COMMUNITY BANCORP /VT - Quarter Report: 2008 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, 2008
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.
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Vermont
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03-0284070
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(State
of Incorporation)
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(IRS
Employer Identification Number)
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4811
US Route 5, Derby, Vermont
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05829
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(Address
of Principal Executive Offices)
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(zip
code)
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Registrant's
Telephone Number: (802)
334-7915
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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 a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer”,
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
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Large
accelerated filer ( )
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Accelerated
filer ( )
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Non-accelerated
filer ( ) (Do not check
if a smaller reporting company)
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Smaller
reporting company ( X )
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
YES
( ) NO(X)
At
November 12, 2008, there were 4,450,937 shares outstanding of the Corporation's
common stock.
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FORM
10-Q
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Page
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PART
I FINANCIAL INFORMATION
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Item
I Financial
Statements
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4
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15
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30
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Item
4T Controls and
Procedures
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30
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PART
II OTHER INFORMATION
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Item
1 Legal
Proceedings
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31
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31
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31
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Item
5 Other Events
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31
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Item
6 Exhibits
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31
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32
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PART
I. FINANCIAL INFORMATION
The
following are the unaudited consolidated financial statements for Community
Bancorp. and Subsidiary, "the Company".
|
COMMUNITY
BANCORP. AND SUBSIDIARY
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September
30
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December
31
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September
30
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|||||||||
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Consolidated
Balance Sheets
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2008
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2007
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2007
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|||||||||
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(Unaudited)
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(Unaudited)
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|||||||||||
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Assets
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||||||||||||
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Cash
and due from banks
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$ | 9,709,904 | $ | 17,486,535 | $ | 7,609,332 | ||||||
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Federal
funds sold and overnight deposits
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32,353 | 2,785,988 | 12,389,462 | |||||||||
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Total
cash and cash equivalents
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9,742,257 | 20,272,523 | 19,998,794 | |||||||||
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Securities
held-to-maturity (fair value $46,600,000 at 09/30/08,
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||||||||||||
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$34,273,000
at 12/31/07, and $29,472,000 at 09/30/07)
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46,368,055 | 34,310,833 | 29,431,718 | |||||||||
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Securities
available-for-sale
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29,638,437 | 46,876,771 | 25,074,048 | |||||||||
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Restricted
equity securities, at cost
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3,906,850 | 3,456,850 | 2,450,150 | |||||||||
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Loans
held-for-sale
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742,778 | 685,876 | 982,576 | |||||||||
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Loans
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358,358,089 | 355,885,207 | 255,926,578 | |||||||||
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Allowance
for loan losses
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(3,058,882 | ) | (3,026,049 | ) | (2,321,409 | ) | ||||||
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Unearned
net loan fees
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(352,142 | ) | (443,372 | ) | (490,826 | ) | ||||||
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Net
loans
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354,947,065 | 352,415,786 | 253,114,343 | |||||||||
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Bank
premises and equipment, net
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15,163,398 | 16,361,152 | 12,072,266 | |||||||||
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Accrued
interest receivable
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2,235,882 | 2,304,055 | 1,755,545 | |||||||||
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Bank
owned life insurance
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3,658,911 | 3,559,376 | 0 | |||||||||
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Core
deposit intangibles
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3,536,850 | 4,161,000 | 0 | |||||||||
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Goodwill
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11,567,032 | 10,347,455 | 0 | |||||||||
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Other
real estate owned
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185,000 | 0 | 0 | |||||||||
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Other
assets
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7,853,715 | 7,279,941 | 5,928,109 | |||||||||
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Total
assets
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$ | 489,546,230 | $ | 502,031,618 | $ | 350,807,549 | ||||||
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Liabilities
and Shareholders' Equity
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||||||||||||
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Liabilities
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||||||||||||
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Deposits:
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||||||||||||
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Demand,
non-interest bearing
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$ | 54,499,372 | $ | 64,019,707 | $ | 50,485,030 | ||||||
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NOW
and money market accounts
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122,491,455 | 120,993,657 | 77,204,394 | |||||||||
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Savings
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50,523,075 | 46,069,943 | 39,505,522 | |||||||||
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Time
deposits, $100,000 and over
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55,806,941 | 58,860,374 | 40,455,562 | |||||||||
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Other
time deposits
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124,551,597 | 126,276,429 | 94,388,283 | |||||||||
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Total
deposits
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407,872,440 | 416,220,110 | 302,038,791 | |||||||||
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Federal
funds purchased and other borrowed funds
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13,616,000 | 13,760,000 | 40,000 | |||||||||
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Repurchase
agreements
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14,615,209 | 17,444,933 | 14,212,876 | |||||||||
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Capital
lease obligations
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856,376 | 943,227 | 0 | |||||||||
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Junior
subordinated debentures
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12,887,000 | 12,887,000 | 0 | |||||||||
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Accrued
interest and other liabilities
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4,895,509 | 5,855,988 | 2,653,456 | |||||||||
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Total
liabilities
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454,742,534 | 467,111,258 | 318,945,123 | |||||||||
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Shareholders'
Equity
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||||||||||||
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Preferred
stock 1,000,000 shares authorized, 25 shares issued and
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||||||||||||
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outstanding
at 09/30/08 and 12/31/07, ($100,000 liquidation value),
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||||||||||||
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and
no shares issued and outstanding at 09/30/07
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2,500,000 | 2,500,000 | 0 | |||||||||
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Common
stock - $2.50 par value; 10,000,000 shares authorized,
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||||||||||||
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4,659,603
shares issued at 09/30/08, 4,609,268 shares issued
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||||||||||||
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at
12/31/07, and 4,592,735 shares issued at 09/30/07
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11,649,007 | 11,523,170 | 11,481,838 | |||||||||
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Additional
paid-in capital
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25,579,898 | 25,006,439 | 24,818,896 | |||||||||
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Accumulated
deficit
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(2,585,311 | ) | (1,597,682 | ) | (1,749,560 | ) | ||||||
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Accumulated
other comprehensive income (loss)
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282,879 | 111,210 | (65,971 | ) | ||||||||
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Less:
treasury stock, at cost; 210,101 shares at 09/30/08,
12/31/07,
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||||||||||||
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and
09/30/07
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(2,622,777 | ) | (2,622,777 | ) | (2,622,777 | ) | ||||||
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Total
shareholders' equity
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34,803,696 | 34,920,360 | 31,862,426 | |||||||||
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Total
liabilities and shareholders' equity
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$ | 489,546,230 | $ | 502,031,618 | $ | 350,807,549 | ||||||
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COMMUNITY
BANCORP. AND SUBSIDIARY
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||||||||
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Consolidated
Statements of Income
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||||||||
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(Unaudited)
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||||||||
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For
The Third Quarter Ended September 30,
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2008
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2007
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||||||
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Interest
income
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||||||||
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Interest
and fees on loans
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$ | 5,912,812 | $ | 4,778,687 | ||||
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Interest
on debt securities
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||||||||
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Taxable
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331,231 | 215,234 | ||||||
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Tax-exempt
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455,017 | 259,404 | ||||||
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Dividends
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41,240 | 37,329 | ||||||
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Interest
on federal funds sold and overnight deposits
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2,077 | 133,350 | ||||||
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Total
interest income
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6,742,377 | 5,424,004 | ||||||
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Interest
expense
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||||||||
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Interest
on deposits
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2,141,927 | 1,957,858 | ||||||
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Interest
on federal funds purchased and other borrowed funds
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142,644 | 63,283 | ||||||
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Interest
on repurchase agreements
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60,138 | 79,004 | ||||||
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Interest
on junior subordinated debentures
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243,564 | 0 | ||||||
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Total
interest expense
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2,588,273 | 2,100,145 | ||||||
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Net
interest income
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4,154,104 | 3,323,859 | ||||||
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Provision
for loan losses
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112,499 | 47,500 | ||||||
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Net
interest income after provision for loan losses
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4,041,605 | 3,276,359 | ||||||
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Non-interest
income
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||||||||
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Service
fees
|
562,319 | 350,054 | ||||||
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Income
on bank owned life insurance
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33,924 | 0 | ||||||
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Other
income
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487,731 | 760,304 | ||||||
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Total
non-interest income
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1,083,974 | 1,110,358 | ||||||
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Non-interest
expense
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||||||||
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Salaries
and wages
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1,361,196 | 1,168,792 | ||||||
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Employee
benefits
|
522,770 | 477,144 | ||||||
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Occupancy
expenses, net
|
759,576 | 539,202 | ||||||
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Write
down of Fannie Mae preferred stock
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739,332 | 0 | ||||||
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Other
expenses
|
1,260,686 | 1,061,908 | ||||||
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Total
non-interest expense
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4,643,560 | 3,247,046 | ||||||
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Income
before income taxes
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482,019 | 1,139,671 | ||||||
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Income
tax expense
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167,406 | 212,499 | ||||||
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Net
Income
|
$ | 314,613 | $ | 927,172 | ||||
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Earnings
per common share
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$ | 0.06 | $ | 0.21 | ||||
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Weighted
average number of common shares
|
||||||||
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used
in computing earnings per share
|
4,438,225 | 4,372,670 | ||||||
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Dividends
declared per common share
|
$ | 0.17 | $ | 0.17 | ||||
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Book
value per share on common shares outstanding at September
30,
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$ | 7.26 | $ | 7.27 | ||||
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COMMUNITY
BANCORP. AND SUBSIDIARY
|
||||||||
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Consolidated
Statements of Income
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||||||||
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(Unaudited)
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||||||||
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For
the Nine Months Ended September 30,
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2008
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2007
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||||||
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Interest
income
|
||||||||
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Interest
and fees on loans
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$ | 17,866,539 | $ | 14,406,502 | ||||
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Interest
on debt securities
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||||||||
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Taxable
|
1,142,179 | 630,478 | ||||||
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Tax-exempt
|
1,358,519 | 691,445 | ||||||
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Dividends
|
148,908 | 126,370 | ||||||
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Interest
on federal funds sold and overnight deposits
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63,044 | 191,178 | ||||||
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Total
interest income
|
20,579,189 | 16,045,973 | ||||||
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Interest
expense
|
||||||||
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Interest
on deposits
|
7,498,218 | 5,774,457 | ||||||
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Interest
on federal funds purchased and other borrowed funds
|
397,359 | 90,642 | ||||||
|
Interest
on repurchase agreements
|
195,746 | 240,688 | ||||||
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Interest
on junior subordinated debentures
|
732,776 | 0 | ||||||
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Total
interest expense
|
8,824,099 | 6,105,787 | ||||||
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Net
interest income
|
11,755,090 | 9,940,186 | ||||||
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Provision
for loan losses
|
237,497 | 122,500 | ||||||
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Net
interest income after provision for loan losses
|
11,517,593 | 9,817,686 | ||||||
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Non-interest
income
|
||||||||
|
Service
fees
|
1,641,457 | 1,031,526 | ||||||
|
Income
on bank owned life insurance
|
99,535 | 0 | ||||||
|
Other
income
|
1,455,761 | 1,676,660 | ||||||
|
Total
non-interest income
|
3,196,753 | 2,708,186 | ||||||
|
Non-interest
expense
|
||||||||
|
Salaries
and wages
|
4,487,017 | 3,421,779 | ||||||
|
Employee
benefits
|
1,751,617 | 1,349,547 | ||||||
|
Occupancy
expenses, net
|
2,416,944 | 1,776,935 | ||||||
|
Write
down of Fannie Mae preferred stock
|
739,332 | 0 | ||||||
|
Other
expenses
|
3,919,695 | 3,004,450 | ||||||
|
Total
non-interest expense
|
13,314,605 | 9,552,711 | ||||||
|
Income
before income taxes
|
1,399,741 | 2,973,161 | ||||||
|
Income
tax (benefit) expense
|
(5,481 | ) | 512,850 | |||||
|
Net
Income
|
$ | 1,405,222 | $ | 2,460,311 | ||||
|
Earnings
per common share
|
$ | 0.29 | $ | 0.56 | ||||
|
Weighted
average number of common shares
|
||||||||
|
used
in computing earnings per share
|
4,421,759 | 4,357,565 | ||||||
|
Dividends
declared per common share
|
$ | 0.51 | $ | 0.50 | ||||
|
Book
value per share on common shares outstanding at September
30,
|
$ | 7.26 | $ | 7.27 | ||||
|
All
share and per share data for prior periods restated to reflect a 5% stock
dividend declared in June 2007.
|
||||||||
|
Consolidated
Statements of Cash Flows
|
||||||||
|
For
the Nine Months Ended September 30,
|
2008
|
2007
|
||||||
|
Cash
Flow from Operating Activities:
|
||||||||
|
Net
Income
|
$ | 1,405,222 | $ | 2,460,311 | ||||
|
Adjustments
to Reconcile Net Income to Net Cash Provided by Operating
Activities:
|
||||||||
|
Depreciation
and amortization
|
809,686 | 710,591 | ||||||
|
Provision
for loan losses
|
237,497 | 122,500 | ||||||
|
Provision
(credit) for deferred income taxes
|
290,296 | (34,470 | ) | |||||
|
Net
gain on sale of loans
|
(250,845 | ) | (226,492 | ) | ||||
|
Loss
on sale or disposal of fixed assets
|
1,757 | 8,415 | ||||||
|
Gain
on investment in Trust LLC
|
(44,604 | ) | (104,337 | ) | ||||
|
Amortization
(accretion) of bond premium (discount), net
|
(47,448 | ) | 8,301 | |||||
|
Write
down of Fannie Mae preferred stock
|
739,332 | 0 | ||||||
|
Proceeds
from sales of loans held for sale
|
20,470,308 | 22,295,686 | ||||||
|
Originations
of loans held for sale
|
(20,276,365 | ) | (22,485,470 | ) | ||||
|
Decrease
in taxes payable
|
(164,283 | ) | (202,680 | ) | ||||
|
Decrease
(increase) in interest receivable
|
68,173 | (88,410 | ) | |||||
|
Decrease
(increase) in mortgage servicing rights
|
30,055 | (90,643 | ) | |||||
|
Decrease
(increase) in other assets
|
785,861 | (366,050 | ) | |||||
|
Increase
in bank owned life insurance
|
(99,535 | ) | 0 | |||||
|
Amortization
of core deposit intangible
|
624,150 | 0 | ||||||
|
Amortization
of limited partnerships
|
278,313 | 292,530 | ||||||
|
Decrease
in unamortized loan fees
|
(91,230 | ) | (141,279 | ) | ||||
|
Decrease
in interest payable
|
(109,609 | ) | (49,183 | ) | ||||
|
Increase
in accrued expenses
|
23,438 | 88,396 | ||||||
|
(Decrease)
increase in other liabilities
|
(3,256,848 | ) | 22,037 | |||||
|
Net
cash provided by operating activities
|
1,423,321 | 2,219,753 | ||||||
|
Cash
Flows from Investing Activities:
|
||||||||
|
Investments
- held to maturity
|
||||||||
|
Maturities
and paydowns
|
24,921,147 | 17,709,462 | ||||||
|
Purchases
|
(36,978,370 | ) | (26,071,314 | ) | ||||
|
Investments
- available for sale
|
||||||||
|
Sales
and maturities
|
17,229,897 | 3,000,000 | ||||||
|
Purchases
|
(1,079,688 | ) | (5,160,000 | ) | ||||
|
Proceeds
from (purchase) redemption of restricted equity securities
|
(450,000 | ) | 378,100 | |||||
|
Decrease
in limited partnership contributions payable
|
0 | (236,094 | ) | |||||
|
Investments
in limited partnership
|
(5,000 | ) | (264,800 | ) | ||||
|
(Increase)
decrease in loans, net
|
(2,940,890 | ) | 12,686,366 | |||||
|
Capital
expenditures, net of proceeds from sales of bank
|
||||||||
|
premises
and equipment
|
386,311 | (457,248 | ) | |||||
|
Recoveries
of loans charged off
|
78,344 | 47,870 | ||||||
|
Net
cash provided by investing activities
|
1,161,751 | 1,632,342 | ||||||
|
Cash
Flows from Financing Activities:
|
||||||||
|
Net
decrease in demand, NOW, money market and savings accounts
|
(3,569,405 | ) | (82,051 | ) | ||||
|
Net
(decrease) increase in time deposits
|
(4,778,265 | ) | 1,132,648 | |||||
|
Net
decrease in repurchase agreements
|
(2,829,724 | ) | (2,871,070 | ) | ||||
|
Net
increase in short-term borrowings
|
7,856,000 | 0 | ||||||
|
Repayments
on long-term borrowings
|
(8,000,000 | ) | 0 | |||||
|
Decrease
in capital lease obligations
|
(86,851 | ) | 0 | |||||
|
Dividends
paid on preferred stock
|
(140,625 | ) | 0 | |||||
|
Payments
to acquire treasury stock
|
0 | (8,045 | ) | |||||
|
Dividends
paid on common stock
|
(1,566,468 | ) | (1,491,393 | ) | ||||
|
Net
cash used in financing activities
|
(13,115,338 | ) | (3,319,911 | ) | ||||
|
Net
(decrease) increase in cash and cash equivalents
|
(10,530,266 | ) | 532,184 | |||||
|
Cash
and cash equivalents:
|
||||||||
|
Beginning
|
20,272,523 | 19,466,610 | ||||||
|
Ending
|
$ | 9,742,257 | $ | 19,998,794 | ||||
|
Supplemental
Schedule of Cash Paid During the Period
|
||||||||
|
Interest
|
$ | 8,933,708 | $ | 6,154,970 | ||||
|
Income
taxes
|
$ | 405,000 | $ | 750,000 | ||||
|
Supplemental
Schedule of Noncash Investing and Financing Activities:
|
||||||||
|
Change
in unrealized gain on securities available-for-sale
|
$ | 260,105 | $ | 310,142 | ||||
|
Other
real estate owned acquired in settlement of loans
|
$ | 185,000 | $ | 0 | ||||
|
Fair
value adjustment of Fannie Mae preferred stock
|
$ | 656,347 | $ | 0 | ||||
|
Investments
in limited partnership
|
||||||||
|
Increase
in limited partnerships
|
$ | (1,462,000 | ) | $ | (264,800 | ) | ||
|
Increase
in contributions payable
|
$ | 1,457,000 | $ | 0 | ||||
| $ | (5,000 | ) | $ | (264,800 | ) | |||
|
Common
Shares Dividends Paid
|
||||||||
|
Dividends
declared
|
$ | 2,252,226 | $ | 2,149,218 | ||||
|
Increase
(decrease) in dividends payable attributable to dividends
declared
|
13,538 | (42,872 | ) | |||||
|
Dividends
reinvested
|
(699,296 | ) | (614,953 | ) | ||||
| $ | 1,566,468 | $ | 1,491,393 | |||||
|
Stock
Dividends
|
$ | 0 | $ | 2,821,320 | ||||
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, 2007 contained in the Company's Annual
Report on Form 10-K.
NOTE
2. 5% STOCK DIVIDEND
In
June 2007, the Company declared a 5% stock dividend payable August 15, 2007 to
shareholders of record as of July 15, 2007. As a result of this stock
dividend, all per share data and weighted average number of shares for prior
periods have been restated.
NOTE
3. RECENT ACCOUNTING DEVELOPMENTS
In
September 2006, the Financial Accounting Standards Board (the FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value
Measurements”, which provides enhanced guidance for using fair value to measure
assets and liabilities. This Statement defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value
measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not
require any new fair value measurements. SFAS No. 157 is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Company
adopted SFAS No. 157 effective January 1, 2008. Additional
information regarding the Company’s fair value measurements under SFAS No. 157
is contained in Note 8. FASB Staff Position (FSP) No. FAS 157-2
delays the effect of SFAS No. 157 on the measurement of goodwill and other
intangible assets measured at fair value on a nonrecurring basis until the first
quarter of 2009.
In
October 2008, the FASB issued FSP No. 157-3, Determining The Fair Value of a
Financial Asset when the Market for that Asset is not Active. FSP No.
157-3 amended SFAS No. 157 by incorporating an example to illustrate key
considerations in determining the fair value of a financial asset in an inactive
market. The FSP was effective upon issuance. The Company
is currently evaluating FSP No. 157-3 for materiality.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”, which gives entities the option to
measure eligible financial assets and financial liabilities at fair value on an
instrument by instrument basis. The election to use the fair value option is
available when an entity first recognizes a financial asset or financial
liability. Subsequent changes in fair value must be recorded in earnings. SFAS
No. 159 contains provisions to apply the fair value option to existing eligible
financial instruments at the date of adoption. This statement is effective as of
the beginning of an entity’s first fiscal year beginning after November 15,
2007, with provisions for early adoption. To date the Company has not
applied the fair value option to any financial instruments; therefore, SFAS No.
159 has not had any impact on the Company’s financial statements.
In
November 2007, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 109, Written Loan Commitments Recorded at
Fair Value Through Earnings, in which the SEC Staff expressed its views
concerning written loan commitments accounted for as derivatives or at fair
value through earnings, as permitted by SFAS No. 159.
It is the Staff's position that expected net future cash flows from servicing a
loan should be included in the fair value measurement of a loan commitment when
it qualifies for derivative accounting under SFAS No.
133 or at fair value through earnings, as permitted by SFAS No. 159.
Implementation of SAB No. 109 did not have a material effect on the financial
condition or results of operations of the Company.
In
December 2007, the FASB revised SFAS No. 141, “Business Combinations” (SFAS
No.141R). This statement requires an acquirer to recognize the assets acquired,
the liabilities assumed, and any non-controlling interest in the acquiree at the
acquisition date, measured at their fair values as of that date. SFAS No. 141R
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase. Additionally, SFAS No. 141R defines the
acquirer as the entity that obtains control of one or more businesses in the
business combination, establishes the acquisition date as the date that the
acquiree achieves control and determines what information to disclose to enable
users of the financial statements to evaluate the nature and financial effects
of the business combination. SFAS No. 141R is effective for fiscal years
beginning after December 15, 2008. Accordingly, SFAS No. 141R did not apply to
the Company’s acquisition of LyndonBank completed at year-end 2007, but would
apply to business combinations (if any) in 2009 and subsequent
years.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
(ARB) No. 51”. This statement applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary. This statement
amends ARB No. 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for fiscal years beginning after December 15,
2008. Management does not expect it will have a material effect on
its financial condition or results of operations.
In
March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No. 133”.
This statement requires enhanced disclosures about an entity’s derivative and
hedging activities and thereby improves the transparency of financial reporting.
Entities are required to provide enhanced disclosures about (a) how and why an
entity uses derivative instruments, (b) how derivative instruments and related
hedged items are accounted for under SFAS No. 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
SFAS No. 161 is effective for fiscal years and interim periods beginning after
November 15, 2008. The Company is currently evaluating the impact of SFAS No.
161 but does not expect it will have a material effect on its financial
condition or results of operations.
NOTE
4. INCOME TAXES
Section
301 of the Emergency Economic Stabilization Act of 2008 provides tax relief to
banking organizations that have suffered losses on certain holdings of Federal
National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage
Corporation (Freddie Mac) preferred stock by changing the character of these
losses from capital to ordinary for federal income tax
purposes. However, under generally accepted accounting principles,
because the Act was not enacted on October 3, 2008, banking organizations will
not be able to recognize the tax effect of the ordinary losses resulting from
Section 301 in their financial statements for the third
quarter. Accordingly, the tax benefit resulting from the Company’s
third quarter write down of its Fannie Mae preferred shareholdings
(approximately $251,000) will not be recorded for financial statement purposes
until the fourth quarter of 2008. (See Note 8.)
In
July 2006, the FASB issued Financial Accounting Standards Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of
FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in a company’s financial statements in
accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN
48 prescribes a recognition threshold of more-likely-than-not, and a measurement
attribute for all tax positions taken or expected to be taken on a tax return,
in order for those tax positions to be recognized in the financial statements.
FIN 48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosures and transitions. Effective
January 1, 2007, the Company adopted FIN 48. The implementation of FIN 48 did
not have a material impact on the Company’s financial statements.
The
Company’s income tax returns for the years ended December 31, 2004, 2005, 2006
and 2007 are open to audit under the statute of limitations by the Internal
Revenue Service. The Company’s policy is to record interest and
penalties related to uncertain tax positions as part of its provision for income
taxes. A late estimated tax payment for the first quarter of 2006
resulted in a penalty of $15,208 which is reflected in income tax expense for
2007.
NOTE
5. EARNINGS PER COMMON SHARE
Earnings
per common share amounts are computed based on the weighted average number of
shares of common stock issued during the period (retroactively adjusted for
stock splits and stock dividends) and reduced for shares held in Treasury. The
following table illustrates the calculation for the third quarter and nine
months ended September 30, as adjusted for the cash dividend declared on the
preferred stock:
|
For
the third quarter ended September 30,
|
2008
|
2007
|
||||||
|
Net
income, as reported
|
$ | 314,613 | $ | 927,172 | ||||
|
Less:
dividends to preferred shareholders
|
46,875 | 0 | ||||||
|
Net
income available to common shareholders
|
$ | 267,738 | $ | 927,172 | ||||
|
Weighted
average number of common shares used in calculating
|
||||||||
|
earnings
per share
|
4,438,225 | 4,372,670 | ||||||
|
Earnings
per common share
|
$ | 0.06 | $ | 0.21 | ||||
|
For
the nine months ended September 30,
|
2008
|
2007
|
||||||
|
Net
income, as reported
|
$ | 1,405,222 | $ | 2,460,311 | ||||
|
Less:
dividends to preferred shareholders
|
140,625 | 0 | ||||||
|
Net
income available to common shareholders
|
$ | 1,264,597 | $ | 2,460,311 | ||||
|
Weighted
average number of common shares used in calculating
|
||||||||
|
earnings
per share
|
4,421,759 | 4,357,565 | ||||||
|
Earnings
per common share
|
$ | 0.29 | $ | 0.56 | ||||
NOTE
6. COMPREHENSIVE INCOME
Accounting
principles generally require recognized revenue, expenses, gains, and losses to
be included in net income. Certain changes in assets and liabilities,
such as the after-tax effect of unrealized gains and losses on
available-for-sale securities, are not reflected in the statement of income, but
the cumulative effect of such items from period-to-period is reflected as a
separate component of the equity section of the balance sheet (accumulated other
comprehensive income or loss). Other comprehensive income or loss,
along with net income, comprises the Company's total comprehensive
income.
The
Company's total comprehensive income for the comparison periods is calculated as
follows:
|
For
the third quarter ended September 30,
|
2008
|
2007
|
||||||
|
Net
income
|
$ | 1,053,945 | $ | 927,172 | ||||
|
Realized
loss on write down of Fannie Mae preferred stock
|
739,332 | 0 | ||||||
|
Net
income after realized loss
|
314,613 | 927,172 | ||||||
|
Other
comprehensive income (loss), net of tax:
|
||||||||
|
Unrealized
holding gains (losses) on available-for-sale
|
||||||||
|
securities
arising during the period
|
784,997 | 221,604 | ||||||
|
Tax
effect
|
(266,899 | ) | (75,345 | ) | ||||
|
Other
comprehensive income (loss), net of tax
|
518,098 | 146,259 | ||||||
|
Total
comprehensive income
|
$ | 832,711 | $ | 1,073,431 | ||||
|
For
the nine months ended September 30,
|
2008
|
2007
|
||||||
|
Net
income
|
$ | 2,144,554 | $ | 2,460,311 | ||||
|
Realized
loss on write down of Fannie Mae preferred stock
|
739,332 | 0 | ||||||
|
Net
income after realized loss
|
1,405,222 | 2,460.311 | ||||||
|
Other
comprehensive income (loss), net of tax:
|
||||||||
|
Unrealized
holding gains (losses) on available-for-sale
|
||||||||
|
securities
arising during the period
|
260,105 | 310,142 | ||||||
|
Tax
effect
|
(88,436 | ) | (105,448 | ) | ||||
|
Other
comprehensive income (loss), net of tax
|
171,669 | 204,694 | ||||||
|
Total
comprehensive income
|
$ | 1,576,891 | $ | 2,665,005 | ||||
NOTE
7. MERGER AND INTANGIBLE ASSETS
On
December 31, 2007, the Company completed its acquisition of LyndonBank,
Lyndonville, Vermont, through the merger of LyndonBank with and into Community
National Bank, the Company’s wholly-owned subsidiary. On that date,
Community National Bank sold the former Vergennes, Vermont branch of LyndonBank
consisting of approximately $8.7 million in deposits and $12.1 million in branch
assets, including $10.5 in loans. The aggregate purchase price in the
LyndonBank merger was approximately $26.7 million in cash. To finance
a portion of the acquisition costs, the Company issued approximately $12.9
million of junior subordinated debentures in a trust preferred securities
financing (See Note 10.) and 25 shares of non-cumulative perpetual preferred
stock for gross sale proceeds of $2.5 million.
The
transaction was accounted for as a purchase and, accordingly, the operations of
LyndonBank are included in the Company’s consolidated financial statements from
the date of the acquisition. The purchase price has been allocated to
assets acquired and liabilities assumed based on estimates of fair value at the
date of acquisition. The excess of purchase price over the fair value
of net tangible and intangible assets acquired has been recorded as
goodwill. During the first quarter of 2008, the Company received
valuations on bank premises and equipment to determine fair value and make the
necessary adjustments to bank premises and equipment, goodwill and the related
deferred tax liability. The adjustment to goodwill was an increase of
$212,884. During the second quarter of 2008, additional adjustments
amounting to a net decrease of $57,536 were made to goodwill for the settlement
of certain LyndonBank liability accounts. During the third quarter of
2008, adjustments amounting to a net increase were made totaling $1,064,228 for
some additional costs related to the merger, disposal of software used during
the first quarter of 2008 that is no longer needed, and a fair value adjustment
totaling $656,347 on Fannie Mae preferred stock the Company acquired through the
acquisition.
The
purchase price allocation to the acquired assets, net of the Vergennes branch
sale and including adjustments described above, was as follows:
|
Cash
and cash equivalents
|
$ | 12,060,208 | ||
|
Federal
Home Loan Bank stock
|
1,006,700 | |||
|
Investments
|
22,885,546 | |||
|
Loans,
net
|
94,871,768 | |||
|
Bank
premises and equipment
|
3,774,657 | |||
|
Prepaid
expenses and other assets
|
4,773,431 | |||
|
Identified
intangible asset
|
4,161,000 | |||
|
Goodwill
|
11,567,032 | |||
|
Deposits
|
(110,044,422 | ) | ||
|
Borrowings
|
(14,269,911 | ) | ||
|
Long-term
debt
|
(943,227 | ) | ||
|
Accrued
expenses and other liabilities
|
(3,124,959 | ) | ||
|
Aggregate
purchase price
|
$ | 26,717,823 |
The
$4.2 million of indentified acquired intangible asset represents the core
deposit intangible and is subject to amortization over the weighted-average life
of the core deposit base which was determined to be approximately 10
years. The amortization expense related to the core deposit
intangible for the three month and nine month periods ended September 30, 2008
was $208,050 and $624,150, respectively.
The
goodwill is not deductible for tax purposes.
NOTE
8. FAIR VALUE MEASUREMENTS
Effective
January 1, 2008, the Company adopted SFAS No. 157, which provides a framework
for measuring and disclosing fair value under generally accepted accounting
principles. SFAS No. 157 requires disclosures about the fair value of
assets and liabilities recognized in the balance sheet in periods subsequent to
initial recognition, whether the measurements are made on a recurring basis (for
example, available-for-sale investment securities) or on a nonrecurring basis
(for example, impaired loans).
SFAS
No. 157 defines fair value as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. SFAS No. 157 also
establishes a fair value hierarchy which requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring
fair value. The standard describes three levels of inputs that may be
used to measure fair value:
|
Level
1
|
Quoted
prices in active markets for identical assets or
liabilities. Level 1 assets and liabilities include debt and
equity securities and derivative contracts that are traded in an active
exchange market, as well as U.S. Treasury, other U.S. Government and
agency mortgage-backed debt securities that are highly liquid and are
actively traded in over-the-counter
markets.
|
|
Level
2
|
Observable
inputs other than Level 1 prices such as quoted prices for similar assets
and liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market
data for substantially the full term of the assets or
liabilities. Level 2 assets and liabilities include debt
securities with quoted prices that are traded less frequently than
exchange-traded instruments and derivative contracts whose value is
determined using a pricing model with inputs that are observable in the
market or can be derived principally from or corroborated by observable
market data. This category generally includes certain
derivative contracts, residential mortgage servicing rights, and impaired
loans.
|
|
Level
3
|
Unobservable
inputs that are supported by little or no market activity and that are
significant to the fair value of the assets or
liabilities. Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models, discounted
cash flow methodologies, or similar techniques, as well as instruments for
which the determination of fair value requires significant management
judgment or estimation. For example, this category generally
includes certain private equity investments, retained residual interest in
securitizations, and highly-structured or long-term derivative
contracts.
|
A
financial instrument’s categorization within the valuation hierarchy is based
upon the lowest level of input that is significant to the fair value
measurement. Assets measured at fair value on a recurring basis at
September 30, 2008 are summarized below:
|
Level
1
|
Level
2
|
Level
3
|
Fair
Value
|
|||||||||||||
|
Assets:
|
||||||||||||||||
|
Securities
available-for-sale
|
$ | 4,246,566 | $ | 25,391,871 | $ | 0 | $ | 29,638,437 | ||||||||
The
fair value of securities available for sale equals quoted market prices, if
available. If quoted market prices are not available, fair value is
determined using quoted market prices for similar securities. Level 1
securities include U.S. Government Bonds and certain preferred
stock. Level 2 securities include asset-backed securities including
obligations of government sponsored entities, mortgage backed securities,
municipal bonds and equity securities.
During
the third quarter of 2008, the Company recorded a noncash other than temporary
impairment charge totaling $739,332 for its investment in two classes of Fannie
Mae preferred stock. That action was taken after the federal
government placed Fannie Mae and its sister government sponsored enterprise,
Freddie Mac under conservatorship on September 7, 2008.
Assets
measured at fair value on a nonrecurring basis and reflected in the balance
sheet at September 30, 2008 are summarized below:
|
Level
1
|
Level
2
|
Level
3
|
Fair
Value
|
|||||||||||||
|
Restricted
equity securities
|
0 | 3,906,850 | 0 | 3,906,850 | ||||||||||||
|
Mortgages
held-for-sale
|
0 | 742,778 | 0 | 742,778 | ||||||||||||
|
Mortgage
servicing rights
|
0 | 1,068,130 | 0 | 1,068,130 | ||||||||||||
|
Impaired
loans
|
0 | 1,022,193 | 0 | 1,022,193 | ||||||||||||
|
Other
real estate owned
|
0 | 185,000 | 0 | 185,000 | ||||||||||||
|
Total
|
$ | 0 | $ | 1,207,193 | $ | 0 | $ | 1,207,193 | ||||||||
The
fair value of loans held-for-sale is based upon an actual purchase and sale
agreement between the Company and an independent market
participant. The sale is executed within a reasonable period
following quarter end at the stated fair value.
Mortgage
servicing rights are initially recorded at estimated fair value and are then
periodically measured for impairment by projecting and discounting future cash
flows associated with servicing at market rates. The projection of
cash flows is a Level 2 measurement, incorporating assumptions of changes in
cash flows due to estimated prepayments, estimated costs to service and
estimates of other servicing income. Market assumptions are used and
primarily include discount rates and expected prepayments. As of
September 30, 2008, the Company’s mortgage servicing rights measured at fair
value totaled $1.07 million. During the third quarter of 2008, the
Company recorded $94,945 of further impairment of mortgage servicing
rights. This was partially offset by $6,312 in new servicing rights
income, resulting in a net negative valuation adjustment of $88,633 for the
third quarter of 2008.
Loans
that are deemed to be impaired or transferred to other real estate owned are
valued at the lower of cost or the fair value of the underlying real estate
collateral. Impaired loans are measured at fair value on a
nonrecurring basis, with such fair values obtained using independent
appraisals. The fair market value of properties transferred to other
real estate owned is determined prior to transferring the balance of the loan to
other real estate owned. The balance transferred to other real estate
owned is the lesser of the estimated fair market value of the property, or the
book value of the loan, less estimated cost to sell. The Company
considers impaired loans and other real estate owned to be level 2
inputs.
NOTE
9. LEGAL PROCEEDINGS
The
Company has a pending legal issue involving safe deposit box procedures with a
potential claim amounting to $50,000. The Company’s subsidiary,
Community National Bank, as successor by merger to LyndonBank, is a party to a
contract dispute with a service provider involving disputed charges of
approximately $72,000. The dispute is currently in mediation and may
proceed to binding arbitration if the parties are unable to settle the
matter. Currently the Company has not accrued for either of these
matters, but will do so before year end if either matter is still outstanding at
that time.
In
addition to the foregoing matters, in the normal course of business the Company
and its subsidiary are involved in litigation that is considered incidental to
their business. Management does not expect that any such litigation
will be material to the Company's consolidated financial condition or results of
operations.
NOTE 10.
JUNIOR SUBORDINATED DEBT SECURITIES DUE 2037
As
of September 30, 2008, the Company had outstanding $12,887,000 principal amount
of Junior Subordinated Debentures Due 2037 (the “Debentures”). The
Debentures, which were issued to finance the LyndonBank acquisition (see Note
7), pay interest quarterly at a fixed annual rate of interest of 7.56% through
December 15, 2012, and thereafter at a floating rate equal to the 3-month London
Interbank Offered Rate (LIBOR) plus 2.85% and mature on December 15,
2037. The Debentures are subordinated and junior in right of payment
to all senior indebtedness of the Company, as defined in the Indenture dated as
of October 31, 2007 (the “Indenture”) between the Company and First Tennessee
Bank, National Association, as Trustee. The Debentures are first
redeemable, in whole or in part, by the Company on December 15,
2012.
The
Debentures were issued and sold to CMTV Capital Trust I (the
“Trust”). The Trust is a special purpose trust funded by a capital
contribution of $387,000 from the Company, in exchange for 100% of the Trust’s
common equity. The Trust was formed for the purpose of issuing
corporation-obligated mandatorily redeemable Capital Securities (“Capital
Securities”) in the principal amount of $12.5 million to third-party investors
and using the proceeds from the sale of such Capital Securities and the
Company’s initial capital contribution to purchase the
Debentures. The Debentures are the sole asset of the
Trust. Distributions on the Capital Securities issued by the Trust
are payable quarterly at a rate per annum equal to the interest rate being
earned by the Trust on the Debentures. The Capital Securities are
subject to mandatory redemption, in whole or in part, upon repayment of the
Debentures. The Company has entered into an agreement which, taken
collectively, fully and unconditionally guarantees the Capital Securities
subject to the terms of the guarantee.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
for the
Period Ended September 30, 2008
FORWARD-LOOKING
STATEMENTS
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 contained 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 Federal Home Loan Bank (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, which erode the competitive advantage of in-market branch facilities;
(2) interest rates change in such a way as to reduce the Company's margins; (3)
adverse changes in the financial markets or in general economic conditions,
either nationally or regionally, result in a deterioration in credit quality or
a diminished demand for the Company's products and services; (4) changes in laws
or government rules, or the way in which courts interpret those laws or rules,
adversely affect the Company's business; and (5) unanticipated difficulties,
expenses or delays might arise in the integration of LyndonBank’s operations or
we may not fully realize the anticipated benefits of the acquisition or realize
them within expected timeframes.
These
risks are heightened by the recent adverse developments in national and global
financial markets. During 2008, the capital and credit markets have
experienced extended and significant volatility and disruption. We
are unable to predict what effect these uncertain market conditions will have on
the banking industry generally or, in particular, on the Company’s business,
financial condition and results of operations.
A Note to
Reader
The
Company’s acquisition of LyndonBank became effective on December 31,
2007. Accordingly, the Company’s results for the third quarter and
first nine months of 2008 discussed in this report are of the merged
institution. The comparative period information in this report as of
September 30, 2007 and for the third quarter and nine months then ended does not
include data for LyndonBank.
OVERVIEW
The
Government’s takeover of Federal National Mortgage Association (Fannie Mae) and
Federal Home Loan Mortgage Corporation (Freddie Mac) had a negative impact on
the Company’s third quarter earnings. The Company owned two classes
of Fannie Mae preferred stock and after these agencies were placed under
conservatorship, the value of their stock plummeted. This resulted in
a write down of the investment portfolio and a non-cash charge to earnings in
the amount of approximately $739,000 for the third quarter. Section
301 of the Emergency Economic Stabilization Act (EESA) of 2008 provides tax
relief to banking organizations that have suffered losses on certain holdings of
Fannie Mae and Freddie Mac preferred stock by changing the character of these
losses from capital to ordinary for federal income tax
purposes. Although the EESA allows the write down to be taken as an
ordinary loss, the tax benefit is not applicable until the fourth quarter
according to generally accepted accounting principles. Therefore, the
write down of $739,000 was taken in the third quarter; and the applicable tax
benefit of approximately $251,000 will be taken in the fourth
quarter.
Total
assets at September 30, 2008 were $489.55 million compared to $502.03 million at
December 31, 2007 and $350.81 at September 30, 2007. The year-to-year
increase reflects the acquisition of LyndonBank. After a seasonal decline
in assets at the end of the second quarter due to the municipal loans that
mature, total assets have increased as new municipal loans were booked during
the first weeks of the third quarter. Although assets have increased
during this quarter, total assets are still below prior year-end
levels. The Company’s cyclical pattern is to grow deposits through
out the fourth quarter. Gross loans increased from year-end by
$1.46 million while deposits decreased by $27.09 million. The
decrease in deposits during the first half of the year is due in part to
seasonal municipal activity; however this year, the Company also experienced
some post-merger deposit runoff. Low interest rates have made growing
deposits a challenge. The Company is also aware that the recent
turmoil in the investment banking industry has caused erosion in customer
confidence. The increase in FDIC insurance coverage from $100,000 to
$250,000 through the end of 2009 provided in the EESA has helped ease customers’
fears.
A
major component of the EESA is the Troubled Asset Relief Program (TARP) Capital
Purchase Program (the “Program”). Under the Program, the U.S.
Treasury Department will purchase from participating banking institutions a
limited amount of senior perpetual preferred securities equal to up to 3% of the
institution’s risk-weighted assets, for a purchase price (liquidation
preference) of $1,000 per share. Treasury will also receive warrants
for the purchase of common stock having an aggregate market value equal to 15%
of the amount of its preferred stock investment, with the number of common
shares and the warrant exercise price based on the average market price of the
common stock for the 20 trading days preceding Treasury’s approval of the
institution’s application. The preferred shares will pay an annual
dividend of 5% for five years, which then increases to 9%, and are redeemable in
whole or in part at any time after three years. The preferred shares,
warrants and any common stock issued upon exercise of the warrants must be
freely transferable. For so long as Treasury holds any of a banking
institution’s securities, subject to certain exceptions, the institution will be
subject to limitations on certain executive compensation expenses, increases in
dividend payments and on share buy back programs. Participation in
the program is voluntary, although the Treasury Department is encouraging
healthy banks to participate. The objective of the Program is to
strengthen the financial system and increase credit availability in the economy,
by building stronger capital base in the financial sector, especially in healthy
banks, thereby providing them with additional capital to lend.
Although
the Company is “well capitalized” under all applicable regulatory measures,
management believes that the TARP Capital Purchase Program represents a useful,
cost-effective source of additional Tier 1 capital, and is considering whether
to file an application under the Program. Issuance of the preferred stock
to Treasury would require the consent of the Company's existing preferred
shareholders (three local banking institutions). The terms of any such
investment by Treasury in the Company could differ from those described
above. That description is based on the terms announced by Treasury
thus far for stock-exchange listed companies, which Treasury has stated may be
modified in some respects for other banking organizations, including smaller
public companies, such as Community Bancorp.
The
Company had strong enough core earnings to absorb the loss from the write down
of the Fannie Mae preferred stock and reported positive earnings for both
comparison periods. Net income for the third quarter of 2008 was
$314,613. Without the write down, net income would have been $1.05
million compared to $927,172 for the third quarter of 2007. Earnings
per common share were reported as $0.06 for the third quarter of 2008 compared
to earnings per common share of $0.21 for the same period last
year. Net interest income, after the provision for loan losses, was
$4.04 million for the third quarter of 2008, compared to $3.28 million for the
third quarter of 2007. Yields on assets have stabilized somewhat
while deposit rates continue to decrease. This combined with some
steepening of the yield curve has resulted in some improvement in spreads since
the first two quarters. Loan demand has been
steady. However, since much of the activity consists of refinancings,
the increased loan activity has not resulted in significant growth of the
portfolio.
Non-interest
income, which is derived primarily from charges and fees on deposit and loan
products, was $1.08 million for the third quarter of 2008 compared to $1.11
million for the second quarter of 2007, a decrease of 2.4%. This
decrease is largely due to mark-to-market accounting adjustments to the mortgage
servicing rights (MSR) which resulted in a net negative valuation adjustment and
charge to income of $88,633 for the third quarter of 2008 compared to MSR income
of $48,467 for the same period in 2007. Non-interest
expense, which is where the write down of the Fannie Mae preferred stock is
carried, was $4.64 million for the third quarter of 2008 versus $3.25 million
for the 2007 comparison period, an increase of 43%. Without the write
down, non-interest expense would have been $3.90 million for the quarter, an
increase of 20% over the same quarter last year. With most of the
merger related costs having been expensed in the first quarter, expenses are
starting to reflect the normal post-merger operating expense levels for the
Company. The regulatory environment continues to increase operating
costs and place extensive burden on management resources to comply with rules
such as Sarbanes-Oxley Act of 2002, the US Patriot Act and the Bank Secrecy Act
to protect the U.S. financial system and the customer from fraud, identity
theft, anti-money laundering, and terrorism.
The
following pages describe our third quarter and nine months ended September 30,
2008 financial results in much more detail. Please take the time to read them to
more fully understand the results of those periods in relation to the 2007
comparison periods. The discussion below should be read in
conjunction with the Consolidated Financial Statements of the Company and
related notes included in this report and with the Company's Annual Report on
Form 10-K for the year ended December 31, 2007. This report includes
forward-looking statements within the meaning of the Securities and Exchange Act
of 1934 (the "Exchange Act"). (See “FORWARD-LOOKING STATEMENTS”
above.)
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
evaluates on an ongoing basis its judgment as to which policies are considered
to be critical. Management believes that the calculation of the allowance for
loan losses (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 considers
historical experience as well as other factors including the effect of changes
in the local real estate market on collateral values, current economic
indicators and their probable impact on borrowers and changes in delinquent,
non-performing or impaired loans. Management’s estimates used in
calculating the ALL may increase or decrease based on changes in these factors,
which in turn will affect the amount of the Company’s provision for loan losses
charged against current period income. 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. Because the extent of any recovery on these
loans depends largely on the amount the Company is able to realize upon
liquidation of the underlying collateral, 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.
Companies
are required to perform periodic reviews of individual securities in their
investment portfolios to determine whether decline in the value of a security is
other than temporary. A review of other-than-temporary impairment requires
companies to make certain judgments regarding the materiality of the decline,
its effect on the financial statements and the probability, extent and timing of
a valuation recovery and the Company’s intent and ability to hold the security.
Pursuant to these requirements, management assesses valuation declines to
determine the extent to which such changes are attributable to fundamental
factors specific to the issuer, such as financial condition, business prospects
or other factors or market-related factors, such as interest rates. Declines in
the fair value of securities below their cost that are deemed to be other than
temporary are recorded in earnings as realized losses.
Under
current accounting rules, mortgage servicing rights associated with loans
originated and sold, where servicing is retained, are capitalized and included
in other assets in the consolidated balance sheet. Mortgage servicing rights are
amortized into non-interest income in proportion to, and over the period of,
estimated future net servicing income of the underlying financial assets.
Mortgage servicing rights are evaluated for impairment based upon the fair value
of the rights as compared to amortized cost. The value of capitalized servicing
rights represents the present value of the future servicing fees arising from
the right to service loans in the portfolio. The carrying value of the mortgage
servicing rights is periodically reviewed for impairment based on a
determination of fair value and impairment, if any, is recognized through a
valuation allowance and is recorded as amortization of other
assets. Fair value in excess of the carrying value of mortgage
servicing rights is not recognized. Critical accounting policies for
mortgage servicing rights relate to the initial valuation and subsequent
impairment tests. The methodology used to determine the valuation of mortgage
servicing rights requires the development and use of a number of estimates,
including anticipated principal amortization and loan prepayments. Events that
may significantly affect the estimates used are changes in interest rates and
the payment performance of the underlying loans. As required by SFAS
No. 156, “Accounting for Servicing of Financial Assets-an Amendment to FASB
Statement No. 140”, the Company utilizes the services of a third party provider
to perform a quarterly valuation analysis.
Accounting
for a business combination requires the application of the purchase method of
accounting. Under the purchase method, the Company is required to
record the net assets and liabilities acquired through the merger at fair market
value, with the excess of the purchase price over the fair market value of the
net assets recorded as goodwill and evaluated annually for
impairment. The determination of fair value requires management to
make various assumptions, including discount rates, and changes in those
assumptions could significantly affect fair values.
Management
utilizes numerous techniques to estimate the carrying value of various assets
held by the Company, including, but not limited to, bank premises and equipment
and deferred taxes. The assumptions considered in making these estimates are
based on historical experience and on various other factors that are believed by
management to be reasonable under the circumstances. Management
acknowledges that the use of different estimates or assumptions could produce
different estimates of carrying values.
RESULTS OF
OPERATIONS
The
third quarter of 2008 and the nine months then ended reflect the combined
operations following the Company’s acquisition of LyndonBank, which became
effective on December 31, 2007. Accordingly, in the discussion that
follows, prior period income and expense figures are for the Company prior to
the merger, and do not include LyndonBank’s results of operations.
The
Company’s net income for the third quarter and first nine months of 2008 was
adversely affected by a write down in the amount of $739,332 taken for the
Company’s investment in two classes of Fannie Mae preferred
stock. Although the write down was taken in the third quarter and the
EESA permits the associated loss to be treated as ordinary rather than capital
for tax purposes, due to the fourth quarter enactment date of EESA, the tax
benefit amounting to approximately $251,000 will not be recorded until the
fourth quarter.
The
Company’s net income for the third quarter of 2008 was $314,613, representing a
decrease of $612,559 or 66.1% over net income of $927,172 for the third quarter
of 2007. This resulted in earnings per common share of $0.06 and $0.21,
respectively, for the third quarters of 2008 and 2007. Despite the
volatility in the financial markets, core earnings (net interest income) for the
third quarter of 2008 were strong, with an increase of $830,245 or 25.0% over
the third quarter of 2007. Interest income on loans, the major
component of interest income, increased $1.1 million or 23.7%, for the third
quarter of 2008 to $5.9 million compared to $4.8 million for the third quarter
of 2007. Interest and dividend income on investments increased
$315,521 or 61.6%. Interest paid on deposits, the major component of interest
expense, increased $184,069 or 9.4%, between periods. Interest paid on junior
subordinated debentures, a new component of interest expense between comparison
periods, amounted to $243,564 for the third quarter of 2008. This
interest is paid out quarterly on the Company’s $12.9 million in junior
subordinated debentures issued in October, 2007 in connection with a trust
preferred securities financing to finance the Company’s acquisition of
LyndonBank.
Net
income for the first nine months of 2008 was $1.4 million, representing a
decrease of $1.1 million, or 42.9% compared to $2.5 million for the first nine
months of 2007, with earning per share of $0.29 and $0.56 for the respective
nine month periods. Core earnings for the same comparison periods
were $11.8 million for 2008, compared to $9.9 million for 2007, resulting in an
increase of approximately $1.8 million, or 18.3%. Interest income on
loans increased $3.5 million or 24.0% for the first nine months of 2008 to
approximately $17.9 million compared to $14.4 million for the same period in
2007, and interest and dividend income on investments increased $1.2 million or
82.9% between periods, to $2.6 million for the first nine months of 2008, versus
$1.4 million for the 2007 comparison period. Interest paid on
deposits increased $1.7 million to $7.5 million for the first nine months of
2008 compared to $5.8 million for the first nine months of 2007, and interest
paid on junior subordinated debentures amounted to $732,776 for the first nine
months of 2008. These increases are predominantly the result of
increases in earning assets and interest bearing liabilities related to the
Company’s recent merger with LyndonBank. As a result of the merger,
the Company is required to amortize the fair value adjustments of the acquired
loans and deposits through net interest income. The loan fair value
adjustment was a net premium, therefore resulting in a decrease of $56,283 in
interest income for the third quarter of 2008, and $253,100 for the first nine
months of 2008. The amortization of the core deposit intangible and
the certificate of deposit fair value adjustment resulted in $273,050 of
additional interest expense for the third quarter of 2008 and $819,150 for the
first nine months of 2008. The Company also incurred some additional
expenses during the first half of 2008 that were a direct result of the merger,
including costs to terminate service contracts held by the former LyndonBank,
costs of outside contracts to complete the computer and network conversions, the
cost of a communication booklet for the customers, and salary and wages for the
personnel needed to complete the merger and the conversion of computer
systems.
Return
on average assets (ROA), which is net income divided by average total assets,
measures how effectively a corporation uses its assets to produce
earnings. Return on average equity (ROE), which is net income divided
by average shareholders' equity, measures how effectively a corporation uses its
equity capital to produce earnings. ROA and ROE were significantly
lower in the third quarter and first nine months of 2008 compared to 2007,
reflecting the effect of merger-related expenses including the write down on the
Fannie Mae preferred stock discussed throughout the narrative. The
following table shows these ratios annualized for the comparison
periods.
|
For
the third quarter ended September 30,
|
2008
|
2007
|
||||||
|
Return
on Average Assets
|
0.25 | % | 1.03 | % | ||||
|
Return
on Average Equity
|
3.63 | % | 11.66 | % | ||||
|
For
the first nine months ended September 30,
|
2008
|
2007
|
||||||
|
Return
on Average Assets
|
0.38 | % | .93 | % | ||||
|
Return
on Average Equity
|
5.41 | % | 10.82 | % | ||||
INTEREST INCOME LESS
INTEREST EXPENSE (NET INTEREST INCOME)
Net
interest income, the difference between interest income and interest expense,
represents the largest portion of the Company's earnings, and is affected by the
volume, mix, and rate sensitivity of earning assets and interest bearing
liabilities, market interest rates and the amount of non-interest bearing funds
which support earning assets. The three tables below provide a visual
comparison of the consolidated figures, and are stated on a tax equivalent basis
assuming a federal tax rate of 34%, the Company’s corporate tax rate. Therefore,
to equalize tax-free and taxable income in the comparison, we divide the
tax-free income by 66%, with the result that every tax-free dollar is equal to
$1.52 in taxable income.
Tax-exempt
income is derived from municipal investments, which comprise the entire
held-to-maturity portfolio of $46.4 million, along with a small municipal
portfolio classified as available-for-sale amounting to approximately $1.2
million that was acquired through the merger with LyndonBank. The
Company also acquired Fannie Mae preferred stock through the acquisition of
LyndonBank which is also included in its available-for-sale
portfolio. Prior to the third quarter of 2008, this preferred stock
carried a fair value of approximately $1.2 million with a 70% tax exemption on
the interest income generated. During the third quarter of 2008, the
Company consulted an independent securities valuation firm to determine a more
accurate estimated fair value at the merger acquisition date, December 31,
2007. The fair value adjustment amounted to $656,347 and was recorded
through goodwill. When Fannie Mae was placed under conservatorship,
the Company was required to write down the stock to a fair value of $162,610 as
of September 30, 2008, resulting in a write down of $739,332 during the third
quarter of 2008. Although the EESA accords ordinary loss rather than
capital loss treatment to the write down, that tax benefit will not be
recognized until the fourth quarter. Dividend payments, which
amounted to $68,843 for the first nine months of 2008, have ceased on this stock
beginning with the last quarter of 2008.
The
following table shows the reconciliation between reported net interest income
and tax equivalent, net interest income for the nine month comparison periods of
2008 and 2007:
|
For
the nine months ended September 30,
|
2008
|
2007
|
||||||
|
Net
interest income as presented
|
$ | 11,755,090 | $ | 9,940,186 | ||||
|
Effect
of tax-exempt income
|
684,486 | 356,199 |
|
|||||
|
Net
interest income, tax equivalent
|
$ | 12,439,576 | $ | 10,296,385 | ||||
AVERAGE
BALANCES AND INTEREST RATES
The
table below presents average earning assets and average interest-bearing
liabilities supporting earning assets. Interest income (excluding
interest on non-accrual loans) and interest expense are both expressed on a tax
equivalent basis, both in dollars and as a rate/yield for the 2008 and 2007
comparison periods. Loans are stated before deduction of non-accrual
loans, unearned discount and allowance for loan losses. Average earning assets and
liabilities for the 2007 comparison period do not include the earning assets and
liabilities of LyndonBank.
|
For
the Nine Months Ended:
|
||||||||||||||||||||||||
|
2008
|
2007
|
|||||||||||||||||||||||
|
Average
|
Income/
|
Rate/
|
Average
|
Income/
|
Rate/
|
|||||||||||||||||||
|
Balance
|
Expense
|
Yield
|
Balance
|
Expense
|
Yield
|
|||||||||||||||||||
|
EARNING
ASSETS
|
||||||||||||||||||||||||
|
Loans
(gross)
|
$ | 356,861,435 | $ | 17,866,539 | 6.69 | % | $ | 265,366,409 | $ | 14,406,502 | 7.26 | % | ||||||||||||
|
Taxable
Investment Securities
|
33,252,461 | 1,142,179 | 4.59 | % | 21,882,922 | 630,477 | 3.85 | % | ||||||||||||||||
|
Tax
Exempt Investment Securities
|
45,715,510 | 2,043,005 | 5.97 | % | 22,309,646 | 1,047,645 | 6.28 | % | ||||||||||||||||
|
Federal
Funds Sold and Interest
Earning
Deposit Accounts
|
1,751,793 | 63,044 | 4.81 | % | 4,948,974 | 191,178 | 5.16 | % | ||||||||||||||||
|
Other
Investments
|
4,118,120 | 148,908 | 4.83 | % | 2,370,985 | 126,370 | 7.13 | % | ||||||||||||||||
|
TOTAL
|
$ | 441,699,319 | $ | 21,263,675 | 6.43 | % | $ | 316,878,936 | $ | 16,402,172 | 6.92 | % | ||||||||||||
|
INTEREST
BEARING LIABILITIES & EQUITY
|
||||||||||||||||||||||||
|
NOW
& Money Market Funds
|
$ | 120,495,421 | $ | 2,081,421 | 2.31 | % | $ | 71,331,482 | $ | 1,367,627 | 2.56 | % | ||||||||||||
|
Savings
Deposits
|
50,204,538 | 325,358 | 0.87 | % | 39,401,552 | 102,845 | 0.35 | % | ||||||||||||||||
|
Time
Deposits
|
176,392,223 | 5,091,439 | 3.86 | % | 132,389,714 | 4,303,985 | 4.35 | % | ||||||||||||||||
|
Fed
Funds Purchased and Other
Borrowed
Funds
|
16,988,013 | 340,637 | 2.68 | % | 2,223,615 | 90,642 | 5.45 | % | ||||||||||||||||
|
Repurchase
Agreements
|
16,030,850 | 195,746 | 1.63 | % | 14,489,925 | 240,688 | 2.22 | % | ||||||||||||||||
|
Capital
Lease Obligations
|
933,634 | 56,722 | 8.12 | % | 0 | 0 | 0.00 | % | ||||||||||||||||
|
Junior
Subordinated Debentures
|
12,887,000 | 732,776 | 7.60 | % | 0 | 0 | 0.00 | % | ||||||||||||||||
|
TOTAL
|
$ | 393,931,679 | $ | 8,824,099 | 2.99 | % | $ | 259,836,288 | $ | 6,105,787 | 3.14 | % | ||||||||||||
|
Net
Interest Income
|
$ | 12,439,576 | $ | 10,296,385 | ||||||||||||||||||||
|
Net
Interest Spread(1)
|
3.44 | % | 3.78 | % | ||||||||||||||||||||
|
Interest
Margin(2)
|
3.76 | % | 4.34 | % | ||||||||||||||||||||
|
(2) Interest
margin is net interest income divided by average earning
assets.
|
The
average volume of earning assets for the first nine months of 2008 increased
$124.8 million, or 39.4% compared to the same period of 2007, reflecting the
effect of the LyndonBank merger, while average yield decreased 49 basis points
reflecting the low interest rate environment. The average volume of
loans increased $91.5 million or 34.5%, and the average volume of the investment
portfolio increased $36.5 million or 78.5% between periods. These
increases are attributable to the merger with LyndonBank at December 31, 2007,
in which the Company acquired $94.8 million in loans and $23.5 million in
available-for-sale investments. LyndonBank figures are actual,
compared to the average volumes discussed above and throughout this
section. Interest earned on the loan portfolio comprised
approximately 84.0% of total interest income for the first nine months of 2008
and 87.8% for the 2007 comparison period. Interest earned on tax
exempt investments (which is presented on a tax equivalent basis) comprised 9.6%
of net interest income for the first nine months of 2008 compared to 6.4% for
the same period in 2007. As discussed above, the Company
acquired certain tax exempt, or partially tax exempt, investments in the merger
with LyndonBank, contributing to this increase. Those investments included the
Fannie Mae preferred stock, which was originally booked at $1.5 million using
reported trading prices on December 31, 2007. A revised valuation
analysis by an independent third party resulted in a fair market value of
$902,000 at December 31, 2007, creating a goodwill adjustment of
$656,347. At September 30, 2008, the other-than-temporary impairment
of the Fannie Mae preferred stock was determined to be $739,332, resulting in a
noncash charge to income in that amount.
The
average volume of interest-bearing liabilities for the first nine months of 2008
increased approximately $134.1 million, or 51.6% over the 2007 comparison
period, again reflecting the effect of the LyndonBank merger, while the average
rate paid on these accounts decreased 15 basis points, which is attributable to
the low interest rate environment. The average volume of time
deposits increased $44.0 million, or 33.2%, and the interest paid on time
deposits increased $787,454, or 18.3%, and comprised 57.7% and 70.5%,
respectively, of total interest expense for the 2008 and 2007 comparison
periods. NOW and money market funds increased $49.2 million or 68.9%,
and the interest paid on these funds increased $713,794, or 52.2% and comprised
23.6% and 22.4%, respectively, of the total interest expense for the first nine
months of 2008 and 2007. The Company acquired actual balances
totaling $29.7 million in NOW and money market funds and $54.1 million in time
deposits at December 31, 2007 through the merger with LyndonBank. The
average rate paid on the capital lease obligation the Company acquired through
the merger was 8.12%, and the average rate paid on the junior subordinated
debentures was 7.60%. Although these rates are quite high, the rest
of the portfolio, which is substantially more than these two items, reported
decreases for the first nine months of 2008, accounting for the decrease in the
overall average rate paid on interest-bearing liabilities. The junior
subordinated debentures totaling $12.9 million helped to finance the year-end
acquisition of LyndonBank.
The
cumulative result of all these changes was a decline of 34 basis points in the
net interest spread and an increase of $2.1 million in tax equivalent net
interest income. However, the significant increase in the balance
sheet resulted in a decrease of 58 basis points in the interest
margin.
The
following table summarizes the variances in interest income and interest expense
on a fully tax-equivalent basis for the 2008 and 2007 comparison periods
resulting from volume changes in average assets and average liabilities and
fluctuations in rates earned and paid.
|
CHANGES
IN INTEREST INCOME AND INTEREST EXPENSE
|
||||||||||||
|
Variance
|
Variance
|
|||||||||||
|
RATE
/ VOLUME
|
Due
to
|
Due
to
|
Total
|
|||||||||
|
Rate(1)
|
Volume(1)
|
Variance
|
||||||||||
|
INCOME
EARNING ASSETS
|
||||||||||||
|
Loans
(2)
|
(1,508,218 | ) | 4,968,255 | 3,460,037 | ||||||||
|
Taxable
Investment Securities
|
184,306 | 327,396 | 511,702 | |||||||||
|
Tax
Exempt Investment Securities
|
(104,036 | ) | 1,099,396 | 995,360 | ||||||||
|
Federal
Funds Sold and Interest Earning Deposit Accounts
|
(13,006 | ) | (115,128 | ) | (128,134 | ) | ||||||
|
Other
Investments
|
(70,634 | ) | 93,172 | 22,538 | ||||||||
|
Total
Interest Earnings
|
(1,511,466 | ) | 6,372,969 | 4,861,503 | ||||||||
|
INTEREST
BEARING LIABILITIES
|
||||||||||||
|
NOW
& Money Market Funds
|
(227,567 | ) | 941,361 | 713,794 | ||||||||
|
Savings
Deposits
|
194,233 | 28,280 | 222,513 | |||||||||
|
Time
Deposits
|
(644,195 | ) | 1,431,649 | 787,454 | ||||||||
|
Fed
Funds Purchased and Other Borrowed Funds
|
(351,846 | ) | 601,841 | 249,995 | ||||||||
|
Repurchase
Agreements
|
(70,528 | ) | 25,586 | (44,942 | ) | |||||||
|
Capital
Lease Obligations
|
56,722 | 0 | 56,722 | |||||||||
|
Junior
Subordinated Debentures
|
732,776 | 0 | 732,776 | |||||||||
|
Total
Interest Expense
|
(310,405 | ) | 3,028,717 | 2,718,312 | ||||||||
|
Changes
in Net Interest Income
|
(1,201,061 | ) | 3,344,252 | 2,143,191 | ||||||||
|
(1)
Items which have shown a year-to-year increase in volume have variances
allocated as follows:
|
|
Variance
due to rate = Change in rate x new volume
|
|
Variance
due to volume = Change in volume x old rate
|
|
Items
which have shown a year-to-year decrease in volume have variances
allocated as follows:
|
|
Variance
due to rate = Change in rate x old volume
|
|
Variances
due to volume = Change in volume x new rate
|
|
(2)
Loans are stated before deduction of unearned discount and allowances for
loan losses. The
|
|
principal
balances of non-accrual loans is included in calculations of the yield on
loans, while
|
|
the
interest on these non-performing assets is
excluded.
|
NON-INTEREST INCOME AND
NON-INTEREST EXPENSE
Non-interest
income decreased $26,384 or 2.4% for the third quarter of 2008 compared to the
third quarter of 2007, from $1.11 million to $1.08 million. Service
fees increased $212,265 or 60.6%, while other income decreased $272,573 or 35.9%
for the third quarter of 2008 compared to the same quarter in
2007. The increase in service fees was not only attributable to the
increase in deposit accounts acquired through the merger with LyndonBank, but
also the result of an increase in various service fees on deposit accounts and
increased customer utilization. The Company sold its credit card
portfolio during the third quarter of 2007 resulting in a gain of $257,836,
partially accounting for the decrease in other income for the third quarter of
2008 compared to the third quarter of 2007. Non-interest income
increased $488,567 or 18.0% for the first nine months of 2008 compared to the
same period in 2007 from $2.7 million to $3.2 million. Service fees
increased $609,931 or 59.1%, while other income decreased $220,899 or
13.2%. The Company acquired bank owned life insurance (BOLI) through
the merger, and recognized $99,535 in non-taxable income on this asset during
the first nine months of 2008. Commissions and distributions from
insurance companies increased $261,545, with $336,415 reported for the first
nine months of 2008 versus $74,870 for the same period in 2007. This
increase was attributable primarily to a receivable booked based on the balance
of undistributed income allocation held by the mortgage guaranty reinsurer New
England Mortgage Insurance Exchange (NEMIE) for its subscribers. The
Company is a subscriber of NEMIE and receives distributions
annually. Income from the sale and servicing of loans was down
approximately $100,000 due in part to a decrease in the servicing percentage fee
the Company receives as well as a decrease in secondary market
volume. Investment income from assets held in a rabbi trust under the
Company’s Supplemental Employee Retirement Plan (SERP) was down $123,114 due to
the current financial market.
Non-interest
expense increased $1.4 million or 43.0% for the third quarter of 2008 compared
to 2007. Salaries and wages increased $192,404 or 16.5% for the third
quarter of 2008 compared to the same period in 2007 attributable to normal year
to year increases as well as an increase in staff from the LyndonBank
acquisition. The merger with LyndonBank also resulted in the Company
acquiring more premises and equipment, accounting for the increase of $220,374
or 40.9% in occupancy expenses for the third quarter of 2008 compared to the
third quarter of 2007. As mentioned in various sections throughout
this discussion, the Company wrote down its investment in Fannie Mae preferred
stock during the third quarter of 2008 resulting in a noncash expense totaling
$739,332. The tax benefit on this write down of approximately
$251,000 was not recordable during the third quarter under GAAP, but will be
recorded during the fourth quarter of 2008. Non-interest expense
increased $3.8 million or 39.4% for the first nine months of 2008 compared to
the same period in 2007 to end the first nine months of 2008 at $13.3 million,
compared to $9.6 million in 2007. Salaries and wages heads the list
of increases at $1.1 million or 31.1%, followed closely by other expenses with
an increase of $915,245 or 30.5%, and occupancy expense with an increase of
$640,009 or 36.0% for the first nine months of 2008 compared to the same period
in 2007. All increases are again attributable to the LyndonBank
merger ranging from an increase in personnel, both permanent and temporary, to
increases in building related expenses such as taxes, rent, heating and
telephone. Advertising and postage expenses were higher due in part
to an increased customer base as well as an increase in mailings due to the
Company’s efforts to keep customers informed of any and all changes occurring as
a result of the merger process.
Management
monitors all components of other non-interest 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
Provision
for income taxes decreased $45,093 or 21.2% for the third quarter of 2008
compared to the same quarter of 2007, and decreased $518,331 or 101.1% for the
first nine months of 2008 compared to the first nine months of
2007, These decreases are the direct result of the decrease in income
before taxes of $657,652 and $1.6 million, respectively for the third quarter
and nine month comparison periods. At December 31, 2007, the
Company’s deferred tax liability increased through the valuation of fixed assets
and deposits acquired through the merger with LyndonBank contributing to the
increase of $255,826 in the deferred tax provision thereby decreasing taxes
currently payable.
As
noted previously, in accordance with GAAP, an estimated tax benefit of
approximately $251,000 from the write down of the Company’s Fannie Mae preferred
shareholdings will be recognized in the fourth quarter of
2008.
CHANGES IN FINANCIAL
CONDITION
The
merger of the Bank and LyndonBank occurred on December 31, 2007. Therefore, the
assets and liabilities presented in the discussion below at that date and at
September 30, 2008 include the assets and liabilities of the former
LyndonBank.
The
following table reflects the composition of the Company's major categories of
assets and liabilities as a percent of total assets or liabilities and
shareholders’ equity, as the case may be, as of the dates
indicated:
|
ASSETS
|
30-Sep-08
|
31-Dec-07
|
30-Sep-07
|
|||||||||||||||||||||
|
Loans
(gross)*
|
$ | 359,100,867 | 73.35 | % | $ | 356,571,083 | 71.03 | % | $ | 256,909,154 | 73.23 | % | ||||||||||||
|
Available
for Sale Securities
|
29,638,437 | 6.05 | % | 46,876,771 | 9.34 | % | 25,074,048 | 7.15 | % | |||||||||||||||
|
Held
to Maturity Securities
|
46,368,055 | 9.47 | % | 34,310,833 | 6.83 | % | 29,431,718 | 8.39 | % | |||||||||||||||
|
*includes
loans held for sale
|
||||||||||||||||||||||||
|
LIABILITIES
|
||||||||||||||||||||||||
|
Time
Deposits
|
$ | 180,358,538 | 36.84 | % | $ | 185,136,803 | 36.88 | % | $ | 134,843,845 | 38.44 | % | ||||||||||||
|
Savings
Deposits
|
50,523,075 | 10.32 | % | 46,069,943 | 9.18 | % | 39,505,522 | 11.26 | % | |||||||||||||||
|
Demand
Deposits
|
54,499,372 | 11.13 | % | 64,019,707 | 12.75 | % | 50,485,030 | 14.39 | % | |||||||||||||||
|
NOW
& Money Market Funds
|
122,491,455 | 25.02 | % | 120,993,657 | 24.10 | % | 77,204,394 | 22.01 | % | |||||||||||||||
The
Company's loan portfolio increased $2.5 million or 0.7% from December 31, 2007
to September 30, 2008, and $102.2 million or 39.8%, from September 30, 2007 to
September 30, 2008. The year-to-year comparison reflects $94.0
million in loans recorded as a result of the LyndonBank acquisition on December
31, 2007. Available-for-sale investments decreased $17.2 million or
36.8% through maturities and calls during the first nine months of 2008, as
these funds were then used to cover the outflow of deposit accounts and to fund
loan demand. The increase of $4.6 million in available-for-sale
investments at September 30, 2008 compared Sept 30, 2007 is the result of $23.5
million in available-for-sale securities acquired in the merger, less $18.9
million in maturities and calls as well as the write down of the Fannie Mae
preferred stock. Held-to-maturity securities increased $12.1 million
or 35.1% during the first nine months of 2008, and $16.9 million or 57.5% year
to year. All LyndonBank investments were classified as
available-for-sale, therefore, none of the increases in the held-to-maturity
portfolio were attributable to securities acquired in the merger.
Time
deposits decreased $4.8 million or 2.6% for the first nine months of 2008, while
an increase of $45.5 million or 33.8% is noted year to year. This
year to year increase, when offset by the acquisition of $53.4 million in time
deposits on December 31, 2007 in the LyndonBank merger, net of fair value
adjustments and the sale of deposits associated with the Vergennes branch of
LyndonBank, nets a decrease of $7.9 million from September 30, 2007 to September
30, 2008. Demand deposits decreased $9.5 million or 14.9% for the first nine
months of 2008, compared to an increase of just over $4.0 million or
approximately 8.0% year to year. Although $18.1 million in demand
deposits were acquired in the merger, approximately $8 million were reclassified
to NOW accounts after the conversion, resulting in a net decrease of $6.1
million year to year. Savings deposits increased $4.5 million or 9.7%
for the first nine months of 2008, and $11.0 million or 27.9% year to
year. Approximately $8.8 million were acquired in the merger, making
the net increase $2.2 million or 4.6%. NOW and money market funds
reported an increase of $1.5 million or 1.2% for the first nine months of 2008,
but when netted against the $8 million in funds that were reclassified to NOW
accounts, a decrease of $6.5 million was recognized. NOW and money
market accounts increased $45.3 million or 58.7% year to year, or $37.3 million
net of the account reclassification during 2008. The Company
anticipated a post-merger runoff of 3% in non-maturing deposits during the
first quarter of 2008; actual run off of these deposits during the first quarter
was approximately 5%. The expected seasonal increase in municipal
deposits has begun as municipalities have started collecting tax payments from
its residents and business customers.
RISK
MANAGEMENT
Interest Rate
Risk and Asset and Liability Management - 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 Management
Committee (ALCO) 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 ALCO meets monthly to review financial statements,
liquidity levels, yields and spreads to better understand, measure, monitor and
control the Company’s interest rate risk. In the ALCO process, the
committee members apply policy limits set forth in the Asset Liability,
Liquidity and Investment policies approved by the Company’s Board of
Directors. The ALCO's methods for evaluating interest rate risk
include an analysis of the effects of interest rate changes on net interest
income and 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.
Interest
rate risk represents the sensitivity of earnings to changes in market interest
rates. As interest rates change, the interest income and expense
streams associated with the Company’s interest sensitive assets and liabilities
also change, thereby impacting net interest income (NII), the primary component
of the Company’s earnings. Fluctuations in interest rates can also
have an impact on liquidity. The ALCO uses an outside consultant to
perform quarterly rate shock simulations to the Company's net interest income,
as well as a variety of other analyses. It is the ALCO’s function to
provide the assumptions used in the modeling process. The ALCO
utilizes the results of this simulation model to quantify the estimated exposure
of NII and liquidity to sustained interest rate changes. The
simulation model captures the impact of changing interest rates on the interest
income received and interest expense paid on all interest-earning assets 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 200 basis point (bp) shift upward and a 100 bp
shift downward in interest rates. The analysis also provides a
summary of the Company's liquidity position. Furthermore, the analysis provides
testing of the assumptions used in previous simulation models by comparing the
projected NII with actual NII. The asset/liability simulation model
provides management with an important tool for making sound economic decisions
regarding the balance sheet.
While
assumptions are developed based upon current economic and local market
conditions, the Company cannot provide any assurances as to the predictive
nature of these assumptions including how or when customer preferences or
competitor influences might change. In addition, recent market
turmoil and volatility may adversely affect the predictive nature of the
Company’s assumptions.
Credit
Risk - A primary
concern of management is to reduce the exposure to credit loss within the loan
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 help ensure 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. Credit risk may also arise from geographic concentration of
loans. While the Company’s loan portfolio is derived primarily from
its primary market area in northeastern Vermont, geographic concentration is
partially mitigated by the continued growth of the Company’s loan portfolio in
Washington, Lamoille and Franklin counties, its newest market
areas.
The
following table reflects the composition of the Company's loan portfolio as of
the dates indicated:
|
September
30, 2008
|
December
31, 2007
|
|||||||||||||||
|
Total
Loans
|
%
of Total
|
Total
Loans
|
%
of Total
|
|||||||||||||
|
Real
Estate Loans
|
||||||||||||||||
|
Construction
& Land Development
|
$ | 16,011,480 | 4.46 | % | $ | 12,896,803 | 3.62 | % | ||||||||
|
Farm
Land
|
8,958,744 | 2.49 | % | 9,645,648 | 2.70 | % | ||||||||||
|
1-4
Family Residential
|
206,797,708 | 57.59 | % | 195,843,105 | 54.92 | % | ||||||||||
|
Commercial
Real Estate
|
85,187,549 | 23.72 | % | 85,576,002 | 24.00 | % | ||||||||||
|
Loans
to Finance Agricultural Production
|
928,658 | 0.26 | % | 2,430,454 | 0.68 | % | ||||||||||
|
Commercial
& Industrial
|
24,850,690 | 6.92 | % | 31,258,211 | 8.77 | % | ||||||||||
|
Consumer
Loans
|
16,141,842 | 4.50 | % | 18,461,620 | 5.18 | % | ||||||||||
|
All
Other Loans
|
224,195 | 0.06 | % | 459,241 | 0.13 | % | ||||||||||
|
Gross
Loans
|
359,100,867 | 100.00 | % | 356,571,083 | 100.00 | % | ||||||||||
|
Allowance
for Loan Losses
|
(3,058,882 | ) | -0.65 | % | (3,026,049 | ) | -0.85 | % | ||||||||
|
Unearned
net Loan Fees
|
(352,142 | ) | -0.14 | % | (443,372 | ) | -0.13 | % | ||||||||
|
Net
Loans
|
$ | 355,689,843 | 99.21 | % | $ | 353,101,662 | 99.02 | % | ||||||||
Allowance for
loan losses and provisions - The Company maintains an
allowance for loan losses at a level that management believes is appropriate to
absorb losses inherent in the loan portfolio (See “Critical Accounting
Policies”). As of September 30, 2008, the Company maintained a residential loan
portfolio (including $19.9 million in home equity lines of credit (HELOC) of
$206.8 million, compared to $195.8 million at December 31, 2007, accounting for
57.6% and 54.9%, respectively, of the total loan portfolio. The
commercial real estate portfolio (including construction, land development and
farmland loans) totaled $110.2 million and $108.1 million, respectively, at
September 30, 2008 and December 31, 2007, comprising 30.7% and 30.3%,
respectively, of the total loan portfolio. The Company's commercial
loan portfolio includes loans that carry guarantees from government programs,
thereby mitigating the Company's credit risk on such loans. At
September 30, 2008, the Company had $18.2 million in loans of which $12.8
million was guaranteed, compared to almost $19.0 million in loans with a
guaranteed portion totaling $14.1 million at December 31, 2007. The
Company's estimate for loan loss coverage is based upon such factors as trends
in the volumes of residential and commercial loans secured by real estate,
historical loan loss experience on these portfolios, and the experience of loan
origination, underwriting and credit administration
staff. Additionally, the Company does not have any “Sub-Prime” loans
in its loan portfolio, nor does it intend to become involved with such
loans. The Company utilizes prudent underwriting standards, such as
conservative loan-to-value ratios for secured loans, including home equity loans
and takes a proactive approach to loan administration, thereby helping to reduce
the risk inherent in the loan portfolio. Based upon management's
analysis of these and other factors, management believes its coverage for
potential loan loss is adequate for the current environment.
The
following table summarizes the Company's loan loss experience for the nine
months ended September 30,
|
2008
|
2007
|
|||||||
|
Loans
Outstanding End of Period
|
$ | 359,100,867 | $ | 256,909,154 | ||||
|
Average
Loans Outstanding During Period
|
$ | 356,861,435 | $ | 265,366,409 | ||||
|
Loan
Loss Reserve, Beginning of Period
|
$ | 3,026,049 | $ | 2,267,821 | ||||
|
Loans
Charged Off:
|
||||||||
|
Residential
Real Estate
|
56,757 | 0 | ||||||
|
Commercial
Real Estate
|
121,166 | 0 | ||||||
|
Commercial
Loans not Secured by Real Estate
|
9,635 | 0 | ||||||
|
Consumer
Loans
|
95,450 | 116,782 | ||||||
|
Total
Loans Charged Off
|
283,008 | 116,782 | ||||||
|
Recoveries:
|
||||||||
|
Residential
Real Estate
|
6,585 | 13,446 | ||||||
|
Commercial
Real Estate
|
1,601 | 12,459 | ||||||
|
Commercial
Loans not Secured by Real Estate
|
12,090 | 1,944 | ||||||
|
Consumer
Loans
|
58,068 | 20,021 | ||||||
|
Total
Recoveries
|
78,344 | 47,870 | ||||||
|
Net
Loans Charged Off
|
204,664 | 68,912 | ||||||
|
Provision
Charged to Income
|
237,497 | 122,500 | ||||||
|
Loan
Loss Reserve, End of Period
|
$ | 3,058,882 | $ | 2,321,409 | ||||
|
Net
Charge Offs to Average Loans Outstanding
|
0.057 | % | 0.026 | % | ||||
|
Loan
Loss Reserve to Average Loans Outstanding
|
0.857 | % | 0.875 | % | ||||
Non-performing
assets for the comparison periods were as follows:
|
September
30, 2008
|
December
31, 2007
|
|||||||||||||||
|
Percent
|
Percent
|
|||||||||||||||
|
Balance
|
of
Total
|
Balance
|
of
Total
|
|||||||||||||
|
Non-Accruing
loans
|
$ | 1,301,946 | 69.94 | % | $ | 1,337,641 | 90.66 | % | ||||||||
|
Loans
past due 90 days or more and still accruing
|
559,631 | 30.06 | % | 137,742 | 9.34 | % | ||||||||||
|
Total
|
$ | 1,861,577 | 100.00 | % | $ | 1,475,383 | 100.00 | % | ||||||||
Specific
allocations are made in the allowance for loan losses in situations management
believes may represent a greater risk for loss. In addition, a
portion of the allowance (termed "unallocated") is established to absorb
inherent losses that probably exist as of the valuation date although not
identified through management's objective processes for estimated credit
losses. 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. Due in part to local economic
conditions, the Company continues to focus more intently on this section, making
adjustments when deemed necessary to ensure adequate coverage in more vulnerable
areas. 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. While the allowance is described as consisting of
separate allocated portions, the entire allowance is available to support loan
losses, regardless of category.
The
Company has experienced an increase in collection activity on loans 30 to 60
days past due during the first nine months of 2008. The Company works
actively with customers early in the delinquency process to help them to avoid
default or foreclosure. The Company’s non-accruing loan portfolio
decreased $35,695 or 2.7% during the first nine months of 2008, mostly through
foreclosure sales, however the loans brought into non-accrual have been
substantial in size, offsetting most of the decrease. The increase of
$421,889 in the loans 90 days or more past due is attributable to three
residential mortgage loans amounting to $388,567. These residential
loans are well secured minimizing the potential loss.
Market Risk
- In
addition to credit risk in the Company’s loan portfolio and liquidity risk, the
Company’s business activities also generate market risk. 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, investing, and
deposit taking activities. Interest rate risk is directly related to
the different maturities and repricing characteristics of interest-bearing
assets and liabilities, as well as to loan prepayment risks, early withdrawal of
time deposits, and the fact that the speed and magnitude of responses to
interest rate changes vary by product. Changes in interest rates also
have a direct impact on the market value of the securities portfolio and the
mortgage servicing rights. As discussed above under "Interest Rate
Risk and Asset and Liability Management", the Company actively monitors and
manages its interest rate risk through the ALCO process.
FINANCIAL INSTRUMENTS WITH
OFF-BALANCE-SHEET RISK
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 (including commercial
and construction lines of 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 nine
months of 2008, the Company did not engage in any activity that 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 or
commitments whose contract amount represents credit risk as of September 30,
2008 were as follows:
|
Contract
or
|
||||
|
Notional
Amount
|
||||
|
Unused
portions of home equity lines of credit
|
15,659,560 | |||
|
Other
commitments to extend credit
|
19,559,529 | |||
|
Residential
and commercial construction lines of credit
|
5,750,962 | |||
|
Standby
letters of credit and commercial letters of credit
|
326,200 | |||
|
Recourse
on sale of credit card portfolio
|
940,900 | |||
|
MPF
credit enhancement obligation, net of liability recorded
|
1,381,020 | |||
Since
some commitments expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The recourse
provision under the terms of the sale of the Company’s credit card portfolio in
2007 is based on total lines, not balances outstanding. Based on
historical losses, the Company does not expect any significant losses from this
commitment.
The
Company has guaranteed the payment obligations under the $12.5 million principal
amount of Capital Securities of its subsidiary, CMTV Statutory Trust
I. The source of funds for payments by the Trust on its Capital
Securities is payments made by the Company on its junior subordinated debentures
due 2037 issued to the Trust. The Company's obligation under those
debentures (which reflects initial capital funding for the Trust of
approximately $400,000) is fully reflected in the Company's balance sheet, in
the amount of $12.9 million at September 30, 2008.
LIQUIDITY AND CAPITAL
RESOURCES
Managing
liquidity risk is essential to maintaining both depositor confidence and
stability in earnings. 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 Company’s principal sources of funds are
deposits, amortization and prepayment of loans and securities, maturities of
investment securities, sales of loans available for sale, and earnings and funds
provided from operations. Maintaining a relatively stable funding
base, which is achieved by diversifying funding sources, competitively pricing
deposit products, and extending the contractual maturity of liabilities, reduces
the Company’s exposure to roll over risk on deposits and limits reliance on
volatile short-term borrowed funds. Short-term funding needs arise
from declines in deposits or other funding sources and funding of loan
commitments. The Company’s strategy is to fund assets to the maximum
extent possible with core deposits that provide a sizable source of relatively
stable and low-cost funds. When funding needs, including loan demand,
out pace deposit growth, it is necessary for the Company to use alternative
funding sources, such as investment portfolio maturities and short-term
borrowings, to meet these funding needs. During 2008, the Company’s
liquidity management has also been impacted by net deposit out-flows of
approximately $27.09 million.
The
Company has taken the approach of offering deposit specials at competitive
rates, in varying terms that fit within the balance sheet mix. The
strategy of offering specials is meant to provide a means to retain deposits
while not having to reprice the entire deposit portfolio. The Company
recognizes that with increasing competition for deposits, it may at times be
desirable to utilize alternative sources of funding to supplement
deposits. In 2007, the Board of Directors approved an updated Asset
Liability Management Funding Policy that includes the expanded use of brokered
deposits. This will allow the Company to augment retail deposits and
borrowings with brokered deposits as needed to help fund loans. As of
September 30, 2008, the Company had $16.3 million in deposits placed in the Certificate
of Deposit Account Registry Service (CDARS) of Promontory Interfinancial Network
account, which allows the Company to provide FDIC deposit insurance in
excess of account coverage limits by exchanging deposits with other CDARS
members. The Company may also purchase deposits from other CDARS
members. All such deposits are considered a form of brokered
deposits. Of the $16.3 million in CDARS deposits at September 30,
2008, $10 million represented exchanged deposits.
During
the first nine months of 2008, the Company's available-for-sale investment
portfolio decreased $17.2 million through maturities and calls and the write
down on the Fannie Mae preferred stock, while the held-to-maturity investment
portfolio increased $12.1 million and the loan portfolio increased $2.5
million. At September 30, 2008, 8 debt securities had aggregate
unrealized losses totaling $8,071. The primary factors considered in
the determination of the values of these investments are the general market
conditions, changes in interest rates and the quality of the
issuer. The Company evaluates debt securities for impairment at least
quarterly, or more frequently as conditions warrant. The Company
considers factors it deems relevant in light of the nature of the security and
the issuer, including whether the issuer is a government unit, a government
agency or a government-sponsored enterprise, whether the security bears a
government guarantee, whether downgrades have been made by rating agencies, and
more recently, the status of relevant legislative and regulatory actions
affecting the market for mortgage related securities. As mentioned
earlier in this report, the Company’s Fannie Mae preferred stock portfolio
decreased in value to a point that a write down of $739,332 was deemed necessary
to recognize the loss as other-than-temporary impairment. Except for
the write down of the Fannie Mae stock, no other declines in value were deemed
by management to be other than temporary at September 30, 2008.
On
the liability side, NOW and money market accounts increased $1.5 million and
savings deposits increased $4.5 million during the first nine months of 2008,
while time deposits decreased $4.8 million, and demand deposits decreased $9.5
million. Approximately $8 million in demand deposits were
reclassified into NOW accounts, accounting for most of the decrease in demand
deposits. Without the reclassification NOW and money market accounts
would have decreased by approximately $6.5 million.
As
a member of the Federal Home Loan Bank of Boston (FHLBB), the Company has access
to pre-approved lines of credit. The Company had a $1.0 million
unsecured Federal Funds line with an available balance of the same at September
30, 2008. Interest is chargeable at a rate determined daily,
approximately 25 basis points higher than the rate paid on federal funds
sold. At September 30, 2008 the Company also had additional borrowing
capacity of approximately $97.8 million, less outstanding advances and certain
pledged collateral amounts, through the FHLBB, secured by the Company's
qualifying loan portfolio.
To
cover seasonal decreases in deposits primarily associated with municipal
accounts, the Company typically borrows short-term advances from the FHLBB at
the end of the second quarter and pays the advances down as the municipal
deposits flow back into the bank during the third and fourth
quarter. With the latest decrease in Federal Funds rate, most of the
Company’s borrowings in the third quarter were placed in overnight
funds. At the end of the third quarter, the Company had outstanding
advances of $13.6 million consisting of the following:
|
Annual
|
Principal
|
|||||||||
|
Purchase
Date
|
Rate
|
Maturity
Date
|
Balance
|
|||||||
|
Long-term
Advance
|
||||||||||
|
November
16, 1992
|
7.67 | % |
November
16, 2012
|
$ | 10,000 | |||||
|
Short-term
Advances
|
||||||||||
|
Overnight
Funds Purchased (FHLBB)
|
1.00 | % |
October
1, 2008
|
$ | 13,606,000 | |||||
Under
a separate agreement with FHLBB, the Company has the authority to collateralize
public unit deposits, up to its FHLBB borrowing capacity ($97.8 million less
outstanding advances noted above) with letters of credit issued by the
FHLBB. At September 30, 2008, approximately $70.1 million was pledged
under this agreement, as collateral for these deposits. A letter of
credit fee is charged to the Company quarterly based on the average daily
balance for the quarter at an annual rate of 20 basis points. The
average daily balance for the third quarter of 2008 was approximately $12.2
million.
Other
alternative sources of funding come from unsecured Federal Funds lines with two
other correspondent banks that total $7.5 million. There were no
balances outstanding on either line at September 30, 2008.
In
the third quarter of 2008, the Company declared a cash dividend of $0.17 per
common share, payable in the fourth quarter of 2008, requiring an accrual of
$753,571 at September 30, 2008. Although dividend payments for the
third quarter of 2008 and year-to-date exceeded net income, the Board of
Directors concluded that the quarterly dividend rate of $0.17 per share should
remain unchanged for those periods in light of the Company’s strong core
earnings and the nonrecurring nature of a number of current year expenses,
including merger-related expenses and the write down of the Company’s Fannie Mae
shareholdings.
The
following table illustrates the changes in shareholders' equity from December
31, 2007 to September 30, 2008:
|
Balance
at December 31, 2007 (book value $7.94 per common share)
|
$ | 34,920,360 | ||
|
Net
income
|
1,405,222 | |||
|
Issuance
of stock through the Dividend Reinvestment Plan
|
699,296 | |||
|
Total
dividends declared on common stock
|
(2,252,226 | ) | ||
|
Total
dividends declared on preferred stock
|
(140,625 | ) | ||
|
Unrealized
holding gain arising during the period on available-for-sale securities,
net of tax
|
171,669 | |||
|
Balance
at September 30, 2008 (book value $7.26 per common share)
|
$ | 34,803,696 |
The
primary source of funds for the Company's payment of dividends to its
shareholders is dividends paid to the Company by the Bank. The Bank,
as a national bank, is subject to the dividend restrictions contained in the
National Bank Act, administered by the Comptroller of the Currency
("OCC"). Under such restrictions, the Bank 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.
The
U.S. Treasury Department (“Treasury”), working with the Federal Reserve Board
and other banking regulators, recently announced the Troubled Asset Relief
Program Capital Purchase Program (TARP Capital Purchase Program), which is
intended to stabilize the financial services industry. One of the
components of the Program is a $250 billion voluntary capital purchase program
for banking institutions. Pursuant to the TARP Capital Purchase
Program, Treasury will purchase from qualifying financial institutions, a
limited amount of senior perpetual preferred securities equal to between 1-3% of
a company’s risk-weighted assets. Treasury will also receive a
warrant for the purchase of common stock having an aggregate market value equal
to 15% of the amount of its preferred stock investment, with the number of
common shares and warrant exercise price based on the average trading price of
the institution’s common stock for the 20 trading days immediately preceding
Treasury’s approval of the institution’s application. The preferred
shares will pay an annual dividend of 5% for the first five years, which will
increase to 9% thereafter, and are redeemable in whole or in part, after three
years. The preferred shares, warrants and common stock issued upon
exercise of the warrants must be freely transferable. For so long as
Treasury holds any of a banking institution’s securities, subject to certain
limited exceptions, the institution will be prohibited from (a) increasing the
dividend to common shareholders and (b) conducting share repurchases without
Treasury’s prior approval. Participating financial institutions will
also be subject to certain limitations on executive compensation as well as
other conditions. The foregoing description of the investment terms
is based on the published terms applicable to Treasury’s investments under the
Program in large, stock exchange listed public companies. Treasury
has stated that it may modify some of the investment terms for other types of
banking institutions, including smaller reporting companies such as Community
Bancorp. Participation in the Program is voluntary, although Treasury
is encouraging healthy institutions to participate.
Although
the Company and Bank are well capitalized, management believes that the TARP
Capital Purchase Program represents a cost-effective source of additional
Tier 1 capital and is considering whether to file an application to participate
in the Program. Issuance of the preferred stock to Treasury would require
the consent of the Company's existing preferred shareholders (three local
banking institutions).
Quantitative
measures established by regulation to ensure capital adequacy require the
Company to maintain minimum amounts and ratios of total and Tier 1 capital (as
defined in the regulations) to risk-weighted assets (as defined), and a
so-called leverage ratio of Tier 1 capital (as defined) to average assets (as
defined). Under current guidelines, banks must maintain a risk-based
capital ratio of 8.0%, of which at least 4.0% must be in the form of core
capital (as defined).
Regulators
have also established minimum capital ratio guidelines for FDIC-insured banks
under the prompt corrective action provisions of the Federal Deposit Insurance
Act, as amended. These minimums are a total risk-based capital ratio
of 10.0%, a Tier I risk-based capital ratio of 6%, and a leverage ratio of
5%. As of September 30, 2008, the Company’s subsidiary was 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 Subsidiary's classification.
The risk
based ratios of the Company and its subsidiary as of September 30, 2008 and
December 31, 2007 exceeded regulatory guidelines and are presented in the table
below. At September 30, 2008, risk weighted assets of $323.9 million
were reported for the consolidated Company and its subsidiary and $328.2 million
were reported for the Bank, compared to $238.8 million and $237.7 million,
respectively at December 31, 2007. In accordance with regulatory
guidance issued by the banking regulators, the September 30, 2008 capital ratios
reflect the tax benefit from the write down on the Fannie Mae preferred stock
notwithstanding that the tax benefit will not be recorded under GAAP until the
fourth quarter.
|
Minimum
To Be Well
|
||||||
|
Minimum
|
Capitalized
Under
|
|||||
|
For
Capital
|
Prompt
Corrective
|
|||||
|
Actual
|
Adequacy
Purposes:
|
Action
Provisions:
|
||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|
|
(Dollars
in Thousands)
|
||||||
|
As
of September 30, 2008:
|
||||||
|
Total
capital (to risk-weighted assets)
|
||||||
|
Consolidated
|
$34,354
|
10.44%
|
$26,314
|
8.00%
|
N/A
|
N/A
|
|
Bank
|
$35,294
|
10.75%
|
$26,255
|
8.00%
|
$32,819
|
10.00%
|
|
Tier
I capital (to risk-weighted assets)
|
||||||
|
Consolidated
|
$31,295
|
9.51%
|
$13,157
|
4.00%
|
N/A
|
N/A
|
|
Bank
|
$32,235
|
9.82%
|
$13,128
|
4.00%
|
$19,691
|
6.00%
|
|
Tier
I capital (to average assets)
|
||||||
|
Consolidated
|
$31,295
|
6.64%
|
$18,867
|
4.00%
|
N/A
|
N/A
|
|
Bank
|
$32,235
|
6.85%
|
$18,837
|
4.00%
|
$23,569
|
5.00%
|
|
As
of December 31, 2007:
|
||||||
|
Total
capital (to risk-weighted assets)
|
||||||
|
Consolidated*
|
$36,975
|
15.48%
|
$19,104
|
8.00%
|
N/A
|
N/A
|
|
Community
National Bank
|
$48,506
|
20.41%
|
$19,013
|
8.00%
|
$23,766
|
10.00%
|
|
Former
LyndonBank
|
$13,536
|
12.94%
|
$ 8,365
|
8.00%
|
$10,457
|
10.00%
|
|
Tier
I capital (to risk-weighted assets)
|
||||||
|
Consolidated*
|
$34,736
|
14.55%
|
$ 9,552
|
4.00%
|
N/A
|
N/A
|
|
Community
National Bank
|
$46,267
|
19.47%
|
$ 9,506
|
4.00%
|
$14,260
|
6.00%
|
|
Former
LyndonBank
|
$12,749
|
12.19%
|
$ 4,183
|
4.00%
|
$ 6,274
|
6.00%
|
|
Tier
I capital (to average assets)
|
||||||
|
Consolidated*
|
$34,736
|
9.40%
|
$14,785
|
4.00%
|
N/A
|
N/A
|
|
Community
National Bank
|
$46,267
|
12.54%
|
$14,752
|
4.00%
|
$18,440
|
5.00%
|
|
Former
LyndonBank
|
$12,749
|
8.26%
|
$ 6,153
|
4.00%
|
$ 7,691
|
5.00%
|
*Consolidated
refers to Community Bancorp. and Community National Bank before consolidation of
the former LyndonBank assets. The Federal Regulators approved the
filing of separate Call Reports for Community National Bank and the former
LyndonBank; therefore, numbers presented in the table above for 2007 are as
filed with the applicable reporting agencies at December 31, 2007.
The
Company intends to maintain a capital resource position in excess of the
minimums shown above. 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's management of the credit, liquidity and market risk inherent in its
business operations is discussed in Part 1, Item 2 of this report under the
caption "RISK MANAGEMENT", which is incorporated herein by
reference. Management does not believe that there have been any
material changes in the nature or categories of the Company's risk exposures
from those disclosed in the Company’s 2007 annual report on form
10-K.
Disclosure
Controls and Procedures
Management
is responsible for establishing and maintaining effective disclosure controls
and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934 (the “Exchange Act”). As of September 30, 2008, an evaluation
was performed under the supervision and with the participation of management,
including the principal executive officer and principal financial officer, of
the effectiveness of the design and operation of the Company’s disclosure
controls and procedures. Based on that evaluation, management
concluded that its disclosure controls and procedures as of September 30, 2008
were effective in ensuring that material information required to be disclosed in
the reports it files with the Commission under the Exchange Act was recorded,
processed, summarized, and reported on a timely basis.
Management’s
Report on Internal Control Over Financial Reporting
Management
is responsible for establishing and maintaining effective internal controls over
financial reporting, as defined in Rule 13a-15(f) under the Exchange
Act. As of December 31, 2007, an evaluation was performed under the
supervision and with the participation of management, including the principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of the Company’s internal controls over financial
reporting. Management assessed the Company’s system of internal
control over financial reporting as of December 31, 2007, in relation to
criteria for effective internal control over financial reporting as described in
“Internal Control – Integrated Framework,” issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment,
management believes that, as of December 31, 2007, its system of internal
control over financial reporting met those criteria and is
effective. As required by Rule 13a-15 under the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), 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
President and Chief Executive Officer and its Vice President and 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. For this purpose, the term “disclosure
controls and procedures” means controls and other procedures of the Company that
are designed to ensure that information required to be disclosed by it in the
reports that it files or submits under the Exchange Act (15 U.S.C. 78a et seq.) is recorded,
processed, summarized and reported, within the time periods specified in the
SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the Company’s
management, including its principal executive and principal financial officers,
or persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.
Changes
in Internal Control Over Financial Reporting
There
were no changes in the Company’s internal control over financial reporting that
occurred during the quarter ended September 30, 2008 that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
PART II.
OTHER INFORMATION
The
Company has a pending legal issue involving safe deposit box procedures with a
potential claim amounting to $50,000. The Company’s subsidiary,
Community National Bank, as successor by merger to LyndonBank, is a party to a
contract dispute with a service provider involving disputed charges of
approximately $72,000. The dispute is currently in mediation and may
proceed to binding arbitration if the parties are unable to settle the
matter. Currently the Company has not accrued for either of these
matters, but will do so before year end if either matter is still outstanding at
that time.
In
addition to the foregoing matters, in the normal course of business the Company
and its subsidiary are involved in litigation that is considered incidental to
their business. Management does not expect that any such litigation
will be material to the Company's consolidated financial condition or results of
operations.
The
following table provides information as to purchases of the Company’s common
stock during the third quarter ended September 30, 2008, by the Company and by
any affiliated purchaser (as defined in SEC Rule 10b-18):
|
Maximum
Number of
|
||||||||||||||||
|
Total
Number of
|
Shares
That May Yet
|
|||||||||||||||
|
Total
Number
|
Average
|
Shares
Purchased
|
Be
Purchased Under
|
|||||||||||||
|
Of
Shares
|
Price
Paid
|
as
Part of Publicly
|
the
Plan at the End
|
|||||||||||||
|
For
the period:
|
Purchased(1)(2)
|
Per
Share
|
Announced
Plan
|
of
the Period
|
||||||||||||
|
July
1 – July 30
|
0 | $ | 0.00 | N/A | N/A | |||||||||||
|
August
1 – August 31
|
2,380 | $ | 12.83 | N/A | N/A | |||||||||||
|
September
1 – September 30
|
0 | $ | 0.00 | N/A | N/A | |||||||||||
|
Total
|
2,380 | $ | 12.83 | N/A | N/A | |||||||||||
(1) All
2,380 shares were purchased for the account of participants invested in the
Company Stock Fund under the Company’s Retirement Savings Plan by or on behalf
of the Plan Trustee, the Human Resources Committee of Community National
Bank. Such share purchases were facilitated through Community
Financial Services Group, LLC (“CFSG”), which provides certain investment
advisory services to the Plan. Both the Plan Trustee and CFSG may be
considered affiliates of the Company under Rule 10b-18.
(2) Shares
purchased during the period do not include fractional shares repurchased from
time to time in connection with the participant's election to discontinue
participation in the Company's Dividend Reinvestment Plan.
ITEM 6.
Exhibits
The
following exhibits are filed with this report:
Exhibit
3.1 - Amended and Restated Bylaws of Community Bancorp.
Exhibit
31.1 - Certification from the Chief Executive Officer of the Company pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit
31.2 - Certification from the Chief Financial Officer of the Company pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit
32.1 - Certification from the Chief Executive Officer of the Company pursuant to
18 U.S.C., Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
Exhibit
32.2 - Certification from the Chief Financial Officer of the Company pursuant to
18 U.S.C., Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
*This
exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities
Exchange Act of 1934, or otherwise subject to the liability of that section, and
shall not be deemed to be incorporated by reference into any filing under the
Securities Act of 1933 or the Securities Act of 1934.
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
COMMUNITY
BANCORP.
|
DATED: November
13, 2008
|
/s/ Stephen P.
Marsh
|
|
|
Stephen
P. Marsh, President &
|
||
|
Chief
Executive Officer
|
||
|
DATED: November
13, 2008
|
/s/ Louise M.
Bonvechio
|
|
|
Louise
M. Bonvechio, Vice President
|
||
|
&
Chief Financial Officer
|
EXHIBIT
INDEX
The
following exhibits are filed with this report:
Exhibit
3.1 - Amended and Restated Bylaws of Community Bancorp.
Exhibit
31.1 - Certification from the Chief Executive Officer of the Company pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit
31.2 - Certification from the Chief Financial Officer of the Company pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit
32.1 - Certification from the Chief Executive Officer of the Company pursuant to
18 U.S.C., Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
Exhibit
32.2 - Certification from the Chief Financial Officer of the Company pursuant to
18 U.S.C., Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
*This
exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities
Exchange Act of 1934, or otherwise subject to the liability of that section, and
shall not be deemed to be incorporated by reference into any filing under the
Securities Act of 1933 or the Securities Act of 1934.