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COMMUNITY BANCORP /VT - Quarter Report: 2010 March (Form 10-Q)

form10qmarch2010.htm
UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

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

For the Quarterly Period Ended March 31, 2010

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



Vermont
03-0284070
(State of Incorporation)
(IRS Employer Identification Number)
 
4811 US Route 5, Derby, Vermont
05829
(Address of Principal Executive Offices)
(zip code)
   
Registrant's Telephone Number:  (802) 334-7915

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.

Large accelerated filer (  )
Accelerated filer (  )
Non-accelerated filer   (  )    (Do not check if a smaller reporting company)
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 May 10, 2010, there were 4,568,592 shares outstanding of the Corporation's common stock.


 
 

 


FORM 10-Q
Index
   
   
Page
PART I
FINANCIAL INFORMATION
 
     
Item 1
4  
Item 2
17  
Item 3
32  
Item 4
32  
     
PART II
OTHER INFORMATION
 
     
Item 1
33  
Item 2
33  
Item 6
33  
 
34  


 
 

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  Financial Statements (Unaudited)

The following are the unaudited consolidated financial statements for Community Bancorp. and Subsidiary, "the Company".
 
Community Bancorp. and Subsidiary
 
March 31
   
December 31
   
March 31
 
Consolidated Balance Sheets
 
2010
   
2009
   
2009
 
   
(Unaudited)
         
(Unaudited)
 
Assets
                 
  Cash and due from banks
  $ 9,280,046     $ 9,598,107     $ 8,408,662  
  Federal funds sold and overnight deposits
    1,213       5,036       8,196  
     Total cash and cash equivalents
    9,281,259       9,603,143       8,416,858  
  Securities held-to-maturity (fair value $47,593,000 at 03/31/10,
                       
   $45,543,000 at 12/31/09 and $40,875,000 at 03/31/09)
    47,157,935       44,766,250       40,091,646  
  Securities available-for-sale
    22,872,120       23,974,830       29,940,628  
  Restricted equity securities, at cost
    3,906,850       3,906,850       3,906,850  
  Loans held-for-sale
    460,795       321,983       1,262,322  
  Loans
    383,672,422       381,937,123       362,353,977  
    Allowance for loan losses
    (3,545,807 )     (3,450,542 )     (3,311,554 )
    Unearned net loan fees
    (123,171 )     (152,188 )     (260,199 )
        Net loans
    380,003,444       378,334,393       358,782,224  
  Bank premises and equipment, net
    13,247,973       13,637,414       14,814,515  
  Accrued interest receivable
    2,118,425       1,895,313       2,091,316  
  Bank owned life insurance
    3,842,739       3,813,016       3,720,676  
  Core deposit intangible
    2,529,888       2,663,040       3,162,360  
  Goodwill
    11,574,269       11,574,269       11,574,269  
  Other real estate owned (OREO)
    718,000       743,000       185,000  
  Prepaid expense Federal Deposit Insurance Corporation (FDIC)
    1,959,157       2,105,565       0  
  Other assets
    8,398,651       7,948,031       7,653,280  
        Total assets
  $ 508,071,505     $ 505,287,097     $ 485,601,944  
                         
Liabilities and Shareholders' Equity
                       
 Liabilities
                       
  Deposits:
                       
    Demand, non-interest bearing
  $ 51,665,027     $ 52,821,573     $ 49,322,103  
    NOW and money market accounts
    140,384,990       146,244,454       120,669,051  
    Savings
    55,259,464       52,448,863       54,048,600  
    Time deposits, $100,000 and over
    53,689,519       63,261,583       56,542,427  
    Other time deposits
    98,987,259       104,009,257       113,442,820  
        Total deposits
    399,986,259       418,785,730       394,025,001  
  Federal funds purchased and other borrowed funds
    36,022,000       13,411,000       16,750,000  
  Repurchase agreements
    17,815,163       19,042,214       21,002,058  
  Capital lease obligations
    866,420       876,536       905,707  
  Junior subordinated debentures
    12,887,000       12,887,000       12,887,000  
  Accrued interest and other liabilities
    3,092,536       3,394,779       4,249,220  
        Total liabilities
    470,669,378       468,397,259       449,818,986  
                         
 Shareholders' Equity
                       
  Preferred stock, 1,000,000 shares authorized, 25 shares issued
                       
    and outstanding ($100,000 liquidation value)
    2,500,000       2,500,000       2,500,000  
  Common stock - $2.50 par value; 10,000,000 shares authorized,
                       
   4,782,483 shares issued at 03/31/10, 4,759,913  shares
                       
   issued at 12/31/09, and 4,683,143 shares issued at 03/31/09
    11,956,208       11,899,783       11,707,858  
  Additional paid-in capital
    26,308,634       26,192,359       25,736,372  
  Accumulated deficit
    (843,864 )     (1,192,409 )     (1,956,344 )
  Accumulated other comprehensive income
    103,926       112,882       417,849  
  Less: treasury stock, at cost; 210,101 shares at 03/31/10,
                       
   12/31/09 and 03/31/09
    (2,622,777 )     (2,622,777 )     (2,622,777 )
        Total shareholders' equity
    37,402,127       36,889,838       35,782,958  
        Total liabilities and shareholders' equity
  $ 508,071,505     $ 505,287,097     $ 485,601,944  
                         
The accompanying notes are an integral part of these consolidated financial statements.
 
 

 
 

 
Community Bancorp. and Subsidiary
           
 Consolidated Statements of Income
           
(Unaudited)
           
 For The First Quarter Ended March 31,
 
2010
   
2009
 
             
 Interest income
           
   Interest and fees on loans
  $ 5,451,021     $ 5,448,273  
   Interest on debt securities
               
     Taxable
    112,281       305,003  
     Tax-exempt
    307,450       324,160  
   Dividends
    16,137       16,137  
   Interest on federal funds sold and overnight deposits
    350       9  
        Total interest income
    5,887,239       6,093,582  
                 
 Interest expense
               
   Interest on deposits
    1,214,480       1,757,547  
   Interest on federal funds purchased and other borrowed funds
    137,201       61,362  
   Interest on repurchase agreements
    48,851       69,146  
   Interest on junior subordinated debentures
    243,564       243,564  
        Total interest expense
    1,644,096       2,131,619  
                 
     Net interest income
    4,243,143       3,961,963  
     Provision for loan losses
    125,001       125,001  
     Net interest income after provision for loan losses
    4,118,142       3,836,962  
                 
 Non-interest income
               
   Service fees
    560,804       492,305  
   Income from sold loans
    136,282       340,424  
   Income on bank owned life insurance
    29,723       30,597  
   Net realized gains on securities
    0       23,635  
   Other income
    504,992       264,595  
        Total non-interest income
    1,231,801       1,151,556  
                 
 Non-interest expense
               
   Salaries and wages
    1,392,671       1,393,846  
   Employee benefits
    555,856       537,983  
   Occupancy expenses, net
    779,175       796,265  
   FDIC insurance
    158,368       273,832  
   Amortization of core deposit intangible
    133,152       166,440  
   Other expenses
    1,269,599       1,331,745  
        Total non-interest expense
    4,288,821       4,500,111  
                 
    Income before income taxes
    1,061,122       488,407  
 Income tax expense (benefit)
    122,210       (194,846 )
        Net income
  $ 938,912     $ 683,253  
                 
 Earnings per common share
  $ 0.20     $ 0.14  
 Weighted average number of common shares
               
  used in computing earnings per share
    4,558,198       4,473,042  
 Dividends declared per common share
  $ 0.12     $ 0.00  
 Book value per share on common shares outstanding at March 31,
  $ 7.63     $ 7.44  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 

 
 
 

 
 
Community Bancorp. and Subsidiary
           
Consolidated Statements of Cash Flows
           
(Unaudited)
           
For the Three Months Ended March 31,
 
2010
   
2009
 
             
Cash Flow from Operating Activities:
           
  Net Income
  $ 938,912     $ 683,253  
  Adjustments to Reconcile Net Income to Net Cash Provided by
               
   Operating Activities:
               
    Depreciation and amortization, premises and equipment
    264,548       275,093  
    Provision for loan losses
    125,001       125,001  
    Deferred income tax benefit
    (86,466 )     (86,182 )
    Net gain on sale of securities
    0       (23,635 )
    Net gain on sale of loans
    (136,282 )     (340,424 )
    Gain on sale of fixed assets
    (9,649 )     0  
    (Gain) loss on Trust LLC
    (16,296 )     17,195  
    Amortization (accretion) of bond premium (discount), net
    95,390       (457 )
    Write down on OREO
    25,000       0  
    Proceeds from sales of loans held for sale
    6,414,847       25,908,639  
    Originations of loans held for sale
    (6,417,377 )     (25,648,693 )
    Decrease in taxes payable
    (291,324 )     (108,664 )
    Increase in interest receivable
    (223,112 )     (46,766 )
    Decrease in prepaid FDIC insurance assessment
    146,408       0  
    Increase in mortgage servicing rights
    (57,733 )     (6,157 )
    Increase in other assets
    (118,085 )     (187,289 )
    Increase in bank owned life insurance
    (29,723 )     (30,597 )
    Amortization of core deposit intangible
    133,152       166,440  
    Amortization of limited partnerships
    123,897       244,890  
    Decrease in unamortized loan fees
    (29,017 )     (40,805 )
    Decrease in interest payable
    (24,620 )     (8,105 )
    (Decrease) increase in accrued expenses
    (298,487 )     11,472  
    Increase (decrease) in other liabilities
    23,116       (445,071 )
       Net cash provided by operating activities
    552,100       459,138  
                 
Cash Flows from Investing Activities:
               
  Investments - held-to-maturity
               
    Maturities and pay downs
    9,092,359       9,143,094  
    Purchases
    (11,484,044 )     (11,946,382 )
  Investments - available-for-sale
               
    Sales and maturities
    2,000,000       3,556,320  
    Purchases
    (1,006,250 )     (4,197,691 )
  (Increase) decrease in loans, net
    (1,698,119 )     2,399,580  
  Proceeds from sales of bank premises and equipment,
               
    net of capital expenditures
    134,543       (100,179 )
  Proceeds from sale of OREO
    (81,650 )     0  
  Recoveries of loans charged off
    14,734       11,747  
       Net cash used in investing activities
    (3,028,427 )     (1,133,511 )

The accompanying notes are an integral part of these consolidated financial statements.

 
 
 

 
   
2010
   
2009
 
 Cash Flows from Financing Activities:
           
  Net decrease in demand, NOW, money market & savings accounts
    (4,205,409 )     (2,862,698 )
  Net decrease in time deposits
    (14,594,062 )     (5,353,081 )
  Net (decrease) increase in repurchase agreements
    (1,227,051 )     1,915,602  
  Net decrease in short-term borrowings
    (389,000 )     (5,822,000 )
  Proceeds from long-term borrowings
    23,000,000       10,000,000  
  Decrease in capital lease obligations
    (10,116 )     (9,345 )
  Dividends paid on preferred stock
    (46,875 )     (46,875 )
  Dividends paid on common stock
    (373,044 )     0  
       Net cash provided by (used in) financing activities
    2,154,443       (2,178,397 )
                 
       Net decrease in cash and cash equivalents
    (321,884 )     (2,852,770 )
  Cash and cash equivalents:
               
          Beginning
    9,603,143       11,269,628  
          Ending
  $ 9,281,259     $ 8,416,858  
                 
 Supplemental Schedule of Cash Paid During the Period
               
  Interest
  $ 1,668,716     $ 2,139,724  
                 
  Income taxes
  $ 500,000     $ 0  
                 
 Supplemental Schedule of Noncash Investing and Financing Activities:
               
  Change in unrealized gain on securities available-for-sale
  $ (13,570 )   $ (174,258 )
                 
  Loans and bank premises transferred to OREO
  $ 81,650     $ 0  
                 
 Common Shares Dividends Paid
               
  Dividends declared
  $ 543,492     $ 0  
  Decrease (increase) in dividends payable attributable to dividends declared
    2,252       (11,302 )
  Dividends reinvested
    (172,700 )     11,302  
    $ 373,044     $ 0  

The accompanying notes are an integral part of these consolidated financial statements.


 
 

 
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, 2009 contained in the Company's Annual Report on Form 10-K/A.  The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full annual period ending December 31, 2010, or for any other interim period.

     Certain amounts in the 2009 financial statements have been reclassified to conform to the current year presentation.

Note 2.  Recent Accounting Developments

     In June 2009, the Financial Accounting Standards Board (FASB) issued a change to Accounting Standards Codification (ASC) Topic 860, "Transfers and Servicing",  to improve the reporting for the transfer of financial assets resulting from (1) practices that have developed since the issuance of a previous FASB statement that are not consistent with the original intent and key requirements of that statement and (2) concerns of financial statement users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors. This ASC became effective for the Company on January 1, 2010.  Adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.

     In June 2009, the FASB issued a change to ASC Topic 810, "Consolidation", to amend certain requirements of consolidation of variable interest entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. The ASC became effective for the Company on January 1, 2010.  Adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.
 
 
     In January 2010, the FASB issued Accounting Standards Update (ASU) 2010-06, "Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements," to amend the disclosure requirements related to recurring and nonrecurring fair value measurements.  The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers.  Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements).  The guidance became effective for the Company on January 1, 2010, except for the disclosure on the roll forward activities for any Level 3 fair value measurements, which will become effective with the reporting period beginning January 1, 2011.  Adoption of this new guidance requires additional disclosures of fair value measurements but did not have a material impact on the Company’s consolidated financial statements.

     In February 2010, the FASB issued ASU 2010-09, “Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements,” related to events that occur after the balance sheet date but before financial statements are issued. This guidance amends existing standards to address potential conflicts with Securities and Exchange Commission (“SEC”) guidance and refines the scope of the reissuance disclosure requirements to include revised financial statements only. Under this guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated. The adoption of this update did not have a material effect on the Company’s consolidated financial statements.

Note 3.  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), including Dividend Reinvestment Plan shares issuable upon reinvestment of dividends, and reduced for shares held in treasury.

The following table illustrates the calculation for the periods ended March 31, as adjusted for the cash dividends declared on the preferred stock:

For The First Quarter Ended March 31,
 
2010
   
2009
 
             
Net income, as reported
  $ 938,912     $ 683,253  
Less: dividends to preferred shareholders
    46,875       46,875  
Net income available to common shareholders
  $ 892,037     $ 636,378  
Weighted average number of common shares
               
   used in calculating earnings per share
    4,558,198       4,473,042  
Earnings per common share
  $ 0.20     $ 0.14  

 
 

 
Note 4.  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 First Quarter Ended March 31,
 
2010
   
2009
 
             
Net income
  $ 938,912     $ 683,253  
Other comprehensive loss, net of tax:
               
     Change in unrealized holding gain on available-for-sale
               
       securities arising during the period
    (13,570 )     (150,623 )
     Reclassification adjustment for gains realized in income
    0       (23,635 )
       Net change in unrealized holding gain
    (13,570 )     (174,258 )
       Tax effect
    4,614       59,248  
       Other comprehensive loss, net of tax
    (8,956 )     (115,010 )
               Total comprehensive income
  $ 929,956     $ 568,243  

Note 5.  Investment Securities

Securities available-for-sale (AFS) and held-to-maturity (HTM) consisted of the following:

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
Securities AFS
 
Cost
   
Gains
   
Losses
   
Value*
 
                         
March 31, 2010
                       
U. S. Government sponsored enterprise securities
  $ 17,598,571     $ 125,439     $ 6,323     $ 17,717,687  
U. S. Government securities
    5,047,922       37,571       3,532       5,081,961  
Preferred stock
    68,164       4,308       0       72,472  
    $ 22,714,657     $ 167,318     $ 9,855     $ 22,872,120  
December 31, 2009
                               
U. S. Government sponsored enterprise securities
  $ 18,686,949     $ 138,283     $ 18,582     $ 18,806,650  
U. S. Government securities
    5,048,683       48,773       764       5,096,692  
Preferred stock
    68,164       3,324       0       71,488  
    $ 23,803,796     $ 190,380     $ 19,346     $ 23,974,830  
March 31, 2009
                               
U. S. Government sponsored enterprise securities
  $ 12,359,235     $ 202,459     $ 21,922     $ 12,539,772  
U. S. Government securities
    4,045,081       106,638       0       4,151,719  
Mortgage-backed securities
    12,740,598       476,447       574       13,216,471  
Preferred stock
    162,610       0       129,944       32,666  
    $ 29,307,524     $ 785,544     $ 152,440     $ 29,940,628  

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
Securities HTM
 
Cost
   
Gains
   
Losses
   
Value*
 
                         
March 31, 2010
                       
States and political subdivisions
  $ 47,157,935     $ 435,065     $ 0     $ 47,593,000  
                                 
December 31, 2009
                               
States and political subdivisions
  $ 44,766,250     $ 776,750     $ 0     $ 45,543,000  
                                 
March 31, 2009
                               
States and political subdivisions
  $ 40,091,646     $ 783,354     $ 0     $ 40,875,000  

 
 

 
The scheduled maturities of debt securities available-for-sale were as follows:

   
Amortized
   
Fair
 
   
Cost
   
Value
 
March 31, 2010
           
Due in one year or less
  $ 10,251,580     $ 10,308,291  
Due from one to five years
    12,394,913       12,491,357  
    $ 22,646,493     $ 22,799,648  
December 31, 2009
               
Due in one year or less
  $ 8,229,400     $ 8,310,668  
Due from one to five years
    15,506,232       15,592,674  
    $ 23,735,632     $ 23,903,342  
March 31, 2009
               
Due in one year or less
  $ 11,871,417     $ 12,119,098  
Due from one to five years
    8,409,068       8,533,326  
Due from five to ten years
    333,222       340,125  
Due after ten years
    8,531,207       8,915,413  
    $ 29,144,914     $ 29,907,962  

The scheduled maturities of debt securities held-to-maturity were as follows:

   
Amortized
   
Fair
 
   
Cost
   
Value*
 
March 31, 2010
           
Due in one year or less
  $ 38,844,223     $ 38,844,000  
Due from one to five years
    4,458,048       4,567,000  
Due from five to ten years
    1,345,755       1,455,000  
Due after ten years
    2,509,909       2,727,000  
    $ 47,157,935     $ 47,593,000  
December 31, 2009
               
Due in one year or less
  $ 35,864,578     $ 35,865,000  
Due from one to five years
    4,034,674       4,229,000  
Due from five to ten years
    1,483,336       1,677,000  
Due after ten years
    3,383,662       3,772,000  
    $ 44,766,250     $ 45,543,000  
March 31, 2009
               
Due in one year or less
  $ 31,639,918     $ 31,640,000  
Due from one to five years
    4,026,116       4,222,000  
Due from five to ten years
    1,203,233       1,399,000  
Due after ten years
    3,222,379       3,614,000  
    $ 40,091,646     $ 40,875,000  

*Method used to determine fair value on held-to-maturity securities rounds values to nearest thousand.

 
 

 

     All investments with unrealized losses are presented either as those with a continuous loss position less than 12 months or as those with a continuous loss position for 12 months or more. Investments with unrealized losses were as follows:

   
Less than 12 months
   
12 months or more
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
March 31, 2010
                                   
U.S. Government sponsored
                                   
     enterprise securities
  $ 2,057,787     $ 6,323     $ 0     $ 0     $ 2,057,787     $ 6,323  
U.S. Government securities
    1,002,445       3,532       0       0       1,002,445       3,532  
    $ 3,060,232     $ 9,855     $ 0     $ 0     $ 3,060,232     $ 9,855  
December 31, 2009
                                               
U.S. Government sponsored
                                               
     enterprise securities
  $ 2,055,018     $ 18,582     $ 0     $ 0     $ 2,055,018     $ 18,582  
U.S. Government securities
    1,003,233       764       0       0       1,003,233       764  
    $ 3,058,251     $ 19,346     $ 0     $ 0     $ 3,058,251     $ 19,346  
March 31, 2009
                                               
U.S. Government sponsored
                                               
     enterprise securities
  $ 4,167,441     $ 21,922     $ 0     $ 0     $ 4,167,441     $ 21,922  
Mortgage-backed securities
    263,266       231       72,810       343       336,076       574  
Preferred stock
    32,666       129,944       0       0       32,666       129,944  
    $ 4,463,373     $ 152,097     $ 72,810     $ 343     $ 4,536,183     $ 152,440  

     With the exception of the two classes of Fannie Mae preferred stock, the unrealized losses are a result of increases in market interest rates and not of deterioration in the creditworthiness of the issuer.  At March 31, 2010 and December 31, 2009, there were two U.S. Government sponsored enterprise securities and one U.S. Government security in the investment portfolio in an unrealized loss position compared to four U.S. Government sponsored enterprise securities and one mortgage-backed security (MBS) in an unrealized loss position less than 12 months and one MBS in an unrealized loss position more than 12 months at March 31, 2009. These unrealized losses were principally attributable to changes in prevailing interest rates for similar types of securities.  The Company sold its entire MBS portfolio during the second quarter of 2009 and recorded a net gain of $447,419.

     Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions, or adverse developments relating to the issuer, warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.  At March 31, 2010 and December 31, 2009, the Company’s available-for-sale portfolio included two classes of Fannie Mae preferred stock with a book value of $68,164, which reflected two other-than-temporary impairment write downs on the investment in prior periods.  The fair market value of the Fannie Mae preferred stock as of March 31, 2010 was $72,472, an increase of $984 over the December 31, 2009 fair market value of $71,488.

Note 6.  Goodwill and Other Intangible Assets

     As a result of the merger with Lyndonbank on December 31, 2007, the Company recorded goodwill amounting to $11.6 million.  The goodwill is not amortizable and is not deductible for tax purposes.

     The Company also recorded $4.2 million of acquired identified intangible assets representing the core deposit intangible which is subject to amortization as a non-interest expense over a ten year period using a double declining method and is deductible for tax purposes.
 
As of March 31, 2010, the remaining amortization expense related to core deposit intangible is expected to be as follows:

2010
  $ 399,456  
2011
    426,086  
2012
    340,869  
2013
    272,695  
2014
    272,695  
Thereafter
    818,087  
Total
  $ 2,529,888  

     Management evaluates goodwill and the core deposit intangible asset for impairment periodically.  As of the date of the most recent such evaluation (December 31, 2009), management concluded that no impairment existed.

Note 7.  Income Taxes

     The Company receives tax credits for its investments in various low income housing partnerships which reduce taxes payable.  Periodically the Company has the opportunity to participate in a low income housing project that offers one-time historic tax credits.  In 2008, the Company was given this opportunity through a local project, with historic tax credit for 2009 amounting to $535,000, or $133,750 quarterly.  This one-time historic tax credit is reflected in the variance between the tax expense for the first quarter of 2010 and the tax benefit for the first quarter of 2009.

 
 

 
Note 8.  Fair Value

     ASC Topic 820-10-20, Fair Value Measurements and Disclosures provides a framework for measuring and disclosing fair value under U.S. Generally Accepted Accounting Principles.  The Statement 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).

     Fair value is 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.  ASC Topic 820-10-20 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 and reflected in the balance sheet at the dates presented are summarized below:

March 31, 2010
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
U.S. Government sponsored enterprise securities
  $ 0     $ 17,717,687     $ 0     $ 17,717,687  
U.S. Government securities
    2,006,935       3,075,026       0       5,081,961  
Preferred stock
    72,472       0       0       72,472  
  Total
  $ 2,079,407     $ 20,792,713     $ 0     $ 22,872,120  
                                 
December 31, 2009
                               
Assets:
                               
U.S. Government sponsored enterprise securities
  $ 0     $ 18,806,650     $ 0     $ 18,806,650  
U.S. Government securities
    1,003,233       4,093,459       0       5,096,692  
Preferred stock
    71,488       0       0       71,488  
  Total
  $ 1,074,721     $ 22,900,109     $ 0     $ 23,974,830  
                                 
March 31, 2009
                               
Assets:
                               
U.S. Government sponsored enterprise securities
  $ 0     $ 12,539,772     $ 0     $ 12,539,772  
U.S. Government securities
    4,151,719       0       0       4,151,719  
Mortgage-backed securities
    0       13,216,471       0       13,216,471  
Preferred stock
    32,666       0       0       32,666  
  Total
  $ 4,184,385     $ 25,756,243     $ 0     $ 29,940,628  

 
 

 
Assets measured at fair value on a nonrecurring basis and reflected in the balance sheet at the dates presented are summarized below:

March 31, 2010
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
Loans held-for-sale
  $ 460,795     $ 0     $ 0     $ 460,795  
Residential mortgage servicing rights
    0       1,029,799       0       1,029,799  
Impaired loans, net of related allowance
    0       2,341,106       0       2,341,106  
Other real estate owned
    0       718,000       0       718,000  
   Total
  $ 460,795     $ 4,088,905     $ 0     $ 4,549,700  
                                 
December 31, 2009
                               
Assets:
                               
Loans held-for-sale
  $ 321,983     $ 0     $ 0     $ 321,983  
Residential mortgage servicing rights
    0       1,011,360       0       1,011,360  
Impaired loans, net of related allowance
    0       2,186,171       0       2,186,171  
Other real estate owned
    0       743,000       0       743,000  
   Total
  $ 322,983     $ 3,940,531     $ 0     $ 4,262,514  
                                 
March 31, 2009
                               
Assets:
                               
Loans held-for-sale
  $ 1,262,322     $ 0     $ 0     $ 1,262,322  
Residential mortgage servicing rights
    0       966,267       0       966,267  
Impaired loans, net of related allowance
    0       713,157       0       713,157  
Other real estate owned
    0       185,000       0       185,000  
   Total
  $ 1,262,322     $ 1,864,424     $ 0     $ 3,126,746  

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.

Real estate properties acquired through or in lieu of loan foreclosure are carried as OREO and are initially recorded at fair value less estimated selling cost at the date of foreclosure.  Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses.  After foreclosure, these assets are carried at the lower of their new cost basis or fair value, less estimated cost to sell.  Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed.  Appraisals are then done periodically on properties that management deems significant, or evaluations may be performed by management on properties in the portfolio that are less vulnerable to market conditions.  Subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its cost or fair value, less estimated cost to sell.

Fair values of financial instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and cash equivalents:  The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair values.

Investment securities:  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 certain U.S. Government Bonds and preferred stock.  Level 2 securities include asset-backed securities, including obligations of government sponsored entities, certain U.S Government securities, mortgage-backed securities, municipal bonds and certain equity securities.

Restricted equity securities:  Restricted equity securities are comprised of Federal Reserve Bank (FRB) stock and Federal Home Loan Bank of Boston (FHLBB) stock.  These securities are carried at cost, which is believed to approximate fair value, based on the redemption provisions of the FRB and the FHLBB.  The stock is nonmarketable, and redeemable at par value.

Loans and loans held-for-sale:  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts.  The fair values for other loans (for example, fixed rate residential, commercial real estate, and rental property mortgage loans, and commercial and industrial loans) are estimated using discounted cash flow analyses, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics.  The carrying amounts reported in the balance sheet for loans that are held-for-sale approximate their fair values.  Loans that are deemed to be impaired are valued at the lower of the loan’s carrying value or the loan’s impaired basis.  The impaired basis is measured using the impairment method that the Company has applied, be it the present value of cash flows, the observable market price, or the fair value of collateral. The Company selects the measurement method on a loan-by-loan basis, except that when a foreclosure of a collateral dependent loan is probable then the fair value of collateral method is used. The fair value of real estate collateral is usually determined using independent appraisals and evaluations.   The Company considers impaired loans to be valued based on Level 2 inputs.

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:  Mortgage servicing rights are evaluated regularly for impairment based upon the fair   value of the servicing rights as compared to their amortized cost. The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income, with loans divided into strata for valuation purposes based on their rates, terms and features. The Company obtains a third party valuation based upon loan level data, including note rate, type and term of the underlying loans. The model utilizes a variety of observable inputs for its assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows.  Mortgage servicing rights are subject to measurement at fair value on a nonrecurring basis and are classified as Level 2 assets.

Deposits and borrowed funds:  The fair values disclosed for demand deposits (for example, checking and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit and debt are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates and debt to a schedule of aggregated contractual maturities on such time deposits and debt.

Short-term borrowings:  The fair value is estimated using current interest rates on borrowings of similar maturity.

Junior subordinated debentures:  Fair value is estimated using current rates for debentures of similar maturity.

Capital lease obligations:  Fair value is determined using a discounted cash flow calculation using current rates.  Based on current rates, carrying value approximates fair value.

Accrued interest:  The carrying amounts of accrued interest approximate their fair values.

Off-balance-sheet credit related instruments:  Commitments to extend credit were evaluated and fair value was estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit-worthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The estimated fair values of the Company's financial instruments were as follows:

   
March 31, 2010
   
December 31, 2009
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
         
(in thousands)
       
Financial assets:
                       
Cash and cash equivalents
  $ 9,281     $ 9,281     $ 9,603     $ 9,603  
Securities held-to-maturity
    47,158       47,593       44,766       45,543  
Securities available-for-sale
    22,872       22,872       23,975       23,975  
Restricted equity securities
    3,907       3,907       3,907       3,907  
Loans and loans held-for-sale, net
    380,464       390,874       378,656       388,199  
Mortgage servicing rights
    991       1,030       933       1,011  
Accrued interest receivable
    2,118       2,118       1,895       1,895  
                                 
Financial liabilities:
                               
Deposits
  $ 399,986     $ 402,241     $ 418,786     $ 420,933  
Federal funds purchased and other
                               
  borrowed funds
    36,022       35,991       13,411       13,549  
Repurchase agreements
    17,815       17,815       19,042       19,042  
Capital lease obligations
    866       866       877       877  
Subordinated debentures
    12,887       12,541       12,887       11,370  
Accrued interest payable
    209       209       234       234  

The estimated fair values of commitments to extend credit and letters of credit were immaterial at March 31, 2010 and December 31, 2009.

Note 9.  Mortgage Servicing Rights

     During the first quarter of 2010, the market rates used to determine the fair value of the Company’s mortgage servicing rights remained relatively stable and at levels higher than the end of 2009.  Given this factor and the secondary market volume within the residential mortgage loan portfolio, management believes that the fair value of the mortgage servicing rights has increased since December 31, 2009 and that a write up in the amount of $104,176 was deemed appropriate as of March 31, 2010.

     The following table shows the changes on the mortgage servicing rights for the dates indicated:

   
March 31,
   
December 31,
   
March 31,
 
   
2010
   
2009
   
2009
 
                   
Balance at beginning of year
  $ 932,961     $ 960,110     $ 960,110  
 Mortgage servicing rights capitalized
    48,222       584,004       242,334  
 Mortgage servicing rights amortized
    (94,668 )     (363,755 )     (78,301 )
 Increase (decrease) in market value
    104,179       (247,398 )     (157,876 )
Balance at end of period
  $ 990,694     $ 932,961     $ 966,267  

Note 10.  Legal Proceedings

     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 11.  Subsequent Event

     On March 30, 2010, the Company declared a cash dividend of $0.12 per share payable May 1, 2010 to shareholders of record as of April 15, 2010.  This dividend, amounting to $543,492, was accrued at March 31, 2010.
 
     For purposes of accrual or disclosure in these financial statements, the Company has evaluated subsequent events through the date of issuance of these financial statements.
 
 
 

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

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for the Period Ended March 31, 2010

     Under Securities and Exchange Commission (SEC) Regulation G, public companies making disclosures containing financial measures that are not in accordance with generally accepted accounting principles in the United States (U.S. GAAP or GAAP) must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure, as well as a statement of the company’s reasons for utilizing the non-GAAP financial measure.  The SEC has exempted from the definition of non-GAAP financial measures certain commonly used financial measures that are not based on GAAP.  However, two non-GAAP financial measures commonly used by financial institutions, namely tax-equivalent net interest income and tax- equivalent net interest margin, have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G.  However, we are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G.

FORWARD-LOOKING STATEMENTS

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

     Forward-looking statements are not guarantees of future performance.  They necessarily involve risks, uncertainties and assumptions.  Future results of the Company may differ materially from those expressed in these forward-looking statements.  Examples of forward looking statements included in this discussion include, but are not limited to, estimated contingent liability related to assumptions made within the asset/liability management process, management's expectations as to the future interest rate environment and the Company's related liquidity level, credit risk expectations relating to the Company's loan portfolio and its participation in the Federal Home Loan Bank of Boston (FHLBB) Mortgage Partnership Finance (MPF) program, and management's general outlook for the local and national economy and the future performance of the Company.  Although forward-looking 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 does not undertake, and disclaims any obligation, to revise or update any forward-looking statements to reflect the occurrence or anticipated occurrence of events or circumstances after the date of this Report, except as required by applicable law.  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) general economic or monetary conditions, either nationally or regionally, continue to deteriorate, resulting in a decline in credit quality or a diminished demand for the Company's products and services; (2) competitive pressures increase among financial service providers in the Company's northern New England market area or in the financial service industry generally, including competitive pressures from non-bank financial service providers, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; (3) interest rates change in such a way as to reduce the Company's margins;  (4) changes in laws or government rules, or the way in which courts and government agencies interpret those laws or rules, increase our costs of doing business or otherwise adversely affect the Company's business; (5) changes in federal or state tax policy; (6) changes in the level of nonperforming assets and charge-offs; (7) changes in estimates of future reserve requirements based upon relevant regulatory and accounting requirements; (8) changes in consumer and business spending, borrowing and savings habits; and (9) the effect of and changes in the United States monetary and fiscal policies, including the interest rate policies and regulation of the money supply by the Federal Reserve Board, which, in turn, may result in inflation and interest rate, securities market and monetary fluctuations.

OVERVIEW

     Despite continuing challenges in the local and national economy, the Company’s consolidated assets on March 31, 2010 increased to $508.1 million from $505.3 million on December 31, 2009 and $485.6 million on March 31, 2009, representing an increase of 0.6% and 4.6%, respectively.  The most significant change in assets was an increase of $20.5 million in gross loans when comparing the first quarter 2009 to the first quarter 2010, and an increase of approximately $2.0 million from December 31, 2009 to March 31, 2010.   The increase in gross loans, quarter-to-quarter, was due to a $14.2 million increase in commercial loans and an increase in 1-4 family residential loans of $7.2 million, partially offset by a decrease of $1.5 million in consumer loans.  The $2.0 million increase in gross loans from December 31, 2009 to March 31, 2010 reflected a similar pattern of change in loan categories.

     Borrowed funds increased $22.6 million at March 31, 2010 compared to December 31, 2009.  The historic low interest rate environment in 2009 and into the first quarter of 2010 allowed the Company to fund the balance sheet with lower cost funds, resulting in an improvement in net interest margin of 8 basis points for the first quarter of 2010 compared to the first quarter of 2009.  The Company had taken advantage of the low fed funds rate and funded balance sheet growth throughout 2009 with short-term funds.  During the first quarter of 2010, anticipating an increase in long-term rates due to a steepening yield curve, the Company extended $18.0 million of short-term funding into longer-term FHLBB advances with two, three and five year maturities.  This will provide the Company with protection from interest-rate risk in the event of a rising rate environment.  $15.1 million of the Bank’s short-term funding replaced with FHLBB long-term borrowings had been in the form of one-way purchased funds in the Certificate of Deposit Account Registry Service (CDARS) program of Promontory Interfinancial Network (described in the Liquidity and Capital Resources section later).  This reallocation of funds contributed to the overall decrease in deposits of $18.7 million at March 31, 2010 compared to December 31, 2009, and in particular to the decrease in certificates of deposit during the same period.  NOW and money market accounts also decreased between periods, which is normal for the Company during the first quarter of the year as municipal accounts follow their annual finance cycle.  Deposits at March 31, 2010 include a new $11.2 million money market account of the Company's trust company affiliate, Community Financial Service Group (CFSG), which helped to offset the $14.0 million seasonal decrease in municipal accounts.

     Net income for the first quarter of 2010 was $938,912 or $0.20 per share compared to $683,253 or $0.14 per share in 2009.  As mentioned above, net interest income contributed to the increase with a higher net interest margin.  Non-interest income was also greater than the first quarter 2009 in spite of the fact that last year the Company generated record fee income from the sale of residential loans in the secondary market.  One of the more significant items that contributed to the positive variance was the valuation adjustment to mortgage servicing rights.  The increase in residential mortgage rates at the end of the quarter resulted in an increase of $104,179 in the value of the servicing rights as of March 31, 2010 versus a decrease in value of $157,876 as of March 31, 2009, creating a variance of $262,055 between periods.  Also contributing to an increase in first quarter net income this year compared to the same period last year is a decrease in non-interest expense of $211,290.  Two items contributing to the decrease are Federal Deposit Insurance Corporation (FDIC) insurance and losses on limited partnerships.  Last year in the first quarter the Company recorded an accrual of $133,000 for a special assessment by the FDIC and in 2009 the Company made a significant investment in a local senior housing project that increased the losses in those partnerships for the year.

     Throughout 2009, the Federal Reserve purchased trillions of dollars of mortgage-backed securities from Freddie Mac and Fannie Mae to support mortgage lending and the housing markets, driving down secondary market interest rates during the year and into the first quarter of 2010.  This action was abated at the end of the first quarter and mortgage rates started to increase.  The low interest rates in 2009 fueled stronger than expected income for the Company from the origination and subsequent sale of residential fixed rate mortgages to Freddie Mac.  However, these levels are not expected to continue in 2010, and the Company has already seen a decline in residential mortgage loan activity in the first quarter of 2010, compared to 2009.

     On April 13, 2010, the Board of Directors of the FDIC approved an interim rule to extend the Transaction Account Guarantee (TAG) program to December 31, 2010. Last year the program had been previously extended to June 30, 2010. Under the TAG program, customers of participating insured depository institutions are provided full deposit insurance coverage on transaction accounts. The interim rule gives the Board discretion to extend the program to the end of 2011, without additional rulemaking, if it determines that economic conditions warrant such an extension.  The TAG program provides unlimited FDIC insurance on deposits in transaction accounts earning less than or equal to 25 basis points.  This gives financial institutions who are participating in the TAG program an option for their customers with large dollar accounts who are looking for insured funds beyond the current FDIC coverage of $250,000.

     On March 30, 2010, the Company's Board of Directors declared a quarterly cash dividend of $0.12 per common share, payable on May 1, 2010 to shareholders of record on April 15, 2010.  The Company is focused on increasing the profitability of the balance sheet, improving expense efficiency, and prudently managing risk, particularly as it pertains to credit in order to remain a well-capitalized bank in this challenging economic environment.

    Recent national economic news is declaring that the recession is over, or at least abating, and that there are signs that the economy is improving.  This glimmer of hope is based on increased spending in the business sector, supported by increases in manufacturing activity, increased spending at the consumer level, in retail and vehicle purchases and in tourism spending.  While there are signs of economic growth and some evidence that the labor market is stabilizing, the fact that unemployment rates remain high, the housing markets remain soft and expectations of inflation are low indicates that it will take time before the recovery shows true signs of expansion.  We believe it likely, therefore, that the Federal Reserve will maintain the low levels of the federal funds rate for an extended period of time.

     Local economic conditions are similar to national conditions, with high unemployment rates and a housing market that was sluggish, particularly at the beginning of the quarter.  More recently, activity in the residential real estate market has increased and was evident in an increase in the pipeline of mortgage applications at the end of the quarter, although, as expected, no where near the levels of 2009.  Jobless claims in the local manufacturing sector have subsided and some factories have increased work hours for production crews.  Areas that are struggling are the dairy industry and tourism due to a winter season that was negatively affected by limited snow and warmer than normal temperatures.  One positive note for the northeastern Vermont market area is a multi-phase expansion project of a local ski area, where construction of two hotels, a hockey arena, an indoor water park and a golf club house are expected to transform the ski resort to a year-round indoor and outdoor recreation destination resort.  This project is expected to inject $90 million of construction funding into the local economy over the next two years.  Each of the Company’s markets seems to have some project, segment or niche that is breathing life into its local economy and contributing to the increased level of commercial applications during the first quarter.

     While there are some signs of a recovery, the number of people unemployed and the limited new job opportunities suggest that the recovery will be slow and the economy in the Company’s markets will remain constrained for the time being.  The recent poor economic conditions continue to have a negative impact on the consumer, particularly as it relates to credit performance, which tends to lag economic cycles.  Past dues and non-performing loans increased during the first quarter of 2010 compared to 2009 as customers continue to struggle to make their mortgage payments, not only due to layoffs and reduced income, but some are plagued by high levels of other consumer debt as well.  These economic factors are considered in assessing the level of the Company’s reserve for loan losses in an effort to adequately reserve for probable losses due to consequences of the recession.

     The regulatory environment continues to increase operating costs and place extensive burden on management resources to comply with rules such as the Sarbanes-Oxley Act of 2002, the USA Patriot Act and the Bank Secrecy Act, established to protect the U.S. financial system and the customer from fraud, identity theft, money laundering, and terrorism.  The Company implemented significant changes to lending procedures brought on by the Mortgage Disclosure Improvement Act, which became effective in July 2009, and changes in the regulations under the Real Estate Settlement Procedures Act, which took effect on January 1, 2010. These burdens and associated costs will only increase if certain of the regulatory reform proposals currently being considered in Congress, including the creation of a new Consumer Financial Protection Agency, are enacted.

     The following pages describe our first quarter financial results in much more detail. Please take the time to read them to more fully understand the results of the three months ended March 31, 2010 in relation to the 2009 comparison period.  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/A for the year ended December 31, 2009.

     This report includes forward-looking statements within the meaning of the Securities and Exchange Act of 1934 (the "Exchange Act").

CRITICAL ACCOUNTING POLICIES

    The Company’s consolidated financial statements are prepared according to U.S. GAAP.  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 SEC has defined a Company’s critical accounting policies as those 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 qualitative factors, including the effect of current economic indicators and their probable impact on borrowers and collateral, trends in delinquent and non-performing loans, trends in criticized and classified assets, concentrations of credit, levels of exceptions, and the impact of competition in the market. 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 debts previously contracted, other real estate owned (OREO).  Such properties are carried at fair value, which is the market value less estimated cost of disposition, i.e. sales commissions and costs associated with the sale.  Market value is defined as the cash price that might reasonably be anticipated in a current sale that is within 12 months, under all conditions requisite to a fair sale.  A fair sale means that a buyer and seller are each acting prudently, knowledgeably, and under no necessity to buy or sell.  Market value is determined, as appropriate, either by obtaining a current appraisal or evaluation prepared by an independent, qualified appraiser, by obtaining a Broker’s Price Opinion, or if the Company has limited exposure and limited risk of loss, by the opinion of management as supported by an inspection of the property and its most recent tax valuation.  If the Company has a valid appraisal or an appropriate evaluation obtained in connection with the real estate loan, and there has been no obvious and material change in market conditions or physical aspects of the property, then the Company need not obtain another appraisal or evaluation when it acquires ownership of the property. Under recent and current market conditions, and periods of declining market values, the Company will generally obtain a new appraisal or evaluation.

     The amount, if any, by which the recorded amount of the loan exceeds the fair value, less cost to sell, is a loss which is charged to the allowance for loan losses at the time of foreclosure or repossession. The recorded amount of the loan is the loan balance adjusted for any unamortized premium or discount and unamortized loan fees or costs, less any amount previously charged off, plus recorded accrued interest.

     The Company performs quarterly reviews of individual debt and equity securities in the investment portfolio 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 and the probability, extent and timing of a valuation recovery, the company’s intent to continue to hold the security and, in the case of debt securities, the likelihood that the company will not have to sell the security before recovery of its cost basis.  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 and business prospects, or to market-related or other factors, such as interest rates, and in the case of debt securities, the extent to which the impairment relates to credit losses of the issuer, as compared to other factors.  Declines in the fair value of securities below their cost that are deemed in accordance with GAAP to be other than temporary, and declines in fair value of debt securities below their cost that are related to credit losses, are recorded in earnings as realized losses.  The non-credit loss portion of an other than temporary decline in the fair value of debt securities below their cost basis (generally, the difference between the fair value and the estimated net present value of the debt security) is recognized in other comprehensive income as an unrealized loss.

     Mortgage servicing rights associated with loans originated and sold, where servicing is retained, are required to be initially capitalized at fair value and subsequently accounted for using the “fair value method” or the “amortization method”. Capitalized mortgage servicing rights are 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.  The value of capitalized servicing rights represents the estimated 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 compared to amortized cost, and impairment, if any, is recognized through a valuation allowance and is recorded as amortization of other assets.  Subsequent improvement (if any) in the estimated fair value of impaired mortgage servicing rights is reflected in a positive valuation adjustment and is recognized in other income up to (but not in excess of) the amount of any prior impairment. 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 prepayments of that principal balance. Factors that may significantly affect the estimates used are changes in interest rates and the payment performance of the underlying loans.  The Company analyzes and accounts for the value of its servicing rights with the assistance of a third party consultant.

     The Company’s 2007 acquisition of LyndonBank 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 an acquisition at fair value, with the excess of the purchase price over the fair value of the net assets recorded as goodwill and evaluated annually for impairment based on its fair value.  The determination of fair value requires the use of assumptions, including discount rates, changes in which could significantly affect assigned 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.  The use of different estimates or assumptions could produce different estimates of carrying values and those differences could be material in some circumstances.

RESULTS OF OPERATIONS

     The Company’s net income for the first quarter of 2010 was $938,912, representing an increase of $255,659 or 37.4% over net income of $683,253 for the first quarter of 2009. This resulted in earnings per share of $0.20 and $0.14, respectively, for the first quarters of 2010 and 2009.  Net interest income for the first quarter of 2010 increased $281,180 or 7.1% over the first quarter of 2009.  Although total interest income decreased $206,343 or 3.4%, this decrease was more than offset by a decrease in interest expense of $487,523 or 22.9% year over year, accounting for the increase in net interest income.  Despite a $20.5 million increase in loans between the first quarter of 2009 and 2010, interest and fees on loans, the major component of interest income, increased $2,748 or 0.1%.  Interest expense on deposits, the major component of interest expense, decreased $543,067 or 30.9% between the first quarter of 2009 and 2010, attributable in part to a decrease of $17.3 million in time deposits as well as a decrease in the rates paid on these deposit accounts.  NOW and money market accounts increased $19.7 million or 16.3% while the rate paid on these accounts decreased, contributing to the decrease in interest expense on deposits.

     As a result of the LyndonBank merger, the Company is required to amortize the fair value adjustments of the acquired loans and time deposits against net interest income and the core deposit intangible against non-interest expense.  The loan fair value adjustment was a net premium, creating a decrease in interest income of $11,978 for the first three months of 2010 compared to a decrease of $22,631 for the first three months of 2009.  The certificate of deposit fair value adjustment resulted in an increase in interest expense of $78,000 for the first three months of 2010, compared to an increase of $65,000 for the same period in 2009.  The amortization of the core deposit intangible amounted to a non-interest expense of $133,152 for the first three months of 2010, compared to $166,440 for the first three months of 2009.

     The low interest rate environment that prevailed throughout 2009 and into 2010 not only helped the Company to build its commercial and residential real estate mortgage loan portfolios, but also generated secondary market residential mortgage loan activity. Although secondary market activity was not as strong as a year ago, non-interest income from loan sales was still significant for the first three months of 2010, with income from sold loans totaling $136,282 versus $340,424 for the same period in 2009.  Most of the major components of non-interest expense decreased during the first three months of 2010, with FDIC insurance accounting for the largest decrease.  During the first quarter of 2009, the Company recorded FDIC insurance expense totaling $140,499 and a special assessment fee of $133,333, compared to FDIC insurance expense of $158,368 during the first quarter of 2010.

      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.  The Company’s ROA and ROE began to return to more normal levels in 2009 and into 2010 as the LyndonBank merger related expenses become a part of the past.  The following table shows these ratios annualized for the comparison periods.

For the first quarter ended March 31,
 
2010
   
2009
 
             
Return on Average Assets
    0.76 %     0.58 %
Return on Average Equity
    10.18 %     7.83 %
                 

 
 

 
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 is 34%; therefore, to equalize tax-free and taxable income in the comparison, the tax-free income is divided 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 comprised the entire held-to-maturity portfolio of $47.2 million at March 31, 2010, and $40.1 million at March 31, 2009.  The Company acquired municipal investments through the merger with LyndonBank amounting to approximately $1.1 million, which were sold in January 2009, for a net loss of $12,122.  Also included in the Company’s available-for-sale portfolio are two classes of Fannie Mae preferred stock acquired in the merger, which, until the last quarter of 2008, carried a 70% tax exemption on dividends received.  Dividend payments on the Fannie Mae preferred stock ceased following the federal government’s action in September 2008, placing Fannie Mae under conservatorship.  Dividend payments on the Company’s holdings of FHLBB stock also ceased during the last quarter of 2008, as the FHLBB adopted measures to conserve its capital, including suspension of dividend payments.  Resumption of dividend payments on the Fannie Mae and FHLBB stock in 2010, and possibly beyond, is unlikely.
 
     The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the three month comparison periods of 2010 and 2009.

For the three months ended March 31,
 
2010
   
2009
 
             
Net interest income as presented
  $ 4,243,143     $ 3,961,963  
Effect of tax-exempt income
    158,383       167,215  
   Net interest income, tax equivalent
  $ 4,401,526     $ 4,129,178  

     The following table 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 2010 and 2009 comparison periods.

Average Balances and Interest Rates
 
   
   
For the Three Months Ended March 31:
 
         
2010
               
2009
       
   
Average
   
Income/
   
Rate/
   
Average
   
Income/
   
Rate/
 
   
Balance
   
Expense
   
Yield
   
Balance
   
Expense
   
Yield
 
Interest-Earning Assets
 
   
 Loans (1)
  $ 382,812,068     $ 5,451,021       5.77 %   $ 367,427,373     $ 5,448,273       6.01 %
 Taxable investment securities
    23,606,738       112,281       1.93 %     27,636,654       305,003       4.48 %
 Tax exempt investment securities
    46,423,263       465,833       4.07 %     39,117,504       491,375       5.09 %
 Federal funds sold and overnight   deposits
    110,943       350       1.28 %     232,714       9       0.02 %
 Other investments
    975,150       16,137       6.71 %     975,150       16,137       6.71 %
     Total
  $ 453,928,162     $ 6,045,622       5.40 %   $ 435,389,395     $ 6,260,797       5.83 %
   
Interest-Bearing Liabilities
 
   
 NOW & money market funds
  $ 136,775,027     $ 319,199       0.95 %   $ 125,313,270     $ 374,590       1.21 %
 Savings deposits
    53,209,384       40,569       0.31 %     51,095,067       38,500       0.31 %
 Time deposits
    157,259,018       854,712       2.20 %     172,922,618       1,344,458       3.15 %
 Federal funds purchased and other   borrowed funds
    33,970,678       119,572       1.43 %     14,120,078       42,959       1.23 %
 Repurchase agreements
    19,336,027       48,851       1.02 %     19,396,523       69,146       1.45 %
 Capital lease obligations
    869,919       17,629       8.22 %     908,940       18,402       8.21 %
 Junior subordinated debentures
    12,887,000       243,564       7.66 %     12,887,000       243,564       7.66 %
     Total
  $ 414,307,053     $ 1,644,096       1.61 %   $ 396,643,496     $ 2,131,619       2.18 %
   
Net interest income
          $ 4,401,526                     $ 4,129,178          
Net interest spread (2)
                    3.79 %                     3.65 %
Net interest margin (3)
                    3.93 %                     3.85 %
   
(1) Included in gross loans are non-accrual loans with an average balance of $4,719,812 and $2,251,281 for the three
 
months ended 2010 and 2009, respectively. Loans are stated before deduction of unearned discount and allowance
 
for loan losses.
 
(2) Net interest spread is the difference between the yield on earning assets and the rate paid on interest-bearing
 
liabilities.
 
(3) Net interest margin is net interest income divided by average earning assets.
 

     The average volume of earning assets for the first three months of 2010 increased $18.5 million or 4.3% compared to the same period of 2009, while the average yield decreased 43 basis points.  The average volume of loans increased $15.4 million or 4.2%, while the average yield decreased 24 basis points.  Interest earned on the loan portfolio comprised 90.2% of total interest income for the first three months of 2010 and 87.0% for the 2009 comparison period.  Loan activity was steady during the latter part of 2009 and into the first quarter of 2010 primarily in the residential and commercial real estate portfolios, contributing to the increase in the average loan portfolio.  The average volume of the taxable investment portfolio (classified as available-for-sale) decreased approximately $4.0 million or 14.6% between periods, and the average yield decreased 255 basis points.  The Company sold its entire collateralized mortgage obligation (CMO) and mortgage-backed securities (MBS) investment portfolio classified as available-for-sale, for approximately $14.6 million during the first half of 2009, and replaced it with $13.0 million in U.S. Government Agencies, accounting for a portion of the decrease in the average balances of the investment portfolio.  The remaining decrease in average investments is due to maturities within the Company’s available-for-sale portfolio, which were used to help fund loan growth.  The average volume of the tax exempt investment portfolio (classified as held-to-maturity) increased $7.3 million or 18.7%, due to new municipal investment for the Company, and the average tax equivalent yield decreased 102 basis points.  Interest earned on tax exempt investments (which is presented on a tax equivalent basis) comprised 7.7% of total interest income for the first three months of 2010 compared to 7.9% for the same period in 2009.

     In comparison, the average volume of interest bearing liabilities for the first three months of 2010 increased $17.7 million or 4.5% over the 2009 comparison period, while the average rate paid on these accounts decreased 57 basis points.  The average volume of NOW and money market funds increased $11.5 million or 9.2% and the average rate paid decreased 26 basis points.  This increase was due in part to an increase in municipal deposits that correspond to the new municipal investments mentioned in the prior paragraph.   The average volume of time deposits decreased $15.7 million, or 9.1%, and the average rate paid on time deposits decreased 95 basis points.  Competition for time deposits remains aggressive in the Company's market area and the Company has chosen to not pay up on these deposits and replace them with other funding sources, primarily borrowings from the FHLBB.  The average volume of federal funds purchased and other borrowed funds increased $19.9 million or 140.6% from an average volume of $14.1 million for the first three months of 2009 to $34.0 million for the same period in 2010.  Given the low rates on borrowed funds, both in overnight funds purchased and in long-term borrowings, the Company extended some of its overnight funds into two, three and five year advances to supplement its deposit funding.  The Company also increased core deposits at the end of March 2010 with an $11.2 million money market account from its affiliate, CFSG.

     The cumulative result of all these changes was an increase of 14 basis points in the net interest spread and an increase of eight basis points in the net interest margin.  The increase in the loan portfolio and the change in the mix of interest bearing liabilities, primarily time deposits versus borrowed funds, helped to increase net interest income and maintain a positive net interest spread and net interest margin despite a sustained low rate environment.

    The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the first three months of 2010 and 2009 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
 
Interest-Earning Assets
 
 Loans
  $ (225,241 )   $ 227,989     $ 2,748  
 Taxable investment securities
    (173,544 )     (19,178 )     (192,722 )
 Tax exempt investment securities
    (117,233 )     91,692       (25,541 )
 Federal funds sold and overnight deposits
    725       (384 )     341  
 Other investments
    0       0       0  
     Total
  $ (515,293 )   $ 300,119     $ (215,174 )
   
Interest-Bearing Liabilities
 
 NOW & money market funds
  $ (89,588 )   $ 34,197     $ (55,391 )
 Savings deposits
    453       1,616       2,069  
 Time deposits
    (404,776 )     (84,970 )     (489,746 )
 Federal funds purchased and other borrowed funds
    16,409       60,204       76,613  
 Repurchase agreements
    (20,143 )     (152 )     (20,295 )
 Capital lease obligations
    18       (791 )     (773 )
 Junior subordinated debentures
    0       0       0  
     Total
  $ (497,627 )   $ 10,104     $ (487,523 )
   
       Changes in Net Interest Income
  $ (17,666 )   $ 290,015     $ 272,349  
   
(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
 
 
 
 

 
NON-INTEREST INCOME AND NON-INTEREST EXPENSE

     Non-interest income increased $80,245 or 7.0% for the first quarter of 2010 compared to the first quarter of 2009, from $1.15 million to $1.23 million.  A change in the structure of fees charged on deposit accounts and more favorable interchange rates contributed to the increase in these fees of $68,499 or 13.9% for the first quarter of 2010 compared to the first quarter of 2009.  The Company experienced strong loan activity during the first three months of 2009, primarily in residential mortgage loans sold to the secondary market, compared to the first three months of 2010, accounting for the decrease of $204,142 or 60.0% in income on sold loans.  The volume of loans sold during the first three months of 2009 was $25.9 million compared to $6.4 million in the same period in 2010.  The Company recognized income of $32,934 from its Supplemental Executive Retirement Program investment assets compared to a loss of $84,609 for the first three months of 2009, reflecting improved stock market conditions between periods.  The increase in activity in the commercial loan portfolio has helped to generate more non-interest income with fees totaling $95,786 for the first quarter of 2010 compared to $37,904 for the same period in 2009.

     Non-interest expense decreased $211,290 or 4.7% to $4.3 million for the first quarter of 2010 compared to $4.5 million for the 2009 comparison period.  Total FDIC insurance expense for the first quarter of 2010 was $158,368 compared to $273,832 for the first quarter of 2009.  The amortization of the core deposit intangible associated with the LyndonBank acquisition decreased $33,288 or 20.0% to $133,152 for the first quarter of 2010 compared to $166,440 for the first quarter of 2009.

     Non-interest expense for the first quarter of 2009 included a write down of $25,000 in the carrying value of the former LyndonBank Derby branch, held in OREO, resulting in an adjusted carrying value of $560,000 as of March 31, 2010.  The property’s original carrying value of $675,000 had previously been written down by $90,000 during 2009.

     Management monitors all components of other non-interest expense; additionally, a quarterly review is performed to assure that the accruals for these expenses are accurate and timely.  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

     The provision for income taxes changed from a tax benefit of $194,846 for the first quarter of 2009 to a tax expense of $122,210 for the first quarter of 2010.  The Company receives tax credits for its investments in various low income housing partnerships which reduce taxes payable.  From time to time, the Company has the opportunity to participate in a low income housing project that offers one-time historic tax credits.  In 2008, the Company was given this opportunity through a local project, with historic tax credit for 2009 amounting to $535,000, or $133,750 quarterly.  Total tax credits, including the one-time historic tax credit, recorded for the first quarter of 2009 amounted to $263,343, compared to regular tax credits of $133,701 for the first quarter of 2010.

CHANGES IN FINANCIAL CONDITION

     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:

   
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
Assets
                                   
 Loans (gross)*
  $ 384,133,217       75.61 %   $ 382,259,106       75.65 %   $ 363,616,299       74.88 %
 Available for Sale Securities
    22,872,120       4.50 %     23,974,830       4.74 %     29,940,628       6.17 %
 Held to Maturity Securities
    47,157,935       9.28 %     44,766,250       8.86 %     40,091,646       8.26 %
*includes loans held for sale
                                               
Liabilities
                                               
 Time Deposits
  $ 152,676,778       30.05 %   $ 167,270,840       33.10 %   $ 169,985,247       35.01 %
 Savings Deposits
    55,259,464       10.88 %     52,448,863       10.38 %     54,048,600       11.13 %
 Demand Deposits
    51,665,027       10.17 %     52,821,573       10.45 %     49,322,103       10.16 %
 NOW & Money Market Funds
    140,384,990       27.63 %     146,244,454       28.94 %     120,669,051       24.85 %
 Federal Funds Purchased and
                                               
    Other Borrowed Funds
    36,022,000       7.09 %     13,411,000       2.65 %     16,750,000       3.45 %

     The Company's loan portfolio increased $1.9 million, or 0.5% from December 31, 2009 to March 31, 2010, and $20.5 million, or 5.6%, from March 31, 2009 to March 31, 2010.  The decrease in mortgage interest rates throughout 2009 triggered an increase in new loan activity during 2009, with an even larger increase in refinancing activity, especially in the residential loan portfolio.  During the last quarter of 2009 and into the first quarter of 2010, the Company experienced an increase in loan activity within the commercial and residential mortgage loan portfolio that the Company retains in-house.  Available-for-sale investments decreased $1.1 million or 4.6% through maturities and sales from December 31, 2009 to March 31, 2010, and $7.1 million or 23.6% year over year.  Most of the maturities and sales during 2009 and 2010 were used to fund loan growth and reinvestment in U.S. Government agencies.  Held-to-maturity securities increased $2.4 million or 5.3% during the first three months of 2010, and $7.1 million or 17.6% year to year.  As noted earlier in this discussion, the growth in the held-to-maturity portfolio is attributable to increased municipal investments.

     Time deposits decreased $14.6 million or 8.7% from December 31, 2009 to March 31, 2010 and $17.3 million or 10.2% from March 31, 2009 to March 31, 2010.  Competitive interest rate programs at other financial institutions accounted for some of the decrease as the Company chose to seek alternate sources of funding (primarily FHLBB borrowings) to replace these higher cost deposits.  Also affecting the time deposit balances in the comparison was the balance of one-way purchased funds in the CDARS program.   These funds totaled $5 million on March 31, 2009, and $15.1 million on December 31, 2009.  During the first quarter of 2010, as the $15.1 million in purchased CDARS funds matured, they were replaced with FHLBB advances, which are included in the $23 million increase in borrowed funds compared to year end 2009.  Savings deposits increased $2.8 million or 5.4% during the first three months of 2010 and $1.2 million or 2.2% year to year.  Demand deposits decreased $1.2 million or 2.2% during the first three months of 2010, compared to an increase of $2.3 million or 4.8% year to year.  NOW and money market funds reported a decrease of $5.9 million or 4.0% for the first three months of 2010, while year over year an increase of $19.7 million or 16.3% was reported.  The Company’s municipal accounts, which are primarily a component of NOW and money market funds, increased during the last half of 2009 to levels above the volume in the first quarter of 2009; however, due to normal cyclical activity, the volume on these accounts decreased during the first three months of 2010, accounting for most of the changes in both comparison periods.  The decrease was offset by an $11 million money market account from the Company’s affiliate, CFSG.  Other borrowed funds increased $22.6 million or 168.6% from December 31, 2009 to March 31, 2010 and $19.3 million or 115.1% year to year.  The average cost of funds from FHLBB during 2009 and into 2010 was approximately 0.30%, causing the Company to rely more heavily on this source of funding as opposed to offering higher rates in order to replace maturing time deposits, including the $15.1 million in purchased CDARS deposits.  While the Company strives to keep its core customers, there was not as much emphasis placed on attracting rate shoppers.

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) is made up of the Executive Officers and all the Vice Presidents of the Bank.  The 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 financial instruments 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 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.  All rate scenarios are simulated assuming a parallel shift of the yield curve; however further simulations are performed utilizing a flattening and steepening 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 upward and downward shifts in interest rates depending on the current rate environment.  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.

     The Company’s Asset/Liability Policy has been enhanced with a contingency funding plan to help management prepare for unforeseen liquidity challenges, with modeling based on hypothetical severe liquidity crisis scenarios.

     While management’s 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 customer preferences or competitor influences might change.  This is especially true in light of the continued significant market volatility during the last eighteen months and the unprecedented, sustained low interest rate environment.

Credit Risk - A primary challenge of management is to reduce the exposure to credit loss within the loan portfolio. Management follows established underwriting guidelines, and exceptions to the policy must be approved in accordance with limits prescribed by the Board of Directors.  The adequacy of the loan loss coverage is reviewed quarterly by the risk management committee of the Board of Directors and then presented to the full Board of Directors for approval.  This committee meets to discuss, among other matters, potential exposures, historical loss experience, and overall economic conditions.  Existing or potential problems are noted and addressed by senior management in order to assess the risk of probable loss or delinquency.  A variety of loans are reviewed periodically by an independent firm in order to assure accuracy of the Company's internal risk ratings and compliance with various internal policies and procedures, as well as those set by the regulatory authorities.  The Company also has a Credit Administration department whose function includes credit analysis and 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 northern Vermont, geographic concentration is partially mitigated by the continued growth of the Company’s loan portfolio in central Vermont, and through the year-end 2007 LyndonBank acquisition, which increased the level of loans particularly in Caledonia County, and to a lesser extent in Lamoille and Franklin Counties.  The Company also monitors concentrations of credit to individual borrowers, to various industries, and to owner and non-owner occupied commercial real estate.

The following table reflects the composition of the Company's loan portfolio as of the dates indicated:

   
March 31, 2010
   
December 31, 2009
 
   
Total Loans
   
% of Total
   
Total Loans
   
% of Total
 
                         
  Construction & Land Development
  $ 14,629,844       3.81 %   $ 16,868,447       4.41 %
  Secured by Farm Land
    9,398,030       2.45 %     10,038,998       2.63 %
  1-4 Family Residential
    217,526,833       56.62 %     216,458,286       56.62 %
  Commercial Real Estate
    100,337,682       26.12 %     97,620,300       25.54 %
Loans to Finance Agricultural Production
    997,739       0.26 %     952,305       0.25 %
Commercial & Industrial Loans
    27,760,026       7.23 %     26,496,269       6.93 %
Consumer Loans
    13,209,440       3.44 %     13,634,490       3.57 %
All other loans
    273,623       0.07 %     190,011       0.05 %
     Total Gross Loans
    384,133,217       100.00 %     382,259,106       100.00 %
 Reserve for loan losses
    (3,545,807 )             (3,450,542 )        
 Unearned loan fees
    (123,171 )             (152,188 )        
      Net Loans
  $ 380,464,239             $ 378,656,376          

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”). Although the Company, in establishing the allowance, considers the inherent losses in individual loans and pools of loans, the allowance is a general reserve available to absorb all credit losses in the loan portfolio.  No part of the allowance is segregated for, or allocated to, any particular loan or pools of loans.

     When establishing the allowance each quarter the Company applies a combination of historical loss factors and qualitative factors to pools of loans including the residential mortgage, commercial real estate, commercial and industrial, and consumer loan and overdraft portfolios.  The Company will shorten or lengthen its look back period for determining average portfolio historical loss rates as the economy either contracts or expands; during a period of economic contraction a shortening of the look back period may more conservatively reflect the current economic climate.  In light of the current recession, in late 2008 the Company modified its allowance methodology by shortening its historical look back period from five years to one to two years, and by also comparing loss rates to losses experienced during the last economic downturn, from 1999 to 2002. The highest loss rates experienced for these look back periods are applied to the various pools in establishing the allowance.

     The Company then applies numerous qualitative factors to each of these segments of the loan portfolio. Those factors include the levels of and trends in delinquencies and non-accrual loans; criticized and classified assets; volumes and terms of loans; and the impact of any loan policy changes. Experience, ability and depth of lending personnel, levels of policy and documentation exceptions, national and local economic trends, the competitive environment, and concentrations of credit are also factors considered.

     Specific allocations to the reserve are made for impaired loans.  Impaired loans are those that have been placed in non-accrual status. Commercial and commercial real estate loans are placed in non-accrual status when there is deterioration in the financial position of the borrower, payment in full of principal and interest is not expected, and/or principal or interest has been in default for 90 days or more. Such a loan need not be placed in non-accrual status if it is both well secured and in the process of collection.  Residential mortgages and home equity loans are considered for non-accrual status at 90 days past due and are evaluated on a case by case basis to assure that the Company’s net income is not materially overstated. Once the loan is deemed impaired, the Company obtains current property appraisals and valuations on significant properties and considers the cost to carry and sell collateral in order to assess the level of specific allocations required. Consumer loans are not placed in non-accrual but are charged off by the time they reach 120 days past due.

     The Company’s impaired loans increased $1.5 million or 38.1% during the quarter from $3.8 million at December 31, 2009 to $5.3 million as of March 31, 2010, reflecting the continued economic downturn.  The increase primarily consisted of three commercial mortgage loans totaling $1.4 million with two of the loans to the same borrower carrying 90% guarantees amounting to $998,699 from the USDA Rural Development.  Specific allocations to the reserve increased accordingly for the same period, from $232,900 to $298,100.  Loans rewritten through a troubled debt restructuring in 2009 consisted of three loans to one borrower with a balance of $629,457 as of December 31, 2009 and $610,944 as of March 31, 2010.  The combined restructured loan is being repaid according to the restructured terms.  The impaired portfolio mix as of March 31, 2010 includes 48% in both residential and commercial real estate compared to December 31, 2009 totals of approximately 65% residential real estate and 30% commercial real estate.  Management reports increasing trends in the levels of non-performing loans and criticized and classified assets, which is consistent with the length and depth of the current economic recession.  Accordingly, beginning in 2009, in its loan loss reserve analysis, the Company has carried the maximum qualitative factor adjustment for economic conditions and has increased the factors for trends in delinquency and non-accrual loans and criticized and classified assets.

     The Company is not contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans.

     The Company’s OREO portfolio at March 31, 2010 and December 31, 2009 consisted of two properties acquired through the normal foreclosure process amounting to $158,000 and one former LyndonBank branch property in Derby, Vermont with a carrying value of $560,000 at March 31, 2010, which was placed in OREO a short time after the merger, when that branch was consolidated with the Company’s main office.  The March 31, 2010 carrying value of the property reflects a first quarter write down of $25,000.  In March, 2010, the Company acquired a property through the normal foreclosure process and then immediately sold the property to a third party, with no gain or loss recognized from the sale.  As of March 31, 2010 and December 31, 2009, the OREO balance was $718,000 and $743,000, respectively.

     The Company is committed to a conservative lending philosophy and maintains high credit and underwriting standards. As of March 31, 2010, the Company maintained a residential loan portfolio of $217.5 million compared to $216.5 million as of December 31, 2009 and a commercial real estate portfolio (including construction, land development and farm land loans) of $124.4 million as of March 31, 2010 and $124.5 million as of December 31, 2009, together accounting for approximately 90% of the total loan portfolio for each period.

     The residential mortgage portfolio makes up the largest part of the overall loan portfolio and continues to have the lowest historical loss ratio.  The Company maintains a mortgage loan portfolio of traditional mortgage products and has not engaged in higher risk loans such as option ARM products, high loan-to-value products, interest only mortgages, subprime loans and products with deeply discounted teaser rates.  In areas of the country where such risky products were originated, borrowers with little or no equity in their property have been defaulting on mortgages they can no longer afford, and are walking away from those properties as real estate values have fallen precipitously.  While real estate values have declined in the Company’s market area, the sound underwriting standards historically employed by the Company have mitigated the trends in defaults and property surrenders experienced elsewhere.  The Company generally requires private mortgage insurance (PMI) on residential mortgages with loan-to-values exceeding 80%.  A 90% loan-to-value residential mortgage product without PMI is only available to borrowers with excellent credit and low debt-to-income ratios and has not been widely originated.  Junior lien home equity products make up 24% of the Company’s residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%.  The residential mortgage portfolio has performed well in light of current economic conditions.

     Risk in the Company’s commercial and commercial real estate loan portfolios is mitigated in part by using government guarantees issued by federal agencies such as the US Small Business Administration and USDA Rural Development. At March 31, 2010, the Company had $18.3 million in guaranteed loans, compared to $17.8 million at December 31, 2009.

     Given these trends and the current recession, the provision for loan losses for both periods was $125,001. Management will continue to monitor the activity of non-performing assets and adjust the provision in future periods if situations warrant an increase.  The Company has an experienced collections department that continues to actively work with borrowers to resolve problem loans.
 
 
 

 
The following table summarizes the Company's loan loss experience for the three months ended March 31,

   
2010
   
2009
 
             
Loans Outstanding End of Period
  $ 384,133,217     $ 363,616,299  
Average Loans Outstanding During Period
  $ 382,812,068     $ 367,427,373  
Non-Accruing Loans
  $ 5,306,490     $ 2,408,386  
                 
Loan Loss Reserve, Beginning of Period
  $ 3,450,542     $ 3,232,932  
Loans Charged Off:
               
  Residential Real Estate
    17,000       0  
  Commercial Real Estate
    0       0  
  Commercial Loans not Secured by Real Estate
    40       14,747  
  Consumer Loans
    27,430       43,379  
       Total Loans Charged Off
    44,470       58,126  
Recoveries:
               
  Residential Real Estate
    1,078       0  
  Commercial Real Estate
    1,022       1,085  
  Commercial Loans not Secured by Real Estate
    1,539       3,512  
  Consumer Loans
    11,095       7,150  
        Total Recoveries
    14,734       11,747  
Net Loans Charged Off
    29,736       46,379  
Provision Charged to Income
    125,001       125,001  
Loan Loss Reserve, End of Period
  $ 3,545,807     $ 3,311,554  
                 
Net Charge Offs to Average Loans Outstanding
    0.008 %     0.013 %
Provision Charged to Income as a Percent of Average Loans
    0.033 %     0.034 %
Loan Loss Reserve to Average Loans Outstanding
    0.926 %     0.901 %
Loan Loss Reserve to Non-Accruing Loans*
    66.820 %     137.501 %

*The percentage for 2010 includes two loans that were transferred to non-accrual status during the first quarter of 2010 carrying 90% guarantees by USDA Rural Development which, if deducted, would increase the coverage to 144.618% as of March 31, 2010.

Non-performing assets for the comparison periods were as follows:

   
March 31, 2010
   
December 31, 2009
 
         
Percent
         
Percent
 
   
Balance
   
of Total
   
Balance
   
of Total
 
                         
Non-Accruing loans
  $ 5,306,490       87.46 %   $ 3,843,820       87.32 %
Loans past due 90 days or more and still accruing
    760,715       12.54 %     557,976       12.68 %
   Total
  $ 6,067,205       100.00 %   $ 4,401,796       100.00 %

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.  Changes in the capital markets result from events and conditions outside the Company’s control or ability to predict with any certainty, such as changes in general economic conditions of growth or recession, inflation, regulatory or other government actions and changes in interest rates and government monetary policy.  Market risk comprises many individual risks that, when combined, create a macroeconomic impact.

     The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities.  During times of recessionary periods, a declining housing market can result in an increase in loan loss reserves or ultimately an increase in foreclosures.  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.  The recent deterioration of the economy and disruption in the financial markets has heightened the Company’s market risk.  The Company actively monitors and manages its interest rate risk through the ALCO process.

     During the first quarter of 2010, the market rates used to determine the fair value of the Company’s mortgage servicing rights have remained relatively stable and at levels higher than the end of 2009.  Given this factor and the secondary market volume within the residential mortgage loan portfolio, management believes that the fair value of the mortgage servicing rights has increased since December 31, 2009 and that a write up in the amount of $104,176 was deemed appropriate as of March 31, 2010.  At such date, the net carrying value of the Company’s mortgage servicing rights portfolio was $990,694, compared to $932,961 at year end 2009 and $966,267 at March 31, 2009.

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 three months of 2010, 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 March 31, 2010 were as follows:

   
Contract or
 
   
Notional Amount
 
       
Unused portions of home equity lines of credit
  $ 16,599,751  
Other commitments to extend credit
    25,825,698  
Residential construction lines of credit
    692,035  
Commercial real estate and other construction lines of credit
    25,692,343  
Standby letters of credit and commercial letters of credit
    1,318,391  
Recourse on sale of credit card portfolio
    404,030  
MPF credit enhancement obligation, net of liability recorded
    1,504,535  

     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.  The remaining recourse, which consists of business customers and Canadian customers, is subject to increase if the Company were to approve a requested increase by a customer whose credit line was still active and included in the recourse portfolio.  Based on historical losses, and adjusting for current economic conditions, the Company does not expect any significant losses from this commitment.

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, FHLBB borrowings and outside deposit funding such as CDARS deposits (described below), to meet these funding needs.

     In order to attract deposits, the Company has from time to time 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 deposit funding to augment retail deposits and borrowings.  One-way deposits purchased through the CDARS provide an alternative funding source when needed.  Such deposits are generally considered a form of brokered deposits.  These funds totaled $5.0 million and $15.1 million on March 31, 2009 and December 31, 2009, respectively.  During the first quarter of 2010, as the $15.1 million in purchased deposits matured, they were replaced with FHLBB advances, which are included in the $23.0 million increase in borrowed funds compared to year end 2009.  Anticipating an increase in long-term rates due to a steepening yield curve, the Company extended $18.0 million of short-term funding into longer-term FHLBB advances with two, three and five year maturities.  This will provide the protection for the balance sheet from interest-rate risk during a rising rate environment.  This reallocation of funds contributed to the decrease in certificates of deposit during the comparison period.  In addition, two-way CDARS deposits allow the Company to provide FDIC deposit insurance in excess of account coverage limits by exchanging deposits with other CDARS members.    At March 31, 2010, the entire balance of $2.9 million in CDARS deposits represented exchanged deposits with other CDARS participating banks and at December 31, 2009, $2.1 million of the $17.2 million in CDARS deposits represented exchanged deposits.

     During the first three months of 2010, the Company's loan portfolio increased $1.8 million or 0.5%.  Demand for residential mortgages was moderate compared to the level of activity in 2009, while commercial mortgage demand increased during this period and remains favorable into the second quarter of 2010.  The available-for-sale investment portfolio decreased $1.1 million or 4.6% while the held-to-maturity investment portfolio increased $2.4 million or 5.4% compared to 2009 year end levels.  Maturities in the available-for-sale portfolio were used in part to fund loan growth.  On the liability side, savings deposits increased $2.8 million or 5.4%, while NOW and money market accounts decreased $5.9 million or 4.0% and time deposits decreased $14.6 million or 8.7%.  Aggressive pricing from other financial institutions for time deposits, as well as a shift to alternate sources of funding, were both factors in the decrease in deposits.  Other borrowed funds (the alternate funding source), increased $22.6 million or 168.6% for the first three months of 2010.  The low cost of funds at FHLBB, which remains at approximately 0.30%, caused the Company to utilize this source of funding over the higher yielding time deposits.

     In 2009 the Company established a borrowing line with the Federal Reserve Bank of Boston (FRB) to be used as a contingency funding source.  For this Borrower-in-Custody arrangement, the Company pledged eligible commercial loans, commercial real estate loans and home equity loans, resulting in an available line of $68.8 million as of March 31, 2010 and $71.0 million as of December 31, 2009.  Credit advances in the FRB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 75 basis points.  As of March 31, 2010 and December 31, 2009, the Company had not borrowed any amount against this line.

     As a member of the FHLBB, the Company has access to pre-approved lines of credit.  The Company had a $500,000 unsecured Federal Funds line with an available balance of the same amount at March 31, 2010.  Interest is chargeable at a rate determined daily, approximately 25 basis points higher than the rate paid on federal funds sold.  As of March 31, 2010 and December 31, 2009, additional borrowing capacity of approximately $92.1 million and $90.1 million, respectively, less outstanding advances, through the FHLBB was secured by the Company's qualifying loan portfolio.

     Given the Federal Funds rate prevailing in March 2010, the Company extended a portion of its overnight funding into $10 million in long-term advances scheduled to mature within two years, with the remainder falling into overnight funding at this time.

 
 

 
     At the end of the first three months of 2010 and 2009, the Company had outstanding FHLBB advances against the respective lines consisting of the following:

   
2010
   
2009
 
Long-Term Borrowings
           
FHLBB term borrowing, 2.13% fixed rate, due January 31, 2011
  $ 10,000,000     $ 10,000,000  
Community Investment Program borrowing, 7.67% fixed rate,
               
   due November 16, 2012
    10,000       10,000  
FHLBB term borrowing, 0.31% fixed rate, due July 23, 2010
    5,000,000       0  
FHLBB term borrowing, 1.00% fixed rate, due January 27, 2012
    6,000,000       0  
FHLBB term borrowing, 1.71% fixed rate, due January 27, 2013
    6,000,000       0  
FHLBB term borrowing, 2.72% fixed rate, due January 27, 2015
    6,000,000       0  
      33,010,000       10,010,000  
                 
Overnight Borrowings
               
Federal funds purchased (FHLBB), 0.280% and 0.3125%, respectively
    3,012,000       3,401,000  
                 
Total
  $ 36,022,000     $ 13,411,000  

     Under a separate agreement with the FHLBB, the Company has the authority to collateralize public unit deposits, up to its FHLBB borrowing capacity ($92.1 million at March 31, 2010, less outstanding advances noted above) with letters of credit issued by the FHLBB.  At March 31, 2010 approximately $22.3 million of eligible collateral was pledged as collateral to the FHLBB to secure the Company’s obligations relating to these letters of credit.

     Other alternative sources of funding come from unsecured Federal Funds lines with one unaffiliated correspondent bank in the amount of $3.5 million.  There was no balance outstanding on this line at March 31, 2010.

The following table illustrates the changes in shareholders' equity from December 31, 2009 to March 31, 2010:

Balance at December 31, 2009 (book value $7.56 per share)
  $ 36,889,838  
    Net income
    938,912  
    Issuance of stock through the Dividend Reinvestment Plan
    172,700  
    Purchase of treasury stock
    0  
    Dividends declared on common stock
    (543,492 )
    Dividends declared on preferred stock
    (46,875 )
    Change in unrealized gain on available-for-sale securities, net of tax
    (8,956 )
       Balance at March 31, 2010 (book value $7.63 per share)
  $ 37,402,127  

     On March 30, 2010, the Company declared a cash dividend of $0.12 on common stock payable on May 1, 2010, to shareholders of record as of April 15, 2010, which is accrued in the financial statements at March 31, 2010.

     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 certain dividend restrictions under the National Bank Act and regulations of 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 Company is also subject to regulatory restrictions applicable to payment of dividends by bank holding companies, some circumstances, such as where dividends would exceed current period earnings, or where the bank holding company is in a troubled financial condition.

     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 March 31, 2010, 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.
 
 
 

 
Index
The regulatory capital ratios of the Company and its subsidiary as of March 31, 2010 and December 31, 2009 exceeded regulatory guidelines and are presented in the following table.

         
Minimum
     
Minimum
To Be Well
     
For Capital
Capitalized Under
     
Adequacy
Prompt Corrective
 
Actual
Purposes:
Action Provisions:
 
Amount
Ratio 
Amount
Ratio
Amount
Ratio
 
(Dollars in Thousands)
As of March 31, 2010:
           
Total capital (to risk-weighted assets)
           
   Consolidated
$41,231
11.77%
$28,032
8.00%
N/A
N/A
   Bank
$41,077
11.74%
$27,992
8.00%
$34,990
10.00%
Tier I capital (to risk-weighted assets)
           
   Consolidated
$37,659
10.75%
$14,016
4.00%
N/A
N/A
   Bank
$37,505
10.72%
$13,996
4.00%
$20,994
6.00%
Tier I capital (to average assets)
           
   Consolidated
$37,659
7.63%
$19,750
4.00%
N/A
N/A
   Bank
$37,505
7.60%
$19,732
4.00%
$24,665
5.00%
             
As of December 31, 2009:
           
Total capital (to risk-weighted assets)
           
   Consolidated
$40,326
11.57%
$27,877
8.00%
N/A
N/A
   Community National Bank
$40,336
11.60%
$27,811
8.00%
$34,764
10.00%
Tier I capital (to risk-weighted assets)
           
   Consolidated
$36,875
10.58%
$13,939
4.00%
N/A
N/A
   Community National Bank
$36,885
10.61%
$13,906
4.00%
$20,858
6.00%
Tier I capital (to average assets)
           
   Consolidated
$36,875
7.50%
$19,674
4.00%
N/A
N/A
   Community National Bank
$36,885
7.51%
$19,643
4.00%
$24,554
5.00%

     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.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

     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 captions "RISK MANAGEMENT" and “FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK”, which are 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 2009 annual report on form 10-K/A.

ITEM 4. Controls and Procedures

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 March 31, 2010, 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 March 31, 2010 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.

     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 March 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

     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.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

     The following table provides information as to purchases of the Company’s common stock during the quarter ended March 31, 2010, 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
         
January 1 – January 31
2,245
$  8.82
N/A
N/A
February 1 – February 28
2,399
$  8.68
N/A
N/A
March 1 – March 31
4,119
$10.43
N/A
N/A
     Total
8,763
$  9.54
N/A
N/A

(1)  All 8,763 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 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 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.

 
 

 

Index

SIGNATURES

     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:  May 11, 2010
/s/ Stephen P. Marsh                    
 
 
Stephen P. Marsh, President &
 
 
Chief Executive Officer
 
     
DATED:  May 11, 2010
/s/ Louise M. Bonvechio                
 
 
Louise M. Bonvechio,  Vice President
 
 
& Chief Financial Officer