COMMUNITY BANCORP /VT - Quarter Report: 2002 September (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2002
Commission File Number 000-16435

COMMUNITY BANCORP.

(Exact Name of Registrant as Specified in its Charter)

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 12 months (or for such shorter period that the Registrant was required to file for 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 Rule 12b-2 of the Exchange Act).  Yes ( )  No (X)

At October 21, 2002 there were 3,558,088 shares outstanding of the Corporation's common stock.

Total Pages - 24 Pages

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited)

The following are the consolidated financial statements for Community Bancorp. and subsidiaries, "the Company".

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION AND CONSOLIDATION

     The interim consolidated financial statements of Community Bancorp. and subsidiaries are unaudited. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments necessary for fair presentation of the financial condition and results of operations of the Company contained herein have been made. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2001, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

NOTE 2. RECENT ACCOUNTING DEVELOPMENTS

     The FASB recently issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting, and prohibits the use of the pooling-of-interests method for such transactions. The new standard also requires identified intangible assets acquired in a business combination be recognized as an asset apart from goodwill if they meet certain criteria. Adoption of SFAS No. 141 has had no material impact on the Company's consolidated financial statements.

     SFAS No. 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill, including that acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually. The effect of the adoption of SFAS No. 142 is disclosed in this report in the section labeled "Other Operating Income and Expenses".

     The FASB has also issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. SFAS No. 144 amends accounting and reporting standards for the disposal of segments of a business and addresses various issues related to the accounting for impairments or disposals of long-lived assets. The provisions of SFAS No. 144 are effective for the Company's fiscal year ending December 31, 2002. The Company is currently assessing the financial statement impact of this pronouncement and does not believe that the statements will have a material adverse effect upon its financial condition or the results of operations.

NOTE 3. EARNINGS PER SHARE

Earnings per common share amounts are computed based on the weighted average number of shares of common stock outstanding during the period (retroactively adjusted for stock splits and stock dividends) and reduced for shares held in treasury. The assumed conversion of subordinated debentures does not result in material dilution.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Nine Months Ended September 30, 2002

     Forward-looking statements are not guarantees of future performance. They necessarily involve risks, uncertainties and assumptions. Future results of the Company may differ materially from those expressed in these forward-looking statements. Although these statements are based on management's current expectations and estimates, many of the factors that could influence or determine actual results are unpredictable and not within the Company's control. In addition, the Company does not undertake to, and disclaims any obligation to, publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence or anticipated occurrence of events or circumstances after the date of this Report. The Company claims the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995.

     Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities: (1) competitive pressures increase among financial services providers in the Company's northern New England market area or in the financial services industry generally, including competitive pressures from nonbank financial service providers, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; (2) interest rates change in such a way as to reduce the Company's margins; (3) general economic or monetary conditions, either nationally or regionally, are less favorable than expected, resulting in a deterioration in credit quality or a diminished demand for the Company's products and services; and (4) changes in laws or government rules, or the way in which courts interpret those laws or rules, adversely affect the Company's business.

     Community Bancorp. (the "Company") is a bank holding company headquartered in Derby, Vermont, which has one operating commercial bank subsidiary, Community National Bank (the "Bank"). The Bank is a commercial banking institution, which offers a full range of retail banking services to residents and businesses in northeastern and north central Vermont. The Bank has eight offices, five of which are located in Orleans County, one in Essex County, one in Caledonia County and the newest office, located in Washington County.

     The Company also owns all of the stock of Liberty Savings Bank ("Liberty"), an inactive New Hampshire guaranty savings bank charter. Liberty has no substantial assets and does not have any offices or deposit taking authority and there are currently no plans to activate this charter.

     Prior to March 31, 2002 Community National Bank operated a trust department through which it offered personal fiduciary services. As of such date, the Bank transferred its trust operations to a newly formed Vermont-chartered nondepository trust and investment management affiliate, Community Financial Services Group, LLC based in Newport, Vermont ("CFSG"). The Bank's ownership interest in CFSG is held indirectly, through Community Financial Services Partners, LLC, a Vermont limited liability company ("Partners"), which owns 100% of the limited liability company equity interests of CFSG. On April 1, 2002, the Bank sold a one-third interest in Partners to each of the National Bank of Middlebury, in Middlebury, Vermont and Guaranty Bancorp, Inc., the bank holding company parent of Woodsville Guaranty Savings Bank, Woodsville, New Hampshire. As of such date the Bank retained a one-third ownership interest in Partners and, indirectly, in CFSG. Partners and CFSG are not consolidated subsidiaries of the Company.

     Substantially all of the Company's business is conducted through Community National Bank; therefore, the following narrative is based primarily on the Bank's operations. The balance sheet and statements of income preceding this section are consolidated figures for Community Bancorp. and subsidiaries and should be read in conjunction with the other information and reports following them to provide a more detailed comparison of the information disclosed in the following narrative.

RESULTS OF OPERATIONS

     Net income for the third quarter ended September 30, 2002 was $801,209, representing an increase of 22.4% and 26.7%, respectively, over the net income figures of $654,867 for the third quarter ended September 30, 2001, and $632,348 for the same period in 2000. The results of this are earnings per share of $0.23 for the third quarter of 2002 and $0.18 for each of 2001 and 2000. The third quarter of 2002 was profitable due in part to a decrease in interest expense, as well as an increase in non interest income attributable to the heavy volume of loans sold into the secondary market. Net income of $2.4 million for the first nine months of 2002 resulted in increases 32.5% and 38%, respectively compared to $1.8 million for the same period in 2001 and $1.7 million in 2000. Earnings per share of $0.67, $0.50, and $0.48, respectively, were reported for 2002, 2001, and 2000. The first nine months of 2002 have been very profitable compared to 2001 and 2000, due to the issues mentioned above as well as income of $617,355 generated through the sale of the Bank's trust operations mentioned above, and in the previous 10-Q report filed for June 30, 2002. As a result of a 5% stock dividend paid in February 2001, all per share information for 2000 cited in this report has been restated. The Company paid a cash dividend of $0.16 per share August 1, 2002 to shareholders of record as of July 15, 2002.

     Net interest income, the difference between interest income and expense, represents the largest portion of the Company's earnings, and is affected by the volume, mix, and rate sensitivity of earning assets as well as by interest bearing liabilities, market interest rates and the amount of non-interest bearing funds which support earning assets. Tables A and B at the end of this narrative provide a visual comparison for each period. Figures presented on these two reports are consolidated and are stated on a tax equivalent basis assuming a federal tax rate of 34%.

     Net interest income for the third quarter comparison period was almost $3 million for 2002 compared to $2.6 million for 2001, resulting in an increase of 11.6%. Total interest income for the third quarter decreased $128,972 or by 2.7% from $4.7 million in 2001 to $4.6 million in 2002. Interest expense decreased $437,179 or by almost 21% from $2.1 million in 2001 to $1.6 million in 2002. A review of the third quarter figures for interest earned on loans, the major source of interest income, reveals a decrease of $278,145 or 7.1% for 2002 compared to 2001. In comparison, interest paid on deposits, the major source of interest expense, shows a decrease of $404,288 or 21.3% for the same comparison period. Net interest income for the nine months comparison period was $8.6 million for 2002 compared to $7.6 million for 2001, an increase of $1.0 million or 13.8%. Total interest income for the first nine months of 2002 decreased $494,063, or 3.5%, from $14.3 million to $13.8 million. These figures convert to tax equivalent interest income of $14.1 million and $14.5 million for the first nine months of 2002 and 2001, respectively. Although a substantial increase is noted in the average volume of loans compared to the first nine months of 2001, a decrease of 127 basis points is noted in the average yield, contributing to the decrease in income. In comparison, an increase is noted in the average volume of interest bearing accounts, while the rate paid on these accounts has decreased 145 basis points, with time deposits accounting for most of the decrease in interest expense. As a result of these changes, the tax equivalent spread for the first nine months increased 17 basis points to 3.85% for 2002 versus 3.68% for 2001.

CHANGES IN FINANCIAL CONDITION

     The Company had total average assets of $291 million at September 30, 2002 and $259 million at December 31, 2001. Average earning assets were $279 million for the period ended September 30, 2002, including average loans of $194 million and average investment securities of $81 million. Average earning assets were $249 million for the year ended December 31, 2001 including average loans of $182 million and average investment securities of $58 million. An increase in available for sale agencies as well as municipal investments accounts for a substantial portion of the increase in investment securities.

     Average interest bearing liabilities at September 30, 2002 were $235 million, with average time deposits reported totaling $99 million and NOW & money market funds of $80 million. At December 31, 2001, average interest bearing liabilities of just over $209 million were reported including average time deposits of $99 million and NOW & money market funds at $57 million. An increase in municipal deposits, from the new collateralized deposit product as discussed below, accounts for most of the increase in NOW & money market funds, as well as the decrease in repurchase agreements.

RISK MANAGEMENT

Liquidity Risk - Liquidity management refers to the ability of the Company to adequately cover fluctuations in assets and liabilities. Meeting loan demand (assets) and covering the withdrawal of deposit funds (liabilities) are two key components of the liquidity management process. The repayment of loans and growth in deposits are two of the major sources of liquidity. Other time deposits increased almost $2 million as of the end of the first nine months of 2002, while time deposits greater than $100,000 increased $3 million. A review of these deposits indicates that they are primarily generated locally and regionally and are established customers of the Company. The Company has no brokered deposits. Competitive time deposit rates and offerings have helped to increase these funds. Now and money market funds increased $3 million from December 31, 2001 to end the first nine months of 2002 to a balance of $79.7 million. The Company began offering a new interest bearing collateralized deposit account to its municipal account holders during the last part of 2001. This account has been well received during 2002, contributing to the increase in NOW and money market funds. Savings accounts increased $3.6 million for the first nine months of 2002, despite the less than favorable rates. The Company's in house loan portfolio has increased $8.7 million over the last nine months, and the investment portfolio increased $9.6 million for the same time period. As of September 30, 2002, the Company held in its investment portfolio securities classified as "Available for Sale" at a fair value of $39.6 million, compared to $32.5 million as of December 31, 2001, an increase of $7.1 million or 22%. Securities classified as "Held to Maturity" ended the first nine months of 2002 at a book value of just over $43 million compared to almost $41 million as of the end of the 2001 calendar year. Both of these types of investments mature at monthly intervals as shown on the gap report at the end of this section. Securities classified as "Restricted Equity Securities" are made up of equity securities the Company is required to maintain in the form of Federal Home Loan Bank of Boston (FHLB) and Federal Reserve Bank stock. FHLB stock increased $84,400, increasing the combined stock balance to $1.3 million as of September 30, 2002.

     The Company has a credit line with FHLB with an available balance of $4.3 million. Interest is chargeable at a rate determined daily of approximately 25 basis points higher than the rate paid on fed funds sold. Additional borrowing capacity of approximately $103 million is available through the FHLB, which is secured by the Company's qualifying loan and investment portfolio. As of September 30, 2002, the Company has advances of just over $10 million against the $103 million in borrowing authority at FHLB, with no advances against the $4.3 million. Under a separate agreement, the Bank has the authority to collateralize public unit deposits, up to its FHLB borrowing capacity ($103 million less outstanding advances) with letters of credit issued by FHLB. At September 30, 2002, approximately $31 million was pledged as collateral for these deposits. Interest is charged to the Bank quarterly based on the average daily balance outstanding on these collateralized deposits at a rate of 20 basis points. At September 30, 2002, an average daily balance of approximately $3.8 million was reported.

Credit Risk - A primary concern of management is to reduce the exposure of credit loss within the portfolio. Management follows established underwriting guidelines, and any exceptions to policy must be approved by a lender with higher authority than the lender originating the loan. The adequacy of the loan loss coverage is reviewed quarterly by the risk management committee of the Board of Directors. This committee meets to discuss, among other matters, potential exposures, historical loss experience, and overall economic conditions. Existing or potential problems are noted and addressed by senior management in order to assess the risk of probable loss or delinquency. A variety of loans are reviewed periodically by an independent firm in order to assure accuracy of the Banks internal risk ratings and compliance with various internal policies and procedures, as well as those set by the regulatory authorities. The Bank also employs a Credit Administration Officer whose duties include, among others, a review of the loan portfolio including delinquent and non-performing loans.

     Specific allocations are made in situations management believes may represent a greater risk for loss. A quarterly review of various qualitative factors, including levels of, and trends in, delinquencies and non-accruals and national and local economic trends and conditions, helps to ensure that areas with potential risk are noted and coverage increased or decreased to reflect the trends in delinquencies and non-accruals. Residential first mortgage loans make up the largest part of the loan portfolio and have the lowest historical loss ratio helping to alleviate the overall risk.

Allowance for loan losses and provisions - The valuation allowance for loan losses of $2.2 million as of September 30, 2002 composed 1.1% of the total gross loan portfolio. As of such date, the Company maintained a residential loan portfolio of approximately $117 million and a commercial real estate portfolio of approximately $43 million. The total portfolio of approximately $160 million of real estate secured mortgages accounted for almost 80% of the total loan portfolio at September 30, 2002, and together with the low historical loan loss experience in these portfolios, helps to support the Company's basis for loan loss coverage.

     Non-Performing assets for the company are made up of three different types of loans, "90 Days or More Past Due", "Other Real Estate Owned" (OREO), and "Non-Accruing Loans". A comparison of these non-performing assets reveals a decrease for the first nine months of 2002 in non-accruing loans of $329,642, while an increase of $333,504 is noted in loans 90 days or more past due, and the Company's OREO portfolio increased $10,259 compared to the respective totals at December 31, 2001. The portfolio of non-accruing loans makes up the biggest portion of the non-performing assets and, as of September 30, 2002, $1.22 million or 98% were real estate secured mortgage loans, thereby reducing the exposure to loss.

Non-performing assets as of September 30, 2002 and December 31, 2001 were as follows:

     Other real estate owned is made up of property that the Company has acquired by deed in lieu of foreclosure or through normal foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The value of the property is determined prior to transferring the balance to other real estate owned. The balance transferred to OREO is the lesser of the appraised value of the property, less cost to sell, or the book value of the loan. A write-down may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals are then done periodically thereafter charging any additional write-downs to the appropriate expense account.

Market Risk and Asset and Liability Management - Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. The Company's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. To that end, management actively monitors and manages its interest rate risk exposure. The Company does not have any market risk sensitive instruments acquired for trading purposes. The Company attempts to structure its balance sheet to maximize net interest income while controlling its exposure to interest rate risk. The Company's Asset/Liability Committee formulates strategies to manage interest rate risk by evaluating the impact on earnings and capital of such factors as current interest rate forecasts and economic indicators, potential changes in such forecasts and indicators, liquidity, and various business strategies. The Asset/Liability Committee's methods for evaluating interest rate risk include an analysis of the Company's interest rate sensitivity "gap", which provides a static analysis of the maturity and repricing characteristics of the entire balance sheet, and a simulation analysis which calculates projected net interest income based on alternative balance sheet and interest rate scenarios, including "rate shock" scenarios involving immediate substantial increases or decreases in market rates of interest.

Interest Rate Sensitivity "Gap" Analysis - An interest rate sensitivity "gap" is defined as the difference between the interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market interest rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category.

     The following tables set forth the estimated maturity or repricing of the Company's interest earning assets and interest-bearing liabilities at September 30, 2002, and December 31, 2001. The Company prepares its interest rate sensitivity "gap" analysis by scheduling assets and liabilities into periods based upon the next date on which such assets and liabilities could mature or reprice. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual term of the assets and liabilities, except that:

     Management believes that these assumptions approximate actual experience and considers them reasonable. However, the interest rate sensitivity of the Company's assets and liabilities in the tables could vary substantially if different assumptions were used or actual experience differs from the historical experiences on which the assumptions are based.