COMMUNITY BANCORP /VT - Quarter Report: 2003 June (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 June 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 August 12, 2003 there were 3,777,686 shares outstanding of the Corporation's common stock.

Total Pages - 52 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.  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 the allowances for losses on loans and foreclosed real estate, management 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.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances 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.

NOTE 4.  RECENT ACCOUNTING DEVELOPMENTS

In April 2003, Financial Accounting Standards Board (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.

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 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 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, the Company recorded an asset and related income of $217,845 representing the fair value of these loan commitments as of June 30, 2003.

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.

NOTE 5.  TOTAL COMPREHENSIVE INCOME

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 June 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. 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 town 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 November.

     The Company also owns all of the stock of Liberty Savings Bank ("Liberty"), an inactive New Hampshire guaranty savings bank charter. The Company is negotiating a sale of this charter, which expects to complete during the third quarter of 2003.

     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 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 accounting policies the Company feels are most important are discussed in Note 3 of the Notes to Consolidated Financial Statements.

RESULTS OF OPERATIONS

     Income before income taxes of $1.38 million was reported for the second quarter of 2003 compared to $1.39 million for 2002, resulting in a decrease of $9,664. Income before income taxes for the first six months of 2003 was $2.59 million compared to $2.15 million for 2002, an increase of $435,660 or 20.3%. Net income for the second quarter ended June 30, 2003 was $1.1 million, representing an increase of 14.8% over the net income figure of $948,460 for the second quarter ended June 30, 2002. Net income was just under $2 million for the first six months of 2003 compared to $1.56 million for the same period in 2002, an increase of $433,554 or 27.7%. The results of this are earnings per share of $0.29 and $0.25, respectively for the second quarter of 2003 and 2002, and $0.53 and $0.42, respectively for the first six months of 2003 and 2002. Among other factors discussed throughout this narrative, the volume of loans sold on the secondary market continues to be more favorable than expected contributing to the increase in income for both periods.

     Return on average assets (ROA), which measures how effectively a corporation uses its assets to produce earnings, reported ratios of 1.42% and 1.32%, respectively for the second quarter ended 2003 and 2002, as well as 1.31% and 1.10%, respectively for the first six months of 2003 and 2002. Return on average equity (ROE), which is the ratio of income earned to average shareholders' equity was 16.18% for the second quarter of 2003 compared to 15.96% for same period in 2002, and 15.16% and 13.31%, respectively for the first six 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 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%.

As shown in the table below, net interest income on a tax equivalent basis for the six months comparison period was $6.2 million for 2003 compared to $5.9 million for 2002.

     The tax equivalent net interest spread, defined as the difference between the yield on earning assets and the rate paid on interest bearing liabilities, was 3.86% for both comparison periods. The interest differential, defined as net interest income divided by average earning assets, was 4.23% and 4.33%, for the respective comparison periods.

     Total interest income for the first six months decreased $426,278 or by 4.5% from $9.4 million in 2002 to $9.0 million in 2003. Interest expense decreased $682,059 or by 19.6% from $3.5 million in 2002 to $2.8 million in 2003. Interest earned on the loan portfolio accounts for approximately 70% of total interest income reporting a decrease of $122,543 or 1.7% for 2003 compared to 2002. In comparison, interest paid on deposits comprises 93% of total interest expense and shows a decrease of $559,272 or 17.7% for the same comparison period. Although an increase is noted in the average volume of earning assets for the first six months of 2003 compared to the same period of 2002, a decrease of 72 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 as well.

CHANGES IN FINANCIAL CONDITION

     The Company had total average assets of approximately $309 million at June 30, 2003 and $296 million at December 31, 2002. Average earning assets were $294 million for the period ended June 30, 2003, including average loans of $205 million and average investment securities of $84 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. Although the actual balance of the loan portfolio decreased from December 31, 2002 to June 30, 2003, the substantial growth in the loan portfolio during the last quarter of 2002 helped to boost the average volume for the first six months of 2003.

     Average interest bearing liabilities at June 30, 2003 were $246 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, generated from the new collateralized deposit product discussed below, helped to boost the average volume on these deposit accounts for the first six months of 2003.

     Additionally, the Bank experienced a one-day decrease in the balance of NOW and money market accounts on June 30, 2003 as municipal customers paid off their borrowings. These borrowings are classified as securities and are held in the Company's portfolio of held to maturity investments, accounting for the decrease in this line item. Most of these borrowings were renewed on July 1, 2003, thereby increasing both the deposit and loan balances.

     Total other operating income for the second quarter of 2003 was $989,715 compared to $1.2 million for the same quarter in 2002, a decrease of $182,630 or 15.6%. In June 2003, the Company booked income and a related receivable account in the amount of $217,845 in accordance with implementation guidance for SFAS No. 133 mentioned in Note 4 to the Consolidated Financial Statements labeled Recent Accounting Developments. A one-time gain of $617,355 through the sale of the Company's trust operations helped to boost income for the second quarter of 2002. Total other operating income for the first six months amounted to $1.94 million for 2003 compared to $1.87 for 2002. The Company sold four of its investments from the Corporate Bond portfolio netting a gain before taxes of $132,312 contributing to the increase for 2003. Income generated through the sale and servicing of loans sold to the secondary market for the first six months of 2003 constitutes a large portion of other income with figures of $972,158 for the first six months of 2003 compared to $365,711 for 2002.

     In February of 2003, the Company began selling loans under a new program with the Federal Home Loan Bank of Boston (FHLB), the Mortgage Partnership Finance program (MPF). The MPF program offers members a new opportunity to originate and sell investment quality mortgages. While selling loans to the secondary market is not new business for the Company, this partnership with FHLB is different in that the bank shares in the credit risk of each mortgage. These loans meet specific underwriting standards of the FHLB. To date, the Company has funded $11.3 million in loans with MPF.

     Total other operating expenses for the second quarter comparison periods increased to $2.62 million for 2003 from $2.59 million for 2002, with other expenses noting the only decrease for 2003 versus 2002. Expenses of $245,575 were booked in the second quarter of 2002 when the Company chose to expense the remaining goodwill associated with the acquisition of the Liberty Savings Bank charter in 1997. Salaries and wages show the biggest increase due to the opening of the Barre branch mentioned earlier. Total other operating expenses of $5.19 million and $5.16 million, are reported for the first six months of 2003 and 2002, respectively. The only decrease for the comparison period was in other expenses, due in part to trust expense of $34,465 for 2003 versus $95,985 for 2002. Losses on the Company's investment in Limited Partnerships totaled $197,791 for 2003 compared to $225,000 for 2002 further supporting the decrease in other expense for the first six months of 2003 compared to 2002.

     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 decreased $150,085 with figures of $287,451 for the second quarter of 2003 versus $437,536 for the same period in 2002. The decrease in computed tax expense is a result of additional tax advantages attributable to the Limited Partnerships that were booked in June. Provisions for income taxes for the first six months were reported at $588,284 for 2003 and $586,178 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 increased $184,826 as of the end of the first six months of 2003, while time deposits greater than $100,000 increased $736,715. A review of these deposits indicates that they are primarily generated locally and regionally and are established customers of the Company. Savings accounts increased $3.2 million, despite the decrease in the rate earned on these funds. The Company began offering a new interest bearing collateralized deposit account to its municipal account holders during the last part of 2001. This account was well received during 2002, contributing to the increase in NOW and money market funds in that time period. These accounts decreased during the first three months of 2003, and then as anticipated, due to normal municipal tax collection cycles, began to increase during the second quarter of 2003. Despite this progressive increase, the reader will note that NOW and money market funds ended the first six months of 2003 at a balance of $65.9 million, a decrease of almost $23 million compared to December 31, 2002. This is due to the "one-day decrease" mentioned earlier. The Company reports current balances in these accounts at the time of this report totaling approximately $84 million.

     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.

     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 June 30, 2003, the Company reported a total balance of $244,000 in this product. 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 $1.7 million over the last six months, and the investment portfolio decreased a total of $9.9 million for the same time period. As of June 30, 2003, the Company held in its investment portfolio securities classified as "Available for Sale" at a fair value of $47.3 million, compared to $41.1 million as of December 31, 2002, an increase of $6.2 million or 15%. Securities classified as "Held to Maturity" ended the first six months of 2003 at a book value of $22.8 million compared to $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 June 30, 2003.

     The Company has a $4.3 million credit line with FHLB. 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 $95.5 million is available through the FHLB, which is secured by the Company's qualifying loan portfolio. As of June 30, 2003, the Company has advances of just over $5 million against the $95.5 million in borrowing authority at FHLB, and advances of almost $4.3 million against the $4.3 million credit line. Under a separate agreement, the Company has the authority to collateralize public unit deposits, such as the Company's collateralized government agency accounts mentioned above, up to its FHLB borrowing capacity ($95.5 million less outstanding advances) with letters of credit issued by FHLB. At June 30, 2003, approximately $41.5 million was pledged as collateral for these deposits. Interest is charged to the Company quarterly based on the average daily balance outstanding at an annual rate of 20 basis points. At June 30, 2003, an average daily balance of approximately $10.2 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 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.

Allowance for loan losses and provisions - The valuation allowance for loan losses of $2.2 million as of June 30, 2003 composed 1.1% of the total gross loan portfolio. As of such date, the Company maintained a residential loan portfolio of $119 million and a commercial real estate portfolio of almost $42 million, accounting for approximately 79% of the total loan portfolio. This volume, 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". Loans 90 days or more past due totaled $302,631 and accounted for 18% of the total non-performing assets as of June 30, 2003, compared to a volume of $356,874 comprising 18% as of December 31, 2002. Non-Accruing loans made up 78% of these non-performing assets with a balance of $1.3 million, compared to $1.63 million or 82% for the same comparison periods. As of June 30, 2003, the Company's OREO portfolio consisted of one property with a balance of $58,800, while the 2002 year ended with no OREO properties.

Non-performing assets as of June 30, 2003 and December 31, 2002 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, or the book value of the loan, less cost to sell. 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 does not have any market risk sensitive instruments acquired for trading purposes. The Company's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure and attempts to structure the 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 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. The tables on the following two pages set forth the estimated maturity or repricing of the Company's interest earning assets and interest-bearing liabilities at June 30, 2003, and December 31, 2002.