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EX-32.1 - CERTIFICATION - COMMUNITY BANCORP /VTcmtv_ex321.htm
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EX-32.2 - CERTIFICATION - COMMUNITY BANCORP /VTcmtv_ex322.htm
EX-31.1 - CERTIFICATION - COMMUNITY BANCORP /VTcmtv_ex311.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 June 30, 2015

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  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 August 6, 2015, there were 4,964,500 shares outstanding of the Corporation's common stock.
 


 
 
 
 
 
FORM 10-Q
Index
   
   
Page  
PART I
FINANCIAL INFORMATION
 
     
Item 1
Financial Statements
3  
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29  
Item 3
Quantitative and Qualitative Disclosures About Market Risk
50  
Item 4
Controls and Procedures
50  
     
PART II
OTHER INFORMATION
 
     
Item 1
Legal Proceedings
50  
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
51  
Item 6
Exhibits
51  
 
Signatures
52  
 
 
 
 
2

 
 
PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited)

The following are the unaudited consolidated financial statements for Community Bancorp. and Subsidiary, "the Company".
 
 
3

 
 
 
Community Bancorp. and Subsidiary
 
June 30,
   
December 31,
   
June 30,
 
Consolidated Balance Sheets
 
2015
   
2014
   
2014
 
   
(Unaudited)
         
(Unaudited)
 
Assets
                 
  Cash and due from banks
  $ 11,233,651     $ 11,935,993     $ 16,321,342  
  Federal funds sold and overnight deposits
    8,220,300       13,026,181       21,474  
     Total cash and cash equivalents
    19,453,951       24,962,174       16,342,816  
  Securities held-to-maturity (fair value $26,055,000 at 06/30/15,
                       
   $42,234,000 at 12/31/14 and $23,373,000 at 06/30/14)
    25,738,769       41,810,945       22,966,558  
  Securities available-for-sale
    31,204,034       32,946,894       31,198,958  
  Restricted equity securities, at cost
    3,332,450       3,332,450       3,332,450  
  Loans held-for-sale
    360,225       26,250       670,255  
  Loans
    459,482,050       447,804,955       450,593,304  
    Allowance for loan losses
    (5,095,212 )     (4,905,874 )     (4,876,816 )
    Deferred net loan costs
    307,235       303,394       288,237  
        Net loans
    454,694,073       443,202,475       446,004,725  
  Bank premises and equipment, net
    11,702,753       11,488,948       11,516,750  
  Accrued interest receivable
    1,577,886       1,698,448       1,444,775  
  Bank owned life insurance (BOLI)
    4,466,781       4,413,574       4,358,117  
  Core deposit intangible
    681,731       818,081       954,431  
  Goodwill
    11,574,269       11,574,269       11,574,269  
  Other real estate owned (OREO)
    1,122,500       1,238,320       916,820  
  Other assets
    10,589,228       9,198,216       10,960,831  
        Total assets
  $ 576,498,650     $ 586,711,044     $ 562,241,755  
Liabilities and Shareholders' Equity
                       
 Liabilities
                       
  Deposits:
                       
    Demand, non-interest bearing
  $ 84,396,417     $ 88,758,469     $ 81,327,974  
    Interest-bearing transaction accounts
    111,758,309       125,388,872       104,820,943  
    Money market funds
    71,676,688       88,820,124       67,525,017  
    Savings
    81,578,169       77,029,722       75,556,376  
    Time deposits, $100,000 and over
    43,309,486       45,284,645       54,293,241  
    Other time deposits
    62,348,260       67,737,631       71,541,368  
        Total deposits
    455,067,329       493,019,463       455,064,919  
  Federal funds purchased and other borrowed funds
    30,000,000       0       19,915,000  
  Repurchase agreements
    24,403,315       28,542,961       23,583,153  
  Capital lease obligations
    599,772       639,544       677,251  
  Junior subordinated debentures
    12,887,000       12,887,000       12,887,000  
  Accrued interest and other liabilities
    3,500,041       2,626,874       2,723,488  
        Total liabilities
    526,457,457       537,715,842       514,850,811  
 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; 15,000,000 shares authorized
                       
   5,176,128 shares issued at 06/30/15, 5,142,475 shares issued
                       
   at 12/31/14 and 5,110,096 shares issued at 06/30/14
    12,940,320       12,856,188       12,775,241  
  Additional paid-in capital
    29,748,084       29,359,300       28,975,974  
  Retained earnings
    7,475,708       6,909,934       5,752,161  
  Accumulated other comprehensive (loss) income
    (142 )     (7,443 )     10,345  
  Less: treasury stock, at cost; 210,101 shares at 06/30/15,
                       
    12/31/14 and 06/30/14
    (2,622,777 )     (2,622,777 )     (2,622,777 )
        Total shareholders' equity
    50,041,193       48,995,202       47,390,944  
        Total liabilities and shareholders' equity
  $ 576,498,650     $ 586,711,044     $ 562,241,755  


The accompanying notes are an integral part of these consolidated financial statements
 
 
4

 
 


Community Bancorp. and Subsidiary
 
Three Months Ended June 30,
 
Consolidated Statements of Income
 
2015
   
2014
 
(Unaudited)
           
Interest income
           
   Interest and fees on loans
  $ 5,346,764     $ 5,373,903  
   Interest on debt securities
               
     Taxable
    102,608       73,040  
     Tax-exempt
    276,254       241,342  
   Dividends
    23,788       23,026  
   Interest on federal funds sold and overnight deposits
    1,770       2,836  
        Total interest income
    5,751,184       5,714,147  
                 
Interest expense
               
   Interest on deposits
    529,181       642,719  
   Interest on federal funds purchased and other borrowed funds
    23,535       20,450  
   Interest on repurchase agreements
    17,933       14,385  
   Interest on junior subordinated debentures
    101,655       100,442  
        Total interest expense
    672,304       777,996  
                 
     Net interest income
    5,078,880       4,936,151  
 Provision for loan losses
    150,000       135,000  
     Net interest income after provision for loan losses
    4,928,880       4,801,151  
                 
Non-interest income
               
   Service fees
    642,981       658,972  
   Income from sold loans
    247,565       260,330  
   Other income from loans
    186,433       122,066  
   Net realized gain on sale of securities available-for-sale
    2,723       21,828  
   Other income
    224,779       274,026  
        Total non-interest income
    1,304,481       1,337,222  
                 
Non-interest expense
               
   Salaries and wages
    1,683,200       1,650,000  
   Employee benefits
    672,527       573,501  
   Occupancy expenses, net
    609,365       623,843  
   Other expenses
    1,814,748       1,530,104  
        Total non-interest expense
    4,779,840       4,377,448  
                 
    Income before income taxes
    1,453,521       1,760,925  
 Income tax expense
    375,817       476,539  
        Net income
  $ 1,077,704     $ 1,284,386  
                 
 Earnings per common share
  $ 0.21     $ 0.26  
 Weighted average number of common shares
               
  used in computing earnings per share
    4,954,879       4,889,257  
 Dividends declared per common share
  $ 0.16     $ 0.16  
 Book value per common share outstanding at June 30,
  $ 9.57     $ 9.16  


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

 
5

 

Community Bancorp. and Subsidiary
 
Six Months Ended June 30,
 
Consolidated Statements of Income
 
2015
   
2014
 
(Unaudited)
           
Interest income
           
   Interest and fees on loans
  $ 10,811,025     $ 10,644,679  
   Interest on debt securities
               
     Taxable
    207,647       139,384  
     Tax-exempt
    547,380       497,970  
   Dividends
    47,671       46,310  
   Interest on federal funds sold and overnight deposits
    4,260       4,080  
        Total interest income
    11,617,983       11,332,423  
                 
Interest expense
               
   Interest on deposits
    1,121,638       1,299,974  
   Interest on federal funds purchased and other borrowed funds
    38,276       39,136  
   Interest on repurchase agreements
    37,570       30,983  
   Interest on junior subordinated debentures
    202,333       201,193  
        Total interest expense
    1,399,817       1,571,286  
                 
     Net interest income
    10,218,166       9,761,137  
 Provision for loan losses
    300,000       270,000  
     Net interest income after provision for loan losses
    9,918,166       9,491,137  
                 
Non-interest income
               
   Service fees
    1,274,418       1,305,785  
   Income from sold loans
    448,240       509,460  
   Other income from loans
    320,632       266,466  
   Net realized gain on sale of securities available-for-sale
    2,723       21,828  
   Other income
    471,253       547,184  
        Total non-interest income
    2,517,266       2,650,723  
                 
Non-interest expense
               
   Salaries and wages
    3,338,352       3,300,000  
   Employee benefits
    1,336,680       1,204,698  
   Occupancy expenses, net
    1,299,667       1,308,041  
   Other expenses
    3,501,869       3,165,947  
        Total non-interest expense
    9,476,568       8,978,686  
                 
    Income before income taxes
    2,958,864       3,163,174  
 Income tax expense
    771,320       807,223  
        Net income
  $ 2,187,544     $ 2,355,951  
                 
 Earnings per common share
  $ 0.43     $ 0.47  
 Weighted average number of common shares
               
  used in computing earnings per share
    4,946,734       4,880,969  
 Dividends declared per common share
  $ 0.32     $ 0.32  
 Book value per common share outstanding at June 30,
  $ 9.57     $ 9.16  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6

 
 


Community Bancorp. and Subsidiary
           
Consolidated Statements of Comprehensive Income
           
(Unaudited)
 
Three Months Ended June 30,
 
   
2015
   
2014
 
             
Net income
  $ 1,077,704     $ 1,284,386  
                 
Other comprehensive (loss) income, net of tax:
               
  Unrealized holding (loss) gain on available-for-sale securities
               
    arising during the period
    (189,219 )     47,464  
  Reclassification adjustment for gain realized in income
    (2,723 )     (21,828 )
     Net change in unrealized (loss) gain
    (191,942 )     25,636  
  Tax effect
    65,260       (8,716 )
  Other comprehensive (loss) income, net of tax
    (126,682 )     16,920  
          Total comprehensive income
  $ 951,022     $ 1,301,306  
                 
                 
   
Six Months Ended June 30,
 
      2015       2014  
                 
                 
Net income
  $ 2,187,544     $ 2,355,951  
                 
Other comprehensive income, net of tax:
               
  Unrealized holding gain on available-for-sale securities
               
    arising during the period
    13,785       109,420  
  Reclassification adjustment for gain realized in income
    (2,723 )     (21,828 )
     Net change in unrealized gain
    11,062       87,592  
  Tax effect
    (3,761 )     (29,781 )
  Other comprehensive income, net of tax
    7,301       57,811  
          Total comprehensive income
  $ 2,194,845     $ 2,413,762  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
7

 


Community Bancorp. and Subsidiary
           
Consolidated Statements of Cash Flows
           
(Unaudited)
 
Six Months Ended June 30,
 
   
2015
   
2014
 
             
Cash Flows from Operating Activities:
           
  Net income
  $ 2,187,544     $ 2,355,951  
  Adjustments to reconcile net income to net cash provided by
               
   operating activities:
               
    Depreciation and amortization, bank premises and equipment
    487,192       488,888  
    Provision for loan losses
    300,000       270,000  
    Deferred income tax
    (147,121 )     (75,275 )
    Gain on sale of securities available-for-sale
    (2,723 )     (21,828 )
    Gain on sale of loans
    (194,924 )     (251,370 )
    (Gain) loss on sale of OREO
    (51 )     1,840  
    Gain on Trust LLC
    (175,191 )     (163,260 )
    Amortization of bond premium, net
    95,186       283,156  
    Write down of OREO
    45,320       0  
    Proceeds from sales of loans held for sale
    11,515,834       10,147,291  
    Originations of loans held for sale
    (11,654,885 )     (10,356,676 )
    (Decrease) increase in taxes payable
    (1,225 )     542,007  
    Decrease in interest receivable
    120,562       333,530  
    Decrease in mortgage servicing rights
    13,547       4,366  
    Increase in other assets
    (391,951 )     (154,554 )
    Increase in cash surrender value of BOLI
    (53,207 )     (54,810 )
    Amortization of core deposit intangible
    136,350       136,350  
    Amortization of limited partnerships
    282,666       295,560  
    (Increase) decrease in unamortized loan costs
    (3,841 )     12,192  
    Decrease in interest payable
    (16,375 )     (4,937 )
    Decrease in accrued expenses
    (69,111 )     (59,879 )
    Decrease in other liabilities
    (17,813 )     (7,032 )
       Net cash provided by operating activities
    2,455,783       3,721,510  
                 
Cash Flows from Investing Activities:
               
  Investments - held-to-maturity
               
    Maturities and pay downs
    21,967,164       23,035,127  
    Purchases
    (5,894,988 )     (8,064,774 )
  Investments - available-for-sale
               
    Maturities, calls, pay downs and sales
    9,659,289       16,527,429  
    Purchases
    (7,997,830 )     (12,711,520 )
  Proceeds from redemption of restricted equity securities
    0       300,400  
  Increase in limited partnership contributions payable
    975,000       0  
  Increase in limited partnerships
    (975,500 )     0  
  Increase in loans, net
    (11,925,533 )     (11,019,180 )
  Capital expenditures of bank premises and equipment
    (700,995 )     (282,170 )
  Proceeds from sales of OREO
    141,051       237,865  
  Recoveries of loans charged off
    67,276       35,703  
       Net cash provided by investing activities
    5,314,934       8,058,880  

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

 
8

 

   
2015
   
2014
 
             
Cash Flows from Financing Activities:
           
  Net decrease in demand and interest-bearing transaction accounts
    (17,992,615 )     (22,585,289 )
  Net decrease in money market and savings accounts
    (12,594,989 )     (8,785,431 )
  Net (decrease) increase in time deposits
    (7,364,530 )     4,883,070  
  Net decrease in repurchase agreements
    (4,139,646 )     (6,061,462 )
  Net increase in short-term borrowings
    30,000,000       13,915,000  
  Proceeds from long-term borrowings
    0       6,000,000  
  Decrease in capital lease obligations
    (39,772 )     (33,791 )
  Dividends paid on preferred stock
    (40,625 )     (40,625 )
  Dividends paid on common stock
    (1,106,763 )     (1,059,035 )
       Net cash used in financing activities
    (13,278,940 )     (13,767,563 )
                 
       Net decrease in cash and cash equivalents
    (5,508,223 )     (1,987,173 )
  Cash and cash equivalents:
               
          Beginning
    24,962,174       18,329,989  
          Ending
  $ 19,453,951     $ 16,342,816  
                 
Supplemental Schedule of Cash Paid During the Period:
               
  Interest
  $ 1,416,192     $ 1,576,223  
                 
  Income taxes
  $ 637,000     $ 44,931  
                 
Supplemental Schedule of Noncash Investing and Financing Activities:
               
  Change in unrealized gain on securities available-for-sale
  $ 11,062     $ 87,592  
                 
  Loans transferred to OREO
  $ 70,500     $ 51,000  
                 
Common Shares Dividends Paid:
               
  Dividends declared
  $ 1,581,145     $ 1,560,309  
  Increase in dividends payable attributable to dividends declared
    (1,466 )     (59,135 )
  Dividends reinvested
    (472,916 )     (442,139 )
    $ 1,106,763     $ 1,059,035  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
9

 
 
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 the 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, 2014 contained in the Company's Annual Report on Form 10-K.  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, 2015, or for any other interim period.

Certain amounts in the 2014 unaudited consolidated income statements have been reclassified to conform to the 2015 presentation.  Reclassifications had no effect on prior period net income or shareholders’ equity.

Note 2.  Recent Accounting Developments

There are no recently issued accounting developments applicable to the Company as of this current report.

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 declared, and reduced for shares held in treasury.

The following tables illustrate the calculation of earnings per common share for the periods presented, as adjusted for the cash dividends declared on the preferred stock:

   
Three Months Ended June 30,
 
   
2015
   
2014
 
             
Net income, as reported
  $ 1,077,704     $ 1,284,386  
Less: dividends to preferred shareholders
    20,312       20,312  
Net income available to common shareholders
  $ 1,057,392     $ 1,264,074  
Weighted average number of common shares
               
   used in calculating earnings per share
    4,954,879       4,889,257  
Earnings per common share
  $ 0.21     $ 0.26  
                 
   
Six Months Ended June 30,
 
      2015       2014  
                 
Net income, as reported
  $ 2,187,544     $ 2,355,951  
Less: dividends to preferred shareholders
    40,625       40,625  
Net income available to common shareholders
  $ 2,146,919     $ 2,315,326  
Weighted average number of common shares
               
   used in calculating earnings per share
    4,946,734       4,880,969  
Earnings per common share
  $ 0.43     $ 0.47  
 
 
10

 

Note 4.  Investment Securities

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

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
Securities AFS
 
Cost
   
Gains
   
Losses
   
Value
 
                         
June 30, 2015
                       
U.S. Government sponsored enterprise (GSE) debt securities
  $ 14,862,842     $ 59,687     $ 14,425     $ 14,908,104  
U.S. Government securities
    2,991,281       11,688       0       3,002,969  
Agency mortgage-backed securities (Agency MBS)
    11,614,125       356       54,708       11,559,773  
Other investments
    1,736,000       904       3,716       1,733,188  
    $ 31,204,248     $ 72,635     $ 72,849     $ 31,204,034  
                                 
December 31, 2014
                               
U.S. GSE debt securities
  $ 19,929,061     $ 50,378     $ 72,289     $ 19,907,150  
U.S. Government securities
    3,997,451       3,486       0       4,000,937  
Agency MBS
    9,031,661       19,472       12,326       9,038,807  
    $ 32,958,173     $ 73,336     $ 84,615     $ 32,946,894  
                                 
June 30, 2014
                               
U.S. GSE debt securities
  $ 15,950,885     $ 80,833     $ 73,657     $ 15,958,061  
U.S. Government securities
    5,518,770       14,716       480       5,533,006  
Agency MBS
    9,713,629       3,847       9,585       9,707,891  
    $ 31,183,284     $ 99,396     $ 83,722     $ 31,198,958  
                                 
           
Gross
   
Gross
         
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
Securities HTM
 
Cost
   
Gains
   
Losses
   
Value*
 
                                 
June 30, 2015
                               
States and political subdivisions
  $ 25,738,769     $ 316,231     $ 0     $ 26,055,000  
                                 
December 31, 2014
                               
States and political subdivisions
  $ 41,810,945     $ 423,055     $ 0     $ 42,234,000  
                                 
June 30, 2014
                               
States and political subdivisions
  $ 22,966,558     $ 406,442     $ 0     $ 23,373,000  

*Method used to determine fair value of HTM securities rounds values to nearest thousand.

 
11

 
 
The scheduled maturities of debt securities AFS were as follows:

   
Amortized
   
Fair
 
   
Cost
   
Value
 
June 30, 2015
           
Due in one year or less
  $ 5,115,547     $ 5,133,829  
Due from one to five years
    14,474,576       14,510,432  
Agency MBS
    11,614,125       11,559,773  
    $ 31,204,248     $ 31,204,034  
                 
December 31, 2014
               
Due in one year or less
  $ 5,027,864     $ 5,034,248  
Due from one to five years
    18,898,648       18,873,839  
Agency MBS
    9,031,661       9,038,807  
    $ 32,958,173     $ 32,946,894  
                 
June 30, 2014
               
Due in one year or less
  $ 2,025,196     $ 2,030,578  
Due from one to five years
    19,444,459       19,460,489  
Agency MBS
    9,713,629       9,707,891  
    $ 31,183,284     $ 31,198,958  

Because the actual maturities of Agency MBS usually differ from their contractual maturities due to the right of borrowers to prepay the underlying mortgage loans, usually without penalty, those securities are not presented in the table by contractual maturity date.
 
The scheduled maturities of debt securities HTM were as follows:

   
Amortized
   
Fair
 
   
Cost
   
Value*
 
June 30, 2015
           
Due in one year or less
  $ 12,851,025     $ 12,851,000  
Due from one to five years
    4,101,928       4,181,000  
Due from five to ten years
    2,166,612       2,246,000  
Due after ten years
    6,619,204       6,777,000  
    $ 25,738,769     $ 26,055,000  
                 
December 31, 2014
               
Due in one year or less
  $ 28,158,718     $ 28,159,000  
Due from one to five years
    4,637,913       4,744,000  
Due from five to ten years
    2,305,353       2,411,000  
Due after ten years
    6,708,961       6,920,000  
    $ 41,810,945     $ 42,234,000  
                 
June 30, 2014
               
Due in one year or less
  $ 12,616,400     $ 12,616,000  
Due from one to five years
    4,239,436       4,341,000  
Due from five to ten years
    2,381,853       2,484,000  
Due after ten years
    3,728,869       3,932,000  
    $ 22,966,558     $ 23,373,000  

*Method used to determine fair value of HTM securities rounds values to nearest thousand.

 
12

 
 
There were no debt securities HTM in an unrealized loss position as of the balance sheet dates.  Debt securities AFS with unrealized losses as of the balance sheet dates are presented in the table below.

   
Less than 12 months
   
12 months or more
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
June 30, 2015
                                   
U.S. GSE debt securities
  $ 4,235,402     $ 9,709     $ 995,284     $ 4,716     $ 5,230,686     $ 14,425  
Agency MBS
    10,702,696       54,708       0       0       10,702,696       54,708  
Other investments
    1,236,283       3,716       0       0       1,236,283       3,716  
    $ 16,174,381     $ 68,133     $ 995,284     $ 4,716     $ 17,169,665     $ 72,849  
                                                 
December 31, 2014
                                               
U.S. GSE debt securities
  $ 6,023,946     $ 8,548     $ 5,186,258     $ 63,741     $ 11,210,204     $ 72,289  
Agency MBS
    3,206,389       12,326       0       0       3,206,389       12,326  
    $ 9,230,335     $ 20,874     $ 5,186,258     $ 63,741     $ 14,416,593     $ 84,615  
                                                 
June 30, 2014
                                               
U.S. GSE debt securities
  $ 0     $ 0     $ 5,176,343     $ 73,657     $ 5,176,343     $ 73,657  
U.S. Government securities
    1,490,193       480       0       0       1,490,193       480  
Agency MBS
    4,937,780       9,585       0       0       4,937,780       9,585  
    $ 6,427,973     $ 10,065     $ 5,176,343     $ 73,657     $ 11,604,316     $ 83,722  


Debt securities in the table above consisted of five U.S. GSE debt securities, eleven Agency MBS securities and five certificates of deposit carried under the heading of “Other investments” at June 30, 2015, ten U.S. GSE debt securities and four Agency MBS securities at December 31, 2014, and five U.S. GSE debt securities, two U.S. Government securities and five Agency MBS securities at June 30, 2014.  The unrealized losses for all periods presented were principally attributable to changes in prevailing interest rates for similar types of securities and not deterioration in the creditworthiness of the issuer.

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 the carrying value, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment 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 or other adverse developments in the status of the securities have occurred, and the results of reviews of the issuer's financial condition.  As of June 30, 2015, there were no declines in the fair value of any of the securities reflected in the table above that were deemed by management to be other than temporary.

Note 5.  Loans, Allowance for Loan Losses and Credit Quality

The composition of net loans as of the balance sheet dates was as follows:

   
June 30,
   
December 31,
   
June 30,
 
   
2015
   
2014
   
2014
 
                   
Commercial & industrial
  $ 73,561,125     $ 64,390,220     $ 64,475,384  
Commercial real estate
    172,565,221       166,611,830       164,302,843  
Residential real estate - 1st lien
    162,109,916       163,966,124       169,367,709  
Residential real estate - Jr lien
    43,816,552       44,801,483       44,564,026  
Consumer
    7,429,236       8,035,298       7,883,342  
      459,482,050       447,804,955       450,593,304  
Deduct (add):
                       
Allowance for loan losses
    5,095,212       4,905,874       4,876,816  
Deferred net loan costs
    (307,235 )     (303,394 )     (288,237 )
      4,787,977       4,602,480       4,588,579  
     Net Loans
  $ 454,694,073     $ 443,202,475     $ 446,004,725  
 
 
13

 
 
The following is an age analysis of past due loans (including non-accrual), by portfolio segment:

                                       
90 Days or
 
         
90 Days
   
Total
               
Non-Accrual
   
More
 
June 30, 2015
 
30-89 Days
   
or More
   
Past Due
   
Current
   
Total Loans
   
Loans
   
and Accruing
 
                                           
Commercial & industrial
  $ 177,758     $ 174,184     $ 351,942     $ 73,209,183     $ 73,561,125     $ 767,235     $ 0  
Commercial real estate
    740,547       239,619       980,166       171,585,055       172,565,221       1,909,917       5,313  
Residential real estate - 1st lien
    2,222,425       828,694       3,051,119       159,058,797       162,109,916       1,927,300       528,211  
Residential real estate - Jr lien
    346,444       82,021       428,465       43,388,087       43,816,552       311,571       82,021  
Consumer
    38,159       8,987       47,146       7,382,090       7,429,236       0       8,987  
     Total
  $ 3,525,333     $ 1,333,505     $ 4,858,838     $ 454,623,212     $ 459,482,050     $ 4,916,023     $ 624,532  
                                                         
                                                   
90 Days or
 
           
90 Days
   
Total
                   
Non-Accrual
   
More
 
December 31, 2014
 
30-89 Days
   
or More
   
Past Due
   
Current
   
Total Loans
   
Loans
   
and Accruing
 
                                                         
Commercial & industrial
  $ 439,151     $ 299,095     $ 738,246     $ 63,651,974     $ 64,390,220     $ 552,386     $ 23,579  
Commercial real estate
    988,924       5,313       994,237       165,617,593       166,611,830       1,934,096       5,313  
Residential real estate - 1st lien
    4,446,138       1,484,334       5,930,472       158,035,652       163,966,124       1,263,046       980,138  
Residential real estate - Jr lien
    637,917       179,920       817,837       43,983,646       44,801,483       404,061       115,852  
Consumer
    56,392       0       56,392       7,978,906       8,035,298       0       0  
     Total
  $ 6,568,522     $ 1,968,662     $ 8,537,184     $ 439,267,771     $ 447,804,955     $ 4,153,589     $ 1,124,882  
                                                         
                                                   
90 Days or
 
           
90 Days
   
Total
                   
Non-Accrual
   
More
 
June 30, 2014
 
30-89 Days
   
or More
   
Past Due
   
Current
   
Total Loans
   
Loans
   
and Accruing
 
                                                         
Commercial & industrial
  $ 373,363     $ 605,406     $ 978,769     $ 63,496,615     $ 64,475,384     $ 1,347,748     $ 102,961  
Commercial real estate
    1,378,654       94,609       1,473,263       162,829,580       164,302,843       1,661,324       5,313  
Residential real estate - 1st lien
    2,542,507       991,146       3,533,653       165,834,056       169,367,709       1,943,475       231,085  
Residential real estate - Jr lien
    228,014       110,451       338,465       44,225,561       44,564,026       453,304       57,241  
Consumer
    54,479       17,927       72,406       7,810,936       7,883,342       0       17,927  
     Total
  $ 4,577,017     $ 1,819,539     $ 6,396,556     $ 444,196,748     $ 450,593,304     $ 5,405,851     $ 414,527  
 
For all loan segments, loans over 30 days past due are considered delinquent.
As of June 30, 2015, there were four residential mortgage loans in process of foreclosure totaling $403,526.

Allowance for loan losses

The allowance for loan losses is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is probable. Subsequent recoveries, if any, are credited to the allowance.

Unsecured loans, primarily consumer loans, are charged off when they become uncollectible and no later than 120 days past due.  Unsecured loans to customers who subsequently file bankruptcy are charged off within 30 days of receipt of the notification of filing or by the end of the month in which the loans become 120 days past due, whichever occurs first.  For secured loans, both residential and commercial, the potential loss on impaired loans is carried as a loan loss reserve specific allocation; the loss portion is charged off when collection of the full loan appears unlikely.  The unsecured portion of a real estate loan is that portion of the loan exceeding the "fair value" of the collateral less the estimated cost to sell. Value of the collateral is determined in accordance with the Company’s appraisal policy.  The unsecured portion of an impaired real estate secured loan is charged off by the end of the month in which the loan becomes 180 days past due.

As described below, the allowance consists of general, specific and unallocated components.  However, the entire allowance is available to absorb losses in the loan portfolio, regardless of specific, general and unallocated components considered in determining the amount of the allowance.
 
 
14

 

General component

The general component of the allowance for loan losses is based on historical loss experience, adjusted for qualitative factors and stratified by the following loan segments: commercial and industrial, commercial real estate, residential real estate first (“1st”) lien, residential real estate junior (“Jr”) lien and consumer loans. The Company does not disaggregate its portfolio segments further into classes.  Loss ratios are calculated by loan segment for one year, two year, three year, four year and five year look back periods.  The highest loss ratio among these look-back periods is then applied against the respective segment.  Management uses an average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels of and trends in delinquencies and non-performing loans, levels of and trends in loan risk groups, trends in volumes and terms of loans, effects of any changes in loan related policies, experience, ability and the depth of management, documentation and credit data exception levels, national and local economic trends, external factors such as competition and regulation and lastly, concentrations of credit risk in a variety of areas, including portfolio product mix, the level of loans to individual borrowers and their related interests, loans to industry segments, and the geographic distribution of commercial real estate loans. This evaluation is inherently subjective as it requires estimates that are susceptible to revision as more information becomes available.

The reserve methodology was modified during the quarter ended June 30, 2015 to eliminate using the higher of the 1999-2001 losses as compared to current losses, by eliminating the use of the 1999-2001 period.  The 1999-2001 information has become dated and the Bank’s credit portfolio management has evolved during that time.  The revised methodology now considers the highest annual loss rates for the most recent one to five year look back periods for each segment of the portfolio. This change resulted in a reduction to required reserves of $529,234.  Adjustments were made to the commercial & industrial and commercial real estate qualitative factors to adjust for the impact of the change in methodology, principally in the area of loan growth, loan policy, and delinquency factors.  The commercial & industrial and commercial real estate factors were each increased a total of 10 basis points, amounting to increases of $171,000 and $70,000 respectively.

The qualitative factors are determined based on the various risk characteristics of each loan segment. The Company has policies, procedures and internal controls that management believes are commensurate with the risk profile of each of these segments.  Major risk characteristics relevant to each portfolio segment are as follows:

Commercial & Industrial – Loans in this segment include commercial and industrial loans and to a lesser extent loans to finance agricultural production. Commercial loans are made to businesses and are generally secured by assets of the business, including trade assets and equipment. While not the primary collateral, in many cases these loans may also be secured by the real estate of the business. Repayment is expected from the cash flows of the business. A weakened economy, soft consumer spending, unfavorable foreign trade conditions and the rising cost of labor or raw materials are examples of issues that can impact the credit quality in this segment.

Commercial Real Estate – Loans in this segment are principally made to businesses and are generally secured by either owner-occupied, or non-owner occupied commercial real estate. A relatively small portion of this segment includes farm loans secured by farm land and buildings.  As with commercial and industrial loans, repayment of owner-occupied commercial real estate loans is expected from the cash flows of the business and the segment would be impacted by the same risk factors as commercial and industrial loans. The non-owner occupied commercial real estate portion includes both residential and commercial construction loans, vacant land and real estate development loans, multi-family dwelling loans and commercial rental property loans. Repayment of construction loans is expected from permanent financing takeout; the Company generally requires a commitment or eligibility for the take-out financing prior to construction loan origination. Real estate development loans are generally repaid from the sale of the subject real property as the project progresses. Construction and development lending entail additional risks, including the project exceeding budget, not being constructed according to plans, not receiving permits, or the pre-leasing or occupancy rate not meeting expectations. Repayment of multi-family loans and commercial rental property loans is expected from the cash flow generated by rental payments received from the individuals or businesses occupying the real estate. Commercial real estate loans are impacted by factors such as competitive market forces, vacancy rates, cap rates, net operating incomes, lease renewals and overall economic demand. In addition, loans in the recreational and tourism sector can be affected by weather conditions, such as unseasonably low winter snowfalls. Commercial real estate lending also carries a higher degree of environmental risk than other real estate lending.

Residential Real Estate - 1st Lien – All loans in this segment are collateralized by first mortgages on 1 – 4 family owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, has an impact on the credit quality of this segment.

Residential Real Estate – Jr Lien – All loans in this segment are collateralized by junior lien mortgages on 1 – 4 family residential real estate and repayment is primarily dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, has an impact on the credit quality of this segment.

Consumer – Loans in this segment are made to individuals for consumer and household purposes.  This segment includes both loans secured by automobiles and other consumer goods, as well as loans that are unsecured.  This segment also includes overdrafts, which are extensions of credit made to both individuals and businesses to cover temporary shortages in their deposit accounts and are generally unsecured.  The Company maintains policies restricting the size and term of these extensions of credit.  The overall health of the economy, including unemployment rates, has an impact on the credit quality of this segment.
 
 
15

 

Specific component

The specific component of the allowance for loan losses relates to loans that are impaired.  Impaired loans are loan(s) to a borrower that in the aggregate are greater than $100,000 and that are in non-accrual status or are troubled debt restructurings (“TDR”) regardless of amount.  A specific allowance is established for an impaired loan when its estimated impaired basis is less than the carrying value of the loan.  For all loan segments, except consumer loans, a loan is considered impaired when, based on current information and events, in management’s estimation it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value and probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant or temporary payment delays and payment shortfalls generally are not classified as impaired. Management evaluates the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and frequency of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis, by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Impaired loans also include troubled loans that are restructured. A TDR occurs when the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that would otherwise not be granted. TDRs may include the transfer of assets to the Company in partial satisfaction of a troubled loan, a modification of a loan’s terms, or a combination of the two.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment evaluation, unless such loans are subject to a restructuring agreement.

Unallocated component

An unallocated component of the allowance for loan losses is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component reflects management’s estimate of the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.  While unallocated reserves have increased, they are considered by management to be appropriate in light of the Company’s continued growth strategy and shift in the portfolio from residential loans to commercial and commercial real estate loans and the risk associated with the relatively new, unseasoned loans in those portfolios.

The following tables summarize changes in the allowance for loan losses and select loan information, by portfolio segment, for the periods indicated:

As of or for the three months ended June 30, 2015
 
               
Residential
   
Residential
                   
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
                   
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses
 
Beginning balance
  $ 750,491     $ 2,325,111     $ 1,322,017     $ 321,407     $ 86,084     $ 197,939     $ 5,003,049  
  Charge-offs
    0       0       (78,700 )     0       (22,816 )     0       (101,516 )
  Recoveries
    37,306       0       0       60       6,313       0       43,679  
  Provision (credit)
    93,297       (340,552 )     115,187       30,658       (5,768 )     257,178       150,000  
Ending balance
  $ 881,094     $ 1,984,559     $ 1,358,504     $ 352,125     $ 63,813     $ 455,117     $ 5,095,212  

 
16

 
 
As of or for the six months ended June 30, 2015
 
               
Residential
   
Residential
                   
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
                   
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses
 
Beginning balance
  $ 646,719     $ 2,311,936     $ 1,270,766     $ 321,099     $ 118,819     $ 236,535     $ 4,905,874  
  Charge-offs
    (35,059 )     0       (94,575 )     (20,199 )     (28,105 )     0       (177,938 )
  Recoveries
    42,913       0       6,042       120       18,201       0       67,276  
  Provision (credit)
    226,521       (327,377 )     176,271       51,105       (45,102 )     218,582       300,000  
Ending balance
  $ 881,094     $ 1,984,559     $ 1,358,504     $ 352,125     $ 63,813     $ 455,117     $ 5,095,212  
                                                         
Allowance for loan losses
 
Evaluated for impairment
                                                       
  Individually
  $ 70,000     $ 0     $ 71,800     $ 47,500     $ 0     $ 0     $ 189,300  
  Collectively
    811,094       1,984,559       1,286,704       304,625       63,813       455,117       4,905,912  
     Total
  $ 881,094     $ 1,984,559     $ 1,358,504     $ 352,125     $ 63,813     $ 455,117     $ 5,095,212  
   
Loans evaluated for impairment
 
  Individually
  $ 594,176     $ 1,845,751     $ 1,345,820     $ 238,623     $ 0             $ 4,024,370  
  Collectively
    72,966,949       170,719,470       160,764,096       43,577,929       7,429,236               455,457,680  
     Total
  $ 73,561,125     $ 172,565,221     $ 162,109,916     $ 43,816,552     $ 7,429,236             $ 459,482,050  


As of or for the year ended December 31, 2014
 
               
Residential
   
Residential
                   
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
                   
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses
 
Beginning balance
  $ 516,382     $ 2,143,398     $ 1,452,184     $ 366,471     $ 105,279     $ 271,201     $ 4,854,915  
  Charge-offs
    (153,329 )     (167,841 )     (58,904 )     (51,389 )     (112,376 )     0       (543,839 )
  Recoveries
    6,249       0       14,543       240       33,766       0       54,798  
  Provision (credit)
    277,417       336,379       (137,057 )     5,777       92,150       (34,666 )     540,000  
Ending balance
  $ 646,719     $ 2,311,936     $ 1,270,766     $ 321,099     $ 118,819     $ 236,535     $ 4,905,874  
                                                         
Allowance for loan losses
 
Evaluated for impairment
                                                       
  Individually
  $ 0     $ 34,400     $ 43,400     $ 0     $ 0     $ 0     $ 77,800  
  Collectively
    646,719       2,277,536       1,227,366       321,099       118,819       236,535       4,828,074  
     Total
  $ 646,719     $ 2,311,936     $ 1,270,766     $ 321,099     $ 118,819     $ 236,535     $ 4,905,874  
   
Loans evaluated for impairment
 
  Individually
  $ 390,605     $ 1,930,993     $ 721,241     $ 328,889     $ 0             $ 3,371,728  
  Collectively
    63,999,615       164,680,837       163,244,883       44,472,594       8,035,298               444,433,227  
     Total
  $ 64,390,220     $ 166,611,830     $ 163,966,124     $ 44,801,483     $ 8,035,298             $ 447,804,955  


As of or for the three months ended June 30, 2014
 
               
Residential
   
Residential
                   
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
                   
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses
 
Beginning balance
  $ 556,223     $ 2,172,678     $ 1,396,934     $ 348,738     $ 100,386     $ 262,619     $ 4,837,578  
  Charge-offs
    (70,534 )     (30,819 )     0       0       (14,241 )     0       (115,594 )
  Recoveries
    2,124       0       1,725       60       15,923       0       19,832  
  Provision (credit)
    199,603       13,879       (61,648 )     (54,184 )     (17,953 )     55,303       135,000  
Ending balance
  $ 687,416     $ 2,155,738     $ 1,337,011     $ 294,614     $ 84,115     $ 317,922     $ 4,876,816  
 
 
17

 
 
As of or for the six months ended June 30, 2014
 
               
Residential
   
Residential
                   
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
                   
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses
 
Beginning balance
  $ 516,382     $ 2,143,398     $ 1,452,184     $ 366,471     $ 105,279     $ 271,201     $ 4,854,915  
  Charge-offs
    (87,214 )     (130,819 )     0       0       (65,769 )     0       (283,802 )
  Recoveries
    2,236       0       11,098       120       22,249       0       35,703  
  Provision (credit)
    256,012       143,159       (126,271 )     (71,977 )     22,356       46,721       270,000  
Ending balance
  $ 687,416     $ 2,155,738     $ 1,337,011     $ 294,614     $ 84,115     $ 317,922     $ 4,876,816  
                                                         
Allowance for loan losses
 
Evaluated for impairment
                                                       
  Individually
  $ 99,300     $ 18,900     $ 100,600     $ 13,100     $ 0     $ 0     $ 231,900  
  Collectively
    588,116       2,136,838       1,236,411       281,514       84,115       317,922       4,644,916  
     Total
  $ 687,416     $ 2,155,738     $ 1,337,011     $ 294,614     $ 84,115     $ 317,922     $ 4,876,816  
   
Loans evaluated for impairment
 
  Individually
  $ 1,233,885     $ 1,558,186     $ 1,374,851     $ 370,775     $ 0             $ 4,537,697  
  Collectively
    63,241,499       162,744,657       167,992,858       44,193,251       7,883,342               446,055,607  
     Total
  $ 64,475,384     $ 164,302,843     $ 169,367,709     $ 44,564,026     $ 7,883,342             $ 450,593,304  

Impaired loans, by portfolio segment, were as follows:

   
As of June 30, 2015
             
         
Unpaid
         
Average
   
Average
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Recorded
 
   
Investment
   
Balance
   
Allowance
   
Investment(1)
   
Investment(2)
 
                               
With no related allowance recorded
                             
   Commercial & industrial
  $ 502,237     $ 560,173     $ 0     $ 555,057     $ 300,144  
   Commercial real estate
    1,845,751       1,856,008       0       1,976,769       1,136,004  
   Residential real estate - 1st lien
    1,095,830       1,470,050       0       780,255       433,329  
   Residential real estate - Jr lien
    0       0       0       120,465       113,964  
    $ 3,443,818     $ 3,886,231     $ 0     $ 3,432,546     $ 1,983,441  
                                         
With an allowance recorded
                                       
   Commercial & industrial
  $ 91,940     $ 94,826     $ 70,000     $ 93,398     $ 37,359  
   Commercial real estate
    0       0       0       0       40,902  
   Residential real estate - 1st lien
    249,989       284,200       71,800       302,937       144,196  
   Residential real estate - Jr lien
    238,623       284,202       47,500       152,865       61,146  
    $ 580,552     $ 663,228     $ 189,300     $ 549,200     $ 283,603  
                                         
     Total
  $ 4,024,370     $ 4,549,459     $ 189,300     $ 3,981,746     $ 2,267,044  
   
(1) For the three months ended June 30, 2015
 
(2) For the six months ended June 30, 2015
 

 
18

 
 
   
As of December 31, 2014
   
2014
 
         
Unpaid
         
Average
 
   
Recorded
   
Principal
   
Related
   
Recorded
 
   
Investment
   
Balance
   
Allowance
   
Investment
 
                         
With no related allowance recorded
                       
   Commercial & industrial
  $ 390,605     $ 424,598     $ 0     $ 507,232  
   Commercial real estate
    1,726,482       1,689,772       0       1,294,710  
   Residential real estate - 1st lien
    606,133       875,841       0       971,542  
   Residential real estate - Jr lien
    328,889       390,260       0       238,826  
    $ 3,052,109     $ 3,380,471     $ 0     $ 3,012,310  
                                 
With an allowance recorded
                               
   Commercial & industrial
  $ 0     $ 0     $ 0     $ 158,690  
   Commercial real estate
    204,511       220,981       34,400       280,104  
   Residential real estate - 1st lien
    115,108       144,708       43,400       294,807  
   Residential real estate - Jr lien
    0       0       0       149,772  
    $ 319,619     $ 365,689     $ 77,800     $ 883,373  
                                 
     Total
  $ 3,371,728     $ 3,746,160     $ 77,800     $ 3,895,683  


   
As of June 30, 2014
             
         
Unpaid
         
Average
   
Average
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Recorded
 
   
Investment
   
Balance
   
Allowance
   
Investment(1)
   
Investment(2)
 
                               
With no related allowance recorded
 
   Commercial & industrial
  $ 819,016     $ 884,377     $ 0     $ 552,178     $ 472,955  
   Commercial real estate
    1,337,570       1,431,199       0       1,248,510       1,147,288  
   Residential real estate - 1st lien
    832,008       905,092       0       1,042,268       1,146,323  
   Residential real estate - Jr lien
    269,912       316,506       0       183,089       176,772  
    $ 3,258,506     $ 3,537,174     $ 0     $ 3,026,045     $ 2,943,338  
With an allowance recorded
                                       
   Commercial & industrial
    414,869       415,759       99,300       238,953       179,031  
   Commercial real estate
    220,616       231,221       18,900       165,405       257,481  
   Residential real estate - 1st lien
    542,843       579,363       100,600       394,924       408,070  
   Residential real estate - Jr lien
    100,863       109,217       13,100       176,875       249,621  
    $ 1,279,191     $ 1,335,560     $ 231,900     $ 976,157     $ 1,094,203  
                                         
     Total
  $ 4,537,697     $ 4,872,734     $ 231,900     $ 4,002,202     $ 4,037,541  
                                         
(1) For the three months ended June 30, 2014
                                 
(2) For the six months ended June 30, 2014
                                 
 
Interest income recognized on impaired loans was immaterial for all periods presented.

For all loan segments, the accrual of interest is discontinued when a loan is specifically determined to be impaired or when the loan is delinquent 90 days and management believes, after considering collection efforts and other factors, that the borrower's financial condition is such that collection of interest is considered by management to be doubtful.  Any unpaid interest previously accrued on those loans is reversed from income.  Interest income is generally not recognized on specific impaired loans unless the likelihood of further loss is considered by management to be remote.  Interest payments received on impaired loans are generally applied as a reduction of the loan principal balance.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are considered by management to be reasonably assured.
 
 
19

 

As of the balance sheet dates, the Company was not contractually committed to lend additional funds to debtors with impaired, non-accrual or restructured loans.
 
Credit Quality Grouping
 
In developing the allowance for loan losses, management uses credit quality grouping to help evaluate trends in credit quality. The Company groups credit risk into Groups A, B and C. The manner the Company utilizes to assign risk grouping is driven by loan purpose. Commercial purpose loans are individually risk graded while the retail portion of the portfolio is generally grouped by delinquency pool.
 
Group A loans - Acceptable Risk – are loans that are expected to perform as agreed under their respective terms.  Such loans carry a normal level of risk that does not require management attention beyond that warranted by the loan or loan relationship characteristics, such as loan size or relationship size. Group A loans include commercial purpose loans that are individually risk rated and retail loans that are rated by pool. Group A retail loans include both performing consumer and residential real estate loans. Residential real estate loans are loans to individuals secured by 1-4 family homes, including first mortgages, home equity and home improvement loans. Loan balances fully secured by deposit accounts or that are fully guaranteed by the Federal Government are considered acceptable risk.
 
Group B loans – Management Involved - are loans that require greater attention than the acceptable loans in Group A. Characteristics of such loans may include, but are not limited to, borrowers that are experiencing negative operating trends such as reduced sales or margins, borrowers that have exposure to adverse market conditions such as increased competition or regulatory burden, or borrowers that have had unexpected or adverse changes in management. These loans have a greater likelihood of migrating to an unacceptable risk level if these characteristics are left unchecked. Group B is limited to commercial purpose loans that are individually risk rated.
 
Group C loans – Unacceptable Risk – are loans that have distinct shortcomings that require a greater degree of management attention.  Examples of these shortcomings include a borrower's inadequate capacity to service debt, poor operating performance, or insolvency.  These loans are more likely to result in repayment through collateral liquidation. Group C loans range from those that are likely to sustain some loss if the shortcomings are not corrected, to those for which loss is imminent and non-accrual treatment is warranted. Group C loans include individually rated commercial purpose loans, and retail loans adversely rated in accordance with the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification Policy. Group C retail loans include 1-4 family residential real estate loans and home equity loans past due 90 days or more with loan-to-value ratios greater than 60%, home equity loans 90 days or more past due where the bank does not hold first mortgage, irrespective of loan-to-value, loans in bankruptcy where repayment is likely but not yet established, and lastly consumer loans that are 90 days or more past due.
 
Commercial purpose loan ratings are assigned by the commercial account officer; for larger and more complex commercial loans, the credit rating is a collaborative assignment by the lender and the credit analyst. The credit risk rating is based on the borrower's expected performance, i.e., the likelihood that the borrower will be able to service its obligations in accordance with the loan terms. Credit risk ratings are meant to measure risk versus simply record history.  Assessment of expected future payment performance requires consideration of numerous factors.  While past performance is part of the overall evaluation, expected performance is based on an analysis of the borrower's financial strength, and historical and projected factors such as size and financing alternatives, capacity and cash flow, balance sheet and income statement trends, the quality and timeliness of financial reporting, and the quality of the borrower’s management.  Other factors influencing the credit risk rating to a lesser degree include collateral coverage and control, guarantor strength and commitment, documentation, structure and covenants and industry conditions.  There are uncertainties inherent in this process.
 
Credit risk ratings are dynamic and require updating whenever relevant information is received.  The risk ratings of larger or more complex loans, and Group B and C rated loans, are assessed at the time of their respective annual reviews, during quarterly updates, in action plans or at any other time that relevant information warrants update. Lenders are required to make immediate disclosure to the Chief Credit Officer of any known increase in loan risk, even if considered temporary in nature.
 
 
20

 
 
The risk ratings within the loan portfolio, by segment, as of the balance sheet dates were as follows:

As of June 30, 2015
 
               
Residential
   
Residential
             
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
             
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Total
 
                                     
Group A
  $ 70,152,385     $ 162,191,020     $ 158,224,270     $ 43,196,452     $ 7,420,249     $ 441,184,376  
Group B
    2,451,677       4,819,930       231,391       228,892       0       7,731,890  
Group C
    957,063       5,554,271       3,654,255       391,208       8,987       10,565,784  
     Total
  $ 73,561,125     $ 172,565,221     $ 162,109,916     $ 43,816,552     $ 7,429,236     $ 459,482,050  


As of December 31, 2014
 
               
Residential
   
Residential
             
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
             
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Total
 
                                     
Group A
  $ 61,201,586     $ 157,767,641     $ 160,912,689     $ 44,018,956     $ 8,035,298     $ 431,936,170  
Group B
    2,316,908       3,280,904       228,148       251,822       0       6,077,782  
Group C
    871,726       5,563,285       2,825,287       530,705       0       9,791,003  
     Total
  $ 64,390,220     $ 166,611,830     $ 163,966,124     $ 44,801,483     $ 8,035,298     $ 447,804,955  


As of June 30, 2014
 
               
Residential
   
Residential
             
   
Commercial
   
Commercial
   
Real Estate
   
Real Estate
             
   
& Industrial
   
Real Estate
   
1st Lien
   
Jr Lien
   
Consumer
   
Total
 
                                     
Group A
  $ 60,373,539     $ 155,124,213     $ 166,345,054     $ 43,883,107     $ 7,865,415     $ 433,591,328  
Group B
    2,730,275       3,586,566       598,381       147,531       0       7,062,753  
Group C
    1,371,570       5,592,064       2,424,274       533,388       17,927       9,939,223  
     Total
  $ 64,475,384     $ 164,302,843     $ 169,367,709     $ 44,564,026     $ 7,883,342     $ 450,593,304  
 
Modifications of Loans and TDRs

A loan is classified as a TDR if, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider.

The Company is deemed to have granted such a concession if it has modified a troubled loan in any of the following ways:

Reduced accrued interest;
Reduced the original contractual interest rate to a rate that is below the current market rate for the borrower;
Converted a variable-rate loan to a fixed-rate loan;
Extended the term of the loan beyond an insignificant delay;
Deferred or forgiven principal in an amount greater than three months of payments; or
Performed a refinancing and deferred or forgiven principal on the original loan.

An insignificant delay or insignificant shortfall in the amount of payments typically would not require the loan to be accounted for as a TDR.  However, pursuant to regulatory guidance, any payment delay longer than three months is generally not considered insignificant. Management’s assessment of whether a concession has been granted also takes into account payments expected to be received from third parties, including third-party guarantors, provided that the third party has the ability to perform on the guarantee.

 
21

 

The Company’s TDRs are principally a result of extending loan repayment terms to relieve cash flow difficulties. The Company has only, on a limited basis, reduced interest rates for borrowers below the current market rate for the borrower.  The Company has not forgiven principal or reduced accrued interest within the terms of original restructurings, nor has it converted variable rate terms to fixed rate terms.  However, the Company evaluates each TDR situation on its own merits and does not foreclose the granting of any particular type of concession.

TDRs, by portfolio segment, for the periods presented were as follows:

   
Three months ended June 30, 2015
   
Six months ended June 30, 2015
 
         
Pre-
   
Post-
         
Pre-
   
Post-
 
         
Modification
   
Modification
         
Modification
   
Modification
 
         
Outstanding
   
Outstanding
         
Outstanding
   
Outstanding
 
   
Number of
   
Recorded
   
Recorded
   
Number of
   
Recorded
   
Recorded
 
   
Contracts
   
Investment
   
Investment
   
Contracts
   
Investment
   
Investment
 
                                     
Commercial & industrial
    3     $ 198,999     $ 198,829       3     $ 198,999     $ 198,829  
Residential real estate
                                               
 - 1st lien
    3       618,317       660,196       8       962,646       1,021,102  
 - Jr lien
    0       0       0       2       117,745       121,672  
          Total
    6     $ 817,316     $ 859,025       13     $ 1,279,390     $ 1,341,603  


   
Year ended December 31, 2014
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
         
Outstanding
   
Outstanding
 
   
Number of
   
Recorded
   
Recorded
 
   
Contracts
   
Investment
   
Investment
 
                   
Commercial real estate
    1     $ 301,823     $ 301,823  
Residential real estate - 1st lien
    11       1,294,709       1,332,336  
          Total
    12     $ 1,596,532     $ 1,634,159  


 
Three months ended June 30, 2014
Six months ended June 30, 2014
   
Pre-
Post-
 
Pre-
Post-
   
Modification
Modification
 
Modification
Modification
   
Outstanding
Outstanding
 
Outstanding
Outstanding
 
Number of
Recorded
Recorded
Number of
Recorded
Recorded
 
Contracts
Investment
Investment
Contracts
Investment
Investment
             
Residential real estate
           
 - 1st lien
3
$218,330
$237,090
6
$480,899
$510,737
 
 
22

 

The TDR’s for which there was a payment default during the twelve month periods presented were as follows:

Twelve months ended June 30, 2015
           
   
Number of
   
Recorded
 
   
Contracts
   
Investment
 
             
Commercial
    1     $ 82,336  
Residential real estate - 1st lien
    3       258,568  
          Total
    4     $ 340,904  


Year ended December 31, 2014
 
 
   
Number of
   
Recorded
 
   
Contracts
   
Investment
 
             
Residential real estate - 1st lien
    2     $ 137,830  


Twelve months ended June 30, 2014
           
   
Number of
   
Recorded
 
   
Contracts
   
Investment
 
             
Residential real estate – 1st lien
    5     $ 441,679  
 
TDRs are treated as other impaired loans and carry individual specific reserves with respect to the calculation of the allowance for loan losses.  These loans are categorized as non-performing, may be past due, and are generally adversely risk rated. The TDRs that have defaulted under their restructured terms are generally in collection status and their reserve is typically calculated using the fair value of collateral method. At June 30, 2015 and 2014, the specific allocation related to TDRs was approximately $104,600 and $88,300, respectively.  There was no specific allowance related to TDRs at December 31, 2014.

As of June 30, 2015, the Company is contractually committed to lend up to $450,000 in additional funds to one debtor with an impaired SBA guaranteed cap line of credit; that debtor’s loan relationship is expected to strengthen as a result of a prior troubled debt restructuring.  With this exception, as of the balance sheet dates, the Company was not contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans.

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 $11,574,269.  The goodwill is not amortizable and is not deductible for tax purposes.

The Company also recorded $4,161,000 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.  The accumulated amortization expense was $3,479,269 and $3,206,569 as of June 30, 2015 and 2014, respectively.

Amortization expense for the core deposit intangible for the first six months of 2015 and 2014 was $136,350.  As of June 30, 2015, the remaining annual amortization expense related to the core deposit intangible, absent any future impairment, is expected to be as follows:

2015
  $ 136,345  
2016
    272,695  
2017
    272,691  
Total remaining core deposit intangible
  $ 681,731  

Management evaluates goodwill for impairment annually and the core deposit intangible for impairment if conditions warrant.  As of the date of the most recent evaluation (December 31, 2014), management concluded that no impairment existed in either category.

 
23

 

Note 7.  Fair Value

Certain assets and liabilities are recorded at fair value to provide additional insight into the Company’s quality of earnings. The fair values of some of these assets and liabilities are measured on a recurring basis while others are measured on a non-recurring basis, with the determination based upon applicable existing accounting pronouncements. For example, securities available-for-sale are recorded at fair value on a recurring basis. Other assets, such as mortgage servicing rights, loans held-for-sale, impaired loans, and OREO are recorded at fair value on a non-recurring basis using the lower of cost or market methodology to determine impairment of individual assets. The Company groups assets and liabilities which are recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with Level 1 considered highest and Level 3 considered lowest). A brief description of each level follows.

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 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 mortgage servicing rights, impaired loans and OREO.

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.

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

Cash and cash equivalents:  The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair values.  As such, the Company classifies these financial instruments as Level 1.

Securities available-for-sale and held-to-maturity: Fair value measurement is based upon quoted prices for similar assets, if available. If quoted prices are not available, fair values are measured using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as yield curves, prepayment speeds and default rates.  Level 1 securities would include U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.  Level 2 securities include federal agency securities and securities of local municipalities.

Restricted equity securities:  Restricted equity securities are comprised of Federal Reserve Bank of Boston (FRBB) 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 FRBB and the FHLBB.  The stock is nonmarketable, and redeemable at par value, subject to certain conditions.  As such the Company classifies these securities as Level 2.

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.  Loan impairment is deemed to exist when full repayment of principal and interest according to the contractual terms of the loan is no longer probable.  Impaired loans are reported based on one of three measures: the present value of expected future cash flows discounted at the loan’s effective interest rate; the loan’s observable market price; or the fair value of the collateral if the loan is collateral dependent.  If the fair value is less than an impaired loan’s recorded investment, an impairment loss is recognized as part of the allowance for loan losses.  Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis.  Management has estimated the fair values of these assets using Level 2 inputs, such as the fair value of collateral based on independent third-party appraisals for collateral-dependent loans.  All other loans are valued using Level 3 inputs.
 
 
24

 

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 represent the value associated with servicing residential mortgage loans. Servicing assets and servicing liabilities are reported using the amortization method and compared to fair value for impairment. In evaluating the carrying values of mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, and the type and term of the underlying loans. As such, the Company classifies mortgage servicing rights as non-recurring Level 2.

OREO:  Real estate acquired through or in lieu of foreclosure and bank properties no longer used as bank premises are initially recorded at fair value. The fair value of OREO is based on property appraisals and an analysis of similar properties currently available. As such, the Company records OREO as non-recurring Level 2.

Deposits, federal funds purchased and borrowed funds:  The fair values disclosed for demand deposits (for example, checking accounts, savings accounts and repurchase agreements) 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 borrowed funds are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates and indebtedness to a schedule of aggregated contractual maturities on such time deposits and indebtedness.  As such the Company classifies deposits, federal funds purchased and borrowed funds as Level 2.

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.  As such the Company classifies these obligations as Level 2.

Junior subordinated debentures:  Fair value is estimated using current rates for debentures of similar maturity.  As such the Company classifies these instruments as Level 2.

Accrued interest:  The carrying amounts of accrued interest approximate their fair values.  As such the Company classifies accrued interest as Level 2.

Off-balance-sheet credit related instruments:  Commitments to extend credit are evaluated and fair value is 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.

FASB Accounting Standards Codification (ASC) Topic 825 “Financial Instruments”, requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, if the fair values can be reasonably determined. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques using observable inputs when available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Topic 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Assets measured at fair value on a recurring basis and reflected in the consolidated balance sheets at the dates presented, segregated by fair value hierarchy, are summarized below:

June 30, 2015
 
Level 1
   
Level 2
 
Assets: (market approach)
           
U.S. GSE debt securities
  $ 0     $ 14,908,104  
U.S. Government securities
    3,002,969       0  
Agency MBS
    0       11,559,773  
Other investments
    0       1,733,188  
  Total
  $ 3,002,969     $ 28,201,065  

 
25

 
 
December 31, 2014
 
Level 1
   
Level 2
 
Assets: (market approach)
           
U.S. GSE debt securities
  $ 0     $ 19,907,150  
U.S. Government securities
    4,000,937       0  
Agency MBS
    0       9,038,807  
  Total
  $ 4,000,937     $ 28,945,957  
                 
June 30, 2014
               
Assets: (market approach)
               
U.S. GSE debt securities
  $ 0     $ 15,958,061  
U.S. Government securities
    5,533,006       0  
Agency MBS
    0       9,707,891  
  Total
  $ 5,533,006     $ 25,665,952  
 
There were no transfers between Levels 1 and 2 for the periods presented.  There were no Level 3 assets or liabilities measured on a recurring basis as of the balance sheet dates presented.
 
Assets and Liabilities Recorded at Fair Value on a Non-Recurring Basis

The following table includes assets measured at fair value on a non-recurring basis that have had a fair value adjustment since their initial recognition. Impaired loans measured at fair value only include impaired loans with a related specific allowance for loan losses and are presented net of specific allowances as disclosed in Note 5.

Assets measured at fair value on a non-recurring basis and reflected in the consolidated balance sheets at the dates presented, segregated by fair value hierarchy, are summarized below:

June 30, 2015
 
Level 2
 
Assets: (market approach)
     
Residential mortgage servicing rights
  $ 1,298,418  
Impaired loans, net of related allowance
    391,252  
OREO
    1,122,500  
         
December 31, 2014
       
Assets: (market approach)
       
Residential mortgage servicing rights
  $ 1,311,965  
Impaired loans, net of related allowance
    241,819  
OREO
    1,238,320  
         
June 30, 2014
       
Assets: (market approach)
       
Residential mortgage servicing rights
  $ 1,324,713  
Impaired loans, net of related allowance
    1,047,291  
OREO
    916,820  

There were no Level 1 or Level 3 assets or liabilities measured on a non-recurring basis as of the balance sheet dates presented.

 
26

 
 
The estimated fair values of commitments to extend credit and letters of credit were immaterial as of the dates presented in the tables below.  The estimated fair values of the Company's financial instruments were as follows:

June 30, 2015
       
Fair
   
Fair
   
Fair
   
Fair
 
   
Carrying
   
Value
   
Value
   
Value
   
Value
 
   
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Financial assets:
                             
Cash and cash equivalents
  $ 19,454     $ 19,454     $ 0     $ 0     $ 19,454  
Securities held-to-maturity
    25,739       0       26,055       0       26,055  
Securities available-for-sale
    31,204       3,003       28,201       0       31,204  
Restricted equity securities
    3,332       0       3,332       0       3,332  
Loans and loans held-for-sale
                                       
  Commercial & industrial
    72,607       0       524       73,638       74,162  
  Commercial real estate
    170,410       0       1,846       174,080       175,926  
  Residential real estate - 1st lien
    160,951       0       1,274       164,014       165,288  
  Residential real estate - Jr lien
    43,421       0       191       44,160       44,351  
  Consumer
    7,358       0       0       7,695       7,695  
Mortgage servicing rights
    1,298       0       1,496       0       1,496  
Accrued interest receivable
    1,578       0       1,578       0       1,578  
                                         
Financial liabilities:
                                       
Deposits
                                       
  Other deposits
    432,657       0       432,533       0       432,533  
  Brokered deposits
    22,410       0       22,426       0       22,426  
Federal funds purchased and short-term borrowings
    30,000       0       30,000       0       30,000  
Repurchase agreements
    24,403       0       24,403       0       24,403  
Capital lease obligations
    600       0       600       0       600  
Subordinated debentures
    12,887       0       12,856       0       12,856  
Accrued interest payable
    47       0       47       0       47  


December 31, 2014
       
Fair
   
Fair
   
Fair
   
Fair
 
   
Carrying
   
Value
   
Value
   
Value
   
Value
 
   
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Financial assets:
                             
Cash and cash equivalents
  $ 24,962     $ 24,962     $ 0     $ 0     $ 24,962  
Securities held-to-maturity
    41,811       0       42,234       0       42,234  
Securities available-for-sale
    32,947       4,001       28,946       0       32,947  
Restricted equity securities
    3,332       0       3,332       0       3,332  
Loans and loans held-for-sale
                                       
  Commercial & industrial
    63,709       0       391       64,800       65,191  
  Commercial real estate
    164,212       0       1,897       167,961       169,858  
  Residential real estate - 1st lien
    162,635       0       678       166,171       166,849  
  Residential real estate - Jr lien
    44,457       0       329       45,113       45,442  
  Consumer
    7,912       0       0       8,315       8,315  
Mortgage servicing rights
    1,312       0       1,528       0       1,528  
Accrued interest receivable
    1,698       0       1,698       0       1,698  
                                         
Financial liabilities:
                                       
Deposits
                                       
  Other deposits
    472,966       0       473,100       0       473,100  
  Brokered deposits
    20,053       0       20,054       0       20,054  
Repurchase agreements
    28,543       0       28,543       0       28,543  
Capital lease obligations
    640       0       640       0       640  
Subordinated debentures
    12,887       0       12,867       0       12,867  
Accrued interest payable
    64       0       64       0       64  

 
27

 

June 30, 2014
       
Fair
   
Fair
   
Fair
   
Fair
 
   
Carrying
   
Value
   
Value
   
Value
   
Value
 
   
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
Financial assets:
                             
Cash and cash equivalents
  $ 16,343     $ 16,343     $ 0     $ 0     $ 16,343  
Securities held-to-maturity
    22,967       0       23,373       0       23,373  
Securities available-for-sale
    31,199       5,533       25,666       0       31,199  
Restricted equity securities
    3,332       0       3,332       0       3,332  
Loans and loans held-for-sale
                                       
  Commercial & industrial
    63,742       0       1,135       64,023       65,158  
  Commercial real estate
    162,031       0       1,539       165,635       167,174  
  Residential real estate - 1st lien
    168,582       0       1,274       172,278       173,552  
  Residential real estate - Jr lien
    44,238       0       358       44,839       45,197  
  Consumer
    7,793       0       0       8,167       8,167  
Mortgage servicing rights
    1,325       0       1,523       0       1,523  
Accrued interest receivable
    1,445       0       1,445       0       1,445  
                                         
Financial liabilities:
                                       
Deposits
                                       
  Other deposits
    428,186       0       428,924       0       428,924  
  Brokered deposits
    26,879       0       26,884       0       26,884  
Federal funds purchased and short-term borrowings
    13,915       0       13,915       0       13,915  
Long-term borrowings
    6,000       0       6,000       0       6,000  
Repurchase agreements
    23,583       0       23,583       0       23,583  
Capital lease obligations
    677       0       677       0       677  
Subordinated debentures
    12,887       0       12,869       0       12,869  
Accrued interest payable
    70       0       70       0       70  

Note 8.  Loan Servicing

The following table shows the changes in the carrying amount of the mortgage servicing rights, included in other assets on the consolidated balance sheets, for the periods indicated:

   
June 30,
   
December 31,
   
June 30,
 
   
2015
   
2014
   
2014
 
                   
Balance at beginning of year
  $ 1,311,965     $ 1,329,079     $ 1,329,079  
   Mortgage servicing rights capitalized
    112,687       209,713       112,601  
   Mortgage servicing rights amortized
    (128,791 )     (250,955 )     (122,727 )
   Change in valuation allowance
    2,557       24,128       5,760  
Balance at end of period
  $ 1,298,418     $ 1,311,965     $ 1,324,713  
 
Note 9.  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 10.  Subsequent Event

The Company has evaluated events and transactions through the date that the financial statements were issued for potential recognition or disclosure in these financial statements, as required by GAAP.  On June 9, 2015, the Company declared a cash dividend of $0.16 per common share payable August 1, 2015 to shareholders of record as of July 15, 2015.  This dividend, amounting to $791,903, was accrued at June 30, 2015.
 
28

 

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
Period Ended June 30, 2015

The following discussion analyzes the consolidated financial condition of Community Bancorp. (the Company) and its wholly-owned subsidiary, Community National Bank (the Bank), as of June 30, 2015, December 31, 2014 and June 30, 2014, and its consolidated results of operations for the two interim periods presented.  The Company is considered a “smaller reporting company” under applicable regulations of the Securities and Exchange Commission (SEC) and is therefore eligible for relief from certain disclosure requirements.  In accordance with such provisions, the Company has elected to provide its interim consolidated statements of income, comprehensive income, and cash flows for two, rather than three, years.

The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 2014 Annual Report on Form 10-K filed with the SEC.

FORWARD-LOOKING STATEMENTS

This 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. Words used in the discussion below such as "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 future performance of the Company or the local or national economy. 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 conditions, either nationally, regionally or locally 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 services 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, including the rules of the federal Consumer Financial Protection Bureau, or the way in which courts or government agencies interpret or implement those laws or rules, increase our costs of doing business causing us to limit or change our product offerings or pricing, 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; (9) the effect of changes to the calculation of the Company’s regulatory capital ratios under the recently adopted Basel III capital framework which, among other things, requires additional regulatory capital, and change the framework for risk-weighting of certain assets; (10) the effect of and changes in the United States monetary and fiscal policies, including the interest rate policies of the Federal Reserve Board (FRB) and its regulation of the money supply; and (11) adverse changes in the credit rating of U.S. government debt.

NON-GAAP FINANCIAL MEASURES

Under SEC Regulation G, public companies making disclosures containing financial measures that are not in accordance with generally accepted accounting principles in the United States (US 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 (as presented in the tables in the section labeled Interest Income Versus Interest Expense (Net Interest Income), have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G.  We are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G.
 
 
29

 
 
Management believes that these non-GAAP financial measures are useful in evaluating the Company’s financial performance and facilitate comparisons with the performance of other financial institutions.  However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.

OVERVIEW

The Company’s consolidated assets on June 30, 2015 were $576,498,650, a decrease of $10,212,394 or 1.7% from December 31, 2014 and an increase of $14,256,895, or 2.5%, from June 30, 2014.  Contributing to the decrease in assets from year end was a decrease in short-term municipal loans, recorded as held-to-maturity securities which generally mature at the end of the second quarter and are not replaced until after the start of the third quarter.  Municipal loans totaling $23,051,194 matured on June 30, 2015, with renewals and new municipal loans of approximately $22 million recorded in July, 2015.   Net loans increased $11,491,598, or 2.6%, since December 31, 2014 and $8,689,348, or 2.0%, since June 30, 2014.  The increase in net loans is attributable to solid growth in commercial loans.  The loan growth has been funded primarily through short-term borrowings, totaling $30,000,000 at June 30, 2015 compared with no borrowings at December 31, 2014, and a combination of $17,000,000 in short term borrowings and $7,066,165 of brokered time deposits at June 30, 2014.

Total deposits declined $37,952,134, or 7.7%, since December 31, 2014 due primarily to the seasonal runoff of municipal deposits.  In the year over year comparison, deposits declined $2,410, or 0.0%.  Core deposits saw increases in all areas except time deposits, which continue to shift into non-maturity deposits as they mature.  The decrease in retail time deposits is a trend that has been prevalent for several years while rates have been at historic lows. Management believes that the low interest rates being paid on certificates of deposit and other investment products is likely causing some depositors to place their money in non-maturity products such as demand and savings accounts while awaiting an improvement in interest rates and market conditions.

Interest rates remain at historically low levels, causing continued pressure on yields as earning assets re-price at lower rates, although the rate of decline has slowed in 2015 as rates have stabilized at this lower base.  Growth of the commercial loan portfolio, which typically carries higher yields than consumer loans, has helped to maintain a stable level of interest income.  This shift in asset mix is in line with the Company’s strategic plan to increase its concentration in commercial loans while maintaining a sizeable residential loan portfolio.  While commercial loans inherently carry more risk, the Company has dedicated significant resources in the credit administration department to mitigate the additional risk.  The opportunities for growth continue to be primarily in the Central Vermont market where economic activity is more robust than in the Company’s Orleans and Caledonia county markets, and where the Company is increasing its presence and market share.  The shift of a portion of the investment portfolio to higher yielding mortgage backed securities at the end of the second quarter of 2014 has also improved overall asset yields year to year.

Interest income increased $37,037, or 0.7%, for the second quarter of 2015 compared to the same period in 2014.   Interest expense declined $105,692, or 13.6%, due to the continued decrease in interest rates paid on deposits and borrowings.  The decrease in interest paid on deposits is largely attributable to a shift of customer funds out of higher yielding CDs to lower yielding demand and savings accounts.  Rates paid on non-maturity deposits have also been adjusted downward when necessary to account for changes in market rates.

Net interest income after the provision for loan losses improved by $127,729, or 2.7%, for the three months ended June 30, 2015 compared to the same period in 2014.  The charge to income for the provision for loan losses increased $15,000, or 11.1%, year over year based on the increase in the loan portfolio for the year, not a decline in asset quality.

Net income for the second quarter of 2015 was $1,077,704, a decrease of $206,682, or 16.1%, compared with the same period in 2014.  Net income for the first six months of 2015 was $2,187,544, a decrease of $168,407 or 7.2% compared to the same period in 2014. Total non-interest income decreased $32,741, or 2.4%, during the second quarter of 2015 compared to 2014, with declines seen in all major categories.  One of the components of non-interest income is income generated from selling loans in the secondary market.  For several years, the Federal Reserve’s efforts to stimulate the real estate market by keeping mortgage interest rates low provided for several refinancing cycles.  The residential mortgage lending activity slowed during 2014, resulting in decreases in the Company’s fee income from the sale of residential loans in the secondary market.  In 2015, this trend has started to turn with new mortgage originations totaling $20,136,238 for the first six months of 2015, compared with $16,975,336 for the same period in 2014, an increase of $3,160,902, or 18.6%.  Of those originations, during the first six months of 2015 secondary market sales totaled $11,654,885, compared to $10,356,676 for the first six months of 2014, providing points and premiums from the sales of these mortgages of $168,670 and $235,150, respectively, a decline of 28.4%.  Mirroring trends in the mortgage banking industry, as mortgage rates decreased to spur higher volume, margins declined to keep mortgage rates competitive, resulting in the decline between periods in points and premiums from the sale of mortgages on the secondary market.  The remainder of the loans originated were held in portfolio.  Total operating expenses increased by $497,882, or 5.6%, for the first six months 2015 when compared to the same period in 2014, including non-recurring charges associated with the mandated replacement of customer debit cards with computer chip enhanced cards and costs associated with the closure of two branch offices in July.  Please refer to the Non-interest Income and Expense sections for more information.
 
 
30

 

The regulatory environment continues to increase operating costs and place extensive burdens on personnel resources to comply with a myriad of legal requirements, including those under the Dodd-Frank Act of 2010, and the numerous rulemakings it has spawned, the Sarbanes-Oxley Act of 2002, the USA Patriot Act, the Bank Secrecy Act, the Real Estate Settlement Procedures Act and the Truth in Lending Act, as well as the new Basel III capital framework.  It is unlikely that these administrative costs and burdens will moderate in the future.

On June 9, 2015, the Company's Board of Directors declared a quarterly cash dividend of $0.16 per common share, payable on August 1, 2015 to shareholders of record on July 15, 2015.  The Company is focused on increasing the profitability of the balance sheet, and prudently managing operating expenses and risk, particularly credit risk, in order to remain a well-capitalized bank in this challenging economic environment.
 
On April 16, 2015, the Company announced plans to close two branch office locations in Caledonia County, effective at the close of business on July 17, 2015.  The two affected locations will be consolidated into the Bank’s two other Caledonia County branch offices.

CRITICAL ACCOUNTING POLICIES

The Company’s significant accounting policies, which are described in Note 1 (Significant Accounting Policies) to the Company’s audited consolidated financial statements in its 2014 Annual Report on Form 10-K, are fundamental to understanding the Company’s results of operations and financial condition because they require management to use estimates and assumptions that may affect the value of the Company’s assets or liabilities and financial results.  These policies are considered by management to be critical because they require subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.  The Company’s critical accounting policies govern:

· the allowance for loan losses;
· other real estate owned (OREO);
· valuation of residential mortgage servicing rights (MSRs);
· other than temporary impairment of investment securities; and
· the carrying value of goodwill.

These policies are described further in the Company’s 2014 Annual Report on Form 10-K in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and in Note 1 (Significant Accounting Policies) to the audited consolidated financial statements.  Except for certain changes to the methodology for calculating the allowance for loan losses as described below under “RISK MANAGEMENT – Allowance for loan losses and provisions”, there have been no material changes in the critical accounting policies described in the 2014 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Net income for the second quarter of 2015 was $1,077,704, a decrease of $206,682, or 16.1%, compared with the same period in 2014.  This resulted in earnings per share of $0.21, compared with $0.26 for the second quarter 2014.  Net income for the first six months of 2015 was $2,187,544 or $0.43 per common share, compared to $2,355,951 or $0.47 per common share for the same period in 2014. Core earnings (net interest income before the provision for loan losses) for the second quarter of 2015 increased $142,729, or 2.9%, compared to the second quarter of 2014.  For the six months ended June 30, 2015, core earnings increased $457,029, or 4.7% compared to the prior year.  In light of the continued pressure on net interest margin and spread in this persistently low interest rate environment, the Company is pleased with these increases.  To help offset this pressure, the Company shifted assets from lower yielding taxable investments to loans, and shifted a portion of the investment portfolio to higher yielding agency mortgage-backed securities (Agency MBS) within its available-for-sale portfolio during the second quarter of 2014.  The Company has continued to maintain that overall mix of investments.  The tax-exempt municipal loan portfolio also increased significantly compared with the prior year, generating additional interest income.  During 2015, the loan mix has continued to shift in favor of higher yielding commercial loans, while the deposit mix is shifting to lower cost non-maturity deposits, both of which have benefitted the Company’s net interest income.  Interest paid on deposits, which is the major component of total interest expense, decreased $105,692, or 13.6%, in the second quarter 2015 compared to the same period of 2014.  The Company recorded a provision for loan losses of $150,000 for the first six months of 2015, compared to $135,000 for the same period of 2014.  Non-interest income decreased $32,741, or 2.5%, for the second quarter of 2015 compared to 2014, partly due to a lower pace of residential mortgage loan sales, together with a decrease in overdraft charges and paper statement fees.  Non-interest expense increased $402,392, or 9.2%, for the second quarter of 2015 compared to the prior year with increases in salaries & benefits as well as other non-interest expenses including collection and OREO write-down expense. The section below labeled Non-Interest Income and Non-Interest Expense provides a more detailed discussion on the significant components of these two items.
 
 
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Return on average assets, which is net income divided by average total assets, measures how effectively a corporation uses its assets to produce earnings.  Return on average equity, which is net income divided by average shareholders' equity, measures how effectively a corporation uses its equity capital to produce earnings.

The following table shows these ratios annualized for the comparison periods.

   
Three Months Ended June 30,
 
   
2015
   
2014
 
Return on Average Assets
    0.74 %     0.90 %
Return on Average Equity
    8.60 %     10.91 %
                 
                 
   
Six Months Ended June 30,
 
      2015       2014  
Return on Average Assets
    0.76 %     0.83 %
Return on Average Equity
    8.84 %     10.15 %

 
32

 
 
The following table summarizes the earnings performance and certain balance sheet data of the Company for the periods presented.

SELECTED FINANCIAL DATA (Unaudited)
 
         
   
June 30,
   
December 31,
   
June 30,
 
   
2015
   
2014
   
2014
 
                   
Balance Sheet Data
                 
Net loans
  $ 454,694,073     $ 443,202,475     $ 446,004,725  
Total assets
    576,498,650       586,711,044       562,241,755  
Total deposits
    455,067,329       493,019,463       455,064,919  
Borrowed funds
    30,000,000       0       19,915,000  
Total liabilities
    526,457,457       537,715,842       514,850,811  
Total shareholders' equity
    50,041,193       48,995,202       47,390,944  
                         
           
Six Months Ended June 30,
 
              2015       2014  
                         
Operating Data
                       
Total interest income
          $ 11,617,983     $ 11,332,423  
Total interest expense
            1,399,817       1,571,286  
     Net interest income
            10,218,166       9,761,137  
                         
Provision for loan losses
            300,000       270,000  
     Net interest income after provision for loan losses
            9,918,166       9,491,137  
                         
Non-interest income
            2,517,266       2,650,723  
Non-interest expense
            9,476,568       8,978,686  
     Income before income taxes
            2,958,864       3,163,174  
Applicable income tax expense(1)
            771,320       807,223  
                         
     Net Income
          $ 2,187,544     $ 2,355,951  
                         
Per Common Share Data
                       
                         
Earnings per common share (2)
          $ 0.43     $ 0.47  
Dividends declared per common share
          $ 0.32     $ 0.32  
Book value per common share outstanding, period end
          $ 9.57     $ 9.16  
Weighted average number of common shares outstanding
            4,946,734       4,880,969  
Number of common shares outstanding, period end
            4,966,027       4,899,995  
                         
(1) Applicable income tax expense assumes a 34% tax rate.
                 
(2) Computed based on the weighted average number of common shares outstanding during the periods presented.
 


INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME)

The largest component of the Company’s operating income is net interest income, which is the difference between interest earned on loans and investments versus the interest paid on deposits and other sources of funds (i.e. other borrowings).  The Company’s level of net interest income can fluctuate over time due to changes in the level and mix of earning assets, and sources of funds (volume) and from changes in the yield earned and costs of funds (rate).  A portion of the Company’s income from municipal investments is not subject to income taxes.  Because the proportion of tax-exempt items in the Company's portfolio varies from year-to-year, to improve comparability of information, the non-taxable income shown in the tables below has been converted to a tax equivalent basis. Because the Company’s corporate tax rate is 34%, to equalize tax-free and taxable income in the comparison, we divide the tax-free income by 66%, with the result that every tax-free dollar is equivalent to $1.52 in taxable income.
 
 
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The Company’s tax-exempt interest income is derived from municipal investments, which comprised the entire held-to-maturity portfolio of $25,738,769 at June 30, 2015, and $22,966,558 at June 30, 2014.

The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the quarterly comparison periods presented.

   
Three Months Ended June 30,
 
   
2015
   
2014
 
             
Net interest income as presented
  $ 5,078,880     $ 4,936,151  
Effect of tax-exempt income
    142,313       124,328  
   Net interest income, tax equivalent
  $ 5,221,193     $ 5,060,479  

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 comparison periods presented.

   
Three Months Ended June 30,
 
         
2015
               
2014
       
               
Average
               
Average
 
   
Average
   
Income/
   
Rate/
   
Average
   
Income/
   
Rate/
 
   
Balance
   
Expense
   
Yield
   
Balance
   
Expense
   
Yield
 
Interest-Earning Assets
                                   
                                     
 Loans (1)
  $ 455,618,414     $ 5,346,764       4.71 %   $ 450,294,322     $ 5,373,903       4.79 %
 Taxable investment securities
    31,166,027       102,608       1.32 %     30,894,207       73,040       0.95 %
 Tax-exempt investment securities
    43,458,469       418,567       3.86 %     39,420,328       365,670       3.72 %
 Sweep and interest-earning accounts
    2,521,651       1,770       0.28 %     4,215,122       2,836       0.27 %
 Other investments (2)
    3,719,450       23,788       2.57 %     3,821,784       23,026       2.42 %
     Total
  $ 536,484,011     $ 5,893,497       4.41 %   $ 528,645,763     $ 5,838,475       4.43 %
                                                 
Interest-Bearing Liabilities
                                               
                                                 
 Interest-bearing transaction accounts
  $ 112,569,304     $ 53,844       0.19 %   $ 110,063,106     $ 57,926       0.21 %
 Money market accounts
    87,385,306       221,765       1.02 %     82,360,369       209,803       1.02 %
 Savings deposits
    80,726,280       24,414       0.12 %     75,552,538       23,674       0.13 %
 Time deposits
    107,895,810       229,158       0.85 %     129,584,072       351,315       1.09 %
 Federal funds purchased and
                                               
  other borrowed funds
    17,293,077       11,182       0.26 %     12,350,604       6,576       0.21 %
 Repurchase agreements
    25,538,488       17,933       0.28 %     23,917,037       14,385       0.24 %
 Capital lease obligations
    606,498       12,353       8.15 %     683,027       13,875       8.13 %
 Junior subordinated debentures
    12,887,000       101,655       3.16 %     12,887,000       100,442       3.13 %
     Total
  $ 444,901,763     $ 672,304       0.61 %   $ 447,397,753     $ 777,996       0.70 %
                                                 
Net interest income
          $ 5,221,193                     $ 5,060,479          
Net interest spread (3)
                    3.80 %                     3.73 %
Net interest margin (4)
                    3.90 %                     3.84 %
 
(1) Included in gross loans are non-accrual loans with an average balance of $5,058,480 and $5,228,954 for the three
 
months ended June 30, 2015 and 2014, respectively. Loans are stated before deduction of unearned discount and
 
allowance for loan losses.
 
(2) Included in other investments is the Company’s FHLBB Stock with an average balance of $2,744,300 and $2,846,634
 
for the three months ended June 30, 2015 and 2014, respectively, and dividend payout rates of approximately 1.74%
 
and 1.49%, respectively, per quarter.
 
(3) Net interest spread is the difference between the average yield on average interest-earning assets and the average
 
rate paid on average interest-bearing liabilities.
 
(4) Net interest margin is net interest income divided by average earning assets.
 
 
 
34

 
 
The average volume of interest-earning assets for the second quarter of 2015 increased $7,838,248, or 1.5% compared to the same period of 2014, and the average yield decreased two basis points to 4.41% for the second quarter of 2015 compared to 4.43% for the same quarter of 2014.  The average volume of loans increased $5,324,092, or 1.2%, and the average yield declined by eight basis points.  Interest earned on the loan portfolio equaled approximately 90.7% of total interest income for the second quarter of 2015 and 92.0% for the 2014 comparison period.  The average volume of the taxable investment portfolio (classified as available-for-sale) increased $271,820, or 0.9%, for the same period, while the average yield increased 37 basis points due in part to the shift to higher yielding mortgage backed securities late in the second quarter of 2014.  The average volume of the tax-exempt investment portfolio (classified as held-to-maturity) increased $4,038,141, or 10.2%, between periods, while the average tax equivalent yield increased 14 basis points year over year.  The average volume of sweep and interest-earning accounts, which is primarily made up of the interest-earning deposit account at the Federal Reserve Bank of Boston (FRBB), decreased $1,693,471, or 40.2%.  The balance of these funds has remained relatively low as all excess cash has been used to fund loan growth.

In comparison, the average volume of interest-bearing liabilities for the second quarter of 2015 decreased $2,495,990, or 0.6% over the 2014 comparison period, and the average rate paid on these liabilities decreased nine basis points.  The average volume of money market funds increased $5,024,937, or 6.1%, while the average rate paid remained flat at 1.02%.  The increase in money market funds is due primarily to approximately $8,000,000 of construction related escrow accounts opened in the fourth quarter of 2014, which are expected to remain in place into 2016.  The average volume of savings accounts increased $5,173,742 or 6.9% for the second quarter of 2015 compared to the same period in 2014 due to the continued shift in product mix from time deposits to savings accounts as consumers anticipate higher rates in the near future.  The average total volume of time deposits, both retail and wholesale, decreased $21,688,262, or 16.7%.  This includes average wholesale time deposits of $7,066,165.  The average volume of federal funds purchased and other borrowed funds increased $4,942,473, or 40.0%, as short term advances were largely used in place of overnight funds in 2015.  A decrease of 24 basis points is noted in the average rate paid on time deposits while an increase of five basis points is noted on the average rate paid on federal funds purchased and other borrowed funds.  The Company drew down short-term FHLBB advances totaling $30,000,000 in the second quarter of 2015 to fund loan growth and offset the seasonal runoff of municipal deposits.  This compares with $17,000,000 of FHLBB advances and $7,066,165 of brokered time deposits at June 30, 2014.

The prolonged low interest rate environment has resulted in continued pressure on the Company’s net interest spread and margin.  The Company’s earning assets are being both replaced with, and repricing to, lower interest rates, while the opportunity to reduce rates further on non-maturing interest-bearing deposits is limited given the already low rates paid on deposits.  For the second quarter comparison periods of 2015 and 2014 the average yield in interest-earning assets stayed relatively flat, while the average rate paid on interest-bearing liabilities decreased nine basis points.  Net interest margin for the second quarter was 3.80% for 2015, down from 3.84% the prior year.

The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the year to date comparison periods presented.

   
Six Months Ended June 30,
 
   
2015
   
2014
 
             
Net interest income as presented
  $ 10,218,166     $ 9,761,137  
Effect of tax-exempt income
    281,984       256,530  
   Net interest income, tax equivalent
  $ 10,500,150     $ 10,017,667  

 
35

 

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 comparison periods presented.

   
Six Months Ended June 30,
 
         
2015
               
2014
       
               
Average
               
Average
 
   
Average
   
Income/
   
Rate/
   
Average
   
Income/
   
Rate/
 
   
Balance
   
Expense
   
Yield
   
Balance
   
Expense
   
Yield
 
Interest-Earning Assets
                                   
                                     
 Loans (1)
  $ 453,180,622     $ 10,811,025       4.81 %   $ 448,006,236     $ 10,644,679       4.79 %
 Taxable investment securities
    31,758,150       207,647       1.32 %     31,600,140       139,384       0.89 %
 Tax-exempt investment securities
    43,123,366       829,364       3.88 %     39,086,004       754,500       3.89 %
 Sweep and interest-earning accounts
    3,207,206       4,260       0.27 %     3,077,958       4,080       0.27 %
 Other investments (2)
    3,719,450       47,671       2.58 %     3,920,270       46,310       2.38 %
     Total
  $ 534,988,794     $ 11,899,967       4.49 %   $ 525,690,608     $ 11,588,953       4.45 %
                                                 
Interest-Bearing Liabilities
                                               
                                                 
 Interest-bearing transaction accounts
  $ 114,728,976     $ 111,859       0.20 %   $ 113,564,182     $ 121,358       0.22 %
 Money market accounts
    89,645,735       446,545       1.00 %     82,929,078       421,232       1.02 %
 Savings deposits
    79,084,511       47,751       0.12 %     73,915,242       46,307       0.13 %
 Time deposits
    109,957,225       515,483       0.95 %     125,852,809       711,077       1.14 %
 Federal funds purchased and
                                               
  other borrowed funds
    10,000,442       13,171       0.27 %     10,059,033       11,049       0.22 %
 Repurchase agreements
    26,906,269       37,570       0.28 %     25,674,294       30,983       0.24 %
 Capital lease obligations
    616,527       25,105       8.14 %     691,579       28,087       8.12 %
 Junior subordinated debentures
    12,887,000       202,333       3.17 %     12,887,000       201,193       3.15 %
     Total
  $ 443,826,685     $ 1,399,817       0.64 %   $ 445,573,217     $ 1,571,286       0.71 %
                                                 
Net interest income
          $ 10,500,150                     $ 10,017,667          
Net interest spread (3)
                    3.85 %                     3.74 %
Net interest margin (4)
                    3.96 %                     3.84 %
 
(1)  Included in gross loans are non-accrual loans with an average balance of $4,897,435 and $4,865,916 for the six
      months ended June 30, 2015 and 2014, respectively.  Loans are stated before deduction of unearned discount
      and allowance for loan losses.
(2)  Included in other investments is the Company’s FHLBB Stock with an average balance of $2,744,300 and $2,945,120,
      respectively, for the first six months of 2015 and 2014, and dividend payout rates of approximately 1.74% and 1.49%,
      respectively, six month period.
(3)  Net interest spread is the difference between the average yield on average interest-earning assets and the average
      rate paid on average interest-bearing liabilities.
(4)  Net interest margin is net interest income divided by average earning assets.

For the six months ended June 30, 2015, average interest-earning assets grew $9,298,186, or 1.8% compared with the same period in 2014, split between growth in commercial loan and municipal securities.

Interest income increased by $311,014, or 2.7% between periods resulting in a corresponding increase in yield on average assets of four basis points to 4.49%.  Contributing to the increase was a one-time recovery of non-accrual interest on loans during the first quarter of 2015 of approximately $200,000. Accordingly, management believes the three month average yield of 4.43% better reflects the true current yield on loans.

The investment portfolios also contributed to the increase in interest income with an increase of $68,263, or 49.0% in the interest income from the taxable investment securities.  Despite flat average balances, yields and income for the investment portfolio increased substantially year to date in 2015 compared to the prior year, due to the addition of mortgage backed securities as a portion of the portfolio.  The increased tax exempt income in 2015 of $74,864, or 9.9%, is a result of a higher volume of non-arbitrage municipal loans.
 
 
36

 

The total cost of interest bearing liabilities declined by seven basis points for the first half of 2015 versus the first half of 2014, with the continued shift from time deposits to non-maturity products, and the repricing of the remaining time deposit balances to lower rates.

The resulting net interest spread and margin improved by 11 and 12 basis points, respectively, between the first six months of 2015 and the same period a year earlier.

The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the periods presented for 2015 and 2014 resulting from volume changes in average assets and average liabilities and fluctuations in average rates earned and paid.

Changes in Interest Income and Interest Expense
                                     
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
Variance
   
Variance
         
Variance
   
Variance
       
   
Due to
   
Due to
   
Total
   
Due to
   
Due to
   
Total
 
   
Rate (1)
   
Volume (1)
   
Variance
   
Rate (1)
   
Volume (1)
   
Variance
 
Average Interest-Earning Assets
                                   
 Loans
  $ (90,720 )   $ 63,581     $ ( 27,139 )   $ 43,438     $ 122,908     $ 166,346  
 Taxable investment securities
    28,924       644       29,568       67,566       697       68,263  
 Tax-exempt investment securities
    15,445       37,452       52,897       (3,017 )     77,881       74,864  
 Sweep and interest-earning accounts
    116       (1,182 )     (1,066 )     7       173       180  
 Other investments
    1,418       (656 )     762       3,930       (2,569 )     1,361  
     Total
  $ (44,817 )   $ 99,839     $ 55,022     $ 111,924     $ 199,090     $ 311,014  
                                                 
Average Interest-Bearing Liabilities
                                               
 Interest-bearing transaction accounts
  $ ( 5,394 )   $ 1,312     $ ( 4,082 )   $ ( 10,770 )   $ 1,271     $ ( 9,499 )
 Money market accounts
    (816 )     12,778       11,962       (8,660 )     33,973       25,313  
 Savings deposits
    (937 )     1,677       740       (1,888 )     3,332       1,444  
 Time deposits
    (76,196 )     (45,961 )     (122,157 )     (120,711 )     (74,883 )     (195,594 )
 Federal funds purchased and
                                               
  other borrowed funds
    2,018       2,588       4,606       2,200       (78 )     2,122  
 Repurchase agreements
    2,578       970       3,548       5,121       1,466       6,587  
 Capital lease obligations
    33       (1,555 )     (1,522 )     48       (3,030 )     (2,982 )
 Junior subordinated debentures
    1,213       0       1,213       1,140       0       1,140  
     Total
  $ (77,501 )   $ (28,191 )   $ (105,692 )   $ (133,520 )   $ ( 37,949 )   $ (171,469 )
                                                 
       Changes in net interest income
  $ 32,684     $ 128,030     $ 160,714     $ 245,444     $ 237,039     $ 482,483  
 
(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

 
37

 
 
NON-INTEREST INCOME AND NON-INTEREST EXPENSE

Non-interest Income

The components of non-interest income for the periods presented are as follows:

   
Three Months Ended
               
Six Months Ended
             
   
June 30,
   
Change
   
June 30,
   
Change
 
   
2015
   
2014
    $       %       2015       2014     $       %  
                                                         
Service fees
  $ 642,981     $ 658,972     $ (15,991 )     -2.43 %   $ 1,274,418     $ 1,305,785     $ (31,367 )     -2.40 %
Income from sold loans
    247,565       260,330       (12,765 )     -4.90 %     448,240       509,460       (61,220 )     -12.02 %
Other income from loans
    186,433       122,066       64,367       52.73 %     320,632       266,466       54,166       20.33 %
Net realized gain (loss) on sale of securities available-for-sale
    2,723       21,828       (19,105 )     -87.53 %     2,723       21,828       (19,105 )     -87.53 %
Income from CFSG Partners
    81,345       83,448       (2,103 )     -2.52 %     175,191       163,260       11,931       7.31 %
Rental income on OREO properties
    1,101       1,270       (169 )     -13.31 %     36,521       49,807       (13,286 )     -26.67 %
Exchange income
    23,000       36,500       (13,500 )     -36.99 %     38,500       65,000       (26,500 )     -40.77 %
SERP fair value adjustment
    (10,442 )     28,690       (39,132 )     -136.40 %     529       44,738       (44,209 )     -98.82 %
Other income
    129,775       124,118       5,657       4.56 %     220,512       224,379       (3,867 )     -1.72 %
     Total non-interest income
  $ 1,304,481     $ 1,337,222     $ (32,741 )     -2.45 %   $ 2,517,266     $ 2,650,723     $ (133,457 )     -5.03 %
 
Total non-interest income decreased $32,741 for the second quarter of 2015 versus the same quarter last year and $133,457 for the first six months of 2015 versus the same period in 2014, with significant changes noted in the following:

Service fees declined a net 2.4% in the second quarter, including decreases of $21,578, or 11.6%, in overdraft fees and $11,611, or 16.8%, in paper statement fees as customers move to online banking, partially offset by an increase of $23,663, or 10.1%, in Visa interchange fee income.

Income from sold loans decreased $12,765 for the second quarter, or 4.9%, and $61,220, or 12.0%, for the year to date, which is attributable primarily to a decrease in secondary market loan sales in the first quarter of 2015 compared with 2014.

Other income from loans increased $64,367, or 52.7% for the second quarter 2015, as documentation fees on all loan types have improved compared with the same period a year ago.

Exchange income decreased $13,500, or 37.0%, for the second quarter, and $26,500, or 40.8%, for the six month period year over year due to the weakening Canadian dollar during 2015.

SERP fair value adjustment decreased $39,132, or 136.4% compared with the second quarter 2014 due to changes in equity markets.  For the six months ended June 30, 2015, the net adjustment was similar, with a decrease of $44,209 compared with the same period in 2014.

 
38

 
 
Non-interest Expense

The components of non-interest expense for the periods presented are as follows:

   
Three Months Ended
               
Six Months Ended
             
   
June 30,
   
Change
   
June 30,
   
Change
 
   
2015
   
2014
    $       %       2015       2014     $       %  
                                                         
Salaries and wages
  $ 1,683,200     $ 1,650,000     $ 33,200       2.01 %   $ 3,338,352     $ 3,300,000     $ 38,352       1.16 %
Employee benefits
    672,527       573,501       99,026       17.27 %     1,336,680       1,204,698       131,982       10.96 %
Occupancy expenses, net
    609,365       623,843       (14,478 )     -2.32 %     1,299,667       1,308,041       (8,374 )     -0.64 %
Other expenses
                                                               
  Computer outsourcing
    124,302       105,533       18,769       17.78 %     242,869       209,588       33,281       15.88 %
  Service contracts - administrative
    57,915       116,614       (58,699 )     -50.34 %     155,667       225,728       (70,061 )     -31.04 %
  Telephone expense
    78,572       82,479       (3,907 )     -4.74 %     159,713       163,718       (4,005 )     -2.45 %
  Loss on limited partnerships
    100,860       110,958       (10,098 )     -9.10 %     201,720       221,916       (20,196 )     -9.10 %
  Collection & non-accruing loan
                                                               
    expense
    41,005       (26,469 )     67,474       254.92 %     53,005       (4,826 )     57,831       1198.32 %
  OREO expense
    67,320       7,563       59,757       790.12 %     80,286       50,403       29,883       59.29 %
  Debit cards/ATM cards losses
    7,933       10,759       (2,826 )     -26.27 %     13,720       16,628       (2,908 )     -17.49 %
  ATM fees
    95,375       92,333       3,042       3.29 %     182,778       186,069       (3,291 )     -1.77 %
  State deposit tax
    137,905       135,794       2,111       1.55 %     275,695       271,063       4,632       1.71 %
  Other miscellaneous expenses
    1,103,561       894,540       209,021       23.37 %     2,136,416       1,825,660       310,756       17.02 %
     Total non-interest expense
  $ 4,779,840     $ 4,377,448     $ 402,392       9.19 %   $ 9,476,568     $ 8,978,686     $ 497,882       5.55 %
 
Total non-interest expense increased $402,392, or 9.2%, for the second quarter of 2015 compared to the same quarter in 2014 and $497,882, or 5.6%, for the first six months of 2015 compared to the same period in 2014 with significant changes noted in the following:

Salaries increased $33,200, or 2.0%, primarily as a result of severance cost accruals associated with the closure of two branch offices in July 2015.

Employee benefits increased $99,026, or 17.3%, due to group insurance premium increases of $60,649, and increased retirement account contributions of $32,874.  Employee benefits for the six months ended June 30, 2015 increased $131,982, or 10.9% year over year with similar increases.
 
 
Computer outsourcing increased $18,769, or 17.8%, for the quarter and $33,281, or 15.9%, year to date with the continued addition of services being performed by a third party.

Service contracts – administrative decreased $58,699, or 50.3%, for the quarter compared with the prior year due to the reallocation of certain occupancy related expenses.

Collection & non-accruing loan expense increased $57,831 during the first six months of 2015 compared with the prior year, as the bank had substantial recoveries in 2014 which offset expenses, and this has not occurred in 2015.

OREO expense in the second quarter of 2015 increased by $59,757 compared with the same period in 2014 due primarily to a write-down of $45,320 in the second quarter of 2015, with no write-down taken in the same period of the prior year.

Other miscellaneous expenses increased $209,021, or 23.4% in the second quarter, due primarily to the $110,850 increase in printing & supplies expense associated with the mandatory re-issuance of customer debit cards with enhanced security chip technology.  In addition, advertising expense increased $30,954 in the second quarter with upgrades to the bank’s website.

 
39

 
 
APPLICABLE INCOME TAXES

The provision for income taxes decreased $100,722, or 21.1% to $375,817 for the second quarter of 2015 compared to the second quarter of 2014, and $35,903, or 4.5%, for the first six months of 2015 compared to the first six months of 2014, with provisions of $771,320 and $807,223, respectively.  The decrease was primarily due to lower income before taxes. Income before taxes was $1,453,521 for the second quarter of 2015 compared to $1,760,925 for the second quarter of 2014 and $2,958,864 for the first six months of 2015 and $3,163,174 for the first six months of 2014.  Tax credits related to limited partnerships amounted to $107,928 and $128,130, respectively, for the second quarter of 2015 and 2014 and $215,856 and $256,260, respectively, for the first six months of 2015 and 2014.

Pursuant to Accounting Standards Update (ASU) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, effective December 15, 2014, losses related to limited partnership investments, are included as a component of tax expense and amounted to $100,860 and $110,958 for the second quarters of 2015 and 2014, respectively and $201,720 and $221,916 for the first six months of 2015 and 2014, respectively.  These investments provide tax benefits, including tax credits, and are designed to provide an effective yield between 8% and 10%.

Losses relating to the Company’s New Market Tax Credit (NMTC) investment are recorded as a separate component of tax expense and for the second quarter of 2015 amounted to $40,473 compared to $36,822 for the second quarter of 2014 and for the first six months of 2015 and 2014 amounted to $80,946 and $73,644, respectively.  The Company amortizes these investments under the effective yield method.

CHANGES IN FINANCIAL CONDITION

The following table reflects the composition of the Company's major categories of assets and liabilities as a percentage of total assets or liabilities and shareholders’ equity, as the case may be, as of the dates indicated:

   
June 30, 2015
   
December 31, 2014
   
June 30, 2014
 
Assets
                                   
 Loans
  $ 459,482,050       79.70 %   $ 447,804,955       76.32 %   $ 450,593,304       80.14 %
 Securities available-for-sale
    31,204,034       5.41 %     32,946,894       5.62 %     31,198,958       5.55 %
 Securities held-to-maturity
    25,738,769       4.46 %     41,810,945       7.13 %     22,966,558       4.08 %
                                                 
Liabilities
                                               
 Time deposits
  $ 105,657,746       18.33 %   $ 113,022,276       19.26 %   $ 125,834,609       22.38 %
 Savings deposits
    81,578,169       14.15 %     77,029,722       13.13 %     75,556,376       13.44 %
 Demand deposits
    84,396,417       14.64 %     88,758,469       15.13 %     81,327,974       14.46 %
 Interest-bearing transaction accounts
    111,758,309       19.39 %     125,388,872       21.37 %     104,820,943       18.64 %
 Money market accounts
    71,676,688       12.43 %     88,820,124       15.14 %     67,525,017       12.01 %
 Federal funds purchased
    0       0.00 %     0       0.00 %     2,915,000       0.52 %
 Short-term advances
    30,000,000       5.20 %     0       0.00 %     11,000,000       1.96 %
 Long-term advances
    0       0.00 %     0       0.00 %     6,000,000       1.07 %


The Company's loan portfolio at June 30, 2015 increased $11,677,095, or 2.6%, from December 31, 2014 and $8,888,746, or 2.0%, year over year.  These increases reflect continued strong commercial loan growth during the first six months of 2015 which has offset the continued decline in the residential loan portfolio.  The Company set goals to increase its commercial loan portfolio, and with the help of a seasoned commercial lending team with a strong presence in the small business community, these goals are becoming a reality.  Most of the growth in the commercial loan portfolio has occurred in the Company’s Washington County (Central Vermont) market.  Securities available-for-sale remained stable through the three periods reported, ending the second quarter essentially unchanged compared with the same period in 2014.  Securities held-to-maturity increased $2,772,211, or 12.1%, at June 30, 2015, compared with a year prior, and declined $16,072,176 compared to December 31, 2014 due to the maturity of municipal tax anticipation loans.  Held-to-maturity securities are made up of investments from the Company’s municipal customers in its service areas.  The decrease is cyclical in nature as June 30 is the end of the annual municipal finance cycle for school districts in Vermont.  Tax anticipation loans for fiscal year 2016 were funded on July 1, 2015, replenishing this asset class to a comparable level with the maturing securities.

Total deposits decreased $37,952,134, or 7.7%, from December 31, 2014 to June 30, 2015 and $2,410 or 0%, year over year.  The decrease compared with December 31, 2014 is primarily the result of municipal deposit runoff associated with the repayment of tax anticipation loans.  Time deposits decreased $7,364,530, or 6.5%, from December 31, 2014 to June 30, 2015 and $20,176,863, or 16.0%, year over year as retail customers continue to roll maturing funds into non-maturity deposits, and $10,000,000 of CDARS one way funds obtained in the first quarter of 2014 were not replaced at maturity.  As a result, savings deposits increased in both comparison periods, by $4,548,447 or 5.9% year to date, and $6,021,793, or 8.0%, year to year.  Demand deposits decreased $4,362,052, or 4.9%, during the second quarter of 2015, and increased $3,068,443, or 3.8%, year to year.  Short-term advances from the FHLBB totaling $30,000,000 were reported at June 30, 2015 compared to no borrowings at December 31, 2014 and $17,000,000 in combined short-term and long-term advances at June 30, 2014. This fluctuation is due to the seasonal outflow of municipal deposits and continued loan growth.
 
 
40

 

RISK MANAGEMENT

Interest Rate Risk and Asset and Liability Management - Management actively monitors and manages the Company’s 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 certain 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 at least quarterly 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 and periodically reviewed 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.  The ALCO Policy also includes a contingency funding plan to help management prepare for unforeseen liquidity restrictions, including hypothetical severe liquidity crises.

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.  Assumptions used in prior period simulation models are regularly tested by comparing projected NII with actual NII.  The ALCO utilizes the results of the 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.  The model also simulates the balance sheet’s sensitivity to a prolonged flat rate environment. All rate scenarios are simulated assuming a parallel shift of the yield curve; however further simulations are performed utilizing non-parallel changes in the yield curve.   The results of this sensitivity analysis are compared to the ALCO policy limits which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) shift upward and a 100 bp shift downward in interest rates.

Under the Company’s rate sensitivity modeling, in the current flat rate environment, NII levels are projected to be flat as the downward pressure on asset yields is projected to slow down as cash flow is replaced at equal yields.  Funding costs are expected to provide slight relief as longer-term time deposits mature and are replaced at current rates.  In a rising rate environment, NII is expected to trend upward as the short-term asset base (cash and adjustable rate loans) quickly cycle upward while the retail funding base (deposits) lags the market.  If rates paid on deposits have to be increased more and/or more quickly than projected, the expected benefit to rising rates would be reduced.  In a falling rate environment, NII is expected to trend in-line with the current rate environment scenario for the first year of the simulation as asset yield erosion is offset by decreasing funding costs.  Thereafter, net interest income is projected to experience sustained downward pressure as funding costs reach their assumed floors and asset yields continue to reprice into the lower rate environment.

The following table summarizes the estimated impact on the Company's NII over a twelve month period, assuming a gradual parallel shift of the yield curve beginning June 30, 2015:

Rate Change
Percent Change in NII
   
Down 100 basis points
-.60%
Up 200 basis points
5.70%

The amounts shown in the table are well within the ALCO Policy limits.  However, those amounts do not represent a forecast and should not be relied upon as indicative of future results.  While assumptions used in the ALCO process, including the interest rate simulation analyses, are developed based upon current economic and local market conditions, and expected future conditions, the Company cannot provide any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
 
 
41

 

Credit Risk - As a financial institution, one of the primary risks the Company manages is credit risk, the risk of loss stemming from borrowers’ failure to repay loans or inability to meet other contractual obligations.  The Company’s Board of Directors prescribes policies for managing credit risk, including Loan, Appraisal and Environmental policies.  These policies are supplemented by comprehensive underwriting standards and procedures.  The Company maintains a Credit Administration Department whose function includes credit analysis and monitoring of and reporting on the status of the loan portfolio, including delinquent and non-performing loan trends. The Company also monitors concentration of credit risk in a variety of areas, including portfolio mix, the level of loans to individual borrowers and their related interest, loans to industry segments, and the geographic distribution of commercial real estate loans. Loans are reviewed periodically by an independent loan review firm in order to assure accuracy of the Company's internal risk ratings and compliance with various internal policies and procedures and regulatory guidance.

As of June 30, 2015, the residential mortgage portfolio, consisting of first mortgages and junior liens, accounted for 44.8% of the Company’s loan portfolio, down from 47.5% a year ago, consistent with the Company’s strategy to grow the commercial loan portfolio.  The drop is also attributable to the late 2014 increase in long-term interest rates that brought to an end the large volume of refinance activity seen in recent years. Early 2015 saw mortgage rates decrease once again, spurring some refinance activity; home purchase activity is seeing a modest increase.  The Company originates and services a mortgage loan portfolio of traditional mortgage products and does not offer higher risk loan products such as option adjustable rate mortgage products, high loan-to-value products, interest only mortgages, subprime loans and products with deeply discounted teaser rates. Residential mortgages with loan-to-values exceeding 80% are generally covered by private mortgage insurance (PMI).  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 approximately 21% of the residential mortgage portfolio with maximum loan-to-value ratios, including senior liens, of 80%.

The Company’s strategy is to continue growing the commercial & industrial and commercial real estate portfolios. Consistent with the strategic focus on commercial lending, both segments saw solid growth during 2014 that has continued into 2015.  Commercial and commercial real estate loans together comprised 50.8% of the Company’s loan portfolio at June 30, 2014, growing to 51.6% at December 31, 2014 and 53.6% at June 30, 2015.  The increase in the size of the commercial loan portfolio has also increased geographic diversification, with much of the growth in commercial loans occurring in central Vermont and in Chittenden County.

Risk in the Company’s commercial & industrial and commercial real estate loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the U.S. Small Business Administration and U.S. Department of Agriculture (USDA) Rural Development. At June 30, 2015, the Company had $27,550,093 in guaranteed loans with guaranteed balances of $21,617,082, compared to $27,410,531 in guaranteed loans with guaranteed balances of $21,585,884 at December 31, 2014 and $24,725,030 in guaranteed loans with guaranteed balances of $19,491,555 at June 30, 2014.

The following table reflects the composition of the Company's loan portfolio, by portfolio segment, as a percentage of total loans as of the dates indicated:

   
June 30, 2015
   
December 31, 2014
   
June 30, 2014
 
                                     
Commercial & industrial
  $ 73,561,125       16.01 %   $ 64,390,220       14.38 %   $ 64,475,384       14.31 %
Commercial real estate
    172,565,221       37.56 %     166,611,830       37.21 %     164,302,843       36.46 %
1 - 4 family residential - 1st lien
    162,109,916       35.28 %     163,966,124       36.62 %     169,367,709       37.59 %
1 - 4 family residential - Jr lien
    43,816,552       9.53 %     44,801,483       10.00 %     44,564,026       9.89 %
Consumer
    7,429,236       1.62 %     8,035,298       1.79 %     7,883,342       1.75 %
     Total loans
    459,482,050       100.00 %     447,804,955       100.00 %     450,593,304       100.00 %
Deduct (add):
                                               
Allowance for loan losses
    5,095,212               4,905,874               4,876,816          
Deferred net loan costs
    (307,235 )             (303,394 )             (288,237 )        
      4,787,977               4,602,480               4,588,579          
      Net loans
  $ 454,694,073             $ 443,202,475             $ 446,004,725          
 
The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure. With the economic recovery continuing, the levels of both Group B (Management Involved) and Group C (Unacceptable Risk) loans (as defined in Note 5 to the Company’s unaudited interim consolidated financial statements) showed gradual improvement throughout 2012 and into 2013 and thus the loan loss reserve factors for trends in delinquency and non-accrual loans and criticized and classified loans were gradually decreased. However, qualitative factors were increased principally to account for growth in the commercial & industrial and commercial real estate segments of the loan portfolio.  During 2013 and into 2014, lower loan losses were offset by strong commercial loan volume, the deterioration of several commercial & industrial and commercial real estate loans and the migration of some past due residential loans to later stage delinquency, resulting in increases in the associated loan loss reserve qualitative factors.  Continued growth in the level of the loan loss reserve is attributable to gradual increases in both Group B and C loans during the first six months of 2015, as well as continued growth in the commercial & industrial and commercial real estate portfolios.
 
 
42

 

Commercial & industrial and commercial real estate loans are generally placed on 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. However, such a loan need not be placed on 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.  The Company obtains current property appraisals or market value analyses and considers the cost to carry and sell collateral in order to assess the level of specific allocations required. Consumer loans are generally not placed in non-accrual but are charged off by the time they reach 120 days past due. When a loan is placed in non-accrual status, the Company's policy is to reverse the accrued interest against current period income and to discontinue the accrual of interest until the borrower clearly demonstrates the ability and intention to resume normal payments, typically demonstrated by regular timely payments for a period of not less than six months.  Interest payments received on non-accrual or impaired loans are generally applied as a reduction of the loan principal balance.  Deferred taxes are calculated monthly, based on interest amounts that would have accrued through the normal accrual process.

The Company’s non-performing assets were relatively unchanged, increasing $146,264 or 2.2% during the first six months of 2015.  Several past due commercial & industrial and residential real estate loans were moved from accruing to non-accrual status, but these additions were more than offset by the resolution of several other problem loans.  Claims receivable on related government guarantees were $88,177 at June 30, 2015 compared to $365,147 at June 30, 2014, with numerous USDA and SBA claims settled and paid throughout the year.

The following table reflects the composition of the Company's non-performing assets, by portfolio segment, as a percentage of total non-performing assets as of the dates indicated:

   
June 30, 2015
   
December 31, 2014
   
June 30, 2014
 
                                     
Loans past due 90 days or more
                                   
 and still accruing
                                   
  Commercial & industrial
  $ 0       0.00 %   $ 23,579       0.36 %   $ 102,961       1.53 %
  Commercial real estate
    5,313       0.08 %     5,313       0.08 %     5,313       0.08 %
  Residential real estate - 1st lien
    528,211       7.93 %     980,138       15.04 %     231,085       3.43 %
  Residential real estate - Jr lien
    82,021       1.23 %     115,852       1.78 %     57,241       0.85 %
  Consumer
    8,987       0.13 %     0       0.00 %     17,927       0.27 %
     Total
    624,532       9.37 %     1,124,882       17.26 %     414,527       6.16 %
                                                 
Non-accrual loans (1)
                                               
  Commercial & industrial
    767,235       11.51 %     552,386       8.48 %     1,347,748       20.00 %
  Commercial real estate
    1,909,917       28.66 %     1,934,096       29.68 %     1,661,324       24.66 %
  Residential real estate - 1st lien
    1,927,300       28.93 %     1,263,046       19.38 %     1,943,475       28.84 %
  Residential real estate - Jr lien
    311,571       4.68 %     404,061       6.20 %     453,304       6.73 %
     Total
    4,916,023       73.78 %     4,153,589       63.74 %     5,405,851       80.23 %
                                                 
Other real estate owned
    1,122,500       16.85 %     1,238,320       19.00 %     916,820       13.61 %
                                                 
     Total
  $ 6,663,055       100.00 %   $ 6,516,791       100.00 %   $ 6,737,198       100.00 %

(1)  No consumer loans were in non-accrual status as of the consolidated balance sheet dates.  In accordance with Company policy, delinquent consumer loans are charged off at 120 days past due.
 
As of June 30, 2015, the Company is contractually committed to lend up to $450,000 in additional funds to one debtor with an impaired SBA guaranteed cap line of credit; that debtor’s loan relationship is expected to strengthen as a result of a prior troubled debt restructuring.  With this exception, as of the balance sheet dates, the Company was not contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans.
 
 
43

 

The Company’s Troubled Debt Restructurings (TDRs) are principally a result of extending loan repayment terms to relieve cash flow difficulties. The Company has only infrequently reduced interest rates for borrowers below the current market rate. The Company has not forgiven principal or reduced accrued interest within the terms of original restructurings.  Management evaluates each TDR situation on its own merits and does not foreclose the granting of any particular type of concession. The Non-Performing Assets table above includes 21 TDRs totaling $2,642,536 that were past due 90 days or more or in non-accrual status as of June 30, 2015, compared to 12 TDRs totaling $1,777,463 as of December 31, 2014 and 15 TDRs totaling $2,021,140 as of June 30, 2014.  The remainder of the Company’s TDRs consist of 19 residential mortgage loans, one home equity loan, one commercial real estate loan and one commercial & industrial loan totaling $1,967,437 at June 30, 2015 compared to 18 residential mortgage loans and one commercial real estate loan totaling $1,740,246 at December 31, 2014 and 14 residential mortgage loans and one commercial real estate loan totaling $1,214,617 at June 30, 2014.

The Company’s OREO portfolio at June 30, 2015 consisted of four residential properties and one commercial property compared to four residential properties and one commercial property at December 31, 2014 and three residential properties and one commercial property at June 30, 2014.  All properties were acquired through the normal foreclosure process or by deed-in-lieu of foreclosure.  The Company sold two of the residential properties with balances totaling $70,500 which were taken into the portfolio during the fourth quarter of 2014 and one residential property with a balance of $70,500 that the Company took control of during the first three months of 2015.  The Company recorded a write-down of $45,320 on one of the residential properties resulting in a decrease of $115,820 in its OREO portfolio, to end the first six months of 2015 at $1,122,500.

Allowance for loan losses and provisions - The Company maintains an allowance for loan losses (allowance) at a level that management believes is appropriate to absorb losses inherent in the loan portfolio as of the measurement date (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 to absorb losses from any particular loan or segment of loans.

When establishing the allowance each quarter the Company applies a combination of historical loss factors and qualitative factors to loan segments, including residential first and junior lien mortgages, commercial real estate, commercial & industrial, and consumer loan 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. The highest loss rates experienced for the look back period are applied to the various segments in establishing the allowance.

The reserve methodology was modified during the quarter ending June 30, 2015 to eliminate using the higher of the  1999-2001 losses as compared to current losses, by eliminating use of the 1999-2001 period.  The 1999-2001 information has become dated and the bank’s credit portfolio management has evolved during that time.  The revised methodology now considers the highest annual loss rates for the most recent one to five year look back periods for each segment of the portfolio.  This change resulted in a reduction to required reserves of $529,234.

The Company applies numerous qualitative factors to each segment 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.  Adjustments were made to the commercial and commercial real estate qualitative factors to adjust for the impact of the change in methodology, principally in the area of loan growth, loan policy, and delinquency factors.  The commercial and commercial real estate factors were each increased a total of 10 basis points, amounting to increases of $171,000 and $70,000 respectively.  The unallocated reserve increased from $197,939 at March 31, 2015 to $455,117 at June 30, 2015.  While unallocated reserves have increased, they are considered by management to be appropriate in light of the Company’s continued growth strategy and shift in the portfolio from residential loans to commercial and commercial real estate loans and the risk associated with the relatively new, unseasoned loans in those portfolios.

The adequacy of the allowance is reviewed quarterly by the risk management committee of the Board of Directors and then presented to the full Board of Directors for approval.

 
44

 

The following table summarizes the Company's loan loss experience for the periods presented:

   
As of or for the six months ended June 30,
 
   
2015
   
2014
 
             
Loans outstanding, end of period
  $ 459,482,050     $ 450,593,304  
Average loans outstanding during period
  $ 453,180,622     $ 448,006,236  
Non-accruing loans, end of period
  $ 4,916,023     $ 5,405,851  
Non-accruing loans, net of government guarantees
  $ 4,140,634     $ 4,449,212  
                 
Allowance, beginning of period
  $ 4,905,874     $ 4,854,915  
Loans charged off:
               
  Commercial & industrial
    (35,059 )     (87,214 )
  Commercial real estate
    0       (130,819 )
  Residential real estate - 1st lien
    (94,575 )     0  
  Residential real estate - Jr lien
    (20,199 )     0  
  Consumer loans
    (28,105 )     (65,769 )
       Total loans charged off
    (177,938 )     (283,802 )
Recoveries(1):
               
  Commercial & industrial
    42,913       2,236  
  Residential real estate - 1st lien
    6,042       11,098  
  Residential real estate - Jr lien
    120       120  
  Consumer loans
    18,201       22,249  
        Total recoveries
    67,276       35,703  
Net loans charged off
    (110,662 )     (248,099 )
Provision charged to income
    300,000       270,000  
Allowance, end of period
  $ 5,095,212     $ 4,876,816  
                 
Net charge offs to average loans outstanding
    0.024 %     0.055 %
Provision charged to income as a percent of average loans
    0.066 %     0.060 %
Allowance to average loans outstanding
    1.124 %     1.089 %
Allowance to non-accruing loans
    103.645 %     90.214 %
Allowance to non-accruing loans net of government guarantees
    123.054 %     109.611 %

(1)  No commercial real estate recoveries were recorded during the periods presented in the table above.

The Company increased its provision during the first six months of 2015, resulting in a provision of $300,000 for the six months ended June 30, 2015 compared to $270,000 for the same period in 2014, an increase of $30,000 or 11.1%.  The increase in the provision is principally related to loan portfolio growth and the strategic increase in commercial and commercial real estate lending.  The Company’s allowance coverage of non-accruing loans as of the end of the first six months of 2015 reflected an increase year over year as did the coverage of non-accruing loans net of government guarantees, and remain within the historical ranges for their respective coverages.  The Company has an experienced collections department that continues to work actively with borrowers to resolve problem loans and manage the OREO portfolio, and management continues to monitor the loan portfolio closely.

Specific allocations to the allowance are made for certain impaired loans. Impaired loans include loans to a borrower that in aggregate are greater than $100,000 and that are in non-accrual status or are current year troubled debt restructurings. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including interest and principal, according to the contractual terms of the loan agreement. The Company will review all the facts and circumstances surrounding non-accrual loans and on a case-by-case basis may consider loans below the threshold as impaired when such treatment is material to the financial statements.  See Note 5 to the accompanying unaudited interim consolidated financial statements for information on the recorded investment in impaired loans and their related allocations.

The portion of the allowance termed "unallocated" is established to absorb inherent losses that exist as of the measurement date although not specifically identified through management's process for estimating credit losses.  While the allowance is described as consisting of separate allocated portions, the entire allowance is available to support loan losses, regardless of category.
 
 
45

 

Market Risk - In addition to credit risk in the Company’s loan portfolio and liquidity risk in its loan and deposit-taking operations, 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.  Declining capital markets can result in fair value adjustments necessary to record decreases in the value of the investment portfolio for other-than-temporary-impairment.  The Company does not have any market risk sensitive instruments acquired for trading purposes.  The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. 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 prolonged weak economy and disruption in the financial markets in recent years may heighten the Company’s market risk.  As discussed above under "Interest Rate Risk and Asset and Liability Management", the Company actively monitors and manages its interest rate risk through the ALCO process.

COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET ARRANGEMENTS

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.  These financial instruments include commitments to extend credit, standby letters of credit and risk-sharing commitments on certain sold loans.  Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. During the first six months of 2015, 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 whose contract amount represents credit risk were as follows:

   
Contract or Notional Amount
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Unused portions of home equity lines of credit
  $ 25,416,274     $ 23,519,696  
Other commitments to extend credit
    69,517,819       59,558,700  
Residential construction lines of credit
    2,142,349       2,308,167  
Commercial real estate and other construction lines of credit
    16,336,436       15,894,462  
Standby letters of credit and commercial letters of credit
    1,989,059       1,714,382  
Recourse on sale of credit card portfolio
    249,700       265,650  
MPF credit enhancement obligation, net of liability recorded
    1,025,202       1,007,250  
 
Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company sold its credit card portfolio during the third quarter of 2007, but retained a partial recourse obligation under the terms of the sale, based on total lines, not balances outstanding.  Based on historical losses, the Company does not expect any significant losses from this commitment.

In connection with its 2007 trust preferred securities financing, the Company guaranteed the payment obligations under the $12,500,000 of capital securities of its subsidiary, CMTV Statutory Trust I.  The source of funds for payments by the Trust on its capital securities is payments made by the Company on its debentures issued to the Trust.  The Company's obligation under those debentures is fully reflected in the Company's balance sheet, in the gross amount of $12,887,000 for each of the comparison periods, of which $12,500,000 represents external financing through the issuance to investors of capital securities by CMTV Statutory Trust I.

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 from funding requirements for 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.
 
 
46

 

The Company recognizes that, at times, when loan demand exceeds deposit growth or the Company has other liquidity demands, it may be desirable to utilize alternative sources of deposit funding to augment retail deposits and borrowings.  One-way deposits purchased through the CDARS program provide an alternative funding source when needed.  Such deposits are generally considered a form of brokered deposits.  At June 30, 2015 and December 31, 2014, the Company did not have any one way CDARS outstanding, compared with $8,727,500 at June 30, 2014.  In addition, two-way CDARS deposits allow the Company to provide Federal Deposit Insurance Corporation (FDIC) deposit insurance to its customers in excess of account coverage limits by exchanging deposits with other CDARS members.  At June 30, 2015, the Company reported $2,769,581 in two-way CDARS deposits representing exchanged deposits with other CDARS participating banks, compared to $1,103,008 at December 31, 2014 and $1,108,246 at June 30, 2014.  The balance in insured cash sweep (ICS) reciprocal money market deposits was $12,255,211 at June 30, 2015, compared to $18,943,667 at December 31, 2014 and $17,043,076 at June 30, 2014.

The Company has a Borrower-in-Custody (BIC) arrangement with the FRBB secured by eligible commercial loans, commercial real estate loans and home equity loans, resulting in an available credit line of $87,450,601, $78,580,859, and $77,988,919, respectively, at June 30, 2015, December 31, 2014 and June 30, 2014.  Credit advances in this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 75 basis points.  The Company had no outstanding advances against this credit line during any of the periods presented.

The Company has an unsecured Federal Funds credit line with the FHLBB with an available balance of $500,000 at June 30, 2015, December 31, 2014 and June 30, 2014.  Interest is chargeable at a rate determined daily, approximately 25 basis points higher than the rate paid on federal funds sold.  In addition, at June 30, 2015, December 31, 2014 and June 30, 2014, additional borrowing capacity of approximately $73,238,055, $67,136,178 and $70,071,212, respectively, was available through the FHLBB, secured by the Company's qualifying loan portfolio (generally, residential mortgage loans).

The Company has unsecured credit lines with two of its correspondent banks with available lines of $7,500,000 at June 30, 2015, December 31, 2014 and June 30, 2014.  There were no outstanding advances against either of these lines during any of the respective comparison periods.
 
 
47

 
 
The following table reflects the Company’s outstanding FHLBB advances against the respective lines as of the dates indicated:

   
June 30,
   
December 31,
   
June 30,
 
   
2015
   
2014
   
2014
 
Long-Term Advances
                 
FHLBB term borrowing, 0.23% fixed rate, due August 29, 2014
  $ 0     $ 0     $ 6,000,000  
                         
Short-Term Advances
                       
FHLBB term advances, 0.24% and 0.19% fixed rate, due
    10,000,000       0       6,000,000  
 July 31, 2015 and July 7, 2014, respectively
                       
FHLBB term advances, 0.24% and 0.23% fixed rate, due
    10,000,000       0       5,000,000  
 August 28, 2015 and September 26, 2014, respectively
                       
FHLBB term advance, 0.24% fixed rate, due September 30, 2015
    10,000,000       0       0  
      30,000,000       0       11,000,000  
Overnight Borrowings
                       
Federal funds purchased (FHLBB), 0.3125%
    0       0       2,915,000  
                         
     Total Advances and Overnight Borrowings
  $ 30,000,000     $ 0     $ 19,915,000  
 
The following table illustrates the changes in shareholders' equity from December 31, 2014 to June 30, 2015:

Balance at December 31, 2014 (book value $9.43 per common share)
  $ 48,995,202  
    Net income
    2,187,544  
    Issuance of stock through the Dividend Reinvestment Plan
    472,916  
    Dividends declared on common stock
    (1,581,145 )
    Dividends declared on preferred stock
    (40,625 )
    Change in unrealized loss on available-for-sale securities, net of tax
    7,301  
Balance at June 30, 2015 (book value $9.57 per common share)
  $ 50,041,193  

 
The primary objective of the Company’s capital planning process is to balance appropriately the retention of capital to support operations and future growth, with the goal of providing shareholders an attractive return on their investment.  To that end, management monitors capital retention and dividend policies on an ongoing basis.

As described in more detail in the Company’s 2014 Annual Report on Form 10-K in Note 20 to the audited consolidated financial statements contained therein and under the caption “LIQUIDITY AND CAPITAL RESOURCES” in the Management’s Discussion and Analysis section of such report, the Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies pursuant to which they must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items.   Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

As of June 30, 2015, the Bank was considered well capitalized under the regulatory capital framework for Prompt Corrective Action and the Company exceeded all applicable consolidated regulatory capital guidelines.

 
48

 

The following table shows the Company’s actual capital ratios and those of its subsidiary, as well as applicable regulatory capital requirements, as of June 30, 2015 and December 31, 2014:
 
     
Minimum
   
Minimum
To Be Well
   
For Capital
Capitalized Under
   
Adequacy
Prompt Corrective
 
Actual
Purposes:
Action Provisions(1):
  Amount Ratio  Amount Ratio Amount Ratio
 
(Dollars in Thousands)
June 30, 2015
 
Common equity tier I capital (to risk-weighted assets)
 
   Company
  $ 51,004       12.18 %   $ 18,849       4.50 %     N/A       N/A  
   Bank
  $ 50,314       12.03 %   $ 18,826       4.50 %   $ 27,193       6.50 %
                                                 
Tier I capital (to risk-weighted assets)
                                               
   Company
  $ 51,004       12.18 %   $ 25,132       6.00 %     N/A       N/A  
   Bank
  $ 50,314       12.03 %   $ 25,101       6.00 %   $ 33,468       8.00 %
                                                 
Total capital (to risk-weighted assets)
                                               
   Company
  $ 56,220       13.42 %   $ 33,509       8.00 %     N/A       N/A  
   Bank
  $ 55,453       13.26 %   $ 33,468       8.00 %   $ 41,835       10.00 %
                                                 
Tier I capital (to average assets)
                                               
   Company
  $ 51,004       8.93 %   $ 22,847       4.00 %     N/A       N/A  
   Bank
  $ 50,314       8.82 %   $ 22,829       4.00 %   $ 28,536       5.00 %
 
   
December 31, 2014:
 
   
Tier I capital (to risk-weighted assets)
                                   
   Company
  $ 49,071       12.31 %   $ 15,949       4.00 %     N/A       N/A  
   Bank
  $ 48,952       12.30 %   $ 15,924       4.00 %   $ 23,886       6.00 %
                                                 
Total capital (to risk-weighted assets)
                                               
   Company
  $ 54,447       13.66 %   $ 31,897       8.00 %     N/A       N/A  
   Bank
  $ 53,902       13.54 %   $ 31,847       8.00 %   $ 39,809       10.00 %
                                                 
Tier I capital (to average assets)
                                               
   Company
  $ 49,071       8.62 %   $ 22,768       4.00 %     N/A       N/A  
   Bank
  $ 48,952       8.61 %   $ 22,745       4.00 %   $ 28,431       5.00 %

(1)  Applicable to banks, but not bank holding companies.

As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC, the FRB and the Office of the Comptroller of the Currency (OCC) issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes.  The rules revise minimum capital requirements and adjust prompt corrective action thresholds. The final rules revise the regulatory capital elements, add a new common equity Tier 1 capital ratio, increase the minimum Tier 1 ratio requirements and implement a new capital conservation buffer.  The rules also permit certain banking organizations to retain, through a one-time election, the existing regulatory treatment for accumulated other comprehensive income.  The Company and the Bank have made the election to retain the existing regulatory treatment for accumulated other comprehensive income.  The final rules took effect for the Company and the Bank on January 1, 2015, subject to a transition period for certain parts of the rules.

The table above includes the new regulatory capital ratio requirements that became effective on January 1, 2015.  Beginning in 2016, an additional capital conservation buffer will be added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period.  The capital conservation buffer will be fully phased-in on January 1, 2019 at 2.5 percent.  A banking organization with a conservation buffer of less than 2.5 percent (or the required phase-in amount in years prior to 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers.  As of June 30, 2015, on a pro forma basis both the Company and the Bank would be compliant with the fully phased-in capital conservation buffer requirement.
 
 
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The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company.  In general, a national bank may not pay dividends that exceed net income for the current and preceding two years regardless of statutory restrictions, as a matter of regulatory policy, banks and bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, they remain adequately capitalized.

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". “COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET ARRANGEMENTS” and “LIQUIDITY & CAPITAL RESOURCES”, 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 2014 Annual Report on Form 10-K.

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 June 30, 2015, 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 June 30, 2015 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 June 30, 2015 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.

 
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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 June 30, 2015, by the Company and by any affiliated purchaser (as defined in SEC Rule 10b-18):

   
  Total Number
of Shares Purchased(1)(2)
   
 Average
Price Paid
Per Share
     Total Number of Shares Purchased as Part of Publicly Announced Plan     Maximum Number of Shares That May Yet Be Purchased Under the Plan at the End of the Period  
                 
                 
                 
For the period:
               
                         
April 1 - April 30
    0     $ 0.00       N/A       N/A  
May 1 - May 30
    0       0.00       N/A       N/A  
June 1 - June 30
    1,050       14.40       N/A       N/A  
     Total
    1,050     $ 14.40       N/A       N/A  

(1)  All 1,050 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*

Exhibit 101--
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in eXtensible Business Reporting Language (XBRL): (i) the unaudited consolidated balance sheets, (ii) the unaudited consolidated statements of income for the three month and six month interim periods ended June 30, 2015 and 2014, (iii) the unaudited consolidated statements of comprehensive income, (iv) the unaudited consolidated statements of cash flows and (v) related notes.

*  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 Exchange Act of 1934.

 
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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:  August 13, 2015
/s/ Stephen P. Marsh                    
 
 
Stephen P. Marsh, Chairman, President
 
 
& Chief Executive Officer
 
     
DATED:  August 13, 2015
/s/ Louise M. Bonvechio                
 
 
Louise M. Bonvechio,  Treasurer
 
 
(Principal Financial Officer)
 

 
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