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EX-31.2 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) CERTIFICATIONS SECTION 302 OF - COMMUNITY BANCORP /VTexhibit31_2certificationl.htm
EX-32.2 - CERTIFICATE PURSUANT TO SECTION 18 U.S.C. PURSUANT TO SECTION 906 OF THE SARBANE - COMMUNITY BANCORP /VTexhibit32_2certificationl.htm
EX-32.1 - CERTIFICATE PURSUANT TO SECTION 18 U.S.C. PURSUANT TO SECTION 906 OF THE SARBANE - COMMUNITY BANCORP /VTexhibit32_1certificationk.htm
EX-31.1 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) CERTIFICATIONS SECTION 302 OF - COMMUNITY BANCORP /VTexhibit31_1certificationk.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, 2018
 
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 ( X )
Non-accelerated filer (  ) (Do not check if a smaller reporting company)
Smaller reporting company (  )
 
Emerging growth company (  )
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. (  )
 
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 03, 2018, there were 5,141,766 shares outstanding of the Corporation's common stock.
 
1
 
 
 
 
 
FORM 10-Q
Index
 
 
 
 
Page  
PART I
FINANCIAL INFORMATION
 
 
 
 
Financial Statements
3  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
31  
Quantitative and Qualitative Disclosures About Market Risk
51  
Controls and Procedures
51  
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Legal Proceedings
51  
Risk Factors
51  
Unregistered Sales of Equity Securities and Use of Proceeds
52  
Exhibits
52  
 
53  
 
54  
 
 
 
PART I. FINANCIAL INFORMATION
 
ITEM 1. Financial Statements (Unaudited)
 
The following are the unaudited consolidated financial statements for Community Bancorp. and Subsidiary, "the Company".
 
2
 
 
Community Bancorp. and Subsidiary
 
June 30,
 
 
December 31,
 
 
June 30,
 
Consolidated Balance Sheets
 
2018
 
 
2017
 
 
2017
 
 
 
(Unaudited)
 
 
 
 
 
(Unaudited)
 
Assets
 
 
 
 
 
 
 
 
 
  Cash and due from banks
 $19,669,010 
 $10,690,396 
 $21,659,982 
  Federal funds sold and overnight deposits
  9,140,793 
  31,963,105 
  15,365,739 
     Total cash and cash equivalents
  28,809,803 
  42,653,501 
  37,025,721 
  Securities held-to-maturity (fair value $32,292,000 at 06/30/18,
    
    
    
  $48,796,000 at 12/31/17 and $37,065,000 at 06/30/17)
  32,205,722 
  48,824,965 
  36,418,414 
  Securities available-for-sale
  38,760,368 
  38,450,653 
  35,634,716 
  Restricted equity securities, at cost
  2,434,050 
  1,703,650 
  1,942,550 
  Loans held-for-sale
  0 
  1,037,287 
  571,200 
  Loans
  521,091,943 
  502,864,651 
  502,772,845 
    Allowance for loan losses
  (5,413,023)
  (5,438,099)
  (5,374,378)
    Deferred net loan costs
  345,177 
  318,651 
  323,371 
        Net loans
  516,024,097 
  497,745,203 
  497,721,838 
  Bank premises and equipment, net
  9,717,004 
  10,344,177 
  10,555,451 
  Accrued interest receivable
  1,952,304 
  2,051,918 
  1,746,403 
  Bank owned life insurance
  4,767,646 
  4,721,782 
  4,673,739 
  Core deposit intangible
  0 
  0 
  136,341 
  Goodwill
  11,574,269 
  11,574,269 
  11,574,269 
  Other real estate owned
  364,235 
  284,235 
  343,928 
  Other assets
  8,386,276 
  7,653,955 
  9,829,772 
        Total assets
 $654,995,774 
 $667,045,595 
 $648,174,342 
Liabilities and Shareholders' Equity
    
    
    
 Liabilities
    
    
    
  Deposits:
    
    
    
    Demand, non-interest bearing
 $112,159,218 
 $117,245,565 
 $110,398,464 
    Interest-bearing transaction accounts
  126,164,648 
  132,633,533 
  116,869,761 
    Money market funds
  75,983,544 
  93,392,005 
  73,279,696 
    Savings
  101,030,190 
  97,516,284 
  97,929,768 
    Time deposits, $250,000 and over
  13,728,867 
  18,909,898 
  23,808,349 
    Other time deposits
  97,852,444 
  100,937,695 
  111,021,241 
        Total deposits
  526,918,911 
  560,634,980 
  533,307,279 
  Borrowed funds
  22,550,000 
  3,550,000 
  13,550,000 
  Repurchase agreements
  30,294,972 
  28,647,848 
  28,862,766 
  Capital lease obligations
  325,441 
  381,807 
  435,243 
  Junior subordinated debentures
  12,887,000 
  12,887,000 
  12,887,000 
  Accrued interest and other liabilities
  2,562,817 
  3,008,106 
  3,014,740 
        Total liabilities
  595,539,141 
  609,109,741 
  592,057,028 
 Shareholders' Equity
    
    
    
  Preferred stock, 1,000,000 shares authorized, 20 and 25 shares
    
    
    
    issued and outstanding in 2018 and 2017, respectively
    
    
    
    ($100,000 liquidation value)
  2,000,000 
  2,500,000 
  2,500,000 
  Common stock - $2.50 par value; 15,000,000 shares authorized,
    
    
    
    5,350,131 shares issued at 06/30/18, 5,322,320 shares issued
    
    
    
    at 12/31/17 and 5,297,753 shares issued at 06/30/17
  13,375,328 
  13,305,800 
  13,244,383 
  Additional paid-in capital
  32,048,600 
  31,639,189 
  31,227,266 
  Retained earnings
  15,477,941 
  13,387,739 
  11,809,846 
  Accumulated other comprehensive loss
  (822,459)
  (274,097)
  (41,404)
  Less: treasury stock, at cost; 210,101 shares at 06/30/18,
    
    
    
   12/31/17 and 06/30/17
  (2,622,777)
  (2,622,777)
  (2,622,777)
        Total shareholders' equity
  59,456,633 
  57,935,854 
  56,117,314 
        Total liabilities and shareholders' equity
 $654,995,774 
 $667,045,595 
 $648,174,342 
 
    
    
    
Book value per common share outstanding
 $11.18 
 $10.84 
 $10.54 
 
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
3
 
 
Community Bancorp. and Subsidiary
 
Three Months Ended June 30,
 
Consolidated Statements of Income
 
2018
 
 
2017
 
(Unaudited)
 
 
 
 
 
 
Interest income
 
 
 
 
 
 
   Interest and fees on loans
 $6,387,493 
 $5,875,766 
   Interest on debt securities
    
    
     Taxable
  221,016 
  164,644 
     Tax-exempt
  312,488 
  336,197 
   Dividends
  30,857 
  40,864 
   Interest on federal funds sold and overnight deposits
  77,005 
  27,366 
        Total interest income
  7,028,859 
  6,444,837 
 
    
    
Interest expense
    
    
   Interest on deposits
  719,389 
  568,110 
   Interest on borrowed funds
  17,642 
  28,044 
   Interest on repurchase agreements
  37,641 
  22,235 
   Interest on junior subordinated debentures
  163,827 
  131,115 
        Total interest expense
  938,499 
  749,504 
 
    
    
     Net interest income
  6,090,360 
  5,695,333 
 Provision for loan losses
  180,000 
  150,000 
     Net interest income after provision for loan losses
  5,910,360 
  5,545,333 
 
    
    
Non-interest income
    
    
   Service fees
  810,731 
  772,238 
   Income from sold loans
  190,710 
  184,072 
   Other income from loans
  198,351 
  209,288 
   Net realized (loss) gain on sale of securities AFS
  (6,375)
  1,270 
   Other income
  496,744 
  214,863 
        Total non-interest income
  1,690,161 
  1,381,731 
 
    
    
Non-interest expense
    
    
   Salaries and wages
  1,914,616 
  1,703,751 
   Employee benefits
  722,302 
  692,418 
   Occupancy expenses, net
  657,596 
  661,294 
   Other expenses
  1,809,461 
  1,835,105 
        Total non-interest expense
  5,103,975 
  4,892,568 
 
    
    
    Income before income taxes
  2,496,546 
  2,034,496 
 Income tax expense
  493,892 
  534,983 
        Net income
 $2,002,654 
 $1,499,513 
 
    
    
 Earnings per common share
 $0.39 
 $0.29 
 Weighted average number of common shares
    
    
  used in computing earnings per share
  5,130,809 
  5,077,698 
 Dividends declared per common share
 $0.19 
 $0.17 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
4
 
 
Community Bancorp. and Subsidiary
 
Six Months Ended June 30,
 
Consolidated Statements of Income
 
2018
 
 
2017
 
(Unaudited)
 
 
 
 
 
 
Interest income
 
 
 
 
 
 
   Interest and fees on loans
 $12,528,037 
 $11,492,633 
   Interest on debt securities
    
    
     Taxable
  423,901 
  316,370 
     Tax-exempt
  622,644 
  660,729 
   Dividends
  59,548 
  76,660 
   Interest on federal funds sold and overnight deposits
  171,567 
  54,838 
        Total interest income
  13,805,697 
  12,601,230 
 
    
    
Interest expense
    
    
   Interest on deposits
  1,406,451 
  1,105,899 
   Interest on borrowed funds
  25,125 
  80,279 
   Interest on repurchase agreements
  68,847 
  43,762 
   Interest on junior subordinated debentures
  306,824 
  253,975 
        Total interest expense
  1,807,247 
  1,483,915 
 
    
    
     Net interest income
  11,998,450 
  11,117,315 
 Provision for loan losses
  360,000 
  300,000 
     Net interest income after provision for loan losses
  11,638,450 
  10,817,315 
 
    
    
Non-interest income
    
    
   Service fees
  1,580,813 
  1,520,355 
   Income from sold loans
  374,329 
  374,367 
   Other income from loans
  410,621 
  394,905 
   Net realized (loss) gain on sale of securities AFS
  (10,236)
  3,400 
   Other income
  730,304 
  458,922 
        Total non-interest income
  3,085,831 
  2,751,949 
 
    
    
Non-interest expense
    
    
   Salaries and wages
  3,530,002 
  3,414,875 
   Employee benefits
  1,396,304 
  1,333,979 
   Occupancy expenses, net
  1,332,470 
  1,348,727 
   Other expenses
  3,576,316 
  3,526,106 
        Total non-interest expense
  9,835,092 
  9,623,687 
 
    
    
    Income before income taxes
  4,889,189 
  3,945,577 
 Income tax expense
  903,992 
  1,031,848 
        Net income
 $3,985,197 
 $2,913,729 
 
    
    
 Earnings per common share
 $0.77 
 $0.57 
 Weighted average number of common shares
    
    
  used in computing earnings per share
  5,123,947 
  5,070,453 
 Dividends declared per common share
 $0.36 
 $0.34 
 
 
The accompanying notes are an integral part of these consolidated financial statements 
 
 
5
 
 
 
Community Bancorp. and Subsidiary
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
 
(Unaudited)
 
Three Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net income
 $2,002,654 
 $1,499,513 
 
    
    
Other comprehensive (loss) income, net of tax:
    
    
  Unrealized holding (loss) gain on securities AFS arising during the period
  (127,242)
  95,682 
  Reclassification adjustment for loss (gain) realized in income
  6,375 
  (1,270)
     Unrealized (loss) gain during the period
  (120,867)
  94,412 
  Tax effect
  25,385 
  (32,100)
  Other comprehensive (loss) income, net of tax
  (95,482)
  62,312 
          Total comprehensive income
 $1,907,172 
 $1,561,825 
 
 
 
 
Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net income
 $3,985,197 
 $2,913,729 
 
    
    
Other comprehensive (loss) income, net of tax:
    
    
  Unrealized holding (loss) gain on securities AFS arising during the period
  (704,367)
  78,212 
  Reclassification adjustment for loss (gain) realized in income
  10,236 
  (3,400)
     Unrealized (loss) gain during the period
  (694,131)
  74,812 
  Tax effect
  145,769 
  (25,437)
  Other comprehensive (loss) income, net of tax
  (548,362)
  49,375 
          Total comprehensive income
 $3,436,835 
 $2,963,104 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6
 
 
 
Community Bancorp. and Subsidiary
 
 
 
 
 
 
Consolidated Statements of Cash Flows
 
 
 
 
 
 
(Unaudited)
 
Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Cash Flows from Operating Activities:
 
 
 
 
 
 
  Net income
 $3,985,197 
 $2,913,729 
  Adjustments to reconcile net income to net cash provided by
    
    
   operating activities:
    
    
    Depreciation and amortization, bank premises and equipment
  490,702 
  512,956 
    Provision for loan losses
  360,000 
  300,000 
    Deferred income tax
  (76,957)
  (216,506)
    Loss (gain) on sale of securities AFS
  10,236 
  (3,400)
    Gain on sale of loans
  (161,899)
  (159,123)
    (Gain) loss on sale of bank premises and equipment
  (264,087)
  1,580 
    Loss on sale of OREO
  0 
  617 
    Income from CFSG Partners
  (270,786)
  (198,514)
    Amortization of bond premium, net
  65,691 
  56,186 
    Proceeds from sales of loans held for sale
  5,078,916 
  7,600,841 
    Originations of loans held for sale
  (3,879,730)
  (8,012,918)
    Increase in taxes payable
  82,207 
  539,738 
    Decrease in interest receivable
  99,614 
  72,107 
    Decrease in mortgage servicing rights
  49,607 
  59,454 
    Increase in other assets
  (559,365)
  (462,492)
    Increase in cash surrender value of BOLI
  (45,864)
  (48,333)
    Amortization of core deposit intangible
  0 
  136,350 
    Amortization of limited partnerships
  188,742 
  308,616 
    Increase in unamortized loan costs
  (26,526)
  (13,241)
    (Decrease) increase in interest payable
  (6,254)
  52,847 
    Decrease in accrued expenses
  (200,085)
  (108,774)
    Increase (decrease) in other liabilities
  36,223 
  (68,688)
       Net cash provided by operating activities
  4,955,582 
  3,263,032 
 
    
    
Cash Flows from Investing Activities:
    
    
  Investments - HTM
    
    
    Maturities and pay downs
  21,333,215 
  22,418,808 
    Purchases
  (4,713,972)
  (8,950,591)
  Investments - AFS
    
    
    Maturities, calls, pay downs and sales
  5,187,588 
  2,324,014 
    Purchases
  (6,267,361)
  (4,221,653)
  Proceeds from redemption of restricted equity securities
  0 
  813,300 
  Purchases of restricted equity securities
  (730,400)
  0 
  Decrease in limited partnership contributions payable
  (380,250)
  (27,000)
  Increase in loans, net
  (18,908,933)
  (16,101,325)
  Capital expenditures net of proceeds from sales of bank
    
    
   premises and equipment
  400,558 
  (239,431)
  Proceeds from sales of OREO
  169,900 
  383,117 
  Recoveries of loans charged off
  46,665 
  39,977 
       Net cash used in investing activities
  (3,862,990)
  (3,560,784)
 
 
 
7
 
 
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Cash Flows from Financing Activities:
 
 
 
 
 
 
  Net (decrease) increase in demand and interest-bearing transaction accounts
  (11,555,232)
  4,742,597 
  Net (decrease) increase in money market and savings accounts
  (13,894,555)
  5,389,989 
  Net (decrease) increase in time deposits
  (8,266,282)
  18,439,661 
  Net increase (decrease) in repurchase agreements
  1,647,124 
  (1,560,429)
  Net increase (decrease) in short-term borrowings
  21,000,000 
  (20,000,000)
  Proceeds from long-term borrowings
  0 
  2,000,000 
  Repayments on long-term borrowings
  (2,000,000)
  0 
  Decrease in capital lease obligations
  (56,366)
  (47,918)
  Redemption of preferred stock
  (500,000)
  0 
  Dividends paid on preferred stock
  (51,875)
  (48,438)
  Dividends paid on common stock
  (1,259,104)
  (1,206,275)
       Net cash (used in) provided by financing activities
  (14,936,290)
  7,709,187 
 
    
    
       Net (decrease) increase in cash and cash equivalents
  (13,843,698)
  7,411,435 
  Cash and cash equivalents:
    
    
          Beginning
  42,653,501 
  29,614,286 
          Ending
 $28,809,803 
 $37,025,721 
 
    
    
Supplemental Schedule of Cash Paid During the Period:
    
    
  Interest
 $1,813,501 
 $1,431,068 
 
    
    
  Income taxes, net of refunds
 $710,000 
 $400,000 
 
    
    
Supplemental Schedule of Noncash Investing and Financing Activities:
    
    
  Change in unrealized (loss) gain on securities AFS
 $(694,131)
 $74,812 
 
    
    
  Loans transferred to OREO
 $249,900 
 $333,662 
 
    
    
Common Shares Dividends Paid:
    
    
  Dividends declared
 $1,843,120 
 $1,722,227 
  Increase in dividends payable attributable to dividends declared
  (105,077)
  (42,594)
  Dividends reinvested
  (478,939)
  (473,358)
 
 $1,259,104 
 $1,206,275 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
8
 
 
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 consolidated financial condition and results of operations of the Company and its subsidiary, Community National Bank (the Bank), contained herein have been made. The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2017 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, 2018, or for any other interim period.
 
Certain amounts in the 2017 unaudited consolidated income statements have been reclassified to conform to the 2018 presentation. Reclassifications had no effect on prior period net income or shareholders’ equity.
 
In addition to the definitions provided elsewhere in this quarterly report, the definitions, acronyms and abbreviations identified below are used throughout this Form 10-Q, including Part I. “Financial Information” and Part II. “Other Information”, and is intended to aid the reader and provide a reference page when reviewing this Form 10Q.
 
ABS and OAS:
Asset backed or other amortizing security
FRB:
Federal Reserve Board
AFS:
Available-for-sale
FRBB:
Federal Reserve Bank of Boston
Agency MBS:
MBS issued by a US government agency or GSE
GAAP:
Generally Accepted Accounting Principles in the United States
ALCO:
Asset Liability Committee
GSE
Government sponsored enterprise
ALL:
Allowance for loan losses
HTM:
Held-to-maturity
ASC:
Accounting Standards Codification
ICS:
Insured Cash Sweeps of the Promontory Interfinancial Network
ASU:
Accounting Standards Update
IRS:
Internal Revenue Service
BIC:
Borrower-in-Custody
JNE:
Jobs for New England
Board:
Board of Directors
Jr:
Junior
BOLI
Bank owned life insurance
MBS:
Mortgage-backed security
bp or bps:
Basis point(s)
MPF:
Mortgage Partnership Finance
CBLR:
Community Bank Leverage Ratio
MSRs:
Mortgage servicing rights
CDARS:
Certificate of Deposit Accounts Registry Service of the Promontory Interfinancial Network
NII:
Net interest income
CDs:
Certificates of deposit
OCI:
Other comprehensive income (loss)
CDI:
Core deposit intangible
OREO:
Other real estate owned
CECL:
Current Expected Credit Loss
OTTI:
Other-than-temporary impairment
CFSG:
Community Financial Services Group
PMI
Private mortgage insurance
CFSG Partners:
Community Financial Services Partners, LLC
RD:
USDA Rural Development
Company:
Community Bancorp. and Subsidiary
SBA
U.S. Small Business Administration
CRE:
Commercial Real Estate
SEC:
U.S. Securities and Exchange Commission
DRIP:
Dividend Reinvestment Plan
SERP
Supplemental Employee Retirement Plan
Exchange Act:
Securities Exchange Act of 1934
TDR:
Troubled-debt restructuring
FASB:
Financial Accounting Standards Board
USDA:
U.S. Department of Agriculture
FDIC:
Federal Deposit Insurance Corporation
VA:
U.S. Veterans Administration
FHLBB:
Federal Home Loan Bank of Boston
2017 Tax Act:
Tax Cut and Jobs Act of 2017
FHLMC
Federal Home Loan Mortgage Corporation
2018 Regulatory Relief Act:
Economic Growth, Regulatory Relief and Consumer Protection Act of 2018
 
 
 
9
 
 
Note 2. Recent Accounting Developments
 
The FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, in 2014 to replace the current plethora of industry-specific rules with a broad, principles-based framework for recognizing and measuring revenue. Due to the complexity of the new pronouncement and the anticipated effort required by entities in many industries to implement ASU No. 2014-09, FASB delayed the effective date. ASU 2014-09 became effective for the Company on January 1, 2018 and has been applied prospectively.
 
FASB formed a Transition Resource Group to assist it in identifying implementation issues that may require further clarification or amendment to ASU No. 2014-09. As a result of that group’s deliberations, FASB has issued several amendments, which became effective concurrently with ASU No. 2014-09, including ASU No. 2016-08, Principal versus Agent Considerations, which clarifies whether an entity should record the gross amount of revenue or only its ultimate share when a third party is also involved in providing goods or services to a customer. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. This ASU did not have a material impact on the Company’s consolidated financial statements.
 
In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. This guidance also changes certain disclosure requirements and other aspects of current accounting principles. Public businesses must use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The impact of adopting this ASU was not material on the Company’s consolidated financial statements.
 
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in the ASU is permitted for all entities. The Company is currently evaluating the impact of the adoption of the ASU on its consolidated financial statements, but does not anticipate any material impact at this time.
 
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Under the new guidance, which will replace the existing incurred loss model for recognizing credit losses, banks and other lending institutions will be required to recognize the full amount of expected credit losses. The new guidance, which is referred to as the CECL model, requires that expected credit losses for financial assets held at the reporting date that are accounted for at amortized cost be measured and recognized based on historical experience and current and reasonably supportable forecasted conditions to reflect the full amount of expected credit losses. A modified version of these requirements also applies to debt securities classified as available for sale, which will require that credit losses on those securities be recorded through an allowance for credit losses rather than a write-down. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within such years. The Company is evaluating the impact of the adoption of the ASU on its consolidated financial statements. The ASU may have a material impact on the Company's consolidated financial statements upon adoption as it will require a change in the Company's methodology for calculating its ALL and allowance on unused commitments. The Company will transition from an incurred loss model to an expected loss model, which will likely result in an increase in the ALL upon adoption and may negatively impact the Company’s and the Bank's regulatory capital ratios. Additionally, ASU No. 2016-13 may reduce the carrying value of the Company's HTM investment securities as it will require an allowance for the expected losses over the life of these securities to be recorded upon adoption. The Company has formed a committee to assess the implications of this new pronouncement and transitioned to a software solution for preparing the ALL calculation and related reports that provides the Company with stronger data integrity, ease and efficiency in ALL preparation. The new software solution also provides numerous training opportunities for the appropriate personnel within the Company. The Company has gathered and will analyze the historical data to serve as a basis for estimating the ALL under CECL.
 
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU was issued to reduce the cost and complexity of the goodwill impairment test. To simplify the subsequent measurement of goodwill, step two of the goodwill impairment test was eliminated. Instead, a Company will recognize an impairment of goodwill should the carrying value of a reporting unit exceed its fair value (i.e., step one). The ASU will be effective for the Company on January 1, 2020 and will be applied prospectively.
 
The Company has goodwill from its acquisition of LyndonBank in 2007 and performs an impairment test annually or more frequently if circumstances warrant (see Note 6). The Company is currently evaluating the impact of the adoption of the ASU on its consolidated financial statements, but does not anticipate any material impact at this time.
 
 
10
 
 
In February 2018, FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU was issued to allow a reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from the 2017 Tax Act to improve the usefulness of information reported to financial statement users. The ASU is effective for fiscal years beginning after December 15, 2018, with early adoption permitted for financial statements which have not yet been issued. The Company adopted the ASU for the December 31, 2017 consolidated financial statements. See Note 12 to the audited consolidated financial statements contained in the Company’s December 31, 2017 Annual Report on Form 10-K for more information.
 
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, if any), 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,
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net income, as reported
 $2,002,654 
 $1,499,513 
Less: dividends to preferred shareholders
  23,750 
  25,000 
Net income available to common shareholders
 $1,978,904 
 $1,474,513 
Weighted average number of common shares
    
    
   used in calculating earnings per share
  5,130,809 
  5,077,698 
Earnings per common share
 $0.39 
 $0.29 
 
 
Six Months Ended June 30,
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net income, as reported
 $3,985,197 
 $2,913,729 
Less: dividends to preferred shareholders
  51,875 
  48,438 
Net income available to common shareholders
 $3,933,322 
 $2,865,291 
Weighted average number of common shares
    
    
   used in calculating earnings per share
  5,123,947 
  5,070,453 
Earnings per common share
 $0.77 
 $0.57 
 
 
Note 4.  Investment Securities
 
Securities AFS and 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, 2018
 
 
 
 
 
 
 
 
 
 
 
 
U.S. GSE debt securities
 $15,017,800 
 $0 
 $399,321 
 $14,618,479 
Agency MBS
  16,358,655 
  2,835 
  490,914 
  15,870,576 
ABS and OAS
  1,000,000 
  0 
  5,688 
  994,312 
Other investments
  7,425,000 
  0 
  147,999 
  7,277,001 
 
 $39,801,455 
 $2,835 
 $1,043,922 
 $38,760,368 
 
    
    
    
    
December 31, 2017
    
    
    
    
U.S. GSE debt securities
 $17,308,229 
 $0 
 $149,487 
 $17,158,742 
Agency MBS
  16,782,380 
  11,144 
  180,187 
  16,613,337 
Other investments
  4,707,000 
  165 
  28,591 
  4,678,574 
 
 $38,797,609 
 $11,309 
 $358,265 
 $38,450,653 
 
 
 
11
 
 
 
 
 
 
 
Gross
 
 
Gross
 
 
 
 
 
 
Amortized
 
 
Unrealized
 
 
Unrealized
 
 
Fair
 
Securities AFS
 
Cost
 
 
Gains
 
 
Losses
 
 
Value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
U.S. GSE debt securities
 $18,356,415 
 $14,654 
 $57,881 
 $18,313,188 
Agency MBS
  13,128,034 
  23,950 
  73,365 
  13,078,619 
Other investments
  4,213,000 
  31,180 
  1,271 
  4,242,909 
 
 $35,697,449 
 $69,784 
 $132,517 
 $35,634,716 
 
 
 
 
 
 
 
Gross
 
 
Gross
 
 
 
 
 
 
Amortized
 
 
Unrealized
 
 
Unrealized
 
 
Fair
 
Securities HTM
 
Cost
 
 
Gains
 
 
Losses
 
 
Value*
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
 $32,205,722 
 $338,294 
 $252,017 
 $32,292,000 
 
    
    
    
    
December 31, 2017
    
    
    
    
States and political subdivisions
 $48,824,965 
 $0 
 $28,965 
 $48,796,000 
 
    
    
    
    
June 30, 2017
    
    
    
    
States and political subdivisions
 $36,418,414 
 $646,586 
 $0 
 $37,065,000 
 
 
*Method used to determine fair value of HTM securities rounds values to nearest thousand.
 
 
The scheduled maturities of debt securities AFS as of the balance sheet dates were as follows:
 
 
 
Amortized
 
 
Fair
 
 
 
Cost
 
 
Value
 
June 30, 2018
 
 
 
 
 
 
Due from one to five years
 $13,982,713 
 $13,689,583 
Due from five to ten years
  9,460,087 
  9,200,209 
Agency MBS
  16,358,655 
  15,870,576 
 
 $39,801,455 
 $38,760,368 
 
    
    
December 31, 2017
    
    
Due in one year or less
 $3,749,956 
 $3,739,512 
Due from one to five years
  11,275,824 
  11,168,065 
Due from five to ten years
  6,989,449 
  6,929,739 
Agency MBS
  16,782,380 
  16,613,337 
 
 $38,797,609 
 $38,450,653 
 
    
    
June 30, 2017
    
    
Due in one year or less
 $3,001,770 
 $3,001,473 
Due from one to five years
  17,322,645 
  17,326,400 
Due from five to ten years
  2,245,000 
  2,228,224 
Agency MBS
  13,128,034 
  13,078,619 
 
 $35,697,449 
 $35,634,716 
 
 
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.
 
 
12
 
 
 
The scheduled maturities of debt securities HTM as of the balance sheet dates were as follows:
 
 
 
Amortized
 
 
Fair
 
 
 
Cost
 
 
Value*
 
June 30, 2018
 
 
 
 
 
 
Due in one year or less
 $8,223,089 
 $8,223,000 
Due from one to five years
  4,724,770 
  4,746,000 
Due from five to ten years
  4,394,497 
  4,416,000 
Due after ten years
  14,863,366 
  14,907,000 
 
 $32,205,722 
 $32,292,000 
 
    
    
December 31, 2017
    
    
Due in one year or less
 $24,817,334 
 $24,817,000 
Due from one to five years
  4,494,343 
  4,487,000 
Due from five to ten years
  4,338,246 
  4,331,000 
Due after ten years
  15,175,042 
  15,161,000 
 
 $48,824,965 
 $48,796,000 
 
    
    
June 30, 2017
    
    
Due in one year or less
 $11,987,857 
 $11,988,000 
Due from one to five years
  3,987,322 
  4,149,000 
Due from five to ten years
  3,744,385 
  3,906,000 
Due after ten years
  16,698,850 
  17,022,000 
 
 $36,418,414 
 $37,065,000 
 
 
*Method used to determine fair value of HTM securities rounds values to nearest thousand.
 
Debt securities AFS and HTM 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
 
 
Number of
 
 
Fair
 
 
Unrealized
 
 
 
Value
 
 
Loss
 
 
Value
 
 
Loss
 
 
Securities
 
 
Value
 
 
Loss
 
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. GSE debt securities
 $11,732,997 
 $284,803 
 $2,885,482 
 $114,518 
  13 
 $14,618,479 
 $399,321 
Agency MBS
  10,449,556 
  323,950 
  3,997,985 
  166,964 
  23 
  14,447,541 
  490,914 
ABS and OAS
  994,312 
  5,688 
  0 
  0 
  1 
  994,312 
  5,688 
Other investments
  6,060,871 
  127,129 
  723,130 
  20,870 
  28 
  6,784,001 
  147,999 
State and political subdivisions
  28,006,864 
  252,017 
  0 
  0 
  107 
  28,006,864 
  252,017 
 
 $57,244,600 
 $993,587 
 $7,606,597 
 $302,352 
  172 
 $64,851,197 
 $1,295,939 
 
    
    
    
    
    
    
    
December 31, 2017
    
    
    
    
    
    
    
U.S. GSE debt securities
 $13,223,739 
 $84,490 
 $3,935,003 
 $64,997 
  15 
 $17,158,742 
 $149,487 
Agency MBS
  9,251,323 
  105,063 
  4,542,446 
  75,124 
  21 
  13,793,769 
  180,187 
Other investments
  3,692,571 
  25,429 
  244,838 
  3,162 
  16 
  3,937,409 
  28,591 
State and political subdivisions
  22,530,141 
  28,965 
  0 
  0 
  79 
  22,530,141 
  28,965 
 
 $48,697,774 
 $243,947 
 $8,722,287 
 $143,283 
  131 
 $57,420,061 
 $387,230 
 
    
    
    
    
    
    
    
June 30, 2017
    
    
    
    
    
    
    
U.S. GSE debt securities
 $10,724,642 
 $57,881 
 $0 
 $0 
  9 
 $10,724,642 
 $57,881 
Agency MBS
  8,751,252 
  73,365 
  0 
  0 
  13 
  8,751,252 
  73,365 
Other investments
  990,729 
  1,271 
  0 
  0 
  4 
  990,729 
  1,271 
 
 $20,466,623 
 $132,517 
 $0 
 $0 
  26 
 $20,466,623 
 $132,517 
 
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.
 
 
13
 
 
 
Management evaluates securities for OTTI 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, 2018, 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 OTTI.
 
Investments pledged as collateral for repurchase agreements consisted of U.S. GSE debt securities, Agency MBS securities, ABS and OAS, and CDs. These repurchase agreements mature daily. These investments as of the balance sheet dates were as follows:
 
 
 
Amortized
 
 
Fair
 
 
 
Cost
 
 
Value
 
 
 
 
 
 
 
 
June 30, 2018
 $39,801,455 
 $38,760,368 
December 31, 2017
  38,797,609 
  38,450,653 
June 30, 2017
  35,697,449 
  35,634,716 
 
 
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,
 
 
 
2018
 
 
2017
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
 $88,336,757 
 $77,110,747 
 $79,361,739 
Commercial real estate
  217,268,526 
  207,044,227 
  209,886,793 
Residential real estate - 1st lien
  165,347,241 
  168,184,135 
  164,398,836 
Residential real estate - Jr lien
  45,127,750 
  45,256,862 
  42,166,407 
Consumer
  5,011,669 
  5,268,680 
  6,959,070 
     Gross Loans
  521,091,943 
  502,864,651 
  502,772,845 
Deduct (add):
    
    
    
Allowance for loan losses
  5,413,023 
  5,438,099 
  5,374,378 
Deferred net loan costs
  (345,177)
  (318,651)
  (323,371)
     Net Loans
 $516,024,097 
 $497,745,203 
 $497,721,838 
 
 
The following is an age analysis of loans (including non-accrual) as of the balance sheet dates, by portfolio segment:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
90 Days or
 
 
 
 
 
 
90 Days
 
 
Total
 
 
 
 
 
 
 
 
Non-Accrual
 
 
More and
 
June 30, 2018
 
30-89 Days
 
 
or More
 
 
Past Due
 
 
Current
 
 
Total Loans
 
 
Loans
 
 
Accruing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
 $230,784 
 $0 
 $230,784 
 $88,105,973 
 $88,336,757 
 $197,079 
 $0 
Commercial real estate
  1,195,120 
  315,881 
  1,511,001 
  215,757,525 
  217,268,526 
  1,957,183 
  0 
Residential real estate
    
    
    
    
    
    
    
 - 1st lien
  2,255,600 
  1,081,853 
  3,337,453 
  162,009,788 
  165,347,241 
  1,749,608 
  406,196 
 - Jr lien
  332,650 
  238,534 
  571,184 
  44,556,566 
  45,127,750 
  369,493 
  101,713 
Consumer
  48,155 
  0 
  48,155 
  4,963,514 
  5,011,669 
  0 
  0 
 
 $4,062,309 
 $1,636,268 
 $5,698,577 
 $515,393,366 
 $521,091,943 
 $4,273,363 
 $507,909 
 
 
 
14
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
90 Days or
 
 
 
 
 
 
90 Days
 
 
Total
 
 
 
 
 
 
 
 
Non-Accrual
 
 
More and
 
December 31, 2017
 
30-89 Days
 
 
or More
 
 
Past Due
 
 
Current
 
 
Total Loans
 
 
Loans
 
 
Accruing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
 $308,712 
 $0 
 $308,712 
 $76,802,035 
 $77,110,747 
 $98,806 
 $0 
Commercial real estate
  1,482,982 
  418,255 
  1,901,237 
  205,142,990 
  207,044,227 
  1,065,385 
  0 
Residential real estate
    
    
    
    
    
    
    
 - 1st lien
  4,238,933 
  2,011,419 
  6,250,352 
  161,933,783 
  168,184,135 
  1,585,473 
  1,249,241 
 - Jr lien
  156,101 
  168,517 
  324,618 
  44,932,244 
  45,256,862 
  346,912 
  0 
Consumer
  80,384 
  1,484 
  81,868 
  5,186,812 
  5,268,680 
  0 
  1,484 
 
 $6,267,112 
 $2,599,675 
 $8,866,787 
 $493,997,864 
 $502,864,651 
 $3,096,576 
 $1,250,725 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
90 Days or
 
 
 
 
 
 
90 Days
 
 
Total
 
 
 
 
 
 
 
 
Non-Accrual
 
 
More and
 
June 30, 2017
 
30-89 Days
 
 
or More
 
 
Past Due
 
 
Current
 
 
Total Loans
 
 
Loans
 
 
Accruing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
 $121,737 
 $86,994 
 $208,731 
 $79,153,008 
 $79,361,739 
 $135,379 
 $0 
Commercial real estate
  2,398,960 
  228,621 
  2,627,581 
  207,259,212 
  209,886,793 
  728,093 
  15,011 
Residential real estate
    
    
    
    
    
    
    
 - 1st lien
  1,886,256 
  1,225,362 
  3,111,618 
  161,287,218 
  164,398,836 
  1,403,312 
  354,988 
 - Jr lien
  252,557 
  237,483 
  490,040 
  41,676,367 
  42,166,407 
  398,862 
  71,614 
Consumer
  54,835 
  0 
  54,835 
  6,904,235 
  6,959,070 
  0 
  0 
 
 $4,714,345 
 $1,778,460 
 $6,492,805 
 $496,280,040 
 $502,772,845 
 $2,665,646 
 $441,613 
 
 
For all loan segments, loans over 30 days past due are considered delinquent.
 
As of the balance sheet dates presented, residential mortgage loans in process of foreclosure consisted of the following:
 
 
 
Number of loans
 
 
Balance
 
 
 
 
 
 
 
 
June 30, 2018
  10 
 $615,038 
December 31, 2017
  10 
  791,944 
June 30, 2017
  7 
  448,622 
 
 
Allowance for loan losses
 
The ALL 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.
 
 
15
 
 
General component
 
The general component of the ALL is based on historical loss experience and various qualitative factors and is stratified by the following loan segments: commercial and industrial, CRE, residential real estate 1st lien, residential real estate 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. Management uses an average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment in the current economic climate. During periods of economic stability, a relatively longer period (e.g., five years) may be appropriate. During periods of significant expansion or contraction, the Company may appropriately shorten the historical time period. The Company is currently using an extended look back period of five years.
 
Qualitative factors include the 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 CRE loans. This evaluation is inherently subjective as it requires estimates that are susceptible to revision as more information becomes available.
 
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 CRE. 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 CRE 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 CRE 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. CRE 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. CRE 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.
 
 
16
 
 
 
Specific component
 
The specific component of the ALL 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 ALL 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.
 
The tables below summarize changes in the ALL and select loan information, by portfolio segment, for the periods indicated.
 
As of or for the three months ended June 30, 2018
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Unallocated
 
 
Total
 
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 $666,660 
 $2,666,704 
 $1,407,801 
 $289,292 
 $44,162 
 $266,601 
 $5,341,220 
  Charge-offs
  (42,380)
  (3,645)
  (45,362)
  0 
  (39,758)
  0 
  (131,145)
  Recoveries
  15,027 
  0 
  300 
  240 
  7,381 
  0 
  22,948 
  Provision (credit)
  145,782 
  45,180 
  35,302 
  (1,930)
  39,850 
  (84,184)
  180,000 
Ending balance
 $785,089 
 $2,708,239 
 $1,398,041 
 $287,602 
 $51,635 
 $182,417 
 $5,413,023 
 
 
 
 
17
 
 
As of or for the six months ended June 30, 2018
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Unallocated
 
 
Total
 
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 $675,687 
 $2,674,029 
 $1,460,547 
 $316,982 
 $43,303 
 $267,551 
 $5,438,099 
  Charge-offs
  (131,273)
  (124,645)
  (78,435)
  (24,000)
  (73,388)
  0 
  (431,741)
  Recoveries
  20,041 
  0 
  9,158 
  675 
  16,791 
  0 
  46,665 
  Provision (credit)
  220,634 
  158,855 
  6,771 
  (6,055)
  64,929 
  (85,134)
  360,000 
Ending balance
 $785,089 
 $2,708,239 
 $1,398,041 
 $287,602 
 $51,635 
 $182,417 
 $5,413,023 
 
    
    
    
    
    
    
    
Allowance for loan losses
    
    
    
    
    
    
    
Evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $0 
 $0 
 $129,488 
 $1,007 
 $0 
 $0 
 $130,495 
  Collectively
  785,089 
  2,708,239 
  1,268,553 
  286,595 
  51,635 
  182,417 
  5,282,528 
 
 $785,089 
 $2,708,239 
 $1,398,041 
 $287,602 
 $51,635 
 $182,417 
 $5,413,023 
 
 
 
Loans evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $197,079 
 $2,064,330 
 $4,315,348 
 $305,363 
 $0 
    
 $6,882,120 
  Collectively
  88,139,678 
  215,204,196 
  161,031,893 
  44,822,387 
  5,011,669 
    
  514,209,823 
 
 $88,336,757 
 $217,268,526 
 $165,347,241 
 $45,127,750 
 $5,011,669 
    
 $521,091,943 
 
 
As of or for the year ended December 31, 2017
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Unallocated
 
 
Total
 
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 $726,848 
 $2,496,085 
 $1,369,757 
 $371,176 
 $83,973 
 $230,606 
 $5,278,445 
  Charge-offs
  (20,000)
  (160,207)
  (159,533)
  (118,359)
  (124,042)
  0 
  (582,141)
  Recoveries
  27,051 
  230 
  26,826 
  465 
  37,223 
  0 
  91,795 
  Provision (credit)
  (58,212)
  337,921 
  223,497 
  63,700 
  46,149 
  36,945 
  650,000 
Ending balance
 $675,687 
 $2,674,029 
 $1,460,547 
 $316,982 
 $43,303 
 $267,551 
 $5,438,099 
 
    
    
    
    
    
    
    
Allowance for loan losses
    
    
    
    
    
    
    
Evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $0 
 $69,015 
 $125,305 
 $26,353 
 $0 
 $0 
 $220,673 
  Collectively
  675,687 
  2,605,014 
  1,335,242 
  290,629 
  43,303 
  267,551 
  5,217,426 
 
 $675,687 
 $2,674,029 
 $1,460,547 
 $316,982 
 $43,303 
 $267,551 
 $5,438,099 
 
    
    
    
    
    
    
    
Loans evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $98,806 
 $1,306,057 
 $4,075,666 
 $300,759 
 $0 
    
 $5,781,288 
  Collectively
  77,011,941 
  205,738,170 
  164,108,469 
  44,956,103 
  5,268,680 
    
  497,083,363 
 
 $77,110,747 
 $207,044,227 
 $168,184,135 
 $45,256,862 
 $5,268,680 
    
 $502,864,651 
 
 
 
 
18
 
 
As of or for the three months ended June 30, 2017
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Unallocated
 
 
Total
 
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 $719,773 
 $2,521,121 
 $1,312,795 
 $370,454 
 $61,322 
 $272,975 
 $5,258,440 
  Charge-offs
  0 
  0 
  0 
  (15,311)
  (37,326)
  0 
  (52,637)
  Recoveries
  1,422 
  230 
  3,981 
  60 
  12,882 
  0 
  18,575 
  Provision (credit)
  (25,532)
  8,864 
  46,548 
  19,161 
  14,417 
  86,542 
  150,000 
Ending balance
 $695,663 
 $2,530,215 
 $1,363,324 
 $374,364 
 $51,295 
 $359,517 
 $5,374,378 
 
 
As of or for the six months ended June 30, 2017
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Unallocated
 
 
Total
 
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 $726,848 
 $2,496,085 
 $1,369,757 
 $371,176 
 $83,973 
 $230,606 
 $5,278,445 
  Charge-offs
  0 
  (160,207)
  (4,735)
  (15,311)
  (63,791)
  0 
  (244,044)
  Recoveries
  4,318 
  230 
  10,217 
  120 
  25,092 
  0 
  39,977 
  Provision (credit)
  (35,503)
  194,107 
  (11,915)
  18,379 
  6,021 
  128,911 
  300,000 
Ending balance
 $695,663 
 $2,530,215 
 $1,363,324 
 $374,364 
 $51,295 
 $359,517 
 $5,374,378 
 
    
    
    
    
    
    
    
Allowance for loan losses
    
    
    
    
    
    
    
Evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $0 
 $74,249 
 $154,760 
 $126,053 
 $0 
 $0 
 $355,062 
  Collectively
  695,663 
  2,455,966 
  1,208,564 
  248,311 
  51,295 
  359,517 
  5,019,316 
 
 $695,663 
 $2,530,215 
 $1,363,324 
 $374,364 
 $51,295 
 $359,517 
 $5,374,378 
 
 
 
Loans evaluated for impairment
    
    
    
    
    
    
    
  Individually
 $135,379 
 $1,968,144 
 $3,577,837 
 $419,550 
 $0 
    
 $6,100,910 
  Collectively
  79,226,360 
  207,918,649 
  160,820,999 
  41,746,857 
  6,959,070 
    
  496,671,935 
 
 $79,361,739 
 $209,886,793 
 $164,398,836 
 $42,166,407 
 $6,959,070 
    
 $502,772,845 
 
 
19
 
 
Impaired loans, by portfolio segment, were as follows:
 
 
 
As of June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unpaid
 
 
 
 
 
Average
 
 
Average
 
 
Interest
 
 
 
Recorded
 
 
Principal
 
 
Related
 
 
Recorded
 
 
Recorded
 
 
Income
 
 
 
Investment
 
 
Balance
 
 
Allowance
 
 
Investment (1)
 
 
Investment (2)
 
 
Recognized (2)
 
 
 
 
    
    
    
Related allowance recorded
 
 
 
 
 
 
 
 
 
    
    
    
   Commercial real estate
 $0 
 $0 
 $0 
 $41,823 
 $96,097 
 $0 
   Residential real estate
    
    
    
    
    
    
    - 1st lien
  789,471 
  831,434 
  129,488 
  791,676 
  793,859 
  31,785 
    - Jr lien
  7,798 
  7,788 
  1,007 
  7,990 
  54,211 
  1,482 
 
  797,269 
  839,222 
  130,495 
  841,489 
  944,167 
  33,267 
 
    
    
    
    
    
    
No related allowance recorded
    
    
    
    
    
    
   Commercial & industrial
  197,079 
  216,691 
    
  191,045 
  160,299 
  0 
   Commercial real estate
  2,065,267 
  2,235,772 
    
  1,794,217 
  1,563,764 
  37,813 
   Residential real estate
    
    
    
    
    
    
    - 1st lien
  3,543,703 
  4,189,432 
    
  3,525,807 
  3,450,597 
  120,756 
    - Jr lien
  297,575 
  298,931 
    
  280,965 
  238,682 
  0 
 
  6,103,624 
  6,940,826 
    
  5,792,034 
  5,413,342 
  158,569 
 
    
    
    
    
    
    
 
 $6,900,893 
 $7,780,048 
 $130,495 
 $6,633,523 
 $6,357,509 
 $191,836 
 
 
(1) For the three months ended June 30, 2018
(2) For the six months ended June 30, 2018
 
In the table above, recorded investment in impaired loans as of June 30, 2018 includes accrued interest receivable and deferred net loan costs of $18,773.
 
 
 
As of December 31, 2017
 
 
2017
 
 
 
 
 
 
Unpaid
 
 
 
 
 
Average
 
 
Interest
 
 
 
Recorded
 
 
Principal
 
 
Related
 
 
Recorded
 
 
Income
 
 
 
Investment
 
 
Balance
 
 
Allowance
 
 
Investment
 
 
Recognized
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Related allowance recorded
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Commercial real estate
 $204,645 
 $225,681 
 $69,015 
 $210,890 
 $0 
   Residential real estate
    
    
    
    
    
    - 1st lien
  798,226 
  837,766 
  125,305 
  646,799 
  29,262 
    - Jr lien
  146,654 
  293,351 
  26,353 
  220,274 
  400 
 
  1,149,525 
  1,356,798 
  220,673 
  1,077,963 
  29,662 
 
    
    
    
    
    
No related allowance recorded
    
    
    
    
    
   Commercial & industrial
  98,806 
  136,590 
    
  75,868 
  72,426 
   Commercial real estate
  1,102,859 
  1,226,040 
    
  1,105,030 
  237,792 
   Residential real estate
    
    
    
    
    
    - 1st lien
  3,300,175 
  3,641,627 
    
  1,930,108 
  133,732 
    - Jr lien
  154,116 
  154,423 
    
  116,519 
  16,574 
 
  4,655,956 
  5,158,680 
    
  3,227,525 
  460,524 
 
    
    
    
    
    
 
 $5,805,481 
 $6,515,478 
 $220,673 
 $4,305,488 
 $490,186 
 
In the table above, recorded investment in impaired loans as of December 31, 2017 includes accrued interest receivable and deferred net loan costs of $24,193.
 
 
20
 
 
 
 
 
As of June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unpaid
 
 
 
 
 
Average
 
 
Average
 
 
Interest
 
 
 
Recorded
 
 
Principal
 
 
Related
 
 
Recorded
 
 
Recorded
 
 
Income
 
 
 
Investment
 
 
Balance
 
 
Allowance
 
 
Investment (1)
 
 
Investment (2)
 
 
Recognized (2)
 
 
 
 
    
    
    
Related allowance recorded
 
 
 
 
 
 
 
 
 
    
    
    
   Commercial real estate
 $210,499 
 $228,074 
 $74,249 
 $212,451 
 $215,053 
 $0 
   Residential real estate - 1st lien
  1,038,752 
  1,074,246 
  154,760 
  545,895 
  454,686 
  15,720 
   Residential real estate - Jr lien
  283,626 
  348,416 
  126,053 
  252,853 
  243,253 
  1,301 
 
  1,532,877 
  1,650,736 
  355,062 
  1,011,199 
  912,992 
  17,021 
 
    
    
    
    
    
    
No related allowance recorded
    
    
    
    
    
    
   Commercial & industrial
  135,379 
  218,023 
    
  91,882 
  77,383 
  0 
   Commercial real estate
  1,763,013 
  2,324,546 
    
  1,109,536 
  895,437 
  32,923 
   Residential real estate - 1st lien
  2,556,076 
  2,802,565 
    
  1,484,683 
  1,214,864 
  57,116 
   Residential real estate - Jr lien
  136,821 
  136,821 
    
  136,821 
  91,214 
  0 
 
  4,591,289 
  5,481,955 
    
  2,822,922 
  2,278,898 
  90,039 
 
    
    
    
    
    
    
 
 $6,124,166 
 $7,132,691 
 $355,062 
 $3,834,121 
 $3,191,890 
 $107,060 
 
(1) For the three months ended June 30, 2017
(2) For the six months ended June 30, 2017
 
In the table above, recorded investment in impaired loans as of June 30, 2017 includes accrued interest receivable and deferred net loan costs of $23,256.
 
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.
 
Credit Quality Grouping
 
In developing the ALL, 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 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 risk 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.
 
 
 
21
 
 
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.
 
The risk ratings within the loan portfolio, by segment, as of the balance sheet dates were as follows:
 
As of June 30, 2018
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Group A
 $84,161,408 
 $202,424,493 
 $162,200,561 
 $44,426,013 
 $5,011,669 
 $498,224,144 
Group B
  2,499,460 
  5,770,651 
  283,148 
  35,279 
  0 
  8,588,538 
Group C
  1,675,889 
  9,073,382 
  2,863,532 
  666,458 
  0 
  14,279,261 
 
 $88,336,757 
 $217,268,526 
 $165,347,241 
 $45,127,750 
 $5,011,669 
 $521,091,943 
 
 
As of December 31, 2017
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Group A
 $73,352,768 
 $194,066,034 
 $165,089,999 
 $44,687,951 
 $5,267,196 
 $482,463,948 
Group B
  617,526 
  4,609,847 
  282,671 
  37,598 
  0 
  5,547,642 
Group C
  3,140,453 
  8,368,346 
  2,811,465 
  531,313 
  1,484 
  14,853,061 
 
 $77,110,747 
 $207,044,227 
 $168,184,135 
 $45,256,862 
 $5,268,680 
 $502,864,651 
 
 
 
22
 
 
As of June 30, 2017
 
 
 
 
 
 
 
 
 
Residential
 
 
Residential
 
 
 
 
 
 
 
 
 
Commercial
 
 
Commercial
 
 
Real Estate
 
 
Real Estate
 
 
 
 
 
 
 
 
 
& Industrial
 
 
Real Estate
 
 
1st Lien
 
 
Jr Lien
 
 
Consumer
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Group A
 $75,971,101 
 $199,768,226 
 $162,224,767 
 $41,503,823 
 $6,959,070 
 $486,426,987 
Group B
  520,555 
  1,169,093 
  0 
  162,321 
  0 
  1,851,969 
Group C
  2,870,083 
  8,949,474 
  2,174,069 
  500,263 
  0 
  14,493,889 
 
 $79,361,739 
 $209,886,793 
 $164,398,836 
 $42,166,407 
 $6,959,070 
 $502,772,845 
 
 
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.
 
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.
 
New TDRs, by portfolio segment, during the periods presented were as follows:
 
 
Three months ended June 30, 2018
 
Six months ended June 30, 2018
 
 
 
Number of Contracts
 
 
Pre-Modification Outstanding Recorded Investment
 
 
Post-Modification Outstanding Recorded Investment
 
 
Number of Contracts
 
 
Pre-Modification Outstanding Recorded Investment
 
 
Post-Modification Outstanding Recorded Investment
 
Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
- 1st lien
  2 
 $215,772 
 $218,157 
  7 
 $898,563 
 $1,003,466 
 
Year ended December 31, 2017
 
 
 
Number of Contracts
 
 
Pre-Modification Outstanding Recorded Investment
 
 
Post-Modification Outstanding Recorded Investment
 
Residential real estate
 
 
 
 
 
 
 
 
 
- 1st lien
  4 
 $256,353 
 $287,385 
 
 
23
 
 
Six months ended June 30, 2017
 
 
 
Number of Contracts
 
 
Pre-Modification Outstanding Recorded Investment
 
 
Post-Modification Outstanding Recorded Investment
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
  1 
 $41,857 
 $57,418 
 
The TDRs for which there was a payment default during the twelve month periods presented were as follows:
 
Twelve months ended June 30, 2018
 
Number of
 
 
Recorded
 
 
 
Contracts
 
 
Investment
 
 
 
 
 
 
 
 
Residential real estate – 1st lien
  3 
 $267,418 
 
 
Twelve months ended December 31, 2017
 
Number of
 
 
Recorded
 
 
 
Contracts
 
 
Investment
 
 
 
 
 
 
 
 
Residential real estate - 1st lien
  1 
 $87,696 
 
 
Twelve months ended June 30, 2017
 
Number of
 
 
Recorded
 
 
 
Contracts
 
 
Investment
 
 
 
 
 
 
 
 
Residential real estate - 1st lien
  2 
 $80,485 
 
 
TDRs are treated as other impaired loans and carry individual specific reserves with respect to the calculation of the ALL. 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.
 
The specific allowances related to TDRs as of the balance sheet dates are presented in the table below.
 
 
 
June 30,
 
 
December 31,
 
 
June 30,
 
 
 
2018
 
 
2017
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
Specific Allocation
 $130,495 
 $197,605 
 $237,551 
 
 
As of the balance sheet dates, the Company evaluates whether it is contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans. The Company is contractually committed to lend on one SBA guaranteed line of credit to a borrower whose lending relationship was previously restructured.
 
Note 6. Goodwill and Other Intangible Assets
 
As a result of a 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 initially recorded $4,161,000 of acquired identified intangible assets in the LyndonBank merger, representing the CDI which was subject to amortization as a non-interest expense over a ten year period and was fully amortized in 2017.
 
Management evaluates goodwill for impairment annually. As of the date of the most recent evaluation (December 31, 2017), management concluded that no impairment existed.
 
 
 
24
 
 
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 MSRs, 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 MSRs, 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 AFS and HTM:  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 primarily of FRBB stock and 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. 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, CRE, 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 ALL. Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis. Management has estimated the fair values of collateral-dependent loans using Level 2 inputs, such as the fair value of collateral based on independent third-party appraisals. All other loans are valued using Level 3 inputs.
 
 
25
 
 
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.
 
MSRs:  MSRs 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 MSRs, the Company obtains third party valuations based on loan level data including note rate, and the type and term of the underlying loans. The Company classifies MSRs as non-recurring Level 2. See Note 1 under the “Use of estimates” section to the audited consolidated financial statements contained in the Company’s December 31, 2017 Annual Report on Form 10-K for more information.
 
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. The Company records OREO as non-recurring Level 2.
 
Deposits, repurchase agreements and borrowed funds:  The fair values disclosed for demand deposits (for example, checking accounts and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying value of repurchase agreements approximates fair value due to their short term. 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. The Company classifies deposits, repurchase agreements 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. The Company classifies these obligations as Level 2.
 
Junior subordinated debentures:  Fair value is estimated using current rates for debentures of similar maturity. The Company classifies these instruments as Level 2.
 
Accrued interest:  The carrying amounts of accrued interest approximate their fair values. 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 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, 2018
 
Level 2
 
Assets: (market approach)
 
 
 
U.S. GSE debt securities
 $14,618,479 
Agency MBS
  15,870,576 
ABS and OAS
  994,312 
Other investments
  7,277,001 
 
 $38,760,368 
 
 
26
 
 
 
December 31, 2017
 
Level 2
 
Assets: (market approach)
 
 
 
U.S. GSE debt securities
 $17,158,742 
Agency MBS
  16,613,337 
Other investments
  4,678,574 
 
 $38,450,653 
 
June 30, 2017
 
Level 2
 
Assets: (market approach)
 
 
 
U.S. GSE debt securities
 $18,313,188 
Agency MBS
  13,078,619 
Other investments
  4,242,909 
 
 $35,634,716 
 
 
There were no Level 1 or Level 3 assets or liabilities measured on a recurring basis as of the balance sheet dates presented, nor were there any transfers of assets between Levels during 2018 or 2017.
 
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 ALL 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, 2018
 
Level 2
 
Assets: (market approach)
 
 
 
MSRs (1)
 $1,033,679 
OREO
  364,235 
 
    
 
December 31, 2017
 
Level 2
 
Assets: (market approach)
 
 
 
MSRs (1)
 $1,083,286 
Impaired loans, net of related allowance
  135,630 
OREO
  284,235 
 
June 30, 2017
 
Level 2
 
Assets: (market approach)
 
 
 
MSRs (1)
 $1,151,241 
Impaired loans, net of related allowance
  25,050 
OREO
  343,928 
 
    
 
 
(1) Represents MSRs at lower of cost or fair value, including MSRs deemed to be impaired and for which a valuation allowance was established to carry at fair value as of the balance sheet dates presented.
 
There were no Level 1 or Level 3 assets or liabilities measured on a non-recurring basis as of the balance sheet dates presented, nor were there any transfers of assets between Levels during 2018 or 2017.
 
 
 
27
 
 
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, 2018
 
 
 
 
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
 $28,810 
 $28,810 
 $0 
 $0 
 $28,810 
Securities HTM
  32,206 
  0 
  32,292 
  0 
  32,292 
Securities AFS
  38,760 
  0 
  38,760 
  0 
  38,760 
Restricted equity securities
  2,434 
  0 
  2,434 
  0 
  2,434 
Loans and loans held-for-sale, net of ALL
    
    
    
    
    
  Commercial & industrial
  87,521 
  0 
  0 
  87,348 
  87,348 
  Commercial real estate
  214,484 
  0 
  0 
  212,767 
  212,767 
  Residential real estate - 1st lien
  163,891 
  0 
  0 
  161,167 
  161,167 
  Residential real estate - Jr lien
  44,824 
  0 
  0 
  44,229 
  44,229 
  Consumer
  4,959 
  0 
  0 
  5,053 
  5,053 
MSRs (1)
  1,034 
  0 
  1,449 
  0 
  1,449 
Accrued interest receivable
  1,952 
  0 
  1,952 
  0 
  1,952 
 
    
    
    
    
    
Financial liabilities:
    
    
    
    
    
Deposits
    
    
    
    
    
  Other deposits
  484,387 
  0 
  482,454 
  0 
  482,454 
  Brokered deposits
  42,532 
  0 
  42,485 
  0 
  42,485 
Short-term borrowings
  21,000 
  0 
  21,000 
  0 
  21,000 
Long-term borrowings
  1,550 
  0 
  1,386 
  0 
  1,386 
Repurchase agreements
  30,295 
  0 
  30,295 
  0 
  30,295 
Capital lease obligations
  325 
  0 
  325 
  0 
  325 
Subordinated debentures
  12,887 
  0 
  12,811 
  0 
  12,811 
Accrued interest payable
  94 
  0 
  94 
  0 
  94 
 
 
(1) Reported fair value represents all MSRs for loans serviced by the Company at June 30, 2018, regardless of carrying amount.
 
28
 
 
 
December 31, 2017
 
 
 
 
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
 $42,654 
 $42,654 
 $0 
 $0 
 $42,654 
Securities HTM
  48,825 
  0 
  48,796 
  0 
  48,796 
Securities AFS
  38,451 
  0 
  38,451 
  0 
  38,451 
Restricted equity securities
  1,704 
  0 
  1,704 
  0 
  1,704 
Loans and loans held-for-sale, net of ALL
    
    
    
    
    
  Commercial & industrial
  76,394 
  0 
  0 
  76,799 
  76,799 
  Commercial real estate
  204,260 
  0 
  136 
  204,697 
  204,833 
  Residential real estate - 1st lien
  167,671 
  0 
  0 
  169,205 
  169,205 
  Residential real estate - Jr lien
  44,916 
  0 
  0 
  45,207 
  45,207 
  Consumer
  5,223 
  0 
  0 
  5,425 
  5,425 
MSRs(1)
  1,083 
  0 
  1,337 
  0 
  1,337 
Accrued interest receivable
  2,052 
  0 
  2,052 
  0 
  2,052 
 
    
    
    
    
    
Financial liabilities:
    
    
    
    
    
Deposits
    
    
    
    
    
  Other deposits
  509,686 
  0 
  508,407 
  0 
  508,407 
  Brokered deposits
  50,949 
  0 
  50,926 
  0 
  50,926 
Long-term borrowings
  3,550 
  0 
  3,191 
  0 
  3,191 
Repurchase agreements
  28,648 
  0 
  28,648 
  0 
  28,648 
Capital lease obligations
  382 
  0 
  382 
  0 
  382 
Subordinated debentures
  12,887 
  0 
  12,832 
  0 
  12,832 
Accrued interest payable
  101 
  0 
  101 
  0 
  101 
 
(1) Reported fair value represents all MSRs for loans serviced by the Company at December 31, 2017, regardless of carrying amount.
 
 
29
 
 
June 30, 2017
 
 
 
 
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
 $37,026 
 $37,026 
 $0 
 $0 
 $37,026 
Securities HTM
  36,418 
  0 
  37,065 
  0 
  37,065 
Securities AFS
  35,635 
  0 
  35,635 
  0 
  35,635 
Restricted equity securities
  1,943 
  0 
  1,943 
  0 
  1,943 
Loans and loans held-for-sale, net of ALL
    
    
    
    
    
  Commercial & industrial
  78,609 
  0 
  0 
  79,311 
  79,311 
  Commercial real estate
  207,207 
  0 
  0 
  208,632 
  208,632 
  Residential real estate - 1st lien
  163,489 
  0 
  25 
  166,085 
  166,110 
  Residential real estate - Jr lien
  41,762 
  0 
  0 
  42,199 
  42,199 
  Consumer
  6,903 
  0 
  0 
  7,147 
  7,147 
MSRs (1)
  1,151 
  0 
  1,341 
  0 
  1,341 
Accrued interest receivable
  1,746 
  0 
  1,746 
  0 
  1,746 
 
    
    
    
    
    
Financial liabilities:
    
    
    
    
    
Deposits
    
    
    
    
    
  Other deposits
  479,131 
  0 
  478,412 
  0 
  478,412 
  Brokered deposits
  54,176 
  0 
  54,177 
  0 
  54,177 
Short-term borrowings
  10,000 
  0 
  10,000 
  0 
  10,000 
Long-term borrowings
  3,550 
  0 
  3,205 
  0 
  3,205 
Repurchase agreements
  28,863 
  0 
  28,863 
  0 
  28,863 
Capital lease obligations
  435 
  0 
  435 
  0 
  435 
Subordinated debentures
  12,887 
  0 
  12,844 
  0 
  12,844 
Accrued interest payable
  125 
  0 
  125 
  0 
  125 
 
(1) Reported fair value represents all MSRs for loans serviced by the Company at June 30, 2017, regardless of carrying amount.
 
 
Note 8. Loan Servicing
 
The following table shows the changes in the carrying amount of the MSRs, included in other assets in the consolidated balance sheets, for the periods indicated:
 
 
 
Six Months Ended
 
 
Year Ended
 
 
Six Months Ended
 
 
 
June 30, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 $1,083,286 
 $1,210,695 
 $1,210,695 
   MSRs capitalized
  43,678 
  109,297 
  54,603 
   MSRs amortized
  (93,285)
  (236,706)
  (114,057)
Balance at end of period
 $1,033,679 
 $1,083,286 
 $1,151,241 
 
There were no changes in the valuation allowance for the periods presented.
 
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 14, 2018, the Company declared a cash dividend of $0.19 per common share payable August 1, 2018 to shareholders of record as of July 15, 2018. This dividend has been recorded as of the declaration date, including shares issuable under the DRIP.
 
 
30
 
 
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, 2018
 
The following discussion analyzes the consolidated financial condition of the Company and its wholly-owned subsidiary, Community National Bank (the Bank), as of June 30, 2018, December 31, 2017, and June 30, 2017, and its consolidated results of operations for the three- and six-month interim periods presented.
 
The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 2017 Annual Report on Form 10-K filed with the SEC.
 
Capitalized terms, abbreviations and acronyms used throughout the following discussion are defined in Note 1 to the Company’s unaudited consolidated financial statements contained in Part I, Item 1 of this report.
 
FORWARD-LOOKING STATEMENTS
 
This Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, regarding 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," “projects”, "plans," “assumes”, "predicts," “may”, “might”, “will”, “could”, “should” and 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. 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 FHLBB 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 expectations and estimates as of the date they are made, many of the factors that could influence or determine actual results are unpredictable and not within the Company's control.
 
Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities:
 
general economic or business conditions, either nationally, regionally or locally, deteriorate, resulting in a decline in credit quality or a diminished demand for the Company's products and services;
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;
interest rates change in such a way as to negatively affect the Company's net income, asset valuations or margins;
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;
changes in federal or state tax laws or policy;
changes in the level of nonperforming assets and charge-offs;
changes in applicable accounting policies, practices and standards;
changes in consumer and business spending, borrowing and savings habits;
reductions in deposit levels, which necessitate increased borrowings to fund loans and investments;
the geographic concentration of the Company’s loan portfolio and deposit base;
losses due to the fraudulent or negligent conduct of third parties, including the Company’s service providers, customers and employees;
cybersecurity risks could adversely affect the Company’s business, financial performance or reputation and could result in financial liability for losses incurred by customers or others due to data breaches or other compromise of the Company’s information security systems;
higher-than-expected costs are incurred relating to information technology or difficulties arise in implementing technological enhancements;
changes to the calculation of the Company’s regulatory capital ratios which began in 2015 under the Basel III capital framework and which, among other things, requires additional regulatory capital, and changes the framework for risk-weighting of certain assets;
 
 
31
 
 
management’s risk management measures may not be completely effective;
changes in the United States monetary and fiscal policies, including the interest rate policies of the FRB and its regulation of the money supply; and
adverse changes in the credit rating of U.S. government debt.
 
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.
 
NON-GAAP FINANCIAL MEASURES
 
Under SEC Regulation G, public companies making disclosures containing financial measures that are not in accordance with 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, three 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)) and core earnings (as defined and discussed in the Results of Operations section), 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.
 
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, 2018 were $654,995,774, a decrease of $12,049,821, or 1.8%, from December 31, 2017 and an increase of $6,821,432, or 1.1%, from June 30, 2017. Net loans increased $18,278,894, or 3.7%, since December 31, 2017 and $18,302,259, or 3.7%, since June 30, 2017. The year to date and year over year increases in the loan portfolio were primarily attributable to growth in commercial loans and were funded primarily through an increase in borrowed funds. In the year to date comparison, while net loans increased 3.7%, this was offset by a decrease of $16,619,243, or 34.0%, in the held-to-maturity security portfolio due to the seasonal maturing of tax anticipation loans with the local school districts on June 30, 2018. The decrease in municipal investments 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 2019 were funded on July 1, 2018 in an amount comparable to the balances that matured on June 30.
 
Total deposits decreased $33,716,069, or 6.0%, since December 31, 2017 with a notable decrease in money market funds of $17,408,461, or 18.6%, and $11,555,232, or 4.6%, in checking accounts. In the year over year comparison, deposits decreased $6,388,368, or 1.2%. The decrease in money market funds is predominantly due to a decrease of $12,886,644 in municipal deposit accounts due to the seasonal runoff of municipal deposits. Core deposits saw increases in all areas in the year over year comparison, with the most significant increase noted in interest-bearing transaction accounts. These increases were, however, more than offset by a $23,248,279 decrease in time deposits year over year. The decrease in time deposits is attributable to a decrease in retail time deposits of $3,560,543 and a decrease in brokered time deposits of $19,687,735, as the Company shifted some of its funding for its loan growth from brokered deposits to overnight borrowings, which can be closely tailored to the Company’s liquidity needs.
 
Interest income increased $584,022, or 9.1%, for the second quarter of 2018 compared to the same quarter in 2017, and $1,204,467, or 9.6%, for the first six months of 2018 compared to the same period in 2017. Interest expense increased $188,995, or 25.2%, for the second quarter of 2018 compared to the same quarter in 2017, and $323,332, or 21.8%, for the first six months of 2018 compared to the same period in 2017. The increase in interest income year over year is partly due to the higher average loan balances, which exceeded the prior year by $18.5 million, or 3.8%, as well as the recent increases in short-term rates. While the increase in short-term rates is having a positive impact on interest income, it is also continuing to put upward pressure on interest rates paid on deposit accounts. During the first six months of 2018, the increase in short-term rates, coupled with the increase in average interest-bearing deposit account balances, resulted in an increase in interest paid on deposit accounts of $300,552 year over year.
 
 
32
 
 
Net interest income after the provision for loan losses improved by $365,027, or 6.6%, for the second quarter of 2018 compared to the same quarter in 2017, and $821,135, or 7.6%, year over year. The charge to income for the provision for loan losses increased $30,000, or 20.0%, for the second quarter of 2018 and $60,000, or 20.0%, for the first six months of 2018, compared to the same periods last year, in order to accommodate the continued increase in the loan portfolio. Please refer to the ALL and provisions discussion in the Credit Risk section for more information.
 
Net income for the second quarter of 2018 was $2,002,654, an increase of $503,141, or 33.6%, over net income of $1,499,513 for the second quarter of 2017. Net income for the first six months of 2018 increased $1,071,468, or 36.8%, from $2,913,729 for 2017 to $3,985,197 for 2018. As stated above, net interest income contributed significantly to the Company’s increase in earnings in both periods. Increases in non-interest income of $308,430, or 22.3%, for the second quarter and $333,882, or 12.1%, for the first six months of 2018 are also noted, while total non-interest expense increased $211,407, or 4.3%, for the second quarter and $211,405, or 2.2%, for the first six months of 2018. Please refer to the Non-interest Income and Expense sections for more information.
 
The financial statements and capital sections of this report reflect a partial redemption of the Company’s outstanding Series A non-cumulative perpetual preferred stock. On March 31, 2018, five shares were redeemed at par, representing 20% of the then outstanding preferred shares, at an aggregate redemption price of $500,000, plus accrued dividends.
 
On June 14, 2018, the Company's Board declared a quarterly cash dividend of $0.19 per common share, payable on August 1, 2018 to shareholders of record on July 15, 2018. This dividend represents an increase of $0.02 per common share, or 11.8%, over the quarterly dividend paid in recent quarters.
 
There were two favorable legal developments during the second quarter of 2018 intended to lighten the regulatory burden on community banks and small public companies such as the Company and the Bank. In May, Congress enacted the 2018 Regulatory Relief Act, which rolls back some of the regulatory excesses of the Dodd-Frank Act and contains provisions aimed specifically at relieving some of the regulatory burdens on community banks, including simplifying the calculation of regulatory capital. In addition, in June the SEC adopted regulations increasing the thresholds for companies to qualify as smaller reporting companies, which are permitted to utilize the SEC’s scaled disclosure requirements. Management believes that these regulatory developments represent a positive change that will help reduce the unproductive diversion of management resources resulting from excessive regulation.
 
CRITICAL ACCOUNTING POLICIES
 
The Company’s significant accounting policies 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 ALL;
 OREO;
 valuation of residential MSRs;
 OTTI of investment securities; and
 the carrying value of goodwill.
 
These policies are described further in the Company’s 2017 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. There were no material changes during the first six months of 2018 in the Company’s critical accounting policies.
 
RESULTS OF OPERATIONS
 
Net income for the second quarter of 2018 was $2,002,654 or $0.39 per common share, compared to $1,499,513 or $0.29 per common share for the same quarter of 2017. Net income for the first six months of 2018 was $3,985,197 or $0.77 per common share, compared to $2,913,729 or $0.57 per common share for 2017. Core earnings (net interest income) for the second quarter of 2018 increased $395,027, or 6.9%, compared to the same quarter in 2017, and $881,135, or 7.9%, year over year. The loan mix continued to shift in favor of higher yielding commercial loans, while the deposit mix experienced an increase in 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, increased $151,279, or 26.6%, for the second quarter of 2018 compared to the same quarter of 2017, and $300,552, or 27.2%, year over year, reflecting the increases in short term rates and higher interest-bearing deposit balances. The recent increases in prime rate also had an impact on the interest paid on the junior subordinated debentures, contributing to the increase in interest expense in both comparison periods. The Company recorded a provision for loan losses of $180,000 for the second quarter of 2018 and $360,000 for the first six months of 2018, compared to $150,000 and $300,000, respectively in 2017, reflecting the growth in the loan portfolio between periods.
 
33
 
 
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,
 
 
 
2018
 
 
2017
 
Return on Average Assets
  1.23%
  0.93%
Return on Average Equity
  13.66%
  10.80%
 
 
 
 
 
Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
Return on Average Assets
  1.22%
  0.92%
Return on Average Equity
  13.73%
  10.64%
 
 
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,
 
 
 
2018
 
 
2017
 
 
2017
 
Balance Sheet Data
 
 
 
 
 
 
 
 
 
Net loans
 $516,024,097 
 $497,745,203 
 $497,721,838 
Total assets
  654,995,774 
  667,045,595 
  648,174,342 
Total deposits
  526,918,911 
  560,634,980 
  533,307,279 
Borrowed funds
  22,550,000 
  3,550,000 
  13,550,000 
Junior subordinated debentures
  12,887,000 
  12,887,000 
  12,887,000 
Total liabilities
  595,539,141 
  609,109,741 
  592,057,028 
Total shareholders' equity
  59,456,633 
  57,935,854 
  56,117,314 
 
    
    
    
Book value per common share outstanding
 $11.18 
 $10.84 
 $10.54 
 
 
 
Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
Operating Data
 
 
 
 
 
 
Total interest income
 $13,805,697 
 $12,601,230 
Total interest expense
  1,807,247 
  1,483,915 
     Net interest income
  11,998,450 
  11,117,315 
 
    
    
Provision for loan losses
  360,000 
  300,000 
     Net interest income after provision for loan losses
  11,638,450 
  10,817,315 
 
    
    
Non-interest income
  3,085,831 
  2,751,949 
Non-interest expense
  9,835,092 
  9,623,687 
     Income before income taxes
  4,889,189 
  3,945,577 
Applicable income tax expense(1)
  903,992 
  1,031,848 
 
    
    
     Net Income
 $3,985,197 
 $2,913,729 
 
    
    
Per Common Share Data
    
    
Earnings per common share (2)
 $0.77 
 $0.57 
Dividends declared per common share
 $0.36 
 $0.34 
Weighted average number of common shares outstanding
  5,123,947 
  5,070,453 
Number of common shares outstanding, period end
  5,140,030 
  5,087,652 
 
(1) Applicable income tax expense assumes a 21% and 34% tax rate for 2018 and 2017, respectively.
(2) Computed based on the weighted average number of common shares outstanding during the periods presented.
 
 
 
34
 
 
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 and the interest paid on deposits and other sources of funds (i.e., 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 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 21% for 2018 and was 34% for previous years, to equalize tax-free and taxable income in the comparison, we divide the tax-free income by 79% for 2018 and 66% for 2017, with the result that every tax-free dollar is equivalent to $1.27 and $1.52, for the two periods respectively, in taxable income.
 
The Company’s tax-exempt interest income of $312,488 and $336,197 for the three months ended June 30, 2018 and 2017, respectively, and $622,644 and $660,729 for the six months ended June 30, 2018 and 2017, respectively, was derived from municipal investments, which comprised the entire HTM portfolio of $32,205,722 at June 30, 2018, and $36,418,414 at June 30, 2017.
 
The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the comparison periods presented.
 
 
 
Three Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net interest income as presented
 $6,090,360 
 $5,695,333 
Effect of tax-exempt income
  83,066 
  173,192 
   Net interest income, tax equivalent
 $6,173,426 
 $5,868,525 
 
 
 
 
Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Net interest income as presented
 $11,998,450 
 $11,117,315 
Effect of tax-exempt income
  165,513 
  340,376 
   Net interest income, tax equivalent
 $12,163,963 
 $11,457,691 
 
 
 
35
 
 
The following tables present average interest-earning assets and average interest-bearing liabilities supporting earning assets. Interest income (excluding interest on non-accrual loans) is expressed on a tax equivalent basis, both in dollars and as a rate/yield for the comparison periods presented, utilizing an effective tax rate of 21% for the three- and six-month periods ended June 30, 2018 and 34% for the 2017 comparison periods.
 
 
 
Three Months Ended June 30,
 
 
 
 
 
 
2018
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
Average
 
 
 
 
 
 
 
 
Average
 
 
 
 Average
 
 
Income/
 
 
Rate/
 
 
 Average
 
 
Income/
 
 
Rate/
 
 
 
Balance
 
 
Expense
 
 
Yield
 
 
Balance
 
 
Expense
 
 
Yield
 
Interest-Earning Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Loans (1)
 $508,935,823 
 $6,387,493 
  5.03%
 $493,133,662 
 $5,875,766 
  4.78%
 Taxable investment securities
  37,477,496 
  221,016 
  2.37%
  33,512,371 
  164,644 
  1.97%
 Tax-exempt investment securities
  47,606,468 
  395,554 
  3.33%
  54,233,974 
  509,389 
  3.77%
 Sweep and interest-earning accounts
  15,113,075 
  77,005 
  2.04%
  11,456,863 
  27,366 
  0.96%
 Other investments (2)
  2,232,804 
  30,857 
  5.54%
  2,427,314 
  40,864 
  6.75%
 
 $611,365,666 
 $7,111,925 
  4.67%
 $594,764,184 
 $6,618,029 
  4.46%
 
    
    
    
    
    
    
Interest-Bearing Liabilities
    
    
    
    
    
    
 Interest-bearing transaction accounts
 $127,178,316 
 $128,935 
  0.41%
 $118,247,103 
 $67,062 
  0.23%
 Money market accounts
  97,451,375 
  276,229 
  1.14%
  88,031,136 
  203,376 
  0.93%
 Savings deposits
  99,755,031 
  31,512 
  0.13%
  97,448,357 
  30,895 
  0.13%
 Time deposits
  110,111,222 
  282,713 
  1.03%
  122,874,075 
  266,777 
  0.87%
 Borrowed funds
  4,998,681 
  10,746 
  0.86%
  10,300,659 
  18,979 
  0.74%
 Repurchase agreements
  31,338,855 
  37,641 
  0.48%
  29,644,902 
  22,235 
  0.30%
 Capital lease obligations
  335,077 
  6,897 
  8.23%
  443,522 
  9,065 
  8.18%
 Junior subordinated debentures
  12,887,000 
  163,827 
  5.10%
  12,887,000 
  131,115 
  4.08%
 
 $484,055,557 
 $938,499 
  0.78%
 $479,876,754 
 $749,504 
  0.63%
 
    
    
    
    
    
    
Net interest income
    
 $6,173,426 
    
    
 $5,868,525 
    
Net interest spread (3)
    
    
  3.89%
    
    
  3.83%
Net interest margin (4)
    
    
  4.05%
    
    
  3.96%
 
 
(1) Included in gross loans are non-accrual loans with an average balance of $4,257,250 and $2,562,901 for the three months ended June 30, 2018 and 2017, respectively.
       Loans are stated before deduction of unearned discount and ALL, less loans held-for-sale.
     
(2) Included in other investments is the Company’s FHLBB Stock with an average balance of $1,167,654 and $1,452,164 for the three months ended June 30, 2018 and
       2017, respectively, and a dividend rate of approximately 5.46% and 4.08%, 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.
 
 
 
36
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
 
2018
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
Average
 
 
 
 
 
 
 
 
Average
 
 
 
 Average
 
 
Income/
 
 
Rate/
 
 
 Average
 
 
Income/
 
 
Rate/
 
 
 
Balance
 
 
Expense
 
 
Yield
 
 
Balance
 
 
Expense
 
 
Yield
 
Interest-Earning Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Loans (1)
 $507,766,674 
 $12,528,037 
  4.98%
 $489,232,619 
 $11,492,633 
  4.74%
 Taxable investment securities
  37,867,928 
  423,901 
  2.26%
  34,737,861 
  316,370 
  1.84%
 Tax-exempt investment securities
  47,693,329 
  788,157 
  3.33%
  53,102,100 
  1,001,105 
  3.80%
 Sweep and interest-earning accounts
  18,318,075 
  171,567 
  1.89%
  12,743,237 
  54,838 
  0.87%
 Other investments (2)
  2,171,070 
  59,548 
  5.53%
  2,722,976 
  76,660 
  5.68%
 
 $613,817,076 
 $13,971,210 
  4.59%
 $592,538,793 
 $12,941,606 
  4.40%
 
    
    
    
    
    
    
Interest-Bearing Liabilities
    
    
    
    
    
    
 Interest-bearing transaction accounts
 $126,128,102 
 $231,067 
  0.37%
 $116,998,410 
 $124,276 
  0.21%
 Money market accounts
  100,723,921 
  553,904 
  1.11%
  86,341,709 
  407,273 
  0.95%
 Savings deposits
  98,504,902 
  61,817 
  0.13%
  95,020,360 
  59,320 
  0.13%
 Time deposits
  111,871,677 
  559,663 
  1.01%
  120,921,569 
  515,030 
  0.86%
 Borrowed funds
  4,279,006 
  10,761 
  0.51%
  16,005,359 
  61,667 
  0.78%
 Repurchase agreements
  30,546,716 
  68,847 
  0.45%
  29,532,936 
  43,762 
  0.30%
 Capital lease obligations
  349,137 
  14,364 
  8.23%
  455,473 
  18,612 
  8.17%
 Junior subordinated debentures
  12,887,000 
  306,824 
  4.80%
  12,887,000 
  253,975 
  3.97%
 
 $485,290,461 
 $1,807,247 
  0.75%
 $478,162,816 
 $1,483,915 
  0.63%
 
    
    
    
    
    
    
Net interest income
    
 $12,163,963 
    
    
 $11,457,691 
    
Net interest spread (3)
    
    
  3.84%
    
    
  3.77%
Net interest margin (4)
    
    
  4.00%
    
    
  3.90%
 
 
(1) Included in gross loans are non-accrual loans with an average balance of $3,783,183 and $2,549,410 for the six months ended June 30, 2018 and 2017, respectively.
       Loans are stated before deduction of unearned discount and ALL, less loans held-for-sale.
     
(2) Included in other investments is the Company’s FHLBB Stock with average balances of $1,141,721 and $1,747,826, respectively, and a dividend rate of approximately
       5.77% and 4.11%, respectively, for the first six months of 2018 and 2017, respectively.
     
(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.
 
 
The average volume of interest-earning assets for the three- and six-month periods ended June 30, 2018 increased 2.8% and 3.6%, respectively, compared to the same periods last year. Average yield on interest-earning assets for the second quarter increased 21 bps, to 4.67%, compared to 4.46% for the same period last year, and increased 19 bps for the six months ended June 30, 2018, to 4.59%, from 4.40% for the same period last year.
 
The average volume of loans increased over the three- and six-month comparison periods of 2018 versus 2017, by 3.2% and 3.8%, respectively, while the average yield on loans increased 25 bps for the second quarter, to 5.03%, compared to 4.78% for the second quarter of 2017, and 24 bps for the six months ended June 30, 2018, to 4.98%, from 4.74% for the same period in 2017. These increases reflected a combination of the steadily increasing federal funds rate over the periods noted, and a shift in asset mix toward commercial loans; however, this has been partially offset by continued pressure on medium term (5-10 year) fixed rates. Interest earned on the loan portfolio as a percentage of total interest income increased in both comparison periods, comprising approximately 89.8% and 89.7% for the three- and six-month comparison periods of 2018, versus 88.8% for both comparison periods last year.
 
 
37
 
 
The average volume of the taxable investment portfolio (classified as AFS) increased 11.8% during the second quarter of 2018 and 9.0% year to date, compared to the same periods last year. These increases are due primarily to an effort to continue to incrementally grow the investment portfolio as the balance sheet grows in order to provide additional liquidity and pledge quality assets.  Average yields on the taxable investment portfolio increased 40 bps and 42 bps, respectively, during the three- and six-month comparison periods of 2018 compared to the same periods last year, due primarily to rising market rates, as the mix of the portfolio remained relatively stable.  The average volume of the tax-exempt portfolio (classified as HTM and consisting of municipal securities) decreased 12.2% during the second quarter of 2018 and 10.2% year to date, compared to the same periods last year, as competitive pressures for municipal loan and deposit relationships increase and market pricing has not yet fully reflected the effect of lower federal tax rates under the 2017 Tax Act. The average tax-equivalent yield on the tax-exempt portfolio decreased 44 bps during the second quarter of 2018, and 47 bps for the six-month period ended June 30, 2018, compared to the same periods last year, due to the effect of the lower tax rate on the existing tax-exempt portfolio.
 
The average volume of sweep and interest-earning accounts, which consists primarily of an interest-bearing account at the FRBB and two correspondent banks, increased 32.0% during the three-month period and 43.8% during the six-month period ended June 30, 2018, compared to the same periods last year, and the average yield on these funds increased 108 bps and 102 bps, respectively. These increases in volume are attributable to a higher balance of cash periodically held on hand in anticipation of funding loan growth and other liquidity needs. The increases in rate are directly related to the increases in the federal funds rate.
 
The average volume of interest-bearing liabilities for the three- and six-month periods ended June 30, 2018 increased 0.9% and 1.5%, respectively, compared to the same periods last year. The average rate paid on interest-bearing liabilities increased 15 bps during the second quarter of 2018 and 12 bps during the first six months of 2018, compared to the same periods last year, reflecting the rising rate environment and competitive pressures in deposit pricing.
 
The average volume of interest-bearing transaction accounts increased 7.6% and 7.8%, respectively, during the second quarter and first six months of 2018, compared to the same periods last year, and the average rate paid on these accounts increased 18 bps and 16 bps, respectively. The average volume of money market accounts increased 10.7% during the three-month period and 16.7% during the six-month period ended June 30, 2018 compared to the same periods in 2017, and the average rate paid on these deposits increased 21 bps and 16 bps, respectively. The average volume of savings accounts increased 2.4% for the three-month period and 3.7% for the six-month period of 2018 versus 2017. Some of the increase is due to the continued shift in product mix from retail time deposits to savings accounts as consumers anticipate higher rates in the near future. Compared to the same periods in 2017, the average volume of retail time deposits decreased 3.7% during the second quarter, and 3.8% year to date 2018, while the average volume of wholesale time deposits decreased 37.8% and 24.2%, respectively. Following the most recent increase in short term rates, there has been more pressure for higher rates from the more rate sensitive deposit holders and the local market is now showing signs of a willingness to pay higher rates on deposit products. While the Company relied less on wholesale time deposits during this reporting period, the brokered deposit market is still considered a beneficial source of funding to help smooth out the fluctuations in core deposit balances without the need to disrupt deposit pricing in the Company’s local markets. These funds can be obtained relatively quickly on an as-needed basis, making them a valuable alternative to traditional term borrowings from the FHLBB.
 
The average volume of borrowed funds decreased 51.5% and 73.3%, respectively, for the three- and six-month comparison period of 2018 versus 2017. The average rate paid on these borrowings increased 12 bps for the three-month period, and decreased 27 bps for the six-month period in 2018 as compared to the same periods in 2017. The average volume of repurchase agreements increased 5.7% and 3.4%, respectively, for three- and six-month periods ended June 30, 2018, compared to the same periods in 2017, while the average rate paid on repurchase agreements increased 18 bps and 15 bps, respectively, compared to the same periods in 2017.
 
Between the three-month periods ended June 30, 2018 and 2017, the average yield on interest-earning assets increased 21 bps, while the average rate paid on interest-bearing liabilities increased 15 bps. Between the six months ended June 30, 2018 and 2017, the average yield on interest-earning assets increased 19 bps, while the average rate paid on interest-bearing liabilities increased 12 bps. Net interest spread for the second quarter of 2018 was 3.89%, an increase of six bps from 3.83% for the same period in 2017, and for the six-month comparison periods of 2018 and 2017 was 3.84% and 3.77%, respectively. Net interest margin increased nine bps during the second quarter of 2018 compared to the second quarter of 2017, and 10 bps during the six-month comparison periods of 2018 and 2017.
 
 
 
38
 
 
The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the periods presented for 2018 and 2017 resulting from volume changes in average assets and average liabilities and fluctuations in average rates earned and paid.
 
 
 
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)(2)
 
 
Volume (1)(2)
 
 
Variance
 
 
Rate (1)(2)
 
 
Volume (1)(2)
 
 
Variance
 
Average Interest-Earning Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Loans
 $323,409 
 $188,318 
 $511,727 
 $599,757 
 $435,647 
 $1,035,404 
 Taxable investment securities
  36,897 
  19,475 
  56,372 
  78,971 
  28,560 
  107,531 
 Tax-exempt investment securities
  (58,812)
  (55,023)
  (113,835)
  (123,632)
  (89,316)
  (212,948)
 Sweep and interest-earning accounts
  40,816 
  8,751 
  49,567 
  92,678 
  24,051 
  116,729 
 Other investments
  (7,239)
  (2,696)
  (9,935)
  (1,977)
  (15,135)
  (17,112)
 
 $335,071 
 $158,825 
 $493,896 
 $645,797 
 $383,807 
 $1,029,604 
 
    
    
    
    
    
    
Average Interest-Bearing Liabilities
    
    
    
    
    
    
 Interest-bearing transaction accounts
 $56,752 
 $5,121 
 $61,873 
 $97,284 
 $9,507 
 $106,791 
 Money market accounts
  51,011 
  21,842 
  72,853 
  78,877 
  67,754 
  146,631 
 Savings deposits
  (131)
  748 
  617 
  251 
  2,246 
  2,497 
 Time deposits
  48,710 
  (32,774)
  15,936 
  89,959 
  (45,326)
  44,633 
 Borrowed funds
  3,135 
  (11,368)
  (8,233)
  (21,250)
  (29,656)
  (50,906)
 Repurchase agreements
  14,138 
  1,267 
  15,405 
  23,577 
  1,508 
  25,085 
 Capital lease obligations
  57 
  (2,225)
  (2,168)
  92 
  (4,340)
  (4,248)
 Junior subordinated debentures
  32,712 
  0 
  32,712 
  52,849 
  0 
  52,849 
 
 $206,384 
 $(17,389)
 $188,995 
 $321,639 
 $1,693 
 $323,332 
 
    
    
    
    
    
    
Changes in net interest income
 $128,687 
 $176,214 
 $304,901 
 $324,158 
 $382,114 
 $706,272 
 
 
(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) Tax equivalent interest income is calculated utilizing an effective tax rate of 21% for 2018 and 34% for 2017.
 
39
 
 
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
 
 
 
2018
 
 
2017
 
 
Income
 
 
Percent
 
 
2018
 
 
2017
 
 
Income
 
 
Percent
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service fees
 $810,731 
 $772,238 
 $38,493 
  4.98%
 $1,580,813 
 $1,520,355 
 $60,458 
  3.98%
Income from sold loans
  190,710 
  184,072 
  6,638 
  3.61%
  374,329 
  374,367 
  (38)
  -0.01%
Other income from loans
  198,351 
  209,288 
  (10,937)
  -5.23%
  410,621 
  394,905 
  15,716 
  3.98%
Net realized (loss) gain on sale
    
    
    
    
    
    
    
    
  of securities AFS
  (6,375)
  1,270 
  (7,645)
  -601.97%
  (10,236)
  3,400 
  (13,636)
  -401.06%
Other income
    
    
    
    
    
    
    
    
  Income from CFSG Partners
  142,603 
  85,334 
  57,269 
  67.11%
  270,786 
  198,514 
  72,272 
  36.41%
  SERP fair value adjustment
  0 
  17,377 
  (17,377)
  -100.00%
  0 
  47,491 
  (47,491)
  -100.00%
  Gain on sale of property
  263,118 
  0 
  263,118 
  100.00%
  263,118 
  0 
  263,118 
  100.00%
  Other miscellaneous income
  91,023 
  112,152 
  (21,129)
  -18.84%
  196,400 
  212,917 
  (16,517)
  -7.76%
     Total non-interest income
 $1,690,161 
 $1,381,731 
 $308,430 
  22.32%
 $3,085,831 
 $2,751,949 
 $333,882 
  12.13%
 
 
Total non-interest income increased $308,430, or 22.3%, for the second quarter of 2018 and $333,882, or 12.1%, for the first six months of 2018 versus the same periods in 2017, with significant changes noted in the following:
 
Service fees on deposit accounts increased $38,493, or 5.0%, for the second quarter and $60,458, or 4.0%, year over year due primarily to an increase in fee income from interchange income and over draft charges.
 
A realized loss of $6,375 for the second quarter of 2018 and $10,236 for the first six months of 2018, compared to realized gains of $1,270 and $3,400, respectively, for the same periods in 2017 are the result of sales of low-yielding, short-duration securities held in the Company’s AFS portfolio which were replaced with higher-yielding investments available in the current market. Management expects that the higher interest income earned by the replacement securities will quickly recover any realized losses.
 
Income from CFSG Partners increased $57,269, or 67.1%, for the second quarter and $72,272, or 36.4%, year over year due to an increase in fee income, which is generally based on the market value of assets under management.
 
There were SERP fair value adjustments of $17,377 for the second quarter and $47,491 for the first six months of 2017, but no SERP fair value adjustments during the comparable 2018 periods. The final payment of SERP benefits to the last participant was made on July 1, 2017 and the related asset was liquidated shortly thereafter.
 
Gain on sale of property of $263,118 was directly related to the sale of an office condominium unit to the Company’s affiliate, CFSG. Prior to the sale, CFSG had rented this unit since its formation in 2002.
 
 
 
40
 
 
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
 
 
 
2018
 
 
2017
 
 
Expense
 
 
Percent
 
 
2018
 
 
2017
 
 
Expense
 
 
Percent
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries and wages
 $1,914,616 
 $1,703,751 
 $210,865 
  12.38%
 $3,530,002 
 $3,414,875 
 $115,127 
  3.37%
Employee benefits
  722,302 
  692,418 
  29,884 
  4.32%
  1,396,304 
  1,333,979 
  62,325 
  4.67%
Occupancy expenses, net
  657,596 
  661,294 
  (3,698)
  -0.56%
  1,332,470 
  1,348,727 
  (16,257)
  -1.21%
Other expenses
    
    
    
    
    
    
    
    
  Service contracts - administrative
  121,203 
  101,655 
  19,548 
  19.23%
  247,161 
  196,663 
  50,498 
  25.68%
  Marketing expense
  138,501 
  126,992 
  11,509 
  9.06%
  277,002 
  247,498 
  29,504 
  11.92%
  Audit Fees
  95,751 
  90,592 
  5,159 
  5.69%
  203,377 
  185,990 
  17,387 
  9.35%
  Consultant services
  78,153 
  53,342 
  24,811 
  46.51%
  143,236 
  101,822 
  41,414 
  40.67%
  Collection & non-accruing loan expense
  40,213 
  17,055 
  23,158 
  135.78%
  93,499 
  20,710 
  72,789 
  351.47%
  Amortization of CDI
  0 
  68,175 
  (68,175)
  -100.00%
  0 
  136,350 
  (136,350)
  -100.00%
  Other miscellaneous expenses
  1,335,640 
  1,377,294 
  (41,654)
  -3.02%
  2,612,041 
  2,637,073 
  (25,032)
  -0.95%
     Total non-interest expense
 $5,103,975 
 $4,892,568 
 $211,407 
  4.32%
 $9,835,092 
 $9,623,687 
 $211,405 
  2.20%
 
 
Total non-interest expense increased $211,407, or 4.3%, for the second quarter of 2018 and $211,405, or 2.2%, for the first six months of 2018, compared to the same periods in 2017 with significant changes noted in the following:
 
Salaries and wages increased $210,865, or 12.4%, for the second quarter and $115,127, or 3.4%, year over year. The quarterly increase is due primarily to differences in the timing of pay periods, while the year over year increase is due to normal cost of living increases and net new hires.
 
Employee benefits increased $29,884, or 4.3%, for the second quarter and $62,325, or 4.7%, year over year due to increases in the cost of the employee health insurance plan.
 
Service contracts – administrative increased $19,548 or 19.2% for the second quarter of 2018 and $50,498, or 25.7%, year over year due to the increasing cost to support information technology and branch infrastructure.
 
Marketing expense increased $11,509, or 9.1%, for the second quarter and $29,504, or 11.9%, year over year due to the Company’s strategic decision to enhance marketing efforts, including a shift to television ads from paper and radio and marketing efforts to promote strategic initiatives.
 
Audit fees increased $5,159, or 5.7%, for the second quarter and $17,387, or 9.4%, year over year due to increased audit requirements on internal control over financial reporting as the Company transitioned to accelerated filer status for SEC reporting purposes.
 
Consultant services increased $24,811, or 46.5%, for the second quarter and $41,414, or 40.7% year over year mostly due to a contract with a consultant for technology related projects.
 
Collection & non-accruing loan expense increased $23,158, or 135.8%, for the second quarter and $72,789, or 351.5%, year over year. Expenses on non-performing loans are increasing due to the length of time it takes to go through the foreclosure process, contributing to the increase in both periods. The variance year over year is due primarily to non-recurring recovery of expenses of approximately $30,000 in the first quarter of 2017 compared to none in 2018.
 
The CDI from the 2007 acquisition of LyndonBank was fully amortized in 2017, accounting for the absence of a CDI amortization expense during 2018, compared to an expense of $68,175 and $136,350 for the three- and six-month periods ended June 2017, respectively.
 
 
 
41
 
 
APPLICABLE INCOME TAXES
 
The provision for income taxes decreased in both periods, by $41,091, or 7.7%, to $493,892 for the second quarter of 2018 compared to $534,983 for the same period in 2017, and $127,856, or 12.4%, to $903,992 for the first six months of 2018 compared to $1,031,848 for the same period in 2017. This decrease is due primarily to a decrease in the corporate tax rate from 34% to 21% effective January 1, 2018, resulting from passage of the 2017 Tax Act. Income before taxes increased $462,050, or 22.7%, for the second quarter of 2018 compared to the same quarter in 2017, and $943,612, or 23.9%, for the first six months of 2018 compared to the same period in 2017. Tax credits related to limited partnerships amounted to $100,140 and $106,599, respectively, for the second quarters of 2018 and 2017, and $200,280 and $213,198, respectively, for the first six months of 2018 compared to 2017.
 
Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $94,371 and $105,414, respectively, for the second quarter of 2018 and 2017, and $188,742 and $210,828 for the first six months of 2018 and 2017, respectively. These investments provide tax benefits, including tax credits, and are designed to provide a targeted effective yield between 7% and 10%.
 
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, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Loans
 $521,091,943 
  79.56%
 $502,864,651 
  75.39%
 $502,772,845 
  77.57%
 Securities AFS
  38,760,368 
  5.92%
  38,450,653 
  5.76%
  35,634,716 
  5.50%
 Securities HTM
  32,205,722 
  4.92%
  48,824,965 
  7.32%
  36,418,414 
  5.62%
 
    
    
    
    
    
    
Liabilities
    
    
    
    
    
    
 Demand deposits
  112,159,218 
  17.12%
  117,245,565 
  17.58%
  110,398,464 
  17.03%
 Interest-bearing transaction accounts
  126,164,648 
  19.26%
  132,633,533 
  19.88%
  116,869,761 
  18.03%
 Money market accounts
  75,983,544 
  11.60%
  93,392,005 
  14.00%
  73,279,696 
  11.31%
 Savings deposits
  101,030,190 
  15.42%
  97,516,284 
  14.62%
  97,929,768 
  15.11%
 Time deposits
  111,581,311 
  17.04%
  119,847,593 
  17.97%
  134,829,590 
  20.80%
 Borrowed funds
  21,000,000 
  3.21%
  0 
  0.00%
  10,000,000 
  1.54%
 Long-term advances
  1,550,000 
  0.24%
  3,550,000 
  0.53%
  3,550,000 
  0.55%
 
 
The Company's total loan portfolio at June 30, 2018 increased $18,227,292, or 3.6%, from December 31, 2017 and $18,319,098, or 3.6%, year over year. AFS securities increased $309,715 or 0.8%, year to date, and $3,125,652, or 8.8%, year over year. AFS securities have increased in order to stay proportional to the overall asset base, as this portfolio serves an important role in the Company’s liquidity position. HTM securities decreased $16,619,243 or 34.0%, year to date, and decreased $4,212,692, or 11.6%, year over year. HTM securities consist entirely of investments from the Company’s municipal customers in its service areas. The decline in HTM securities from year end 2017 is due to the seasonal runoff of municipal securities associated with the underlying entity’s June 30 fiscal year end. Replacement securities are typically booked on July 1 for the ensuing fiscal year. The decrease in HTM securities at June 30, 2018 compared to June 30, 2017 reflects the increasing competition for municipal funding relationships in our market.
 
Total deposits decreased $33,716,069, or 6.0%, from December 31, 2017 to June 30, 2018, and $6,388,368, or 1.2%, year over year. Demand deposits decreased $5,086,347, or 4.3%, year to date and increased $1,760,754, or 1.6%, year over year. Business checking accounts account for most of the fluctuations in balances with a decrease in balances of $3,835,017 year to date, and an increase of $6,295,275 year over year. The Company is seeing growth in the business customer base and improvements in financial health of existing business customers. Money market accounts decreased $17,408,461, or 18.6%, year to date, and increased $2,703,848, or 3.7%, year over year. The year to date decrease is attributable to the seasonal municipal deposit decline.  Savings deposits increased in both periods, with increases of $3,513,906, or 3.6%, year to date and $3,100,422, or 3.2%, year over year. Time deposits decreased $8,266,282, or 6.9%, year to date and $23,248,279, or 17.2%, year over year. These decreases in part reflected a reduced reliance on brokered time deposits for liquidity funding, resulting in a decrease in brokered time deposits of $7,385,405 year to date and $19,687,736 year over year. There were $21 million in overnight purchases from the FHLBB at June 30, 2018, compared to no overnight purchases at December 31, 2017 and $10 million at June 30, 2017. In addition, there were outstanding long-term advances from the FHLBB of $1,550,000 at June 30, 2018 and $3,550,000 at December 31, 2017 and June 30, 2017. See “Liquidity and Capital Resources” section for a discussion on the change in long-term advances during 2018.
 
 
42
 
 
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 ALCO is made up of the Executive Officers and certain Vice Presidents of the Bank representing major business lines. 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 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 bps shift upward and a 100 bps shift downward in interest rates.
 
Under the Company’s interest rate sensitivity modeling, with the continued asset sensitive balance sheet, 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 slightly downward compared with the current rate environment scenario for the first year of the simulation as asset yield erosion is not fully 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 recent increases in the federal funds rate have generated a positive impact to the Company’s NII as variable rate loans reprice; however the behavior of the long end of the yield curve will also be very important to the Company’s margins going forward, as funding costs continue to rise and the long end remains relatively anchored.
 
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, 2018:
 
Rate Change
 
Percent Change in NII
 
 
 
 
 
Down 100 bps
  -2.4%
Up 200 bps
 2.1%
 
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.
 
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 to help ensure accuracy of the Company's internal risk ratings and compliance with various internal policies, procedures and regulatory guidance.
 
43
 
 
Residential mortgages represent 40.4% of the Company’s loan balances; that level has been on a gradual decline in recent years, with a strategic shift to commercial lending. The Company maintains a mortgage loan portfolio of traditional mortgage products and does not engage in higher risk loans 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 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 21.4% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%. The Company also originates some home equity loans greater than 80% under an insured loan program with stringent underwriting criteria.
 
Consistent with the strategic focus on commercial lending, commercial and CRE loan demand continued through 2017 and into 2018 with the funding of construction projects and draws on lines of credit. The increase in CRE loans during 2018 was driven by a combination of construction draws and new CRE term loans, while the rise in commercial loan balances was driven by seasonal draws on commercial lines of credit. Commercial and commercial real estate loans together comprised 58.7% of the Company’s loan portfolio at June 30, 2018, 56.5% at December 31, 2017 and 57.5% at June 30, 2017. The increase in the absolute and relative size of the commercial loan portfolio has also increased geographic diversification, with much of the growth in commercial loans occurring along the I-89 corridor from White River Junction through Chittenden County.
 
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, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
 $88,336,757 
  16.95%
 $77,110,747 
  15.33%
 $79,361,739 
  15.78%
Commercial real estate
  217,268,526 
  41.70%
  207,044,227 
  41.17%
  209,886,793 
  41.75%
Residential real estate - 1st lien
  165,347,241 
  31.73%
  168,184,135 
  33.45%
  164,398,836 
  32.70%
Residential real estate - Jr lien
  45,127,750 
  8.66%
  45,256,862 
  9.00%
  42,166,407 
  8.39%
Consumer
  5,011,669 
  0.96%
  5,268,680 
  1.05%
  6,959,070 
  1.38%
     Total loans
  521,091,943 
  100.00%
  502,864,651 
  100.00%
  502,772,845 
  100.00%
Deduct (add):
    
    
    
    
    
    
Allowance for loan losses
  5,413,023 
    
  5,438,099 
    
  5,374,378 
    
Deferred net loan costs
  (345,177)
    
  (318,651)
    
  (323,371)
    
      Net loans
 $516,024,097 
    
 $497,745,203 
    
 $497,721,838 
    
 
 
Risk in the Company’s commercial & industrial and CRE loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the SBA and RD. At June 30, 2018, the Company had $27,132,581 in guaranteed loans with guaranteed balances of $20,331,925, compared to $25,457,081 in guaranteed loans with guaranteed balances of $19,101,965 at December 31, 2017 and $25,530,712 in guaranteed loans with guaranteed balances of $18,128,676 at June 30, 2017.
 
The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure. Commercial & industrial and CRE 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 reverses the accrued interest against current period income and discontinues 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 book balance.
 
 
44
 
 
 
The Company’s non-performing assets increased $513,971, or 11.1%, during the first six months of 2018. Reductions in past due residential mortgages were offset by several CRE and commercial loan relationships moving into non-accrual status. Claims receivable on related government guarantees were $182,948 at June 30, 2018 compared to $6,771 at December 31, 2017 and $0 at June 30, 2017, with numerous RD and SBA claims settled and paid throughout 2017, and three new claims pending settlement in 2018. Non-performing loans as of June 30, 2018 carried RD and SBA guarantees totaling $397,184, compared to $59,617 at December 31, 2017 and $137,468 at June 30, 2017.
 
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, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans past due 90 days or more
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 and still accruing (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Commercial real estate
 $0 
  0.00%
 $0 
  0.00%
 $15,011 
  0.43%
  Residential real estate - 1st lien
  406,196 
  7.89%
  1,249,241 
  26.97%
  354,988 
  10.29%
  Residential real estate - Jr lien
  101,713 
  1.98%
  0 
  0.00%
  71,614 
  2.07%
  Consumer
  0 
  0.00%
  1,484 
  0.03%
  0 
  0.00%
 
  507,909 
  9.87%
  1,250,725 
  27.00%
  441,613 
  12.79%
 
    
    
    
    
    
    
Non-accrual loans (1)
    
    
    
    
    
    
  Commercial & industrial
  197,079 
  3.83%
  98,806 
  2.14%
  135,379 
  3.92%
  Commercial real estate
  1,957,183 
  38.04%
  1,065,385 
  23.00%
  728,093 
  21.10%
  Residential real estate - 1st lien
  1,749,608 
  34.00%
  1,585,473 
  34.23%
  1,403,312 
  40.66%
  Residential real estate - Jr lien
  369,493 
  7.18%
  346,912 
  7.49%
  398,862 
  11.56%
 
  4,273,363 
  83.05%
  3,096,576 
  66.86%
  2,665,646 
  77.24%
 
    
    
    
    
    
    
Other real estate owned
  364,235 
  7.08%
  284,235 
  6.14%
  343,928 
  9.97%
 
    
    
    
    
    
    
 
 $5,145,507 
  100.00%
 $4,631,536 
  100.00%
 $3,451,187 
  100.00%
 
 
(1) No commercial loans were past due 90 days or more and no consumer loans were in non-accrual status as of the consolidated balance sheet dates presented. In accordance with Company policy, delinquent consumer loans are charged off at 120 days past due.
 
The Company’s OREO portfolio consisted of one residential property and two commercial properties at June 30, 2018, compared to one residential and one commercial property at December 31, 2017 and two residential properties and one commercial property at June 30, 2017. The residential properties were acquired through the normal foreclosure process, while the Company took control of the commercial properties. All properties in the current OREO portfolio are listed for sale, with the residential property under contract for sale as of early July 2018.
 
The Company’s TDRs are principally a result of extending loan repayment terms to relieve cash flow difficulties. The Company has only infrequently reduced interest rates 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 in the table above include the following TDRs that were past due 90 days or more or in non-accrual status as of the dates presented:
 
 
 
June 30, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
 
 
Number of
 
 
Principal
 
 
Number of
 
 
Principal
 
 
Number of
 
 
Principal
 
 
 
Loans
 
 
Balance
 
 
Loans
 
 
Balance
 
 
Loans
 
 
Balance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
  1 
 $24,685 
  1 
 $24,685 
  2 
 $135,379 
Commercial real estate
  4 
  496,190 
  3 
  531,117 
  2 
  337,516 
Residential real estate - 1st lien
  12 
  1,088,650 
  7 
  412,134 
  7 
  427,170 
 
  17 
 $1,609,525 
  11 
 $967,937 
  12 
 $900,065 
 
 
 
45
 
 
The remaining TDRs were performing in accordance with their modified terms as of the dates presented and consisted of the following:
 
 
 
June 30, 2018
 
 
December 31, 2017
 
 
June 30, 2017
 
 
 
Number of
 
 
Principal
 
 
Number of
 
 
Principal
 
 
Number of
 
 
Principal
 
 
 
Loans
 
 
Balance
 
 
Loans
 
 
Balance
 
 
Loans
 
 
Balance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
  1 
 $107,147 
  2 
 $308,460 
  5 
 $1,312,535 
Residential real estate - 1st lien
  52 
  2,805,652 
  54 
  2,837,572 
  53 
  2,742,449 
Residential real estate - Jr lien
  1 
  7,788 
  1 
  8,358 
  2 
  63,452 
 
  54 
 $2,920,587 
  57 
 $3,154,389 
  60 
 $4,118,436 
 
 
As of the balance sheet dates, the Company evaluates whether it is contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans. The Company is contractually committed to lend on one SBA guaranteed line of credit to a borrower whose lending relationship was previously restructured.
 
Allowance for loan losses and provisions - The Company maintains an ALL at a level that management believes is appropriate to absorb losses inherent in the loan portfolio as of the measurement date (See Note 5 to the accompanying unaudited interim consolidated financial statements). Although the Company, in establishing the ALL, considers the inherent losses in individual loans and pools of loans, the ALL is a general reserve available to absorb all credit losses in the loan portfolio. No part of the ALL is segregated to absorb losses from any particular loan or segment of loans.
 
When establishing the ALL 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 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.
 
Specific allocations to the ALL are made for certain impaired loans. Impaired loans include all troubled debt restructurings regardless of amount, and all loans to a borrower that in aggregate are greater than $100,000 and that are in non-accrual status. 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.
 
 
 
46
 
 
The following table summarizes the Company's loan loss experience for the periods presented:
 
 
 
As of or Six Months Ended June 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Loans outstanding, end of period
 $521,091,943 
 $502,772,845 
Average loans outstanding during period
 $507,766,674 
 $489,232,619 
Non-accruing loans, end of period
 $4,273,363 
 $2,665,646 
Non-accruing loans, net of government guarantees
 $3,876,179 
 $2,528,178 
 
    
    
Allowance, beginning of period
 $5,438,099 
 $5,278,445 
Loans charged off:
    
    
  Commercial & industrial
  (131,273)
  0 
  Commercial real estate
  (124,645)
  (160,207)
  Residential real estate - 1st lien
  (78,435)
  (4,735)
  Residential real estate - Jr lien
  (24,000)
  (15,311)
  Consumer loans
  (73,388)
  (63,791)
       Total loans charged off
  (431,741)
  (244,044)
Recoveries:
    
    
  Commercial & industrial
  20,041 
  4,318 
  Commercial real estate
  0 
  231 
  Residential real estate - 1st lien
  9,158 
  10,216 
  Residential real estate - Jr lien
  675 
  120 
  Consumer loans
  16,791 
  25,092 
        Total recoveries
  46,665 
  39,977 
Net loans charged off
  (385,076)
  (204,067)
Provision charged to income
  360,000 
  300,000 
Allowance, end of period
 $5,413,023 
 $5,374,378 
 
    
    
Net charge offs to average loans outstanding
  0.076%
  0.042%
Provision charged to income as a percent of average loans
  0.071%
  0.061%
Allowance to average loans outstanding
  1.066%
  1.099%
Allowance to non-accruing loans
  126.669%
  201.616%
Allowance to non-accruing loans net of government guarantees
  139.648%
  212.579%
 
 
The provision increased $60,000, or 20.0%, for the first six months of 2018 compared to the same period in 2017. The higher 2018 budgeted provision level is intended to support continued growth in the Company’s loan portfolio and to compensate for loan charge off activity. The first quarter 2018 provision supported higher losses driven by one particular CRE charge off and two commercial loan relationship charge offs. The reserve requirement remained relatively unchanged with a reduction in specific reserves as a result of those charge offs, a drop in unguaranteed pooled loan balances at quarter-end, along with improvement in some qualitative factor adjustments. With lower losses and little change to specific reserves, the second quarter provision largely supported strong second quarter loan growth.
 
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.
 
The second quarter ALL analysis shows the reserve balance of $5,413,023 at June 30, 2018 is appropriate in management’s view to cover losses that are probable and estimable, with an unallocated reserve of $182,417 compared to $267,551 at December 31, 2017, and $359,517 at June 30, 2017. The reserve balance and unallocated amount continue to be directionally consistent with the overall risk profile of the Company’s loan portfolio and credit risk appetite. The portion of the ALL 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 ALL is described as consisting of separate allocated portions, the entire ALL is available to support loan losses, regardless of category. Unallocated reserves 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 appropriateness of the ALL is reviewed quarterly by the risk management committee of the Board of Directors and then presented to the full Board of Directors for approval.
 
 
47
 
 
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 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. 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 2018, the Company did not engage in any activity that created any additional types of off-balance sheet risk.
 
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 rollover 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.
 
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 acquired through the CDARS program provide an alternative funding source when needed. At June 30, 2018, the Company had one-way CDARS outstanding totaling $5,752,748 compared to $12,258,265 at December 31, 2017 and $15,000,923 at June 30, 2017. In addition, two-way (that is, reciprocal) CDARS deposits, as well as reciprocal ICS money market and demand deposits, allow the Company to provide FDIC deposit insurance to its customers in excess of account coverage limits by exchanging deposits with other participating FDIC-insured financial institutions. Until recently these reciprocal deposits were considered a form of brokered deposits, which are treated less favorably than other deposits for certain purposes; however, a provision of the 2018 Regulatory Relief Act provides that reciprocal deposits held by a well-capitalized and well managed bank are no longer classified as brokered deposits. At June 30, 2018, the Company reported $8,073,908 in reciprocal CDARS deposits, compared to $2,817,715 at December 31, 2017 and $3,058,649 at June 30, 2017. The balance in ICS reciprocal money market deposits was $16,391,236 at June 30, 2018, compared to $17,137,985 at December 31, 2017 and $13,110,607 at June 30, 2017, and the balance in ICS reciprocal demand deposits as of those dates was $9,667,103, $9,951,078 and $4,903,771, respectively.
 
At June 30, 2018, December 31, 2017 and June 30, 2017, borrowing capacity of $106,038,279, $109,726,508 and $85,030,206, respectively, was available through the FHLBB, secured by the Company's qualifying loan portfolio (generally, residential mortgage and commercial loans), reduced by outstanding advances and by collateral pledges securing FHLBB letters of credit collateralizing public unit deposits. The Company also has an unsecured Federal Funds credit line with the FHLBB with an available balance of $500,000 and no outstanding advances during any of the respective comparison periods. Interest is chargeable at a rate determined daily, approximately 25 bps higher than the rate paid on federal funds sold.
 
 
 
48
 
 
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,
 
 
 
2018
 
 
2017
 
 
2017
 
Long-Term Advances(1)
 
 
 
 
 
 
 
 
 
FHLBB term advance, 0.00%, due February 26, 2021
 $350,000 
 $350,000 
 $350,000 
FHLBB term advance, 0.00%, due November 22, 2021
  1,000,000 
  1,000,000 
  1,000,000 
FHLBB term advance, 0.00%, due June 09, 2022
  0 
  2,000,000 
  2,000,000 
FHLBB term advance, 0.00%, due September 22, 2023
  200,000 
  200,000 
  200,000 
 
  1,550,000 
  3,550,000 
  3,550,000 
 
    
    
    
Overnight Borrowings
    
    
    
Federal funds purchased (FHLBB), 2.16% and 1.30%, respectively
  21,000,000 
  0 
  10,000,000 
 
    
    
    
 
 $22,550,000 
 $3,550,000 
 $13,550,000 
 
 
(1)
As of June 30, 2018, the Company had borrowed a total of $3,550,000 under the FHLBB’s JNE program, a program dedicated to supporting job growth and economic development throughout New England. The FHLBB is providing a subsidy, funded by the FHLBB’s earnings, to write down interest rates to zero percent on advances that finance qualifying loans to small businesses. JNE advances must support small business in New England that create and/or retain jobs, or otherwise contribute to overall economic development activities. During the second quarter of 2018, the Company repaid a $2 million advance because the “qualifying loan” did not close as intended.
 
The Company has a 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 $46,309,141, $45,305,894, and $40,390,404, respectively, at June 30, 2018, December 31, 2017 and June 30, 2017. Credit advances under this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 250 bps. The Company had no outstanding advances against this credit line during any of the periods presented.
 
The Company has unsecured lines of credit with three correspondent banks with aggregate available borrowing capacity totaling $12,500,000 as of the balance sheet dates presented in this quarterly report. There were no outstanding advances against any of these lines during any of the respective comparison periods.
 
Securities sold under agreements to repurchase provide another funding source for the Company. At June 30, 2018, December 31, 2017 and June 30, 2017, the Company had outstanding repurchase agreement balances of $30,294,972, $28,647,848 and $28,862,766, respectively. These repurchase agreements mature and are repriced daily.
 
The following table illustrates the changes in shareholders' equity from December 31, 2017 to June 30, 2018, including a partial redemption of the Company’s Series A non-cumulative perpetual preferred stock, effective March 31, 2018:
 
Balance at December 31, 2017 (book value $10.84 per common share)
 $57,935,854 
    Net income
  3,985,197 
    Issuance of stock through the DRIP
  478,939 
    Redemption of preferred stock
  (500,000)
    Dividends declared on common stock
  (1,843,120)
    Dividends declared on preferred stock
  (51,875)
    Unrealized loss on securities AFS during the period, net of tax
  (548,362)
Balance at June 30, 2018 (book value $11.18 per common share)
 $59,456,633 
 
 
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 Note 20 to the audited consolidated financial statements contained in the Company’s 2017 Annual Report on Form 10-K and under the caption “LIQUIDITY AND CAPITAL RESOURCES” in the MD&A section of that 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.
 
49
 
 
Beginning in 2016, an additional capital conservation buffer was 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% of risk-weighted assets. A banking organization with a conservation buffer of less than 2.5% (or the required phase-in amount in years prior to 2019) is subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. The Company’s and the Bank’s capital conservation buffer was 5.96% and 5.81%, respectively, at June 30, 2018. As of June 30, 2018, both the Company and the Bank exceeded the required capital conservation buffer of 1.25% and on a pro forma basis would be compliant with the fully phased-in capital conservation buffer requirement.
 
Under the 2018 Regulatory Relief Act, these capital requirements will be simplified for qualifying community banks and bank holding companies (that is, institutions with less than $10 billion in assets). The Act requires the federal banking regulators to develop a new CBLR set at between 8% and 10% of unweighted assets. The CBLR will be determined by dividing tangible equity capital by average total consolidated assets. If a community bank exceeds the CBLR threshold, it will be considered to have met the risk-based capital and leverage capital requirements that would otherwise apply, as well as any applicable “prompt correction action” capital requirements to be considered well capitalized.
 
As of June 30, 2018, the Bank was considered well capitalized under the regulatory capital framework for Prompt Corrective Action and the Company exceeded currently applicable consolidated regulatory guidelines for capital adequacy.
 
The following table shows the Company’s actual capital ratios and those of its subsidiary, as well as currently applicable regulatory capital requirements, as of the dates indicated.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Company
 $61,592 
  12.82%
 $21,619 
  4.50%
  N/A 
  N/A 
   Bank
 $60,833 
  12.68%
 $21,597 
  4.50%
 $31,196 
  6.50%
 
    
    
    
    
    
    
Tier 1 capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $61,592 
  12.82%
 $28,826 
  6.00%
  N/A 
  N/A 
   Bank
 $60,833 
  12.68%
 $28,797 
  6.00%
 $38,395 
  8.00%
 
    
    
    
    
    
    
Total capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $67,049 
  13.96%
 $38,434 
  8.00%
  N/A 
  N/A 
   Bank
 $66,290 
  13.81%
 $38,395 
  8.00%
 $47,994 
  10.00%
 
    
    
    
    
    
    
Tier 1 capital (to average assets)
    
    
    
    
    
    
   Company
 $61,592 
  9.56%
 $25,758 
  4.00%
  N/A 
  N/A 
   Bank
 $60,833 
  9.45%
 $25,740 
  4.00%
 $32,175 
  5.00%
 
    
    
    
    
    
    
December 31, 2017:
    
    
    
    
    
    
 
    
    
    
    
    
    
Common equity tier 1 capital
    
    
    
    
    
    
  (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $59,523 
  12.75%
 $21,003 
  4.50%
  N/A 
  N/A 
   Bank
 $58,920 
  12.64%
 $20,972 
  4.50%
 $30,293 
  6.50%
 
    
    
    
    
    
    
Tier 1 capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $59,523 
  12.75%
 $28,004 
  6.00%
  N/A 
  N/A 
   Bank
 $58,920 
  12.64%
 $27,963 
  6.00%
 $37,284 
  8.00%
 
    
    
    
    
    
    
Total capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $65,005 
  13.93%
 $37,338 
  8.00%
  N/A 
  N/A 
   Bank
 $64,401 
  13.82%
 $37,284 
  8.00%
 $46,605 
  10.00%
 
    
    
    
    
    
    
Tier 1 capital (to average assets)
    
    
    
    
    
    
   Company
 $59,523 
  9.05%
 $26,304 
  4.00%
  N/A 
  N/A 
   Bank
 $58,920 
  8.97%
 $26,279 
  4.00%
 $32,849 
  5.00%
 
(1) Applicable to banks, but not bank holding companies.
 
 
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.
 
 
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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 "CHANGES IN FINANCIAL CONDITION", “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 2017 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 Exchange Act. As of June 30, 2018, 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, 2018 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, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
PART II. OTHER INFORMATION
 
ITEM 1. Legal Proceedings
 
In the normal course of business, the Company and its subsidiary are involved in litigation that is considered incidental to their business. Management does not expect that any such litigation will be material to the Company's consolidated financial condition or results of operations.
 
ITEM 1A. Risk Factors
 
The Risk Factors identified in our Annual Report on Form 10-K for the year ended December 31, 2017, continue to represent the most significant risks to the Company's future results of operations and financial condition.
 
51
 
 
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table provides information as to the purchases of the Company’s common stock during the three months ended June 30, 2018, by the Company or by any affiliated purchaser (as defined in SEC Rule 10b-18). During the monthly periods presented, the Company did not have any publicly announced repurchase plans or programs.
 
 
 
Total Number
 
 
Average
 
 
 
of Shares
 
 
Price Paid
 
For the period:
 
Purchased(1)(2)
 
 
Per Share
 
 
 
 
 
 
 
 
April 1 - April 30
  2,589 
 $17.71 
May 1 - May 31
  1,810 
  17.10 
June 1 - June 30
  2,800 
  17.50 
     Total
  7,199 
 $17.47 
 
 
(1)  All 7,199 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 DRIP.
 
 
ITEM 6. Exhibits
 
The following exhibits are filed with this report:
 
Exhibit 31.1 - Certification from the Chief Executive Officer (Principal Executive Officer) of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification from the Treasurer (Principal 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 (Principal 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 Treasurer (Principal 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, 2018 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, 2018 and 2017, (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 Exchange Act, 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 Exchange Act.
 
 
 
52
 
 
 
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 09, 2018
/s/Kathryn M. Austin
 
 
Kathryn M. Austin, President
 
 
& Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
DATED: August 09, 2018
/s/Louise M. Bonvechio
 
 
Louise M. Bonvechio, Corporate
 
 
Secretary & Treasurer
 
 
(Principal Financial Officer)
 
 
 
53
 
 
 
 
 
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, 2018
 
COMMUNITY BANCORP.
 
EXHIBITS
 
EXHIBIT INDEX
 
 
Certification from the Chief Executive Officer (Principal Executive Officer) of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
 
Certification from the Treasurer (Principal Financial Officer) of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
 
Certification from the Chief Executive Officer (Principal 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*
 
 
Certification from the Treasurer (Principal 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, 2018 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, 2018 and 2017, (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 Exchange Act, 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 Exchange Act.
 
 
 
54