COMMUNITY BANCORP /VT - Quarter Report: 2004 March (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 March 31, 2004

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 May 13, 2004, there were 3,813,238 shares outstanding of the Corporation's common stock.

Total Pages - 25 Pages

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited)

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION AND CONSOLIDATION

     The interim consolidated financial statements of Community Bancorp. and subsidiary 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, 2003, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

NOTE 2.  RECENT ACCOUNTING DEVELOPMENTS

     Statement of Financial Accounting Standards (SFAS) No. 133 Implementation Issue C13, "When a Loan Commitment Is Included in the Scope of Statement 133," requires commitments to originate mortgage loans that will be held for sale upon origination to be accounted for as derivatives, but does not provide guidance on how the fair value of those commitments should be measured. 

     In March 2004, the SEC issued Staff Accounting Bulletin (SAB) No. 105, "Application of Accounting Principles to Loan Commitments" in which the staff indicated it believes loan commitments are written options and therefore should never result in the recognition of an asset under SFAS No. 133.  Rather, the staff indicated lenders should initially recognize a liability for loan commitments, with the offsetting debit recognized as a derivative loss to the extent a premium is not received from the potential borrower.

     The staff indicated it would not object to a registrant's recognizing loan commitments as assets provided it discontinues that practice for commitments entered into in the first reporting period beginning after March 15, 2004 and provided assets recorded on loan commitments entered into prior to that date are reversed when the related loan closes or the commitment expires.

     SAB No. 105 is not expected to have a material effect on the Company's consolidated financial statements and results of operations.

     Earnings per common share amounts are computed based on the weighted average number of shares of common stock issued during the period and reduced for shares held in Treasury.

NOTE 4.  COMPREHENSIVE INCOME

The calculation for computing the Company's other comprehensive income for the comparison period is as follows:

NOTE 5. INCOME TAXES

$300,833 for the same period in 2003. The decrease is due to the tax effect of low income housing tax credits and expensing goodwill related to the Company's purchase of the Liberty Savings Bank charter.

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 March 31, 2004

     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, management's expectations as to future asset growth, income trends, results of operations and other matters reflected in the Overview section, 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 undue 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.

     The following Management's Discussion and Analysis explains in detail the results of the first quarter, 2004. As we predicted in the yearend report, mortgage activity was off in the first quarter and interest rates remained flat, thereby continuing the erosion in our spreads resulting in lower income. Net income was $763,842 or $0.20 per share this quarter versus $909,056 or $0.24 per share last year.

     Non-interest income was down by $282,821 because of lower security gains and fewer sales of mortgages in the secondary market. Non-interest expense increased by $175,994 mostly because of the cost associated with the opening of the new Barre office. We expect that this new office will be the center of our continued growth in Washington County.

     Asset growth in the Kingdom follows the weather. We have negative growth in the winter months and blossom when spring finally arrives. The first quarter of 2004 continued this tradition, with assets falling from $330.7 million at year-end to just over $327 million at quarter end. We expect that growth will return at the end of this quarter and build throughout the rest of the year.

     We still believe that this year's results will be slightly lower than last year's, and that we will continue to see eroding spreads until rates rise which we currently predict will be in the final quarter of this year.

to read them to more fully understand first quarter 2004 in relation to other recent first quarters. The discussion below should be read in conjunction with the Consolidated Financial Statements of the Company and related notes. This report includes forward-looking statements within the meaning of the Securities and Exchange Act of 1934 (the "Exchange Act").

CRITICAL ACCOUNTING POLICIES

     The Company's consolidated financial statements are prepared according to accounting principles generally accepted in the United States of America. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities in the consolidated financial statements and related notes. The Securities and Exchange Commission (SEC) has defined a company's critical accounting policies as the ones that are most important to the portrayal of the Company's financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Because of the significance of these estimates and assumptions, there is a high likelihood that materially different amounts would be reported for the Company under different conditions or using different assumptions or estimates.

     Management believes that the calculation of the allowance for loan loss (ALL) is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. In estimating the ALL, management utilizes historical experience as well as other factors including the effect of changes in the local real estate market on collateral values, use of current economic indicators and their probable impact on borrowers and changes in delinquent, nonperforming or impaired loans. Management's estimates used in the ALL may increase or decrease based on changes in these factors resulting in adjustments to the Company's provision for loan losses. Actual results could differ significantly from these estimates under different assumptions, judgments or conditions.

     Occasionally, the Company acquires property in connection with foreclosures or in satisfaction of debt previously contracted. To determine the value of property acquired in foreclosure, management often obtains independent appraisals for significant properties. Accordingly, the recovery of a substantial portion of the carrying amount of foreclosed real estate is susceptible to changes in local market conditions. The amount of the change that is reasonably possible cannot be estimated. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance 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.

     Management utilizes numerous techniques to estimate the carrying value of various assets held by the Company, including, but not limited to, property, plant and equipment, mortgage servicing rights, and deferred taxes. The assumptions considered in making these estimates are based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Management acknowledges that the use of different estimates or assumptions could produce different estimates of carrying values.

Management evaluates on an ongoing basis its judgment as to which policies are considered to be critical.

RESULTS OF OPERATIONS

     Income before income taxes of $777,052 was reported for the first quarter of 2004 compared to $1.2 million for the comparable period in 2003, resulting in a decrease of $432,837, or 35.8%. Net income for the first quarter ended March 31, 2004 was $763,842, representing a decrease of 16.0% over net income of $909,056 for the first quarter ended March 31, 2003. The results are earnings per share of $0.20 and $0.24, respectively, for the first quarters of 2004 and 2003.

INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME)

     The following table shows the reconciliation between reported net interest income and tax equivalent net interest income for the three months comparison period, of 2004 and 2003:

     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 3.62% and 3.79%, for the first three months of 2004 and 2003, respectively. The interest differential, defined as net interest income divided by average earning assets, was 3.92% and 4.16%, for the respective comparison periods.

     The table below presents average earning assets (including non-accrual loans) and average interest-bearing liabilities supporting earning assets, as well as interest income and interest expense expressed both in dollars and as a rate/yield for the 2004 and 2003 comparison periods.

     Although an increase is noted in the average volume of earning assets for the first three months of 2004 compared to the same period of 2003, a decrease of 58 basis points is noted in the average yield, due to the decrease in income. Interest earned on the loan portfolio accounts for approximately 77% of total interest income. The current low interest rate environment continues to have a negative effect on earnings produced from the loan portfolio. The average amount of non-accrual loans can also have an impact on the average yield on outstanding loans in any given period. As of March 31, 2004 and 2003, the average balance on non-accrual loans amounted to $1.3 million and $1.6 million, respectively.

     In comparison, interest paid on time deposits comprises 60% of total interest expense. The average volume of interest bearing liabilities for the first quarter of 2004 increased over the 2003 comparison period, while the rate paid on these accounts decreased 41 basis points. While the spread continues to shrink, the Company has managed to compensate for a portion of the decrease in yield on average earning assets by reducing the interest paid on interest bearing liabilities where the market would permit. The Company realizes that further opportunity to reduce rates on deposits is not likely. In addition, assets will continue to reprice at the lower interest rates, further compressing net interest spread. The asset sensitivity of the balance sheet indicates that the Company would benefit from an increase in interest rates.

    The following table summarizes the variances in income for the first three months of 2004 and 2003 resulting from volume changes in assets and liabilities and fluctuations in rates earned and paid.

     The decrease in non-interest income for the first quarter of 2004 was attributable to a few sources. While in 2003, the Company sold four of its investments from the Corporate Bond portfolio netting a gain before taxes of $132,312, the Company did not experience any gain on sale of investments in the first quarter of 2004. In addition, the volume of loans sold to the secondary market was much lower in the first quarter of 2004 compared to the same period in 2003. As a result, income generated through the sale and servicing of these loans amounted to $179,015 for the first quarter of 2004 versus $371,901 for the 2003 comparison period.

     Non-interest expense increased moderately for the first quarter of 2004 versus 2003 as a result of the new Barre branch. Occupancy expense accounts for the biggest increase in 2004, followed closely by pension and other employee benefits, both of which are directly related to the Barre office, and were anticipated increases.

     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 $287,623 with figures of $13,210 for the first quarter of 2004 versus $300,833 for the same period in 2003. The decrease is due to the tax effect of low income housing tax credits and expensing goodwill related to the Company's purchase of the Liberty Savings Bank charter.

CHANGES IN FINANCIAL CONDITION

     The Company had total average assets of approximately $329 million for the three months ended March 31, 2004 and $316 million for the year ended December 31, 2003. Average earning assets were $311 million for the three month period ended March 31, 2004, including average loans of $205 million and average investment securities of $103 million. Average earning assets were just over $300 million for the year ended December 31, 2003, including average loans of $205 million and average investment securities of $81 million. Average earning assets for March 31, 2004 were approximately $294 million, with $205 million in average loan volume and $82 million in average investment volume. The Company's investment portfolio increased significantly from March 31, 2003 to March 31, 2004 due mostly to an increase in borrowings from municipalities.

million. The demand, NOW, and money market accounts were at higher levels at December 31, 2003, before falling to the March 31, 2004 balances; this is a typical trend for the Company's deposit portfolio. A review of these deposits indicates that they are primarily generated locally and regionally and are established customers of the Company. Municipal deposit accounts make up approximately 48% of NOW and money market accounts and contributed to the seasonal decrease in deposit accounts during the first quarter of the year. This fluctuation is seasonal and it is expected that the levels will increase throughout 2004, mirroring the tax collection cycle.

     Another source of liquidity for the Company is the purchase of overnight funds against the Company's $4.3 million credit line with the FHLB. Interest is chargeable at a rate determined daily of approximately 25 basis points higher than the rate paid on fed funds sold. At March 31, 2004, the Company had no advances against the $4.3 million credit line. Additional borrowing capacity of approximately $91 million is available through the FHLB, which is secured by the Company's qualifying loan portfolio. As of March 31, 2004, the Company had advances of just over $10 million against the $91 million in borrowing authority at FHLB. The $10 million is made up of a $5 million long-term advance borrowed on January 16, 2001 at an annual rate of interest of 4.78% that matures in 2011. At December 31, 2003, the Company had borrowed a short-term advance of $3 million at an annual rate of interest of 1.19% that matured on March 4, 2004. On March 24, 2004 the Company borrowed a $5 million short-term advance at an annual rate of interest of 1.10% that matures April 26, 2004. At March 31, 2003, the Company had no short-term advances borrowed against the line of credit. These short-term advances are used to offset the seasonal fluctuations in deposit balances during the year.

     Under a separate agreement with FHLB, the Company has the authority to collateralize public unit deposits, up to its FHLB borrowing capacity ($91 million less outstanding advances) with letters of credit issued by the FHLB. At March 31, 2004, approximately $47 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 which, for the first quarter of 2004, was approximately $13.5 million.

     The Company's investment portfolio increased during the first quarter of 2004, but in looking ahead, approximately $10 million is scheduled to mature in 2004, with an additional $10 million having call options scheduled throughout 2004. Investments with call options allow the issuer to call in the investment, before maturity, at predetermined call dates. As investments mature and/or are called, the Company reinvests in a structured ladder of securities with graduated maturities allowing for continued cash flow and reinvestment opportunities.

     As of the dates indicated, the Company held in its investment portfolio securities made up of the following:

     The Company is required to maintain equity securities in the form of Federal Home Loan Bank of Boston (FHLB) and Federal Reserve Bank stock. In total, the Company held $1.4 million in such Restricted Equity Securities as of March 31, 2004 and December 31, 2003.

may not, without the prior approval of the OCC, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years.

     In December 2003, the Company declared a cash dividend of $0.17 per share, payable in the first quarter of 2004. In March 2004, the Company declared a cash dividend of $0.17 per share, payable in the second quarter of 2004. As a result of the dividends declared, in December 2003, the Company was required to book an accrual totaling $644,144, and in March 2004, an accrual of $645,875 was required.

     At March 31, 2004, the Company reported that of the 405,000 shares authorized for the stock buyback plan, 155,197 shares have been purchased, leaving 249,803 shares available for repurchase. The repurchase price paid for these shares ranged from $9.75 per share in May of 2000 to $16.45 per share in March of 2004. During the first quarter of 2004, the Company repurchased 2,734 shares pursuant to the buyback authority. For additional information on stock repurchases by the Company and affiliated purchasers (as defined in SEC Rule 10b-18), refer to part II, Item 2 of this Report.

     Regulators have also established guidelines for minimum capital ratio requirements that define a bank as well-capitalized under prompt corrective action provisions. These minimums are risk-based capital ratio of 10.0% and Tier 1 capital ratio of 6.0%. As of March 31, 2004, the Company and its Subsidiary were deemed well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that time that management believes have changed the Company's classification.

     The Company intends to continue the past policy of maintaining a strong capital resource position to support its asset size and level of operations. Consistent with that policy, management will continue to anticipate the Company's future capital needs.

     From time to time the Company may make contributions to the capital of Community National Bank. At present, regulatory authorities have made no demand on the Company to make additional capital contributions.

     The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and risk-sharing commitments on certain sold loans. Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. During the first three months of 2004, there has not been any activity that has created any additional types of off-balance-sheet risk.

     The Company generally requires collateral or other security to support financial instruments with credit risk. The Company's financial instruments whose contract amount represents credit risk as of March 31, 2004 are as follows:

     Rates of inflation affect the reported financial condition and results of operations of all industries, including the banking industry. The effect of monetary inflation is generally magnified in bank financial and operating statements. As costs and prices rise during periods of monetary inflation, cash and credit demands of individuals and businesses increase, and the purchasing power of net monetary assets declines. The Company depends primarily on a strong net interest income to enable it to maintain its purchasing power.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

and interest-bearing liabilities reflected on the Company's balance sheet. Furthermore, the model simulates the balance sheet's sensitivity to a prolonged flat rate environment. All rate scenarios are simulated assuming a parallel shift of the yield curve; however further simulations are performed utilizing a flattening yield curve as well. This sensitivity analysis is compared to the ALCO policy limits which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 100 basis point (bp) and a 200 bp shift upward and a 100 bp downward shift in interest rates in one and two year scenarios. The analysis also provides testing of the assumptions used in previous simulation models by comparing the projected NII with actual NII.

     The following reflects the Company's NII sensitivity analysis over one and two year horizons, assuming a parallel shift of the yield curve, as prepared by the consultant's review and measured as of December 31, 2003;

     The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

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 loan officer with higher authority than the loan officer 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 Company continues to maintain the valuation allowance for loan losses at a level of just over 1% of the total gross loan portfolio. As of March 31, 2004, the Company maintained a residential loan portfolio of $118 million and a commercial real estate portfolio (including construction, land development and farm land loans) of $45 million, accounting for approximately 80% 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 comparison periods 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.

ITEM 4. Controls and Procedures

     As required by Rule 13a-15 under the Securities Exchange Act of 1934, the Company has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. This evaluation was carried out under the supervision and with the participation of the Company's management, including the Company's Chairman and Chief Executive Officer and its President and Chief Operating Officer (Chief Financial Officer). Based upon that evaluation, such officers concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. There were no changes during the Company's last fiscal quarter in the Company's internal control over financial reporting identified in connection with the evaluation of the Company's disclosure controls and procedures that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

     The Company and/or its subsidiary are subject to various claims and legal actions that have arisen in the normal course of business. Management does not expect that the ultimate disposition of these matters, individually or in the aggregate, will have a material adverse impact on the Company's financial statements.

ITEM 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

The following table provides information as to purchases of the Company's common stock during the three months ended March 31, 2004, by the Company and by any affiliated purchaser (as defined in SEC Rule 10b-18):