UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-K
 
[ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2019
 
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 No. 000-16435
 
Community Bancorp.
(Exact name of Registrant as Specified in its Charter)
 
Vermont
03-0284070
(State of Incorporation)
(IRS Employer Identification Number)
Address of Principal Executive Offices: 4811 US Route 5, Derby, Vermont  05829
 
Registrant's telephone number, including area code: (802) 334-7915
 
Securities registered pursuant to Section 12(b) of the Act: NONE
 
Title of Each Class
Trading Symbol(s)
Name of each exchange on which registered
 
(Not Applicable)
 
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - $2.50 par value per share
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     YES (  )     NO (X)
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     YES(  )     NO (X)
 
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 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 every Interactive Data File required to be submitted 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 ( )
 
 
 
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer”, “accelerated filer", “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer (  )
 
Accelerated filer (X)
Non-accelerated filer (  )
 
Smaller reporting company (X)
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 Act). YES (  )     NO(X)
 
As of June 30, 2019 the aggregate market value of the voting stock held by non-affiliates of the registrant was $78,876,887, based on a per share trade price on June 28, 2019 of $16.35, as reported on the OTC Link ATS® system maintained by the OTC Markets Group Inc. For purposes of the calculation, all directors and executive officers were deemed to be affiliates of the registrant. However, such assumption is not intended as an admission of affiliate status as to any such individual.
 
There were 5,539,675 shares outstanding of the issuer's common stock as of the close of business on March 10, 2020.
 
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Annual Report to Shareholders for the year ended December 31, 2019 (2019 Annual Report) are incorporated by reference to Part I and Part II of this Report.
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 19, 2020 (2020 Annual Meeting) are incorporated by reference to Part III of this report.
 
 
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FORM 10-K ANNUAL REPORT
Table of Contents
 
 
 
PART I
 
Page
 
 
 
Item 1
4
Item 1A
15
Item 1B
21
Item 2
21
Item 3
23
Item 4
23
 
 
 
PART II
 
 
 
 
 
Item 5
23
Item 6
23
Item 7
23
Item 7A
23
Item 8
23
Item 9
23
Item 9A
23
Item 9B
24
 
 
 
PART III
 
 
 
 
 
Item 10
24
Item 11
25
Item 12
25
Item 13
25
Item 14
25
 
 
 
PART IV
 
 
 
 
 
Item 15
26
 
27
 
28
 
 
3
 
 
PART I
 
Note Regarding Definitions and Acronyms: Capitalized terms and acronyms used in the discussion below and not otherwise defined have the meaning ascribed to them in Note 1 of the Company’s audited consolidated financial statements filed pursuant to Part II, Item 8 of this Report.
 
Item 1.  The Business
 
Organization and Operation
 
The Company. The Company was organized under the laws of the State of Vermont in 1982 and became a registered bank holding company under the Bank Holding Company Act of 1956, as amended, in October 1983 when it acquired all of the voting shares of the Bank, headquartered in Derby, Vermont. The Bank is the only subsidiary of the Company and principally all of the Company's business operations are presently conducted through it. Therefore, the following narrative and the other information about the Company contained in this report are based primarily on the Bank's operations.
 
The Bank; Banking Services. Community National Bank was organized in 1851 as the Peoples Bank, and was subsequently reorganized as the National Bank of Derby Line in 1865. In 1975, after 110 continuous years of operation as the National Bank of Derby Line, the Bank acquired the Island Pond National Bank and changed its name to "Community National Bank." On December 31, 2007, the Company completed its acquisition of LyndonBank, a Vermont bank headquartered in Lyndonville, Vermont, in a cash merger transaction. As a result of the merger, the Company expanded its existing branch network in Caledonia and Orleans Counties and extended it into Lamoille and Franklin Counties. In addition to its main office in Derby, the Company currently maintains eleven branch offices in northeastern and central Vermont and a loan production office in Chittenden County, in northwestern Vermont, and in 2019, the Company opened a loan production office in Grafton County, in western New Hampshire.
 
The opportunities for growth continue to be primarily in the Central Vermont and Chittenden County markets where economic activity is more robust than in the Company’s Orleans and Caledonia County markets, and where the Company is increasing its presence and market share. The Company is also focusing on expanding its presence in the neighboring state of New Hampshire through the opening of its loan production office in Lebanon, New Hampshire.
 
The Company, through the Bank, provides a broad range of retail banking services to the residents, businesses, nonprofit organizations and municipalities in its northern and central Vermont markets. Significant services offered by the Company include:
 
●
Business Banking – The Company offers a range of credit products for a variety of general business purposes, including financing for commercial business properties, equipment, inventories and accounts receivable, as well as letters of credit. The Company also offers business checking and other deposit accounts, cash management services, repurchase agreements, ACH and wire transfer services and remote deposit capture.
 
●
Commercial Real Estate Lending – The Company provides a range of products to meet the financing needs of commercial developers and investors, residential builders and developers and community development entities. Credit products are available to facilitate the purchase of land and/or build structures for business use and for investors who are developing residential or commercial property, as well as for real estate secured financing of existing businesses. The Bank was recognized by the SBA as Vermont’s top Section 7(a) program lender for 2017, providing financing to startups and other small businesses not eligible for more traditional financing, and as one of Vermont’s top third party small business lenders under the SBA’s Section 504 loan program.
 
●
Residential Real Estate Lending – The Company provides products to help meet the home financing needs of consumers, including conventional permanent and construction/permanent (fixed, adjustable, or variable rate) financing arrangements, and FHA/VA loan products. The Company offers both fixed-rate and adjustable rate residential mortgage (ARM) loans and home equity loans. A portion of the first lien residential mortgage loans originated by the Company are sold into the secondary market. The Company offers these products through its network of banking offices. The Company does not originate subprime residential real estate loans.
 
●
Retail Credit – The Company provides a full-range of loan products to meet the needs of consumers, including personal loans, automobile loans and boat/recreational vehicle loans. In addition, through a marketing alliance with a third party, the Company offers credit cards.
 
 
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●
Municipal and Institutional Banking – The Company provides banking services to meet the needs of state and local governments, schools, charities, membership and not-for-profit associations including deposit account services, tax-exempt loans, lines of credit and term loans. In addition, through an arrangement with the FHLBB, the Company offers a secured deposit product to its municipal customers, collateralized by FHLBB letters of credit.
 
●
Retail Banking – The Company provides a full-range of consumer banking services, including checking accounts, savings programs, ATMs, debit/credit cards, night deposit facilities and online, mobile and telephone banking.
 
The Company focuses on establishing and maintaining long-term relationships with customers and is committed to providing for the financial services needs of the communities it serves. In particular, the Company continues to emphasize its relationships with individual customers and small-to-medium-sized businesses. The Company actively evaluates the banking needs of its markets, including low- and moderate-income areas, and offers products that are responsive to the needs of its customer base. The Company’s markets provide a mix of real estate, commercial and industrial, municipal and consumer lending opportunities, as well as a stable core deposit base. Additional information about our business, including the Company’s deposit-taking activities, lending activities and credit and risk management policies, is set forth under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the 2019 Annual Report filed as Exhibit 13 to this Report and is incorporated herein by reference.
 
Related Trust Company. In 2002, the Bank transferred its trust operations to a newly formed Vermont-chartered non-depository trust and investment management company, CFSG, based in Newport, Vermont. The Bank's ownership interest in CFSG is held indirectly, through CFS Partners, a Vermont limited liability company, which owns 100% of the limited liability company equity interests of CFSG. Immediately following transfer of its trust operations to CFSG, the Bank sold a two-thirds interest in CFS Partners, equally to the National Bank of Middlebury, headquartered in Middlebury, Vermont and Guaranty Bancorp Inc., the bank holding company parent of Woodsville Guaranty Savings Bank, headquartered in Woodsville, New Hampshire. CFSG offers fiduciary services throughout the market areas of the three owner financial institutions and leases space from them in some of their branch offices.
 
Statutory Business Trust. In 2007, the Company formed CMTV Statutory Trust I (the Trust), a Delaware statutory business trust, for the purpose of issuing $12.5 million of trust preferred securities and lending the proceeds to the Company. This funding provided a portion of the cash consideration paid by the Company in the acquisition of LyndonBank and provided additional regulatory capital. The Trust is a variable interest entity for which the Company is not the primary beneficiary, within the meaning of applicable accounting standards. Accordingly, the Trust is not consolidated with the Company for financial reporting purposes.
 
Tax Credit Entity. During the years 2011 through 2018, the Company was the sole owner of a LLC formed to facilitate the Company’s purchase of federal NMTCs under an investment structure designed by a local community development entity. The NMTC financing matured in the fourth quarter of 2018 and the Company exited the investment and terminated its interest in the LLC. The LLC was a variable interest entity for which, in the context of the overall NMTC structure, the Company was not the primary beneficiary, within the meaning of applicable accounting standards. Accordingly, the LLC was not consolidated with the Company for financial reporting purposes.
 
Competition
 
All of the Bank's banking offices are located in northern and central Vermont. The Bank’s main office is located in Derby, in Orleans County. In addition to its main office, the Bank has four other banking offices in Orleans County, one office in Essex County, two offices in Caledonia County, two offices in Washington County and one office each in Franklin and Lamoille Counties. The Bank also maintains loan production offices in Chittenden County, Vermont and Grafton County, New Hampshire. (See Part I, Item 2 (Properties) of this report.)
 
The Bank competes in all aspects of its business with other banks and credit unions in northern and central Vermont, including three of the largest banks operating in the state, which maintain branch offices throughout the Bank's service area. The Bank also competes with bank and non-bank lenders in Chittenden County, Vermont and Grafton County, New Hampshire where it maintains loan production offices. Changes in the regulatory framework of the financial services industry during the past decade have broadened the competition for commercial bank products, such as deposits and loans, to include not only traditional rivals such as banks, savings banks and credit unions, but also many non-traditional rivals such as insurance companies, brokerage firms, mutual funds and consumer and commercial finance and leasing companies. In addition, many out-of-market nationwide banks, nonbank lenders and other financial service firms operate in the Company’s market areas through mass marketing solicitations by mail, radio, television, the internet and email. At the same time, technological changes have facilitated remote delivery of financial services by bank and nonbank competitors outside the context of a traditional branch bank network, thereby intensifying competition from out-of-market firms.
 
 
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Competition from the tax-exempt credit union industry has also intensified in recent years. A number of the Bank’s credit union competitors, including the largest state-chartered Vermont credit union, have converted from an employment based common bond to a community common bond, thereby significantly increasing their fields of membership in the Bank’s market areas. Because federal law subsidizes credit unions by giving them a general exemption from federal income taxes, they have a significant pricing advantage over commercial banks for their deposit and loan products. This pricing advantage, coupled with the relaxing of membership criteria and regulatory restrictions on product offerings, has resulted in increased competition for the Bank from this tax exempt sector of the financial services industry.
 
In order to compete with other bank and non-bank service providers, the Company stresses the community orientation of its banking operations and relies to a large extent upon personal relationships established by its officers, directors and employees with their customers and on their strong ties to the local community. In addition, management's knowledge of the local community assists it in tailoring the Company's products and services to meet the needs of its customer base. Although competition is strong throughout the Company's market area, management believes that the Company can continue to compete effectively, in view of its local market knowledge and community ties and its understanding of customer needs.
 
Employees
 
As of December 31, 2019, the Company did not have any employees at the holding company level. However, as of such date, the Bank employed 123 full-time employees and 13 part-time employees. The Bank is not a party to any collective bargaining agreement and management of the Bank considers its employee relations to be good.
 
Regulation and Supervision
 
The following discussion describes elements of an extensive regulatory framework applicable to bank holding companies and banks, to which the Company and the Bank are subject. Regulation of banks and bank holding companies is intended primarily for the protection of depositors and the Deposit Insurance Fund of the FDIC, rather than for the protection of shareholders and creditors.
 
The Company’s earnings are affected by general economic conditions, management policies, changes in federal and state laws and regulations and actions of various regulatory authorities, including those referred to below. Banking is a highly regulated business and proposals to change the laws and regulations to which the Company and the Bank are subject are frequently introduced at both the federal and state levels. The likelihood and timing of any such changes and the impact such changes may have on the Company and the Bank is impossible to predict with any certainty.
 
The following summary does not purport to be complete and is qualified by reference to the particular statutes and regulations.
 
Dodd–Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act) represents a comprehensive revision and restructuring of many aspects of financial services industry regulation and impacts practically all aspects of a banking organization. Many of the provisions of the Dodd-Frank Act are designed to reduce systemic risk from large, complex “systemically significant” financial institutions, and thus do not apply to a smaller banking organization such as the Company. Nevertheless, certain of its provisions do directly apply to the Company and others will indirectly impact its operations, as the Dodd-Frank Act continues to reshape the financial services environment. Among other things, the Act:
 
●
Established a new independent agency, the CFPB, with centralized responsibility for implementing and (with respect to large organizations) enforcing and examining compliance with federal consumer financial laws. Although the CFPB does not have enforcement or examination authority over smaller banking organizations such as the Company, many of its regulatory standards and mandates apply to them, with enforcement authority vested in other regulatory agencies such as (with respect to the Bank) the OCC;
 
●
Applies the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies, savings and loan holding companies and systemically important non-bank financial companies on a consolidated basis. These changes prohibit the use of additional trust preferred securities as Tier 1 capital, but the Company’s existing trust preferred securities are grandfathered;
 
 
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Requires debit card interchange transaction fees charged by large financial institutions to be reasonable and proportional to the cost incurred by the issuer for the transaction. The FRB adopted regulations in 2011 establishing such fee standards, eliminating exclusivity arrangements between issuers and networks for debit card transactions and limiting restrictions on merchant discounting for use of certain payment forms and minimum or maximum amount thresholds as a condition for acceptance of credit cards. Although smaller institutions such as the Company are not subject to the interchange fee restrictions, it is possible that, over time, competitive pricing pressures in the marketplace may operate to make the restrictions applicable to them by default;
 
●
Requires public companies to periodically seek “say on executive pay” and “say on frequency” votes of shareholders, and in some circumstances, a “say on golden parachute” vote of shareholders. These vote requirements first became applicable for the Company’s 2013 annual meeting of shareholders;
 
●
Allowed depository institutions to pay interest on demand deposits effective July 21, 2011;
 
●
Established by statute the FRB’s “source of strength” doctrine mandating holding company financial support of subsidiary insured depository institutions;
 
●
Eliminated state restrictions on de novo interstate branching;
 
●
Established new requirements related to residential mortgage lending, including prohibitions against payment of steering incentives and provisions relating to underwriting standards, disclosures, appraisals and escrows. Many of these provisions have been implemented through CFPB rulemakings;
 
●
Weakened federal preemption standards for national banks and federal savings associations and their operating subsidiaries by granting states greater authority to enforce consumer protection laws against them;
 
●
Provided permanent relief for non-accelerated filers, from the requirements of Section 404 of the Sarbanes-Oxley Act for auditor attestation of management’s assessment of internal controls and their effectiveness. Effective with the Company’s periodic reports filed in 2018, this relief was no longer available to the Company as it became an accelerated filer for SEC reporting purposes (see “SEC Reporting and Disclosure Requirements” below);
 
●
Requires a bank holding company to be well capitalized and well managed to receive regulatory approval of an interstate bank acquisition; and
 
●
Permanently increased the FDIC’s standard maximum deposit insurance amount to $250,000, changed the FDIC insurance assessment base to assets rather than deposits and increased the reserve ratio for the deposit insurance fund to ensure the future strength of the fund.
 
The Company will continue to monitor the impact of ongoing regulatory implementation of this significant legislation.
 
Bank Holding Company Act. As a registered bank holding company, the Company is subject to on-going regulation, supervision and examination by the Board of Governors of the Federal Reserve System (FRB), under the Bank Holding Company Act of 1956, as amended (the Act). A bank holding company for example, must generally obtain the prior approval of the FRB before it acquires all or substantially all of the assets of any bank, or acquires ownership or control of more than 5% of the voting shares of a bank. FRB approval is also generally required before a bank holding company may acquire more than 5% of any outstanding class of voting securities of a company other than a bank or a more than 5% interest in its property.
 
The Act generally limits the activity in which the Company and its subsidiaries may engage to certain specified activities, including those activities which the FRB may find, by order or regulation, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the FRB has determined to be closely related to banking are: (1) making and servicing loans that could be made by mortgage, finance, credit card or factoring companies; (2) performing the functions of a trust company; (3) certain leasing of real or personal property; (4) providing certain financial, banking or economic data processing services; (5) except as otherwise prohibited by law, acting as an insurance agent or broker with respect to insurance that is directly related to the extension of credit or the provision of other financial services or, under certain circumstances, with respect to insurance that is sold in certain small communities in which the bank holding company system maintains banking offices; (6) acting as an underwriter for credit life insurance and credit health and accident insurance directly related to extensions of credit by the holding company system; (7) providing certain kinds of management consulting advice to unaffiliated banks and non-bank depository institutions; (8) performing real estate appraisals; (9) issuing and selling money order and similar instruments and travelers checks and selling U.S. Savings Bonds; (10) providing certain securities brokerage and related services for the account of bank customers; (11) underwriting and dealing in certain government obligations and other obligations such as bankers' acceptances and certificates of deposit; (12) providing consumer financial counseling; (13) providing tax planning and preparation services; (14) providing check guarantee services to merchants; (15) operating a collection agency; and (16) operating a credit bureau. Trust and investment management activities conducted through a non-depository trust company such as the Company's affiliate, CFSG, are also considered by the FRB to be permissible nonbanking activities that are closely related to banking.
 
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Except for CFSG’s trust and investment management operations, the Company does not presently engage, directly or indirectly through any affiliate, in any other permissible non-banking activities.
 
A bank holding company must obtain prior FRB approval in order to purchase or redeem its own stock if the gross consideration to be paid, when added to the net consideration paid by the company for all purchases or redemptions by the company of its equity securities within the preceding 12 months, will equal 10% or more of the company's consolidated net worth.
 
The Company is required to file with the FRB annual and quarterly reports and such additional information as the Board may require pursuant to the Act. The Board may also make examinations of the Company and any direct or indirect subsidiary of the Company.
 
The Company, the Bank, CFS Partners and CFSG are all considered "affiliates" of each other for the purposes of Section 18(j) of the FDIA, as amended, and Sections 23A and 23B of the Federal Reserve Act, as amended. In particular, section 23A limits loans or other extensions of credit to, asset purchases with and investments in affiliates of the Bank to 10% of the Bank’s capital and surplus. In addition, such loans and extensions of credit and certain other transactions must be collateralized in specified amounts. Section 23B requires, among other things, that certain transactions between the Bank and its affiliates must be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving non-affiliated persons. Further, the Company is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of any property or the furnishing of services.
 
Capital Adequacy Requirements. Revised regulatory capital rules were adopted in July 2013 by the federal banking regulators to implement the Basel III capital standards and certain capital requirements of the Dodd-Frank Act. The effect of the rules was to impose higher minimum capital requirements for bank holding companies and banks. The rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with $500 million or more in total consolidated assets. More stringent requirements apply to certain larger banking organizations. The requirements in the rule were fully phased in on January 1, 2019, for the Company and the Bank.
 
The Basel III capital rules include certain new and higher risk-based capital and leverage requirements than those previously in place. Specifically, the following minimum capital requirements now apply to the Company and the Bank:
 
●
a new common equity Tier 1 risk-based capital ratio of 4.5%;
 
●
a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);
 
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a total risk-based capital ratio of 8% (unchanged from the former requirement); and
 
●
a leverage ratio of 4% (also unchanged from the former requirement).
 
 
Under the rules, Tier 1 capital is redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Although AOCI is presumptively included in Common Equity Tier 1 capital, the rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. The Company and Bank made this opt-out election and, as a result, will retain the pre-existing regulatory capital treatment for AOCI.
 
In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer was phased in incrementally over time and became fully effective on January 1, 2019, consisting of an additional amount of common equity equal to 2.5% of risk-weighted assets. The Company and the Bank satisfied this fully-phased in capital conservation buffer. Failure to maintain the required buffer would result in limitations on permissible shareholder distributions and discretionary bonus payments.
 
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In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.
 
The Company’s capital ratios exceeded all applicable regulatory requirements at December 31, 2019. (See Note 21 to the Company’s audited consolidated financial statements included in Part II, Item 8 of this report for additional information about the Company’s and the Bank’s regulatory capital ratios.)
 
The Basel III capital standards also revised the FDIC’s “prompt corrective action” requirements (see “Prompt Corrective Action” below).
 
Under the 2018 Regulatory Relief Act, these capital requirements have been simplified for qualifying community banks and bank holding companies. In September 2019, the OCC and the other federal bank regulators approved a final joint rule that permits a qualifying community banking organization to opt in to a simplified regulatory capital framework. A qualifying institution that elects to utilize the simplified framework must maintain a CBLR in excess of 9%, and will thereby be deemed to have satisfied the generally applicable risk-based and other leverage capital requirements and (if applicable) the FDIC’s prompt corrective action framework. In order to utilize the CBLR framework, in addition to maintaining a CBLR of over 9%, a community banking organization must have less than $10 billion in total consolidated assets and must meet certain other criteria such as limitations on the amount of off-balance sheet exposures and on trading assets and liabilities. The CBLR will be calculated by dividing tangible equity capital by average total consolidated assets. The final rule became effective on January 1, 2020, and as of that date the Company and Bank qualify to utilize the CBLR framework.
 
Sarbanes-Oxley Act. SOX was enacted to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX and the SEC’s implementing regulations include provisions addressing, among other matters, the duties, functions and qualifications of audit committees for all public companies; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers, except (in the case of banking companies) loans in the normal course of business; expedited filing requirements for reports of beneficial ownership of company stock by insiders; disclosure of a code of ethics for senior officers, and of any change or waiver of such code; the formation of a public accounting oversight board; auditor independence; disclosure of fees paid to the company's auditors for non-audit services and limitations on the provision of such services; attestation requirements for company management and external auditors, relating to internal controls and procedures; and various increased criminal penalties for violations of federal securities laws.
 
Since 2007 Section 404 of SOX has required management of the Company to undertake a periodic assessment of the adequacy and effectiveness of the Company’s internal control over financial reporting. Management's report on internal control over financial reporting for 2019 is contained in Item 9A of this Report. The Company has incurred, and expects to continue to incur, costs in connection with its on-going compliance with Section 404.
 
Effective December 31, 2017, as an accelerated filer for SEC reporting purposes, the Company is required to obtain from its external auditors an audit report on the Company’s internal control over financial reporting and the operating effectiveness of these controls.
 
Information on the Company’s corporate governance practices, including committee charters, is available on the Company’s website at www.communitybancorpvt.com.
 
SEC Reporting and Disclosure Requirements. Under current SEC reporting and disclosure rules, as amended in 2018, the Company is considered to be both an accelerated filer and a smaller reporting company.  As an accelerated filer, the Company is subject to SOX section 404(b) for external auditor attestation of management’s assessment of the Company’s internal controls and their effectiveness and is required to file its periodic reports with the SEC on a more accelerated timetable than applies to non-accelerated filers.   As a smaller reporting company, the Company is permitted to make certain reduced (or scaled) financial and other disclosures in its periodic reports and proxy statements filed with the SEC.
 
 
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Dividends. The Company derives funds for payment of dividends to its shareholders primarily from dividends received from its subsidiary, Community National Bank. Under the National Bank Act, prior approval from the OCC is required if the total of all dividends declared by a national bank in any calendar year will exceed the sum of such bank's net profits for that last year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits national banks from paying dividends greater than the bank's undivided profits after deducting statutory bad debt in excess of the bank's ALL.
 
The Company and the Bank are also subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal or state banking agency is authorized to determine under certain circumstances relating to the financial condition of a bank or bank holding company that the payment of dividends would be an unsafe or unsound practice and to prohibit such payment. In addition, under the Basel III capital requirements, failure to maintain the required capital conservation buffer would result in additional limitations on permissible shareholder distributions.
 
The FRB has issued supervisory guidance on the payment of dividends and redemption and repurchases of stock by bank holding companies reflecting the expectation that a bank holding company will inform and consult with FRB supervisory staff in advance of declaring and paying any dividend that could raise safety and soundness concerns. Examples of actions that might raise such concerns include declaration of a dividend exceeding current period earnings; redeeming or repurchasing regulatory capital instruments when the bank holding company is experiencing financial weaknesses; or redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. The guidance provides that a bank holding company should eliminate, defer or severely limit dividends if net income for the past four quarters is not sufficient to fully fund dividends; the prospective rate of earnings retention is not consistent with the holding company’s capital needs and overall current and prospective financial condition; or the holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios.
 
OCC Supervision. As a national banking association, the Bank is subject to the provisions of the National Bank Act and federal and state statutes and rules and regulations applicable to national banks. The primary supervisory authority for the Bank is the OCC. The Bank is subject to periodic examination by the OCC and must file periodic reports with the OCC containing a complete statement of its financial condition and results of operations. The OCC's examinations are designed for the protection of the Bank's depositors and not the Company’s shareholders.
 
The CFPB created by the Dodd-Frank Act took over responsibility for enforcing the principal federal consumer protection laws, such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and the Truth in Saving Act, among others, in 2011. Institutions that have assets of $10 billion or less, such as our Bank subsidiary, will continue to be supervised and examined in this area by their primary federal regulators (in the case of our Bank subsidiary, the OCC). However, the Dodd-Frank Act gives the CFPB expanded data collecting powers for fair lending purposes for both small business and mortgage loans, as well as expanded authority to prevent unfair, deceptive and abusive practices.
 
Prompt Corrective Action. The Bank is subject to regulatory capital requirements established under FDICIA. Among other things, FDICIA identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective U.S. federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lessor of 5% of the bank's assets at the time it became undercapitalized or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness related generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
 
The federal bank regulatory agencies, including the OCC, have adopted substantially similar regulations that define the five capital categories identified by FDICIA. These regulations establish various degrees of corrective action to be taken when an FDIC-insured depository institution is considered undercapitalized. Effective January 1, 2015, the FDIC’s Prompt Corrective Action regulations were revised in accordance with the Basel III capital standards. The enhanced requirements (i) introduce a Common Equity Tier 1 ratio requirement at each capital category (other than critically undercapitalized), and set the required Common Equity Tier 1 ratio at 6.5% for well-capitalized status; (ii) increase the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), and set the minimum Tier 1 capital ratio for well-capitalized status at 8.0% (as compared to 6.0% under the prior rule); and (iii) eliminate the provision that permitted a bank with a composite supervisory rating of 1 to have a 3% leverage ratio and still be considered adequately capitalized. The Basel III capital standards do not change the total risk-based capital requirement for any prompt corrective action category.
 
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As of December 31, 2019, the Bank was considered "well capitalized" under FDICIA’s Prompt Corrective Action capital requirements. (See Note 20 to the Company’s audited consolidated financial statements included in Part II, Item 8 of this report for additional information about the Bank’s regulatory capital ratios.)
 
Deposit Insurance. The deposits of the Bank are insured by the Deposit Insurance Fund (DIF) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessments system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 and further amended by the Dodd-Frank Act. Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. In addition, previously all FDIC insured depository institutions were required to pay a pro rata portion of the interest due on the obligations issued by the FICO to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. The FDIC discontinued collection of these payments in March 2019.
 
The Dodd-Frank Act changed the assessment formula for determining deposit insurance premiums and modified certain insurance coverage provisions of the FDIA. The FDIC’s implementing rules, which redefined the base for FDIC insurance assessments from the amount of insured deposits to average consolidated total assets less average tangible equity, became effective April 1, 2011. Due to the “Small Bank Assessment Credit issued by the FDIC during the third quarter of 2019, the Bank’s total FDIC insurance assessment decreased for 2019 to $64,079 compared to $274,772 for 2018.
 
The Dodd-Frank Act also permanently increased from $100,000 to $250,000 the maximum per depositor FDIC insurance amount.
 
Brokered Deposits. Under FDICIA, an FDIC-insured bank is prohibited from accepting brokered deposits without prior approval of the FDIC unless it is well capitalized under the FDICIA's prompt corrective actions guidelines. The Company participates in the CDARS of the Promontory Interfinancial Network, which uses a deposit-matching engine to match CDARS deposits in other participating banks, dollar-for-dollar. This product, also known as reciprocal deposits, is designed to provide deposit insurance in excess of FDIC limits and thereby enhance customer attraction and retention, build deposits and improve net interest margins. Until recently 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. CDARS also permits the “one-way” purchase of deposits, which the Company utilizes from time to time for liquidity management purposes. CDARS one-way deposits are considered brokered deposits for certain purposes under the Federal Deposit Insurance Act and FDIC regulations. As of December 31, 2019 the Company had CDARS deposits totaling approximately $6.8 million in exchanged funds and $4.0 million in one-way funds. The Company also relies from time to time on purchased wholesale deposit funding, which is a form of brokered deposits. The Company had $7.1 million in purchased wholesale deposits outstanding at December 31, 2019. The Company’s Asset, Liability and Funds Management Policy limits the use of brokered deposits to 5% of total assets.
 
USA Patriot Act. The USA PATRIOT Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cooperatively to combat terrorism on a variety of fronts. The Act contains extensive anti-money laundering and financial transparency provisions and imposes various requirements, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Secretary of the Treasury and federal banking regulators have adopted several regulations to implement these provisions. The Act also amended the federal Bank Holding Company Act and the Bank Merger Act to require the federal banking regulatory authorities to consider the effectiveness of a bank holding company or a financial institution’s anti-money laundering activities when reviewing an application to expand operations. As required by law, the Bank has in place a Bank Secrecy Act and Anti-Money Laundering compliance program, as well as a customer identification program. (See “BSA/AML Requirements” below.)
 
BSA/AML Requirements. The Company is subject to a number of AML and regulations as a result of being a U.S.-based financial institution. AML requirements are primarily derived from the BSA, as amended by the USA Patriot Act. These laws and regulations are designed to prevent the financial system from being used by criminals to hide illicit proceeds and to impede terrorists’ ability to access and move funds used in support of terrorist activities. Among other things, BSA/AML laws and regulations require financial institutions to establish AML programs that meet certain standards, including, in some instances, expanded reporting, particularly in the area of suspicious transactions, and enhanced information gathering and recordkeeping requirements.  The Company maintains an AML program designed to ensure that it is in compliance with all applicable laws, rules and regulations related to AML and anti-terrorist financing initiatives. The AML program provides for a system of internal controls to ensure that appropriate due diligence and, when necessary, enhanced due diligence, including obtaining and maintaining appropriate documentation, is conducted at account opening and updated, as necessary, through the course of the client relationship. The AML program is also designed to ensure there are appropriate methods of monitoring transactions and account relationships to identify potentially suspicious activity and report suspicious activity to governmental authorities in accordance with applicable laws, rules and regulations. In addition, the AML program requires the training of appropriate personnel with regard to AML and anti-terrorist financing issues and provides for independent testing to ensure that the AML program is in compliance with all applicable laws and regulations. Non-compliance with BSA/AML laws or failure to maintain adequate policies and procedures can lead to significant monetary penalties and reputational damage, and federal regulators evaluate the effectiveness of an applicant in combating money laundering when determining whether to approve a bank merger, bank holding company acquisition or other certain other activities.
 
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New AML customer due diligence requirements became effective on May 11, 2018. Among other things, these new regulations require the Company to collect information on the beneficial ownership and controlling person of legal entity clients and to verify their identity.
 
The U.S. Treasury's OFAC rules prohibit U.S. persons from engaging in financial transactions with certain individuals, entities, or countries, identified as “Specially Designated Nationals,” such as terrorists and narcotics traffickers. These rules require the blocking of assets held by, and prohibit transfers of property to such individuals, entities or countries. Blocked assets, such as property or bank deposits, cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. The Company maintains an OFAC program designed to ensure compliance with OFAC requirements.
 
Financial Privacy. Under the federal Gramm-Leach-Bliley Financial Modernization Act of 1999 all financial institutions, including the Company, are required to adopt privacy policies, restrict the sharing of nonpublic consumer customer data with nonaffiliated parties, and establish procedures and practices to protect customer data from unauthorized access. The Company is also subject to similar, but more stringent, requirements under state law, including the Vermont Financial Privacy Act. In addition, the Company is subject to the federal Fair Credit Reporting Act, including the amendments adopted in the federal Fair and Accurate Credit Transactions Act of 2003 (FACT Act). The FACT Act includes many provisions concerning national credit reporting standards and permits consumers to opt out of information sharing among affiliated companies for marketing purposes. It also requires financial institutions to notify their customers if they report negative information about them to a credit bureau or if they are granted credit terms less favorable than those generally available. The FRB and the OCC have extensive rulemaking authority under the FACT Act and have promulgated rules implementing the Act, including rules limiting information sharing for affiliate marketing and rules requiring programs to identify, detect and mitigate certain identity theft red flags. The Company is also subject to the requirements of the Vermont Fair Credit Reporting Act, which generally requires an individual's consent in order to obtain a credit report.
 
Qualified Mortgage Rules. Pursuant to the Dodd-Frank Act, the CFPB adopted significant amendments to the regulations that implement the Truth in Lending Act. These amendments, which became effective January 10, 2014, address mortgage origination practices by certain housing creditors, including the Bank, and generally require mortgage lenders to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider eight underwriting factors when making the credit decision. Alternatively, the mortgage lender can originate so-called qualified mortgages, or "QMs", which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a qualified mortgage is a residential mortgage loan that does not have certain high risk features, such as negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount and the borrower’s total debt-to-income ratio must be no higher than 43% (subject to certain limited exceptions for loans eligible for purchase, guarantee or insurance by a government sponsored entity or a federal agency).
 
A lender originating a QM is protected against a legal claim that the lender failed to comply with the ability-to-repay requirement. A lender originating a mortgage that is not a QM is exposed to the risk of a potential claim that the lender did not comply with the ability-to-repay rules, which could require the lender to pay damages to the borrower, and could impair the lender’s ability to enforce the loan terms or foreclose on the real estate collateral. The ability-to-repay requirement creates a new basis for after-the-fact challenge of QM status by regulators and by consumers and its future interpretation by the courts may create substantial legal uncertainty. The CFPB’s mission is consumer protection, not lender safety and soundness, and for that reason the CFPB wrote the ability-to-repay rule with the goal of preventing consumers from being steered by lenders into expensive and unsustainable borrowing, rather than with the goal of assuring loan repayment. Accordingly, typical credit-quality features such as loan-to-value standards are not elements of the ability-to-repay rule, and it will not necessarily be the case that QMs have a higher probability or history of repayment than other mortgages.
 
 
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The 2018 Regulatory Relief Act creates a safe harbor for qualifying community banks by providing qualified mortgage status for most residential mortgage loans held in portfolio. The Bank qualifies for this relief.
 
Integrated TILA/RESPA (TRID) Disclosures. As required by the Dodd-Frank Act, the CFPB issued final rules in 2013 revising and integrating previously separate disclosures required under the RESPA and TILA in connection with certain closed-end consumer mortgage loans. These final rules became effective in October 2015 and require lenders to provide a new Loan Estimate (which combines content from the former Good Faith Estimate required under RESPA and the initial disclosures required under TILA) not later than the third business day after submission of a loan application, and a new Closing Disclosure (which combines content of the former HUD-1 Settlement Statement required under RESPA and the final disclosures required under TILA) at least three days prior to the loan closing. Other significant changes included in the TRID rules include: (1) expansion of the scope of loans that require RESPA early disclosures, including bridge loans, vacant land loans, and construction loans; (2) changes and additions to “waiting period” requirements to close a loan; (3) reduced tolerances for estimated fees and (4) the lender, rather than the closing agent, is responsible for providing final disclosures. As with the CFPB’s ability-to-repay/QM rules, compliance with the TRID rules has increased the Company’s compliance costs and may adversely affect the profitability of our routine residential mortgage lending operations.
 
Community Reinvestment Act. The Federal CRA requires banks to define the communities they serve, identify the credit needs of those communities, collect and maintain data for each small business or small farm loan originated or purchased by the Bank, and maintain a Public File at each location. The federal banking regulators examine the institutions they regulate for compliance with the CRA and assign one of the following four ratings: “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance”. The rating assigned reflects the bank’s record of helping to meet the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the bank. As of the Bank’s last CRA examination, completed during 2017, it received a rating of “Outstanding”.
 
Home Mortgage Disclosure Act. The federal HMDA, which is implemented by CFPB’s Regulation C, requires mortgage lenders that maintain offices within MSAs to report and make available to the public specified information regarding their residential mortgage lending activities, such as the pricing of home mortgage loans, including the “rate spread” between the interest rate on loans and certain treasury securities and other benchmarks. The Bank became subject to HMDA reporting requirements as a result of its merger with LyndonBank in 2007, as the former LyndonBank branch in Enosburg Falls in Franklin County is included within the Burlington, Vermont MSA. In July 2015, the CFPB implemented and expanded new HMDA rules. The final rule adopts a dwelling-secured standard for all loans or lines of credit that are for personal, family, or household purposes. Thus, many consumer-purpose transactions, including closed-end home-equity loans, home-equity lines of credit, and reverse mortgages, are subject to the regulation. Most commercial-purpose transactions (i.e., loans or lines of credit not for personal, family, or household purposes) are subject to the regulation only if they are for the purpose of home purchase, home improvement, or refinancing. The final rule excludes from coverage home improvement loans that are not secured by a dwelling (i.e., home improvement loans that are unsecured or that are secured by some other type of collateral) and all agricultural-purpose loans and lines of credit. New HMDA rules that became effective January 1, 2018 significantly increased the overall amount of data required to be collected and submitted, including additional data points about the applicable loans and expanded data about the borrowers. However, the 2018 Regulatory Relief Act provided an exemption from the requirement to collect these additional data fields for banks that have at least a “Satisfactory” CRA rating that originate fewer than 500 closed-end mortgage loans or fewer than 500 open-end lines of credit per year. The Bank qualifies for this relief.
 
Flood Insurance Reform. The Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act), as amended by the Homeowner Flood Insurance Affordability Act of 2014, modified the National Flood Insurance Program by: (i) increasing the maximum civil penalty for Flood Disaster Protection Act violations to $2,000 and eliminating the annual penalty cap; (ii) requiring certain lenders to escrow premiums and fees for flood insurance on residential improved real estate; (iii) directing lenders to accept private flood insurance and to notify borrowers of its availability; (iv) amending the force placement requirement provisions; and (v) permitting lenders to charge borrowers costs for lapses in or insufficient coverage. The civil penalty and force placed insurance provisions were effective immediately.
 
In July 2015, certain federal agencies issued a joint final rule exempting: (1) detached structures that are not used as a residence from the mandatory flood insurance purchase requirements and (2) HELOCs, business purpose loans, nonperforming loans, loans with terms of less than one year, loans for co-ops and condominiums, and subordinate loans on the same property from the mandatory escrow of flood insurance premium requirements. Additionally, the final rule requires certain lenders to escrow flood insurance payments and offer the option to escrow flood insurance premiums on residential improved real estate securing a loan, effective January 1, 2016. New rules effective July 1, 2019, require banks and other regulated financial institutions to accept certain private insurance policies in addition to National Flood Insurance Program policies.
 
 
 
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Reserve Requirements. FRB Regulation D requires all depository institutions to maintain reserves against their transaction accounts (generally, demand deposits, NOW accounts and certain other types of accounts that permit payments or transfers to third parties) and non-personal time deposits (generally, money market deposit accounts or other savings deposits held by corporations or other depositors that are not natural persons, and certain other types of time deposits), subject to certain exemptions. Because required reserves must be maintained in the form of either vault cash, a non-interest bearing account at the FRBB or a pass through account (as defined by the FRB), the effect of these reserve requirements is to reduce the amount of the Company's interest-bearing assets.
 
Federal Home Loan Bank System. The Bank is a member of the FHLB System, which consists of 12 regional Federal Home Loan Banks. The FHLB provides a central credit facility primarily for member institutions. Member institutions are required to purchase and hold shares of capital stock in the applicable regional FHLB (the FHLBB, in the case of the Bank), in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year and 4.5% of its advances (borrowings) from the FHLBB. The Bank was in compliance with this requirement with an investment in FHLBB stock at December 31, 2019 of $753,700. As a member, the Bank is subject to future capital calls by the FHLBB in order to maintain compliance with its capital plan.
 
FRB Executive Compensation Guidelines. In 2009, the FRB issued comprehensive guidance on executive compensation policies, intended to ensure that the incentive compensation practices of banking organizations do not undermine their safety and soundness by encouraging excessive risk-taking. The guidance covers all employees that have the ability to affect materially an institution's risk profile, either individually or as part of a group, and establishes that incentive compensation arrangements should (1) provide incentives that do not encourage risk-taking beyond the institution's ability to identify and manage effectively; (2) be compatible with effective internal controls and risk management; and (3) be supported by strong corporate governance, including active and effective oversight by the board of directors. The guidance instructed institutions to begin an immediate review of their incentive compensation policies to ensure that they do not encourage excessive risk-taking and implement corrective programs as needed. Where deficiencies in incentive compensation arrangements exist, they must be immediately addressed. For institutions such as the Company that are not "large, complex banking organizations" as defined in the guidance, the FRB will review the incentive compensation arrangements as part of its regular, risk-focused examination process and not in a separate examination. These examinations will be tailored to the scope and complexity of the institution's activity and compensation arrangements. The findings will be included in the FRB's examination report and deficiencies will be incorporated into the institution's supervisory ratings. Enforcement actions may be taken against an institution if its incentive compensation arrangements, or related risk management control or governance processes, pose a risk to the institution's safety and soundness and the institution fails to take prompt and effective measures to correct the deficiencies.
 
Other Legislative and Regulatory Initiatives. In addition to the statutes, regulations and regulatory initiatives described above, new legislation and regulations affecting financial institutions are frequently proposed. If enacted or adopted, these measures could change banking statutes and the Company's operating environment in substantial and unpredictable ways and could further increase reporting and compliance requirements, governance structures and costs of doing business. The Company cannot predict whether any such additional legislation or other regulatory initiatives will be adopted or the effect they may have on the Company's business, results of operations or financial condition.
 
Tax Cuts and Jobs Act.  The 2017 Tax Act significantly changed corporate income tax law by reducing the federal corporate income tax rate from 35% to 21%, effective January 1, 2018, creating a territorial tax system, allowing for immediate capital expensing of certain qualified property, and eliminating the deductibility of DIF assessments. These tax laws were generally effective for the 2018 tax year. However, as permitted under the 2017 Tax Act, the Company recognized certain effects of the changes in the tax laws in its 2017 consolidated financial statements
 
Effects of Government Monetary Policy
 
The earnings of the Company are affected by general and local economic conditions and by the policies of various governmental regulatory authorities. In particular, the FRB regulates money supply, credit conditions and interest rates in order to influence general economic conditions, primarily through open market operations in United States Government Securities, varying the discount rate on member bank borrowings, setting reserve requirements against member and nonmember bank deposits, regulating interest rates payable by member banks on time and savings deposits and expanding or contracting the money supply. FRB monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to continue to do so in the future.
 
Other Available Information
 
This annual report on Form 10-K is on file with SEC. The Company also files with the SEC quarterly reports on Form 10-Q and current reports on Form 8-K, as well as proxy materials for its annual meetings of shareholders. These reports and proxy materials are available without charge on the SEC’s website at http://www.sec.gov. The Company's SEC-filed reports and proxy statements are also available without charge through a link on the Company's website at www.communitybancorpvt.com. The Company has also posted on its website the Company’s Code of Ethics for Senior Financial Officers and the Principal Executive Officer, the Insider Trading Policy and the charters of the Audit, Compensation and Nominating Committees. The information and documents contained on the Company's website do not constitute part of this report. Copies of the Company's reports filed with the SEC (other than exhibits) and proxy materials can also be obtained by contacting Melissa Tinker, Assistant Corporate Secretary, at our principal offices, which are located at 4811 U.S. Route 5, Derby, Vermont  05829 or by calling (802) 334-7915.
 
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Item 1A. Risk Factors
 
Before deciding to invest in the Company or to maintain or increase an investment, investors should carefully consider the material risks described below, in addition to the other information contained in this report and in the Company’s other filings with the SEC. The risks and uncertainties described below and in the Company’s other filings are not the only ones the Company faces. Additional risks and uncertainties not presently known to management or that are currently deemed immaterial may emerge or evolve and also affect the Company’s business. If any of these known or unknown risks or uncertainties actually occurs, the Company’s business, financial condition and results of operations could be adversely affected, which in turn could result in a decline in the value of the Company’s capital stock.
 
Our common stock is not exchange-listed and our trading volume is less than that of larger public companies, which can contribute to volatility in our stock price and adversely affect the price and liquidity of an investment in our common stock.
 
Our common stock is included in the OTC QX market tier maintained by the OTC Markets Group, Inc. under the trading symbol CMTV, but is not traded on any securities exchange. Bid and ask quotations and trades in our stock made by certain brokerage firms are reported through the OTC Link® Alternative Trading System (ATS) maintained by a subsidiary of the OTC Markets Group, Inc. However, trading in our stock is sporadic. A public trading market for a particular class of stock having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of numerous buyers and sellers of that stock at any given time, which in turn depends on the individual decisions of investors and general economic and market conditions over which issuers have no control. The trading market in our stock does not exhibit these characteristics. The trading history of our common stock has been characterized by relatively low trading volume. This lack of an active public market means that the value of a shareholder’s investment in our common stock may be subject to sudden fluctuations, as individual trades have a greater effect on our reported trading price than would be the case in a broad public market with significant daily trading volume.
 
The market price of our common stock may also be subject to fluctuations in response to numerous other factors, including the factors discussed below, regardless of our actual operating performance. The possibility of such fluctuations occurring is increased due to the illiquid nature of the trading market in our common stock. Therefore, a shareholder may be unable to sell our common stock at or above the price at which it was purchased, or at or above the current market price or at the time of his or her choosing.
 
Our ability to pay dividends on our capital stock and to service our debt depends primarily on dividends from our subsidiary and may be subject to regulatory and contractual limitations.
 
As a holding company, our cash flow typically comes from dividends that our bank subsidiary, Community National Bank, pays to us. Therefore, our ability to pay dividends on our common and preferred stock and to service our subordinated debentures, depends on the dividends we receive from the Bank. Dividend payments from the Bank are subject to federal statutory and regulatory limitations, generally based on net profits and retained earnings and may be subject to additional prudential considerations, such as capital planning needs. In addition, FRB policy, which applies to us as a registered bank holding company, provides that dividends by bank holding companies should generally be paid out of current earnings looking back over a one-year period and should not be paid if regulatory capital levels are deemed insufficient. Further, regulatory capital requirements could curtail our ability to pay dividends in some cases if we do not maintain a required capital conservation buffer. Our failure to pay dividends on our common or preferred stock or our failure to service our debt could have a material adverse effect on the market price of our common stock. Moreover, if sufficient dividend funding from the Bank is not available to cover all our requirements, we would be obligated first to pay interest and, if applicable, principal on our debentures and then to pay dividends on our preferred stock before making any dividend payments on our common stock.
 
Although we have generally paid quarterly cash dividends on our common stock, we cannot provide any assurance that dividends will continue to be paid in the future or that the dividend rate will not be reduced in future periods.
 
 
 
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Our common stock is subordinate to our existing and future indebtedness and preferred stock. 
 
Shares of our common stock are equity interests and do not constitute indebtedness. As such, our common stock ranks junior to all our customer deposits and indebtedness, whether now existing or hereafter incurred, and other non-equity claims on us, with respect to assets available to satisfy claims. In addition, our common stock is junior in priority, including with respect to dividend and liquidation rights, to our outstanding shares of Series A Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock. Further, the common stock will be subject to the prior liquidation rights of the holders of any debt we may issue in the future and may be subject to the prior dividend and liquidation rights of any series of preferred stock we may issue in the future.
 
Securities issued by us, including our common stock, are not FDIC insured.
 
Securities issued by us, including our common stock, are not savings or deposit accounts or other obligations of any bank and are not insured by the FDIC, the DIF or any other governmental agency or instrumentality, or any private insurer, and are subject to investment risk, including the possible loss of principal.
 
Our organizational documents may have the effect of discouraging a third party from acquiring us.
 
Our Amended and Restated Articles of Association and By-Laws contain provisions, including a staggered board of directors and a supermajority vote requirement, that make it more difficult for a third party to gain control or acquire us without the consent of the board of directors. These provisions could also discourage proxy contests and may make it more difficult for dissident shareholders to elect representatives as directors and take other corporate actions. To the extent that these provisions make these actions more difficult and make us a less attractive takeover candidate, they may not always be in our best interests or in the best interests of our shareholders and in some circumstances may prevent holders of our common stock from receiving a takeover premium.
 
Changes in interest rates could adversely affect our business, results of operations and financial condition.
 
Our results of operations depend substantially on our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits and borrowings. These rates are highly sensitive to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and the monetary policies of the FRB. If the interest rate we pay on deposits and other borrowings increases at a faster rate than the interest rate we earn on loans and other investments, our net interest income and therefore earnings, could be adversely affected. Conversely, our earnings could be adversely affected if the interest rate we earn on loans and other investments falls more quickly than the interest rate we pay on deposits and borrowings. While we have taken measures intended to manage the risks of operating in a changing interest rate environment, we cannot provide assurance that these measures will be effective in avoiding undue interest rate risk.
 
Increases in interest rates also can affect the value of loans and other assets, such as investment securities, and may affect our ability to realize gains on the sale of assets. For example, we originate loans for sale to secondary market investors, and increasing interest rates may reduce the volume of loans originated for sale, resulting in a reduction in the fee income we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans, resulting in an increase in our non-performing assets and a reduction in our income.
 
In addition, increases in interest rates will increase the dividend rate on our Series A preferred stock, which is tied to the prime rate, and the interest rate on our debentures, which is tied to LIBOR. Furthermore, there is uncertainty about the continued availability of LIBOR beyond 2021, due to changes proposed by the United Kingdom regulatory entity that regulates LIBOR. Higher preferred stock dividend payments and debenture interest costs would decrease the amount of funds available for payment of dividends on our common stock.
 
We may be impacted by the retirement of London Interbank Offered Rate (“LIBOR”) as a reference rate.
 
In July 2017, the United Kingdom Financial Conduct Authority announced that LIBOR may no longer be published after 2021. LIBOR is used extensively in the U.S and globally as a “benchmark” or “reference rate” for various commercial and financial contracts. In response, the Alternative Reference Rates Committee (“ARRC”), made up of financial and capital market institutions, was convened to address the replacement of LIBOR in the U.S. The ARRC identified a potential successor to LIBOR in the Secured Overnight Financing Rate (“SOFR”) and crafted a plan to facilitate the transition. However, there are significant conceptual and technical differences between LIBOR and SOFR. The federal Financial Stability Oversight Committee has stated that the end or waning use of LIBOR has the potential to significantly disrupt trading in many important types of financial contracts.
 
 
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As of December 31, 2019, the Company had outstanding $12,887,000 in principal amount of Junior Subordinated Debentures due December 15, 2037, which bear a quarterly floating rate of interest equal to the 3-month LIBOR, plus 2.85%. The Company has reviewed the pertinent language in the Indenture governing the Debentures and believes that the Debenture Trustee has sufficient authority under the Indenture to establish a substitute interest rate benchmark independent of any action or recommendation of the ARRC, and without the need to amend the Indenture. Under the terms of the Indenture, if 3-month LIBOR is not available, the Trustee may obtain substitute quotations from four leading banks in the London interbank market for their offered rate to prime banks in the London market for U.S. dollar deposits having a three month maturity; if at least two such quotations are provided, the quarterly rate on the Debentures will be the arithmetic mean of such quotations. If fewer than two such quotations are received, the Trustee will request substitute quotations from four major New York City banks for their offered rate to leading European banks for loans in U.S. dollars; if at least two such quotations are provided, the quarterly rate on the Debentures will be the arithmetic mean of such quotations. The Debenture Trustee has not yet informed the Company as to how it intends to proceed. Phase out of LIBOR could significantly impact the Company’s interest costs on its Debentures.
 
We are subject to liquidity risk because we rely primarily on deposit-gathering to satisfy our funding needs.
 
Our primary source of liquidity is through the growth of deposits, which provide low cost funding for our operations. If we are unable to attract enough deposits in our market area to fund loan growth and our other funding needs, then we may be forced to purchase deposits or to borrow through the FHLBB or in the capital markets. Purchased deposits and borrowings would tend to be more expensive than funding through core deposits and therefore could have a negative impact on our results of operations, cash flow, liquidity and regulatory capital levels.
 
We are subject to credit risk and if our ALL is not adequate to cover actual losses, our earnings could decrease.
 
We are exposed to the risk that our borrowers may default on their obligations. A borrower's default on its obligations under one or more loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the credit. In certain situations, where collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, we may have to write off the loan in whole or in part. In loan default situations, we may acquire real estate or other assets, if any, that secure the loan, through foreclosure or other similar available remedies, and the amount owed under the defaulted loan could exceed the value of the collateral acquired.
 
We periodically make a determination of the adequacy of our ALL based on available information, including, but not limited to, the quality of the loan portfolio as indicated by loan risk ratings, economic conditions, the value of the underlying collateral and the level of non-accruing and criticized loans. Management relies on its loan officers and credit quality reviews, its experience and its evaluation of economic conditions, among other factors, in determining the amount of the provision required for the allowance. Provisions to this allowance result in an expense for the period. If, as a result of general economic conditions, previously incorrect assumptions, an increase in defaulted loans, or other pertinent factors, we determine that additional increases in the ALL are necessary, additional expenses may be incurred.
 
Determining the amount of the ALL inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and trends, all of which may undergo material changes. At any time, we are likely to have loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be certain that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit or correctly estimate losses on those loans that are identified. The OCC, our subsidiary Bank’s primary federal regulator, reviews the loan portfolio from time to time as part of its regulatory examination and may request that we increase the ALL. Changes in economic conditions or individual business or personal circumstances affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance.  In addition, if charge-offs in future periods exceed the ALL, we will need to make additional provisions to restore the allowance. Any provisions to increase or restore the ALL would decrease our net income and, possibly, our capital, and could have an adverse effect on our results of operations and financial condition.
 
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. Implementation of CECL could have a material impact on the Company’s results of operations and consolidated financial statements upon adoption as it may result in the recording of an increased ALL amount, with a related adverse impact on the calculation of the Company’s regulatory capital ratios. Adoption of the CECL model will become mandatory for the Company beginning with the 2023 fiscal year.
 
17
 
 
Prepayments of loans may negatively impact our business.
 
Generally, our customers may prepay the principal amount of their outstanding loans at any time. The speeds at which such prepayments occur, as well as the size of such prepayments, are within our customers’ discretion and may be affected by many factors beyond our control, including changes in prevailing interest rates. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A significant reduction in interest income could have a negative impact on our results of operations and financial condition.
 
Our loans and deposits are geographically concentrated and adverse local economic conditions could negatively affect our business.
 
Unlike many larger banking institutions, our banking operations are not geographically diversified. Substantially all of our loans, deposits and fee income are generated in northeastern and central Vermont. As a result, poor economic conditions in northeastern and central Vermont could adversely impact the demand for loans and our other financial products and services and may cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. Much of our market area is located in the poorest region of the state. Economic conditions in northeastern and central Vermont are subject to various uncertainties, to a greater degree than other regions of the state. If economic conditions in our market area decline, we expect that our level of problem assets would increase and our prospects for growth would be impaired.
 
Our banking business is highly regulated, and we may be adversely affected by changes in law and regulation.
 
We are subject to regulation and supervision by the FRB, and the Bank is subject to regulation and supervision by the OCC and the FDIC. Federal laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital, the permissible types, amounts and terms of loans and investments, permissible nonbanking activities, the level of reserves against deposits and restrictions on dividend payments. The OCC possesses the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to bank holding companies. We are also subject to certain state laws, including certain Vermont laws designed to protect consumers of banking products and services. These and other federal and state laws and restrictions limit the manner in which we may conduct business and obtain financing.
 
Our business is highly regulated and the various federal and state laws, rules, regulations, and supervisory guidance, policies and interpretations applicable to us are subject to regular modification and change. It is impossible to predict the nature of such changes or their competitive impact on the banking and financial services industry in general or on our banking operations in particular. Such changes may, among other things, increase our cost of doing business, limit our permissible activities, or affect the competitive balance between banks and other financial institutions. In addition, failure to comply with applicable laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties, litigation by private parties, and/or reputational damage, which could have a material adverse effect on our business, results of operations and financial condition.
 
The requirement to record certain assets and liabilities at fair value may adversely affect our financial results.
 
We report certain assets, including investment securities, at fair value. Generally, for assets that are reported at fair value we use quoted market prices or valuation models that utilize market data inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may incur losses even if the asset in question presents minimal credit risk. For example, we could be required to recognize OTTI in future periods with respect to investment securities in our portfolio. The amount and timing of any impairment recognized will depend on the severity and duration of the decline in fair value of our investment securities and our estimation of the anticipated recovery period.
 
Market changes in delivery of financial services may adversely affect demand for our services.
 
Channels for delivering financial products and services to our customers are evolving rapidly, with less reliance on traditional branch facilities and more use of online and mobile banking. We compete with larger providers that have significant resources to dedicate to improved technology and delivery channels. We periodically evaluate the profitability of our branch system and other office and operational facilities to improve efficiencies. However, identification and closure of unprofitable operations and facilities can lead to restructuring charges and introduce the risk of disruptions to revenues and customer relationships.
 
18
 
 
Substantial competition could adversely affect us.
 
Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in northeastern and central Vermont. Our competitors include a number of state and national banks and tax-advantaged credit unions, as well as financial and nonfinancial firms that offer services similar to those that we offer. Some of our competitors are community or regional banks that have strong local market positions. Our large bank competitors, in particular, have substantial capital, technology and marketing resources that are well in excess of ours. These larger financial institutions may have greater access to capital at a lower cost and have a higher per-borrower lending limit than our Company, which may adversely affect our ability to compete with them effectively.
 
In addition, technology and other changes increasingly allow parties to complete financial transactions electronically, without the need for a physical presence in a market area. We are therefore likely to face increasing competition from out-of-market competitors, including national firms. Moreover, in many cases transactions may now be completed without the involvement of banks. For example, consumers can pay bills and transfer funds over the Internet and by telephone without banks. Many non-bank financial service providers have lower overhead costs and are subject to fewer regulatory constraints. If consumers do not use banks to complete their financial transactions, we could potentially lose fee income, deposits and income generated from those deposits.
 
Systems failures, interruptions, cyberattacks or other breaches of information security could disrupt our business and have an adverse effect on our business, results of operations and financial condition.
 
We depend upon data processing, software, communication, and information access and exchange on a variety of computing platforms and networks and over the internet, and we rely on the services of a variety of third party vendors to meet our data processing and communication needs. Consequently, we are subject to certain related operational risks, both in our operations and through those of our service providers. These risks include, but are not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud, cyberattacks and catastrophic failures resulting from terrorist acts or natural disasters. Despite the safeguards we maintain, we cannot be certain that all of our systems are entirely free from vulnerability to attack or other technological difficulties or failures. Information security risks have increased significantly due to the use of online, telephone and mobile banking channels by customers and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Our technologies, systems and networks and those of certain of our service providers as well as our customers’ devices, may be the target of cyberattacks, computer viruses, malicious code, phishing attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, the theft of customer assets through fraudulent transactions or disruption of our or our customers’ or other third parties’ business operations. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and we could be exposed to claims from customers. While we have instituted safeguards and controls, we cannot provide assurance that they will be effective in all cases, and their failure in some circumstances could have a material adverse effect on our business, financial condition or results of operations.
 
We depend on the accuracy and completeness of information about customers and counterparties.
 
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors if made available. If this information is inaccurate, we may suffer financial or reputational harm or other adverse effects with respect to the operation of our business, our financial condition and our results of operations.
 
New products and services are essential to remain competitive but may subject us to additional risks.
 
We consistently attempt to offer new products and services to our customers to remain competitive. There can be risks and uncertainties associated with these new products and services especially if they are dependent on new technologies. We may spend significant time and resources in development of new products and services to market to customers. Through our development and implementation process we may incur risks associated with delivery timetables, pricing and profitability, compliance with regulations, technology failures and shifting customer preferences. Failure to successfully manage these risks could have a material effect on our financial condition, result of operations and business.
 
 
19
 
 
Changes in accounting standards could materially affect our financial statements.
 
From time to time FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements and applicable disclosures in our SEC filings. These changes can be very difficult to predict and can materially affect how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. Implementation of accounting changes, with associated professional consultation and advice, can be costly, even if the change will not have any material effect on our financial statements.
 
Our internal controls and procedures may fail or be circumvented.
 
Management periodically reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. However, any system of controls, no matter how well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have a material adverse effect on our business, results of operations and financial condition.
 
Changes in our tax rates could affect our future results.
 
Our future effective tax rates and tax liabilities could be unfavorably affected by increases in applicable tax rates and by other changes in federal or state tax laws, regulations and agency interpretations. Our effective tax rates could also be affected by changes in the valuation of our deferred tax assets and liabilities or by the outcomes of any examinations of our income tax returns by the IRS or our state income, franchise, sales and use or other tax returns by the Vermont Department of Taxes. Our results of operations and financial condition could also be adversely affected in the short-term by decreases in applicable tax rates that require us to revalue our deferred tax asset, as occurred in 2017 as a result of passage of the 2017 Tax Act.
 
Our business could suffer if we fail to attract and retain skilled personnel.
 
Our success depends, in large part, on our ability to attract and retain key personnel, including executives. Any of our current employees, including our senior management, may terminate their employment with us at any time. Competition for qualified personnel in our industry can be intense and our geographic market area might not be favorably perceived by potential executive management candidates. We may not be successful in attracting and retaining sufficient qualified personnel. We may also incur increased expenses and be required to divert the attention of other senior executives to recruit replacements for the loss of any key personnel.
 
Environmental liability associated with our lending activities could result in losses.
 
In the course of business, we may acquire, through foreclosure, properties securing loans originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that material environmental violations could be discovered on these properties. In this event, we might be required to remedy these violations at the affected properties at our sole cost and expense. The cost of remedial action could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our results of operations and financial condition.
 
We are subject to detailed capital requirements and cannot ensure that we will qualify for simplified capital calculations in any future period.
 
As of January 1, 2015, we were required to comply with new capital rules issued by the federal banking agencies that implemented the Basel III capital standards and established the minimum capital levels required under the Dodd-Frank Act. These new capital rules require banks and bank holding companies to maintain a minimum common equity Tier I capital ratio of 4.5% of risk-weighted assets, a minimum Tier I capital ratio of 6.0% of risk-weighted assets, a minimum total capital ratio of 8.0% of risk-weighted assets, and a minimum leverage ratio of 4.0%. Subject to a transition period, the new capital rules require banks and bank holding companies to maintain a 2.5% common equity Tier I capital conservation buffer above the minimum risk-based capital requirements for adequately capitalized institutions to avoid restrictions on the ability to pay dividends, discretionary bonuses, and to engage in share repurchases. The Company and the Bank met these requirements as of December 31, 2019. The new rules permanently grandfathered trust preferred securities issued before May 19, 2010 for institutions with less than $15.0 billion in total assets as of December 31, 2009, subject to a limit of 25% of Tier I capital. Our trust preferred securities qualify for this grandfather treatment. The new rules increased the required capital for certain categories of assets, including high volatility construction real estate loans and certain exposures related to securitizations, but retained the previous capital treatment of residential mortgages. Under the new rules, we were permitted to make, and did make, a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital.
 
20
 
 
These standards could adversely affect our ability to pay dividends, or require us to reduce business levels or raise capital, including in ways that may adversely affect our results of operations or financial condition.
 
Under the 2018 Regulatory Relief Act, these capital requirements have been simplified for qualifying community banks and bank holding companies. In September 2019, the OCC and the other federal bank regulators approved a final joint rule that permits a qualifying community banking organization to opt in to a simplified regulatory capital framework. A qualifying institution that elects to utilize the simplified framework must maintain a CBLR in excess of 9%, and will thereby be deemed to have satisfied the generally applicable risk-based and other leverage capital requirements and (if applicable) the FDIC’s prompt corrective action framework. In order to utilize the CBLR framework, in addition to maintaining a CBLR of over 9%, a community banking organization must have less than $10 billion in total consolidated assets and must meet certain other criteria such as limitations on the amount of off-balance sheet exposures and on trading assets and liabilities. The CBLR will be calculated by dividing tangible equity capital by average total consolidated assets. The final rule became effective on January 1, 2020. Although management believes that the Company and Bank would have qualified to utilize the CBLR framework on a pro forma basis as of December 31, 2019 had it been in effect on that date, no assurance can be given that they will continue to qualify as of any future date.
 
We may be required to write down goodwill and other identifiable intangible assets.
 
When we acquire a business, a portion of the purchase price of the acquisition may be allocated to goodwill and other identifiable intangible assets. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired determines the amount of the purchase price that is allocated to goodwill acquired. At December 31, 2019, our goodwill totaled approximately $11.6 million, created in connection with the LyndonBank acquisition in 2007. Under current accounting standards, if we determine goodwill is impaired, we would be required to write down the value of these assets to fair value. We conduct a review each year, or more frequently if events or circumstances warrant such, to determine whether goodwill is impaired. We last completed a goodwill impairment analysis as of December 31, 2019, and concluded goodwill was not impaired. We cannot provide assurance that we will not be required to take an impairment charge in the future. Any impairment charge would have a negative effect on our shareholders’ equity and financial results and may cause a decline in our stock price.
 
We are not able to offer all of the financial services and products of a financial holding company.
 
Banks, securities firms, and insurance companies can now combine under a “financial holding company” umbrella. Financial holding companies can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Some of our competitors have elected to become financial holding companies. We offer only traditional banking products and, trust and investment management services indirectly through, our affiliate, CFSG.
 
Item 1B.  Unresolved Staff Comments
 
Not Applicable
 
Item 2.  Properties
 
Although the Bancorp. does not itself own or lease real property, the Bank owns and leases various properties for its banking operations. All of the Bank’s offices are located in Vermont, other than its loan production office in Grafton County, New Hampshire.
 
The Company's administrative offices are located at the main offices of the Bank on U.S. Route 5 in Derby, Vermont, with total office space of approximately 34,000 square feet, including retail banking offices, an operations center as well as a community room used by the Bank for meetings and various functions. This community room has a secure outside access making it possible for the Bank to offer it to non-profit organizations after banking hours free of charge. This office is equipped with a remote drive-up facility and a drive-up ATM as well as an inside lobby ATM.
 
 
 
21
 
 
In addition to its main office, the Company currently owns or leases the following premises in six Vermont counties and one New Hampshire County:
 
Office Location1
Owned
Leased
CFSG Office2
 
 
 
 
Caledonia County, VT
 
 
 
     St. Johnsbury (Railroad Street)3
 
X
 
     St. Johnsbury (Route 5)
 
X
 
     Lyndon (Memorial Drive)
 
X
X
 
 
 
 
Chittenden County, VT
 
 
 
     Burlington (Shelburne Road)4
 
X
 
 
 
 
 
Franklin County, VT
 
 
 
     Enosburg Falls (Sampsonville Road)
X
 
 
 
 
 
 
Grafton County, NH
 
 
 
     Lebanon, NH (367 Route 120) 4
 
X
 
 
 
 
 
Lamoille County, VT
 
 
 
     Morrisville (Route 15 West)
 
X
 
 
 
 
 
Orleans County, VT
 
 
 
     Barton (Church Street)
X
 
 
     Derby Line (Main Street)
X
 
 
     Island Pond (Route 105)
 
X
 
     Newport (Main Street)
X
 
 
     Troy (Route 101)
X
 
 
 
 
 
 
Washington County, VT
 
 
 
     Barre (North Main Street)
X
 
X
     Montpelier (State Street)
 
X
 
 
 
1 All listed locations are operating bank branch offices, except as otherwise noted in footnotes 3 and 4.
 
2 The Bank leases space at two of its branch locations to its affiliated trust and investment management affiliate, CFSG.
 
3 These premises consist of approximately 1,600 square feet on the southern end of Railroad Street and were formerly used as a branch office, now closed and currently vacant. The lease was scheduled to expire in 2020, however the Company negotiated a termination agreement during the last quarter of 2019, thereby paying the lease in full as of December 31, 2019.
 
4 Loan production offices (LPO), opened in the first quarter of 2017 in Chittenden County and the second quarter of 2019 in Grafton County, in western New Hampshire.
 
 
The Company maintains ATMs at the main office and all branch locations. A complete listing of the Company’s banking offices is contained on the Bank’s website at www.communitynationalbank.com.
 
All of the Company’s owned premises are free and clear of any mortgages or encumbrances and, in management’s view, all locations are suitable for conducting the Bank’s business.
 
 
 
22
 
 
Item 3.  Legal Proceedings
 
There are no pending legal proceedings to which the Company or the Bank is a party or of which any of its property is the subject, other than routine litigation incidental to its banking business, none of which, in the opinion of management, is material to the Company's consolidated operations or financial condition.
 
Item 4.  Mine Safety Disclosures
 
Not Applicable
 
PART II.
 
Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Information on the trading market in, market price of, and dividends paid on, the Company's common stock is incorporated by reference to the section of the 2019 Annual Report under the caption “Common Stock Performance by Quarter” immediately following the “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, filed as Exhibit 13 to this report. The balance of the information required by item 201 of Regulation S-K is omitted in accordance with the regulatory relief available to smaller reporting companies under applicable SEC disclosure rules, as amended in 2018 Release Nos. 33-10513 and 34-83550.
 
There were no purchases of the Company’s common stock during the three months ended December 31, 2019, 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.
 
Item 6.  Selected Financial Data
 
Omitted, in accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 and 34-83550.
 
Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Incorporated by reference to the section of the 2019 Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," immediately following the “Notes to Consolidated Financial Statements”, filed as Exhibit 13 to this report.
 
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk
 
Omitted, in accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 and 34-83550.
 
Item 8.  Financial Statements and Supplementary Data
 
The audited consolidated financial statements and related notes of Community Bancorp. and Subsidiary and the report thereon of the independent registered accounting firm of Berry Dunn McNeil & Parker, LLC are incorporated herein by reference from the 2019 Annual Report, filed as Exhibit 13 to this report.
 
In accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 and 34-83550, the Company has elected to present audited statements of income, comprehensive income, cash flows and changes in shareholders’ equity for each of the preceding two, rather than three, fiscal years.
 
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None
  
 
23
 
 
Item 9A.  Controls and Procedures
 
Disclosure Controls and Procedures
 
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). As of December 31, 2019, 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 December 31, 2019 were effective in ensuring that material information required to be disclosed in the reports it files with the Commission under the Exchange Act was recorded, processed, summarized, and reported on a timely basis.
 
Management’s Report on Internal Control Over Financial Reporting
 
Management is responsible for establishing and maintaining effective internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. As of December 31, 2019, an evaluation was performed under the supervision and with the participation of management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s internal control over financial reporting. Management assessed the Company’s system of internal control over financial reporting as of December 31, 2019, in relation to criteria for effective internal control over financial reporting as described in “Internal Control – Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2019, its system of internal control over financial reporting met those criteria and is effective.
 
This report includes an audit report of the Company’s independent registered public accounting firm regarding the Company’s internal control over financial reporting. The audit report is contained in the 2019 Annual Report, filed as Exhibit 13 to this report.
 
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 December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
Item 9B.  Other Information
 
None
 
PART III.
 
Item 10.  Directors, Executive Officers and Corporate Governance
 
The following is incorporated by reference to the Company's Proxy Statement for the 2020 Annual Meeting.
 
Listing of the names, ages, principal occupations, business experience and specific qualifications of the incumbent directors and nominees under the caption "PROPOSAL I - ELECTION OF DIRECTORS."
Listing of the names, ages, titles and business experience of the executive officers under the caption “INFORMATION ABOUT OUR EXECUTIVE OFFICERS."
Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 under the caption "SHARE OWNERSHIP INFORMATION –Delinquent Section 16 Filings."
Information regarding changes in the Company’s procedures for submission of director nominations by shareholders under the caption “SHAREHOLDER NOMINATIONS AND OTHER PROPOSALS.”
Information regarding whether a member of the Audit Committee qualifies as an audit committee financial expert under applicable SEC rules, under the caption "CORPORATE GOVERNANCE - Board Committees."
 
The Code of Ethics for Senior Financial Officers and the Principal Executive Officer is available on the Company's website at www.communitybancorpvt.com. The Code is also listed as Exhibit 14 to this report and incorporated by reference to a prior filing with the SEC. There were no waivers of any provision of the Code during 2019.
 
 
 
 
24
 
 
Item 11.  Executive Compensation
 
The following is incorporated by reference to the Company's Proxy Statement for the 2020 Annual Meeting:
 
Information regarding compensation of directors under the captions "PROPOSAL I - ELECTION OF DIRECTORS - Directors' Fees and Other Compensation" and "-Directors' Deferred Compensation Plan."
Information regarding executive compensation and benefit plans under the caption "EXECUTIVE COMPENSATION."
 
The information required under paragraphs (3)(4) and (e)(5) of Item 407 of Regulation S-K is omitted in accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 and 34-83550.
 
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
The following is incorporated by reference to the Company's Proxy Statement for the 2020 Annual Meeting:
 
Information regarding the share ownership of management and principal shareholders under the caption "SHARE OWNERSHIP INFORMATION."
 
The Company does not maintain any equity compensation plans for which disclosure is required under Item 201(d) of SEC Regulation S-K.
 
Item 13.  Certain Relationships and Related Transactions, and Director Independence
 
The following is incorporated by reference to the Company's Proxy Statement for the 2020 Annual Meeting:
 
Information regarding transactions with management under the caption "CORPORATE GOVERNANCE -Transactions with Management."
Information regarding the independence of directors under the caption “CORPORATE GOVERNANCE – Director Independence.”
 
Item 14.  Principal Accounting Fees and Services
 
The following is incorporated by reference to the Company's Proxy Statement for the 2020 Annual Meeting under the caption "PROPOSAL 2 - RATIFICATION OF SELECTION OF INDEPENDENT AUDITORS - Fees Paid to Independent Auditors":
 
Fees paid to the principal accountant for various audit functions including, but not limited to, the audit of the annual financial statements in the Company's Form 10-K Report and review of the financial statements in the Company's Form 10-Q Reports.
Description of the audit committee's pre-approval policies and procedures required by paragraph (c) (7)(I) of rule 2-01of Regulation S-X.
 
PART IV.
 
Item 15.  Exhibits and Financial Statement Schedules
 
(a)  Financial Statements
 
The following are included in this report and are incorporated by reference to the 2019 Annual Report, filed as Exhibit 13 to this report:
 
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Income for the years ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income for the years ended December 31, 2019 and 2018
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2019 and 2018
Consolidated Statements of Cash Flows for the years ended December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Report of Berry Dunn McNeil & Parker, LLC, independent registered public accountants
 
25
 
 
(b)  Exhibits
 
The following exhibits, previously filed with the Commission, are incorporated by reference:
 
Exhibit 3(i) - Amended and Restated Articles of Association, filed as Exhibit 3.1 to the Company's Form 10-Q Report filed on August 12, 2014.
Exhibit 3(ii) – Certificate of Creation, Designation, Powers, Preferences, Rights, Privileges, Qualifications, Limitations, Restrictions, Terms and Conditions of the Series A Fixed-to-Floating Non-Cumulative Perpetual Preferred Stock, filed as Exhibit 3(i) to the Company’s Form 8-K Report filed on December 31, 2007.
Exhibit 3(iii) - Amended and Restated By-laws of Community Bancorp. as amended and restated through March 12, 2013, filed as Exhibit 3.1 in the Company’s Form 8-K Report filed on March 14, 2013.
Exhibit 4(i) – Indenture dated as of October 31, 2007 between Community Bancorp., as issuer and Wilmington Trust Company, as indenture trustee, filed as Exhibit 4.1 to the Company’s Form 8-K Report filed on November 2, 2007.
Exhibit 4(ii) – Amended and Restated Declaration of Trust dated as of October 31, 2007 among Community Bancorp., as sponsor, Wilmington Trust Company, as Delaware and institutional Trustee, and the administrators named therein, filed as Exhibit 4.2 to the Company’s Form 8-K Report filed on November 2, 2007.
Exhibit 10(i) – Guarantee Agreement dated as of October 31, 2007 between Community Bancorp., as guarantor and Wilmington Trust Company, as guarantee trustee, filed as Exhibit 10.1 to the Company’s Form 8-K Report filed on November 2, 2007.
Exhibit 10(ii)* - Amended and Restated Deferred Compensation Plan for Directors, filed as Exhibit 10.2 to the Company’s Form 8-K Report filed on December 15, 2008.
Exhibit 10(iii)* - Amended and Restated Supplemental Retirement Plan, filed as Exhibit 10.1 to the Company’s Form 8-K Report filed on December 15, 2008.
Exhibit 10(iv)* - Amended and Restated Officer Incentive Plan, filed as Exhibit 10.1 to the Company’s Form 8-K Report filed on March 13, 2015.
Exhibit 10(v)* - Description of the Directors Retirement Plan, filed as Exhibit 10(iv) to the Company's Form 10-K Report filed on March 30, 2005; plan terminated in 2005 with respect to future accruals, as disclosed in the Company's Form 8-K Report filed on December 19, 2005.
Exhibit 10(vi)* - Change in Control Agreement for Executive Vice President (Company), Chief Operating Officer (Bank), filed as Exhibit 10.1 to the Company’s Form 8-K Report filed on June 23, 2015.
Exhibit 10(vii)* - Change in Control Agreement for Treasurer (Company), Senior Vice President and Chief Financial Officer (Bank), filed as Exhibit 10.2 to the Company’s Form 8-K Report filed on June 23, 2015.
Exhibit 10(viii) * - Change in Control Agreement for Vice President (Company), Senior Vice President and Chief Credit Officer (Bank), filed as Exhibit 10.3 to the Company’s Form 8-K Report filed on June 23, 2015.
Exhibit 14 – Amended Code of Ethics for Senior Financial Officers and the Principal Executive Officer, filed as Exhibit 14 to the Company’s Form 8-K Report on July 12, 2010.
 
The following exhibits are filed as part of this report:
Exhibit 4(iii) – Description of Common Stock.
Exhibit 13 - Portions of the 2019 Annual Report, specifically incorporated by reference into this report.
Exhibit 21 - Subsidiaries of Community Bancorp.
Exhibit 23 - Consent of Berry Dunn McNeil & Parker, LLC
Exhibit 31(i) - 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(ii) - Certification from the Treasurer (Principal Financial Officer) of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32(i) - Certification from the Chief Executive Officer (Principal Executive Officer) of the Company pursuant to section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32(ii) - Certification from the Treasurer (Principal Financial Officer) of the Company pursuant to section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 101--The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 formatted in eXtensible Business Reporting Language (XBRL): (i) the audited consolidated balance sheets, (ii) the audited consolidated statements of income, (iii) the audited consolidated statements of comprehensive income; (iv) the audited consolidated statements of changes in shareholders’ equity, (v) the audited consolidated statements of cash flows and (vi) related notes, for the years ended December 31, 2019 and 2018.
 
 
*   Denotes compensatory plan or arrangement.
 
 
 
26
 
 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) 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.
/s/Kathryn M. Austin
 
Date: March 16, 2020
 
   Kathryn M. Austin, President and Chief
 
 
 
   Executive Officer (Principal Executive Officer)
 
 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
/s/Kathryn M. Austin
 
Date: March 16, 2020
   Kathryn M. Austin, President and Chief
 
 
   Executive Officer (Principal Executive Officer)
 
 
 
 
 
/s/Louise M. Bonvechio
 
Date: March 16, 2020
   Louise M. Bonvechio, Corporate Secretary and
 
 
   Treasurer (Principal Financial Officer)
 
 
 
 
 
/s/Candace A. Patenaude
 
Date: March 16, 2020
   Candace A. Patenaude
 
 
   (Principal Accounting Officer)
 
 
 
 
 
COMMUNITY BANCORP. DIRECTORS
/s/Thomas E. Adams
 
Date: March 16, 2020
Thomas E. Adams
 
 
 
 
 
/s/Kathryn M. Austin
 
Date: March 16, 2020
Kathryn M. Austin
 
 
 
 
 
/s/David M. Bouffard
 
Date: March 16, 2020
David M. Bouffard
 
 
 
 
 
/s/Aminta K. Conant
 
Date: March 16, 2020
Aminta K. Conant
 
 
 
 
 
/s/Jacques R. Couture
 
Date: March 16, 2020
Jacques R. Couture
 
 
 
 
 
/s/David P. Laforce
 
Date: March 16, 2020
David P. Laforce
 
 
 
 
 
/s/Rosemary M. Lalime
 
Date: March 16, 2020
Rosemary M. Lalime
 
 
 
 
 
/s/Stephen P. Marsh
 
Date: March 16, 2020
Stephen P. Marsh, Board Chair
 
 
 
 
 
/s/Emma Marvin
 
Date: March 16, 2020
Emma Marvin
 
 
 
 
 
/s/Jeffrey L. Moore
 
Date: March 16, 2020
Jeffrey L. Moore
 
 
 
 
 
/s/Dorothy R. Mitchell
 
Date: March 16, 2020
Dorothy R. Mitchell
 
 
 
 
 
/s/Frederic Oeschger
 
Date: March 16, 2020
Fredric Oeschger
 
 
 
 
 
/s/James G. Wheeler, Jr.
 
Date: March 16, 2020
James G. Wheeler, Jr.
 
 
 
 
27
 
 
SECURITIES AND EXCHANGE COMMISSION
 
Washington, DC 20549
 
FORM 10-K
 
[ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2019
 
COMMUNITY BANCORP.
 
EXHIBITS
 
EXHIBIT INDEX*
 
 
Description of Common Stock.
 
 
Portions of the 2019 Annual Report, specifically incorporated by reference into this report.
 
 
Subsidiaries of Community Bancorp.
 
 
Consent of Berry Dunn McNeil & Parker, LLC
 
 
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 Annual Report on Form 10-K for the year ended December 31, 2019 formatted in eXtensible Business Reporting Language (XBRL): (i) the audited consolidated balance sheets, (ii) the audited consolidated statements of income, (iii) the audited consolidated statements of comprehensive income; (iv) the audited consolidated statements of changes in shareholders’ equity, (v) the audited consolidated statements of cash flows and (vi) related notes, for the years ended December 31, 2019 and 2018.
 
* Other than exhibits incorporated by reference to prior filings.
 
** This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
 
 
28
 
EXHIBIT 4(iii)
 
DESCRIPTION OF COMMUNITY BANCORP. COMMON STOCK
 
The following briefly summarizes certain provisions of our Amended and Restated Articles of Association (“Articles”), our Amended and Restated Bylaws (“Bylaws”) and the Vermont Business Corporation Act, codified in Title 11A of the Vermont Statutes Annotated (the “VBCA”) that holders of our common stock may deem important. The description below is qualified in its entirety by reference to the terms and provisions of our Articles and Bylaws, which have been filed previously with the Commission and are listed as Exhibits 3(i) and 3(iii), respectively, to our Annual Report on Form 10-K.
 
Authorized Common Stock; General Information
Under our Articles, we are authorized to issue up to 15,000,000 shares of common stock having a par value of $2.50 per share. The common stock is the only class of the Company’s securities that is registered under Section 12 of the Securities Exchange Act of 1934, as amended.
 
Our common stock is non-assessable and holders of the stock do not have any cumulative voting, conversion, redemption, preemptive or special liquidation rights.
 
Authorized Preferred Stock; Effect of Preferred Stock on Rights of Common Shareholders
In addition to our common stock, our Articles also authorize the issuance of up to 1,000,000 shares of preferred stock, without par value. The preferred shares are issuable in one or more series, having such rights and preferences as the Board of Directors may determine prior to issuance. Pursuant to that authority, in 2007 the Company issued 25 shares of Series A Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock having a liquidation preference of $100,000 per share (the “Series A Shares”). The text of the Series A Shares Designation is set forth as Exhibit A to the Company’s Articles. As of the date of this Annual Report, 15 shares of preferred stock remained outstanding.
 
In some circumstances the rights of the holders of our Series A Shares may affect the holders of our common stock. For example, we would not be permitted to pay dividends on our common stock at any time there were an arrearage on dividend payments to the holders of the Series A Shares. Similarly, upon any voluntary or involuntary dissolution, liquidation or winding up of the Company, the holders of our Series A Shares would be entitled to receive their liquidation preference ($100,000 per share) out of any assets available for distribution to the shareholders, before any assets may be distributed to the holders of our common stock. In addition, certain corporate actions would require the unanimous affirmative vote of the holders of the Series A Shares voting as a separate class, even if the matter were approved by the Board of Directors or the holders of the common stock. In particular, the unanimous consent of the holders of our Series A Shares is required to approve any of the following: (1) the issuance of additional Series A Shares; (2) the creation of any class or series of preferred shares having parity with, or preference over, the Series A Shares in payment of dividends or liquidation preference; or (3) amendment of the Company’s Articles of Association in any manner that would materially and adversely affect the rights or preferences of the Series A Shares. Except for these matters, the holders of the Series A Shares do not have voting rights.
 
Because our Articles authorize 1,000,000 shares of preferred stock, the Board of Directors has the authority to create additional series of preferred shares out of the remaining authorized and unissued shares of preferred stock, including preferred shares that might have similar or greater preferences over the common shares. Any such preferred stock issuances would not require the vote or consent of the common shareholders.
 
Dividends
After payment of all accrued dividends on any outstanding preferred shares having a dividend preference over the common shares, holders of our common stock are entitled to participate equally in dividends when and if the Board of Directors declares dividends on shares of common stock out of funds legally available for shareholder distribution, and are entitled to participate equally with other common shareholders in any stock dividends. The availability of funds for the Company to pay dividends depends largely on the availability of funds for our subsidiary Bank to pay dividends to the Company. In some circumstances, applicable banking laws could limit those available funds. In addition, payment of dividends by the Company might require approval of the Federal Reserve in some circumstances, such as if regulatory capital levels are deemed insufficient or if dividends exceed net income for the previous four quarters, net of dividend paid during such quarters.
 
1
 
 
As described above, the Series A Shares have a dividend preference over the common shares. (See “Authorized Preferred Stock; Effect of Preferred Stock on Rights of Common Shareholders”)
 
Voting Rights
Holders of our common stock are entitled to one vote for each share held of record on all matters voted on by the common shareholders, including the election of directors. A quorum for the conduct of business is a majority of the shares of common stock entitled to vote on the matter, represented in person or by proxy at the meeting.
 
Generally, a matter submitted to vote of our common shareholders is approved if more votes are cast in favor of the matter than against it, at a meeting at which a quorum is present. In some cases, such as mergers and certain amendments to the Company’s Articles, the VBCA or our Articles or Bylaws may impose a higher vote requirement.
 
Under the VBCA, election of directors is by a plurality of the votes cast, unless the articles of incorporation provide for a higher vote. Our Articles and Bylaws do so, as they require that director nominees receive at least a majority of the votes cast at a meeting of shareholders at which a quorum is present.
 
As described above, in some circumstances the unanimous affirmative vote of the holders of the Series A Shares would be required to approve certain matters, even if approved by the Board of Directors or the common shareholders. (See “Authorized Preferred Stock; Effect of Preferred Stock on Rights of Common Shareholders” above.)
 
Limitation of Director Liability
As permitted by the VBCA, Article Ten of the Company's Articles provides that a director will not have any personal liability to the Company or its shareholders for money damages for any act or omission based on a failure to discharge his or her statutory duties as a director, except for liability relating to (i) any improper financial gain to which the director was not entitled; (ii) an intentional reckless infliction of harm on the Company or its shareholders; (iii) authorization of unlawful distributions; or (iv) an intentional or reckless criminal act. Any future amendment or repeal of the liability limiting provision would apply prospectively only and not to any act or omission occurring before the effective date of such amendment or repeal.
 
Liquidation Rights
In the event of the Company’s liquidation, dissolution or winding-up, holders of our common stock would have the right to a ratable portion of assets remaining after payment of the Company’s creditors and satisfaction in full of the prior claims of any preferred shareholders (including the holders of the Series A Shares).
 
As described above, the Series A Shares have a liquidation preference over the common shares. (See “Authorized Preferred Stock; Effect of Preferred Stock.”)
 
Advance Notice By-Law
Section 2.13 of our Bylaws requires that shareholders provide advance notice to the Company if they intend to submit director nominations or other matters for vote at a meeting of shareholders. Specified information about the nominee or proposal must generally be furnished to the Company no earlier than 180 days nor later than 120 days prior to the date of the annual meeting. Special rules apply for the deadline if the annual meeting is to be held on a date other than the third Tuesday in May, and for special meetings of shareholders. These notice requirements apply whether or not a shareholder seeks to include his or her proposal in the Company’s proxy materials for the meeting under applicable rules of the Securities and Exchange Commission.
 
2
 
 
Certain Provisions That May Have an Anti-Takeover Effect
As discussed below, our Articles and Bylaws contain certain provisions that may deter attempts to takeover the Company.
 
Board of Directors Classification; High Vote for Removal. We have a staggered, or classified, Board of Directors. Our Board of Directors is divided into three classes with the members of each class serving a three-year term. The members of only one class of directors are elected each year by the common shareholders at our annual meeting of shareholders. It would therefore take at least two years to elect (or replace) a majority of our directors. In addition, our Articles and Bylaws provide that directors may be removed from office only for cause and by the affirmative vote of the holders of at least 75% of the outstanding shares of capital stock entitled to vote in an election of directors (that is, the common stock).
 
High Vote for Certain Amendments to our Articles and Bylaws. In order to amend our Articles, Vermont law requires that our Board of Directors adopt a resolution setting forth the amendment, declare the advisability of the amendment and call a shareholders' meeting to adopt the amendment. Generally, under the VBCA, approval of amendments to our Articles requires that the affirmative votes of the common shareholders outnumber the negative votes, or in some cases requires the affirmative vote of a majority of our outstanding common stock. Approval of amendments to our Bylaws may be by vote of the directors or the common shareholders. As described in the next paragraph, however, certain amendments to our Articles and Bylaws may require a supermajority shareholder vote.
 
The vote of the holders of at least 75% of outstanding shares of our capital stock entitled to vote in an election of directors (that is, the holders of at least 75% of the common stock) is required to adopt any amendment to our Articles and Bylaws that relates to the size and classification of our Board of Directors, the vote required to elect our directors and the term of service and procedure for removal of our directors.
 
High Vote for Certain Business Combinations. Under our Articles, certain Business Combinations (as defined) involving a Substantial Shareholder (as defined) must be approved by the holders of the Required Percentage (as defined) of the outstanding common shares. However, this special vote requirement will not apply, and the applicable vote requirements otherwise provided under the VCBA will instead apply, to any Business Combination involving a Substantial Shareholder if either (1) the Business Combination is approved by at least two-thirds of the Disinterested Directors (as defined), or (2) the per share consideration to be received by the common shareholders in the Business Combination is at least equal to the highest price paid by the Substantial Shareholder in acquiring any shares of the Company’s common stock prior to the Business Combination transaction.
 
For purposes of this provision,
 
●
“Business Combination” includes any merger, plan of share exchange or consolidation between the Company or its subsidiary Bank and any Substantial Shareholder or any entity controlled by or under common control with such shareholder; any sale, lease or other of transfer of assets between the Company or the Bank and any Substantial Shareholder or any entity controlled by or under common control with such shareholder; any reclassification of the Company’s securities that would have the effect of increasing the proportionate voting power of a Substantial Shareholder; and any other transaction involving a Substantial Shareholder having the intent or effect to effect a change in control of the Company.
 
●
“Substantial Shareholder” means an individual or entity that, together with its affiliates and associates, is the beneficial owner of 5% or more of the Company’s outstanding common stock.
 
●
“Required Percentage” means at least 53.4% of the outstanding common stock, which is the same percentage as the vote of the common shareholders that approved including the Business Combination provisions in the Articles at the Company’s 2010 annual meeting of shareholders.
 
●
“Disinterested Director” means (i) a director of the Company who was serving as a director immediately prior to the time the Substantial Shareholder became a Substantial Shareholder, and who is not otherwise affiliated with the Substantial Shareholder, and (2) any successor director who is recommended by at least a majority of the Disinterested Directors.
 
The foregoing provisions of the Company’s Articles governing Business Combinations involving a Substantial Shareholder may only be amended by the affirmative vote of the holders of at least the Required Percentage of the outstanding common shares.
 
3
 
 
Consideration of Other Constituencies.  Under the VBCA, a director must generally discharge his or her duties
 
● in good faith;
● with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
●in a manner he or she reasonably believes to be in the corporation's best interests.
 
In determining what is in a corporation's best interests, the VBCA permits directors of corporations, such as Community Bancorp., that have a class of voting stock registered under the Exchange Act, to consider other interests beyond those of the corporation's shareholders. In particular, directors may consider the interests of the corporation's employees, suppliers, creditors and customers; the economy of the state, region and nation; community and societal considerations, including those of any community in which any offices or facilities of the corporation are located; and any other factors the director in his or her discretion reasonably considers appropriate in determining what he or she reasonably believes to be in the best interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation. 
 
Potential Anti-takeover Effect of These Provisions. The provisions described above, as well as the Company’s advance notice bylaw and the ability of the Board of Directors to issue preferred shares, may discourage attempts by others to acquire control of the Company without negotiation with our Board of Directors. This enhances our Board’s ability to attempt to promote the interests of all of our shareholders. However, to the extent that these provisions make us a less attractive takeover candidate, they may not always be in our best interests or in the best interests of our shareholders and in some circumstances may prevent holders of our common stock from receiving a takeover premium.
 
None of the antitakeover provisions in the Company’s Articles or Bylaws was adopted in response to any specific effort by a third party to accumulate our stock or to obtain control of us by means of merger, tender offer, solicitation in opposition to management or otherwise.
 
Repurchase of Shares
Under the VBCA, we may repurchase shares of our capital stock, except if it would constitute an unlawful distribution to the selling shareholder. In general, distributions are permissible under the VBCA unless, after the distribution, we would be unable to pay our debts as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus the amount required to satisfy any preferential rights of shareholders upon dissolution or liquidation (such as the liquidation rights of the holders of the Series A Shares).
 
Because we are a registered bank holding company, repurchases of our shares in excess of certain volume limitations would be subject to prior approval by the Federal Reserve under the federal Bank Holding Company Act and to certain restrictions and limitations in some circumstances, such as if our regulatory capital levels were deemed insufficient.
 
4
 
 
 
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 
 
The Management of the Company is responsible for the preparation and fair presentation of the consolidated financial statements and other financial information contained in this Form 10-K. Management is also responsible for establishing and maintaining adequate internal control over financial reporting and for identifying the framework used to evaluate its effectiveness. Management has designed processes, internal control and a business culture that foster financial integrity and accurate reporting. The Company’s comprehensive system of internal control over financial reporting was designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of the consolidated financial statements of the Company in accordance with generally accepted accounting principles. The Company’s accounting policies and internal control over financial reporting, established and maintained by Management, are under the general oversight of the Company’s Board of Directors, including the Board of Directors’ Audit Committee.
 
Management has made a comprehensive review, evaluation, and assessment of the Company’s internal control over financial reporting as of December 31, 2019. The standard measures adopted by Management in making its evaluation are the measures in the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon its review and evaluation, Management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2019.
 
Berry Dunn McNeil & Parker, LLC, an independent registered public accounting firm, which has audited and reported on the consolidated financial statements contained in this Form 10-K, has issued its written audit report on the Company’s internal control over financial reporting which follows this report.
 
 
 
 
 
 
 
Ms. Kathryn M. Austin, President & Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
 
 
 
Ms. Louise M. Bonvechio, Corporate Secretary & Treasurer
 
(Principal Financial Officer)
 
 
 
 
1
 
 
 
 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 
 
Board of Directors and Shareholders
Community Bancorp. and Subsidiary
 
 
Opinions on the Financial Statements and Internal Control over Financial Reporting
 
We have audited the accompanying consolidated balance sheets of Community Bancorp. and Subsidiary (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for the years then ended, and the related notes (collectively referred to as the financial statements). We have also audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Community Bancorp. and Subsidiary as of December 31, 2019 and 2018, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by COSO.
 
Basis for Opinion
 
The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
 
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
 
2
 
 
 
Board of Directors and Shareholders
Community Bancorp. and Subsidiary
Page 2
 
Definition and Limitations of Internal Control Over Financial Reporting
 
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 
 
 
We have served as the Company's auditor since 2003.
 
 
Portland, Maine
March 16, 2020
Vermont Registration No. 92-0000278
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Maine ● New Hampshire ● Massachusetts ● Connecticut ● West Virginia ● Arizona
berrydunn.com
 
 
 
 
3
 
 
Community Bancorp. and Subsidiary
 December 31, 
 December 31, 
Consolidated Balance Sheets
 2019 
 2018 
Assets
   
   
  Cash and due from banks
 $10,263,535 
 $14,906,529 
  Federal funds sold and overnight deposits
  38,298,677 
  53,028,286 
     Total cash and cash equivalents
  48,562,212 
  67,934,815 
  Securities available-for-sale
  45,966,750 
  39,366,831 
  Restricted equity securities, at cost
  1,431,850 
  1,749,450 
  Loans
  606,988,937 
  578,450,517 
    Allowance for loan losses
  (5,926,491)
  (5,602,541)
    Deferred net loan costs
  362,415 
  363,614 
        Net loans
  601,424,861 
  573,211,590 
  Bank premises and equipment, net
  10,959,403 
  9,713,455 
  Accrued interest receivable
  2,336,553 
  2,300,841 
  Bank owned life insurance
  4,903,012 
  4,814,099 
  Goodwill
  11,574,269 
  11,574,269 
  Other real estate owned
  966,738 
  201,386 
  Other assets
  9,829,671 
  9,480,762 
        Total assets
 $737,955,319 
 $720,347,498 
 
    
    
Liabilities and Shareholders' Equity
    
    
 Liabilities
    
    
  Deposits:
    
    
    Demand, non-interest bearing
 $125,089,403 
 $122,430,805 
    Interest-bearing transaction accounts
  185,102,333 
  177,815,417 
    Money market funds
  91,463,661 
  85,261,685 
    Savings
  97,167,652 
  93,129,875 
    Time deposits, $250,000 and over
  14,565,559 
  14,395,291 
    Other time deposits
  101,632,760 
  115,783,492 
        Total deposits
  615,021,368 
  608,816,565 
  Borrowed funds
  2,650,000 
  1,550,000 
  Repurchase agreements
  33,189,848 
  30,521,565 
  Junior subordinated debentures
  12,887,000 
  12,887,000 
  Accrued interest and other liabilities
  5,312,424 
  3,968,657 
        Total liabilities
  669,060,640 
  657,743,787 
 
    
    
 Shareholders' Equity
    
    
  Preferred stock, 1,000,000 shares authorized, 15 and 20 shares issued and
    
    
    outstanding at December 31, 2019 and 2018, respectively
    
    
    ($100,000 liquidation value, per share)
  1,500,000 
  2,000,000 
  Common stock - $2.50 par value; 15,000,000 shares authorized, 5,449,857
    
    
    and 5,382,103 shares issued at December 31, 2019 and 2018, respectively
    
    
    (including 16,267 and 17,442 shares issued February 1, 2020 and 2019,
    
    
     respectively)
  13,624,643 
  13,455,258 
  Additional paid-in capital
  33,464,381 
  32,536,532 
  Retained earnings
  22,667,949 
  17,882,282 
  Accumulated other comprehensive income (loss)
  260,483 
  (647,584)
  Less: treasury stock, at cost; 210,101 shares at December 31, 2019 and 2018
  (2,622,777)
  (2,622,777)
        Total shareholders' equity
  68,894,679 
  62,603,711 
        Total liabilities and shareholders' equity
 $737,955,319 
 $720,347,498 
 
    
    
Book value per common share outstanding
 $12.86 
 $11.72 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4
 
 
Community Bancorp. and Subsidiary
 Years Ended December 31, 
Consolidated Statements of Income
 2019 
 2018 
 
   
   
 
   
   
Interest income
   
   
   Interest and fees on loans
 $29,883,352 
 $27,609,505 
   Interest on taxable debt securities
  1,089,201 
  895,165 
   Dividends
  100,609 
  125,973 
   Interest on federal funds sold and overnight deposits
  685,646 
  483,960 
        Total interest income
  31,758,808 
  29,114,603 
 
    
    
Interest expense
    
    
   Interest on deposits
  5,124,651 
  3,547,798 
   Interest on borrowed funds
  24,550 
  95,936 
   Interest on repurchase agreements
  299,347 
  190,993 
   Interest on junior subordinated debentures
  694,573 
  650,361 
        Total interest expense
  6,143,121 
  4,485,088 
 
    
    
     Net interest income
  25,615,687 
  24,629,515 
 Provision for loan losses
  1,066,167 
  780,000 
     Net interest income after provision for loan losses
  24,549,520 
  23,849,515 
 
    
    
Non-interest income
    
    
   Service fees
  3,313,833 
  3,238,954 
   Income from sold loans
  706,306 
  780,622 
   Other income from loans
  904,156 
  879,887 
   Net realized loss on sale of securities AFS
  (26,490)
  (32,718)
   Other income
  1,048,261 
  1,314,563 
        Total non-interest income
  5,946,066 
  6,181,308 
 
    
    
Non-interest expense
    
    
   Salaries and wages
  7,271,722 
  7,203,001 
   Employee benefits
  3,118,631 
  2,880,048 
   Occupancy expenses, net
  2,605,995 
  2,545,959 
   Other expenses
  6,884,932 
  7,266,018 
        Total non-interest expense
  19,881,280 
  19,895,026 
 
    
    
    Income before income taxes
  10,614,306 
  10,135,797 
 Income tax expense
  1,789,860 
  1,738,265 
        Net income
 $8,824,446 
 $8,397,532 
 
    
    
 Earnings per common share
 $1.68 
 $1.61 
 Weighted average number of common shares
    
    
  used in computing earnings per share
  5,204,768 
  5,139,297 
 Dividends declared per common share
 $0.76 
 $0.74 
 
 
  The accompanying notes are an integral part of these consolidated financial statements.
 
 
5
 
 
Community Bancorp. and Subsidiary
   
   
Consolidated Statements of Comprehensive Income
   
   
 
 Years Ended December 31, 
 
 2019 
 2018 
 
   
   
Net income
 $8,824,446 
 $8,397,532 
 
    
    
Other comprehensive income (loss), net of tax:
    
    
  Unrealized holding gain (loss) on securities AFS arising during the period
  1,122,961 
  (505,487)
  Reclassification adjustment for loss realized in income
  26,490 
  32,718 
     Unrealized gain (loss) during the period
  1,149,451 
  (472,769)
  Tax effect
  (241,384)
  99,282 
  Other comprehensive income (loss), net of tax
  908,067 
  (373,487)
          Total comprehensive income
 $9,732,513 
 $8,024,045 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6
 
 
Community Bancorp. and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 2019 and 2018
 
 
 Common stock 
 Preferred stock 
 
 Shares 
 Amount 
 Shares 
 Amount 
 
   
   
   
   
Balances, December 31, 2017
  5,322,320 
 $13,305,800 
  25 
 $2,500,000 
 
    
    
    
    
Comprehensive income
    
    
    
    
Net income
  0 
  0 
  0 
  0 
Other comprehensive loss
  0 
  0 
  0 
  0 
 
    
    
    
    
Total comprehensive income
    
    
    
    
 
    
    
    
    
Cash dividends declared - common stock
  0 
  0 
  0 
  0 
Cash dividends declared - preferred stock
  0 
  0 
  0 
  0 
Issuance of common stock
  59,783 
  149,458 
  0 
  0 
 
    
    
    
    
Redemption of preferred stock
  0 
  0 
  (5)
  (500,000)
 
    
    
    
    
Balances, December 31, 2018
  5,382,103 
  13,455,258 
  20 
  2,000,000 
 
    
    
    
    
Comprehensive income
    
    
    
    
Net income
  0 
  0 
  0 
  0 
Other comprehensive income
  0 
  0 
  0 
  0 
 
    
    
    
    
Total comprehensive income
    
    
    
    
 
    
    
    
    
Cash dividends declared - common stock
  0 
  0 
  0 
  0 
Cash dividends declared - preferred stock
  0 
  0 
  0 
  0 
Issuance of common stock
  67,754 
  169,385 
  0 
  0 
 
    
    
    
    
Redemption of preferred stock
  0 
  0 
  (5)
  (500,000)
 
    
    
    
    
Balances, December 31, 2019
  5,449,857 
 $13,624,643 
  15 
 $1,500,000 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
7
 
 
 
 
 
 
 
 
Accumulated
 
 
Additional
 
other
 
Total
paid-in
Retained
comprehensive
Treasury
shareholders'
capital
earnings
(loss) income
stock
equity
 
 
 
 
 
$31,639,189
$13,387,739
($274,097)
($2,622,777)
$57,935,854
 
 
 
 
 
 
 
 
 
 
0
8,397,532
0
0
8,397,532
0
0
(373,487)
0
(373,487)
 
 
 
 
 
 
 
 
 
8,024,045
 
 
 
 
 
0
(3,799,864)
0
0
(3,799,864)
0
(103,125)
0
0
(103,125)
897,343
0
0
0
1,046,801
 
 
 
 
 
0
0
0
0
(500,000)
 
 
 
 
 
32,536,532
17,882,282
(647,584)
(2,622,777)
62,603,711
 
 
 
 
 
 
 
 
 
 
0
8,824,446
0
0
8,824,446
0
0
908,067
0
908,067
 
 
 
 
 
 
 
 
 
9,732,513
 
 
 
 
 
0
(3,951,279)
0
0
(3,951,279)
0
(87,500)
0
0
(87,500)
927,849
0
0
0
1,097,234
 
 
 
 
 
0
0
0
0
(500,000)
 
 
 
 
 
$33,464,381
$22,667,949
$260,483
($2,622,777)
$68,894,679
 
 
 
8
 
 
 
Community Bancorp. and Subsidiary
   
   
Consolidated Statements of Cash Flows
   
   
 
 Years Ended December 31, 
 
 2019 
 2018 
 
   
   
Cash Flows from Operating Activities:
   
   
  Net income
 $8,824,446 
 $8,397,532 
  Adjustments to reconcile net income to net cash provided by
    
    
   operating activities:
    
    
    Depreciation and amortization, bank premises and equipment
  930,035 
  981,691 
    Provision for loan losses
  1,066,167 
  780,000 
    Deferred income tax
  96,236 
  (11,359)
    Net realized loss on sale of securities AFS
  26,490 
  32,718 
    Gain on sale of loans
  (290,116)
  (345,780)
    Loss (gain) on sale of bank premises and equipment
  30,797 
  (260,013)
    Loss on sale of OREO
  817 
  2,397 
    Income from CFS Partners
  (588,696)
  (514,485)
    Amortization of bond premium, net
  120,295 
  128,469 
    Write down of OREO
  95,008 
  78,447 
    Proceeds from sales of loans held for sale
  14,098,560 
  14,793,920 
    Originations of loans held for sale
  (13,808,444)
  (13,410,853)
    Increase (decrease) in taxes payable
  522 
  (23,758)
    Increase in interest receivable
  (35,712)
  (248,923)
    Decrease in mortgage servicing rights
  65,371 
  78,338 
    Decrease in right-of-use assets
  236,395 
  0 
    Decrease in operating lease liabilities
  (227,606)
  0 
    Decrease (increase) in other assets
  335,167 
  (790,320)
    Increase in cash surrender value of BOLI
  (88,913)
  (92,317)
    Amortization of limited partnerships
  312,106 
  411,061 
    Decrease (increase) in unamortized loan costs
  1,199 
  (44,963)
    Increase in interest payable
  26,204 
  12,524 
    Increase in accrued expenses
  66,100 
  149,648 
    (Decrease) increase in other liabilities
  (45,772)
  62,805 
       Net cash provided by operating activities
  11,246,656 
  10,166,779 
 
    
    
Cash Flows from Investing Activities:
    
    
  Investments - AFS
    
    
    Maturities, calls, pay downs and sales
  19,998,076 
  8,543,078 
    Purchases
  (25,595,329)
  (10,093,214)
  Proceeds from redemption of restricted equity securities
  493,600 
  1,147,500 
  Purchases of restricted equity securities
  (176,000)
  (1,193,300)
  Increase in limited partnership contributions payable
  184,000 
  388,750 
  Investments in limited liability entities
  (811,000)
  (877,000)
  Increase in loans, net
  (30,365,217)
  (27,835,972)
  Capital expenditures net of proceeds from sales of bank
    
    
   premises and equipment
  (952,396)
  (90,957)
  Proceeds from sales of OREO
  105,561 
  335,056 
  Recoveries of loans charged off
  117,842 
  126,462 
       Net cash used in investing activities
  (37,000,863)
  (29,549,597)
 
 
 
9
 
 
 
 
 2019 
 2018 
 
   
   
Cash Flows from Financing Activities:
   
   
  Net increase in demand and interest-bearing transaction accounts
  9,945,514 
  50,367,124 
  Net increase (decrease) in money market and savings accounts
  10,239,753 
  (12,516,729)
  Net (decrease) increase in time deposits
  (13,980,464)
  10,331,190 
  Net increase in repurchase agreements
  2,668,283 
  1,873,717 
  Proceeds from long-term borrowings
  1,100,000 
  0 
  Repayments on long-term borrowings
  0 
  (2,000,000)
  Decrease in finance lease obligations
  (166,924)
  (115,060)
  Redemption of preferred stock
  (500,000)
  (500,000)
  Dividends paid on preferred stock
  (87,500)
  (103,125)
  Dividends paid on common stock
  (2,837,058)
  (2,672,985)
       Net cash provided by financing activities
  6,381,604 
  44,664,132 
 
    
    
       Net (decrease) increase in cash and cash equivalents
  (19,372,603)
  25,281,314 
  Cash and cash equivalents:
    
    
          Beginning
  67,934,815 
  42,653,501 
          Ending
 $48,562,212 
 $67,934,815 
 
    
    
Supplemental Schedule of Cash Paid During the Period:
    
    
  Interest
 $6,116,917 
 $4,472,564 
 
    
    
  Income taxes, net of refunds
 $1,381,000 
 $1,365,000 
 
    
    
Supplemental Schedule of Noncash Investing and Financing Activities:
    
    
  Change in unrealized gain (loss) on securities AFS
 $1,149,451 
 $(472,769)
 
    
    
  Loans transferred to OREO
 $966,738 
 $333,051 
 
    
    
Common Shares Dividends Paid:
    
    
  Dividends declared
 $3,951,279 
 $3,799,864 
  Increase in dividends payable attributable to dividends declared
  (16,987)
  (80,078)
  Dividends reinvested
  (1,097,234)
  (1,046,801)
 
 $2,837,058 
 $2,672,985 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
10
 
 
COMMUNITY BANCORP. AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 1.  Significant Accounting Policies
 
The accounting policies of Community Bancorp. and Subsidiary (the Company) are in conformity, in all material respects, with U.S. generally accepted accounting principles (US GAAP) and general practices within the banking industry. The following is a description of the Company’s significant accounting policies.
 
Basis of presentation and consolidation
 
In addition to the definitions provided elsewhere in this Annual Report, the definitions, acronyms and abbreviations identified below are used throughout this Annual Report, including these “Notes to Consolidated Financial Statements” and the section labeled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” immediately following. These definitions are intended to aid the reader and provide a reference page when reviewing this Annual Report.
 
ABS and OAS:
Asset backed or other amortizing security
FHA:
Federal Housing Administration
ACBB:
Atlantic Community Bankers Bank
FHLBB:
Federal Home Loan Bank of Boston
ACBI:
Atlantic Community Bancshares, Inc.
FHLMC :
Federal Home Loan Mortgage Corporation
ACH:
Automated Clearing House
FICO:
Financing Corporation
AFS:
Available-for-sale
FLA:
First Loss Account
Agency MBS:
MBS issued by a US government agency
FOMC:
Federal Open Market Committee
 
or GSE
FRB:
Federal Reserve Board
ALCO:
Asset Liability Committee
FRBB:
Federal Reserve Bank of Boston
ALL:
Allowance for loan losses
GAAP:
Generally Accepted Accounting Principles
AML:
Anti-money laundering laws
 
in the United States
AOCI:
Accumulated other comprehensive income
GSE:
Government sponsored enterprise
ASC:
Accounting Standards Codification
HMDA:
Home Mortgage Disclosure Act
ASU:
Accounting Standards Update
HTM:
Held-to-maturity
ATMs:
Automatic teller machines
ICS:
Insured Cash Sweeps of the Promontory
Bancorp:
Community Bancorp.
 
Interfinancial Network
Bank:
Community National Bank
IRS:
Internal Revenue Service
BHG
Bankers Healthcare Group
JNE:
Jobs for New England
BIC:
Borrower-in-Custody
Jr:
Junior
Board:
Board of Directors
LIBOR:
London Interbank Offered Rate
BOLI:
Bank owned life insurance
LLC:
Limited liability corporation
bp or bps:
Basis point(s)
MBS:
Mortgage-backed security
BSA:
Bank Secrecy Act
MPF:
Mortgage Partnership Finance
CBLR:
Community Bank Leverage Ratio
MSAs
Metropolitan Statistical Areas
CDARS:
Certificate of Deposit Accounts Registry
MSRs:
Mortgage servicing rights
 
Service of the Promontory Interfinancial
NII:
Net interest income
 
Network
NMTC:
New Market Tax Credits
CDs:
Certificates of deposit
OCI:
Other comprehensive income (loss)
CDI:
Core deposit intangible
OFAC:
Office of Foreign Asset Control
CECL:
Current Expected Credit Loss
OREO:
Other real estate owned
CEO:
Credit Enhancement Obligation
OTTI:
Other-than-temporary impairment
CFPB:
Consumer Financial Protection Bureau
PMI:
Private mortgage insurance
CFSG:
Community Financial Services Group, LLC
QM(s):
Qualified Mortgage(s)
CFS Partners:
Community Financial Services Partners,
RD:
USDA Rural Development
 
LLC
RESPA:
Real Estate Settlement Procedures Act
Company:
Community Bancorp. and Subsidiary
SBA:
U.S. Small Business Administration
CRA:
Community Reinvestment Act
SEC:
U.S. Securities and Exchange Commission
CRE:
Commercial Real Estate
SERP:
Supplemental Employee Retirement Plan
DDA or DDAs:
Demand Deposit Account(s)
SOX:
Sarbanes-Oxley Act of 2002
DIF:
Deposit Insurance Fund
TDR:
Troubled-debt restructuring
DTC:
Depository Trust Company
TILA:
Truth in Lending Act
DRIP:
Dividend Reinvestment Plan
USDA:
U.S. Department of Agriculture
Exchange Act:
Securities Exchange Act of 1934
VA:
U.S. Veterans Administration
FASB:
Financial Accounting Standards Board
VIE:
Variable interest entities
FDIA:
Federal Deposit Insurance Act
2017 Tax Act:
Tax Cut and Jobs Act of 2017
FDIC:
Federal Deposit Insurance Corporation
2018
Economic Growth, Regulatory Relief and
FDICIA:
Federal Deposit Insurance Company
Regulatory
Consumer Protection Act of 2018
 
Improvement Act of 1991
Relief Act:
 
 
 
 
11
 
 
The consolidated financial statements include the accounts of the Bancorp. and its wholly-owned subsidiary, the Bank. All significant intercompany accounts and transactions have been eliminated. The Company is considered a “smaller reporting company” under the disclosure rules of the SEC, as amended in 2018. Accordingly, the Company has elected to provide its audited consolidated statements of income, comprehensive income, cash flows and changes in shareholders’ equity for a two year, rather than a three year, period, and intends to provide smaller reporting company scaled disclosures where management deems it appropriate. Beginning with its periodic reports filed in 2018, the Company is considered an accelerated filer under the financial reporting rules of the SEC.
 
FASB ASC Topic 810, “Consolidation”, in part, addresses limited purpose trusts formed to issue trust preferred securities. It also establishes the criteria used to identify VIE, and to determine whether or not to consolidate a VIE. In general, ASC Topic 810 provides that the enterprise with the controlling financial interest, known as the primary beneficiary, consolidates the VIE. In 2007, the Company formed CMTV Statutory Trust I for the purposes of issuing trust preferred securities to unaffiliated parties and investing the proceeds from the issuance thereof and the common securities of the trust in junior subordinated debentures issued by the Company. The Company is not the primary beneficiary of CMTV Statutory Trust I; accordingly, the trust is not consolidated with the Company for financial reporting purposes. CMTV Statutory Trust I is considered an affiliate of the Company (see Note 11).
 
During the years 2011 through 2018, the Company was the sole owner of a LLC formed to facilitate the Company’s purchase of federal NMTC under an investment structure designed by a local community development entity. The NMTC financing matured in the fourth quarter of 2018 and the Company exited the investment and terminated its interest in the LLC. Management evaluated the Company’s interest in the LLC under the ASC guidance relating to VIEs in light of the overall structure and purpose of the NMTC financing transaction and concluded that the LLC should not be consolidated in the Company’s financial statements for financial reporting purposes, as the Company was not the primary beneficiary of the NMTC structure, did not exercise control within the overall structure and was not obligated to absorb a majority of any losses of the NMTC structure (see Note 8).
 
Nature of operations
 
The Company provides a variety of deposit and lending services to individuals, municipalities, and business customers through its branches, ATMs and telephone, mobile and internet banking capabilities in northern and central Vermont, which is primarily a small business and agricultural area. The Company's primary deposit products are checking and savings accounts and certificates of deposit. Its primary lending products are commercial, real estate, municipal and consumer loans.
 
Concentration of risk
 
The Company's operations are affected by various risk factors, including interest rate risk, credit risk, and risk from geographic concentration of its deposit taking and lending activities. Management attempts to manage interest rate risk through various asset/liability management techniques designed to match maturities and repricing of assets and liabilities. Loan policies and administration are designed to provide assurance that loans will only be granted to creditworthy borrowers, although credit losses are expected to occur because of subjective factors inherent in management’s estimate of credit risk and factors beyond the control of the Company. While the Company has a diversified loan portfolio by loan type, most of its lending activities are conducted within the geographic area where its banking offices are located. As a result, the Company and its borrowers may be especially vulnerable to the consequences of changes in the local economy in northern and central Vermont. In addition, a substantial portion of the Company's loans are secured by real estate, which is susceptible to a decline in value, especially during times of adverse economic conditions.
 
Use of estimates
 
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions involve inherent uncertainties. Accordingly, actual results could differ from those estimates and those differences could be material.
 
Material estimates that are particularly susceptible to significant change relate to the determination of the ALL and the valuation of OREO. In connection with evaluating loans for impairment or assigning the carrying value of OREO, management generally obtains independent evaluations or appraisals for significant properties. While the ALL and the carrying value of OREO are determined using management's best estimate of probable loan and OREO losses, respectively, as of the balance sheet date, the ultimate collection of a substantial portion of the Company's loan portfolio and the recovery of a substantial portion of the fair value of OREO are susceptible to uncertainties and changes in a number of factors, especially local real estate market conditions. The amount of the change that is reasonably possible cannot be estimated.
 
 
12
 
 
While management uses available information to recognize losses on loans and OREO, future additions to the allowance or write-downs of OREO may be necessary based on changes in local economic conditions or other relevant factors. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for losses on loans and the carrying value of OREO. Such agencies may require the Company to recognize additions to the allowance or write-downs of OREO based on their judgment about information available to them at the time of their examination.
 
MSRs associated with loans originated and sold in the secondary market, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheets. MSRs are amortized against non-interest income in proportion to, and over the period of, estimated future net servicing income of the underlying loans. The value of capitalized servicing rights represents the present estimated value of the future servicing fees arising from the right to service loans for third parties. The carrying value of the MSRs is periodically reviewed for impairment based on management’s estimate of fair value as compared to amortized cost, and impairment, if any, is recognized through a valuation allowance and is recorded as a write down. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of estimates, including anticipated principal amortization and prepayments. Events that may significantly affect the estimates used are changes in interest rates and the payment performance of the underlying loans. Management uses a third party consultant to assist in estimating the fair value of the Company’s MSRs.
 
Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to various factors, including the length of time and the extent to which the fair value has been less than cost; the nature of the issuer and its financial condition and near-term prospects; and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The evaluation of these factors is a subjective process and involves estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
 
Accounting for a business combination that was completed prior to 2009 requires the application of the purchase method of accounting. Under the purchase method, the Company was required to record the assets and liabilities acquired through the LyndonBank merger in 2007 at fair market value, with the excess of the purchase price over the fair value of the net assets recorded as goodwill and evaluated annually for impairment. Management uses various assumptions in evaluating goodwill for impairment.
 
Management utilizes numerous techniques to estimate the carrying value of various other assets held by the Company, including, but not limited to, bank premises and equipment and deferred taxes. The assumptions considered in making these estimates are based on historical experience and on various other factors that are believed by management to be reasonable under the circumstances. Management acknowledges that the use of different estimates or assumptions could produce different estimates of carrying values.
 
Presentation of cash flows
 
For purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from banks (including cash items in process of clearing), federal funds sold (generally purchased and sold for one day periods) and overnight deposits.
 
Investment securities
 
Change in Accounting Principle
 
Prior to 2019, the entire balance of the Company’s HTM investment portfolio consisted of Municipal notes. Effective January 1, 2019, and in accordance with ASC 250 (Accounting Changes and Error Corrections), the Company chose to reclassify these debt instruments from the investment portfolio into the loan portfolio. This change represents a voluntary reclassification of municipal debt instruments from classification as investment securities under ASC 320 (Investments – Debt and Equity Securities) to classification as loans under ASC 310 (Receivables). All periods presented have been restated to conform to this change. Accordingly, for all periods presented below, the Company’s investment portfolio consists entirely of AFS investments and municipal debt obligations are reported as a component of the Company’s loan portfolio (See Note 3). The reclassification of the municipal debt instruments in this portfolio did not have a material impact on the Company’s consolidated financial statements or results of operations.
 
13
 
 
Debt securities the Company has purchased with the possible intent to sell before maturity are classified as AFS, and are carried at fair value, with unrealized gains and losses, net of tax and reclassification adjustments, reflected as a net amount in the shareholders’ equity section of the consolidated balance sheets and in the statements of changes in shareholders’ equity. Investment securities transactions are accounted for on a trade date basis. The specific identification method is used to determine realized gains and losses on sales of debt securities AFS and equity securities. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or call date. The Company does not hold any securities purchased for the purpose of selling in the near term and classified as trading. As a result of the reclassification noted in the first paragraph of this section, the Company does not hold any securities purchased with the positive intent and ability to hold to maturity and classified as HTM.
 
For individual debt securities that the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to (1) credit loss is recognized in earnings and (2) other factors is recognized in other comprehensive income or loss. Credit loss is deemed to exist if the present value of expected future cash flows using the interest rates at acquisition is less than the amortized cost basis of the debt security. For individual debt securities where the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the OTTI is recognized in earnings equal to the entire difference between the security’s cost basis and its fair value at the balance sheet date.
 
Other investments
 
In December 2011, the Company made an equity investment in a NMTC financing structure, which was fully amortized in 2017 (see Note 8). The Company’s investment in the NMTC financing structure was amortized using the effective yield method.
 
From time to time, the Company acquires partnership interests in limited partnerships for low income housing projects. New investments in limited partnerships are amortized using the proportional amortization method. All investments made before January 1, 2015 are amortized using the effective yield method.
 
The Company has a one-third ownership interest in CFS Partners, which in turn owns 100% of CFSG, a non-depository trust company (see Note 8). The Company's investment in CFS Partners is accounted for under the equity method of accounting.
 
Restricted equity securities
 
The Company holds certain restricted equity securities acquired for non-investment purposes, and required as a matter of law or as a condition to the receipt of certain financial products and services. These securities are carried at cost. As a member of the FRBB, the Company is required to invest in FRBB stock in an amount equal to 6% of the Bank's capital stock and surplus.
 
As a member of the FHLBB, the Company is required to invest in $100 par value stock of the FHLBB in an amount that approximates 1% of unpaid principal balances on qualifying loans, plus an additional amount to satisfy an activity based requirement. The stock is nonmarketable and redeemable at par value, subject to the FHLBB’s right to temporarily suspend such redemptions. Members are subject to capital calls in some circumstances to ensure compliance with the FHLBB’s capital plan.
 
In order to access correspondent banking services from the ACBB, the Company is required to invest in a minimum of 20 shares of the common stock of ACBB’s parent company, ACBI.
 
Loans held-for-sale
 
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
 
Loans
 
As disclosed earlier in Note 1 under the heading “Investment Securities”, effective January 1, 2019 and in accordance with ASC 250 (Accounting Changes and Error Corrections), the Company chose to reclassify its municipal debt instruments from the investment portfolio into the loan portfolio. This change represents a voluntary reclassification of municipal debt instruments by management from classification as investment securities under ASC 320 (Investments – Debt and Equity Securities) to classification as loans under ASC 310 (Receivables). As stated earlier in this section, the reclassification of this portfolio did not have a material impact on the Company’s consolidated financial statements or results of operations.
 
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance, adjusted for any charge-offs, the ALL, loan premiums or discounts for acquired loans and any unearned fees or costs on originated loans.
 
 
14
 
 
Loan interest income is accrued daily on the outstanding balances. 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 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 non-accrual loans are generally applied as a reduction of the loan principal balance. Loans are returned to accrual status when principal and interest payments are brought current and the customer has demonstrated the intent and ability to make future payments on a timely basis. Loans are written down or charged off when collection of principal is considered doubtful.
 
Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount is amortized as an adjustment of the related loan's yield. The Company generally amortizes these amounts over the contractual life of the loans.
 
Loan premiums and discounts on loans acquired in the merger with LyndonBank were amortized as an adjustment to yield on loans. At December 31, 2019, the remainder of these premiums and discounts were fully amortized.
 
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 that future payments of a loan balance are unlikely. 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.
 
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:
 
 
15
 
 
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.
 
Municipal – Loans in this segment are made to local municipalities, attributable to municipal financing transactions and backed by the full faith and credit of town governments or dedicated governmental revenue sources, with no historical losses recognized by the Company.
 
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.
 
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 TDRs 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.
 
 
 
16
 
 
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.
 
Bank premises and equipment
 
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over the estimated useful lives of the assets. The cost of assets sold or otherwise disposed of, and the related accumulated depreciation, are eliminated from the accounts and the resulting gains or losses are reflected in the consolidated statements of income. Maintenance and repairs are charged to current expense as incurred and the cost of major renewals and betterments is capitalized.
 
Other real estate owned
 
Real estate properties acquired through or in lieu of loan foreclosure or properties no longer used for bank operations are initially recorded at fair value less estimated selling cost at the date of acquisition, foreclosure or transfer. Fair value is determined, as appropriate, either by obtaining a current appraisal or evaluation prepared by an independent, qualified appraiser, by obtaining a broker’s market value analysis, and finally, if the Company has limited exposure and limited risk of loss, by the opinion of management as supported by an inspection of the property and its most recent tax valuation. During periods of declining market values, the Company will generally obtain a new appraisal or evaluation. Any write-down based on the asset's fair value at the date of acquisition or institution of foreclosure is charged to the ALL. After acquisition through or in lieu of foreclosure, these assets are carried at the lower of their new cost basis or fair value. Costs of significant property improvements are capitalized, whereas costs relating to holding the property are expensed as incurred. Appraisals by an independent, qualified appraiser are performed periodically on properties that management deems significant, or evaluations may be performed by management or a qualified third party on OREO properties in the portfolio that are deemed less significant or less vulnerable to market conditions. Subsequent write-downs are recorded as a charge to other expense. Gains or losses on the sale of such properties are included in income when the properties are sold.
 
Intangible assets
 
Intangible assets include the excess of the purchase price over the fair value of net assets acquired (goodwill) in the Company’s 2007 acquisition of LyndonBank. Goodwill is not amortizable and is reviewed for impairment annually, or more frequently as events or circumstances warrant.
 
Income taxes
 
The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting bases and the tax bases of the Company's assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. Adjustments to the Company's deferred tax assets are recognized as deferred income tax expense or benefit based on management's judgments relating to the outcome of such asset.
 
Mortgage servicing
 
Servicing assets are recognized as separate assets when rights are acquired through purchase or retained upon the sale of loans. Capitalized servicing rights are reported in other assets and initially recorded at fair value, and are amortized against non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing rights are periodically evaluated for impairment, based upon the estimated fair value of the rights as compared to amortized cost. Impairment is determined by stratifying the rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance and is recorded as amortization of other assets, to the extent that estimated fair value is less than the capitalized amount at the valuation date. Subsequent improvement, if any, in the estimated fair value of impaired MSRs is reflected in a positive valuation adjustment and is recognized in other income up to (but not in excess of) the amount of the prior impairment.
 
17
 
 
Pension costs
 
Pension costs are charged to salaries and employee benefits expense and accrued over the active service period.
 
Advertising costs
 
The Company expenses advertising costs as incurred.
 
Comprehensive income
 
US GAAP generally requires recognized revenue, expenses, gains and losses to be included in net income. Certain changes in assets and liabilities, such as the after-tax effect of unrealized gains and losses on available-for-sale securities, are not reflected in the consolidated statement of income, but the cumulative effect of such items from period-to-period is reflected as a separate component of the shareholders’ equity section of the consolidated balance sheet (accumulated other comprehensive income or loss). Other comprehensive income or loss, along with net income, comprises the Company's total comprehensive income.
 
Preferred stock
 
In December, 2007 the Company issued 25 shares of fixed-to-floating rate non-cumulative perpetual preferred stock, without par value and having a liquidation preference of $100,000 per share. There were 15 shares and 20 shares of preferred stock outstanding as of December 31, 2019 and 2018, respectively. Under the terms of the preferred stock, the Company pays non-cumulative cash dividends quarterly, when, as and if declared by the Board. Dividends are payable at a variable dividend rate equal to the Wall Street Journal Prime Rate in effect on the first business day of each quarterly dividend period. A variable rate of 4.50% was in effect for the first quarter of 2018, with increases during 2018 on a quarterly basis, to a rate of 5.25% for the fourth quarter of 2018. The variable rate increased to 5.50% for the dividend payments due in each of the first three quarters of 2019, followed by a decrease to a rate of 5.00% for the dividend payment in the fourth quarter of 2019. The rate that will be in effect for the first quarter of 2020 is 4.75%. The Company redeemed five shares of preferred stock on March 31, 2019 and 2018, at a redemption price of $500,000 for each such partial redemption, plus accrued dividends.
 
 
Earnings per common share
 
Earnings per common share amounts are computed based on net income, net of dividends to preferred shareholders, and on the weighted average number of shares of common stock issued during the period, including DRIP shares issuable upon reinvestment of dividends (retroactively adjusted for stock splits and stock dividends, if any) and reduced for shares held in treasury.
 
The following table illustrates the calculation of earnings per common share for the periods presented, as adjusted for the cash dividends declared on the preferred stock:
 
Years Ended December 31,
 2019 
 2018 
 
   
   
Net income, as reported
 $8,824,446 
 $8,397,532 
Less: dividends to preferred shareholders
  87,500 
  103,125 
Net income available to common shareholders
 $8,736,946 
 $8,294,407 
Weighted average number of common shares
    
    
   used in calculating earnings per share
  5,204,768 
  5,139,297 
Earnings per common share
 $1.68 
 $1.61 
  
 
18
 
 
Off-balance-sheet financial instruments
 
In the ordinary course of business, the Company is a party to off-balance-sheet financial instruments consisting of commitments to extend credit, commercial and municipal letters of credit, standby letters of credit, and risk-sharing commitments on residential mortgage loans sold through the FHLBB’s MPF program. Such financial instruments are recorded in the consolidated financial statements when they are funded.
 
Transfers of financial assets
 
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
 
Impact of recently issued accounting standards
 
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. In July 2018, the FASB amended the updated guidance and provided an additional transition method for adoption of the guidance. The ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The ASU and related guidance became effective for the Company on January 1, 2019. The impact of adopting this ASU was not material to the Company’s consolidated financial statements.
 
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 current expected credit loss, or 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 and related guidance 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. 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 management believes 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 is continuing to analyze the historical data to serve as a basis for estimating the ALL under CECL and continues to evaluate the impact of the adoption of the ASU on its consolidated financial statements. As initially proposed, the ASU was to be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 15, 2018, including interim periods within such years. However, in November 2019, the FASB issued ASU No. 2019-10, Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The ASU extends the effective date for compliance with the ASU by smaller reporting companies, which are now required to comply with the ASU for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company qualifies for this extension and does not intend to early adopt the ASU at this time. Management will continue to evaluate the Company’s CECL compliance and implementation timetable in light of the extension.
 
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). As initially proposed, the ASU was to be effective for the Company on January 1, 2020; however similar to ASU No. 2016-13, the effective date for this ASU was also extended and will be effective for the Company on January 1, 2023. The Company has evaluated the impact of this ASU and as permitted, plans to early adopt on January 1, 2020, with no material impact expected on its consolidated financial statements.
 
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 7).
 
 
19
 
 
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements as part of its disclosure framework project. The standard is effective for all entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The ASU became effective for the Company on January 1, 2020. The Company does not anticipate that adoption of this ASU will have any material impact on its consolidated financial statements.
 
Note 2.  Investment Securities
 
Change in Accounting Principle
 
Prior to 2019, the entire balance of the Company’s HTM investment portfolio consisted of Municipal notes. Effective January 1, 2019, and in accordance with ASC 250 (Accounting Changes and Error Corrections), the Company chose to reclassify these debt instruments from the investment portfolio into the loan portfolio. This change represents a voluntary reclassification of municipal debt instruments from classification as investment securities under ASC 320 (Investments – Debt and Equity Securities) to classification as loans under ASC 310 (Receivables). All periods presented have been restated to conform to this change. Accordingly, for all periods presented below, the Company’s investment portfolio consists entirely of AFS investments and municipal debt obligations are reported as a component of the Company’s loan portfolio (See Note 3). The reclassification of the municipal debt instruments in this portfolio did not have a material impact on the Company’s consolidated financial statements or results of operations.
 
Debt securities AFS consist of the following:
 
 
   
 Gross 
 Gross 
   
 
 Amortized 
 Unrealized 
 Unrealized 
 Fair 
 
 Cost 
 Gains 
 Losses 
 Value 
 
   
   
   
   
December 31, 2019
   
   
   
   
U.S. GSE debt securities
 $18,002,549 
 $99,743 
 $40,672 
 $18,061,620 
Agency MBS
  16,169,819 
  86,874 
  51,318 
  16,205,375 
ABS and OAS
  2,799,657 
  55,418 
  2,166 
  2,852,909 
Other investments
  8,665,000 
  181,846 
  0 
  8,846,846 
   Total
 $45,637,025 
 $423,881 
 $94,156 
 $45,966,750 
 
    
    
    
    
December 31, 2018
    
    
    
    
U.S. GSE debt securities
 $14,010,100 
 $394 
 $259,391 
 $13,751,103 
Agency MBS
  16,020,892 
  2,701 
  449,068 
  15,574,525 
ABS and OAS
  1,988,565 
  3,806 
  6,242 
  1,986,129 
Other investments
  8,167,000 
  8,472 
  120,398 
  8,055,074 
   Total
 $40,186,557 
 $15,373 
 $835,099 
 $39,366,831 
 
Investments pledged as collateral for larger dollar repurchase agreement accounts and for other purposes as required or permitted by law consisted of U.S. GSE debt securities, Agency MBS, 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 
 
   
   
December 31, 2019
 $45,637,025 
 $45,966,750 
December 31, 2018
  40,186,557 
  39,366,831 
 
Proceeds from sales of debt securities AFS were $6,553,118 in 2019 and $5,715,525 in 2018 with gains of $1,570 and $0, respectively, and losses of $28,060 and $32,718, respectively.
 
The carrying amount and estimated fair value of securities by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may call or prepay obligations with or without call or prepayment penalties, pursuant to contractual terms. 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 following table by contractual maturity date.
 
 
20
 
 
The scheduled maturities of debt securities AFS at December 31, 2019 were as follows:
 
 
 Amortized 
 Fair 
 
 Cost 
 Value 
 
   
   
Due in one year or less
 $2,760,515 
 $2,766,254 
Due from one to five years
  9,674,948 
  9,862,450 
Due from five to ten years
  15,042,170 
  15,147,201 
Due after ten years
  1,989,573 
  1,985,470 
Agency MBS
  16,169,819 
  16,205,375 
     Total
 $45,637,025 
 $45,966,750 
 
 
Debt securities with unrealized losses as of the balance sheet dates are presented in the tables below.
 
 
 Less than 12 months 
 12 months or more 
 Totals 
 
 Fair 
 Unrealized 
 Fair 
 Unrealized 
 Number of 
 Fair 
 Unrealized 
 
 Value 
 Loss 
 Value 
 Loss 
 Securities 
 Value 
 Loss 
December 31, 2019
   
   
   
   
   
   
   
U.S. GSE debt securities
 $7,964,192 
 $40,672 
 $0 
 $0 
  7 
 $7,964,192 
 $40,672 
Agency MBS
  5,273,683 
  24,648 
  2,920,091 
  26,670 
  13 
  8,193,774 
  51,318 
Other investments
  1,000,490 
  2,166 
  0 
  0 
  1 
  1,000,490 
  2,166 
     Total
 $14,238,365 
 $67,486 
 $2,920,091 
 $26,670 
  21 
 $17,158,456 
 $94,156 
 
    
    
    
    
    
    
    
December 31, 2018
    
    
    
    
    
    
    
U.S. GSE debt securities
 $1,465,947 
 $6,752 
 $11,284,761 
 $252,639 
  11 
 $12,750,708 
 $259,391 
Agency MBS
  2,317,838 
  22,029 
  12,223,386 
  427,039 
  24 
  14,541,224 
  449,068 
ABS and OAS
  976,226 
  6,242 
  0 
  0 
  1 
  976,226 
  6,242 
Other investments
  1,956,914 
  20,086 
  4,113,688 
  100,312 
  25 
  6,070,602 
  120,398 
     Total
 $6,716,925 
 $55,109 
 $27,621,835 
 $779,990 
  61 
 $34,338,760 
 $835,099 
 
 
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 cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.
 
As the Company has the ability to hold its debt securities until maturity, or for the foreseeable future if classified as AFS, and it is more likely than not that the Company will not have to sell such securities before recovery of their cost basis, no declines in such securities were deemed to be other-than-temporary as of the balance sheet dates presented.
 
The Bank is a member of the FHLBB. The FHLBB is a cooperatively owned wholesale bank for housing and finance in the six New England States. Its mission is to support the residential mortgage and community-development lending activities of its members, which include over 450 financial institutions across New England. The Company obtains much of its wholesale funding from the FHLBB. As a requirement of membership in the FHLBB, the Bank must own a minimum required amount of FHLBB stock, calculated periodically based primarily on the Bank’s level of borrowings from the FHLBB. As a result of the Bank’s level of borrowings during 2019 and 2018, the Bank was required to purchase additional FHLBB stock in aggregate totaling $176,000 and $1,103,300, respectively. As a member of the FHLBB, the Company is also subject to future capital calls by the FHLBB in order to maintain compliance with its capital plan. During 2019 and 2018, FHLBB exercised capital call options with redemptions totaling $493,600 and $1,147,500, respectively, on the Company’s portfolio of FHLBB stock. As of December 31, 2019 and 2018, the Company’s investment in FHLBB stock was $753,700 and $1,071,300, respectively.
 
 
21
 
 
The Company periodically evaluates its investment in FHLBB stock for impairment based on, among other factors, the capital adequacy of the FHLBB and its overall financial condition. No impairment losses have been recorded through December 31, 2019.
 
The Company’s investment in FRBB Stock was $588,150 at December 31, 2019 and 2018.
 
In 2018, the Company purchased 20 shares of common stock in ACBI at a purchase price of $90,000, for the purpose of obtaining access to correspondent banking services from ABCI’s subsidiary, ACBB. These shares are subject to contractual resale restrictions and considered by management to be restricted and are recorded in the balance sheet at cost amounting to $90,000 at December 31, 2019 and 2018.
 
Note 3.  Loans, Allowance for Loan Losses and Credit Quality
 
Change in Accounting Principle
 
As disclosed in Note 2 (Investment Securities), effective January 1, 2019 and in accordance with ASC 250 (Accounting Changes and Error Corrections), the Company chose to reclassify its municipal debt instruments from the investment portfolio into the loan portfolio. This change represents a voluntary reclassification of municipal debt instruments by management from classification as investment securities under ASC 320 (Investments – Debt and Equity Securities) to classification as loans under ASC 310 (Receivables). As stated in Note 2, the reclassification of this portfolio did not have a material impact on the Company’s consolidated financial statements or results of operations.
 
The composition of net loans as of the balance sheet dates was as follows:
 
December 31,
 2019 
 2018 
 
   
   
Commercial & industrial
 $98,930,831 
 $80,766,693 
Commercial real estate
  246,282,726 
  235,318,148 
Municipal
  55,817,206 
  47,067,023 
Residential real estate - 1st lien
  158,337,296 
  165,665,175 
Residential real estate - Jr lien
  43,230,873 
  44,544,987 
Consumer
  4,390,005 
  5,088,491 
    Total loans
  606,988,937 
  578,450,517 
Deduct (add):
    
    
ALL
  5,926,491 
  5,602,541 
Deferred net loan costs
  (362,415)
  (363,614)
     Net loans
 $601,424,861 
 $573,211,590 
 
 
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 
December 31, 2019
 30-89 Days 
 or More 
 Past Due 
 Current 
 Total Loans 
 Loans 
 Accruing 
 
   
   
   
   
   
   
   
Commercial & industrial
 $68,532 
 $44,503 
 $113,035 
 $98,817,796 
 $98,930,831 
 $480,083 
 $0 
Commercial real estate
  1,690,307 
  151,723 
  1,842,030 
  244,440,696 
  246,282,726 
  1,600,827 
  0 
Municipal
  0 
  0 
  0 
  55,817,206 
  55,817,206 
  0 
  0 
Residential real estate
    
    
    
    
    
    
    
 - 1st lien
  3,871,045 
  1,217,098 
  5,088,143 
  153,249,153 
  158,337,296 
  2,112,267 
  530,046 
 - Jr lien
  331,416 
  147,976 
  479,392 
  42,751,481 
  43,230,873 
  240,753 
  112,386 
Consumer
  49,607 
  0 
  49,607 
  4,340,398 
  4,390,005 
  0 
  0 
     Totals
 $6,010,907 
 $1,561,300 
 $7,572,207 
 $599,416,730 
 $606,988,937 
 $4,433,930 
 $642,432 
 
 
22
 
 
 
 
   
   
   
   
   
   
 90 Days or 
 
   
 90 Days
 Total 
   
   
 Non-Accrual 
 More and 
December 31, 2018
 30-89 Days 
 or More 
 Past Due 
 Current 
 Total Loans 
 Loans 
 Accruing 
 
   
   
   
   
   
   
   
Commercial & industrial
 $217,385 
 $0 
 $217,385 
 $80,549,308 
 $80,766,693 
 $84,814 
 $0 
Commercial real estate
  1,509,839 
  190,789 
  1,700,628 
  233,617,520 
  235,318,148 
  1,742,993 
  0 
Municipal
  0 
  0 
  0 
  47,067,023 
  47,067,023 
  0 
  0 
Residential real estate
    
    
    
    
    
    
    
 - 1st lien
  4,108,319 
  1,371,061 
  5,479,380 
  160,185,795 
  165,665,175 
  2,026,939 
  622,486 
 - Jr lien
  484,855 
  353,914 
  838,769 
  43,706,218 
  44,544,987 
  408,540 
  104,959 
Consumer
  43,277 
  1,661 
  44,938 
  5,043,553 
  5,088,491 
  0 
  1,661 
     Totals
 $6,363,675 
 $1,917,425 
 $8,281,100 
 $570,169,417 
 $578,450,517 
 $4,263,286 
 $729,106 
 
 
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 
December 31, 2019
  9 
 $495,943 
December 31, 2018
  12 
  961,709 
 
 
The following summarizes changes in the ALL and select loan information, by portfolio segment:
 
As of or for the year ended December 31, 2019
 
 
   
   
   
 Residential 
 Residential 
   
   
   
 
 Commercial 
 Commercial 
   
 Real Estate 
 Real Estate 
   
   
   
 
 & Industrial 
 Real Estate 
 Municipal 
 1st Lien 
 Jr Lien 
 Consumer 
 Unallocated 
 Total 
 
   
   
   
   
   
   
   
   
ALL beginning balance
 $697,469 
 $3,019,868 
 $0 
 $1,421,494 
 $273,445 
 $56,787 
 $133,478 
 $5,602,541 
  Charge-offs
  (175,815)
  (116,186)
  0 
  (242,244)
  (222,999)
  (102,815)
  0 
  (860,059)
  Recoveries
  10,768 
  50,388 
  0 
  15,776 
  2,200 
  38,710 
  0 
  117,842 
  Provision
  304,344 
  227,576 
  0 
  193,538 
  237,038 
  59,111 
  44,560 
  1,066,167 
ALL ending balance
 $836,766 
 $3,181,646 
 $0 
 $1,388,564 
 $289,684 
 $51,793 
 $178,038 
 $5,926,491 
 
    
    
    
    
    
    
    
    
ALL evaluated for impairment
    
    
    
    
    
    
    
    
  Individually
 $0 
 $0 
 $0 
 $103,836 
 $712 
 $0 
 $0 
 $104,548 
  Collectively
  836,766 
  3,181,646 
  0 
  1,284,728 
  288,972 
  51,793 
  178,038 
  5,821,943 
     Total
 $836,766 
 $3,181,646 
 $0 
 $1,388,564 
 $289,684 
 $51,793 
 $178,038 
 $5,926,491 
   
Loans evaluated for impairment
    
    
    
    
    
    
    
    
  Individually
 $420,933 
 $1,699,238 
 $0 
 $4,471,902 
 $156,073 
 $0 
    
 $6,748,146 
  Collectively
  98,509,898 
  244,583,488 
  55,817,206 
  153,865,394 
  43,074,800 
  4,390,005 
    
  600,240,791 
     Total
 $98,930,831 
 $246,282,726 
 $55,817,206 
 $158,337,296 
 $43,230,873 
 $4,390,005 
    
 $606,988,937 
 
 
 
23
 
 
As of or for the year ended December 31, 2018
 
 
   
   
   
 Residential 
 Residential 
   
   
   
 
 Commercial 
 Commercial 
   
 Real Estate 
 Real Estate 
   
   
   
 
 & Industrial 
 Real Estate 
 Municipal 
 1st Lien 
 Jr Lien 
 Consumer 
 Unallocated 
 Total 
 
   
   
   
   
   
   
   
   
ALL beginning balance
 $675,687 
 $2,674,029 
 $0 
 $1,460,547 
 $316,982 
 $43,303 
 $267,551 
 $5,438,099 
  Charge-offs
  (152,860)
  (124,645)
  0 
  (251,654)
  (69,173)
  (143,688)
  0 
  (742,020)
  Recoveries
  60,192 
  0 
  0 
  26,832 
  1,420 
  38,018 
  0 
  126,462 
  Provision (credit)
  114,450 
  470,484 
  0 
  185,769 
  24,216 
  119,154 
  (134,073)
  780,000 
ALL ending balance
 $697,469 
 $3,019,868 
 $0 
 $1,421,494 
 $273,445 
 $56,787 
 $133,478 
 $5,602,541 
 
    
    
    
    
    
    
    
    
ALL evaluated for impairment
    
    
    
    
    
    
    
    
  Individually
 $0 
 $0 
 $0 
 $112,969 
 $1,757 
 $0 
 $0 
 $114,726 
  Collectively
  697,469 
  3,019,868 
  0 
  1,308,525 
  271,688 
  56,787 
  133,478 
  5,487,815 
     Total
 $697,469 
 $3,019,868 
 $0 
 $1,421,494 
 $273,445 
 $56,787 
 $133,478 
 $5,602,541 
   
Loans evaluated for impairment
    
    
    
    
    
    
    
    
  Individually
 $60,846 
 $1,746,894 
 $0 
 $4,392,060 
 $319,321 
 $0 
    
 $6,519,121 
  Collectively
  80,705,847 
  233,571,254 
  47,067,023 
  161,273,115 
  44,225,666 
  5,088,491 
    
  571,931,396 
     Total
 $80,766,693 
 $235,318,148 
 $47,067,023 
 $165,665,175 
 $44,544,987 
 $5,088,491 
    
 $578,450,517 
 
 
Impaired loans as of the balance sheet dates, by portfolio segment were as follows:
 
 
 As of December 31, 2019 
 2019 
 
   
 Unpaid 
   
 Average 
 Interest 
 
 Recorded 
 Principal 
 Related 
 Recorded 
 Income 
 
 Investment 
 Balance 
 Allowance 
 Investment 
 Recognized 
 
   
   
   
   
   
Related allowance recorded
   
   
   
   
   
   Commercial & industrial
 $0 
 $0 
 $0 
 $32,466 
 $0 
   Commercial real estate
  0 
  0 
  0 
  97,720 
  0 
   Residential real estate
    
    
    
    
    
    - 1st lien
  878,439 
  902,000 
  103,836 
  982,158 
  86,039 
    - Jr lien
  6,121 
  6,101 
  712 
  6,869 
  648 
     Total with related allowance
  884,560 
  908,101 
  104,548 
  1,119,213 
  86,687 
 
    
    
    
    
    
No related allowance recorded
    
    
    
    
    
   Commercial & industrial
  420,933 
  445,509 
    
  307,208 
  6,396 
   Commercial real estate
  1,699,772 
  2,031,764 
    
  1,812,836 
  21,591 
   Residential real estate
    
    
    
    
    
    - 1st lien
  3,614,960 
  4,273,884 
    
  3,778,822 
  212,883 
    - Jr lien
  149,972 
  157,754 
    
  224,938 
  4,524 
     Total with no related allowance
  5,885,637 
  6,908,911 
    
  6,123,804 
  245,394 
 
    
    
    
    
    
     Total impaired loans
 $6,770,197 
 $7,817,012 
 $104,548 
 $7,243,017 
 $332,081 
 
In the table above, recorded investment in impaired loans as of December 31, 2019 includes accrued interest receivable and deferred net loan costs of $22,051.
 
 
 
24
 
 
 
 
 As of December 31, 2018 
 2018 
 
   
 Unpaid 
   
 Average 
 Interest 
 
 Recorded 
 Principal 
 Related 
 Recorded 
 Income 
 
 Investment 
 Balance 
 Allowance 
 Investment 
 Recognized 
 
   
   
   
   
   
Related allowance recorded
   
   
   
   
   
   Commercial real estate
 $0 
 $0 
 $0 
 $57,658 
 $0 
   Residential real estate
    
    
    
    
    
    - 1st lien
  942,365 
  963,367 
  112,969 
  836,326 
  45,139 
    - Jr lien
  7,271 
  7,248 
  1,757 
  77,555 
  351 
 
  949,636 
  970,615 
  114,726 
  971,539 
  45,490 
 
    
    
    
    
    
No related allowance recorded
    
    
    
    
    
   Commercial & industrial
  60,846 
  80,894 
    
  120,924 
  0 
   Commercial real estate
  1,748,323 
  1,975,831 
    
  1,663,794 
  13,131 
   Residential real estate
    
    
    
    
    
    - 1st lien
  3,465,117 
  4,082,637 
    
  3,497,772 
  94,313 
    - Jr lien
  312,072 
  351,139 
    
  235,970 
  0 
 
  5,586,358 
  6,490,501 
    
  5,518,460 
  107,444 
 
    
    
    
    
    
 
 $6,535,994 
 $7,461,116 
 $114,726 
 $6,489,999 
 $152,934 
 
 
In the table above, recorded investment in impaired loans as of December 31, 2018 includes accrued interest receivable and deferred net loan costs of $16,873.
 
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.
 
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.
 
 
25
 
 
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. Risk ratings are assessed on an ongoing basis and at various points, including at delinquency or at the time of other adverse events. For larger, more complex or adversely rated loans, risk ratings are also assessed at the time of annual or periodic review. Lenders are required to make immediate disclosure to the Senior 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 December 31, 2019
 
   
   
   
 Residential 
 Residential 
   
   
 
 Commercial 
 Commercial 
   
 Real Estate 
 Real Estate 
   
   
 
 & Industrial 
 Real Estate 
 Municipal 
 1st Lien 
 Jr Lien 
 Consumer 
 Total 
 
   
   
   
   
   
   
   
Group A
 $93,774,871 
 $233,702,063 
 $55,817,206 
 $154,770,678 
 $42,725,543 
 $4,390,005 
 $585,180,366 
Group B
  3,295,223 
  4,517,811 
  0 
  0 
  0 
  0 
  7,813,034 
Group C
  1,860,737 
  8,062,852 
  0 
  3,566,618 
  505,330 
  0 
  13,995,537 
   Total
 $98,930,831 
 $246,282,726 
 $55,817,206 
 $158,337,296 
 $43,230,873 
 $4,390,005 
 $606,988,937 
 
 
 
As of December 31, 2018
 
 
   
   
   
 Residential 
 Residential 
   
   
 
 Commercial 
 Commercial 
   
 Real Estate 
 Real Estate 
   
   
 
 & Industrial 
 Real Estate 
 Municipal 
 1st Lien 
 Jr Lien 
 Consumer 
 Total 
 
   
   
   
   
   
   
   
Group A
 $78,585,348 
 $226,785,919 
 $47,067,023 
 $161,293,233 
 $43,817,872 
 $5,086,830 
 $562,636,225 
Group B
  90,763 
  246,357 
  0 
  224,992 
  0 
  0 
  562,112 
Group C
  2,090,582 
  8,285,872 
  0 
  4,146,950 
  727,115 
  1,661 
  15,252,180 
   Total
 $80,766,693 
 $235,318,148 
 $47,067,023 
 $165,665,175 
 $44,544,987 
 $5,088,491 
 $578,450,517 
 
 
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.
 
 
 
26
 
 
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, for the periods presented were as follows:
 
Year ended December 31, 2019
 
 
   
 Pre- 
 Post- 
 
   
 Modification 
 Modification 
 
   
 Outstanding 
 Outstanding 
 
 Number of 
 Recorded 
 Recorded 
 
 Contracts 
 Investment 
 Investment 
 
   
   
   
Commercial & industrial
  6 
 $371,358 
 $372,259 
Commercial real estate
  1 
  19,266 
  21,628 
Residential real estate
    
    
    
 - 1st lien
  6 
  755,476 
  798,800 
 - Jr lien
  1 
  55,557 
  57,415 
 
  14 
 $1,201,657 
 $1,250,102 
 
 
Year ended December 31, 2018
 
 
   
 Pre- 
 Post- 
 
   
 Modification 
 Modification 
 
   
 Outstanding 
 Outstanding 
 
 Number of 
 Recorded 
 Recorded 
 
 Contracts 
 Investment 
 Investment 
 
   
   
   
Commercial real estate
  1 
 $406,920 
 $406,920 
Residential real estate - 1st lien
  10 
  1,031,330 
  1,142,089 
 
  11 
 $1,438,250 
 $1,549,009 
 
 
The TDRs for which there was a payment default during the twelve month periods presented were as follows:
 
Year ended December 31, 2019
 
 
 Number of 
 Recorded 
 
 Contracts 
 Investment 
 
   
   
Commercial & industrial
  2 
 $27,818 
Residential real estate - 1st lien
  1 
  227,907 
Residential real estate - Jr lien
  1 
  55,010 
 
  4 
 $310,735 
 
 
 
27
 
 
Year ended December 31, 2018
 
 
 Number of 
 Recorded 
 
 Contracts 
 Investment 
 
   
   
Commercial real estate
  1 
 $400,646 
Residential real estate - 1st lien
  3 
  518,212 
 
  4 
 $918,858 
 
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 presented were as follows:
 
 
 2019 
 2018 
 
   
   
Specific Allowance
 $104,548 
 $114,726 
 
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 under one SBA guaranteed line of credit to a borrower whose lending relationship was previously restructured.
 
Note 4.  Loan Servicing
 
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $167,673,467 and $176,083,984 at December 31, 2019 and 2018, respectively. Net gain realized on the sale of loans was $290,116 and $345,780 for the years ended December 31, 2019 and 2018, respectively.
 
The following table summarizes changes in MSRs for the years ended December 31,
 
 
 2019 
 2018 
 
   
   
Balance at beginning of year
 $1,004,948 
 $1,083,286 
   MSRs capitalized
  114,580 
  110,209 
   MSRs amortized
  (179,951)
  (188,547)
Balance at end of year
 $939,577 
 $1,004,948 
 
There was no valuation allowance in the periods presented.
 
Note 5.  Bank Premises and Equipment
 
The major classes of bank premises and equipment and accumulated depreciation and amortization at December 31 were as follows:
 
 
 2019 
 2018 
 
   
   
Buildings and improvements
 $10,575,514 
 $10,555,868 
Land and land improvements
  2,650,671 
  2,586,373 
Furniture and equipment
  6,848,263 
  6,460,625 
Leasehold improvements
  1,161,073 
  1,155,284 
Finance lease
  588,347 
  991,014 
Operating leases
  1,490,779 
  0 
Other prepaid assets
  159,914 
  55,406 
 
  23,474,561 
  21,804,570 
Less accumulated depreciation and amortization
  (12,515,158)
  (12,091,115)
Net bank premises and equipment
 $10,959,403 
 $9,713,455 
 
28
 
 
Note 6. Leases
 
The Company adopted ASU No. 2016-02 (Leases) on January 1, 2019 with no required adjustment to prior periods presented or cumulative-effect adjustment to retained earnings. The Company has operating and finance leases for some of its bank premises, with remaining lease terms of one year to seven years. Some of the operating leases have options to renew, which are reflected in the seven years. The Company’s operating lease right-of-use assets and finance lease assets are included in “Bank premises and equipment, net” in the consolidated balance sheet and operating lease liabilities and finance lease liabilities are included in other liabilities in the consolidated balance sheet.
 
The components of lease expense for the periods presented were as follows:
 
Years Ended December 31,
 2019 
 2018 
 
   
   
Operating lease cost
 $255,475 
 $230,888 
 
    
    
Finance lease cost:
    
    
   Amortization of right-of-use assets
 $70,667 
 $70,667 
   Interest on lease liabilities
  16,705 
  26,399 
   Variable rent expense
  33,940 
  33,940 
     Total finance lease cost
 $121,312 
 $131,006 
 
Total rental expense not associated with operating lease costs above amounted to $16,601 and $16,924 for the years ended December 31, 2019 and 2018, respectively.
 
Supplemental cash flow information related to right-of-use assets and for lease obligations recorded upon adoption of ASU No. 2016-02 (Note 1) was as follows:
 
Year Ended December 31,
 2019 
 
   
Operating Leases
 $1,455,829 
 
Supplemental balance sheet information related to leases was as follows:
 
December 31,
 2019 
 2018 
 
   
   
Operating Leases
   
   
Operating lease right-of-use assets
 $1,254,384 
 $0 
 
    
    
Operating lease liabilities
 $1,263,173 
 $0 
 
    
    
Finance Leases
    
    
Finance lease right-of-use assets
 $124,347 
 $213,679 
 
    
    
Finance lease liabilities
 $99,823 
 $266,747 
 
December 31,
 2019 
 2018 
 
   
   
Weighted Average Remaining Lease Term
   
   
  Operating Leases
 4.4 Years 
 5.9 Years 
  Finance Leases
 1.5 Years 
 2.0 Years 
 
   
   
Weighted Average Discount Rate
   
   
  Operating Leases
  1.28%
  N/A 
  Finance Leases
  7.50%
  7.86%
 
 
29
 
 
Operating lease obligations
 
The Company is obligated under non-cancelable operating leases for bank premises expiring in various years through 2026, with options to renew. Minimum future rental payments for these leases with original terms in excess of one year as of December 31, 2019 for each of the next five years and in aggregate are:
 
2020
 $257,039 
2021
  210,350 
2022
  207,380 
2023
  210,232 
2024
  186,448 
Subsequent to 2024
  249,424 
     Total
 $1,320,873 
 
 
Finance lease obligations
 
The following is a schedule by years of future minimum lease payments under capital leases, together with the present value of the net minimum lease payments as of December 31, 2019:
 
2020
 $67,060 
2021
  39,119 
Total minimum lease payments
  106,179 
Less amount representing interest
  (6,356)
Present value of net minimum lease payments
 $99,823 
 
 
A reconciliation of the undiscounted cash flows in the maturity analysis above and the lease liability recognized in the consolidated balance sheet as of December 31, 2019, is shown below:
 
 
 Operating Leases 
 Finance Leases 
 
   
   
Undiscounted cash flows
 $1,320,873 
 $106,179 
Discount effect of cash flows
  (57,700)
  (6,356)
  Lease liabilities
 $1,263,173 
 $99,823 
 
 
Note 7.  Goodwill and Other Intangible Asset
 
As a result of the acquisition of 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. Management evaluated goodwill for impairment at December 31, 2019 and 2018 and concluded that no impairment existed as of such dates.
 
Note 8.  Other Investments
 
In 2011, the Company established a single-member LLC to facilitate the purchase of federal NMTC through an investment structure designed by a local community development entity. The equity investment was fully amortized at December 31, 2017, and the Company exited the equity investment, including termination of its interest in the LLC, during the last quarter of 2018.The LLC did not conduct any business apart from its role in the NMTC financing structure.
 
The Company purchases from time to time interests in various limited partnerships established to acquire, own and rent residential housing for low and moderate income residents of northeastern and central Vermont. The tax credits from these investments were $415,099 and $437,229 for the years ended December 31, 2019 and 2018, respectively. Expenses related to amortization of the investments in the limited partnerships are recognized as a component of income tax expense, and were $312,106 and $410,061 for 2019 and 2018, respectively. The carrying values of the limited partnership investments were $2,762,406 and $2,263,512 at December 31, 2019 and 2018, respectively, and are included in other assets.
 
 
 
30
 
 
The Bank has a one-third ownership interest in a non-depository trust company, CFSG, based in Newport, Vermont, which is held indirectly through CFS Partners, a Vermont LLC that owns 100% of the LLC equity interests of CFSG. The Bank accounts for its investment in CFS Partners under the equity method of accounting. The Company's investment in CFS Partners, included in other assets, amounted to $3,535,527 and $2,946,831 as of December 31, 2019 and 2018, respectively. The Company recognized income of $588,696 and $514,485 for 2019 and 2018, respectively, through CFS Partners from the operations of CFSG.
 
Note 9.  Deposits
 
The following is a maturity distribution of time deposits at December 31, 2019:
 
2020
 $55,256,906 
2021
  31,341,156 
2022
  12,249,473 
2023
  7,319,609 
2024
  10,031,175 
     Total CDs
 $116,198,319 
 
 
Total deposits in excess of the FDIC insurance level amounted to $178,997,035 as of December 31, 2019.
 
Note 10.  Borrowed Funds
 
Outstanding advances for the Company as of the balance sheet dates presented were as follows:
 
 
 2019 
 2018 
Long-Term Advances(1)
   
   
FHLBB term advance, 0.00%, due February 26, 2021
 $350,000 
 $350,000 
FHLBB term advance, 0.00%, due November 22, 2021
  1,000,000 
  1,000,000 
FHLBB term advance, 0.00%, due September 22, 2023
  200,000 
  200,000 
FHLBB term advance, 0.00%, due November 12, 2025
  300,000 
  0 
FHLBB term advance, 0.00%, due November 13, 2028
  800,000 
  0 
 
 $2,650,000 
 $1,550,000 
 
 
(1)
The FHLBB is providing a subsidy, funded by the FHLBB’s earnings, to write down interest rates to zero percent on JNE 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.
 
Borrowings from the FHLBB are secured by a blanket lien on qualified collateral consisting primarily of loans with first mortgages secured by 1-4 family residential properties, as well as certain qualifying CRE loans. Qualified collateral for these borrowings totaled $135,672,471 and $148,323,822 as of December 31, 2019 and 2018, respectively, and the Company's gross potential borrowing capacity under this arrangement was $97,358,249 and $108,736,234, respectively, before reduction for outstanding advances and collateral pledges.
 
Under a separate agreement with the FHLBB, the Company has the authority to collateralize public unit deposits, up to its available borrowing capacity, with letters of credit issued by the FHLBB. At December 31, 2019, $14,425,000 in FHLBB letters of credit was utilized as collateral for these deposits compared to $2,625,000 at December 31, 2018. Total fees paid by the Company in connection with issuance of these letters of credit were $41,069 for 2019 and $46,620 for 2018.
 
The Company also maintained a $500,000 IDEAL Way Line of Credit with the FHLBB at December 31, 2019 and 2018, with no outstanding advances under this line at either year-end date. Interest on these borrowings is at a rate determined daily by the FHLBB and payable monthly.
 
The Company also has a line of credit with the FRBB, which is intended to be used as a contingency funding source. For this BIC arrangement, the Company pledged eligible commercial and industrial loans, CRE loans not pledged to FHLBB and home equity loans, resulting in an available line of $56,896,877 and $50,913,351 as of December 31, 2019 and 2018, respectively. Credit advances in the FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), which was 225 basis points as of December 31, 2019. As of December 31, 2019 and 2018, the Company had no outstanding advances against this line.
 
 
31
 
 
The Company has unsecured lines of credit with three correspondent banks, with aggregate available borrowing capacity totaling $12,500,000 at December 31, 2019 and 2018. The Company had no outstanding advances against these lines for the periods presented.
 
Note 11.  Junior Subordinated Debentures
 
As of December 31, 2019 and 2018, the Company had outstanding $12,887,000 principal amount of Junior Subordinated Debentures due in 2037 (the Debentures). The Debentures bear a floating rate equal to the 3-month London Interbank Offered Rate plus 2.85%. During 2019, the floating rate averaged 5.33% per quarter compared to an average rate of 4.95% per quarter for 2018. The Debentures mature on December 15, 2037 and are subordinated and junior in right of payment to all senior indebtedness of the Company, as defined in the Indenture dated as of October 31, 2007 between the Company and Wilmington Trust Company, as Trustee. The Debentures first became redeemable, in whole or in part, by the Company on December 15, 2012. Interest paid on the Debentures for 2019 and 2018 was $694,573 and $650,361, respectively, and is deductible for tax purposes.
 
The Debentures were issued and sold to CMTV Statutory Trust I (the Trust). The Trust is a special purpose trust funded by a capital contribution of $387,000 from the Company, in exchange for 100% of the Trust’s common equity. The Trust was formed for the purpose of issuing corporation-obligated mandatorily redeemable Capital Securities (Capital Securities) in the principal amount of $12.5 million to third-party investors and using the proceeds from the sale of such Capital Securities and the Company’s initial capital contribution to purchase the Debentures. The Debentures are the sole asset of the Trust. Distributions on the Capital Securities issued by the Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Trust on the Debentures. The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures. The Company has entered into an agreement which, taken collectively, fully and unconditionally guarantees the payments on the Capital Securities, subject to the terms of the guarantee.
 
The Debentures are currently includable in the Company’s Tier 1 capital up to 25% of core capital elements (see Note 21).
 
Note 12.  Repurchase Agreements
 
Securities sold under agreements to repurchase mature daily and consisted of the following as of the balance sheet dates:
 
December 31,
 2019 
 2018 
 
   
   
Current balance
 $33,189,848 
 $30,521,565 
Average balance
  33,545,527 
  30,554,953 
Highest month-end balance
  38,868,833 
  32,938,807 
Weighted average interest rate
  0.89%
  0.63%
 
    
    
Pledged Investment (1)
    
    
  Amortized Cost
  45,637,025 
  40,186,557 
  Fair Value
  45,966,750 
  39,366,831 
 
(1) U.S. GSE securities, Agency MBS, ABS and OAS, and CDs were pledged as collateral for the periods presented.
 
Note 13.  Income Taxes
 
The Company prepares its income tax return on a consolidated basis. Income taxes are allocated to members of the consolidated group based on taxable income.
 
The components of the Provision for income taxes for the years ended December 31 were as follows:
 
 
 2019 
 2018 
 
   
   
 Currently paid or payable
 $1,693,624 
 $1,749,624 
 Deferred expense (benefit)
  96,236 
  (11,359)
 Total income tax expense(1)
 $1,789,860 
 $1,738,265 
 
(1)
Due to an increase of loan activity in 2019 in the state of New Hampshire, the Company is now subject to sales tax nexus on the income generated from this loan activity. An estimated tax payment of $10,000 was made to the state of New Hampshire during the fourth quarter of 2019 in anticipation of tax due for the 2019 tax year.
 
 
32
 
 
Total income tax expense differed from the amounts computed at the statutory federal income tax rate of 21% primarily due to the following for the years ended December 31:
 
 
 2019 
 2018 
 
   
   
Computed expense at statutory rates
 $2,236,904 
 $2,128,517 
Tax exempt interest and BOLI
  (306,073)
  (291,550)
Disallowed interest
  15,798 
  11,631 
Partnership rehabilitation and tax credits
  (415,099)
  (437,229)
Low income housing investment amortization expense
  246,564 
  323,948 
Other
  11,766 
  2,948 
 
 $1,789,860 
 $1,738,265 
 
The deferred income tax expense (benefit) consisted of the following items for the years ended December 31:
 
 
 2019 
 2018 
 
   
   
Depreciation
 $126,734 
 $25,782 
MSRs
  (13,728)
  (16,451)
Deferred compensation
  3,701 
  3,681 
Bad debts
  (68,029)
  (34,533)
Limited partnership amortization
  60,588 
  (20,129)
Investment in CFS Partners
  (3,323)
  (1,014)
Loan fair value
  (6,171)
  (2,228)
OREO write down
  0 
  13,860 
Prepaid expenses
  (10,741)
  (846)
Other
  7,205 
  20,519 
     Change in deferred tax expense (benefit)
 $96,236 
 $(11,359)
 
Listed below are the significant components of the net deferred tax asset at December 31:
 
 
 2019 
 2018 
 
   
   
Components of the deferred tax asset:
   
   
   Bad debts
 $1,244,563 
 $1,176,534 
   Deferred compensation
  12,898 
  16,599 
   Contingent liability - MPF program
  17,838 
  17,838 
   Finance lease
  11,930 
  23,287 
   Unrealized loss on debt securities AFS
  0 
  172,143 
   Other
  16,346 
  11,968 
         Total deferred tax asset
  1,303,575 
  1,418,369 
 
    
    
Components of the deferred tax liability:
    
    
   Depreciation
  384,197 
  257,463 
   Limited partnerships
  76,995 
  16,407 
   MSRs
  197,311 
  211,039 
   Unrealized gain on debt securities AFS
  69,242 
  0 
   Investment in CFS Partners
  71,054 
  74,377 
   Operating lease
  226 
  0 
   Prepaid expenses
  68,738 
  79,479 
   Fair value adjustment on acquired loans
  0 
  6,171 
         Total deferred tax liability
  867,763 
  644,936 
         Net deferred tax asset
 $435,812 
 $773,433 
 
US GAAP provides for the recognition and measurement of deductible temporary differences (including general valuation allowances) to the extent that it is more likely than not that the deferred tax asset will be realized.
 
The net deferred tax asset is included in other assets in the consolidated balance sheets.
 
 
33
 
ASC Topic 740, Income Taxes, defines the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company's financial statements. Topic 740 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the consolidated financial statements. The Company has adopted these provisions and there was no material effect on the consolidated financial statements. The Company is currently open to audit under the statute of limitations by the IRS for the years ended December 31, 2016 through 2018. The 2019 tax return has not yet been filed.
 
Note 14.  401(k) and Profit-Sharing Plan
 
The Company has a defined contribution plan covering all employees who meet certain age and service requirements. The pension expense was $624,000 and $617,800 for 2019 and 2018, respectively. These amounts represent discretionary matching contributions of a portion of the voluntary employee salary deferrals under the 401(k) plan and discretionary profit-sharing contributions under the plan.
 
Note 15.  Deferred Compensation and Supplemental Employee Retirement Plans
 
The Company maintains a directors’ deferred compensation plan and, prior to 2005, maintained a retirement plan for its directors. Participants are general unsecured creditors of the Company with respect to these benefits. The benefits accrued under these plans were $61,421 and $79,045 at December 31, 2019 and 2018, respectively. Expenses associated with these plans were $376 and $474 for the years ended December 31, 2019 and 2018, respectively.
 
Note 16.  Financial Instruments with Off-Balance-Sheet Risk
 
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees, commitments to sell loans 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 maximum extent of involvement the Company has in particular classes of financial instruments.
 
The Company's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Company applies the same credit policies and underwriting criteria in making commitments and conditional obligations as it does for on-balance-sheet instruments.
 
The Company generally requires collateral or other security to support financial instruments with credit risk. At December 31, the following off-balance-sheet financial instruments representing credit risk were outstanding:
 
 
 Contract or Notional Amount 
 
 2019 
 2018 
 
   
   
Unused portions of home equity lines of credit
 $32,784,105 
 $31,328,881 
Residential and commercial construction lines of credit
  12,364,436 
  7,251,560 
Commercial real estate commitments
  24,377,588 
  26,588,950 
Commercial and industrial commitments
  47,659,341 
  45,135,452 
Other commitments to extend credit
  64,469,012 
  53,586,720 
Standby letters of credit and commercial letters of credit
  1,375,500 
  2,408,581 
Recourse on sale of credit card portfolio
  254,430 
  284,680 
MPF credit enhancement obligation, net (See Note 17)
  552,158 
  552,158 
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. At December 31, 2019 and 2018, the Company had binding loan commitments to sell residential mortgages at fixed rates totaling $1,643,200 and $391,840, respectively (see Note 17). The recourse provision under the terms of the sale of the Company’s credit card portfolio in 2007 is based on total lines, not balances outstanding. Based on historical losses, the Company does not expect any significant losses from this commitment.
 
 
34
 
 
The Company evaluates each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit, or a commitment to extend credit, is based on management's credit evaluation of the counter-party. Collateral or other security held varies but may include real estate, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
 
Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit or providing reimbursement guarantees for the benefit of the Company’s commercial customers is essentially the same as that involved in extending loans to customers. The fair value of standby letters of credit and reimbursement guarantees on letters of credit has not been included in the balance sheets as the fair value is immaterial.
 
In connection with its 2007 trust preferred securities financing, the Company guaranteed the payment obligations under the $12,500,000 of capital securities of its subsidiary, the Trust. The source of funds for payments by the Trust on its capital trust securities is payments made by the Company on its debentures issued to the Trust. The Company's obligation under those debentures is fully reflected in the Company's consolidated balance sheet, in the gross amount of $12,887,000 as of the dates presented, of which $12,500,000 represents external financing through the issuance to investors of capital securities by the Trust (see Note 11).
 
Note 17.  Contingent Liability
 
The Company sells first lien 1-4 family residential mortgage loans under the MPF program with the FHLBB. Under this program the Company shares in the credit risk of each mortgage loan, while receiving fee income in return. The Company is responsible for a CEO based on the credit quality of these loans. FHLBB funds a FLA based on the Company's outstanding MPF mortgage balances. This creates a laddered approach to sharing in any losses. In the event of default, homeowner's equity and private mortgage insurance, if any, are the first sources of repayment; the FHLBB's FLA funds are then utilized, followed by the participant’s CEO, with the balance of losses absorbed by FHLBB. These loans must meet specific underwriting standards of the FHLBB. As of December 31, 2019 and 2018, the Company had $33,990,463 and $38,935,411, respectively, in loans sold through the MPF program and on which the Company had a CEO. As of December 31, 2019 and 2018, the notional amount of the maximum CEO related to this program was $637,102, and the accrued contingent liability for this CEO was $84,944. The contingent liability is calculated by management based on the methodology used in calculating the ALL, adjusted to reflect the risk sharing arrangements with the FHLBB.
 
Note 18.  Legal Proceedings
 
In the normal course of business, the Company is involved in various claims and legal proceedings. In the opinion of the Company's management, any liabilities resulting from such proceedings are not expected to be material to the Company's consolidated financial condition or results of operations.
 
Note 19.  Transactions with Related Parties
 
Aggregate loan transactions of the Company with directors, principal officers, their immediate families and affiliated companies in which they are principal owners (commonly referred to as related parties) as of December 31 were as follows:
 
 
 2019 
 2018 
 
   
   
Balance, beginning of year
 $6,730,842 
 $7,356,906 
Loans - New Directors
  0 
  936,445 
New loans to existing Principal Officers/Directors
  4,491,524 
  5,582,052 
Repayment
  (2,094,824)
  (7,144,561)
Balance, end of year
 $9,127,542 
 $6,730,842 
 
 
Total funds of related parties on deposit with the Company were $8,942,886 and $6,179,453 at December 31, 2019 and 2018, respectively.
 
Prior to May 2018, the Company leased 2,253 square feet of condominium space in the state office building on Main Street in Newport, Vermont to its trust company affiliate, CFSG, for its principal offices. In May 2018, CFSG purchased the condominium space from the Company. CFSG also leases offices in the Company’s Barre and Lyndonville branches. The amount of rental income received from CFSG for the years ended December 31, 2019 and 2018 was $9,821 and $30,365, respectively.
 
 
35
 
 
The Company utilizes the services of CFSG as an investment advisor for the Company’s 401(k) plan. The Human Resources committee of the Board of Directors is the Trustee of the plan, and CFSG provides investment advice for the plan. CFSG also acts as custodian of the retirement funds and makes investments on behalf of the plan and its participants. In addition, prior to liquidation of the SERP assets, CFSG served as investment advisor and custodian of funds under the Company’s SERP. The Company pays monthly management fees to CFSG for its services to the 401(k) plan amounting to $57,209 and $47,676, respectively, for the years ended December 31, 2019 and 2018.
 
Note 20.  Restrictions on Cash and Due From Banks
 
In the ordinary course of business, the Company may, from time to time, maintain amounts due from correspondent banks that exceed federally insured limits. However, no losses have occurred in these accounts and the Company believes it is not exposed to any significant risk with respect to such accounts. The Company was required to maintain contracted balances with a correspondent bank of $30,000 at December 31, 2019 and 2018.
 
Note 21.  Regulatory Capital Requirements
 
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Additional prompt corrective action capital requirements are applicable to banks, but not to bank holding companies.
 
Under current banking rules governing required regulatory capital, the Company and the Bank are required to maintain minimum amounts and ratios (set forth in the table on the following page) of Common equity tier 1, Tier 1 and Total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). The Company’s non-cumulative Series A preferred stock ($1.5 million liquidation preference in 2019 and $2.0 million in 2018) is includable without limitation in its Common equity tier 1 and Tier 1 capital. The Company is allowed to include in Common equity tier 1 and Tier 1 capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity, less certain intangibles, including goodwill, net of any related deferred income tax liability, with the balance includable in Tier 2 capital. Management believes that, as of December 31, 2019, the Company and the Bank met all capital adequacy requirements to which they were subject.
 
Under the 2018 Regulatory Relief Act, these capital requirements have been simplified for qualifying community banks and bank holding companies. In September 2019, the OCC and the other federal bank regulators approved a final joint rule that permits a qualifying community banking organization to opt in to a simplified regulatory capital framework. A qualifying institution that elects to utilize the simplified framework must maintain a CBLR in excess of 9%, and will thereby be deemed to have satisfied the generally applicable risk-based and other leverage capital requirements and (if applicable) the FDIC’s prompt corrective action framework. In order to utilize the CBLR framework, in addition to maintaining a CBLR of over 9%, a community banking organization must have less than $10 billion in total consolidated assets and must meet certain other criteria such as limitations on the amount of off-balance sheet exposures and on trading assets and liabilities. The CBLR will be calculated by dividing tangible equity capital by average total consolidated assets. The final rule became effective on January 1, 2020. Management believes that the Company and Bank would qualify to utilize the CBLR framework on a pro forma basis as of December 31, 2019 had it been in effect on that date.
 
 
36
 
 
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 was 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% is subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. The Company and the Bank were fully compliant with a capital conservation buffer of 6.63% and 6.53%, respectively, in effect at December 31, 2019, and 6.08% and 5.97%, respectively, in effect at December 31, 2018.
 
As of December 31, 2019, the Bank was considered well capitalized under the regulatory capital framework for Prompt Corrective Action and the Company exceeded applicable consolidated regulatory guidelines for capital adequacy.
 
The following table shows the regulatory capital ratios for the Company and the Bank as of December 31:
 
 
   
   
   
   
 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) 
December 31, 2019
   
   
   
   
   
   
Common equity tier 1 capital  (to risk-weighted assets)
   
   
   
   
   
   
   Company
 $69,947 
  13.48%
 $23,352 
  4.50%
  N/A 
  N/A 
   Bank
 $69,330 
  13.38%
 $23,325 
  4.50%
 $33,691 
  6.50%
Tier 1 capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $69,947 
  13.48%
 $31,135 
  6.00%
  N/A 
  N/A 
   Bank
 $69,330 
  13.38%
 $31,099 
  6.00%
 $41,466 
  8.00%
Total capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $75,943 
  14.63%
 $41,514 
  8.00%
  N/A 
  N/A 
   Bank
 $75,326 
  14.53%
 $41,466 
  8.00%
 $51,832 
  10.00%
Tier 1 capital (to average assets)
    
    
    
    
    
    
   Company
 $69,947 
  9.57%
 $29,223 
  4.00%
  N/A 
  N/A 
   Bank
 $69,330 
  9.50%
 $29,201 
  4.00%
 $36,501 
  5.00%
 
    
    
    
    
    
    
December 31, 2018:
    
    
    
    
    
    
Common equity tier 1 capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $64,564 
  12.94%
 $22,446 
  4.50%
  N/A 
  N/A 
   Bank
 $63,960 
  12.84%
 $22,419 
  4.50%
 $32,384 
  6.50%
Tier 1 capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $64,564 
  12.94%
 $29,928 
  6.00%
  N/A 
  N/A 
   Bank
 $63,960 
  12.84%
 $29,893 
  6.00%
 $39,857 
  8.00%
Total capital (to risk-weighted assets)
    
    
    
    
    
    
   Company
 $70,210 
  14.08%
 $39,904 
  8.00%
  N/A 
  N/A 
   Bank
 $69,606 
  13.97%
 $39,857 
  8.00%
 $49,821 
  10.00%
Tier 1 capital (to average assets)
    
    
    
    
    
    
   Company
 $64,564 
  9.26%
 $27,890 
  4.00%
  N/A 
  N/A 
   Bank
 $63,960 
  9.18%
 $27,867 
  4.00%
 $34,834 
  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. The Bank is restricted by law as to the amount of dividends that can be paid. Dividends declared by national banks that exceed net income for the current and preceding two years must be approved by the Bank’s primary banking regulator, the Office of the Comptroller of the Currency. Regardless of formal regulatory restrictions, the Bank may not pay dividends that would result in its capital levels being reduced below the minimum requirements shown above.
 
 
37
 
 
Note 22.  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, collateral-dependent 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:
 
Debt Securities AFS:  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.
 
Impaired loans: 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.
 
Loans held-for-sale: 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.
 
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.
 
 
38
 
 
 
Assets 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 December 31, segregated by fair value hierarchy, are summarized below:
 
Level 2
 2019 
 2018 
Assets: (market approach)
   
   
U.S. GSE debt securities
 $18,061,620 
 $13,751,103 
Agency MBS
  16,205,375 
  15,574,525 
ABS and OAS
  2,852,909 
  1,986,129 
Other investments
  8,846,846 
  8,055,074 
 
 $45,966,750 
 $39,366,831 
 
 
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 either 2019 or 2018.
 
Assets 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 3, there were none for 2019 and 2018.
 
Assets measured at fair value on a non-recurring basis and reflected in the consolidated balance sheets at December 31, segregated by fair value hierarchy, are summarized below:
 
Level 2
 2019 
 2018 
Assets: (market approach)
   
   
MSRs (1)
 $939,577 
 $1,004,948 
OREO
  966,738 
  201,386 
 
(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 at December 31, 2019 and 2018.
 
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 either 2019 or 2018.
 
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.
 
 
 
39
 
 
The carrying amounts and estimated fair values of the Company's financial instruments were as follows:
 
December 31, 2019
   
 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
 $48,562 
 $48,562 
 $0 
 $0 
 $48,562 
Debt securities AFS
  45,967 
  0 
  45,967 
  0 
  45,967 
Restricted equity securities
  1,432 
  0 
  1,432 
  0 
  1,432 
Loans and loans held-for-sale, net of ALL
    
    
    
    
    
  Commercial & industrial
  98,062 
  0 
  0 
  97,356 
  97,356 
  Commercial real estate
  243,022 
  0 
  0 
  242,735 
  242,735 
  Municipal (1)
  55,817 
  0 
  0 
  55,867 
  55,867 
  Residential real estate - 1st lien
  156,897 
  0 
  0 
  156,520 
  156,520 
  Residential real estate - Jr lien
  42,927 
  0 
  0 
  42,950 
  42,950 
  Consumer
  4,337 
  0 
  0 
  4,306 
  4,306 
MSRs (2)
  940 
  0 
  1,250 
  0 
  1,250 
Accrued interest receivable
  2,337 
  0 
  2,337 
  0 
  2,337 
 
    
    
    
    
    
Financial liabilities:
    
    
    
    
    
Deposits
    
    
    
    
    
  Other deposits
  603,872 
  0 
  604,267 
  0 
  604,267 
  Brokered deposits
  11,149 
  0 
  11,153 
  0 
  11,153 
Long-term borrowings
  2,650 
  0 
  2,427 
  0 
  2,427 
Repurchase agreements
  33,190 
  0 
  33,190 
  0 
  33,190 
Operating lease obligations
  1,263 
  0 
  1,263 
  0 
  1,263 
Finance lease obligations
  100 
  0 
  100 
  0 
  100 
Subordinated debentures
  12,887 
  0 
  12,831 
  0 
  12,831 
Accrued interest payable
  139 
  0 
  139 
  0 
  139 
 
 
(1)
Prior to reclassification to the loan portfolio effective January 1, 2019, all loans in this category were reported as HTM securities as a component of Investment Securities. All prior periods have been restated to conform to the reclassification.
 
(2)
Reported fair value represents all MSRs for loans serviced by the Company at December 31, 2019, regardless of carrying amount.
 
 
40
 
 
December 31, 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
 $67,935 
 $67,935 
 $0 
 $0 
 $67,935 
Debt securities AFS
  39,367 
  0 
  39,367 
  0 
  39,367 
Restricted equity securities
  1,749 
  0 
  1,749 
  0 
  1,749 
Loans and loans held-for-sale, net of ALL
    
    
    
    
    
  Commercial & industrial
  80,049 
  0 
  0 
  79,773 
  79,773 
  Commercial real estate
  232,239 
  0 
  0 
  230,532 
  230,532 
  Municipal (1)
  47,067 
  0 
  0 
  47,228 
  47,228 
  Residential real estate - 1st lien
  164,202 
  0 
  0 
  161,068 
  161,068 
  Residential real estate - Jr lien
  44,260 
  0 
  0 
  44,127 
  44,127 
  Consumer
  5,031 
  0 
  0 
  5,063 
  5,063 
MSRs (2)
  1,005 
  0 
  1,481 
  0 
  1,481 
Accrued interest receivable
  2,301 
  0 
  2,301 
  0 
  2,301 
 
    
    
    
    
    
Financial liabilities:
    
    
    
    
    
Deposits
    
    
    
    
    
  Other deposits
  573,525 
  0 
  571,952 
  0 
  571,952 
  Brokered deposits
  35,292 
  0 
  35,247 
  0 
  35,247 
Long-term borrowings
  1,550 
  0 
  1,425 
  0 
  1,425 
Repurchase agreements
  30,522 
  0 
  30,522 
  0 
  30,522 
Capital lease obligations
  267 
  0 
  267 
  0 
  267 
Subordinated debentures
  12,887 
  0 
  12,807 
  0 
  12,807 
Accrued interest payable
  113 
  0 
  113 
  0 
  113 
 
 
(1)
Prior to reclassification to the loan portfolio effective January 1, 2019, all loans in this category were reported as HTM securities as a component of Investment Securities. All prior periods have been restated to conform to the reclassification.
 
(2)
Reported fair value represents all MSRs for loans serviced by the Company at December 31, 2018, regardless of carrying amount.
 
The estimated fair values of commitments to extend credit, letters of credit and financial guarantees for the benefit of customers were immaterial at December 31, 2019 and 2018.
 
 
41
 
 
Note 23.  Condensed Financial Information (Parent Company Only)
 
The following condensed financial statements are for Community Bancorp. (Parent Company Only), and should be read in conjunction with the consolidated financial statements of the Company.
 
 
Community Bancorp. (Parent Company Only)
 December 31, 
 December 31, 
Balance Sheets
 2019 
 2018 
 
   
   
 
   
   
Assets
   
   
 
   
   
  Cash
 $744,687 
 $720,620 
  Investment in subsidiary - Community National Bank
  81,164,447 
  74,886,386 
  Investment in Capital Trust
  387,000 
  387,000 
  Income taxes receivable
  213,071 
  207,244 
        Total assets
 $82,509,205 
 $76,201,250 
 
    
    
 
    
    
Liabilities and Shareholders' Equity
    
    
 
    
    
 
    
    
 Liabilities
    
    
 
    
    
  Junior subordinated debentures
 $12,887,000 
 $12,887,000 
  Dividends payable
  727,526 
  710,539 
        Total liabilities
  13,614,526 
  13,597,539 
 
    
    
 Shareholders' Equity
    
    
 
    
    
  Preferred stock, 1,000,000 shares authorized, 15 and 20 shares issued and
    
    
    outstanding at December 31, 2019 and 2018, respectively
    
    
    ($100,000 liquidation value, per share)
  1,500,000 
  2,000,000 
  Common stock - $2.50 par value; 15,000,000 shares authorized, 5,449,857
    
    
    and 5,382,103 shares issued at December 31, 2019 and 2018, respectively
    
    
    (including 16,267 and 17,442 shares issued February 1, 2020 and 2019,
    
    
     respectively)
  13,624,643 
  13,455,258 
  Additional paid-in capital
  33,464,381 
  32,536,532 
  Retained earnings
  22,667,949 
  17,882,282 
  Accumulated other comprehensive income (loss)
  260,483 
  (647,584)
  Less: treasury stock, at cost; 210,101 shares at December 31, 2019 and 2018
  (2,622,777)
  (2,622,777)
        Total shareholders' equity
  68,894,679 
  62,603,711 
 
    
    
        Total liabilities and shareholders' equity
 $82,509,205 
 $76,201,250 
 
 
The investment in the subsidiary bank is carried under the equity method of accounting. The investment and cash, which is on deposit with the Bank, have been eliminated in consolidation.
 
 
42
 
 
 
 
Community Bancorp. (Parent Company Only)
 Years Ended December 31, 
Condensed Statements of Income
 2019 
 2018 
 
   
   
Income
   
   
   Bank subsidiary distributions
 $4,256,000 
 $4,137,000 
   Dividends on Capital Trust
  20,858 
  19,530 
      Total income
  4,276,858 
  4,156,530 
 
    
    
Expense
    
    
   Interest on junior subordinated debentures
  694,573 
  650,361 
   Administrative and other
  340,904 
  356,055 
       Total expense
  1,035,477 
  1,006,416 
 
    
    
Income before applicable income tax benefit and equity in
    
    
  undistributed net income of subsidiary
  3,241,381 
  3,150,114 
Income tax benefit
  213,071 
  207,244 
 
    
    
Income before equity in undistributed net income of subsidiary
  3,454,452 
  3,357,358 
Equity in undistributed net income of subsidiary
  5,369,994 
  5,040,174 
        Net income
 $8,824,446 
 $8,397,532 
 
 
Community Bancorp. (Parent Company Only)
 Years Ended December 31, 
Condensed Statements of Cash Flows
 2019 
 2018 
 
   
   
Cash Flows from Operating Activities
   
   
  Net income
 $8,824,446 
 $8,397,532 
  Adjustments to reconcile net income to net cash provided by
    
    
    operating activities
    
    
  Equity in undistributed net income of subsidiary
  (5,369,994)
  (5,040,174)
  (Increase) decrease in income taxes receivable
  (5,827)
  82,980 
     Net cash provided by operating activities
  3,448,625 
  3,440,338 
 
    
    
Cash Flows from Financing Activities
    
    
  Redemption of preferred stock
  (500,000)
  (500,000)
  Dividends paid on preferred stock
  (87,500)
  (103,125)
  Dividends paid on common stock
  (2,837,058)
  (2,672,985)
     Net cash used in financing activities
  (3,424,558)
  (3,276,110)
     Net increase in cash
  24,067 
  164,228 
 
    
    
Cash
    
    
  Beginning
  720,620 
  556,392 
  Ending
 $744,687 
 $720,620 
 
    
    
Cash Received for Income Taxes
 $207,244 
 $290,224 
 
    
    
Cash Paid for Interest
 $694,573 
 $650,361 
 
    
    
Dividends paid:
    
    
  Dividends declared
 $3,951,279 
 $3,799,864 
  Increase in dividends payable attributable to dividends declared
  (16,987)
  (80,078)
     Dividends reinvested
  (1,097,234)
  (1,046,801)
 
 $2,837,058 
 $2,672,985 
 
 
43
 
Note 24.  Quarterly Financial Data (Unaudited)
 
A summary of financial data for the four quarters of 2019 and 2018 is presented below:
 
2019
 March 31, 
 June 30, 
 September 30, 
 December 31, 
 
   
   
   
   
Interest income
 $7,698,368 
 $8,262,422 
 $7,906,454 
 $7,891,564 
Interest expense
  1,538,540 
  1,546,953 
  1,509,033 
  1,548,595 
Provision for loan losses
  212,503 
  141,666 
  412,499 
  299,499 
Non-interest income
  1,318,700 
  1,434,138 
  1,597,332 
  1,595,896 
Non-interest expense
  5,155,924 
  5,079,060 
  4,863,716 
  4,782,580 
Net income
  1,771,905 
  2,419,298 
  2,261,943 
  2,371,300 
Earnings per common share
  0.34 
  0.46 
  0.43 
  0.45 
 
 
2018
 March 31, 
 June 30, 
 September 30, 
 December 31, 
 
   
   
   
   
Interest income
 $6,776,838 
 $7,028,859 
 $7,517,022 
 $7,791,884 
Interest expense
  868,749 
  938,499 
  1,220,145 
  1,457,695 
Provision for loan losses
  180,000 
  180,000 
  210,000 
  210,000 
Non-interest income
  1,395,670 
  1,690,161 
  1,542,793 
  1,552,684 
Non-interest expense
  4,731,116 
  5,103,975 
  4,874,332 
  5,185,603 
Net income
  1,982,543 
  2,002,654 
  2,269,732 
  2,142,603 
Earnings per common share
  0.38 
  0.39 
  0.44 
  0.40 
 
    
    
    
    
 
 
Note 25.  Other Income and Other Expenses
 
The components of other income and other expenses which are in excess of one percent of total revenues in either of the two years disclosed are as follows:
 
 
 2019 
 2018 
Income
   
   
   Income from investment in CFS Partners
 $588,696 
 $514,485 
 
    
    
Expenses
    
    
   Outsourcing expense
 $428,668 
 $480,563 
   Service contracts - administration
  539,510 
  512,902 
   Marketing
  450,533 
  552,617 
   State deposit tax
  669,502 
  633,185 
   ATM fees
  434,270 
  412,813 
 
 
Note 26.  Subsequent Events
 
Declaration of Cash Dividend
 
On December 16, 2019, the Company declared a cash dividend of $0.19 per share payable February 1, 2020 to shareholders of record as of January 15, 2020. On March 11, 2020, the Company declared a cash dividend of $0.19 per share payable May 1, 2020 to shareholders of record as of April 15, 2020. These dividends have been recorded as of each declaration date, including shares issuable under the DRIP. 
 
For purposes of accrual or disclosure in these financial statements, the Company has evaluated subsequent events through the date of issuance of these financial statements.
 
 
44
 
 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 
For the Years Ended December 31, 2019 and 2018
 
The following discussion analyzes the consolidated financial condition of the Company and its wholly-owned subsidiary, Community National Bank, as of December 31, 2019 and 2018, and its consolidated results of operations for the years then ended. The Company is considered a “smaller reporting company” under the disclosure rules of the SEC (as amended in 2018). Accordingly, the Company has elected to provide its audited statements of income, comprehensive income, cash flows and changes in shareholders’ equity for a two year, rather than a three year, period and intends to provide smaller reporting company scaled disclosures where management deems it appropriate. Beginning with its periodic reports filed in 2018, the Company is also considered an accelerated filer under the financial reporting rules of the SEC.
 
The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes. Please refer to Note 1 in the accompanying audited consolidated financial statements for a listing of acronyms and defined terms used throughout the following discussion.
 
FORWARD-LOOKING STATEMENTS
 
This Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements about the results of operations, financial condition and business of the Company and its subsidiary. Words used in the discussion below such as "believes," "expects," "anticipates," "intends," "estimates," "plans," "predicts," or similar expressions, indicate that management of the Company is making forward-looking statements.
 
Forward-looking statements are not guarantees of future performance. They necessarily involve risks, uncertainties and assumptions. Future results of the Company may differ materially from those expressed in these forward-looking statements. Examples of forward looking statements included in this discussion include, but are not limited to, estimated contingent liability related to assumptions made within the asset/liability management process, management's expectations as to the future interest rate environment and the Company's related liquidity level, credit risk expectations relating to the Company's loan portfolio and its participation in the 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 current expectations and estimates, many of the factors that could influence or determine actual results are unpredictable and not within the Company's control. In addition, the factors set forth in Part I, Item 1A-Risk Factors in this report and other cautionary statements and information contained in this report should be carefully considered and understood as being applicable to all related forward-looking statements contained in this report, when evaluating the business prospects of the Company and its subsidiary.
 
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, including, without limitation, implementation of pending changes to the measurement of credit losses in financial statements under US GAAP pursuant to the CECL model;
●
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;
 
 
45
 
 
●
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;
●
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;
●
adverse changes in the credit rating of U.S. government debt; and
●
the planned phase out the London Interbank Offered Rate (LIBOR) by the end of 2021, which could adversely affect the Company’s interest costs in future periods on its $12,887,000 in principal amount of Junior Subordinated Debentures due December 12, 2037, which bear interest at a variable rate, adjusted quarterly, equal to 3-month LIBOR, plus 2.85%.
 
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 (NII)) 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 at year-end 2019 were $738.0 million compared to $720.3 million at year-end 2018, an increase of 2.4%. Net loans increased 4.9% to $601.4 million, driven primarily by an increase in commercial and municipal, loans with a combined increase of $29.1 million year over year, to $345.2 million. Loan growth during 2019 was also enhanced with approximately $7.2 million in purchased commercial loans from BHG and two commercial real estate loans participations totaling $5.4 million with the ACBB. Funding for these increases was provided, in part, by a $6.2 million net increase in deposits, primarily in the form of core non-maturity deposits, as well as a decrease in cash of $19.4 million. The AFS portfolio increased $6.6 million, or 16.8% for year over year. As noted in Note 1 to the accompanying audited consolidated financial statements, the Company chose to reclassify its HTM investment portfolio, which is made up entirely of obligations to local municipalities, into the loan portfolio, effective January 1, 2019. All prior period information has been adjusted accordingly. The Company had no loans held-for-sale at either year-end reporting period. Average non-maturity deposit balances increased year over year, offset in part by a modest 1.3% decline in retail CD balances as rate competition began to increase during the year, drawing away some rate-sensitive accounts. Capital grew to $68.9 million with a book value of $12.86 per common share on December 31, 2019, compared to $62.6 million in capital and a book value of $11.72 per common share on December 31, 2018.
 
The purchased loan volume mentioned above was through a new loan purchasing program with BHG. BHG originates commercial loans to medical professionals nationwide and sells them individually to a secondary market, primarily banks, through a bid process. The Bank has established conservative credit parameters and expects a low risk of default in this portfolio. Average loan size is approximately $200,000, with average term of 100 months. With average duration expected to be slightly longer than the commercial portfolio average, the Company’s participation in the BHG program reduces exposure to falling rates in the near term. In addition, this portfolio supports asset growth and provides geographic diversification.
 
 
46
 
 
The Company’s net income of $8.8 million, or $1.68 per common share, for 2019 was up 5.1%, compared to net income of $8.4 million, or $1.61 per common share, in 2018. Net interest income contributed significantly to the Company’s increase in earnings. Average earning-assets increased $34.0 million, or 5.4%, in 2019, and tax-equivalent interest income increased by $2.7 million, or 9.1%, resulting in an increase in average yield on interest-earning assets of 16 basis points. The increase in interest income is due in part to a $440,000 prepayment penalty received in the second quarter of 2019, as well as increases in short-term rates. While the increase in short-term rates has had a positive impact on interest income earlier in the year, it later put upward pressure on interest rates paid on deposit accounts and other borrowings. This pressure has lessened somewhat, at least in the near term, as short-term rates later declined in the third quarter. Please refer to the interest rate sensitivity discussion in the Interest Rate Risk and Asset and Liability Management section for more information on the impact that changes in interest rates and in the yield curve could have on net interest income.
 
Average interest-bearing liabilities increased $23.2 million, or 4.6%, during the year, and the average rate paid on interest-bearing liabilities increased 28 basis points, resulting in an increase in interest expense of $1.7 million. The combined effect of the changes in average yield and in average rate paid resulted in an increase of $1.0 million in tax-equivalent net interest income, and a slight decrease in net interest margin from 3.95% to 3.90% year over year.
 
Growth of the loan portfolio combined with charge off activity related to write-down adjustments on several loans in workout required a provision for loan losses of $1,066,167 for 2019 compared to $780,000 for 2018, an increase of 36.7%. Please refer to the ALL and provisions discussion in the Credit Risk section for more information on these increases.
 
Non-interest income decreased $235,242, or 3.8%, year over year due mostly to a one-time gain during 2018 of $263,118 from the sale of certain office premises to the Company’s affiliate CFSG. While increases are noted in salaries, wages and employee benefits, both periods were positively impacted by a decrease in other expenses due to the distribution of $164,007 in Small Bank deposit-insurance assessment credits issued by the FDIC, representing 69.5% of the Company’s total FDIC assessment for 2019.  Please refer to the Non-interest Income and Non-interest Expense sections for more information on these changes.
 
According to the State of Vermont Department of Labor, Vermont’s unemployment rate for December, 2019 was 2.3%, compared to 2.7% in December, 2018, and remains well below the national average of 3.5%. General business conditions remain stable to improving with improvements mainly in the Chittenden and Washington Counties, offset by some continued weakness in rural markets. Of the Company’s primary market areas, Orleans, Caledonia, and Essex Counties continue to have the highest unemployment rates in the state, while Washington and Franklin Counties are showing some signs of improvement running slightly below the state average. While employment numbers continue to look good, business expansion is challenged by a lack of skilled workforce. In response to the workforce challenges, the Vermont Department of Labor has placed labor force expansion at the top of its priority list and has created a State Registered Apprenticeship Program, which is an employer-sponsored training program that includes both work experience and industry-specific instruction. Travel and tourism continues to be a focus of the Vermont economy with Orleans, Caledonia and Essex Counties, in particular, focusing on the outdoor recreation economy. The 2019-2020 winter season has been favorable for outdoor recreation with plenty of snowfall and relatively mild temperatures.
 
The Company declared dividends of $0.76 per common share in 2019 compared to $0.74 per common share in 2018. As of December 31, 2019, the Company reported retained earnings of $22.7 million, compared to $17.9 million as of December 31, 2018 and total shareholders’ equity of $68.9 million and $62.6 million, respectively. The Company is committed to remaining a well-capitalized community bank, working to meet the needs of our customers while providing a fair return to our shareholders.
 
CRITICAL ACCOUNTING POLICIES
 
The Company’s consolidated financial statements are prepared according to US GAAP. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities in the consolidated financial statements and related notes. The SEC has defined a company’s critical accounting policies as those that are most important to the portrayal of the Company’s financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Because of the significance of these estimates and assumptions, there is a high likelihood that materially different amounts would be reported for the Company under different conditions or using different assumptions or estimates. Management evaluates on an ongoing basis its judgment as to which policies are considered to be critical.
 
ALL - Management believes that the calculation of the ALL is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. In estimating the ALL, management considers historical experience as well as other qualitative factors, including the effect of current economic indicators and their probable impact on borrowers and collateral, trends in delinquent and non-performing loans, trends in criticized and classified assets, levels of exceptions, the impact of competition in the market, 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. Management’s estimates used in calculating the ALL may increase or decrease based on changes in these factors, which in turn will affect the amount of the Company’s provision for loan losses charged against current period income. This evaluation is inherently subjective and actual results could differ significantly from these estimates under different assumptions, judgments or conditions.
 
47
 
 
OREO – Real estate properties acquired through or in lieu of foreclosure or properties no longer used for bank operations, are initially recorded at fair value less estimated selling cost at the date of acquisition, foreclosure or transfer. Fair value is determined, as appropriate, either by obtaining a current appraisal or evaluation prepared by an independent, qualified appraiser, by obtaining a broker’s market value analysis, and finally, if the Company has limited exposure and limited risk of loss, by the opinion of management as supported by an inspection of the property and its most recent tax valuation. During periods of declining market values, the Company will generally obtain a new appraisal or evaluation. The amount, if any, by which the recorded amount of the loan exceeds the fair value, less estimated cost to sell, is a loss which is charged to the allowance for loan losses at the time of foreclosure or repossession. The recorded amount of the loan is the loan balance adjusted for any unamortized premium or discount and unamortized loan fees or costs, less any amount previously charged off, plus recorded accrued interest. After acquisition through or in lieu of foreclosure, these assets are carried at the lower of their new cost basis or fair value. Costs of significant property improvements are capitalized, whereas costs relating to holding the property are expensed as incurred. Appraisals by an independent, qualified appraiser are performed periodically on properties that management deems significant, or evaluations may be performed by management or a qualified third party on properties in the portfolio that are deemed less significant or less vulnerable to market conditions. Subsequent write-downs are recorded as a charge to other expense. Gains or losses on the sale of such properties are included in income when the properties are sold.
 
Investment Securities - Management performs quarterly reviews of individual debt securities in the investment portfolio to determine whether a decline in the fair value of a security is other than temporary. A review of OTTI requires management to make certain judgments regarding the materiality of the decline and the probability, extent and timing of a valuation recovery, the Company’s intent to continue to hold the security and, in the case of debt securities, the likelihood that the Company will not have to sell the security before recovery of its cost basis. Management assesses fair value declines to determine the extent to which such changes are attributable to fundamental factors specific to the issuer, such as financial condition and business prospects, or to market-related or other external factors, such as interest rates, and in the case of debt securities, the extent to which the impairment relates to credit losses of the issuer, as compared to other factors. Declines in the fair value of debt securities below their cost that are deemed to be other than temporary, and declines in fair value of debt securities below their cost that are related to credit losses, are recorded in earnings as realized losses, net of tax effect. The non-credit loss portion of an other than temporary decline in the fair value of debt securities below their cost basis (generally, the difference between the fair value and the estimated net present value of expected future cash flows from the debt security) is recognized in other comprehensive income as an unrealized loss, provided that the Company does not intend to sell the security and it is more likely than not that the Company will not have to sell the security before recovery of its reduced basis.
 
MSRs - MSRs associated with loans originated and sold, where servicing is retained, are required to be capitalized and initially recorded at fair value on the acquisition date and are subsequently accounted for using the “amortization method”. Mortgage servicing rights are amortized against non-interest income in proportion to, and over the period of, estimated future net servicing income of the underlying financial assets. The value of capitalized servicing rights represents the estimated present value of the future servicing fees arising from the right to service loans for third parties. The carrying value of the mortgage servicing rights is periodically reviewed for impairment based on a determination of estimated fair value compared to amortized cost, and impairment, if any, is recognized through a valuation allowance and is recorded as a reduction of non-interest income. Subsequent improvement (if any) in the estimated fair value of impaired mortgage servicing rights is reflected in a positive valuation adjustment and is recognized in non-interest income up to (but not in excess of) the amount of the prior impairment. Critical accounting policies for mortgage servicing rights relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of mortgage servicing rights requires the development and use of a number of estimates, including anticipated principal amortization and prepayments. Factors that may significantly affect the estimates used are changes in interest rates and the payment performance of the underlying loans. The Company analyzes and accounts for the value of its servicing rights with the assistance of a third party consultant.
 
Goodwill - Goodwill from an acquisition accounted for under the purchase accounting method, such as the Company’s 2007 acquisition of LyndonBank, is subject to ongoing periodic impairment evaluation, which includes an analysis of the ongoing assets, liabilities and revenues from the acquisition and an estimation of the impact of business conditions. This evaluation is inherently subjective.
 
 
48
 
 
Other - Management utilizes numerous techniques to estimate the carrying value of various assets held by the Company, including, but not limited to, bank premises and equipment and deferred taxes. The assumptions considered in making these estimates are based on historical experience and on various other factors that are believed by management to be reasonable under the circumstances. The use of different estimates or assumptions could produce different estimates of carrying values and those differences could be material in some circumstances.
 
RESULTS OF OPERATIONS
 
The Company’s net income increased $426,914, or 5.1%, from 2018 to 2019, resulting in earnings per common share of $1.68 for 2019 versus $1.61 for 2018. Net interest income (core earnings) increased $986,172, or 4.0%, for 2019 compared to 2018. This increase in core earnings is attributable to an increase of $2.6 million, or 9.1% in interest income, which included a $440,000 prepayment penalty, versus an increase of $1.7 million, or 37.0%, in interest expense, year over year. The increase in interest expense is largely the result of higher rates paid on deposit accounts, which have lagged behind increases in the Fed funds rate during the prior year.
 
Non-interest income decreased $235,242, or 3.8%, from 2018 to 2019. A one-time gain of $263,118 in 2018, on the Company’s sale of an office condominium unit to CFSG that it was renting prior to the one-time sale, accounted for most of this decrease in 2019 versus 2018. The largest component of non-interest income for 2019 was deposit service fee income, which noted a moderate increase of $74,879, or 2.3%, primarily from an increase in fee income from interchange fees and overdraft charges. This increase was offset by a decrease in income from sold loans of $74,316, or 9.5% year over year. Originations of residential mortgage loans sold in the secondary market totaled $13.8 million in 2019 compared to $13.4 million in 2018, a 3.0% increase, with net gains from the sales of these mortgages of $290,116 in 2019, compared to $345,780 in 2018, a decrease of $55,664, or 16.1%. Servicing released loans, a component of secondary market loans, generate more income at origination due to the lack of serving income over the life of the loan. The volume of originations of these loans decreased in 2019 compared to 2018, accounting for most of the $55,664 decrease in net gains from sales of loans. Income from fees related to other loan activity increased $24,269, or 2.8%, and while increased commercial loan activity resulted in an increase in commercial loan documentation fees of $43,297, or 8.8%, decreased residential mortgage loan volume resulted in a decrease in residential loan related fees, including home equity loan related fees of $28,290, or 13.5%.
 
Non-interest expense decreased by $13,746, or 0.1%. While some operating expenses increased, most notably an increase in employee benefits of $238,583, or 8.3%, however, increases were partially offset by a $205,320 decrease in FDIC Insurance due to the Small Bank deposit-insurance assessment credits issued by the FDIC in the third quarter. Please refer to the non-interest income and non-interest expense section of this report for more details on other significant changes.
 
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, as well as other equity ratios, for each of the last three fiscal years:
 
December 31,
 2019 
 2018 
 2017 
 
   
   
   
Return on average assets
  1.24%
  1.24%
  0.96%
Return on average equity
  13.91%
  14.08%
  11.16%
Dividend payout ratio (1)
  45.24%
  45.96%
  56.20%
Average equity to average assets ratio
  8.92%
  8.83%
  8.58%
 
(1) Dividends declared per common share divided by earnings per common share.
  
 
49
 
 
 
The following table summarizes the earnings performance and certain balance sheet and per share data of the Company during each of the last five fiscal years:
 
As of December 31,
 2019 
 2018 
 2017 
 2016 
 2015 
 
   
   
   
   
   
Balance Sheet Data
   
   
   
   
   
Net loans (1)
 $601,424,861 
 $573,211,590 
 $546,570,168 
 $532,167,542 
 $496,778,461 
Total assets
  737,955,319 
  720,347,498 
  667,045,595 
  637,653,665 
  596,134,709 
Total deposits
  615,021,368 
  608,816,565 
  560,634,980 
  504,735,032 
  495,485,562 
Borrowed funds
  2,650,000 
  1,550,000 
  3,550,000 
  31,550,000 
  10,000,000 
Junior subordinated debentures
  12,887,000 
  12,887,000 
  12,887,000 
  12,887,000 
  12,887,000 
Total liabilities
  669,060,640 
  657,743,787 
  609,109,741 
  583,202,148 
  544,720,053 
Total shareholders' equity
  68,894,679 
  62,603,711 
  57,935,854 
  54,451,517 
  51,414,656 
 
    
    
    
    
    
Years Ended December 31,
    
    
    
    
    
 
    
    
    
    
    
Operating Data
    
    
    
    
    
Total interest income
 $31,758,808 
 $29,114,603 
 $26,440,949 
 $24,248,114 
 $23,406,689 
Total interest expense
  6,143,121 
  4,485,088 
  3,068,390 
  2,699,299 
  2,645,650 
  Net interest income
  25,615,687 
  24,629,515 
  23,372,559 
  21,548,815 
  20,761,039 
 
    
    
    
    
    
Provision for loan losses
  1,066,167 
  780,000 
  650,000 
  500,000 
  510,000 
  Net interest income after
    
    
    
    
    
  provision for loan losses
  24,549,520 
  23,849,515 
  22,722,559 
  21,048,815 
  20,251,039 
 
    
    
    
    
    
Non-interest income
  5,946,066 
  6,181,308 
  5,584,392 
  5,501,899 
  5,150,155 
Non-interest expense
  19,881,280 
  19,895,026 
  19,166,323 
  19,142,524 
  18,810,973 
  Income before income taxes
  10,614,306 
  10,135,797 
  9,140,628 
  7,408,190 
  6,590,221 
Applicable income tax expense (2)
  1,789,860 
  1,738,265 
  2,909,330 
  1,923,912 
  1,764,630 
   Net income
 $8,824,446 
 $8,397,532 
 $6,231,298 
 $5,484,278 
 $4,825,591 
 
    
    
    
    
    
Per Share Data
    
    
    
    
    
Earnings per common share (3)
 $1.68 
 $1.61 
 $1.21 
 $1.07 
 $0.96 
Dividends declared per common share
 $0.76 
 $0.74 
 $0.68 
 $0.64 
 $0.64 
Book value per common share outstanding
 $12.86 
 $11.72 
 $10.84 
 $10.27 
 $9.79 
Weighted average number of common
    
    
    
    
    
  shares outstanding
  5,204,768 
  5,139,297 
  5,084,102 
  5,024,270 
  4,961,972 
Number of common shares outstanding,
    
    
    
    
    
  period end
  5,239,756 
  5,172,002 
  5,112,219 
  5,058,952 
  4,994,416 
 
 
(1) Net loans reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio
     as of January 1, 2019 and conforming changes to the comparative information presented for all prior periods. See Note 1
     to the accompanying audited consolidated financial statements for additional information.
(2) Applicable income tax expense assumes a 21% tax rate for 2019 and 2018 and a 34% tax rate for 2017, 2016 and 2015.
(3) Computed based on the weighted average number of common shares outstanding during the periods presented.
 
 
50
 
 
INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME)
 
The largest component of the Company’s operating income is net interest income, which is the difference between interest earned on loans and investments versus the interest paid on deposits and other sources of funds (i.e., other borrowings). The Company’s level of net interest income can fluctuate over time due to changes in the level and mix of earning assets, and sources of funds (volume) and from changes in the yield earned and the cost of funds (rate paid). A portion of the Company’s income from municipal loans 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 across years, the non-taxable income shown in the tables below has been converted to a tax equivalent basis. The Company’s corporate tax rate was 21% for 2019 and 2018, and 34% for previous years. Therefore, to equalize tax-free and taxable income in the comparison, we divide the tax-free income by 79% for 2019 and 2018, and 66% for prior years, with the result that every tax-free dollar is equivalent to $1.27 and $1.52 in taxable income, respectively.
 
Tax-exempt income is derived from municipal loans, amounting to $55.8 million, $47.1 million and $48.8 million, at December 31, 2019, 2018 and 2017, respectively.
 
The following table provides the reconciliation between net interest income presented in the consolidated statements of income and the non-GAAP tax equivalent net interest income presented in the table immediately following for each of the last three years.
 
 
Years Ended December 31,
 2019 
 2018 
 2017 
 
 (Dollars in Thousands) 
 
   
   
   
Net interest income as presented
 $25,616 
 $24,630 
 $23,373 
Effect of tax-exempt income
  364 
  344 
  684 
   Net interest income, tax equivalent
 $25,980 
 $24,974 
 $24,057 
 
  
The following table presents average earning assets and average interest-bearing liabilities supporting earning assets for each of the last three fiscal years. Interest income (excluding interest on non-accrual loans) and interest expense are both expressed on a tax equivalent basis, both in dollars and as a rate/yield.
 
 
 Years Ended December 31, 
 
   
 2019 
   
   
 2018 
   
   
 2017 
   
 
   
   
 Average 
   
   
 Average 
   
   
 Average 
 
 Average 
 Income/ 
 Rate/ 
 Average 
 Income/ 
 Rate/ 
 Average 
 Income/ 
 Rate/ 
 
 Balance 
 Expense 
 Yield 
 Balance 
 Expense 
 Yield 
 Balance 
 Expense 
 Yield 
 
 (Dollars in Thousands) 
Interest-Earning Assets
   
   
   
   
   
   
   
   
   
 
   
   
   
   
   
   
   
   
   
 Loans (1)
 $591,616 
 $30,247 
  5.11%
 $568,511 
 $27,954 
  4.92%
 $549,974 
 $26,116 
  4.75%
 Taxable investment securities
  43,334 
  1,089 
  2.51%
  38,372 
  895 
  2.33%
  35,758 
  676 
  1.89%
 Sweep and interest-earning accounts
  29,625 
  686 
  2.32%
  23,256 
  484 
  2.08%
  12,331 
  160 
  1.30%
 Other investments (2)
  1,784 
  101 
  5.66%
  2,249 
  126 
  5.60%
  2,430 
  173 
  7.12%
     Total
 $666,359 
 $32,123 
  4.82%
 $632,388 
 $29,459 
  4.66%
 $600,493 
 $27,125 
  4.52%
Interest-Bearing Liabilities
    
    
    
    
    
    
    
    
    
 
    
    
    
    
    
    
    
    
    
 Interest-bearing transaction accounts
 $161,887 
 $1,523 
  0.94%
 $137,547 
 $865 
  0.63%
 $122,521 
 $324 
  0.26%
 Money market accounts
  94,704 
  1,451 
  1.53%
  91,641 
  1,057 
  1.15%
  86,142 
  782 
  0.91%
 Savings deposits
  96,088 
  162 
  0.17%
  98,154 
  136 
  0.14%
  96,551 
  124 
  0.13%
 Time deposits
  120,937 
  1,988 
  1.64%
  122,499 
  1,489 
  1.22%
  124,134 
  1,126 
  0.91%
 Borrowed funds
  1,996 
  8 
  0.40%
  5,462 
  70 
  1.28%
  9,975 
  65 
  0.65%
 Repurchase agreements
  33,546 
  299 
  0.89%
  30,555 
  191 
  0.63%
  28,950 
  87 
  0.30%
 Finance lease obligations
  197 
  17 
  8.63%
  320 
  27 
  8.44%
  430 
  35 
  8.14%
 Junior subordinated debentures
  12,887 
  695 
  5.39%
  12,887 
  650 
  5.04%
  12,887 
  525 
  4.07%
     Total
 $522,242 
 $6,143 
  1.18%
 $499,065 
 $4,485 
  0.90%
 $481,590 
 $3,068 
  0.64%
 
    
    
    
    
    
    
    
    
    
Net interest income
    
 $25,980 
    
    
 $24,974 
    
    
 $24,057 
    
Net interest spread (3)
    
    
  3.64%
    
    
  3.76%
    
    
  3.88%
Net interest margin (4)
    
    
  3.90%
    
    
  3.95%
    
    
  4.01%
 
(1)
Included in gross loans are non-accrual loans with an average balance of $5.1 million, $4.0 million and $2.6 million for the years ended December 31, 2019, 2018 and 2017, respectively. Loans are stated before deduction of unearned discount and ALL, less loans held-for-sale and includes tax-exempt loans to local municipalities with average balances of $49.2 million, $48.8 million and $52.1 million for the years ended December 31, 2019, 2018, 2017, respectively which were reclassified from the investment portfolio effective January 1, 2019, and restated for the 2018 and 2017 comparison periods. See Note 1 to the accompanying audited consolidated financial statements for additional information.
(2)
Included in other investments is the Company’s FHLBB Stock with an average balance of $1.0 million, $1.2 million and $1.5 million, respectively, for 2019, 2018 and 2017 and a dividend rate of approximately 6.04%, 5.92% and 4.24%, respectively.
(3)
Net interest spread is the difference between the average yield on average 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.
 
 
51
 
 
The average volume of interest-earning assets for the year ended December 31, 2019 increased 5.4% compared to December 31, 2018, which increased 5.3% compared to December 31, 2017. Average yield on interest-earning assets increased 16 basis points and 14 basis points for the respective comparison periods.
 
The average volume of loans increased 4.1% for 2019 versus 2018, and 3.4% for 2018 versus 2017, while the average yield on loans increased 19 basis points to 5.11% for 2019 compared to an increase of 17 basis points, to 4.92% for 2018 versus 2017. The increase in yield during 2019 was partially due to a $440 thousand loan prepayment penalty which added 6 basis points to the annual yield. The remaining increase was due to loans repricing higher during the year, and a shift in asset mix toward commercial loans; however, this increase was partially offset by continued pressure on medium term (5-10 year) fixed rates. The growth in the average volume of loans during each of the last three years, along with the increase in average yield on loans, were reflected in increases in interest earned on the loan portfolio of $2.3 million in 2019 compared to 2018 and $1.8 million in 2018 compared to 2017. Interest earned on the loan portfolio as a percentage of total interest income was approximately 94.2%, 94.9% and 96.3%, respectively for 2019, 2018 and 2017.
 
The average volume of the taxable investment portfolio (classified as AFS) increased 21.7% for 2019 versus 2018 and 7.3% for 2018 versus 2017, and the average yield on the taxable investment portfolio increased 18 basis points and 44 basis points, respectively. The increase in both comparison periods is due primarily to an effort to continue to grow the investment portfolio incrementally as the balance sheet grows in order to provide additional liquidity and pledge quality assets.
 
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 27.4% during 2019 and 88.6% during 2018. This increase in volume is attributable to a higher balance of cash periodically held on hand in anticipation of funding loan growth and other liquidity needs. The average yield on these funds increased 24 basis points and 78 basis points, respectively, reflecting the changes in Fed Funds rate throughout the comparison periods.
 
The average volume of interest-bearing liabilities for the year ended December 31, 2019 increased 4.6% compared to December 31, 2018, and increased 3.6% at December 31, 2018 compared to December 31, 2017. The average rate paid on interest-bearing liabilities increased 28 basis points during 2019 and 26 basis points during 2018.
 
The average volume of interest-bearing transaction accounts increased 17.7% for 2019 versus 2018 and 12.3% for 2018 versus 2017, reflecting strong deposit growth during both periods. The average rate paid on these accounts increased 31 basis points for 2019 versus 2018 and 37 basis points for 2018 versus 2017, reflecting the rising rate environment and competitive pressures on deposit pricing.
 
The average volume of money market accounts increased 3.4% during 2019 and 6.4% during 2018, and the average rate paid on these deposits increased 38 basis points during 2019 and 24 basis points during 2018.
 
The average volume of savings accounts decreased by 2.1% for 2019 versus 2018, but increased by 1.7% for 2018 versus 2017, while the average rate paid on these accounts remained relatively stable. With the recovery in market CD rates, funds have begun migrating back toward CDs, which typically impacts savings account balances.
 
The average volume of time deposits decreased 1.3% for 2019 and 2018, while the average rate paid increased 42 basis points and 31 basis points, respectively. Interest paid on time deposits as a percentage of total interest expense was 32.4%, 33.2% and 36.7%, respectively for 2019, 2018 and 2017. Following the increase in short term rates, there was pressure for higher rates from the more rate sensitive deposit holders with the local market willing to pay higher rates on deposit products. This pressure has lessened with the reduction in interest rates in the third quarter of 2019. Management still considers the brokered deposit market to be 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 63.5% for 2019 versus 2018 and 45.2% for 2018 versus 2017, reflecting an increase in core deposits and brokered deposits to fund loan growth during both periods. The average rate paid on these accounts decreased 88 basis points during 2019 to 0.40%, but increased 63 basis points to 1.28% during 2018 compared 0.65% for 2017.
 
The average volume of repurchase agreements increased 9.8% during 2019 and 5.5% during 2018, and the average rate paid on repurchase agreements increased 26 basis points 0.89% for 2019 versus 2018 and 33 basis points to 0.63% for 2018 versus 2017.
 
In summary, the average yield on interest-earning assets increased 16 basis points during 2019, while the average rate paid on interest-bearing liabilities increased 28 basis points. During 2018, the average yield on interest-earning assets increased 14 basis points, while the average rate paid on interest-bearing liabilities increased 26 basis points. Net interest spread decreased 12 basis points in both comparison periods with 3.64% for 2019 compared to 3.76% for 2018, and 3.88% for 2017. Net interest margin decreased five basis points during 2019 to 3.90%, and six basis points to 3.95% for 2018, compared to 4.01% for 2017.
 
 
52
 
 
The following table summarizes the variances in income for the years presented, resulting from volume changes in interest-earning assets and interest-bearing liabilities and fluctuations in rates earned and paid compared to the prior year.
 
 
 2019 versus 2018 
 2018 versus 2017 
 
 Variance 
 Variance 
   
 Variance 
 Variance 
   
 
 Due to 
 Due to 
 Total 
 Due to 
 Due to 
 Total 
 
 Rate (1) 
 Volume (1) 
 Variance 
 Rate (1) 
 Volume (1) 
 Variance 
 
 (Dollars in Thousands) 
Average Interest-Earning Assets
   
   
   
   
   
   
 Loans (2)
 $1,156 
 $1,137 
 $2,293 
 $957 
 $881 
 $1,838 
 Taxable investment securities
  78 
  116 
  194 
  170 
  49 
  219 
 Sweep and interest-earning accounts
  70 
  132 
  202 
  182 
  142 
  324 
 Other investments
  1 
  (26)
  (25)
  (37)
  (10)
  (47)
     Total
 $1,305 
 $1,359 
 $2,664 
 $1,272 
 $1,062 
 $2,334 
 
    
    
    
    
    
    
Average Interest-Bearing Liabilities
    
    
    
    
    
    
 Interest-bearing transaction accounts
 $505 
 $153 
 $658 
 $502 
 $39 
 $541 
 Money market accounts
  359 
  35 
  394 
  225 
  50 
  275 
 Savings deposits
  30 
  (4)
  26 
  10 
  2 
  12 
 Time deposits
  525 
  (26)
  499 
  383 
  (20)
  363 
 Borrowed funds
  (48)
  (14)
  (62)
  63 
  (58)
  5 
 Repurchase agreements
  89 
  19 
  108 
  99 
  5 
  104 
 Finance lease obligations
  1 
  (11)
  (10)
  1 
  (9)
  (8)
 Junior subordinated debentures
  45 
  0 
  45 
  125 
  0 
  125 
     Total
 $1,506 
 $152 
 $1,658 
 $1,408 
 $9 
 $1,417 
 
    
    
    
    
    
    
       Changes in net interest income
 $(201)
 $1,207 
 $1,006 
 $(136)
 $1,053 
 $917 
 
 
(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) Reflects reclassification of obligations of local municipalities from investment securities to loans effective January 1, 2019, and restated for the 2018 and 2017 comparison periods. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
 
53
 
 
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
 
Non-interest Income
 
The components of non-interest income for the annual periods presented are as follows:
 
 
 Years Ended 
   
   
 
 December 31, 
 Change 
 
 2019 
 2018 
 Income 
 Percent 
 
   
   
   
   
Service fees
 $3,313,833 
 $3,238,954 
 $74,879 
  2.31%
Income from sold loans
  706,306 
  780,622 
  (74,316)
  -9.52%
Other income from loans
  904,156 
  879,887 
  24,269 
  2.76%
Net realized loss on sale of securities AFS
  (26,490)
  (32,718)
  6,228 
  19.04%
Other income
    
    
    
    
  Income from CFS Partners
  588,696 
  514,486 
  74,210 
  14.42%
  Rental income
  9,821 
  30,365 
  (20,544)
  -67.66%
  Gain on sale of property
  0 
  263,118 
  (263,118)
  100.00%
  VISA card commission
  70,994 
  93,377 
  (22,383)
  -23.97%
  Service fee NMTC
  0 
  43,602 
  (43,602)
  -100.00%
  Other miscellaneous income
  378,750 
  369,615 
  9,135 
  2.47%
     Total non-interest income
 $5,946,066 
 $6,181,308 
 $(235,242)
  -3.81%
 
 
Total non-interest income decreased by $235,242 for the year ended December 31, 2019 compared to the same period 2018, with significant changes noted in the following:
 
●
Interchange fees, a component of Service Fees, increased $55,279 for the year due to an increase in debit card transaction activity, accounting for most of the increase year over year.
 
●
Income from sold loans decreased $74,316, or 9.5% as a result of a slowdown in residential mortgage lending activity, as well as the decrease in originations of servicing released loans as mentioned earlier in the Results of Operations section.
 
●
Realized losses on the sale of debt securities AFS of $26,490 for 2019 and $32,718 for 2018, resulted in a 19.0% reduction in net realized loss on sale of such securities between periods. During 2019, the Company continued to sell off low-yielding, short-duration securities held in the Company’s AFS portfolio, which were replaced with higher-yielding investments available in the current market.
 
●
Income from the Company’s trust and investment management affiliate, CFS Partners, increased $74,210, or 14.4%, for the year. This increase was mostly due to strong new business development during the year that provided an increase in fee income.
 
●
Rental income decreased $20,544, or 67.7%, for 2019 due to the Company’s sale of an office condominium unit to CFS Partner’s subsidiary, CFSG, during the second quarter of 2018. Prior to the sale, CFSG had rented this unit from the Company since its formation in 2002.
 
●
Gain on sale of property of $263,118 during 2018 was attributable to the sale of an office condominium unit to the Company’s affiliate, CFSG, during the second quarter of 2018. There was no activity in 2019 that resulted in a gain on sale of property.
 
●
VISA card commission income decreased $22,383 in 2019. The incentive premium program began in 2018, and included a higher “1st year” incentive premium.
 
●
A servicing fee of $43,602, related to a NMTC investment, was recorded in 2018. There was no servicing fee in 2019 as the Company exited this investment in 2018.
 
 
 
54
 
 
Non-interest Expense
 
The components of non-interest expense for the annual periods presented are as follows:
 
 
 Years Ended 
   
   
 
 December 31, 
 Change 
 
 2019 
 2018 
 Expense 
 Percent 
 
   
   
   
   
Salaries and wages
 $7,271,722 
 $7,203,001 
 $68,721 
  0.95%
Employee benefits
  3,118,631 
  2,880,048 
  238,583 
  8.28%
Occupancy expenses, net
  2,605,995 
  2,545,959 
  60,036 
  2.36%
Other expenses
    
    
    
    
  Outsourcing expense
  428,668 
  480,563 
  (51,895)
  -10.80%
  Service contracts - administrative
  539,510 
  512,902 
  26,608 
  5.19%
  Marketing expense
  450,533 
  552,617 
  (102,084)
  -18.47%
  FDIC insurance
  69,452 
  274,772 
  (205,320)
  -74.72%
  Audit fees
  407,303 
  448,439 
  (41,136)
  -9.17%
  Consultant services
  217,352 
  276,972 
  (59,620)
  -21.53%
  Collection & non-accruing loan expense
  185,963 
  145,009 
  40,954 
  28.24%
  Subsequent write downs on OREO
  95,008 
  78,447 
  16,561 
  21.11%
  Other miscellaneous expenses
  4,491,143 
  4,496,297 
  (5,154)
  -0.11%
     Total non-interest expense
 $19,881,280 
 $19,895,026 
 $(13,746)
  -0.07%
 
 
Total non-interest expense decreased $13,746, or 0.1%, for the year 2019 compared to the same period in 2018, with significant changes in “Other expenses” categories noted in the following:
 
●
Employee benefits increased $238,583, or 8.3%, due to an increase in the cost of the employee health insurance plan.
 
●
Outsourcing expense decreased $51,895, or 10.8%, year over year primarily due to credits received from the company core processing system toward current year expense.
 
●
Marketing expense decreased $102,084, or 18.5%, year over year due to a delay in the scheduled creation of promotional television commercials.
 
●
FDIC insurance decreased $205,320, or 74.7%, due in part to the “Small Bank Assessment Credit” issued during the third quarter of 2019, as well as a reduction in the multiplier used to calculate the quarterly assessments. This credit eliminated the assessments due during the third and fourth quarters of 2019, and the remainder of the credit ($56,113) will be applied to the assessment due in the first quarter of 2020.
 
●
Audit fees decreased $41,136, or 9.2%, year over year due mostly to increased audit requirements in 2018 on internal control over financial reporting as the Company transitioned to accelerated filer status for SEC reporting purposes, as well as multiple audits during the 2018 calendar year resulting from a change in Information Security audit vendors.
 
●
Consultant services decreased $59,620, or 21.5%, year over year mostly due to the completion of some technology projects in 2018.
 
●
Collections & non-accruing loan expense increased $40,954, or 28.2%, year over year mostly due to an increase in the non-performing assets portfolio and the length of time, and the associated costs, it takes to go through the foreclosure process.
 
●
The Company recorded write downs of two OREO properties in 2019 compared to one OREO property in 2018, all of which were subsequently sold.
 
APPLICABLE INCOME TAXES
 
Income before income taxes increased $478,509, or 4.7% for 2019 compared to 2018, accounting for the increase in the provision for income taxes of $51,595, or 3.0%. Tax credits from affordable housing investments decreased $22,130, or 5.1%, from $437,229 in 2018 to $415,099 in 2019.
 
55
 
 
Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $312,106 and $410,061 for 2019 and 2018, respectively. These investments provide tax benefits, including tax credits, and are designed to provide an effective yield between 7% and 10%.
 
CHANGES IN FINANCIAL CONDITION
 
The following table provides a visual comparison of the breakdown of average assets and average liabilities as well as average shareholders' equity for the comparison periods and should be reviewed in conjunction with the table on the following page which provides volume changes and percent of change by category.
 
Years Ended December 31,
 2019 
 2018 
 2017 
 
 Balance 
 % 
 Balance 
 % 
 Balance 
 % 
 
 (Dollars in Thousands) 
Average Assets
   
   
   
   
   
   
Cash and due from banks
   
   
   
   
   
   
 Non-interest bearing
 $11,043 
  1.55%
 $10,838 
  1.61%
 $16,427 
  2.53%
 Federal funds sold and overnight deposits
  29,625 
  4.17%
  23,256 
  3.44%
  12,331 
  1.90%
Taxable investment securities
  43,591 
  6.13%
  38,372 
  5.69%
  35,758 
  5.50%
Other securities
  1,397 
  0.20%
  1,862 
  0.28%
  2,043 
  0.31%
  Total investment securities
  44,988 
  6.33%
  40,234 
  5.97%
  37,801 
  5.81%
Gross loans (1)
  591,908 
  83.23%
  568,860 
  84.29%
  550,490 
  84.65%
ALL and deferred net loan costs
  (5,444)
  -0.77%
  (5,176)
  -0.77%
  (5,073)
  -0.78%
Premises and equipment
  10,973 
  1.54%
  9,958 
  1.47%
  10,619 
  1.63%
OREO
  188 
  0.03%
  278 
  0.04%
  377 
  0.06%
Investment in Capital Trust
  387 
  0.05%
  387 
  0.06%
  387 
  0.06%
BOLI
  4,855 
  0.68%
  4,765 
  0.71%
  4,670 
  0.72%
CDI
  0 
  0.00%
  0 
  0.00%
  129 
  0.02%
Goodwill
  11,574 
  1.63%
  11,574 
  1.71%
  11,574 
  1.78%
Other assets
  11,067 
  1.56%
  9,835 
  1.46%
  10,574 
  1.63%
     Total average assets
 $711,164 
  100%
 $674,809 
  100%
 $650,306 
  100%
Average Liabilities
    
    
    
    
    
    
Demand deposits
 $120,689 
  16.97%
 $113,412 
  16.81%
 $109,920 
  16.90%
Interest-bearing transaction accounts
  161,887 
  22.76%
  137,547 
  20.38%
  122,521 
  18.84%
Money market funds
  94,704 
  13.32%
  91,642 
  13.58%
  86,141 
  13.25%
Savings accounts
  96,088 
  13.51%
  98,154 
  14.55%
  96,551 
  14.85%
Time deposits
  120,937 
  17.01%
  122,499 
  18.15%
  124,134 
  19.09%
     Total average deposits
  594,305 
  83.57%
  563,254 
  83.47%
  539,267 
  82.93%
 
    
    
    
    
    
    
Borrowed funds
  1,996 
  0.28%
  5,462 
  0.81%
  9,975 
  1.53%
Repurchase agreements
  33,546 
  4.72%
  30,555 
  4.53%
  28,950 
  4.45%
Junior subordinated debentures
  12,887 
  1.81%
  12,887 
  1.91%
  12,887 
  1.98%
Other liabilities
  4,998 
  0.70%
  3,019 
  0.45%
  3,408 
  0.53%
     Total average liabilities
  647,732 
  91.08%
  615,177 
  91.17%
  594,487 
  91.42%
Average Shareholders' Equity
    
    
    
    
    
    
Preferred stock
  1,618 
  0.23%
  2,119 
  0.31%
  2,500 
  0.38%
Common stock
  13,527 
  1.90%
  13,367 
  1.98%
  13,230 
  2.03%
Additional paid-in capital
  32,925 
  4.63%
  32,000 
  4.74%
  31,159 
  4.79%
Retained earnings
  18,061 
  2.54%
  15,563 
  2.31%
  11,623 
  1.79%
Less: Treasury stock
  (2,623)
  -0.37%
  (2,623)
  -0.39%
  (2,623)
  -0.40%
Accumulated other comprehensive loss
  (76)
  -0.01%
  (794)
  -0.12%
  (70)
  -0.01%
     Total average shareholders' equity
  63,432 
  8.92%
  59,632 
  8.83%
  55,819 
  8.58%
     Total average liabilities and shareholders' equity
 $711,164 
  100%
 $674,809 
  100%
 $650,306 
  100%
 
(1)
Gross loans reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio as of January 1, 2019 and conforming changes to the comparative 2018 and 2017 information presented. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
 
56
 
 
 
The following table provides a breakdown of volume changes and percent of change by category for the table on the preceding page. Please refer to the sections labeled “Interest Income and Interest Expense (Net Interest Income)” and “Liquidity and Capital Resources” for more in-depth discussion of significant changes.
 
Years Ended December 31,
 2019 
 2018 
 2017 
 2019 vs 2018 
 2018 vs 2017 
 
 Average 
 Average 
 Average 
 Volume 
 % of 
 Volume 
 % of 
Average Assets
 Balance 
 Balance 
 Balance 
 Change 
 Change 
 Change 
 Change 
 
 (Dollars in Thousands) 
Cash and due from banks
   
   
   
   
   
   
   
 Non-interest bearing
 $11,043 
 $10,838 
 $16,427 
 $205 
  1.89%
 $(5,589)
  -34.02%
 Federal funds sold and overnight deposits
  29,625 
  23,256 
  12,331 
  6,369 
  27.39%
  10,925 
  88.60%
Taxable investment securities
  43,591 
  38,372 
  35,758 
  5,219 
  13.60%
  2,614 
  7.31%
Other securities
  1,397 
  1,862 
  2,043 
  (465)
  -24.97%
  (181)
  -8.86%
  Total investment securities
  44,988 
  40,234 
  37,801 
  4,754 
  11.82%
  2,433 
  6.44%
Gross loans (1)
  591,908 
  568,860 
  550,490 
  23,048 
  4.05%
  18,370 
  3.34%
ALL and deferred net loan costs
  (5,444)
  (5,176)
  (5,073)
  (268)
  5.18%
  (103)
  2.03%
Premises and equipment
  10,973 
  9,958 
  10,619 
  1,015 
  10.19%
  (661)
  -6.22%
OREO
  188 
  278 
  377 
  (90)
  -32.37%
  (99)
  -26.26%
Investment in Capital Trust
  387 
  387 
  387 
  0 
  0.00%
  0 
  0.00%
BOLI
  4,855 
  4,765 
  4,670 
  90 
  1.89%
  95 
  2.03%
CDI
  0 
  0 
  129 
  0 
  0.00%
  (129)
  -100.00%
Goodwill
  11,574 
  11,574 
  11,574 
  0 
  0.00%
  0 
  0.00%
Other assets
  11,067 
  9,835 
  10,574 
  1,232 
  12.53%
  (739)
  -6.99%
     Total average assets
 $711,164 
 $674,809 
 $650,306 
 $36,355 
  5.39%
 $24,503 
  3.77%
 
    
    
    
    
    
    
    
Average Liabilities
    
    
    
    
    
    
    
 
    
    
    
    
    
    
    
Demand deposits
 $120,689 
 $113,412 
 $109,920 
 $7,277 
  6.42%
 $3,492 
  3.18%
Interest-bearing transaction accounts
  161,887 
  137,547 
  122,521 
  24,340 
  17.70%
  15,026 
  12.26%
Money market funds
  94,704 
  91,642 
  86,141 
  3,062 
  3.34%
  5,501 
  6.39%
Savings accounts
  96,088 
  98,154 
  96,551 
  (2,066)
  -2.10%
  1,603 
  1.66%
Time deposits
  120,937 
  122,499 
  124,134 
  (1,562)
  -1.28%
  (1,635)
  -1.32%
     Total average deposits
  594,305 
  563,254 
  539,267 
  31,051 
  5.51%
  23,987 
  4.45%
 
    
    
    
    
    
    
    
Borrowed funds
  1,996 
  5,462 
  9,975 
  (3,466)
  -63.46%
  (4,513)
  -45.24%
Repurchase agreements
  33,546 
  30,555 
  28,950 
  2,991 
  9.79%
  1,605 
  5.54%
Junior subordinated debentures
  12,887 
  12,887 
  12,887 
  0 
  0.00%
  0 
  0.00%
Other liabilities
  4,998 
  3,019 
  3,408 
  1,979 
  65.55%
  (389)
  -11.41%
     Total average liabilities
  647,732 
  615,177 
  594,487 
  32,555 
  5.29%
  20,690 
  3.48%
 
    
    
    
    
    
    
    
Average Shareholders' Equity
    
    
    
    
    
    
    
 
    
    
    
    
    
    
    
Preferred stock
  1,618 
  2,119 
  2,500 
  (501)
  -23.64%
  (381)
  -15.24%
Common stock
  13,527 
  13,367 
  13,230 
  160 
  1.20%
  137 
  1.04%
Additional paid-in capital
  32,925 
  32,000 
  31,159 
  925 
  2.89%
  841 
  2.70%
Retained earnings
  18,061 
  15,563 
  11,623 
  2,498 
  16.05%
  3,940 
  33.90%
Less: Treasury stock
  (2,623)
  (2,623)
  (2,623)
  0 
  0.00%
  0 
  0.00%
Accumulated other comprehensive loss
  (76)
  (794)
  (70)
  718 
  -90.43%
  (724)
  1034.29%
     Total average shareholders' equity
  63,432 
  59,632 
  55,819 
  3,800 
  6.37%
  3,813 
  6.83%
     Total average liabilities and shareholders' equity
 $711,164 
 $674,809 
 $650,306 
 $36,355 
  5.39%
 $24,503 
  3.77%
 
(1)
Gross loans reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio as of January 1, 2019 and conforming changes to the comparative 2018 and 2017 information presented. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
 
57
 
 
CERTAIN TIME DEPOSITS
 
Increments of maturity of time CDs of $100,000 or more outstanding on December 31, 2019 are summarized as follows:
 
3 months or less
 $13,658,775 
Over 3 through 6 months
  6,910,082 
Over 6 through 12 months
  9,390,244 
Over 12 months
  34,613,090 
 
 $64,572,191 
 
 
RISK MANAGEMENT
 
Interest Rate Risk and Asset and Liability Management - Management actively monitors and manages the Company’s interest rate risk exposure and attempts to structure the balance sheet to maximize net interest income while controlling its exposure to interest rate risk. The Company's 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 bp shift upward and a 100 bp 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 due to competitive pressures, 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. Management expects that the recent decreases in the federal funds rate, including three 25 basis point cuts in 2019, will continue to generate a negative impact to the Company’s NII in 2020 as variable rate loans reprice during the year; This, coupled with the downward pressure on the long end of the yield curve, will continue to adversely impact margins going forward.
 
 
58
 
 
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 December 31, 2019:
 
One Year Horizon
Two Year Horizon
Rate Change       
Percent Change in NII
Rate Change     
Percent Change in NII
 
 
 
 
Down 100 basis points
-1.4%
Down 100 basis points
-5.3%
Up 200 basis points
 1.8%
Up 200 basis points
9.8%
 
The amounts shown in the table are 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. As the market rates continue to increase, the impact of a falling rate environment is more pronounced, and the possibility more plausible than during the last several years of near zero short rates.
 
As of December 31, 2019, the Company had outstanding $12,887,000 in principal amount of Junior Subordinated Debentures due December 15, 2037, which bear a quarterly floating rate of interest equal to the 3-month London Interbank Offered Rate (LIBOR), plus 2.85%. During 2017, the financial authorities in the United Kingdom that administer LIBOR announced that LIBOR will be phased out by the end of 2021. The Company has reviewed the pertinent language in the Indenture governing the Debentures and believes that the Debenture Trustee has sufficient authority under the Indenture to establish a substitute interest rate benchmark without the need to amend the Indenture. However, the Debenture Trustee has not yet informed the Company as to how it intends to proceed. Aside from the Debentures, the Company does not have any other exposures to the phase out of LIBOR. The Company has not generally utilized LIBOR as an interest rate benchmark for its variable rate commercial, residential or other loans and does not utilize derivatives or other financial instruments tied to LIBOR for hedging or investment purposes. Accordingly, management expects that the Company’s exposure to the phase out of LIBOR will be limited to the effect on the interest rate paid on its Debentures.
 
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 CRE 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.
 
Residential mortgages represented 33.2% of the Company’s loan balances at December 31, 2019. The percentage of residential mortgage loans to total loans has been on a gradual decline in recent years, with a strategic shift to commercial lending. The Company maintains a residential 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 21.5% 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, the commercial and CRE loan portfolios have seen solid growth over recent years. Commercial & industrial, CRE and Municipal loans collectively comprised 59.8% of the Company’s loan portfolio at December 31, 2019, compared to 54.3% at December 31, 2018.
 
The Municipal loan portfolio consists of tax-exempt obligations of local municipalities, and is made up of three types of borrowings; term lending, tax anticipation lending, non-arbitrage borrowing. The portfolio increased $8.8 million, or 18.6%, to $55.8 million as of December 31, 2019 compared to $47.1 million at December 31, 2018. During 2019, term lending increased $2.3 million, or 9.3%, tax anticipation lending decreased $3.1 million, or 93.5%, and non-arbitrage borrowing increased $9.6 million, or 49.5%. The non-arbitrage and tax anticipation loans to municipalities are issued annually on a competitive bid basis; as a result the portfolio can fluctuate considerably from year to year based on changes in competitive pressures.
 
 
59
 
 
Growth in the CRE portfolio in recent years has been principally driven by new loan volume in Chittenden County and northern Windsor County around the White River Junction, I91-I93 interchange area. Credits in the Chittenden County market are being managed by two commercial lenders out of the Company’s Burlington loan production office that know the area well, while Windsor County is being served by a commercial lender from the St. Johnsbury office with previous lending experience serving the greater White River Junction area. On May 1, 2019, the Company opened a loan production office in Lebanon, New Hampshire to provide a presence in the greater White River Junction area including Grafton County, New Hampshire. Larger transactions continue to be centrally underwritten and monitored through the Company’s commercial credit department. The types of CRE transactions driving the growth have been a mix of construction, land and development, multifamily, and other non-owner occupied CRE properties including hotels, retail, office, and industrial properties. The largest components of the $246 million CRE portfolio at December 31, 2019 were approximately $93 million in owner-occupied CRE and $85 million in non-owner occupied CRE.
 
The Company’s home equity and commercial line of credit portfolios contain for the most part variable rate loans with the Wall Street Journal Prime rate as the underlying index and rates repricing monthly. The Wall Street Journal Prime index fell to 3.25% in 2008 and remained there until December 2015. Since 2015 numerous rate hikes have increased the Wall Street Journal Prime index by 225 percentage points to 5.5%, before falling 75 percentage points in 2019 to 4.75%. The home equity portfolio and commercial line of credit portfolio have weathered these increases and continue to perform well. Commercial and industrial term loans are generally written on a fixed rate basis with limited risk associated with rising interest rates. CRE loans generally have included an initial fixed rate period typically of 5 years, then enter a variable rate period, again usually tied to Wall Street Prime. Approximately $163 million of CRE loans are scheduled to reprice over the next five years with sizeable rate increases projected based on the current Prime rate index. Many of these loans will ultimately refinance or renegotiate pricing, while the increase may adversely impact the repayment capacity of those CRE loans of lesser credit quality and may ultimately result in higher non-performing loans and losses.
 
The following table reflects the composition of the Company's loan portfolio, by portfolio segment, as a percentage of total loans as of December 31,
 
 
 2019 
 2018 
 2017 
 2016 
 2015 
 
 (Dollars in Thousands) 
Real estate loans
   
   
   
   
   
   
   
   
   
   
 Construction & land
   
   
   
   
   
   
   
   
   
   
   development
 $21,085 
  3.47%
 $26,826 
  4.64%
 $21,968 
  3.98%
 $14,991 
  2.79%
 $21,445 
  4.28%
 Farm land
  13,054 
  2.15%
  10,209 
  1.76%
  10,477 
  1.90%
  13,011 
  2.42%
  12,570 
  2.51%
 1-4 Family residential -
    
    
    
    
    
    
    
    
    
    
    1st lien
  158,337 
  26.09%
  165,665 
  28.64%
  168,184 
  30.48%
  166,692 
  31.03%
  162,760 
  32.46%
    Jr lien
  43,231 
  7.12%
  44,545 
  7.70%
  45,257 
  8.20%
  42,927 
  7.99%
  44,720 
  8.92%
 Commercial real estate
  212,145 
  34.95%
  198,283 
  34.28%
  174,599 
  31.65%
  173,727 
  32.34%
  144,192 
  28.75%
Loans to finance
    
    
    
    
    
    
    
    
    
    
  agricultural production
  3,675 
  0.61%
  2,797 
  0.48%
  887 
  0.16%
  996 
  0.19%
  2,508 
  0.50%
Commercial & industrial
  95,255 
  15.69%
  77,970 
  13.48%
  76,224 
  13.82%
  67,734 
  12.61%
  62,683 
  12.50%
Municipal
  55,817 
  9.20%
  47,067 
  8.14%
  48,825 
  8.85%
  49,887 
  9.29%
  43,354 
  8.64%
Consumer
  4,390 
  0.72%
  5,088 
  0.88%
  5,269 
  0.96%
  7,171 
  1.34%
  7,241 
  1.44%
     Gross loans
  606,989 
  100%
  578,450 
  100%
  551,690 
  100%
  537,136 
  100%
  501,473 
  100%
 
    
    
    
    
    
    
    
    
    
    
Less:
    
    
    
    
    
    
    
    
    
    
 ALL and deferred net loan costs
  (5,564)
    
  (5,238)
    
  (5,120)
    
  (4,968)
    
  (4,695)
    
     Net loans
 $601,425 
    
 $573,212 
    
 $546,570 
    
 $532,168 
    
 $496,778 
    
 
(1)
Gross loans reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio as of January 1, 2019 and conforming changes to the comparative prior period information presented. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
 
 
60
 
 
The following table shows the estimated maturity of the Company's commercial loan portfolio as of December 31, 2019.
 
 
 Fixed Rate Loans 
 Variable Rate Loans 
 
 Within 
 2 - 5 
 After 
   
 Within 
 2 - 5 
 After 
   
 
 1 Year 
 Years 
 5 Years 
 Total 
 1 Year 
 Years 
 5 Years 
 Total 
 
 (Dollars in Thousands) 
Real estate
   
   
   
   
   
   
   
   
  Construction & land development
 $1,226 
 $294 
 $2,943 
 $4,463 
 $1,320 
 $253 
 $15,049 
 $16,622 
  Secured by farm land
  0 
  459 
  47 
  506 
  116 
  471 
  11,961 
  12,548 
  Commercial real estate
  643 
  2,715 
  16,390 
  19,748 
  7,266 
  3,961 
  181,170 
  192,397 
Loans to finance agricultural production
  146 
  205 
  33 
  384 
  608 
  1,365 
  1,318 
  3,291 
Commercial & industrial
  1,215 
  21,646 
  19,730 
  42,591 
  25,968 
  18,353 
  8,343 
  52,664 
Municipal
  33,085 
  5,171 
  6,337 
  44,593 
  0 
  0 
  11,224 
  11,224 
     Total
 $36,315 
 $30,490 
 $45,480 
 $112,285 
 $35,278 
 $24,403 
 $229,065 
 $288,746 
 
 
Risk in the Company’s commercial and CRE loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the SBA and RD. At December 31, 2019 and 2018, although the mix of loans by category varied, in total, the Company had approximately $28.4 million in guaranteed loans with guaranteed balances of approximately $21.0 million.
 
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.
 
During the five year period presented below, the level of non-performing assets fluctuated, with the highest level reported in 2015, followed by a substantial decrease in 2016 in large part due to the restoration to accrual status of one large CRE relationship and another commercial relationship secured by multiple residential properties. Other reductions occurred through the foreclosure process or through borrower initiated payments and payoffs. 2017 increases in non-performing assets generally resulted from numerous smaller loans across the CRE and residential 1st lien portfolios. The increase in 2018 was primarily attributable to higher delinquency in the residential portfolio, and the decline of credit quality in two CRE loans, while the increase in 2019 was primarily due to a large CRE loan being transferred into the Company’s OREO portfolio.
 
 
61
 
 
Non-performing assets at the end of each of the last five fiscal years consisted of the following:
 
December 31,
 2019 
 2018 
 2017 
 2016 
 2015 
 
 (Dollars in Thousands) 
Accruing loans past due 90 days or more(1):
   
   
   
   
   
  Commercial & industrial
 $0 
 $0 
 $0 
 $26 
 $14 
  Commercial real estate
  0 
  0 
  0 
  0 
  45 
  Residential real estate - 1st lien
  530 
  622 
  1,249 
  1,068 
  801 
  Residential real estate - Jr lien
  112 
  105 
  0 
  28 
  63 
  Consumer
  0 
  2 
  1 
  2 
  0 
     Total past due 90 days or more
  642 
  729 
  1,250 
  1,124 
  923 
 
    
    
    
    
    
Non-accrual loans(1):
    
    
    
    
    
  Commercial & industrial
  480 
  85 
  99 
  143 
  441 
  Commercial real estate
  1,601 
  1,743 
  1,065 
  766 
  2,401 
  Residential real estate - 1st lien
  2,112 
  2,027 
  1,585 
  1,227 
  2,009 
  Residential real estate - Jr lien
  241 
  408 
  347 
  339 
  386 
     Total non-accrual loans
  4,434 
  4,263 
  3,096 
  2,475 
  5,237 
 
    
    
    
    
    
Total non-accrual and past due loans
  5,076 
  4,992 
  4,346 
  3,599 
  6,160 
Other real estate owned
  967 
  201 
  284 
  394 
  262 
   Total non-performing assets
 $6,043 
 $5,193 
 $4,630 
 $3,993 
 $6,422 
 
    
    
    
    
    
Percentage by segment of non-performing loans:
    
    
    
    
    
  Commercial & industrial
  9.46%
  1.70%
  2.28%
  4.70%
  7.39%
  Commercial real estate
  31.54%
  34.92%
  24.51%
  21.28%
  39.71%
  Residential real estate - 1st lien
  52.05%
  53.06%
  65.21%
  63.77%
  45.62%
  Residential real estate - Jr lien
  6.95%
  10.28%
  7.98%
  10.20%
  7.29%
  Consumer
  0.00%
  0.04%
  0.02%
  0.06%
  0.00%
 
  100.00%
  100.00%
  100.00%
  100.00%
  100.00%
 
    
    
    
    
    
Percent of gross loans
  1.00%
  0.90%
  0.84%
  0.74%
  1.28%
Reserve coverage of non-performing assets
  98.07%
  107.87%
  117.45%
  132.18%
  78.04%
 
 
(1) No municipal loans were past due 90 days or more, and no municipal or consumer loans were in non-accrual status as of any of the consolidated balance sheet dates. In accordance with Company policy, delinquent consumer loans are charged off at 120 days past due.
 
The Company’s OREO portfolio at December 31, 2019 consisted of one residential and three commercial properties compared to two commercial properties at December 31, 2018. The residential property was acquired through the normal foreclosure process. Both properties held at December 31, 2018 were sold during 2019, and all the properties transferred to OREO in 2019 remain in the portfolio and are listed for sale.
 
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 for borrowers below the current market rates. 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.
 
 
62
 
 
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:
 
 
 December 31, 2019 
 December 31, 2018 
 
 Number of 
 Principal 
 Number of 
 Principal 
 
 Loans 
 Balance 
 Loans 
 Balance 
 
   
   
   
   
Commercial & industrial
  6 
 $331,767 
  1 
 $24,685 
Commercial real estate
  4 
  772,894 
  4 
  862,713 
Residential real estate - 1st lien
  14 
  1,468,415 
  12 
  1,082,187 
Residential real estate - Jr lien
  1 
  55,011 
  0 
  0 
     Total
  25 
 $2,628,085 
  17 
 $1,969,585 
 
 
The remainder of the Company’s TDRs were performing in accordance with their modified terms as of the date presented and consisted of the following:
 
 
 December 31, 2019 
 December 31, 2018 
 
 Number of 
 Principal 
 Number of 
 Principal 
 
 Loans 
 Balance 
 Loans 
 Balance 
 
   
   
   
   
Commercial real estate
  2 
 $106,913 
  1 
 $102,292 
Residential real estate - 1st lien
  30 
  2,459,649 
  31 
  2,544,728 
Residential real estate - Jr lien
  1 
  6,101 
  1 
  7,248 
     Total
  33 
 $2,572,663 
  33 
 $2,654,268 
 
 
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 under one SBA guaranteed line of credit to a borrower whose lending relationship was previously restructured.
 
ALL 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 3 to the accompanying audited 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, CRE, commercial & industrial, and consumer loan portfolios. The Company’s municipal portfolio has no historical losses, therefore no allocation is calculated on this portfolio. Other than the municipal portfolio, 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 3 to the accompanying audited consolidated financial statements for information on the recorded investment in impaired loans and their related allocations.
 
63
 
 
The following table summarizes the Company's loan loss experience for each of the last five years.
 
As of or Years Ended December 31,
 2019 
 2018 
 2017 
 2016 
 2015 
 
 (Dollars in Thousands) 
 
   
   
   
   
   
Loans outstanding, end of year (1)
 $606,989 
 $578,450 
 $551,690 
 $537,136 
 $501,473 
Average loans outstanding during year (1)
 $591,616 
 $568,511 
 $549,974 
 $521,973 
 $499,309 
Non-accruing loans, end of year
 $4,434 
 $4,263 
 $3,096 
 $2,475 
 $5,237 
Non-accruing loans, net of government guarantees
 $4,074 
 $3,887 
 $3,037 
 $2,328 
 $4,551 
 
    
    
    
    
    
ALL, beginning of year
 $5,602 
 $5,438 
 $5,278 
 $5,012 
 $4,906 
Loans charged off:
    
    
    
    
    
  Commercial & industrial
  (176)
  (153)
  (20)
  (49)
  (201)
  Commercial real estate
  (116)
  (124)
  (160)
  0 
  (15)
  Residential real estate - 1st lien
  (242)
  (252)
  (160)
  (244)
  (151)
  Residential real estate - Jr lien
  (223)
  (69)
  (118)
  0 
  (66)
  Consumer
  (103)
  (144)
  (124)
  (16)
  (69)
 
  (860)
  (742)
  (582)
  (309)
  (502)
Recoveries:
    
    
    
    
    
  Commercial & industrial
  11 
  60 
  27 
  25 
  59 
  Commercial real estate
  50 
  0 
  0 
  0 
  0 
  Residential real estate - 1st lien
  16 
  27 
  27 
  24 
  6 
  Residential real estate - Jr lien
  2 
  1 
  1 
  0 
  0 
  Consumer
  39 
  38 
  37 
  26 
  33 
 
  118 
  126 
  92 
  75 
  98 
 
    
    
    
    
    
Net loans charged off
  (742)
  (616)
  (490)
  (234)
  (404)
Provision charged to income
  1,066 
  780 
  650 
  500 
  510 
ALL, end of year
 $5,926 
 $5,602 
 $5,438 
 $5,278 
 $5,012 
 
    
    
    
    
    
Net charge offs to average loans outstanding
  0.13%
  0.11%
  0.09%
  0.04%
  0.08%
Provision charged to income as a percent of
    
    
    
    
    
  average loans
  0.18%
  0.14%
  0.12%
  0.10%
  0.10%
ALL to average loans outstanding
  1.00%
  0.99%
  0.99%
  1.01%
  1.00%
ALL to non-accruing loans
  133.65%
  131.41%
  175.65%
  213.25%
  95.70%
ALL to non-accruing loans, net of government
    
    
    
    
    
  guarantees
  145.46%
  144.12%
  179.06%
  226.72%
  110.13%
 
(1)
Reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio as of January 1, 2019 and conforming changes to the comparative 2018 – 2015 information presented. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
The 2015 provision was maintained at a level consistent with portfolio growth and higher levels of non-performing loans. Despite lower net losses during 2016 and sharply lower non-performing loans, the 2016 provision held steady at $500,000 to support the strong loan growth, particularly in the CRE portfolio. The 2017 provision increased to $650,000, principally to cover higher loan losses experienced during the year, some qualitative adjustment increases related to classified loan levels, along with solid loan portfolio growth. As in 2017, the 2018 provision was increased principally to support strong CRE loan growth along with the higher dollar volume of losses in the Company’s growing loan portfolio. The 2019 provision increased significantly due to increase in the loan portfolio combined with higher than anticipated loan charge off activity during the third quarter of 2019 related to write-down adjustments on several loans in workout. 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.
 
64
 
 
The fourth quarter ALL analysis indicates that the reserve balance of $5.9 million at December 31, 2019 is sufficient to cover losses that are probable and estimable as of the measurement date, with an unallocated reserve of approximately $178,000. Management believes that 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 CRE loans and the risk associated with the relatively new, unseasoned loans in those portfolios. The adequacy of the ALL is reviewed quarterly by the risk management committee of the Board and then presented to the full Board for approval.
 
The following table shows the allocation of the ALL, as well as the percent of each loan category to the total loan portfolio, as of the balance sheet dates for each of the last five years:
 
December 31,
 2019 
 % 
 2018 
 % 
 2017 
 % 
 2016 
 % 
 2015 
 % 
 
 (Dollars in Thousands) 
Domestic
   
   
   
   
   
   
   
   
   
   
 Commercial & industrial
 $837 
  16%
 $697 
  14%
 $676 
  14%
 $726 
  13%
 $713 
  13%
 Commercial real estate
  3,181 
  41%
  3,020 
  41%
  2,674 
  38%
  2,496 
  38%
  2,152 
  36%
 Municipal (1)
  0 
  9%
  0 
  8%
  0 
  9%
  0 
  9%
  0 
  9%
 Residential real estate
    
    
    
    
    
    
    
    
    
    
   1st lien
  1,388 
  26%
  1,422 
  28%
  1,461 
  30%
  1,370 
  31%
  1,368 
  32%
    Jr lien
  290 
  7%
  273 
  8%
  317 
  8%
  371 
  8%
  423 
  9%
 Consumer
  52 
  1%
  57 
  1%
  43 
  1%
  84 
  1%
  76 
  1%
Unallocated
  178 
  0%
  133 
  0%
  267 
  0%
  231 
  0%
  280 
  0%
 
 $5,926 
  100%
 $5,602 
  100%
 $5,438 
  100%
 $5,278 
  100%
 $5,012 
  100%
 
(1)
Gross loans reflects reclassification of obligations of local municipalities from the investment portfolio into the loan portfolio as of January 1, 2019 and conforming changes to the comparative 2018 – 2015 information presented. See Note 1 to the accompanying audited consolidated financial statements for additional information.
 
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.
 
INVESTMENT SECURITIES
 
The Company maintains an investment portfolio of various securities to diversify its revenue sources, as well as to provide interest rate risk and credit risk diversification and to provide for its liquidity and funding needs. The Company’s portfolio of AFS debt securities increased $6.6 million, or 16.8% in 2019 to $46.0 million at December 31, 2019 from $39.4 million at December 31, 2018, and increased just under $1.0 million, or 2.4%, during 2018 from $38.5 million at December 31, 2017.
 
Accounting standards require banks to recognize all appreciation or depreciation of investments classified as either trading securities or AFS, either through the income statement or on the balance sheet even though a gain or loss has not been realized. Securities classified as trading securities are marked to market with any gain or loss net of tax effect, charged to income. The Company's investment policy does not permit the holding of trading securities. Debt securities classified as HTM are recorded at book value, subject to adjustment for OTTI. As noted previously, effective as of January 1, 2019, tax-exempt loans to municipalities, which were previously classified as securities HTM and constituted the entire HTM portfolio, were reclassified to the loan portfolio, with prior period information restated accordingly. Therefore, the Company did not hold any securities HTM as of December 31, 2019, 2018 or 2017.
 
 
65
 
 
Debt securities classified as AFS are marked to market with any gain or loss after taxes charged to shareholders’ equity in the consolidated balance sheets. These adjustments in the AFS portfolio resulted in an accumulated unrealized income net of taxes of $260,483 in 2019, compared to accumulated unrealized loss net of taxes of $647,584 in 2018, and $274,097 in 2017. Included in the 2017 accumulated unrealized loss is a reclassification adjustment of $45,106 for the deferred tax asset revaluation beginning in 2018. Other than the 2017 deferred tax asset reclassification adjustment, the fluctuations in unrealized gains and losses are due to market interest rate changes, and are not based on any deterioration in credit quality of the underlying issuers. The Company’s investment portfolio includes Agency MBS in order to realize a more favorable yield in the portfolio and diversify the holdings. Although classified as AFS, we anticipate holding these securities until maturity. The unrealized loss positions within the investment portfolio as of the balance sheet dates presented are considered by management to be temporary.
 
The restricted equity securities comprise the Company’s membership stock in the FRBB, FHLBB and ACBI. Membership in the FRBB and FHLBB requires the purchase of their stock in specified amounts. On December 31, 2019, 2018 and 2017, the Company held $588,150 in FRBB stock and $753,700, $1.1 million and $1.1 million, respectively, in FHLBB stock. In addition, as disclosed in Note 2 of the accompanying audited consolidated financial statements, during 2018 the Company purchased $90,000 in stock in ACBI, a holding company for ACBB, a correspondent bank. The purchase of ACBI stock is required for receipt of correspondent banking services from ACBB at more favorable pricing. These restricted securities in the FRBB, FHLBB and ACBI are typically held for an extended period of time and are subject to strict limitations on resales. FRBB stock may only be sold back to the issuer, while FHLBB stock may only be repurchased by the FHLBB or resold to a member institution and ACBI stock may only be resold to other depository institutions or their holding companies or subsidiaries, or to the FDIC. Restricted equity stock is generally sold and redeemed at par. Due to the unique nature of the restricted equity stock, including the non-investment purpose for owning it, the ownership structure and restrictions and the absence of a trading market for the stock, these securities are not marked to market, but carried at par. The FHLBB stock is subject to capital call provisions.
 
Some of the Company’s debt securities have a call feature, meaning that the issuer may call in the investment before maturity, at predetermined call dates and prices. In 2019, there were ten call features exercised by the issuer, compared to no calls exercised during 2018 or 2017.
 
The Company's debt securities AFS as of December 31 in each of the last three fiscal years were as follows:
 
 
   
 Gross 
 Gross 
   
 
 Amortized 
 Unrealized 
 Unrealized 
 Fair 
 
 Cost 
 Gains 
 Losses 
 Value 
 
 (Dollars in Thousands) 
December 31, 2019
   
   
   
   
   U.S. GSE debt securities
 $18,003 
 $100 
 $41 
 $18,062 
   Agency MBS
  16,169 
  87 
  51 
  16,205 
   ABS and OAS
  2,800 
  55 
  2 
  2,853 
   Other investments
  8,665 
  182 
  0 
  8,847 
 
 $45,637 
 $424 
 $94 
 $45,967 
 
    
    
    
    
Restricted Equity Securities (1)
 $1,432 
 $0 
 $0 
 $1,432 
 
    
    
    
    
     Total
 $47,069 
 $424 
 $94 
 $47,399 
 
December 31, 2018
   
   
   
   
U.S. GSE debt securities
 $14,010 
 $0 
 $259 
 $13,751 
Agency MBS
  16,021 
  3 
  449 
  15,575 
ABS and OAS
  1,988 
  4 
  6 
  1,986 
Other investments
  8,167 
  8 
  120 
  8,055 
 
 $40,186 
 $15 
 $834 
 $39,367 
 
    
    
    
    
Restricted Equity Securities (1)
 $1,749 
 $0 
 $0 
 $1,749 
 
    
    
    
    
 
 $41,935 
 $15 
 $834 
 $41,116 
 
 
66
 
 
 
 
   
 Gross 
 Gross 
   
 
 Amortized 
 Unrealized 
 Unrealized 
 Fair 
 
 Cost 
 Gains 
 Losses 
 Value 
 
 (Dollars in Thousands) 
December 31, 2017
   
   
   
   
   U.S. GSE debt securities
 $17,308 
 $0 
 $149 
 $17,159 
   Agency MBS
  16,782 
  11 
  180 
  16,613 
   Other investments
  4,707 
  0 
  29 
  4,678 
 
 $38,797 
 $11 
 $358 
 $38,450 
 
    
    
    
    
Restricted Equity Securities (1)
 $1,704 
 $0 
 $0 
 $1,704 
 
    
    
    
    
 
 $40,501 
 $11 
 $358 
 $40,154 
 
 
(1) Required equity purchases for membership in the FRB System and the FHLB System and for access to correspondent banking services from ACBB.
 
The Company did not have investments totaling more than 10% of Shareholders’ equity in any one issuer during any of the periods presented.
 
Realized gains and losses in the Company’s AFS portfolio are presented in the table below.
 
 
 Realized gains 
 Realized losses 
 
 2019 
 2018 
 2017 
 2019 
 2018 
 2017 
   U.S. GSE debt securities
 $0 
 $0 
 $2,021 
 $7,200 
 $32,718 
 $1,804 
   Agency MBS
  1,570 
  0 
  0 
  20,860 
  0 
  0 
   Other investments
  0 
  0 
  6,366 
  0 
  0 
  3,199 
     Total
 $1,570 
 $0 
 $8,387 
 $28,060 
 $32,718 
 $5,003 
 
 
 
67
 
 
The following is an analysis of the maturities and yields of the debt securities AFS in the Company’s investment portfolio for each of the last three fiscal years:
 
December 31,
 2019 
 2018 
 2017 
 
   
 Weighted 
   
 Weighted 
   
 Weighted 
 
 Fair 
 Average 
 Fair 
 Average 
 Fair 
 Average 
 
 Value 
 Yield 
 Value 
 Yield 
 Value 
 Yield 
 
 (Dollars in Thousands) 
 
   
   
   
   
   
   
U.S. GSE debt securities
   
   
   
   
   
   
   Due in one year or less
 $2,020 
  1.81%
 $0 
  0.00%
 $3,740 
  1.30%
   Due from one to five years
  2,007 
  2.25%
  4,944 
  1.69%
  6,978 
  1.64%
   Due from five to ten years
  12,049 
  2.81%
  8,807 
  2.84%
  6,441 
  2.62%
   Due after ten years
  1,986 
  2.70%
  0 
  0.00%
  0 
  0.00%
   Total
 $18,062 
  2.63%
 $13,751 
  2.42%
 $17,159 
  1.93%
 
    
    
    
    
    
    
ABS/AOS
    
    
    
    
    
    
   Due from five to ten years
 $2,853 
  2.94%
 $1,986 
  3.33%
 $0 
  0.00%
 
    
    
    
    
    
    
Other Investments
    
    
    
    
    
    
   Due in one year or less
 $746 
  2.03%
 $0 
  0.00%
 $0 
  0.00%
   Due from one to five years
  7,856 
  2.72%
  7,575 
  2.63%
  4,190 
  2.25%
   Due from five to ten years
  245 
  2.50%
  480 
  2.50%
  488 
  2.50%
   Total
 $8,847 
  2.65%
 $8,055 
  2.62%
 $4,678 
  2.28%
 
    
    
    
    
    
    
Agency MBS (1)
 $16,205 
  2.55%
 $15,575 
  2.33%
 $16,613 
  2.08%
 
    
    
    
    
    
    
FRBB Stock (2)
 $588 
  6.00%
 $588 
  6.00%
 $588 
  6.00%
 
    
    
    
    
    
    
FHLBB Stock (2)
 $754 
  6.04%
 $1,071 
  5.92%
 $1,116 
  5.53%
 
    
    
    
    
    
    
ACBI Stock (2)(3)
 $90 
  1.16%
 $90 
  0.00%
 $0 
  0.00%
 
 
(1)
Agency MBS are not due at a single maturity date and have not been allocated to maturity groupings for purposes of the maturity table.
(2)
Required equity purchases for membership in the FRB System and FHLB System and for access to correspondent banking services from ACBB.
(3)
The Company’s holdings of ACBI stock were purchased during the fourth quarter of 2018 and the first declared dividend was paid during the first quarter of 2019, accounting for the absence in yield for 2018.
 
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 2019, the Company did not engage in any activity that created any additional types of off-balance-sheet risk.
 
The Company generally requires collateral or other security to support financial instruments with credit risk. The Company's financial instruments whose contract amount represents credit risk are disclosed in Note 16 to the accompanying audited consolidated financial statements.
 
 
68
 
 
EFFECTS OF INFLATION
 
Rates of inflation affect the reported financial condition and results of operations of all industries, including the banking industry. The effect of monetary inflation is generally magnified in bank financial and operating statements because most of a bank's assets and liabilities are monetary in nature and, as costs and prices rise, cash and credit demands of individuals and businesses increase, while the purchasing power of net monetary assets declines. During the economic downturn that began in 2008, the capital and credit markets experienced significant volatility and disruption, with the federal government taking unprecedented steps to deal with the economic situation. These measures included significant deficit spending as well as quantitative easing of the money supply by the FRB. With the improvement in the economy during the last three years, the FOMC took steps to increase interest rates in 2018 but the second half of 2019 brought a decrease in interest rates as the economy showed signs of slowing.
 
The impact of inflation on the Company's financial results is affected by management's ability to react to changes in interest rates in order to reduce inflationary effect on performance. Interest rates do not necessarily move in conjunction with changes in the prices of other goods and services. As discussed above, management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against significant interest rate fluctuations, including those resulting from inflation. With inflation holding under or near the 2% target despite the unemployment rate remaining at cycle lows, the Fed has recently softened its intentions to further tighten policy during 2020, in an effort to avoid possibly creating a recession, which has typically been the case in past cycles.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Managing liquidity risk is essential to maintaining both depositor confidence and stability in earnings. Liquidity management refers to the ability of the Company to adequately cover fluctuations in assets and liabilities. Meeting loan demand (assets) and covering the withdrawal of deposit funds (liabilities) are two key components of the liquidity management process. The Company’s principal sources of funds are deposits, amortization and prepayment of loans and securities, maturities of investment securities, sales of loans available-for-sale, and earnings and funds provided from operations. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities, reduces the Company’s exposure to roll over risk on deposits and limits reliance on volatile short-term borrowed funds. Short-term funding needs arise from declines in deposits or other funding sources and funding 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. The Company had one-way CDARS outstanding totaling $4.0 million and $723,774 at December 31, 2019 and 2018, respectively. 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 2018, 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 December 31, 2019 and 2018, the Company reported $6.8 million and $3.5 million, respectively, in reciprocal CDARS deposits. The balance in ICS reciprocal money market deposits was $22.6 million and $23.9 million at December 31, 2019 and 2018, respectively, and the balance in ICS reciprocal demand deposits as of those dates was $39.7 million and $45.7 million, respectively.
 
During 2019 and 2018, the Company continued its use of brokered deposits outside of the CDARS program to satisfy a portion of its short-term funding needs. These are typically short term certificates of deposit with maturity less than one year purchased through a prominent broker of public and institutional funds from across the country, along with the addition of DTC Brokered CD issuance during 2018. During the third quarter of 2018, the Company issued two blocks of DTC Brokered CDs totaling $30 million, with maturities in January 2019 and August 2019. During the first quarter of 2019, the Company partially replaced the $20.0 million block that matured in January with purchases of two blocks of DTC Brokered CDs totaling $15.0 million and having maturities in July, 2019 and January, 2020. The Company did not replace the blocks that matured in July and August of 2019, leaving $6.2 million outstanding as of December 31, 2019. Additionally, the Company had brokered deposits from another source totaling approximately $1.0 million and $4.6 million at December 31, 2019 and 2018, respectively. These relationships have provided increased access to short term funding that is easily accessible without any detrimental effect on the pricing of the core deposit base. In total, the Company had $11.1 million and $35.3 million of brokered CDs outstanding at December 31, 2019 and December 31, 2018, respectively.
 
 
69
 
 
At December 31, 2019 and 2018, gross borrowing capacity of approximately $97.4 million and $108.7 million, 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 collateral pledges. The Company also has an unsecured Federal Funds line with the FHLBB with an available balance of $500,000, with no advances against it at December 31, 2019 or 2018. Interest is chargeable at a rate determined daily approximately 25 basis points higher than the rate paid on federal funds sold.
 
Under a separate agreement with the FHLBB, the Company has the authority to collateralize public unit deposits up to its FHLBB borrowing capacity ($97.4 million and $108.7 million at December 31, 2019 and 2018, respectively, less outstanding advances and collateral pledges) with letters of credit issued by the FHLBB. The Company offers a Government Agency Account to its municipal customers collateralized with these FHLBB letters of credit. At December 31, 2019 and 2018, approximately $14.4 million and $2.6 million, respectively, of qualifying residential real estate loans were pledged as collateral to the FHLBB for these collateralized governmental unit deposits, which reduced dollar-for-dollar the available borrowing capacity under the FHLBB line of credit. Total fees paid by the Company to the FHLBB in connection with these letters of credit were $41,069 for 2019 and $46,620 for 2018.
 
The Company has a BIC arrangement with the FRBB secured by eligible commercial loans, CRE loans and home equity loans, resulting in an available line of $56.9 million and $50.9 million, respectively, at December 31, 2019 and 2018. Credit advances in the FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), which was 225 basis points at December 31, 2019. At December 31, 2019 and 2018, the Company had no outstanding advances against this line.
 
The Company has unsecured lines of credit with three correspondent banks with aggregate available borrowing capacity of $12.5 million at December 31, 2019 and 2018. The Company had no outstanding advances against these lines for the periods presented.
 
Securities sold under agreements to repurchase amounted to $33.2 million, $30.5 million and $28.6 million as of December 31, 2019, 2018 and 2017, respectively. The average daily balance of these repurchase agreements was $33.5 million, $30.6 million and $28.9 million during 2019, 2018, and 2017, respectively. The maximum borrowings outstanding on these agreements at any month-end reporting period of the Company were $38.9 million, $32.9 million and $31.7 million during 2019, 2018 and 2017, respectively. These repurchase agreements mature daily and carried a weighted average interest rate of 0.89% during 2019, 0.63% during 2018 and 0.33% during 2017.
 
The following table illustrates the changes in shareholders' equity from December 31, 2018 to December 31, 2019:
 
Balance at December 31, 2018 (book value $11.72 per common share)
 $62,603,711 
    Net income
  8,824,446 
    Issuance of stock through the DRIP
  1,097,234 
    Redemption of preferred stock
  (500,000)
    Dividends declared on common stock
  (3,951,279)
    Dividends declared on preferred stock
  (87,500)
    Change in AOCI on AFS securities, net of tax
  908,067 
Balance at December 31, 2019 (book value $12.86 per common share)
 $68,894,679 
 
In December, 2019, the Board of the Company declared a $0.19 per common share cash dividend, payable February 1, 2020 to shareholders of record as of January 15, 2020, requiring the Company to accrue a liability of $727,526 for this dividend in the fourth quarter of 2019. In March, 2020, the Board of the Company approved a cash dividend of $0.19 per common share, payable on May 1, 2020 to shareholders of record as of April 15, 2020. The declaration of this dividend required the Company to accrue a liability of $995,538 in the first quarter of 2020. 
 
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Additional Prompt Corrective Action capital requirements are applicable to banks, but not bank holding companies. (See Note 21 to the accompanying audited consolidated financial statements.)
 
 
70
 
 
Common Stock Performance by Quarter*
 
 
 2019 
 2018 
Trade Price
 First 
 Second 
 Third 
 Fourth 
 First 
 Second 
 Third 
 Fourth 
High
 $17.20 
 $17.95 
 $17.00 
 $17.90 
 $18.50 
 $18.25 
 $18.90 
 $19.39 
Low
 $15.94 
 $16.34 
 $15.07 
 $15.15 
 $16.55 
 $16.50 
 $16.91 
 $16.00 
 
 
 2019 
 2018 
Bid Price
 First 
 Second 
 Third 
 Fourth 
 First 
 Second 
 Third 
 Fourth 
High
 $17.20 
 $17.40 
 $16.88 
 $17.00 
 $18.10 
 $17.55 
 $18.80 
 $18.25 
Low
 $16.12 
 $16.34 
 $15.14 
 $15.40 
 $16.55 
 $16.60 
 $16.95 
 $16.00 
 
    
    
    
    
    
    
    
    
Cash Dividends Declared
 $0.19 
 $0.19 
 $0.19 
 $0.19 
 $0.17 
 $0.19 
 $0.19 
 $0.19 
 
*The Company's common stock is not traded on any exchange. However, the Company’s common stock is included in the OTCQX® marketplace tier maintained by the OTC Markets Group Inc. Trade and bid information for the stock appears in the OTC’s interdealer quotation system, OTC Link ATS®. The trade price and bid information in the table above is based on information reported by participating FINRA-registered brokers in the OTC Link ATS® system and may not represent all trades or high and low bids during the relevant periods. Such price quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and bid prices do not necessarily represent actual transactions. The OTC trading symbol for the Company’s common stock is CMTV.
 
As of February 1, 2020, there were 5,239,675 shares of the Corporation's common stock ($2.50 par value) outstanding, owned by 832 shareholders of record.
 
Form 10-K
A copy of the Form 10-K Report filed with the Securities and Exchange Commission may be obtained without charge upon written request to:
 
Kathryn M. Austin, President & CEO
Community Bancorp.
4811 US Route 5
Newport, Vermont 05855
 
Shareholder Services
For shareholder services or information contact:
Melissa Tinker, Assistant Corporate Secretary
Community Bancorp.
4811 US Route 5
Newport, Vermont 05855
(802) 334-7915
 
Transfer Agent:
Computershare Investor Services
PO Box 43078
Providence, RI 02940-3078
www.computershare.com
 
Annual Shareholders' Meeting
The 2020 Annual Shareholders' Meeting will be held at 5:30 p.m., May 19, 2020, at the Elks Club in Derby. We hope to see many of our shareholders there.
 
 
 
71
 
Exhibit 21
 
Subsidiaries of the Company
 
The wholly-owned subsidiary of Community Bancorp. is Community National Bank, a national banking association incorporated under the Banking Laws of The United States. Community National Bank is considered to be a "significant subsidiary" of Community Bancorp., within the meaning of Rule 1-02(w) of SEC Regulation S-X.
 
The unconsolidated subsidiary of Community Bancorp. is CMTV Statutory Trust I, a Delaware statutory business trust.
 
 
 
 
 
 
 
 
 
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
We consent to the inclusion in this Annual Report (Form 10-K) of Community Bancorp. of our report dated March 16, 2020 with respect to the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2019, included in the 2019 Annual Report to Shareholders of Community Bancorp.
 
We also consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-160875 and No. 333-214340) pertaining to the Community Bancorp Dividend Reinvestment Plan and in the Registration Statement (Form S-8 No. 333-133631 and No. 333-212977) pertaining to the Community Bancorp Retirement Savings Plan of our report dated March 16, 2020, with respect to the consolidated financial statements and the effectiveness of internal control over financial reporting, incorporated therein by reference, of Community Bancorp included in the Annual Report (Form 10-K) for the year ended December 31, 2019.
 
 
 
Portland, Maine
March 16, 2020
Vermont Registration No. 92-0000278
 
 
 
 
 
 
Maine ● New Hampshire ● Massachusetts ● Connecticut ● West Virginia ● Arizona
Berrydunn.com
 
Exhibit 31.1
 
CERTIFICATION
 
I, Kathryn M. Austin, President and Chief Executive Officer (Principal Executive Officer), certify that:
 
1.            
I have reviewed this annual report on Form 10-K of Community Bancorp.; 
2. 
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. 
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. 
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
(a) 
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) 
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) 
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
 
5. 
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
(a) 
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) 
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 
 
Community Bancorp.
 
 
 
 
March 16, 2020
By: /s/ Kathryn M. Austin
 
 
      Name: Kathryn M. Austin,
 
 
      Title: President & Chief Executive Officer
 
 
      (Principal Executive Officer)
 
 
 
 
Exhibit 31.2
 
CERTIFICATION
 
I, Louise M. Bonvechio, Corporate Secretary and Treasurer (Principal Financial Officer), certify that:
 
1.            
I have reviewed this annual report on Form 10-K of Community Bancorp.;
2. 
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. 
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. 
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
(a) 
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) 
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) 
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
 
5.            
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
(a) 
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) 
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 
 
Community Bancorp.
 
 
 
 
March 16, 2020
By: /s/ Louise M. Bonvechio
 
 
      Name: Louise M. Bonvechio
 
 
      Title: Corporate Secretary and Treasurer
 
 
      (Principal Financial Officer)
 
 
 
 
Exhibit 32.1
 
 
CERTIFICATION PURSUANT TO 18 U. S. C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
 
In connection with the Annual Report of Community Bancorp. (the Company) on Form 10-K for the period ended December 31, 2019, filed with the Securities and Exchange Commission on the date hereof (the Report), the undersigned Principal Executive Officer of the Company hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods covered in the Report.
 
A signed original of this written statement required by Section 906 has been provided to Community Bancorp. and will be retained by Community Bancorp. and furnished to the Securities and Exchange Commission or its staff upon request.
 
 
 
Community Bancorp.
 
 
 
 
March 16, 2020
By: /s/ Kathryn M. Austin
 
 
      Name: Kathryn M. Austin,
 
 
      Title: President & Chief Executive Officer
 
 
      (Principal Executive Officer)
 
 
 
 
 
 
Exhibit 32.2
 
 
CERTIFICATION PURSUANT TO 18 U. S. C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
 
In connection with the Annual Report of Community Bancorp. (the Company) on Form 10-K for the period ended December 31, 2019 as filed with the Securities and Exchange Commission on the date hereof (the Report), the undersigned Principal Financial Officer of the Company hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods covered in the Report.
 
A signed original of this written statement required by Section 906 has been provided to Community Bancorp. and will be retained by Community Bancorp. and furnished to the Securities and Exchange Commission or its staff upon request.
 
 
 
Community Bancorp.
 
 
 
 
March 16, 2020
By: /s/ Louise M. Bonvechio
 
 
      Name: Louise M. Bonvechio
 
 
      Title: Corporate Secretary and Treasurer
 
 
      (Principal Financial Officer)