COMMUNITY BANCORP /VT - Quarter Report: 2003 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2003

OR

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

For the transition period from                to                 

Commission File Number 000-16435

COMMUNITY BANCORP.

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 November 6, 2003, there were 3,789,084 shares outstanding of the Corporation's common stock.

Total Pages - 28 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, 2002, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

NOTE 2. GOODWILL

     Statement of Financial Accounting Standards (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 Company chose to expense the remainder of the goodwill associated with the acquisition of Liberty Savings Bank during the second quarter of 2002. The result was an expense before taxes of $245,575.

NOTE 3.  RECENT ACCOUNTING DEVELOPMENTS

     The amendment requires contracts with comparable characteristics be accounted for similarly. SFAS No. 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 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.

     SFAS No. 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 SFAS No. 149 that relate to SFAS No. 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 was implemented during the second quarter of 2003 and did not have a material effect on the consolidated financial statements.

     FASB derivative implementation guidance for SFAS No. 133 clarifies that loan commitments relating to the origination of mortgage loans that will be held for resale must be accounted for as derivative instruments in accordance with SFAS No. 133. Accordingly, on June 30, 2003, the Company recorded an account receivable of $217,845 representing the estimated fair value of these loan commitments. As of September 30, 2003, the estimated fair value of these loan commitments was $76,393.

     In May 2003, FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 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 SFAS No. 150 apply to issuers' classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract.

     SFAS No. 150 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 SFAS No. 150 and still existing at the beginning of the interim period of adoption.

SFAS No. 150 is not expected to have a material effect on the Company's consolidated financial statements.

NOTE 4.  TOTAL COMPREHENSIVE INCOME

The calculation for computing total comprehensive income for the two comparison periods is as follows:

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 Period Ended September 30, 2003

     The Company's Management's Discussion and Analysis of Financial Condition and Results of Operations may contain certain forward-looking statements about the Company's operations, financial condition and business. When used therein, the words "believes," "expects," "anticipates," "intends," "estimates," "plans," "predicts," or similar expressions, indicate that management of the Company is making forward-looking statements.

     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. Examples of forward looking statements included in this discussion include, but are not limited to, estimated contingent liability related to the Company's participation in the FHLB Mortgage Partnership Finance (MPF) program, assumptions made within the asset/liability management process, and management's expectations as to the future interest rate environment and the Company's related liquidity level. 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. Readers are cautioned not to place undo reliance on such statements as they speak only as of the date they are made. 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 nine offices, five of which are located in Orleans County, one in Essex County, one in Caledonia County and two located in Washington County. The newest office is located in the city of Barre, and is set up in a temporary office on the site adjacent to the permanent office site, presently under construction, with the permanent office scheduled to open in December.

     Prior to September 11, 2003, the Company owned all the stock of Liberty Savings Bank, an inactive New Hampshire guaranty savings bank charter, with a book value of $300,000 as of such date. On September 11, 2003, the Company sold its stock interest as well as the charter for Liberty Savings Bank for $307,500.

     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, statements of income, and statements of cash flow preceding this section are consolidated figures for Community Bancorp. and subsidiaries and should be read in conjunction with the notes and other information and reports following them to provide a more detailed comparison of the information disclosed in the following narrative.

CRITICAL ACCOUNTING POLICIES

     The Company's critical accounting policies are considered to be the allowance for loan losses and accounting for significant estimates, including valuation of real estate acquired in foreclosure or satisfaction of loans, and accounting for taxes and deferred taxes as described below.

Use of estimates

     The preparation of consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ materially from those estimates.

     Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans and deferred tax assets. In connection with the determination of foreclosed real estate, management often obtains independent appraisals for significant properties. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The amount of the change that is reasonably possible cannot be estimated.

     Management uses available information to recognize losses on loans, foreclosed real estate, and periodic additions to the allowances for loan loss. However, recognition of additional loan losses and additions to the allowance may be necessary based on changes in local economic conditions or other factors beyond the Company's control. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowances for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.

Allowance for loan losses

     The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management's periodic evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries.

     Income before income taxes of $1.29 million was reported for the third quarter of 2003 compared to $1.04 million for 2002, resulting in an increase of $247,151, or 23.7%. Income before income taxes for the first nine months of 2003 was $3.88 million compared to $3.19 million for 2002, an increase of $682,810 or 21.4%. Net income for the third quarter ended September 30, 2003 was just over $1 million, representing an increase of 24.9% over net income of $801,209 for the third quarter ended September 30, 2002. Net income was just under $3 million for the first nine months of 2003 compared to $2.37 million for the same period in 2002, an increase of $632,934 or 26.8%. This results in earnings per share of $0.27 and $0.21, respectively, for the third quarter of 2003 and 2002, and $0.80 and $0.63, respectively, for the first nine months of 2003 and 2002. Although the volume of loans sold on the secondary market decreased during the third quarter of 2003, the income generated through the sale and servicing of these loans continues to be more favorable than expected contributing to the increase in income for this period.

     Return on average assets (ROA), which measures how effectively a corporation uses its assets to produce earnings, reported ratios of 1.25% and 1.06%, respectively, for the third quarter ended 2003 and 2002, as well as 1.29% and 1.09%, respectively for the first nine months of 2003 and 2002. Return on average equity (ROE), which is the ratio of income earned to average shareholders' equity was 14.45% for the third quarter of 2003 compared to 13.20% for same period in 2002, and 14.59% and 13.13%, respectively for the first nine months of 2003 and 2002.

INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME)

     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 below provide a visual comparison for each period. Figures presented on these two tables are consolidated and are stated on a tax equivalent basis assuming a federal tax rate of 34%.

     The following table is intended to show the reconciliation between net interest income presented on the statement of income and the tax equivalent net interest income presented on Table A below for the nine months comparison period of 2003 and 2002.

     Total interest income for the first nine months decreased $501,914, or by 3.6%, from $14.1 million in 2002 to $13.6 million in 2003. Interest expense decreased approximately $1 million or by 20.4% from $5.1 million in 2002 to $4.1 million in 2003. Interest earned on the loan portfolio accounts for approximately 79% of total interest income reporting only a slight decrease in income for 2003 compared to 2002. In comparison, interest paid on time deposits comprises 61% of total interest expense, with a decrease of $302,910 or almost 11% for the same comparison period. Although an increase is noted in the average volume of earning assets for the first nine months of 2003 compared to the same period of 2002, a decrease of 63 basis points is noted in the average yield, contributing to the decrease in income. The average volume of interest bearing liabilities increased, while the rate paid on these accounts decreased 72 basis points. The net effect was an increase of $539,521 in net interest income for the first nine months of 2003 compared to the same period in 2002.

CHANGES IN FINANCIAL CONDITION

     The Company had total average assets of approximately $311 million at September 30, 2003 and $296 million at December 31, 2002. Average earning assets were $296 million for the nine month period ended September 30, 2003, including average loans of $205 million and average investment securities of $88 million. Average earning assets were $283 million for the year ended December 31, 2002 including average loans of $197 million and average investment securities of $81 million.

     Average interest bearing liabilities at September 30, 2003 were $247 million, with average time deposits reported totaling $103 million and NOW & money market funds of $86 million. At December 31, 2002, average interest bearing liabilities of $238 million were reported including average time deposits of $100 million and NOW & money market funds at $82 million. An increase in municipal deposits during the last quarter of 2002, attributable to a new collateralized municipal deposit account mentioned below, helped to boost the average volume on these deposit accounts for the first nine months of 2003. The seasonal increase during the third quarter of 2003 also contributed to this increase.

     Total other operating income for the third quarter of 2003 was $768,058 compared to $731,163 for the same period in 2002, an increase of $36,895, or 5%. Total other operating income for the first nine months amounted to $2.7 million for 2003 compared to $2.6 million for 2002, an increase of $107,579 or just over 4%. In 2003, the Company sold four of its investments from the Corporate Bond portfolio netting a gain before taxes of $132,312 accounting for the increase. Income generated through the sale and servicing of loans sold to the secondary market for the first nine months of 2003 constitutes a large portion of other income with figures of $1.3 million for the first nine months of 2003 compared to $636,445 for 2002. The sale of the Company's Trust Operations in 2002 offset the increase in servicing income for 2003.

     Total other operating expenses for the third quarter comparison periods increased to $2.7 million for 2003 from $2.6 million for 2002, with salaries accounting for 38% of total operating expenses, as well as the biggest increase of $152,917 or 17.2% for 2003 versus 2002. The opening of the Barre branch mentioned earlier attributes to a portion of this increase. Other expenses accounts for 34% of total operating expenses, and notes a decrease of $56,442 for the comparison periods. Total other operating expenses of $7.9 million and $7.8 million are reported for the first nine months of 2003 and 2002, respectively. The only decrease for the comparison period was in other expenses. Losses on the Company's investment in Limited Partnerships for affordable housing (explained below) totaled $298,741 for 2003 compared to $400,500 for 2002 accounting for a portion of the decrease in other expense for the first nine months of 2003 compared to 2002. Additionally, in 2002, the Company chose to expense the remaining goodwill associated with the acquisition of the Liberty Savings Bank charter amounting to $245,575.

     Management monitors all components of other operating expenses; however, a quarterly review is performed to assure that the accruals for these expenses are accurate. This helps alleviate the need to make significant adjustments to these accounts that in turn affect the net income of the Company.

APPLICABLE INCOME TAXES

     Provisions for income taxes increased $47,772 with figures of $289,672 for the third quarter of 2003 versus $241,901 for the same period in 2002. Provisions for income taxes for the first nine months were reported at $877,956 for 2003 and $828,080 for 2002.

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 decreased $528,497 as of the end of the first nine months of 2003, while time deposits greater than $100,000 increased $978,203. A review of these deposits indicates that they are primarily generated locally and regionally and are established customers of the Company. Savings accounts increased $4.8 million, despite the decrease in the rate earned on these funds. The Company experienced a decrease in municipal deposit accounts during the first three months of 2003, and then as anticipated, due to normal municipal tax collection cycles, began to increase during the second and third quarter of 2003.

     The Company believes that a portion of the increase in deposits is due to the current economic environment, as customers seek a safe haven for their money. This has created a high level of liquidity that the Company considers temporary. The Company has purchased assets, primarily 3-5 year Government Agency securities, attempting to maximize yields and maintain adequate liquidity.

     In January of 2003, the Company entered into an agreement with Promontory Interfinancial Network making it possible to offer FDIC Insured deposits beyond the $100,000 limit. This Certificate of Deposit Account Registry Service (CDARS) uses a deposit-matching engine to match CDARS deposits in other participating banks, dollar- for-dollar. This product is designed to enhance customer attraction and retention, build deposits and improve net interest margins, while providing additional FDIC coverage to customers. Promontory now offers member banks an opportunity to participate with one-way orders. Banks can either accept deposits as a surplus bank or invest in CDARS offered by banks seeking funding without matching funds.

     Due to the nature of the placement of funds, CDARS deposits are defined as "brokered deposits". It has always been the Company's policy not to accept brokered deposits. The Company's Asset Liability policy now states that the Company will not accept brokered deposits other than through the CDARS program in the Promontory Interfinancial Network.

     During the first quarter, the Company had placed three test-Certificates of Deposit in the CDARS program. These were short-term and matured during the reporting period. As of September 30, 2003, the Company reported a total balance of $212,000 in this product, $97,000 as a test CD, and $115,000 as surplus funds. The Company will continue to monitor the development of this product closely and manage any associated risk accordingly.

     The Company's in house loan portfolio decreased $929,185 over the last nine months, while the investment portfolio increased a total of $17 million for the same time period. As of September 30, 2003, the Company held in its investment portfolio securities classified as "Available for Sale" at a fair value of $48.5 million, compared to $41 million as of December 31, 2002, an increase of $7.4 million or 18%. Securities classified as "Held to Maturity" ended the first nine months of 2003 at a book value of $48.6 million compared to just under $39.0 million as of the end of the 2002 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 $47,800, increasing the combined restricted stock balance to $1.4 million as of September 30, 2003.

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 the 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 Company's internal risk ratings and compliance with various internal policies and procedures, as well as those set by the regulatory authorities. The Company also employs a Credit Administration Officer whose duties include monitoring and reporting on the status of the loan portfolio including delinquent and non-performing loans.

     Specific allocations are made in the allowance for loan losses 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 mortgage loans make up the largest part of the loan portfolio and have the lowest historical loss ratio helping to alleviate the overall risk.