Financial Assets

Transfers of an entire financial asset, a 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 Bank, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets.

13

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

During the normal course of business, the Bank may transfer a portion of a financial asset, for example, a participation loan or the government-guaranteed portion of a loan.  In order to be eligible for sales treatment, the transfer of the portion of the loan must meet the criteria of a participating interest.  If it does not meet the criteria of a participating interest, the transfer must be accounted for as a secured borrowing.  In order to meet the criteria for a participating interest, all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder has the right to pledge or exchange the entire loan.

Subsequent Events

Events occurring after the balance sheet date are evaluated by management to determine whether such events should be recognized or disclosed in the financial statements.  Management has evaluated subsequent events through February 14, 2019, which is the date the financial statements were available to be issued.

New Accounting Pronouncements

Recognition and Measurement of Financial Instruments

In January 2016 the FASB issued Accounting Standards Update (ASU) 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.  The amendments in this ASU address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.  The more significant changes are:

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OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

ASU 2016-01 is effective for years beginning after December 15, 2018.  Early application of certain amendments within the ASU is permitted for entities not considered public business entities.  The Bank early adopted number 3 above and eliminated certain fair value disclosures for financial instruments measured at amortized cost.  The remaining amendments in ASU 2016-01 will not have a material impact on the Bank’s financial statements.

Accounting for Leases

In February 2016, the FASB issued ASU 2016-02, Leases.  This ASU requires that an operating lease be recognized on the statement of financial condition as a “right-to-use” asset along with a corresponding liability representing the rent obligation.  The asset and liability will initially be measured at the present value of the future lease payments.  The standard is expected to result in an increase to assets and liabilities recognized and, therefore, increase risk-weighted assets for regulatory capital purposes.  The guidance requires the use of the modified retrospective transition approach for existing leases that have not expired before the date of initial application and will become effective for reporting periods beginning after December 15, 2018 for public business entities, and years beginning after December 15, 2019 for all other entities.  Early adoption will be permitted.  The Bank is currently evaluating the impact of the pronouncement on its financial statements.

Credit Losses

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses.  This significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income.  In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses.  The standard will replace today’s “incurred loss” approach with an “expected loss” model.  The new model, referred to as the current expected credit loss (CECL) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures.  This includes, but is not limited to, loans, leases, held to maturity securities, loan commitments, and financial guarantees.  The CECL model does not apply to available-for-sale (AFS) debt securities.  For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities.  As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income, as they do today.  The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans.  It also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan losses.  In addition entities will need to disclose the amortized cost balance of each class of financial asset by credit quality indicator, disaggregated by year of origination.  The standard is effective for the Bank interim and annual reporting periods beginning after December 15, 2021 with early adoption permitted for periods beginning after December 15, 2018.  Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first period in which the guidance is effective.  The Bank is currently evaluating the provisions of the standard to determine the potential impact the new standard will have on its financial statements.

15

The carrying amounts and fair value of debt securities available-for-sale at December 31, 2018, by contractual maturity, are shown below.  Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties:

16

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

The following tables show the Bank’s gross unrealized losses and fair value of securities available for sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2018 and 2017:

The primary cause for unrealized losses within debt securities is the impact movements in market interest rates have had in comparison to the underlying yields on securities and the impact of temporary market fluctuations.  No declines are deemed to be other than temporary and management has the intent and ability to hold depreciated debt securities until recovery or maturity.  All GNMA and SBA securities are backed by the full faith and credit of the United States as to timely payment of principal and interest.

For the year ended December 31, 2018, proceeds from the sales of available-for-sale securities amounted to $3,498,563.  Gross realized gains on those sales amounted to $22,272.  For the year ended December 31, 2017, proceeds from the sales of available-for-sale securities amounted to $2,006,705.  Gross realized gains on those sales amounted to $1,939.

At December 31, 2018, approximately $2,726,000 (fair value) of government-sponsored enterprise obligations have been pledged to secure customer repurchase agreements.

At December 31, 2017, approximately $8,181,000 (fair value) of government-sponsored enterprise obligations and a U.S. Treasury security of $498,000 (fair value) have been pledged to secure customer repurchase agreements.

17

At December 31, 2018 and 2017, certain officers and directors, or their companies, were indebted to the Bank or have available credit in the aggregate amounts of approximately $3,172,000 and $3,193,000, respectively.

Residential mortgage loans serviced for others are not included in the accompanying balance sheets.  The unpaid principal balance of mortgage loans serviced for others was approximately $42,945,000 and $37,951,000 at December 31, 2018 and 2017, respectively.

The amortized cost of mortgage servicing rights (included in other assets) at December 31, 2018 and 2017, of approximately $402,000 and $357,000, respectively, approximates the fair value and no valuation allowance for impairment has been recorded.  Mortgage servicing rights of approximately $145,000 were capitalized in 2018.  There were no mortgage servicing rights capitalized in 2017.  Amortization of mortgage servicing rights was approximately $100,000 and $144,000 in 2018 and 2017, respectively.

18

OPTIMA BANK & TRUST COMPANY

NOTES TO FINANCIAL STATEMENTS

December 31, 2018 and 2017

The following table presents the activity in the allowance for loan losses and select loan information by portfolio segment for the year ended December 31, 2018: