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 1934For the Quarterly Period Ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to
Commission File Number 000-16435
COMMUNITY BANCORP.
Vermont
03-0284070
(State of Incorporation)
(IRS Employer Identification Number)
4811 US Route 5, Derby, Vermont
05829
(Address of Principal Executive Offices)
(zip code)
Registrant's Telephone Number: (802) 334-7915
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file for such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ( X ) No ( )
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
At August 10, 2005, there were 4,055,299 shares outstanding of the Corporation's common stock.
Table of Contents
Page
PART I FINANCIAL INFORMATION
Item I
4
Item 2
10
Item 3
21
Item 4
PART II OTHER INFORMATION
Item 1
22
Item 6
Signatures
23
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
The following are the consolidated financial statements for Community Bancorp. and Subsidiary, "the Company".
COMMUNITY BANCORP. AND SUBSIDIARY
Consolidated Balance Sheets
June 30
December 31
2005
2004
(Unaudited)
Assets
Cash and due from banks
$
8,626,094
8,390,806
12,529,172
Federal funds sold and overnight deposits
74,085
0
3,518,537
Total cash and cash equivalents
8,700,179
16,047,709
Securities held-to-maturity (fair value $18,387,000 at 06/30/05,
$31,587,658 at 12/31/04 and $21,522,492 at 06/30/04)
18,325,736
31,579,178
21,452,759
Securities available-for-sale
42,829,839
51,150,344
49,994,886
Restricted equity securities, at cost
3,015,750
2,315,450
2,310,650
Loans held-for-sale
868,597
1,833,397
1,509,863
Loans
233,864,129
227,799,788
206,914,372
Allowance for loan losses
(2,170,363
)
(2,153,372
(2,254,308
Unearned net loan fees
(695,466
(763,774
(774,697
Net loans
230,998,300
224,882,642
203,885,367
Bank premises and equipment, net
9,422,202
8,057,120
7,763,600
Accrued interest receivable
1,524,401
1,652,827
1,435,856
Other real estate owned, net
82,800
Other assets
4,765,294
4,891,930
4,135,774
Total assets
320,450,298
334,836,494
308,619,264
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand, non-interest bearing
44,801,154
42,725,604
39,011,142
NOW and money market accounts
68,872,277
94,502,798
67,205,425
Savings
47,233,747
47,288,161
46,681,757
Time deposits, $100,000 and over
22,651,208
21,804,521
21,968,820
Other time deposits
75,985,336
76,284,787
77,944,749
Total deposits
259,543,722
282,605,871
252,811,893
Federal funds purchased and other borrowed funds
17,899,000
6,407,000
13,380,000
Repurchase agreements
12,558,291
14,907,518
11,873,549
Accrued interest and other liabilities
1,955,273
2,872,659
3,033,139
Total liabilities
291,956,286
306,793,048
281,098,581
Shareholders' Equity
Common stock - $2.50 par value; 6,000,000 shares authorized
and 4,254,402 shares issued at 06/30/05, 4,037,548 shares
issued at 12/31/04 and 4,014,349 shares issued at 06/30/04
10,636,004
10,093,871
10,035,873
Additional paid-in capital
20,967,782
17,778,605
17,459,952
Retained (deficit) earnings
(387,121
2,776,011
2,260,788
Accumulated other comprehensive loss
(283,453
(168,679
(1,544
Less: treasury stock, at cost; 198,609 shares at 06/30/05, 198,444
shares at 12/31/04, and 185,938 shares at 06/30/04
(2,439,200
(2,436,362
(2,234,386
Total shareholders' equity
28,494,012
28,043,446
27,520,683
Total liabilities and shareholders' equity
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Income
( Unaudited )
For The Second Quarter Ended June 30,
Interest income
Interest and fees on loans
3,752,190
3,369,169
Interest on debt securities
Taxable
376,879
521,559
Tax-exempt
259,420
269,598
Dividends
31,746
12,337
Interest on federal funds sold and overnight deposits
1,713
4,475
Total interest income
4,421,948
4,177,138
Interest expense
Interest on deposits
1,122,531
1,117,351
Interest on borrowed funds
148,798
80,307
Interest on repurchase agreements
47,582
28,607
Total interest expense
1,318,911
1,226,265
Net interest income
3,103,037
2,950,873
Provision for loan losses
37,500
34,000
Net interest income after provision
3,065,537
2,916,873
Non-interest income
Service fees
304,902
354,182
Security gains
18,631
Other income
491,401
511,339
Total non-interest income
796,303
884,152
Non-interest expense
Salaries and wages
1,134,134
1,034,579
Pension and other employee benefits
408,644
340,161
Occupancy expenses, net
497,646
519,013
Other expenses
913,311
883,346
Total non-interest expense
2,953,735
2,777,099
Income before income taxes
908,105
1,023,926
Applicable income taxes
151,061
204,725
Net Income
757,044
819,201
Earnings per share on weighted average
$0.19
$0.20
Weighted average number of common shares
used in computing earnings per share
4,047,504
4,009,254
Dividends declared per share
$0.17
$0.16
Book value per share on shares outstanding at June 30,
$7.03
$6.85
All per share data for prior periods have been restated to reflect a 5% stock dividend declared in May 2005.
For The Six Months Ended June 30,
7,445,551
6,682,771
786,728
1,114,698
484,884
510,412
57,947
20,953
4,001
9,405
8,779,111
8,338,239
2,159,579
2,269,686
257,802
153,637
81,416
58,762
2,498,797
2,482,085
6,280,314
5,856,154
75,000
85,000
6,205,314
5,771,154
590,456
601,148
900,436
927,582
1,490,892
1,547,361
2,272,605
2,065,336
813,308
717,028
1,011,553
1,013,433
1,808,084
1,721,741
5,905,550
5,517,538
1,790,656
1,800,977
303,471
217,934
1,487,185
1,583,043
$0.37
$0.40
4,041,566
3,999,987
$0.33
$0.32
Consolidated Statements of Cash Flows
For the Six Months Ended June 30,
Reconciliation of Net Income to Net Cash Provided by Operating Activities:
Adjustments to Reconcile Net Income to Net Cash Provided by Operating
Activities:
Depreciation and amortization
382,887
387,960
Provision (credit) for deferred income taxes
73,877
( 25,411
Net gain on sale of loans
( 181,526
( 230,173
Gain on sale of fixed assets
8,507
Net gain on sale of securities
( 18,631
Gains on sales of other real estate owned
( 7,710
( 6,314
(Gain) loss on Trust LLC
( 7,526
11,762
Amortization of bond premium, net
142,769
234,724
Proceeds from sales of loans held for sale
12,933,412
19,964,766
Originations of loans held for sale
( 11,787,086
( 18,991,305
(Decrease) increase in taxes payable
( 247,555
201,257
Decrease in interest receivable
128,426
240,334
Increase in mortgage servicing rights
( 78,353
( 103,105
(Increase) decrease in other assets
( 111,183
122,165
Decrease in unamortized loan fees
( 68,308
( 30,587
Increase (decrease) in interest payable
74,349
( 27,572
Increase (decrease) in accrued expenses
41,936
( 383,041
(Decrease) increase in other liabilities
( 35,957
12,296
Net cash provided by operating activities
2,823,144
3,027,168
Cash Flows from Investing Activities:
Investments - held to maturity
Maturities and paydowns
19,647,449
31,502,073
Purchases
( 6,390,171
( 11,410,436
Investments - available for sale
Sales and maturities
9,000,000
11,038,770
( 1,000,000
( 5,680,000
Purchase of restricted equity securities
( 700,300
( 953,800
Investment in limited partnership, net
( 474,299
( 292,118
Increase in loans, net
( 6,166,023
( 2,770,261
Capital expenditures, net
( 1,756,476
( 336,637
Proceeds from sales of other real estate owned
100,510
39,678
Recoveries of loans charged off
33,673
75,812
Net cash provided by investing activities
12,294,363
21,213,081
Cash Flows from Financing Activities:
Net decrease in demand, NOW, money market and savings accounts
( 23,609,385
( 25,016,820
Net increase (decrease) in certificates of deposit
547,236
( 1,850,546
Net decrease in short-term borrowings and repurchase agreements
( 2,349,227
( 143,021
Net increase in borrowed funds and federal funds purchased
11,492,000
5,340,000
Payments to acquire treasury stock
( 2,838
( 49,881
Dividends paid
( 885,920
( 844,182
Net cash used in financing activities
( 14,808,134
( 22,564,450
Net increase in cash and cash equivalents
309,373
1,675,799
Cash and cash equivalents:
Beginning
14,371,910
Ending
Supplemental Schedule of Cash Paid During the Period
Interest
2,424,448
2,509,657
Income taxes
525,000
42,088
Supplemental Schedule of Noncash Investing and Financing Activities:
Change in unrealized gain on securities available-for-sale
( 173,900
( 769,015
Other real estate owned acquired in settlements of loans
10,000
27,887
Investments in limited partnerships
Decrease in limited partnerships
169,500
149,801
Decrease in contributions payable
( 643,799
( 441,919
Dividends Paid
Dividends declared
1,339,986
1,294,125
Increase in dividends payable attributable to dividends declared
( 36,911
( 4,106
Dividends reinvested
( 417,155
( 445,837
885,920
844,182
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION AND CONSOLIDATION
The interim consolidated financial statements of Community Bancorp. and Subsidiary are unaudited. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments necessary for fair presentation of the financial condition and results of operations of the Company contained herein have been made. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2004, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
NOTE 2. 5% STOCK DIVIDEND
In May 2005, the Company declared a 5% stock dividend payable July 1, 2005 to shareholders of record as of June 15, 2005. As a result of this stock dividend, all per share data for prior periods have been restated.
NOTE 3. RECENT ACCOUNTING DEVELOPMENTS
Any accounting developments announced during the first six months of 2005 were not applicable, thereby requiring no disclosure by the Company.
Earnings per common share amounts are computed based on the weighted average number of shares of common stock issued during the period (retroactively adjusted for stock splits and stock dividends) and reduced for shares held in Treasury.
NOTE 5. COMPREHENSIVE INCOME
Accounting principles generally require recognized revenue, expenses, gains, and losses to be included in net income. Certain changes in assets and liabilities, such as the after-tax effect of unrealized gains and losses on available-for-sale securities, are not reflected in the income statement, but the cumulative effect of such items from period-to-period is reflected as a separate component of the equity section of
The Company's total comprehensive income for the comparison period is calculated as follows:
For the second quarter ended June 30,
Other comprehensive income, net of tax:
Change in unrealized holdings gains (losses) on available-for-sale
securities arising during the period
210,289
(1,120,082
Reclassification adjustment for gains (losses) realized in income
(18,631
Net unrealized gains (losses)
(1,138,713
Tax effect
(71,498
387,163
Other comprehensive income (loss), net of tax
138,791
(751,550
Total comprehensive income
895,835
67,651
For the six months ended June 30,
(173,900
(750,384
Net unrealized losses
(769,015
59,126
261,465
Other comprehensive loss, net of tax
(114,774
(507,550
1,372,411
1,075,493
TableofContents
NOTE 6. INCOME TAXES
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 OPERATIONSfor the Period Ended June 30, 2005
FORWARD-LOOKING STATEMENTS
The Company's Management's Discussion and Analysis of Financial Condition and Results of Operations may contain certain forward-looking statements about the Company's operations, financial condition and business. When used therein, the words "believes," "expects," "anticipates," "intends," "estimates," "plans," "predicts," or similar expressions, indicate that management of the Company is making forward-looking statements.
Forward-looking statements are not guarantees of future performance. They necessarily involve risks, uncertainties and assumptions. Future results of the Company may differ materially from those expressed in these forward-looking statements. Examples of forward looking statements included in this discussion include, but are not limited to, management's expectations as to future asset growth, income trends, results of operations and other matters reflected in the Overview section, estimated contingent liability related to the Company's participation in the Federal Home Loan Bank (FHLB) Mortgage Partnership Finance (MPF) program, assumptions made within the asset/liability management process, and management's expectations as to the future interest rate environment and the Company's related liquidity level. Although these statements are based on management's current expectations and estimates, many of the factors that could influence or determine actual results are unpredictable an d not within the Company's control. Readers are cautioned not to place undue reliance on such statements as they speak only as of the date they are made. The Company claims the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995.
Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities: (1) competitive pressures increase among financial services providers in the Company's northern New England market area or in the financial services industry generally, including competitive pressures from nonbank financial service providers, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; (2) interest rates change in such a way as to reduce the Company's margins; (3) general economic or monetary conditions, either nationally or regionally, are less favorable than expected, resulting in a deterioration in credit quality or a diminished demand for the Company's products and services; and (4) changes in laws or government rules, or the way in which courts interpret those laws or rules, adversely affect the Company's business.
The following Management's Discussion and Analysis explains in detail the results of the second quarter and first six months of 2005.
Net Income was down for the first half of 2005 as compared to 2004 by $95,858.This decline reflects the effect of a $116,540 capital loss recognized for tax purposes in 2004, resulting from the sale of our inactive bank franchise in New Hampshire. Without this transaction, earnings would have been higher in 2005 compared to 2004.
In May 2005 the Company declared a 5% stock dividend to be paid in the third quarter of 2005, which required a charge to retained earnings for accounting purposes, resulting in negative retained earnings at June 30, 2005. All per share data for prior periods have been restated to reflect this stock dividend.
Net interest income for the first six months of 2005 was $152,164 over net interest income for the first six months of 2004, however the flattening yield curve will continue to put pressure on our spreads. Short-term interest rates, which affect our deposit rates, continue to rise, but the long-term rates, which affect our lending rates, have stayed relatively flat. We expect this phenomenon to continue until some expectation of inflation introduces itself to the U.S. economy, thus driving long-term rates upward and creating a steepening yield curve.
Total assets grew from June 30, 2004 to June 30, 2005 by $11,831,034, but fell from December 31, 2004 levels by $14,386,196. This loss of assets as of June 30 each year is typical of our cyclical growth pattern. Many of our municipal loans mature at the end of June and likely renew during the first weeks of the third quarter. This year, approximately $22,000,000 of municipal loans matured at the end of June, and at this time we have the same amount expected to close by August 15, 2005.
Non-interest income was down year to date as compared to the first half of 2004 by $56,469. Service fees on deposit accounts are down by $10,692 as more people maintain sufficient balances to avoid service fees and over-draft fees. We had no security gains this year, and other income was down by $27,146. Non-interest expense increased by $388,012 this first half compared to last year. All of the recent corporate scandals such as Enron and the resulting Sarbanes Oxley Act have resulted in dramatic increases in the cost of regulation, particularly in legal and audit fees. An increase in staff required to report to the regulators has also increased the cost of doing business. We have also experienced higher losses due to the fraudulent use of our customers' debit cards.
The following pages describe the financial results of our second quarter and the first six months of 2005 in much more detail. Please take the time to read them to more fully understand those results in relation to the 2004 three month and six month comparison periods. The discussion below should be read in conjunction with the Consolidated Financial Statements of the Company and related notes. This report includes forward-looking statements within the meaning of the Securities and Exchange Act of 1934 (the "Exchange Act").
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared according to accounting principles generally accepted in the United States of America. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities in the consolidated financial statements and related notes. The Securities and Exchange Commission (SEC) has defined a company's critical accounting policies as the ones that are most important to the portrayal of the Company's financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Because of the significance of these estimates and assumptions, there is a high likelihood that materially different amounts would be reported for the Company under different conditions or using different assumptions or estimates.
Management evaluates on an ongoing basis its judgment as to which policies are considered to be critical. Management believes that the calculation of the allowance for loan losses (ALL) is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of the Company's consolidated financial statements. In estimating the ALL, management utilizes historical experience as well as other factors including the effect of changes in the local real estate market on collateral values, use of current economic indicators and their probable impact on borrowers and changes in delinquent, non-performing or impaired loans. Management's estimates used in the ALL may increase or decrease based on changes in these factors resulting in adjustments to the Company's provision for loan losses. Actual results could differ significantly from these estimates under different assumptions, judgments or conditions.
The Company's net income for the second quarter of 2005 was $757,044, representing a decrease of 7.6% over net income of $819,201 for the second quarter of 2004. This resulted in earnings per share of $0.19 and $0.20, respectively, for the second quarter of 2005 and 2004. Net income for the first six months decreased $95,858, or by 6.1%, with net income for the first six months of 2005 reported at $1.49 million compared to $1.58 million for the same period in 2004. Although net income after taxes declined, core earnings (net interest income) for the first six months of 2005 increased $424,160, or 7.2% over the first six months of 2004.
Return on Average Assets
.91%
1.00%
Return on Average Equity
10.73%
11.78%
For the first six months ended June 30,
.90%
.96%
10.56%
11.49%
INTEREST INCOME LESS INTEREST EXPENSE (NET INTEREST INCOME)
Net interest income, the difference between interest income and expense, represents the largest portion of the Company's earnings, and is affected by the volume, mix, and rate sensitivity of earning assets as well as by interest bearing liabilities, market interest rates and the amount of non-interest bearing funds which support earning assets. The three tables below provide a visual comparison of the consolidated figures, and are stated on a tax equivalent basis assuming a federal tax rate of 34%. The Company's corporate tax rate is 34%, therefore, to equalize tax-free and taxable income in the comparison, we must divide the tax-free income by 66%, with the result that every tax-free dollar is equal to $1.52 in taxable income.
The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the six month comparison periods in 2005 and 2004:
Net interest income as presented
Effect of tax-exempt income
249,789
262,939
Net interest income, tax equivalent
6,530,103
6,119,093
AVERAGE BALANCES AND INTEREST RATES
For the Six Months Ended June 30:
Average
Income/
Rate/
Balance
Expense
Yield
INTEREST-EARNING ASSETS
Loans (gross)
230,948,196
6.50%
206,008,649
6.52%
Taxable Investment Securities
47,704,437
3.33%
60,888,762
3.68%
Tax Exempt Investment Securities
32,344,670
734,673
4.58%
40,266,513
773,351
3.86%
Federal Funds Sold
154,558
1,805
2.36%
1,245,753
4,845
0.78%
Sweep Account
181,674
2,196
2.44%
1,382,405
4,560
0.66%
Other Securities
2,780,033
4.20%
1,586,423
2.66%
TOTAL
314,113,568
9,028,900
5.80%
311,378,505
8,601,178
5.55%
INTEREST-BEARING LIABILITIES
Savings Deposits
47,071,363
81,526
0.35%
43,653,997
81,490
0.38%
NOW & Money Market Funds
88,697,030
679,328
1.54%
94,798,167
704,560
1.49%
Time Deposits
97,962,679
1,398,725
2.88%
101,530,835
1,483,636
2.94%
Federal Funds Purchased and
Other Borrowed Funds
14,006,824
256,490
3.69%
9,829,884
150,962
3.09%
Notes Payable
46,961
1,311
5.63%
97,527
2,675
5.52%
Repurchase Agreements
12,759,342
81,417
1.29%
11,831,849
260,544,199
1.93%
261,742,259
1.91%
Net Interest Income
Net Interest Spread
3.87%
3.64%
Interest Differential
4.19%
3.95%
An increase of $2.7 million is noted in the average volume of earning assets for the first six months of 2005 compared to the same period of 2004, with an increase of 25 basis points in the average yield. Interest earned on the loan portfolio accounts for approximately 82.5% of total interest income for 2005 and 77.7% for 2004.
Interest paid on time deposits is the largest component of the Company's interest expense, comprising 56.0% and 59.8%, respectively, of total interest expense for the 2005 and 2004 comparison periods. The average volume of interest-bearing liabilities for the first six months of 2005 decreased approximately $1.2 million over the 2004 comparison period, while the rate paid on these accounts increased two basis points.
The yield on loans has decreased slightly due to the lack of increase in long-term rates. The Company's balance sheet is slightly asset sensitive, therefore those loans that are tied to the Prime rate have repriced to a higher rate, however real estate loans are tied to long-term rates and the long-term rates have not increased, therefore yields are not increasing. On the liability side, the increase in short-term rates over the last six months has created pressure to increase rates on deposit products. The Company has resisted increasing rates on all the non-maturing products in order to manage spreads. The Company has however offered specials such as a high-yielding money market account for higher-balance accounts and various time-deposit specials. As time deposits mature, some are renewing at shorter terms with lower rates, while others are being shifted to other products or moved to other institutions. Managing the liability side of the balance sheet is a balancing act betwe en managing yields while retaining and attracting deposits for funding.
CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the first six months of 2005 and 2004 resulting from volume changes in average assets and average liabilities and fluctuations in rates earned and paid.
Variance
RATE / VOLUME
Due to
Total
Rate(1)
Volume(1)
Loans(2)
(45,806
808,586
762,780
(110,255
(217,715
(327,970
141,241
(179,919
(38,678
9,730
(12,770
(3,040
12,165
(14,529
(2,364
21,206
15,788
36,994
Total Interest Earnings
28,281
399,441
427,722
(6,422
6,458
36
21,361
(46,593
(25,232
(33,952
(50,959
(84,911
41,347
64,181
105,528
48
(1,412
(1,364
18,043
4,612
22,655
Total Interest Expense
40,425
(23,713
16,712
Change in Net Interest Income
(12,144
423,154
411,010
(1) Items which have shown a year-to-year increase in volume have variances allocated as follows:
Variance due to rate = Change in rate x new volume
Variance due to volume = Change in volume x old rate
Items which have shown a year-to-year decrease in volume have variances allocated as follows:
Variance due to rate = Change in rate x old volume
Variances due to volume = Change in volume x new rate
(2) Loans are stated before deduction of unearned discount and allowance for loan losses. The
principal balances of non-accrual loans is included in calculations of the yield on loans, while
the interest on these non-performing assets is excluded.
NON INTEREST INCOME AND NON INTEREST EXPENSE
Increases are noted in non-interest expense for both periods. Salaries and wages, and pension and benefits account for most of the increase, with an increase of $168,038 for the second quarter comparison periods and $303,549 for the six month comparison periods for 2005 versus 2004. This increase is the result of normal salary increases as well as increase in health care costs. The Company has experienced an increase in fraudulent activity related to its ATM and Debit cards, with total charge-offs for the first six months of 2005 of $23,701, compared to $5,623 for the first six months of 2004. Although the dollar amounts of these charge-offs are immaterial, this is a crime that is on the rise and a trend that the Company intends to monitor closely. Additionally, an increase in legal fees is recognized due to increased regulations, requiring the Company to seek legal advice on more issues than in the past. Compliance with the Sarbanes Oxley Act continues to impact both legal and audit fees as the Company prepares to meet the requirements of Section 404 of the Sarbanes Oxley Act. Additionally, increased reporting requirements through the Securities and Exchange Commission (SEC) have also had a financial impact on the Company's earnings.
Management monitors all components of other non-interest expenses; however, a quarterly review is performed to assure that the accruals for these expenses are accurate. This helps alleviate the need to make significant adjustments to these accounts that in turn affect the net income of the Company.
CHANGES IN FINANCIAL CONDITION
The following table reflects the composition of the Company's major categories of assets and liabilities as of the dates indicated:
ASSETS
June 30, 2005
December 31, 2004
June 30, 2004
Loans (gross)*
234,732,726
73.25%
229,633,185
68.58%
208,424,235
67.53%
Available for Sale Securities
13.37%
15.28%
16.20%
Held to Maturity Securities
5.72%
9.43%
6.95%
*includes loans held for sale
LIABILITIES
14.74%
14.12%
15.13%
21.49%
28.22%
21.78%
98,636,544
30.78%
98,089,308
29.29%
99,913,569
32.37%
A new commercial loan program was introduced in the second half of 2004, contributing to the increase in loans in that year. These loans were partially funded with the sale of investments from our available for sale portfolio in 2004. Further funding was achieved in 2005 as investments either matured or call options were exercised, accounting for the decrease in the available for sale portfolio. The Company's held to maturity portfolio decreased from December 31, 2004 to June 30, 2005 due to the maturity of various municipal accounts. Approximately $22 million in short-term municipal borrowings matured on June 30, 2005 with renewals of approximately the same amount expected to be booked by August 15, 2005. NOW and money market accounts decreased due in part to the effects of stiffening competition for municipal account relationships, which are a component of money market accounts, as well as the maturities of the municipal account s mentioned in the prior sentence. Following the normal municipal funding cycle, funds from these accounts were used to pay-off the current borrowings during the second quarter of 2005. Savings accounts and time deposits have shown little activity, while time deposits decreased $1.8 million from June 30, 2004 to December 31, 2004, and then increased $547,236 to end at $98.6 million as of June 30, 2005.
RISK MANAGEMENT
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company's interest sensitive assets and liabilities also change, thereby impacting net interest income (NII), the primary component of the Company's earnings. Fluctuations in interest rates can also have an impact on liquidity. The ALCO uses an outside consultant to perform quarterly rate shock simulations to the Company's net interest income, as well as a variety of other analyses. It is the ALCO's function to provide the assumptions used in the modeling process. The ALCO utilizes the results of this simulation model to quantify the estimated exposure of NII and liquidity to sustained interest rate changes. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflec ted on the Company's balance sheet. Furthermore, the model simulates the balance sheet's sensitivity to a prolonged flat rate environment. All rate scenarios are simulated assuming a parallel shift of the yield curve; however further simulations are performed utilizing a flattening yield curve as well. This sensitivity analysis is compared to the ALCO policy limits which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) shift upward and a 100 bp shift downward in interest rates. During the extended period where interest rates were at an all time low, the sensitivity analysis also provided a 400 bp shift upward scenario. The analysis also provides a summary of the Company's liquidity position. Furthermore, the analysis provides testing of the assumptions used in previous simulation models by comparing the projected NII with actual NII.
While assumptions are developed based upon current economic and local market conditions, the Company cannot provide any assurances as to the predictive nature of these assumptions, including how or when customer preferences or competitor influences might change.
Credit Risk - A primary concern of management is to reduce the exposure to credit loss within the loan portfolio. Management follows established underwriting guidelines, and any exceptions to the policy must be approved by a loan officer with higher authority than the loan officer originating the loan. The adequacy of the loan loss coverage is reviewed quarterly by the risk management committee of the Board of Directors. This committee meets to discuss, among other matters, potential exposures, historical loss experience, and overall economic conditions. Existing or potential problems are noted and addressed by senior management in order to assess the risk of probable loss or delinquency. A variety of loans are reviewed periodically by an independent firm in order to assure accuracy of the Company's internal risk ratings and compliance with various internal policies and procedures, as well as those set by the regulatory authorities. The Company also employs a Credit Administration Office r whose duties include monitoring and reporting on the status of the loan portfolio including delinquent and non-performing loans.
Total Loans
% of Total
Real Estate Loans
Construction & Land Development
13,610,448
11,646,486
5.07%
Farm Land
2,547,947
1.09%
2,495,782
1-4 Family Residential
122,901,183
52.36%
118,973,830
51.81%
Home Equity Lines
10,307,515
4.39%
8,580,929
3.74%
Commercial Real Estate
42,246,828
17.99%
43,609,781
18.99%
Loans to Finance Agricultural Production
274,305
0.12%
443,259
0.19%
Commercial & Industrial
21,281,582
9.07%
21,592,005
9.40%
Consumer Loans
21,029,995
8.96%
21,716,221
9.46%
All Other Loans
532,923
0.22%
574,892
0.25%
Gross Loans
100%
Less:
Allowance for Loan Losses
-0.92%
-0.94%
Deferred Loan Fees
-0.30%
-0.33%
Net Loans
231,866,897
98.78%
226,716,039
98.73%
Allowance for loan losses and provisions
Loans Outstanding End of Period
Average Loans Outstanding During Period
Loan Loss Reserve, Beginning of Period
2,153,372
2,199,110
Loans Charged Off:
Residential Real Estate
4,602
11,431
Commercial Loans not Secured by Real Estate
27,500
59,580
94,183
Total Loans Charged Off
91,682
105,614
Recoveries:
910
1,045
55
4,330
8,421
28,433
66,291
Total Recoveries
Net Loans Charged Off
58,009
29,802
Provision Charged to Income
Loan Loss Reserve, End of Period
2,170,363
2,254,308
Non-performing assets for the comparison periods were as follows:
Percent
of Total
Non-Accruing loans
661,829
85.82%
865,443
75.73%
Loans past due 90 days or more and still accruing
109,368
14.18%
194,594
17.03%
Other real estate owned
0%
7.24%
771,197
100.00%
1,142,837
Other real estate owned is made up of property that the Company has acquired by deed in lieu of foreclosure or through normal foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to other real estate owned. The balance transferred to OREO is the lesser of the estimated fair market value of the property, or the book value of the loan, less estimated cost to sell. A write-down may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then done periodically thereafter charging any additional write-downs to the appropriate expense account.
Specific allocations are made in the allowance for loan losses in situations management believes may represent a greater risk for loss. In addition, a portion of the allowance (termed "unallocated") is established to absorb inherent losses that probably exist as of the valuation date although not identified through management's objective processes for estimated credit losses. A quarterly review of various qualitative factors, including levels of, and trends in, delinquencies and non-accruals and national and local economic trends and conditions, helps to ensure that areas with potential risk are noted and coverage increased or decreased to reflect the trends in delinquencies and non-accruals. Residential mortgage loans make up the largest part of the loan portfolio and have the lowest historical loss ratio, helping to alleviate the overall risk. While the allowance is described as consisting of separate allocated portions, the entire allowance is available to support loan losses , regardless of category.
Market Risk - In addition to credit risk in the Company's loan portfolio and liquidity risk, the Company's business activities also generate market risk. Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. The Company does not have any market risk sensitive instruments acquired for trading purposes. The Company's market risk arises primarily from interest rate risk inherent in its lending, investing, and deposit taking activities. Interest rate risk is directly related to the different maturities and repricing characteristics of interest-bearing assets and liabilities, as well as to loan prepayment risks, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes vary by product. As discussed above under "Interest Rate Risk and Asset and Liability Management", the Company actively monitors and manages its interest ra te risk through the ALCO process.
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and risk-sharing commitments on certain sold loans. Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. During the first six months of 2005, there has not been any activity that has created any additional types of off-balance-sheet risk.
The Company generally requires collateral or other security to support financial instruments with credit risk. The Company's financial instruments whose contract amount represents credit risk as of June 30, 2005 are as follows:
Contract or
Notional Amount
Commitments to extend credit
29,872,069
Unused portions of home equity lines of credit
8,047,292
Unused portions of credit card lines
8,759,859
Standby letters of credit
680,930
MPF credit enhancement obligation, net of liability recorded
960,192
Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table presents, as of June 30, 2005, significant fixed and determinable contractual obligations to third parties, by payment date:
Less than
2-3
4-5
More than
1 year
years
5 years
Operating Leases
165,404
334,717
361,048
851,640
1,712,809
Operations Center Project
3,370,826
Housing Limited Partnerships
62,349
FHLB Borrowings
12,859,000
30,000
5,010,000
16,457,579
364,717
5,861,640
23,044,984
LIQUIDITY AND CAPITAL RESOURCES
Managing liquidity risk is essential to maintaining both depositor confidence and stability in earnings. Liquidity management refers to the ability of the Company to adequately cover fluctuations in assets and liabilities. Meeting loan demand (assets) and covering the withdrawal of deposit funds (liabilities) are two key components of the liquidity management process. The Company's principal sources of funds are deposits, amortization and prepayment of loans and securities, maturities of investment securities, sales of loans available for sale, and earnings and funds provided from operations. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities, reduces the Company's exposure to roll over risk on deposits and limits reliance on volatile short-term borrowed funds. Short-term funding needs arise from declines in deposits or other funding sources and funding of loan commitments. The Company's strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds.
The Company's loan portfolio increased moderately during the first six months of 2005, while the investment portfolio has decreased considerably during the same time period. As mentioned in the section labeled "Changes in Financial Condition", this decrease is attributable to the maturity of various municipal investment accounts. Deposit accounts, primarily NOW and money market accounts have decreased $23.1 million, contributing to the increase in other borrowed funds of $11.5 million in order to fund loan demand, which has remained steady. Most of this decrease is from the municipal accounts. For each maturing municipal loan mentioned earlier in the report, is a corresponding money market account that is closed when the loan matures. These deposits are funded when the new loan is booked. This fluctuation is a cyclical pattern for the Company.
In recent years, while depositors were waiting for improved performance in stock-market based investments, banks were flush with deposits, creating excess liquidity. This liquidity was put to good use while loan demand was high. As depositors gained confidence in the markets, deposit growth has become stagnate, while loan demand has remained steady. Funding for loan growth has been augmented with short-term borrowings and cash flows from maturing investments.
The Company has taken the approach of offering deposit specials at competitive rates, in varying terms that fit within the balance sheet mix. The strategy of offering specials is meant to provide a means to retain deposits while not having to reprice the entire deposit portfolio.
The Company has a $4.3 million credit line with the Federal Home Loan Bank of Boston (FHLB) with an available balance of $2.4 million at June 30, 2005. Interest is chargeable at a rate determined daily, approximately 25 basis points higher than the rate paid on federal funds sold. Additional borrowing capacity of approximately $91.6 million through the FHLB is secured by the Company's qualifying loan portfolio.
As of June 30, 2005, the Company had short-term advances of $11 million and long-term advances of $5.04 million against the $91.6 million and an advance of $1.9 million against the $4.3 million credit line. The advances with maturity dates greater than a year with higher interest rates are subject to a substantial pre-payment penalty. Although the rates are higher than the current market, the imposed penalty far outweighs the interest rate differential. The Company's outstanding advances consist of the following:
Annual
Principal
Purchase Date
Rate
Maturity Date
May 16, 2005
3.15%
July 18, 2005
3,000,000
June 01, 2005
3.22%
August 01, 2005
4,000,000
3.30%
September 16, 2005
3.41%
October 03, 2005
1,000,000
Total Short-term Advances
11,000,000
November 16, 1992
7.57%
November 16, 2007
7.67%
November 16, 2012
January 16, 2001
4.78%
January 18, 2011
5,000,000
Total Long-term Advances
5,040,000
Federal Funds Purchased
1,859,000
Under a separate agreement with FHLB, the Company has the authority to collateralize public unit deposits, up to its FHLB borrowing capacity ($91.6 million less outstanding advances noted above) with letters of credit issued by the FHLB. At June 30, 2005, approximately $53.5 million was pledged, under this agreement, as collateral for these deposits. Interest is charged to the Company quarterly based on the average daily balance for the quarter at an annual rate of 20 basis points. The average daily balance for the second quarter of 2005 was approximately $13.3 million.
In December 2004, the Company declared a cash dividend of $0.16 per share, payable in the first quarter of 2005, requiring the bank to book an accrual of $650,449 during the fourth quarter. In March 2005, the Company declared a cash dividend of $0.17 per share, payable in the second quarter of 2005, requiring an accrual of $652,627 at March 31, 2005. In June 2005, the Company declared a cash dividend of $0.17 per share, payable in the third quarter of 2005, requiring an accrual of $687,360. Additionally, in the second quarter of 2005, the Company announced the intent to pay a 5% stock dividend on July 1, 2005. All per share data for prior periods have been restated to reflect this stock dividend.
Due to the entries required to book the 5% stock dividend and the cash dividend declared in the second quarter of 2005, payable in the third quarter, Retained Earnings became a Retained Deficit at June 30, 2005. Management expects that, as the year progresses, this deficit will revert to earnings.
The following table illustrates the changes in shareholders' equity from December 31, 2004 to June 30, 2005:
Balance at December 31, 2004 (book value $6.96 per share)
Net income
Issuance of stock
420,979
Purchase of treasury stock (fractional share redemption)
(36
Purchase of treasury stock (fractional shares from 5% stock dividend)
(2,802
Total Dividends declared
(1,339,986
Change in unrealized gains on available-for-sale securities, net of tax
Balance at June 30, 2005 (book value $7.03 per share)
At June 30, 2005, of the 405,000 shares authorized for repurchase under the stock buyback plan, 167,993 shares had been purchased, leaving 237,007 shares available for repurchase. The repurchase price paid for these shares ranged from $9.75 per share in May of 2000 to $16.45 per share paid in March of 2004. During the first six months of 2005, the Company did not repurchase any shares pursuant to the buyback authority. The last purchase was October 12, 2004 in which 5,815 shares were repurchased at a price of $16.15 per share. For additional information on stock repurchases by the Company and affiliated purchasers (as defined in SEC Rule 10b-18) refer to Part II, Item 2 of this Report.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Under current guidelines, banks must maintain a risk-based capital ratio of 8.0%, of which at least 4.0% must be in the form of core capital (as defined). The risk-based ratios of the Company and its Subsidiary exceeded regulatory guidelines at June 30, 2005 with reported risk-weighted assets of $200.1 million compared to $196.2 million at December 31, 2004 and total capital of $30.7 million and $30.0 million, respectively. The Company's total risk-based capital to risk-weighted assets was 15.35% and 15.45% at June 30, 2005 and December 31, 2004, respectively. The Company's Tier 1 capital to risk-weighted assets was 14.10% and 14.20% at June 30, 2005 and December 31, 2004, respectively . In addition to risk-based capital requirements, bank holding companies are required to maintain minimum leverage capital ratios of core capital to average assets of $4.0%. The Company exceeded these requirements with leverage ratios of 8.47% as of June 30, 2005, and 8.34% at December 31, 2004.
Regulators have also established guidelines for minimum capital ratio requirements that define a bank as well-capitalized under prompt corrective action provisions. These minimums are risk-based capital ratio of 10.0% and Tier 1 capital ratio of 6.0%. As of June 30, 2005, the Company and its Subsidiary were deemed well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that time that management believes have changed the Company's classification.
The Company intends to continue the past policy of maintaining a strong capital resource position to support its asset size and level of operations. Consistent with that policy, management will continue to anticipate the Company's future capital needs.
From time to time the Company may make contributions to the capital of Community National Bank. At present, regulatory authorities have made no demand on the Company to make additional capital contributions.
The Company's management of the credit, liquidity and market risk inherent in its business operations is discussed in Part 1, Item 2 of this report under the caption "RISK MANAGEMENT", as well as in the Company's 2004 annual report on form 10-K. 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 such 10-K report.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, the Company has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. This evaluation was carried out under the supervision and with the participation of the Company's management, including the Company's Chairman and Chief Executive Officer and its President and Chief Operating Officer (Chief Financial Officer). Based upon that evaluation, such officers concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. There were no changes during the Company's last fiscal quarter in the Company's internal control over financial reporting identified in connection with the evaluation of the Company's disclosure controls and procedures that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company and/or its Subsidiary are subject to various claims and legal actions that have arisen in the normal course of business. Management does not expect that the ultimate disposition of these matters, individually or in the aggregate, will have a material adverse impact on the Company's financial statements.
ITEM 2. Unregistered Sales of Securities and Use of Proceeds
The following table provides information as to purchases of the Company's common stock during the second quarter ended June 30, 2005, by the Company and by any affiliated purchaser (as defined in SEC Rule 10b-18):
Maximum
Number of Shares
Total Number of
That May Yet Be
Shares Purchased
Purchased Under
Average Price
as Part of Publicly
the Plan at the
For the month ended:
Shares Purchased(1)(2)
Paid Per Share
Announced Plan(3)
End of the Period
April 1 -April 30
2,145
$17.16
237,007
May 1 - May 31
1,300
$16.85
June 1 - June 30
300
$16.90
3,745
$17.03
(1) All 3,745 shares were purchased by Community Financial Services Group, LLC ("CFSG"), which may be deemed to be an affiliate of the Company under Rule 10b-18, for the account of participants invested in the Company Stock Fund under the Company's Retirement Savings Plan. All purchases by CFSG were made in the open market in brokerage transactions reported on the OTC Bulletin Board©.
(2) Shares purchased during the period do not include (1) fractional shares repurchased from time to time in connection with the participant's election to discontinue participation in the Company's Dividend Reinvestment Plan; or (2) settlement of fractional shares in connection with the payment of a 5% stock dividend declared in May 2005.
(3) The Company's Board of Directors in April, 2000 initially authorized the repurchase from time to time of up to 205,000 shares of the Company's common stock in open market and privately negotiated transactions, in management's discretion and as market conditions may warrant. The Board extended this authorization on October 15, 2002 to repurchase an additional 200,000 shares, with an aggregate limit for such repurchases under both authorizations of $3.5 million. The approval did not specify a termination date.
ITEM 4. Submission of Matters to a Vote of Security Holders
The following matters were submitted to a vote of security holders, at the Annual Meeting of Shareholders of Community Bancorp. on May 10, 2005:
To elect three directors to serve until the Annual Meeting of Shareholders in 2008;
To ratify the selection of the independent registered public accounting firm of Berry, Dunn, McNeil & Parker as the Corporation's external auditors for the fiscal year ending December 31, 2005;
The results are as follows:
AUTHORITY
WITHHELD/
BROKER
MATTER
FOR
AGAINST
ABSTAIN
NON-VOTE
Election of Directors:
Thomas E. Adams
2,824,555.6895
0.0000
4,935.0430
-0-
Jacques R. Couture
2,818,492.6895
6,063.0000
Richard C. White
2,824,384.8049
170.8846
Selection of Auditors
Berry, Dunn, McNeil & Parker
2,810,060.6493
2,639.0000
16,791.0832
ITEM 6. Exhibits
Exhibit 31.1 - Certification from the Chief Executive Officer of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002Exhibit 31.2 - Certification from the Chief Financial Officer of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002Exhibit 32.1 - Certification from the Chief Executive Officer of the Company pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*Exhibit 32.2 - Certification from the Chief Financial Officer of the Company pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
*This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Act of 1934.
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.
DATED: August 10, 2005
By: /s/ Richard C. White
Richard C. White, Chairman &
Chief Executive Officer
By: /s/ Stephen P. Marsh
Stephen P. Marsh, President &
Chief Operating Officer
(Chief Financial Officer)