UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2013March 31, 2014

OR
o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to                 

Commission File Number 000-16435


Vermont03-0284070
(State of Incorporation)(IRS Employer Identification Number)
4811 US Route 5, Derby, Vermont05829
(Address of Principal Executive Offices)(zip code)
Registrant's Telephone Number:  (802) 334-7915
Registrant's Telephone Number:  (802) 334-7915

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file for such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES þ   NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer   o    (Do not check if a smaller reporting company)
Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o     NO þ

At NovemberMay 7, 2013,2014, there were 4,854,5094,883,976 shares outstanding of the Corporation's common stock.
 
 
 
 
 
FORM 10-Q
 
 
Index  
  Page
PART IFINANCIAL INFORMATION 
   
Item 1Financial Statements3
Item 2Management’s Discussion and Analysis of Financial Condition and Results of Operations2827
Item 3Quantitative and Qualitative Disclosures About Market Risk4543
Item 4Controls and Procedures4543
   
PART IIOTHER INFORMATION 
   
Item 1Legal Proceedings4644
Item 2Unregistered Sales of Equity Securities and Use of Proceeds4644
Item 6Exhibits4645
 Signatures4746
 
 
 
2
 
 
PART I.  FINANCIAL INFORMATION

ITEM 1.  Financial Statements (Unaudited)

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

  March 31,  December 31,  March 31, 
  2014  2013  2013 
  (Unaudited)     (Unaudited) 
Assets         
  Cash and due from banks $12,611,269  $11,841,161  $8,669,614 
  Federal funds sold and overnight deposits  6,515,899   6,488,828   32,556 
     Total cash and cash equivalents  19,127,168   18,329,989   8,702,170 
  Securities held-to-maturity (fair value $39,297,000 at 03/31/14            
   $38,370,000 at 12/31/13 and $42,733,000 at 03/31/13)  38,919,299   37,936,911   42,380,968 
  Securities available-for-sale  31,187,390   35,188,602   46,010,313 
  Restricted equity securities, at cost  3,632,850   3,632,850   3,632,850 
  Loans held-for-sale  505,600   209,500   1,347,961 
  Loans  452,230,767   439,908,926   417,469,135 
    Allowance for loan losses  (4,837,578)  (4,854,915)  (4,493,384)
    Deferred net loan costs  290,265   300,429   206,969 
        Net loans  447,683,454   435,354,440   413,182,720 
  Bank premises and equipment, net  11,599,575   11,723,468   12,172,480 
  Accrued interest receivable  1,998,301   1,778,305   1,970,615 
  Bank owned life insurance  4,330,567   4,303,307   4,215,534 
  Core deposit intangible  1,022,606   1,090,781   1,295,301 
  Goodwill  11,574,269   11,574,269   11,574,269 
  Other real estate owned (OREO)  865,820   1,105,525   879,705 
  Other assets  10,680,849   11,439,457   13,015,495 
        Total assets $583,127,748  $573,667,404  $560,380,381 
Liabilities and Shareholders' Equity            
 Liabilities            
  Deposits:            
    Demand, non-interest bearing $80,608,105  $82,156,154  $64,660,692 
    Interest-bearing transaction accounts  112,378,796   126,578,052   114,257,777 
    Money market funds  84,177,510   81,960,677   94,380,704 
    Savings  74,187,411   69,906,147   68,232,421 
    Time deposits, $100,000 and over  57,849,279   46,928,443   45,220,821 
    Other time deposits  73,406,469   74,023,096   77,509,684 
        Total deposits  482,607,570   481,552,569   464,262,099 
             
  Federal funds purchased and other borrowed funds  12,000,000   0   7,845,000 
  Repurchase agreements  25,885,704   29,644,615   28,623,952 
  Capital lease obligations  694,315   711,042   759,260 
  Junior subordinated debentures  12,887,000   12,887,000   12,887,000 
  Accrued interest and other liabilities  2,429,965   2,736,201   2,151,091 
        Total liabilities  536,504,554   527,531,427   516,528,402 
 Shareholders' Equity            
  Preferred stock, 1,000,000 shares authorized, 25 shares issued            
    and outstanding ($100,000 liquidation value)  2,500,000   2,500,000   2,500,000 
  Common stock - $2.50 par value; 10,000,000 shares authorized,            
    5,091,506 shares issued at 03/31/14, 5,078,707 shares issued            
    at 12/31/13, and 5,037,828 shares issued at 03/31/13  12,728,765   12,696,768   12,594,570 
  Additional paid-in capital  28,754,257   28,612,308   28,177,907 
  Retained earnings  5,269,524   4,997,144   3,046,163 
  Accumulated other comprehensive (loss) income  (6,575)  (47,466)  156,116 
  Less: treasury stock, at cost; 210,101 shares at 03/31/14,            
    12/31/13 and 03/31/13  (2,622,777)  (2,622,777)  (2,622,777)
        Total shareholders' equity  46,623,194   46,135,977   43,851,979 
        Total liabilities and shareholders' equity $583,127,748  $573,667,404  $560,380,381 
  September 30,  December 31,  September 30, 
  2013  2012  2012 
  (Unaudited)     (Unaudited) 
Assets         
  Cash and due from banks $13,106,861  $11,273,575  $9,519,193 
  Federal funds sold and overnight deposits  275,130   18,608,265   5,000 
     Total cash and cash equivalents  13,381,991   29,881,840   9,524,193 
  Securities held-to-maturity (fair value $39,610,000 at 09/30/13            
   $42,291,000 at 12/31/12 and $50,631,000 at 09/30/12)  39,218,785   41,865,555   50,065,653 
  Securities available-for-sale  35,452,071   40,886,059   47,008,818 
  Restricted equity securities, at cost  3,632,850   4,021,350   4,021,350 
  Loans held-for-sale  1,229,490   1,501,706   1,483,940 
  Loans  431,981,787   416,375,448   407,610,705 
    Allowance for loan losses  (4,799,431)  (4,312,080)  (4,115,230)
    Deferred net loan costs  281,747   169,501   101,742 
        Net loans  427,464,103   412,232,869   403,597,217 
  Bank premises and equipment, net  11,913,170   12,243,320   12,351,925 
  Accrued interest receivable  1,632,971   1,751,085   1,810,063 
  Bank owned life insurance  4,274,307   4,187,644   4,156,201 
  Core deposit intangible  1,158,951   1,363,476   1,448,694 
  Goodwill  11,574,269   11,574,269   11,574,269 
  Other real estate owned (OREO)  1,125,105   1,074,705   1,150,198 
  Prepaid expense - Federal Deposit Insurance Corporation (FDIC)  0   775,595   855,513 
  Other assets  12,036,436   12,378,772   12,613,921 
        Total assets $564,094,499  $575,738,245  $561,661,955 
Liabilities and Shareholders' Equity            
 Liabilities            
  Deposits:            
    Demand, non-interest bearing $80,465,454  $72,956,097  $68,580,510 
    NOW  113,732,525   128,824,165   109,271,808 
    Money market funds  83,547,315   86,973,835   84,057,492 
    Savings  70,668,274   65,216,698   66,204,831 
    Time deposits, $100,000 and over  46,573,680   44,229,470   49,474,950 
    Other time deposits  75,562,336   77,296,594   79,511,981 
        Total deposits  470,549,584   475,496,859   457,101,572 
  Federal funds purchased and other borrowed funds  8,325,000   6,000,000   16,850,000 
  Repurchase agreements  23,685,762   34,149,608   28,076,308 
  Capital lease obligations  727,437   774,701   789,836 
  Junior subordinated debentures  12,887,000   12,887,000   12,887,000 
  Accrued interest and other liabilities  2,666,402   3,077,502   3,078,347 
        Total liabilities  518,841,185   532,385,670   518,783,063 
 Shareholders' Equity            
  Preferred stock, 1,000,000 shares authorized, 25 shares issued            
    and outstanding ($100,000 liquidation value)  2,500,000   2,500,000   2,500,000 
  Common stock - $2.50 par value; 10,000,000 shares authorized,            
  5,064,718 shares issued at 09/30/13, 5,023,026 shares issued            
   at 12/31/12, and 5,007,099 shares issued at 09/30/12  12,661,795   12,557,565   12,517,748 
  Additional paid-in capital  28,467,277   28,047,829   27,911,150 
  Retained earnings  4,245,488   2,698,200   2,268,901 
  Accumulated other comprehensive income  1,531   171,758   303,870 
  Less: treasury stock, at cost; 210,101 shares at 09/30/13,            
   12/31/12 and 09/30/12  (2,622,777)  (2,622,777)  (2,622,777)
        Total shareholders' equity  45,253,314   43,352,575   42,878,892 
        Total liabilities and shareholders' equity $564,094,499  $575,738,245  $561,661,955 
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
3
 
 
Community Bancorp. and Subsidiary
Consolidated Statements of Income
(Unaudited)
For The Quarters Ended September 30,
 For The Quarters Ended March 31, 
 2013  2012  2014  2013 
            
Interest income            
Interest and fees on loans $5,264,044  $5,356,710  $5,270,776  $5,207,889 
Interest on debt securities                
Taxable  80,025   119,586   66,344   77,202 
Tax-exempt  248,241   285,099   256,628   255,547 
Dividends  14,762   20,575   23,284   15,079 
Interest on federal funds sold and overnight deposits  64   111   1,244   6,332 
Total interest income  5,607,136   5,782,081   5,618,276   5,562,049 
                
Interest expense                
Interest on deposits  668,327   866,591   657,255   773,770 
Interest on federal funds purchased and other borrowed funds  23,003   94,636   18,686   23,265 
Interest on repurchase agreements  26,355   33,600   16,598   36,019 
Interest on junior subordinated debentures  101,741   243,564   100,751   101,743 
Total interest expense  819,426   1,238,391   793,290   934,797 
                
Net interest income  4,787,710   4,543,690   4,824,986   4,627,252 
Provision for loan losses  137,500   249,999   135,000   206,250 
Net interest income after provision for loan losses  4,650,210   4,293,691   4,689,986   4,421,002 
                
Non-interest income                
Service fees  702,671   597,567   646,813   558,950 
Income from sold loans  396,770   418,594   249,130   387,591 
Other income from loans  203,941   246,566   144,400   143,313 
Net realized (loss) gain on sale of securities available-for-sale  (5,521)  99,676 
Other income  242,564   167,814   273,158   278,338 
Total non-interest income  1,540,425   1,530,217   1,313,501   1,368,192 
                
Non-interest expense                
Salaries and wages  1,610,697   1,547,284   1,650,000   1,657,185 
Employee benefits  487,384   486,103   631,197   609,289 
Occupancy expenses, net  752,019   796,029   684,198   871,904 
FDIC insurance  92,964   92,343 
Amortization of core deposit intangible  68,175   85,217 
Other expenses  1,460,357   1,546,047   1,746,801   1,450,912 
Total non-interest expense  4,471,596   4,553,023   4,712,196   4,589,290 
                
Income before income taxes  1,719,039   1,270,885   1,291,291   1,199,904 
Income tax expense  364,106   3,534   219,726   158,126 
Net income $1,354,933  $1,267,351  $1,071,565  $1,041,778 
                
Earnings per common share $0.28  $0.26  $0.22  $0.21 
Weighted average number of common shares                
used in computing earnings per share  4,845,044   4,781,877   4,872,589   4,816,588 
Dividends declared per common share $0.14  $0.14  $0.16  $0.14 
Book value per share on common shares outstanding at September 30, $8.81  $8.42 
Book value per share on common shares outstanding at March 31, $9.04  $8.57 
 
The accompanying notes are an integral part of these consolidated financial statements.
statements
 
 
4
 
 
Community Bancorp. and Subsidiary
Consolidated Statements of Comprehensive Income
(Unaudited)
For The Nine Months Ended September 30,
 
  2013  2012 
       
Interest income      
   Interest and fees on loans $15,916,025  $15,786,521 
   Interest on debt securities        
     Taxable  242,528   439,642 
     Tax-exempt  762,424   713,081 
   Dividends  45,123   62,162 
   Interest on federal funds sold and overnight deposits  7,933   3,434 
        Total interest income  16,974,033   17,004,840 
         
Interest expense        
   Interest on deposits  2,175,469   2,636,745 
   Interest on federal funds purchased and other borrowed funds  66,939   280,788 
   Interest on repurchase agreements  95,408   100,249 
   Interest on junior subordinated debentures  308,810   730,693 
        Total interest expense  2,646,626   3,748,475 
         
     Net interest income  14,327,407   13,256,365 
 Provision for loan losses  463,750   750,001 
     Net interest income after provision for loan losses  13,863,657   12,506,364 
         
Non-interest income        
   Service fees  1,889,603   1,751,912 
   Income from sold loans  1,236,295   1,256,763 
   Other income from loans  537,630   667,633 
   Net realized (loss) gain on sale of securities available-for-sale  (5,521)  140,971 
   Other income  771,468   600,947 
        Total non-interest income  4,429,475   4,418,226 
         
Non-interest expense        
   Salaries and wages  4,877,483   4,523,882 
   Employee benefits  1,719,128   1,673,327 
   Occupancy expenses, net  2,458,083   2,481,921 
   FDIC insurance  290,021   301,925 
   Amortization of core deposit intangible  204,525   255,652 
   Other expenses  4,329,908   4,584,461 
        Total non-interest expense  13,879,148   13,821,168 
         
    Income before income taxes  4,413,984   3,103,422 
 Income tax expense (benefit)  778,929   (149,970)
        Net income $3,635,055  $3,253,392 
         
 Earnings per common share $0.74  $0.65 
 Weighted average number of common shares        
  used in computing earnings per share  4,831,084   4,759,383 
 Dividends declared per common share $0.42  $0.42 
 Book value per share on common shares outstanding at September 30, $8.81  $8.42 
       
       
  For The Quarters Ended March 31, 
  2014  2013 
       
Net income $1,071,565  $1,041,778 
         
Other comprehensive gain (loss), net of tax:        
  Unrealized holding gain (loss) on available-for-sale securities        
    arising during the period  61,956   (23,700)
  Tax effect  (21,065)  8,058 
  Other comprehensive gain (loss), net of tax  40,891   (15,642)
          Total comprehensive income $1,112,456  $1,026,136 
 
The accompanying notes are an integral part of these consolidated financial statements.
statements
 
 
5
 
 
Community Bancorp. and Subsidiary
Consolidated Statements of Comprehensive IncomeCash Flows
(Unaudited)
For The Quarters Ended September 30,
  2013  2012 
       
Net income $1,354,933  $1,267,351 
         
Other comprehensive income (loss), net of tax:        
  Unrealized holding gain on available-for-sale securities        
    arising during the period  54,595   75,262 
  Reclassification adjustment for loss (gain) realized in income  5,521   (99,676)
     Net change in unrealized gain (loss)  60,116   (24,414)
  Tax effect  (20,439)  8,301 
  Other comprehensive income (loss), net of tax  39,677   (16,113)
          Total comprehensive income $1,394,610  $1,251,238 
Community Bancorp. and Subsidiary
Consolidated Statements of Comprehensive Income
(Unaudited)
For The Nine Months Ended September 30,
  2013  2012 
       
       
Net income $3,635,055  $3,253,392 
         
Other comprehensive (loss) income, net of tax:        
  Unrealized holding (loss) gain on available-for-sale securities        
    arising during the period  (263,440)  398,758 
  Reclassification adjustment for loss (gain) realized in income  5,521   (140,971)
     Net change in unrealized (loss) gain  (257,919)  257,787 
  Tax effect  87,692   (87,648)
  Other comprehensive (loss) income, net of tax  (170,227)  170,139 
          Total comprehensive income $3,464,828  $3,423,531 

The accompanying notes are an integral part of these consolidated financial statements.
       
       
  For The Quarters Ended March 31, 
  2014  2013 
       
Cash Flows from Operating Activities:      
  Net income $1,071,565  $1,041,778 
  Adjustments to reconcile net income to net cash provided by        
   operating activities:        
    Depreciation and amortization, bank premises and equipment  246,008   261,932 
    Provision for loan losses  135,000   206,250 
    Deferred income tax  (27,827)  (144,408)
    Gain on sale of loans  (127,454)  (219,954)
    Loss (gain) on sale of OREO  1,840   (9,728)
    Gain on Trust LLC  (79,812)  (63,594)
    Amortization of bond premium, net  79,113   120,290 
    Proceeds from sales of loans held for sale  4,922,980   8,069,687 
    Originations of loans held for sale  (5,091,626)  (7,695,988)
    Increase in taxes payable  540,800   277,187 
    Increase in interest receivable  (219,996)  (219,530)
    Amortization of FDIC insurance assessment  0   94,105 
    Decrease (increase) in mortgage servicing rights  7,384   (36,629)
    Decrease (increase) in other assets  149,217   (124,301)
    Increase in cash surrender value of bank owned life insurance  (27,260)  (27,890)
    Amortization of core deposit intangible  68,175   68,175 
    Amortization of limited partnerships  147,780   144,570 
    Decrease (increase) in unamortized loan costs  10,164   (37,468)
    Increase (decrease) in interest payable  1,186   (9,891)
    Decrease in accrued expenses  (424,696)  (446,324)
    Increase in other liabilities  15,067   38,046 
       Net cash provided by operating activities  1,397,608   1,286,315 
         
Cash Flows from Investing Activities:        
  Investments - held-to-maturity        
    Maturities and pay downs  3,083,260   4,476,973 
    Purchases  (4,065,647)  (4,992,386)
  Investments - available-for-sale        
    Maturities, calls, pay downs and sales  6,000,000   2,000,000 
    Purchases  (2,015,945)  (7,268,244)
  Proceeds from redemption of restricted equity securities  0   388,500 
  Decrease in limited partnership contributions payable  0   (527,000)
  Increase in loans, net  (12,490,049)  (1,128,848)
  Capital expenditures net of proceeds from sales of bank premises and equipment  (122,115)  (191,092)
  Proceeds from sales of OREO  237,865   204,728 
  Recoveries of loans charged off  15,871   10,215 
       Net cash used in investing activities  (9,356,760)  (7,027,154)
 
 
6
 
 
Community Bancorp. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
For The Nine Months Ended September 30,
  2013  2012 
       
Cash Flows from Operating Activities:      
  Net income $3,635,055  $3,253,392 
  Adjustments to reconcile net income to net cash provided by        
   operating activities:        
    Depreciation and amortization, bank premises and equipment  767,837   837,551 
    Provision for loan losses  463,750   750,001 
    Deferred income tax  407,080   (789,852)
    Net loss (gain) on sale of securities available-for-sale  5,521   (140,971)
    Net gain on sale of loans  (625,171)  (949,833)
    Gain on sale of OREO  (9,728)  (3,740)
    Gain on Trust LLC  (196,216)  (111,573)
    Amortization of bond premium, net  342,865   408,330 
    Write down of OREO  19,500   0 
    Proceeds from sales of loans held-for-sale  15,524,143   37,158,591 
    Originations of loans held-for-sale  (14,626,756)  (35,407,131)
    Increase in taxes payable  295,808   60,128 
    Decrease (increase) in interest receivable  118,114   (109,463)
    Decrease in prepaid FDIC insurance assessment  775,595   276,348 
    (Increase) decrease in mortgage servicing rights  (218,167)  92,105 
    Increase in other assets  (290,733)  (1,095,473)
    Increase in cash surrender value of bank owned life insurance  (86,663)  (92,955)
    Amortization of core deposit intangible  204,525   255,652 
    Amortization of limited partnerships  432,256   915,705 
    Decrease in unamortized loan fees  (112,246)  (94,491)
    Decrease in interest payable  (19,501)  (28,727)
    Increase in accrued expenses  98,794   5,900 
    Increase (decrease) in other liabilities  9,991   (56,152)
       Net cash provided by operating activities  6,915,653   5,133,342 
         
Cash Flows from Investing Activities:        
  Investments - held-to-maturity        
    Maturities and pay downs  34,247,653   18,065,787 
    Purchases  (31,600,883)  (38,429,281)
  Investments - available-for-sale        
    Maturities, calls, pay downs and sales  13,095,380   30,171,833 
    Purchases  (8,267,697)  (11,091,306)
  Proceeds from redemption of restricted equity securities  388,500   287,200 
  Decrease in limited partnership contributions payable  (527,000)  (1,084,000)
  Investments in limited partnerships  0   (213,830)
  Increase in loans, net  (17,228,066)  (22,935,389)
  Capital expenditures net of proceeds from sales of bank premises and equipment  (437,687)  (474,250)
  Proceeds from sales of OREO  1,331,428   58,740 
  Recoveries of loans charged off  253,728   74,685 
       Net cash used in investing activities  (8,744,644)  (25,569,811)
7
 2013  2012  2014  2013 
Cash Flows from Financing Activities:            
Net decrease in demand and NOW accounts  (7,582,283)  (8,386,939)
Net decrease in demand and interest-bearing transaction accounts  (15,747,305)  (22,861,793)
Net increase in money market and savings accounts  2,025,056   19,569,623   6,498,097   10,422,592 
Net increase (decrease) in time deposits  609,952   (8,474,421)
Net (decrease) increase in repurchase agreements  (10,463,846)  6,430,862 
Net increase in time deposits  10,304,209   1,204,441 
Net decrease in repurchase agreements  (3,758,911)  (5,525,656)
Net increase in short-term borrowings  8,325,000   4,840,000   6,000,000   7,845,000 
Proceeds from long-term borrowings  6,000,000   0 
Repayments on long-term borrowings  (6,000,000)  (6,000,000)  0   (6,000,000)
Decrease in capital lease obligations  (47,264)  (43,631)  (16,727)  (15,441)
Dividends paid on preferred stock  (60,938)  (140,625)  (20,313)  (20,313)
Dividends paid on common stock  (1,476,535)  (1,298,983)  (502,719)  (487,661)
Net cash (used in) provided by financing activities  (14,670,858)  6,495,886 
Net cash provided by (used in) financing activities  8,756,331   (15,438,831)
                
Net decrease in cash and cash equivalents  (16,499,849)  (13,940,583)
Net increase (decrease) in cash and cash equivalents  797,179   (21,179,670)
Cash and cash equivalents:                
Beginning  29,881,840   23,464,776   18,329,989   29,881,840 
Ending $13,381,991  $9,524,193  $19,127,168  $8,702,170 
                
Supplemental Schedule of Cash Paid During the Period                
Interest $2,666,127  $3,777,202  $792,104  $944,688 
                
Income taxes $0  $550,000  $(330,069) $0 
                
Supplemental Schedule of Noncash Investing and Financing Activities:                
Change in unrealized (loss) gain on securities available-for-sale $(257,919) $257,787 
        
Loans transferred to OREO $1,391,600  $1,115,198 
        
Investments in limited partnerships        
Investments in limited partnerships $0  $(213,830)
Decrease in limited partnership contributions payable  (527,000)  (1,084,000)
 $(527,000) $(1,297,830)
Change in unrealized gain (loss) on securities available-for-sale $61,956  $(23,700)
                
Common Shares Dividends Paid                
Dividends declared $2,026,829  $1,995,617  $778,872  $673,502 
Increase in dividends payable attributable to dividends declared  (26,616)  (23,440)  (102,207)  (18,758)
Dividends reinvested  (523,678)  (673,194)  (173,946)  (167,083)
 $1,476,535  $1,298,983  $502,719  $487,661 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
87
 

Notes to Consolidated Financial Statements

Note 1.  Basis of Presentation and Consolidation

The interim consolidated financial statements of Community Bancorp. and Subsidiary are unaudited.  All significant intercompany balances and transactions have been eliminated in consolidation.  In the opinion of management, all adjustments necessary for the fair presentation of the financial condition and results of operations of the Company contained herein have been made.  The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 20122013 contained in the Company's Annual Report on Form 10-K.  The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full annual period ending December 31, 2013,2014, or for any other interim period.

Note 2.  Recent Accounting Developments

In December 2011,January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-11, “Balance SheetNo. 2014-01, “Investments – Equity Method and Joint Ventures (Topic 210)323): Disclosures about Offsetting Assets and Liabilities,” amending Topic 210.Accounting for Investments in Qualified Affordable Housing Projects”. The amendments requirein this Update permit institutions to make accounting policy elections to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to disclose both grossthe tax credits and other tax benefits received and recognizes the net information about both instruments and transactionsinvestment performance in the income statement as a component of income tax expense (benefit). For those investments in qualified affordable housing projects not accounted for using the proportional amortization method, the ASU requires the investment to be accounted for as an equity method investment or a cost method investment. The amendments in this Update should be applied retrospectively to all periods presented. A reporting entity that are eligibleuses the effective yield method to account for offset onits investments in qualified affordable housing projects before the balance sheet and instruments and transactions thatdate of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are subject to an agreement similar to a master netting arrangement.  This guidance is effective for annual periods beginning on or after January 1, 2013 and interim reporting periods within those annual periods, with retrospective disclosure for all comparative periods presented.  Adoption ofbeginning after December 15, 2014.  Early adoption is permitted.  Management has reviewed the ASU 2011-11 didand does not believe that it will have a material impact on the Company’sCompany's consolidated financial statements.

In July 2012, theJanuary 2014, FASB issued ASU 2012-02, “Intangibles-Goodwill and Other (Topic 35)No. 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Sub Topic 310-40): Testing Indefinite-Lived Intangible Assets for Impairment,” amending Topic 350.Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure”. The guidance allows entities to first perform an optional qualitative assessment to determine whether it is more likely than notamendments in this Update clarify that an indefinite-lived intangible assetin substance repossession or foreclosure occurs, and a creditor is impairedconsidered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in orderthe residential real estate property to determine whether the asset should be further evaluated under quantitative impairment testing.creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure.  The guidance does not revise the requirement that indefinite-lived intangible assets be tested for impairment at least annually, or more frequently if circumstances warrant, although it does revise the examples of events and circumstances that an entity should consider during interim periods. The ASU isamendments in this Update are effective for annual periods and interim impairment tests performed for fiscal yearsreporting periods within those annual periods, beginning after SeptemberDecember 15, 2012.  Adoption of2014.  Management has reviewed the ASU 2012-02 didand does not believe that it will have a material impact on the Company’sCompany's consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income.” This ASU improves the reporting of reclassifications out of accumulated other comprehensive income. The amendments in the ASU seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under US GAAP to be reclassified in its entirety to net income. For other amounts that are not required under US GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under US GAAP that provide additional detail about those amounts. This guidance is effective for reporting periods beginning after December 15, 2012. Adoption of ASU 2013-02 did not have a material impact on the Company’s consolidated financial statements.

Note 3.  Earnings per Common Share

Earnings per common share amounts are computed based on the weighted average number of shares of common stock issued during the period (retroactively adjusted for stock splits and stock dividends), including Dividend Reinvestment Plan shares issuable upon reinvestment of dividends declared, and reduced for shares held in treasury.

The following tables illustrate the calculation for the periods ended September 30,March 31, as adjusted for the cash dividends declared on the preferred stock:

For The Quarters Ended September 30, 2013  2012 
For The Quarters Ended March 31, 2014  2013 
            
Net income, as reported $1,354,933  $1,267,351  $1,071,565  $1,041,778 
Less: dividends to preferred shareholders (1)  20,313   46,875   20,313   20,313 
Net income available to common shareholders $1,334,620  $1,220,476  $1,051,252  $1,021,465 
Weighted average number of common shares                
used in calculating earnings per share  4,845,044   4,781,877   4,872,589   4,816,588 
Earnings per common share $0.28  $0.26  $0.22  $0.21 

 
98
 
 
For The Nine Months Ended September 30, 2013  2012 
       
Net income, as reported $3,635,055  $3,253,392 
Less: dividends to preferred shareholders (1)  60,938   140,625 
Net income available to common shareholders $3,574,117  $3,112,767 
Weighted average number of common shares        
   used in calculating earnings per share  4,831,084   4,759,383 
Earnings per common share $0.74  $0.65 

(1) Reflects a reduction in the dividend rate paid on the preferred stock, effective January 1, 2013, from a fixed rate of 7.50% to a quarterly adjustable rate equal to the Wall Street Journal Prime Rate in effect on the first business day of the quarter.
Note 4.  Investment Securities

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

    Gross  Gross        Gross  Gross    
 Amortized  Unrealized  Unrealized  Fair  Amortized  Unrealized  Unrealized  Fair 
Securities AFS Cost  Gains  Losses  Value  Cost  Gains  Losses  Value 
                        
September 30, 2013            
March 31, 2014            
U.S. Government sponsored enterprise (GSE) debt securities $28,400,765  $137,888  $149,042  $28,389,611  $25,648,701  $105,874  $124,214  $25,630,361 
U.S. Government securities  7,048,987   14,875   1,402   7,062,460   5,548,652   11,188   2,811   5,557,029 
 $35,449,752  $152,763  $150,444  $35,452,071  $31,197,353  $117,062  $127,025  $31,187,390 
                                
December 31, 2012                
December 31, 2013                
U.S. GSE debt securities $33,552,376  $247,029  $13,936  $33,785,469  $29,220,333  $114,102  $195,521  $29,138,914 
U.S. Government securities  7,073,445   28,217   1,072   7,100,590   6,040,188   10,955   1,455   6,049,688 
 $40,625,821  $275,246  $15,008  $40,886,059  $35,260,521  $125,057  $196,976  $35,188,602 
                                
September 30, 2012                
March 31, 2013                
U.S. GSE debt securities $39,423,142  $419,253  $2,610  $39,839,785  $38,706,702  $238,027  $25,471  $38,919,258 
U.S. Government securities  7,082,906   35,050   300   7,117,656   7,067,072   24,401   418   7,091,055 
U.S. GSE preferred stock  42,360   9,017   0   51,377 
 $46,548,408  $463,320  $2,910  $47,008,818  $45,773,774  $262,428  $25,889  $46,010,313 
                
 
     Gross  Gross         Gross  Gross    
 Amortized  Unrealized  Unrealized  Fair  Amortized  Unrealized  Unrealized  Fair 
Securities HTM Cost  Gains  Losses  Value*  Cost  Gains  Losses  Value* 
                            
September 30, 2013                
March 31, 2014            
States and political subdivisions $39,218,785  $391,215  $0  $39,610,000  $38,919,299  $377,701  $0  $39,297,000 
                                
December 31, 2012                
December 31, 2013                
States and political subdivisions $41,865,555  $425,445  $0  $42,291,000  $37,936,911  $433,089  $0  $38,370,000 
                                
September 30, 2012                
March 31, 2013                
States and political subdivisions $50,065,653  $565,347  $0  $50,631,000  $42,380,968  $352,032  $0  $42,733,000 
*Method used to determine fair value of HTM securities rounds values to nearest thousand.

 
109
 

The scheduled maturities of debt securities AFS were as follows:

 Amortized  Fair  Amortized  Fair 
 Cost  Value  Cost  Value 
September 30, 2013      
March 31, 2014      
Due in one year or less $6,611,216  $6,621,105  $6,631,624  $6,657,510 
Due from one to five years  28,838,536   28,830,966   24,565,729   24,529,880 
 $35,449,752  $35,452,071  $31,197,353  $31,187,390 
                
                
December 31, 2012        
December 31, 2013        
Due in one year or less $4,088,947  $4,104,324  $4,508,181  $4,510,923 
Due from one to five years  36,536,874   36,781,735   30,752,340   30,677,679 
 $40,625,821  $40,886,059  $35,260,521  $35,188,602 
                
September 30, 2012        
March 31, 2013        
Due in one year or less $3,003,306  $3,013,511  $8,184,431  $8,205,591 
Due from one to five years  43,502,742   43,943,930   35,339,343   35,565,694 
Due from five to ten years  2,250,000   2,239,028 
 $46,506,048  $46,957,441  $45,773,774  $46,010,313 
 
The scheduled maturities of debt securities HTM were as follows:

 Amortized  Fair  Amortized  Fair 
 Cost  Value*  Cost  Value* 
September 30, 2013      
March 31, 2014      
Due in one year or less $29,860,867  $29,861,000  $28,961,980  $28,962,000 
Due from one to five years  3,649,393   3,747,000   3,739,065   3,834,000 
Due from five to ten years  2,441,097   2,539,000   2,445,740   2,540,000 
Due after ten years  3,267,428   3,463,000   3,772,514   3,961,000 
 $39,218,785  $39,610,000  $38,919,299  $39,297,000 
                
December 31, 2012        
December 31, 2013        
Due in one year or less $32,741,241  $32,741,000  $27,615,731  $27,616,000 
Due from one to five years  3,849,709   3,956,000   3,939,950   4,048,000 
Due from five to ten years  1,916,266   2,023,000   2,592,045   2,700,000 
Due after ten years  3,358,339   3,571,000   3,789,185   4,006,000 
 $41,865,555  $42,291,000  $37,936,911  $38,370,000 
                
September 30, 2012        
March 31, 2013        
Due in one year or less $40,302,625  $40,303,000  $33,501,248  $33,501,000 
Due from one to five years  4,041,285   4,183,000   3,641,743   3,730,000 
Due from five to ten years  2,286,741   2,428,000   1,898,484   1,986,000 
Due after ten years  3,435,002   3,717,000   3,339,493   3,516,000 
 $50,065,653  $50,631,000  $42,380,968  $42,733,000 

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

 
1110
 

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

  Less than 12 months  12 months or more  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Loss  Value  Loss  Value  Loss 
March 31, 2014                  
U.S. GSE debt securities $8,003,111  $27,981  $5,160,370  $96,233  $13,163,481  $124,214 
U.S. Government securities  1,544,061   2,811   0   0   1,544,061   2,811 
  $9,547,172  $30,792  $5,160,370  $96,233  $14,707,542  $127,025 
                         
December 31, 2013                        
U.S. GSE debt securities $11,094,830  $194,188  $1,004,235  $1,333  $12,099,065  $195,521 
U.S. Government securities  1,034,336   1,455   0   0   1,034,336   1,455 
  $12,129,166  $195,643  $1,004,235  $1,333  $13,133,401  $196,976 
                         
March 31, 2013                        
U.S. GSE debt securities $11,398,359  $25,471  $0  $0  $11,398,359  $25,471 
U.S. Government securities  2,051,016   418   0   0   2,051,016   418 
  $13,449,375  $25,889  $0  $0  $13,449,375  $25,889 
 
  Less than 12 months  12 months or more  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Loss  Value  Loss  Value  Loss 
September 30, 2013                  
U.S. GSE debt securities $9,167,719  $149,042  $0  $0  $9,167,719  $149,042 
U.S. Government securities  1,038,906   1,402   0   0   1,038,906   1,402 
  $10,206,625  $150,444  $0  $0  $10,206,625  $150,444 
                         
December 31, 2012                        
U.S. GSE debt securities $8,715,492  $13,936  $0  $0  $8,715,492  $13,936 
U.S. Government securities  1,052,639   1,072   0   0   1,052,639   1,072 
  $9,768,131  $15,008  $0  $0  $9,768,131  $15,008 
                         
September 30, 2012                        
U.S. GSE debt securities $0  $0  $1,512,667  $2,610  $1,512,667  $2,610 
U.S. Government securities  1,057,928   300   0   0   1,057,928   300 
  $1,057,928  $300  $1,512,667  $2,610  $2,570,595  $2,910 
Debt securities in the table above consisted of nine13 U.S. GSE debt securities and onetwo U.S. Government securitysecurities at September 30, 2013, eightMarch 31, 2014, 12 U.S. GSE debt securities and one U.S. Government security at December 31, 2012,2013, and one11 U.S. GSE debt securitysecurities and onetwo U.S. Government securitysecurities at September 30, 2012.March 31, 2013.  The unrealized losses for all periods presented were principally attributable to changes in prevailing interest rates for similar types of securities and not deterioration in the creditworthiness of the issuer.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions, or adverse developments relating to the issuer, warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than the carrying value, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies or other adverse developments in the status of the securities have occurred, and the results of reviews of the issuer's financial condition.  As of September 30, 2013,March 31, 2014, there were no declines in the fair value of any of the securities reflected in the table above that were deemed by management to be other than temporary.

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

The composition of net loans follows:

  March 31,  December 31,  March 31, 
  2014  2013  2013 
          
Commercial & industrial $60,728,808  $55,619,285  $51,044,490 
Commercial real estate  167,369,628   156,935,803   138,784,472 
Residential real estate – 1st lien
  171,561,880   172,847,074   172,031,283 
Residential real estate - Jr lien  44,528,723   45,687,405   45,912,846 
Consumer  8,041,728   8,819,359   9,696,044 
   452,230,767   439,908,926   417,469,135 
Deduct (add):            
Allowance for loan losses  4,837,578   4,854,915   4,493,384 
Deferred net loan costs  (290,265)  (300,429)  (206,969)
   4,547,313   4,554,486   4,286,415 
          Net Loans $447,683,454  $435,354,440  $413,182,720 
  
September 30,
2013
  
December 31,
2012
  
September 30,
2012
 
          
Commercial & industrial $55,500,735  $49,283,948  $47,484,639 
Commercial real estate  147,280,787   139,807,517   136,016,554 
Residential real estate - 1st lien  175,737,499   171,114,515   168,541,410 
Residential real estate - Jr lien  45,279,400   47,029,023   46,029,238 
Consumer  9,412,856   10,642,151   11,022,804 
   433,211,277   417,877,154   409,094,645 
Deduct (add):            
Allowance for loan losses  4,799,431   4,312,080   4,115,230 
Deferred net loan costs  (281,747)  (169,501)  (101,742)
Loans held-for-sale  1,229,490   1,501,706   1,483,940 
   5,747,174   5,644,285   5,497,428 
          Net Loans $427,464,103  $412,232,869  $403,597,217 

 
1211
 

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

    90 Days  Total        Non-Accrual  90 Days or More     90 Days  Total        Non-Accrual  90 Days or More 
September 30, 2013 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
March 31, 2014 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
                                          
Commercial & industrial $75,101  $269,744  $344,845  $55,155,890  $55,500,735  $493,272  $0  $1,134,539  $289,474  $1,424,013  $59,304,795  $60,728,808  $477,572  $0 
Commercial real estate  982,378   546,252   1,528,630   145,752,157   147,280,787   1,740,350   50,965   1,936,831   128,428   2,065,259   165,304,369   167,369,628   1,299,476   5,313 
Residential real estate - 1st lien  1,270,029   1,071,400   2,341,429   172,166,580   174,508,009   1,999,274   344,193 
Residential real estate - 1st lien
  4,664,185   1,368,469   6,032,654   165,529,226   171,561,880   2,047,423   557,640 
Residential real estate - Jr lien  539,828   223,200   763,028   44,516,372   45,279,400   669,292   62,359   355,723   135,033   490,756   44,037,967   44,528,723   460,590   79,722 
Consumer  95,907   8,755   104,662   9,308,194   9,412,856   0   8,755   106,929   0   106,929   7,934,799   8,041,728   0   0 
Total $2,963,243  $2,119,351  $5,082,594  $426,899,193  $431,981,787  $4,902,188  $466,272  $8,198,207  $1,921,404  $10,119,611  $442,111,156  $452,230,767  $4,285,061  $642,675 
 
     90 Days  Total          Non-Accrual  90 Days or More      90 Days  Total          Non-Accrual  90 Days or More 
December 31, 2012 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
December 31, 2013 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
                                                        
Commercial & industrial $782,937  $377,145  $1,160,082  $48,123,866  $49,283,948  $596,777  $0  $1,060,971  $310,669  $1,371,640  $54,247,645  $55,619,285  $527,105  $21,902 
Commercial real estate  785,890   888,179   1,674,069   138,133,448   139,807,517   1,892,195   53,937   713,160   215,507   928,667   156,007,136   156,935,803   1,403,541   5,313 
Residential real estate - 1st lien  4,654,077   844,803   5,498,880   164,113,929   169,612,809   1,928,097   281,845 
Residential real estate - 1st lien
  5,184,457   1,655,950   6,840,407   166,006,667   172,847,074   2,203,106   817,109 
Residential real estate - Jr lien  379,363   57,128   436,491   46,592,532   47,029,023   338,383   41,434   533,134   289,169   822,303   44,865,102   45,687,405   593,125   56,040 
Consumer  132,624   844   133,468   10,508,683   10,642,151   0   844   136,922   7,784   144,706   8,674,653   8,819,359   0   7,784 
Total $6,734,891  $2,168,099  $8,902,990  $407,472,458  $416,375,448  $4,755,452  $378,060  $7,628,644  $2,479,079  $10,107,723  $429,801,203  $439,908,926  $4,726,877  $908,148 
 
     90 Days  Total          Non-Accrual  90 Days or More      90 Days  Total          Non-Accrual  90 Days or More 
September 30, 2012 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
March 31, 2013 30-89 Days  or More  Past Due  Current  Total Loans  Loans  and Accruing 
                                                        
Commercial & industrial $254,847  $326,693  $581,540  $46,903,099  $47,484,639  $613,817  $75,042  $1,487,049  $303,881  $1,790,930  $49,253,560  $51,044,490  $558,874  $0 
Commercial real estate  426,428   1,331,505   1,757,933   134,258,621   136,016,554   2,321,320   53,936   923,865   1,396,401   2,320,266   136,464,206   138,784,472   2,222,566   186,792 
Residential real estate - 1st lien  749,535   1,102,424   1,851,959   165,205,511   167,057,470   1,441,659   825,843 
Residential real estate - 1st lien
  3,085,496   719,177   3,804,673   168,226,610   172,031,283   1,769,150   164,472 
Residential real estate - Jr lien  456,984   109,222   566,206   45,463,032   46,029,238   326,882   109,222   211,168   104,255   315,423   45,597,423   45,912,846   368,827   53,446 
Consumer  123,197   14,077   137,274   10,885,530   11,022,804   4,841   9,236   93,842   0   93,842   9,602,202   9,696,044   0   0 
Total $2,010,991  $2,883,921  $4,894,912  $402,715,793  $407,610,705  $4,708,519  $1,073,279  $5,801,420  $2,523,714  $8,325,134  $409,144,001  $417,469,135  $4,919,417  $404,710 

For all loan segments, loans over 30 days past due are considered delinquent.
 
Allowance for loan losses

The allowance for loan losses is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is probable. Subsequent recoveries, if any, are credited to the allowance.  No changes in the Company’s policies or methodology pertaining to the allowance for loan losses were made during the first nine monthsquarter of 2013.2014.

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.

 
1312
 

General component

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

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

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

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

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

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

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

 
1413
 
 
Specific component

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

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

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

Unallocated component

An unallocated component of the allowance for loan losses is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component reflects management’s estimate of the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The following summarizes changes in the allowance for loan losses and select loan information, by portfolio segment (excluding loans held-for-sale).segment:
For the quarter ended March 31, 2014
        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses     
Beginning balance $516,382  $2,143,398  $1,452,184  $366,471  $105,279  $271,201  $4,854,915 
  Charge-offs  (16,680)  (100,000)  0   0   (51,528)  0   (168,208)
  Recoveries  112   0   9,373   60   6,326   0   15,871 
  Provision (credit)  56,409   129,280   (64,623)  (17,793)  40,309   (8,582)  135,000 
Ending balance $556,223  $2,172,678  $1,396,934  $348,738  $100,386  $262,619  $4,837,578 
                             
Allowance for loan losses     
Evaluated for impairment                            
  Individually $24,000  $29,000  $92,700  $52,500  $0  $0  $198,200 
  Collectively  532,223   2,143,678   1,304,234   296,238   100,386   262,619   4,639,378 
     Total $556,223  $2,172,678  $1,396,934  $348,738  $100,386  $262,619  $4,837,578 
  
Loans evaluated for impairment     
  Individually $348,376  $1,269,644  $1,499,533  $349,152  $0      $3,466,705 
  Collectively  60,380,432   166,099,984   170,062,347   44,179,571   8,041,728       448,764,062 
     Total $60,728,808  $167,369,628  $171,561,880  $44,528,723  $8,041,728      $452,230,767 

14
 
For the Quarter Ended September 30,year ended December 31, 2013
        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses         
Beginning balance $428,381  $1,536,440  $1,563,576  $332,556  $138,699  $312,428  $4,312,080 
  Charge-offs  (83,344)  (124,849)  (56,430)  (56,797)  (67,009)  0   (388,429)
  Recoveries  2,953   185,791   15,819   21,277   35,424   0   261,264 
  Provision (credit)  168,392   546,016   (70,781)  69,435   (1,835)  (41,227)  670,000 
Ending balance $516,382  $2,143,398  $1,452,184  $366,471  $105,279  $271,201  $4,854,915 
                             
Allowance for loan losses               
Evaluated for impairment                            
  Individually $27,500  $147,700  $99,700  $76,500  $0  $0  $351,400 
  Collectively  488,882   1,995,698   1,352,484   289,971   105,279   271,201   4,503,515 
     Total $516,382  $2,143,398  $1,452,184  $366,471  $105,279  $271,201  $4,854,915 
  
Loans evaluated for impairment               
  Individually $373,696  $1,386,477  $1,788,793  $559,250  $0      $4,108,216 
  Collectively  55,245,589   155,549,326   171,058,281   45,128,155   8,819,359       435,800,710 
     Total $55,619,285  $156,935,803  $172,847,074  $45,687,405  $8,819,359      $439,908,926 

For the quarter ended March 31, 2013

       Residential  Residential                 Residential  Residential          
 Commercial  Commercial  Real Estate  Real Estate           Commercial  Commercial  Real Estate  Real Estate          
 & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Unallocated  Total  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan lossesAllowance for loan losses          
Beginning balance $515,244  $1,698,040  $1,527,962  $414,161  $116,248  $250,524  $4,522,179  $428,381  $1,536,440  $1,563,576  $332,556  $138,699  $312,428  $4,312,080 
Charge-offs  (42,327)  (16,913)  (3,957)  0   (10,647)  0   (73,844)  (17,935)  0   0   0   (17,226)  0   (35,161)
Recoveries  1,126   185,791   3,128   21,110   2,441   0   213,596   200   0   5,626   60   4,329   0   10,215 
Provision (credit)  4,891    72,698   (14,415)  81,589   22,894   (30,157)  137,500   25,743   226,597   (58,063)  53,454   (6,770)  (34,711)  206,250 
Ending balance $478,934  $1,939,616  $1,512,718  $516,860  $130,936  $220,367  $4,799,431  $436,389  $1,763,037  $1,511,139  $386,070  $119,032  $277,717  $4,493,384 
                            
Allowance for loan losses             
Evaluated for impairment                            
Individually $0  $104,500  $116,300  $47,400  $0  $0  $268,200 
Collectively  436,389   1,658,537   1,394,839   338,670   119,032   277,717   4,225,184 
Total $436,389  $1,763,037  $1,511,139  $386,070  $119,032  $277,717  $4,493,384 
 
Loans evaluated for impairment             
Individually $323,486  $2,054,265  $1,490,005  $340,340  $0      $4,208,096 
Collectively  50,721,004   136,730,207   170,541,278   45,572,506   9,696,044       413,261,039 
Total $51,044,490  $138,784,472  $172,031,283  $45,912,846  $9,696,044      $417,469,135 

 
15
 

For the Nine Months Ended September 30, 2013

        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses 
   Beginning balance $428,381  $1,536,440  $1,563,576  $332,556  $138,699  $312,428  $4,312,080 
      Charge-offs  (61,614)  (124,849)  (7,009)  0   (36,655)  0   (230,127)
      Recoveries  2,117   185,791   11,764   21,230   32,826   0   253,728 
      Provision (credit)  110,050   342,234    (55,613)   163,074    (3,934)  (92,061)  463,750 
   Ending balance $478,934  $1,939,616  $1,512,718  $516,860  $130,936  $220,367  $4,799,431 
                             
Allowance for loan losses 
Evaluated for impairment                            
   Individually $ 0  $115,700  $110,500  $185,700  $0  $0  $411,900 
   Collectively  478,934   1,823,916   1,402,218   331,160   130,936   220,367   4,387,531 
          Total $478,934  $1,939,616  $1,512,718  $516,860  $130,936  $220,367  $4,799,431 
  
Loans evaluated for impairment 
   Individually $319,010  $ 1,716,870  $1,734,139  $669,292  $0      $4,439,311 
   Collectively  55,181,725   145,563,917   172,773,870   44,610,108   9,412,856       427,542,476 
          Total $55,500,735  $147,280,787  $174,508,009  $45,279,400  $9,412,856      $431,981,787 
Impaired loans by segments were as follows:

For the year ended December 31, 2012

  As of March 31, 2014    
     Unpaid     Average 
  Recorded  Principal  Related  Recorded 
  Investment  Balance  Allowance  Investment(1) 
             
With no related allowance recorded            
   Commercial & industrial $285,339  $339,849  $0  $299,925 
   Commercial real estate  1,159,450   1,249,304   0   1,052,148 
   Residential real estate - 1st lien
  1,252,528   1,509,290   0   1,303,480 
   Residential real estate - Jr lien  96,266   110,220   0   130,202 
                 
With an allowance recorded                
   Commercial & industrial  63,037   63,037   24,000   61,112 
   Commercial real estate  110,194   188,009   29,000   275,913 
   Residential real estate - 1st lien
  247,005   275,939   92,700   340,683 
   Residential real estate - Jr lien  252,886   283,853   52,500   324,000 
                 
Total                
   Commercial & industrial $348,376  $402,885  $24,000  $361,037 
   Commercial real estate $1,269,644  $1,437,313  $29,000  $1,328,061 
   Residential real estate - 1st lien
 $1,499,533  $1,785,229  $92,700  $1,644,163 
   Residential real estate - Jr lien $349,152  $394,074  $52,500  $454,202 
                 
     Total $3,466,705  $4,019,500  $198,200  $3,787,463 
        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses 
   Beginning balance $342,314  $1,385,939  $1,578,493  $331,684  $124,779  $123,293  $3,886,502 
      Charge-offs  (159,309)  (57,923)  (246,237)  (135,622)  (96,491)  0   (695,582)
      Recoveries  29,769   51,863   5,538   1,538   32,452   0   121,160 
      Provision  215,607   156,561   225,782   134,956   77,959   189,135   1,000,000 
   Ending balance $428,381  $1,536,440  $1,563,576  $332,556  $138,699  $312,428  $4,312,080 
                             
Allowance for loan losses 
Evaluated for impairment                            
   Individually $0  $0  $134,800  $39,200  $0  $0  $174,000 
   Collectively  428,381   1,536,440   1,428,776   293,356   138,699   312,428   4,138,080 
          Total $428,381  $1,536,440  $1,563,576  $332,556  $138,699  $312,428  $4,312,080 
  
Loans evaluated for impairment 
   Individually $435,165  $1,762,615  $1,641,960  $309,606  $0      $4,149,346 
   Collectively  48,848,783   138,044,902   167,970,849   46,719,417   10,642,151       412,226,102 
          Total $49,283,948  $139,807,517  $169,612,809  $47,029,023  $10,642,151      $416,375,448 
 
(1) For the quarter ended September 30, 2012
March 31, 2014
        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses 
   Beginning balance $383,523  $1,386,183  $1,473,661  $368,939  $126,914  $186,899  $3,926,119 
      Charge-offs  (34,375)  (2,821)  (56,126)  (9,447)  (9,065)  0   (111,834)
      Recoveries  17,978   24,587   1,426   60   6,895   0   50,946 
      Provisions  51,298   36,941   85,324   38,815   5,965   31,656   249,999 
   Ending balance $418,424  $1,444,890  $1,504,285  $398,367  $130,709  $218,555  $4,115,230 
  As of December 31, 2013  2013 
     Unpaid     Average 
  Recorded  Principal  Related  Recorded 
  Investment  Balance  Allowance  Investment 
             
With no related allowance recorded            
   Commercial & industrial $314,510  $363,618  $0  $339,519 
   Commercial real estate  944,845   1,021,143   0   1,325,504 
   Residential real estate - 1st lien
  1,354,432   1,654,023   0   1,088,631 
   Residential real estate - Jr lien  164,137   228,134   0   64,606 
                 
With an allowance recorded                
   Commercial & industrial  59,186   59,186   27,500   11,837 
   Commercial real estate  441,632   446,963   147,700   272,174 
   Residential real estate - 1st lien
  434,361   474,496   99,700   515,685 
   Residential real estate - Jr lien  395,113   429,167   76,500   380,855 
                 
Total                
   Commercial & industrial $373,696  $422,804  $27,500  $351,356 
   Commercial real estate $1,386,477  $1,468,106  $147,700  $1,597,678 
   Residential real estate - 1st lien
 $1,788,793  $2,128,519  $99,700  $1,604,316 
   Residential real estate - Jr lien $559,250  $657,301  $76,500  $445,461 
                 
     Total $4,108,216  $4,676,730  $351,400  $3,998,811 

 
16
 

For the nine months ended September 30, 2012
        Residential  Residential          
  Commercial  Commercial  Real Estate  Real Estate          
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Unallocated  Total 
Allowance for loan losses 
   Beginning balance $342,314  $1,385,939  $1,578,493  $331,684  $124,779  $123,293  $3,886,502 
      Charge-offs  (159,309)  (57,878)  (239,600)  (69,734)  (69,437)  0   (595,958)
      Recoveries  20,498   25,450   3,248   1,479   24,010   0   74,685 
      Provisions  214,921   91,379   162,144   134,938   51,357   95,262   750,001 
   Ending balance $418,424  $1,444,890  $1,504,285  $398,367  $130,709  $218,555  $4,115,230 
                             
Allowance for loan losses 
Evaluated for impairment                            
   Individually $0  $8,900  $110,700  $46,400  $0  $0  $166,000 
   Collectively  418,424   1,435,990   1,393,585   351,967   130,709   218,555   3,949,230 
          Total $418,424  $1,444,890  $1,504,285  $398,367  $130,709  $218,555  $4,115,230 
  
Loans evaluated for impairment 
   Individually $446,484  $2,187,060  $1,261,272  $297,898  $0      $4,192,714 
   Collectively  47,038,155   133,829,494   165,796,198   45,731,340   11,022,804       403,417,991 
          Total $47,484,639  $136,016,554  $167,057,470  $46,029,238  $11,022,804      $407,610,705 
Impaired loans by segments were as follows:

  As of September 30, 2013       
     Unpaid     Average  Average 
  Recorded  Principal  Related  Recorded  Recorded 
  Investment  Balance  Allowance  Investment (1)  Investment (2) 
                
With no related allowance recorded               
   Commercial & industrial $319,010  $366,022  $0  $312,218  $345,772 
   Commercial real estate  1,199,398   1,269,979   0   1,085,322   1,420,668 
   Residential real estate - 1st lien  1,156,159   1,390,485   0   1,026,675   1,022,181 
   Residential real estate - Jr lien  102,913   110,997   0   63,752   39,723 
                     
With an allowance recorded                    
   Commercial & industrial  0   0   0   0   0 
   Commercial real estate  517,472   517,472   115,700   307,194   229,809 
   Residential real estate - 1st lien  577,980   657,154   110,500   523,738   536,016 
   Residential real estate - Jr lien  566,379   595,494   185,700   445,302   377,291 
                     
Total                    
   Commercial & industrial $319,010  $366,022  $0  $312,218  $345,772 
   Commercial real estate $1,716,870  $1,787,451  $115,700  $1,392,516  $1,650,477 
   Residential real estate - 1st lien $1,734,139  $2,047,639  $110,500  $1,550,413  $1,558,197 
   Residential real estate - Jr lien $669,292  $706,491  $185,700  $509,054  $417,014 
                     
          Total $4,439,311  $4,907,603  $411,900  $3,764,201  $3,971,460 
(1) For the Quarter Ended September 30, 2013

(2) For the Nine Months Ended September 30, 2013
 
17

As of December 31, 2012
  As of March 31, 2013    
     Unpaid     Average 
  Recorded  Principal  Related  Recorded 
  Investment  Balance  Allowance  Investment(1) 
             
With no related allowance recorded      
   Commercial & industrial $323,486  $360,385  $0  $379,326 
   Commercial real estate  1,749,415   2,123,371   0   1,756,015 
   Residential real estate - 1st lien  1,010,777   1,230,873   0   1,017,687 
   Residential real estate - Jr lien  15,694   77,545   0   15,694 
                 
With an allowance recorded(2)                
   Commercial real estate  304,850   304,850   104,500   152,425 
   Residential real estate - 1st lien  479,228   540,698   116,300   548,295 
   Residential real estate - Jr lien  324,646   352,498   47,400   309,279 
                 
Total                
   Commercial & industrial $323,486  $360,385  $0  $379,326 
   Commercial real estate $2,054,265  $2,428,221  $104,500  $1,908,440 
   Residential real estate - 1st lien $1,490,005  $1,771,571  $116,300  $1,565,982 
   Residential real estate - Jr lien $340,340  $430,043  $47,400  $324,973 
                 
      Total $4,208,096  $4,990,220  $268,200  $4,178,721 
 
(1) For the quarter ended March 31, 2013
(2) There were no commercial & industrial loans with an allowance recorded for the period presented.
     Unpaid     Average 
  Recorded  Principal  Related  Recorded 
  Investment  Balance  Allowance  Investment 
             
With no related allowance recorded            
   Commercial & industrial $435,165  $473,664  $0  $536,973 
   Commercial real estate  1,762,615   2,123,371   0   2,019,449 
   Residential real estate - 1st lien  1,024,598   1,250,224   0   893,629 
   Residential real estate - Jr lien  15,694   76,680   0   34,602 
                 
With an allowance recorded                
   Commercial & industrial  0   0   0   232,743 
   Commercial real estate  0   0   0   920,842 
   Residential real estate - 1st lien  617,362   669,288   134,800   892,339 
   Residential real estate - Jr lien  293,912   319,020   39,200   295,372 
                 
Total                
   Commercial & industrial $435,165  $473,664  $0  $769,716 
   Commercial real estate $1,762,615  $2,123,371  $0  $2,940,291 
   Residential real estate - 1st lien $1,641,960  $1,919,512  $134,800  $1,785,968 
   Residential real estate - Jr lien $309,606  $395,700  $39,200  $329,974 
                 
          Total $4,149,346  $4,912,247  $174,000  $5,825,949 

As of September 30, 2012

     Unpaid     Average  Average 
  Recorded  Principal  Related  Recorded  Recorded 
  Investment  Balance  Allowance  Investment (1)  Investment (2) 
                
With no related allowance recorded               
   Commercial & industrial $446,484  $478,798  $0  $715,917  $562,425 
   Commercial real estate  1,996,452   2,426,167   0   2,152,006   2,083,657 
   Residential real estate - 1st lien  900,217   1,149,862   0   800,820   860,886 
   Residential real estate - Jr lien  0   0   0   15,766   39,329 
                     
With an allowance recorded                    
   Commercial & industrial  0   0   0   0   290,929 
   Commercial real estate  190,608   192,108   8,900   671,132   1,151,053 
   Residential real estate - 1st lien  361,055   402,647   110,700   502,679   961,084 
   Residential real estate - Jr lien  297,898   319,472   46,400   284,081   295,737 
                     
Total                    
   Commercial & industrial $446,484  $478,798  $   0  $715,917  $853,354 
   Commercial real estate $2,187,060  $2,618,275  $ 8,900  $2,823,138  $3,234,710 
   Residential real estate - 1st lien $1,261,272  $1,552,509  $110,700  $1,303,499  $1,821,970 
   Residential real estate - Jr lien $297,898  $319,472  $46,400  $299,847  $335,066 
                     
          Total $4,192,714  $4,969,054  $166,000  $5,142,401  $6,245,100 
(1) For the Quarter Ended September 30, 2012
(2) For the Nine Months Ended September 30, 2012

Interest income recognized on impaired loans iswas immaterial for all periods presented.
 
18
For all loans 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 impaired loans are generally applied as a reduction of the loan principal balance.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are considered by management to be reasonably assured.

As of the balance sheet dates, the Company was not contractually committed to lend additional funds to debtors with impaired, non-accrual or restructured loans.
 
Credit Quality Grouping
 
In developing the allowance for loan losses, management uses credit quality grouping to help evaluate trends in credit quality. The Company groups credit risk into Groups A, B and C. The manner the Company utilizes to assign risk grouping is driven by loan purpose. Commercial purpose loans are individually risk graded while the retail portion of the portfolio is generally grouped by delinquency pool.
 
Group A loans - Acceptable Risk – are loans that are expected to perform as agreed under their respective terms.  Such loans carry a normal level of risk that does not require management attention beyond that warranted by the loan or loan relationship characteristics, such as loan size or relationship size. Group A loans include commercial purpose loans that are individually risk rated and retail loans that are rated by pool. Group A retail loans include both performing consumer and residential real estate loans. Residential real estate loans are loans to individuals secured by 1-4 family homes, including first mortgages, home equity and home improvement loans. Loan balances fully secured by deposit accounts or that are fully guaranteed by the Federal Government are considered acceptable risk.
 
Group B loans – Management Involved - are loans that require greater attention than the acceptable loans in Group A. Characteristics of such loans may include, but are not limited to, borrowers that are experiencing negative operating trends such as reduced sales or margins, borrowers that have exposure to adverse market conditions such as increased competition or regulatory burden, or borrowers that have had unexpected or adverse changes in management. These loans have a greater likelihood of migrating to an unacceptable risk level if these characteristics are left unchecked. Group B is limited to commercial purpose loans that are individually risk rated.
 
17
Group C loans – Unacceptable Risk – are loans that have distinct shortcomings that require a greater degree of management attention.  Examples of these shortcomings include a borrower's inadequate capacity to service debt, poor operating performance, or insolvency.  These loans are more likely to result in repayment through collateral liquidation. Group C loans range from those that are likely to sustain some loss if the shortcomings are not corrected, to those for which loss is imminent and non-accrual treatment is warranted. Group C loans include individually rated commercial purpose loans, and retail loans adversely rated in accordance with the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification Policy. Group C retail loans include 1-4 family residential real estate loans and home equity loans past due 90 days or more with loan-to-value ratios greater than 60%, home equity loans 90 days or more past due where the bank does not hold first mortgage, irrespective of loan-to-value, loans in bankruptcy where repayment is likely but not yet established, and lastly consumer loans that are 90 days or more past due.
 
Commercial purpose loan ratings are assigned by the commercial account officer; for larger and more complex commercial loans, the credit rating is a collaborative assignment by the lender and the credit analyst. The credit risk rating is based on the borrower's expected performance, i.e., the likelihood that the borrower will be able to service its obligations in accordance with the loan terms. Credit risk ratings are meant to measure risk versus simply record history.  Assessment of expected future payment performance requires consideration of numerous factors.  While past performance is part of the overall evaluation, expected performance is based on an analysis of the borrower's financial strength, and historical and projected factors such as size and financing alternatives, capacity and cash flow, balance sheet and income statement trends, the quality and timeliness of financial reporting, and the quality of the borrower’s management.  Other factors influencing the credit risk rating to a lesser degree include collateral coverage and control, guarantor strength and commitment, documentation, structure and covenants and industry conditions.  There are uncertainties inherent in this process.
 
Credit risk ratings are dynamic and require updating whenever relevant information is received.  The risk ratings of larger or more complex loans, and Group B and C rated loans, are assessed at the time of their respective annual reviews, during quarterly updates, in action plans or at any other time that relevant information warrants update. Lenders are required to make immediate disclosure to the Chief Credit Officer of any known increase in loan risk, even if considered temporary in nature.

19
The risk ratings within the loan portfolio by segments as of the balance sheet dates were as follows:

As of September 30, 2013 
        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Total 
                   
Group A $51,937,275  $139,168,914  $171,694,502  $44,144,667  $9,404,101  $416,349,459 
Group B  2,412,663   3,572,369   175,081   497,992   0   6,658,105 
Group C  1,150,797   4,539,504   2,638,426   636,741   8,755   8,974,223 
          Total $55,500,735  $147,280,787  $174,508,009  $45,279,400  $9,412,856  $431,981,787 
As of March 31, 2014

        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Total 
                   
Group A $56,637,600  $157,395,642  $168,645,904  $43,890,056  $8,041,728  $434,610,930 
Group B  2,759,619   4,697,830   214,558   148,881   0   7,820,888 
Group C  1,331,589   5,276,156   2,701,418   489,786   0   9,798,949 
     Total $60,728,808  $167,369,628  $171,561,880  $44,528,723  $8,041,728  $452,230,767 
 
As of December 31, 2012 
        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Total 
                   
Group A $47,689,238  $131,643,756  $166,374,493  $46,162,420  $10,632,404  $402,502,311 
Group B  593,838   4,139,367   404,752   318,248   0   5,456,205 
Group C  1,000,872   4,024,394   2,833,564   548,355   9,747   8,416,932 
          Total $49,283,948  $139,807,517  $169,612,809  $47,029,023  $10,642,151  $416,375,448 
As of December 31, 2013
        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Total 
                   
Group A $51,740,744  $148,516,895  $169,771,357  $44,739,736  $8,800,365  $423,569,097 
Group B  2,824,169   3,292,200   160,468   460,844   0   6,737,681 
Group C  1,054,372   5,126,708   2,915,249   486,825   18,994   9,602,148 
     Total $55,619,285  $156,935,803  $172,847,074  $45,687,405  $8,819,359  $439,908,926 
 
As of September 30, 2012                
        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  1st Lien  Jr Lien  Consumer  Total 
                   
Group A $45,649,737  $127,984,841  $162,990,115  $45,373,633  $11,005,770  $393,004,096 
Group B  590,534   3,787,365   408,051   318,848   0   5,104,798 
Group C  1,244,368   4,244,348   3,659,304   336,757   17,034   9,501,811 
          Total $47,484,639  $136,016,554  $167,057,470  $46,029,238  $11,022,804  $407,610,705 
18
 
As of March 31, 2013

        Residential  Residential       
  Commercial  Commercial  Real Estate  Real Estate       
  & Industrial  Real Estate  
1st Lien
  Jr Lien  Consumer  Total 
                   
Group A $49,335,387  $129,675,041  $168,993,626  $44,989,095  $9,693,695  $402,686,844 
Group B  501,888   4,282,500   183,678   431,348   0   5,399,414 
Group C  1,207,215   4,826,931   2,853,979   492,403   2,349   9,382,877 
     Total $51,044,490  $138,784,472  $172,031,283  $45,912,846  $9,696,044  $417,469,135 
Modifications of Loans and TDRs

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

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

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

An insignificant delay or insignificant shortfall in the amount of payments typically would not require the loan to be accounted for as a TDR.  However, pursuant to regulatory guidance, any payment delay longer than three months is generally not considered insignificant. The 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.

There were no loans modified as TDR’s during the three month period ended March 31, 2013.  TDR’s by segment for the other periods presented were as follows:

  For the quarter ended March 31, 2014 
     Pre-  Post- 
     Modification  Modification 
     Outstanding  Outstanding 
  Number of  Recorded  Recorded 
  Contracts  Investment  Investment 
             
Residential real estate - 1st lien  3  $262,569  $273,647 
 
 
2019
 
There were no TDR’s for the quarter ended September 30, 2013.  TDR’s by segment for the periods presented were as follows:
 
For the nine months ended September 30, 2013

     Pre-  Post- 
     Modification  Modification 
     Outstanding  Outstanding 
  Number of  Recorded  Recorded 
  Contracts  Investment  Investment 
          
Residential real estate - Jr lien  1  $23,425  $23,425 

For the year ended December 31, 2012

     Pre-  Post- 
     Modification  Modification 
     Outstanding  Outstanding 
  Number of  Recorded  Recorded 
  Contracts  Investment  Investment 
          
Commercial real estate  2  $1,030,645  $1,030,645 
Residential real estate - 1st lien  3   200,241   205,588 
          Total  5  $1,230,886  $1,236,233 

For the quarter ended September 30, 2012
     Pre-  Post- 
     Modification  Modification 
     Outstanding  Outstanding 
  Number of  Recorded  Recorded 
  Contracts  Investment  Investment 
          
Residential real estate - 1st lien  1  $52,940  $53,369 

For the nine months ended September 30, 2012

    Pre-  Post- For the year ended December 31, 2013 
    Modification  Modification     Pre-  Post- 
    Outstanding  Outstanding     Modification  Modification 
 Number of  Recorded  Recorded     Outstanding  Outstanding 
 Contracts  Investment  Investment  Number of  Recorded  Recorded 
          Contracts  Investment  Investment 
Commercial real estate  2  $1,030,645  $1,030,645 
Residential real estate - 1st lien  3   200,241   205,588 
         
Residential real estate - 1st lien
  4  $321,406  $330,266 
Residential real estate - Jr lien  1   23,425   23,425 
Total  5  $1,230,886  $1,236,233   5  $344,831  $353,691 
 
There were no TDRs for which there was a payment default under the restructured terms during the twelve month period ended September 30,March 31, 2013.  The TDR’s for which there was a payment default during the twelve month period ended September 30, 2012March 31, 2014 were as follows:

  Number of  Recorded 
  Contracts  Investment 
       
Commercial & industrial  1  $158,076 
  Number of  Recorded 
  Contracts  Investment 
       
Residential real estate - 1st lien
  5  $446,668 
 
21
TDRs are treated as other impaired loans and carry individual specific reserves with respect to the calculation of the allowance for loan losses.  These loans are categorized as non-performing, may be past due, and are generally adversely risk rated. The TDRs that have defaulted under their restructured terms are generally in collection status and their reserve is typically calculated using the fair value of collateral method. At September 30, 2013,March 31, 2014, December 31, 2012,2013, and September 30, 2012,March 31, 2013, the allowance related to TDRs was approximately $0, $23,000$5,800 and $29,000,$12,000, respectively.

At September 30, 2013,March 31, 2014, the Company did not have any commitments to lend additional funds to borrowers with loans classified as TDRs.

Note 6.  Goodwill and Other Intangible Assets

As a result of the merger with LyndonBank on December 31, 2007, the Company recorded goodwill amounting to $11,574,269.  The goodwill is not amortizable and is not deductible for tax purposes.

The Company also recorded $4,161,000 of acquired identified intangible assets representing the core deposit intangible which is subject to amortization as a non-interest expense over a ten year period.  The accumulated amortization expense was $3,002,049$3,138,394 and $2,712,306$2,865,699 as of September 30,March 31, 2014 and 2013, and 2012, respectively.

Amortization expense for the core deposit intangible for the first ninethree months of 2014 and 2013 was $204,525.$68,175.  As of September 30, 2013,March 31, 2014, the remaining annual amortization expense related to the core deposit intangible, absent any future impairment, is expected to be as follows:

2013 $68,170 
2014  272,695  $204,520 
2015  272,695   272,695 
2016  272,695   272,695 
2017  272,696   272,696 
Total remaining core deposit intangible $1,158,951  $1,022,606 

Management evaluates goodwill for impairment annually and the core deposit intangible for impairment if conditions warrant.  As of the date of the most recent evaluation (December 31, 2012)2013), management concluded that no impairment existed in either category.

Note 7.  Fair Value

Certain assets and liabilities are recorded at fair value to provide additional insight into the Company’s quality of earnings. The fair values of some of these assets and liabilities are measured on a recurring basis while others are measured on a nonrecurring basis, with the determination based upon applicable existing accounting pronouncements. For example, securities available-for-sale are recorded at fair value on a recurring basis. Other assets, such as mortgage servicing rights, loans held-for-sale, and impaired loans, are recorded at fair value on a nonrecurring 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.

20
Level 1Quoted prices in active markets for identical assets or liabilities.  Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2Observable inputs other than Level 1 prices such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.  Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.  This category generally includes mortgage servicing rights, impaired loans and OREO.

Level 3Unobservable 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.

22
The following methods and assumptions were used by the Company in estimating its fair value measurements and disclosures:

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

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

Restricted equity securities:  Restricted equity securities are comprised of Federal Reserve Bank of Boston (FRBB) stock and Federal Home Loan Bank of Boston (FHLBB) stock.  These securities are carried at cost, which is believed to approximate fair value, based on the redemption provisions of the FRBB and the FHLBB.  The stock is nonmarketable, and redeemable at par value, subject to certain conditions.  As such the Company classifies these securities as Level 2.

Loans and loans held-for-sale:  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts.  The fair values for other loans (for example, fixed rate residential, commercial real estate, and rental property mortgage loans, and commercial and industrial loans) are estimated using discounted cash flow analyses, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics.  Loan impairment is deemed to exist when full repayment of principal and interest according to the contractual terms of the loan is no longer probable.  Impaired loans are reported based on one of three measures: the present value of expected future cash flows discounted at the loan’s effective interest rate; the loan’s observable market price; or the fair value of the collateral if the loan is collateral dependent.  If the fair value is less than an impaired loan’s recorded investment, an impairment loss is recognized as part of the allowance for loan losses.  Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis.  Management has estimated the fair values of these assets using Level 2 inputs, such as the fair value of collateral based on independent third-party appraisals for collateral-dependent loans.  All other loans are valued using Level 3 inputs.

The fair value of loans held-for-sale is based upon an actual purchase and sale agreement between the Company and an independent market participant.  The sale is executed within a reasonable period following quarter end at the stated fair value.

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

21
OREO.OREO:  Real estate acquired through or in lieu of foreclosure isand bank properties no longer used as bank premises are initially recorded at marketfair value. The fair value of other real estate ownedOREO is based on property appraisals and an analysis of similar properties currently available. As such, the Company records other real estate ownedOREO as nonrecurring Level 2.

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

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

Capital lease obligations:  Fair value is determined using a discounted cash flow calculation using current rates.  Based on current rates, carrying value approximates fair value.  As such the Company classifies these obligations as Level 2.

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

23
Accrued interest:  The carrying amounts of accrued interest approximate their fair values.  As such the Company classifies accrued interest as Level 2.

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

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

22

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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

September 30, 2013 Level 1  Level 2  Total 
March 31, 2014 Level 1  Level 2  Total 
Assets: (market approach)                  
U.S. GSE debt securities $0  $28,389,611  $28,389,611  $0  $25,630,361  $25,630,361 
U.S. Government securities  7,062,460   0   7,062,460   5,557,029   0   5,557,029 
                        
December 31, 2012            
December 31, 2013            
Assets: (market approach)                        
U.S. GSE debt securities $0  $33,785,469  $33,785,469  $0  $29,138,914  $29,138,914 
U.S. Government securities  7,100,590   0   7,100,590   6,049,688   0   6,049,688 
                        
September 30, 2012            
March 31, 2013            
Assets: (market approach)                        
U.S. GSE debt securities $0  $39,839,785  $39,839,785  $0  $38,919,258  $38,919,258 
U.S. Government securities  7,117,656   0   7,117,656   7,091,055   0   7,091,055 
U.S. GSE preferred stock  51,377   0   51,377 
 
There were no transfers between Levels 1 and 2 for the periods presented.  There were no Level 3 assets or liabilities measured on a recurring basis as of the balance sheet dates presented.

Assets and Liabilities Recorded at Fair Value on a Non-Recurring Basis

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

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

September 30, 2013 Level 2 
March 31, 2014 Level 2 
Assets: (market approach)      
Residential mortgage servicing rights $1,227,790  $1,321,695 
Impaired loans, net of related allowance  1,249,931   474,922 
OREO  1,125,105   865,820 
    
December 31, 2013    
Assets: (market approach)    
Residential mortgage servicing rights $1,329,079 
Impaired loans, net of related allowance  978,892 
OREO  1,105,525 
    
March 31, 2013    
Assets: (market approach)    
Residential mortgage servicing rights $1,046,252 
Impaired loans, net of related allowance  840,524 
OREO  879,705 
 
December 31, 2012 Level 2 
Assets: (market approach)    
Residential mortgage servicing rights $1,009,623 
Impaired loans, net of related allowance  737,274 
OREO  1,074,705 
September 30, 2012 Level 2 
Assets: (market approach)    
Residential mortgage servicing rights $1,005,337 
Impaired loans, net of related allowance  683,561 
OREO  1,150,198 
24
There were no Level 1 or Level 3 assets or liabilities measured on a non-recurring basis as of the balance sheet dates presented.

23

The estimated fair values of commitments to extend credit and letters of credit were immaterial as of the dates presented in the tables below.  The estimated fair values of the Company's financial instruments were as follows:
 
September 30, 2013
March 31, 2014    Fair  Fair  Fair  Fair 
  Carrying  Value  Value  Value  Value 
  Amount  Level 1  Level 2  Level 3  Total 
  (Dollars in Thousands) 
Financial assets:               
Cash and cash equivalents $19,127  $19,127  $0  $0  $19,127 
Securities held-to-maturity  38,919   0   39,297   0   39,297 
Securities available-for-sale  31,187   5,557   25,630   0   31,187 
Restricted equity securities  3,633   0   3,633   0   3,633 
Loans and loans held-for-sale                    
  Commercial & industrial  60,138   0   324   61,035   61,359 
  Commercial real estate  165,100   0   1,241   168,597   169,838 
  Residential real estate - 1st lien  170,571   0   1,407   173,511   174,918 
  Residential real estate - Jr lien  44,154   0   296   44,799   45,095 
  Consumer  7,937   0   0   8,321   8,321 
Mortgage servicing rights  1,322   0   1,608   0   1,608 
Accrued interest receivable  1,998   0   1,998   0   1,998 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  454,295   0   455,151   0   455,151 
  Brokered deposits  28,313   0   28,319   0   28,319 
Federal funds purchased and short term-borrowings  6,000   0   6,000   0   6,000 
Long-term borrowings  6,000   0   6,000   0   6,000 
Repurchase agreements  25,886   0   25,886   0   25,886 
Capital lease obligations  694   0   694   0   694 
Subordinated debentures  12,887   0   12,881   0   12,881 
Accrued interest payable  77   0   77   0   77 

 
24
     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 $13,382  $13,382  $0  $0  $13,382 
Securities held-to-maturity  39,219   0   39,610   0   39,610 
Securities available-for-sale  35,452   7,062   28,390   0   35,452 
Restricted equity securities  3,633   0   3,633   0   3,633 
Loans and loans held-for-sale                    
  Commercial & industrial  54,994   0   319   56,038   56,357 
  Commercial real estate  145,266   0   1,601   148,401   150,002 
  Residential real estate - 1st lien  174,135   0   1,624   177,800   179,424 
  Residential real estate - Jr lien  44,739   0   483   45,272   45,755 
  Consumer  9,278   0   0   9,742   9,742 
Mortgage servicing rights  1,228   0   1,228   0   1,228 
Accrued interest receivable  1,633   0   1,633   0   1,633 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  454,521   0   455,772   0   455,772 
  Brokered deposits  16,029   0   16,038   0   16,038 
Federal funds purchased and short-term borrowings  8,325   0   8,325   0   8,325 
Repurchase agreements  23,686   0   23,686   0   23,686 
Capital lease obligations  727   0   727   0   727 
Subordinated debentures  12,887   0   12,872   0   12,872 
Accrued interest payable  73   0   73   0   73 
 
December 31, 2013    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 $18,330  $18,330  $0  $0  $18,330 
Securities held-to-maturity  37,937   0   38,370   0   38,370 
Securities available-for-sale  35,189   6,050   29,139   0   35,189 
Restricted equity securities  3,633   0   3,633   0   3,633 
Loans and loans held-for-sale                    
  Commercial & industrial  55,069   0   346   56,035   56,381 
  Commercial real estate  154,696   0   1,239   157,843   159,082 
  Residential real estate - 1st lien
  171,498   0   1,689   174,776   176,465 
  Residential real estate - Jr lien  45,292   0   483   45,785   46,268 
  Consumer  8,709   0   0   9,130   9,130 
Mortgage servicing rights  1,329   0   1,608   0   1,608 
Accrued interest receivable  1,778   0   1,778   0   1,778 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  463,160   0   464,220   0   464,220 
  Brokered deposits  18,393   0   18,401   0   18,401 
Repurchase agreements  29,645   0   29,645   0   29,645 
Capital lease obligations  711   0   711   0   711 
Subordinated debentures  12,887   0   12,880   0   12,880 
Accrued interest payable  75   0   75   0   75 
March 31, 2013    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 $8,702  $8,702  $0  $0  $8,702 
Securities held-to-maturity  42,381   0   42,733   0   42,733 
Securities available-for-sale  46,010   7,091   38,919   0   46,010 
Restricted equity securities  3,633   0   3,633   0   3,633 
Loans and loans held-for-sale                    
  Commercial & industrial  50,575   0   323   51,347   51,670 
  Commercial real estate  136,929   0   1,949   137,425   139,374 
  Residential real estate - 1st lien
  171,753   0   1,374   177,405   178,779 
  Residential real estate - Jr lien  45,496   0   293   46,250   46,543 
  Consumer  9,571   0   0   10,090   10,090 
Mortgage servicing rights  1,046   0   1,046   0   1,046 
Accrued interest receivable  1,971   0   1,971   0   1,971 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  446,782   0   448,797   0   448,797 
  Brokered deposits  17,480   0   17,492   0   17,492 
Federal funds purchased and short term-borrowings  7,845   0   7,845   0   7,845 
Repurchase agreements  28,624   0   28,624   0   28,624 
Capital lease obligations  759   0   759   0   759 
Subordinated debentures  12,887   0   12,880   0   12,880 
Accrued interest payable  83   0   83   0   83 

 
25
 
December 31, 2012
     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 $29,882  $29,882  $0  $0  $29,882 
Securities held-to-maturity  41,866   0   42,291   0   42,291 
Securities available-for-sale  40,886   7,101   33,785   0   40,886 
Restricted equity securities  4,021   0   4,021   0   4,021 
Loans and loans held-for-sale                    
  Commercial & industrial  48,819   0   435   49,441   49,876 
  Commercial real estate  138,166   0   1,763   139,175   140,938 
  Residential real estate - 1st lien  169,424   0   1,507   175,559   177,066 
  Residential real estate - Jr lien  46,661   0   271   47,484   47,755 
  Consumer  10,495   0   0   11,079   11,079 
Mortgage servicing rights  1,010   0   1,010   0   1,010 
Accrued interest receivable  1,751   0   1,751   0   1,751 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  460,939   0   463,168   0   463,168 
  Brokered deposits  14,558   0   14,559   0   14,559 
Long-term borrowings  6,000   0   6,004   0   6,004 
Repurchase agreements  34,150   0   34,150   0   34,150 
Capital lease obligations  775   0   775   0   775 
Subordinated debentures  12,887   0   13,158   0   13,158 
Accrued interest payable  93   0   93   0   93 
September 30, 2012
     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 $9,524  $9,524  $0  $0  $9,524 
Securities held-to-maturity  50,066   0   50,631   0   50,631 
Securities available-for-sale  47,009   7,169   39,840   0   47,009 
Restricted equity securities  4,021   0   4,021   0   4,021 
Loans and loans held-for-sale                    
  Commercial & industrial  47,041   0   446   47,741   48,187 
  Commercial real estate  134,499   0   2,178   135,566   137,744 
  Residential real estate - 1st lien  166,947   0   1,150   174,547   175,697 
  Residential real estate - Jr lien  45,606   0   252   46,656   46,908 
  Consumer  10,886   0   0   11,465   11,465 
Mortgage servicing rights  1,005   0   1,005   0   1,005 
Accrued interest receivable  1,810   0   1,810   0   1,810 
                     
Financial liabilities:                    
Deposits                    
  Other deposits  443,008   0   445,472   0   445,472 
  Brokered deposits  14,094   0   14,101   0   14,101 
Federal funds purchased and short-term borrowings  4,840   0   4,840   0   4,840 
Long-term borrowings  12,010   0   12,327   0   12,327 
Repurchase agreements  28,076   0   28,076   0   28,076 
Capital lease obligations  790   0   790   0   790 
Subordinated debentures  12,887   0   13,621   0   13,621 
Accrued interest payable  121   0   121   0   121 
26

Note 8.  Loan Servicing

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

 September 30,  December 31,  September 30,  March 31,  December 31,  March 31, 
 2013  2012  2012  2014  2013  2013 
                  
Balance at beginning of year $1,009,623  $1,097,442  $1,097,442  $1,329,079  $1,009,623  $1,009,623 
Mortgage servicing rights capitalized  215,196   406,807   313,082   46,636   274,253   74,507 
Mortgage servicing rights amortized  (259,697)  (409,584)  (314,100)  (57,818)  (317,865)  (104,557)
Change in valuation allowance  262,668   (85,042)  (91,087)  3,798   363,068   66,679 
Balance at end of period $1,227,790  $1,009,623  $1,005,337  $1,321,695  $1,329,079  $1,046,252 
 
Note 9.  Legal Proceedings

In the normal course of business the Company and its subsidiary are involved in litigation that is considered incidental to their business.  Management does not expect that any such litigation will be material to the Company's consolidated financial condition or results of operations.

Note 10.  Subsequent Event

The Company has evaluated events and transactions through the date that the financial statements were issued for potential recognition or disclosure in these financial statements, as required by GAAP.  On September 24, 2013,March 11, 2014, the Company declared a cash dividend of $0.14$0.16 per common share payable NovemberMay 1, 20132014 to shareholders of record as of OctoberApril 15, 2013.2014.  This dividend, amounting to $677,658,$778,872, was accrued at September 30, 2013.March 31, 2014.

 
2726
 

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

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for the Period Ended September 30, 2013March 31, 2014

The following discussion analyzes the consolidated financial condition of Community Bancorp. (the “Company”) and its wholly-owned subsidiary, Community National Bank (the “Bank”), as of September 30, 2013,March 31, 2014, December 31, 20122013 and September 30, 2012,March 31, 2013, and its consolidated results of operations for the two interim periods presented.  The Company is considered a “smaller reporting company” under applicable regulations of the Securities and Exchange Commission (“SEC”) and is therefore eligible for relief from certain disclosure requirements.  In accordance with such provisions, the Company has elected to provide its interim consolidated statements of income, comprehensive income, and cash flows for two, rather than three, years.

The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 20122013 Annual Report on formForm 10-K filed with the SEC.

FORWARD-LOOKING STATEMENTS

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

Forward-looking statements are not guarantees of future performance.  They necessarily involve risks, uncertainties and assumptions.  Future results of the Company may differ materially from those expressed in these forward-looking statements.  Examples of forward looking statements included in this discussion include, but are not limited to, estimated contingent liability related to assumptions made within the asset/liability management process, management's expectations as to the future interest rate environment and the Company's related liquidity level, credit risk expectations relating to the Company's loan portfolio and its participation in the Federal Home Loan Bank of Boston (“FHLBB”) Mortgage Partnership Finance (“MPF”) program, and management's general outlook for the future performance of the Company or the local or national economy. Although forward-looking statements are based on management's current expectations and estimates, many of the factors that could influence or determine actual results are unpredictable and not within the Company's control.  Readers are cautioned not to place undue reliance on such statements as they speak only as of the date they are made.  The Company does not undertake, and disclaims any obligation, to revise or update any forward-looking statements to reflect the occurrence or anticipated occurrence of events or circumstances after the date of this Report, except as required by applicable law.  The Company claims the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995.

Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities: (1) general economic conditions, either nationally, regionally or locally continue to deteriorate, resulting in a decline in credit quality or a diminished demand for the Company's products and services; (2) competitive pressures increase among financial service providers in the Company's northern New England market area or in the financial services industry generally, including competitive pressures from non-bank financial service providers, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; (3) interest rates change in such a way as to reduce the Company's margins;  (4) changes in laws or government rules, including the rules of the federal Consumer Financial Protection Bureau, or the way in which courts or government agencies interpret or implement those laws or rules, increase our costs of doing business causing us to limit or change our product offerings or pricing, or otherwise adversely affect the Company's business; (5) changes in federal or state tax policy; (6) changes in the level of nonperforming assets and charge-offs; (7) changes in estimates of future reserve requirements based upon relevant regulatory and accounting requirements; (8) changes in consumer and business spending, borrowing and savings habits; (9) the effect of changes to the calculation of the Company’s regulatory capital ratios under the recently adopted Basel III capital framework which, among other things, will require additional regulatory capital, and change the framework for risk-weighting of certain assets; and (10) the effect of and changes in the United States monetary and fiscal policies, including the interest rate policies of the Federal Reserve Board (“FRB”) and its regulation of the money supply; and (11) adverse changes in the credit rating of U.S. government debt.

NON-GAAP FINANCIAL MEASURES

Under SEC Regulation G, public companies making disclosures containing financial measures that are not in accordance with generally accepted accounting principles in the United States (“US GAAP” or “GAAP”) must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure, as well as a statement of the company’s reasons for utilizing the non-GAAP financial measure.  The SEC has exempted from the definition of non-GAAP financial measures certain commonly used financial measures that are not based on GAAP.  However, two non-GAAP financial measures commonly used by financial institutions, namely tax-equivalent net interest income and tax-equivalent net interest margin (as presented in the tables in the section labeled Interest Income Versus Interest Expense (Net Interest Income), have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G.  We are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G.
 
 
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Management believes that these non-GAAP financial measures are useful in evaluating the Company’s financial performance and facilitate comparisons with the performance of other financial institutions.  However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.

OVERVIEW

The Company’s consolidated assets on September 30, 2013March 31, 2014 were $564,094,499, a decrease$583,127,748, an increase of $11,643,746,$9,460,344, or 2.02%1.65% from December 31, 2012,2013, and an increase of $2,082,544,$22,747,367, or 0.37%4.06% from September 30, 2012.  Loans increasedMarch 31, 2013.  The growth in assets was due to an increase in the loan portfolio of $12,329,014, or 2.83% and $34,500,734, or 8.35% in the two comparison periods.  The increase in loans was driven primarily by $15,334,123growth in commercial loans, predominantly in the central Vermont market.  The increase from December 31, 2012 and $24,116,632 since September 30, 2012,year to year was partially funded bywith a combination of a decrease in cashthe investment portfolio of $16,499,849 since year end, a decrease in available-for-sale securities of $11,556,747$14,822,923 and an increase in deposits of $13,448,012 since September 30, 2012. The Company’s goal has been$18,345,471.  Contributing to shift lower-yielding assets to loansthe year-over-year increase in an effort to minimize further margin compression in this prolonged low interest rate cycle.  Along with growth in commercial loans, the Company has retained in the loan portfolio some 10 and 15 year fixed rate mortgages to help maintain the relative level of the 1-4 family loans in the overall portfolio.  Demand for commercial loans increased in the third quarter of 2013 and remains steady while demand for 1-4 family residential loans has moderated.  Deposit balances at September 30, 2013 were $470,549,584,deposits was an increase of $13,448,012, or 2.94% from September 30, 2012 and a decrease of $4,947,275, or 1.04% from December 31, 2012.  The increase in deposit balances, year-over-year, reflects the combined effect of increases incore non-interest bearing business and retailpersonal checking accounts and savings accounts, partially offset by decreases in time deposits.  The increase in business checking accounts is somewhat related to the increase in commercial loans since the Company focuses on building a total relationship with the commercial customer whenever possible.  A decrease in a deposit account with the Company’s affiliate, Community Financial Services Group (CFSG)balances in the amount of $4,727,436$11,065,116 and $4,343,842, respectively, from DecemberMarch 31, 20122013 to September 30, 2013March 31, 2014.  During the first quarter of 2014, loan demand remained strong, while demand deposits decreased by $15,747,305; therefore the Company borrowed $12,000,000 from the FHLBB to fund the loan growth.  A decrease in non-maturing deposits is typical for the Company in the first quarter of the year and theis mostly due to cyclical fluctuations in the balances of municipal customer accounts, contributed toas account balances typically increase during the second and third quarters of the year and then run off during the first half of the following year.  To help offset the seasonal fluctuations in NOW and money market accounts,non-maturing account balances in the first quarter of 2014, the Company purchased $10,000,000 in short-term certificates of deposits through Certificate of Deposit Account Registry Service (CDARS) of Promontory Interfinancial Network.

The Company’s net income for the first quarter of 2014 of $1,071,565 or $0.22 per share compares favorably to $1,041,778 or $0.21 per share for the first quarter of 2013.  Interest rates have remained at historically low levels for several years, causing erosion of yields on earning assets; however the combined effect of the increase in average interest-earning assets of $7.2 million combined with a decrease in government agency accounts (NOW accounts) from December 31, 2012 to September 30, 2013 of $7,517,128, and a decrease in the non-arbitrage deposit accounts (money market accounts) of $6,582,059 from December 31, 2012 to September 30, 2013 and $4,852,373 from September 30, 2012 to September 30, 2013.    While an increase is noted in core money market and savings accounts, management believes, to a certain extent that this increase may be related to the $6,850,915 or 5.3% decrease in time deposits year over year as customers shift funds from maturing time deposits to non-maturing deposit accounts due to the low interest rate environment.

Net income for the third quarter of 2013 was $1,354,933 or $0.28 per common share compared to $1,267,351 or $0.26 per common share for the third quarter of 2012.  While interest income decreased in the third quarter of 2013 compared to the third quarter of 2012, that decrease was more than offset by a larger decrease in interest expense.  The lower interest expense was attributed to a combination of the decrease in interest paid on deposits and a decrease in interest paid on borrowings, including the Company’s junior subordinated debentures.  The decrease in interest paid on the debentures is due to a scheduled rate adjustment, which resulted in a decreaseaverage cost of $141,823 for the third quarterfunds of 2013 and $421,883 year over year.  The decrease in interest paid on deposits is attributable to a decrease in the average rate paid on interest bearing liabilities as customer funds shift out of CDs at higher rates to lower interest-bearing demand and savings accounts.  The combined effects of these changes11 basis points has resulted in an increase of $1,096,461 in tax-equivalent net interest income year over year.of $198,291, generating an increase in net interest margin of eleven basis points.

Total non-interest income increased slightly during the third quarter of 2013 compared to the third quarter 2012.  One of the components of non-interest income is income generated from selling loans in the secondary market.  For severalIn recent years, the Federal Reserve’s efforts to stimulate the real estate market by keepingstimulus program has kept mortgage interest rates low provided forproviding several refinancing cycles which continued through 2012.  The momentumsomewhat into 2013.  However the pace of this cyclerefinancings has slowed and mortgage business declinedcontinued to decline resulting in originations of $5,091,626 during the first nine monthsquarter of 2013, causing a decrease in fee income from2014 compared to $7,695,988 for the sale of residential loans in the secondary market.  During the thirdfirst quarter of 2013 mortgage activity resulted in originations of $6,356,815 compared to $12,744,975 for the third quarter of 2012, resulting inand providing points and premiums from the sales of these mortgages of $147,696$111,928 and $199,870, respectively.  These decreases were partially offset by an increase in service fees in 2014 of $87,863 and a decrease in the provision for loan losses of $71,250 compared to $322,637 for the same period last year.  These decreases were offset by an improvement in the balance of the impairment of the mortgage servicing rights for the third quarter of 2013 of $102,660 versus a negative adjustment of $44,251 for the third quarter of 2012, resulting in net gains from the sales of mortgages of $396,770 for the third quarter of 2013 compared to $418,594 for the third quarter of 2012.  Operating expenses for the quarter decreased by $81,427 when compared towere relatively stable resulting in an increase of 2.86% over the thirdfirst quarter of 2012, mostly due to a decrease in amortization of low income housing tax credits associated with the Company’s limited partnerships of $177,548, quarter over quarter.2013.  Please refer to the Non-interest Income and Expense sectionssection for more information.

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On September 25, 2013,The loan growth is in line with the Company's Board of Directors declared a quarterly cash dividend of $0.14 per common share, payable on November 1, 2013Company’s strategic plan to shareholders of record on October 15, 2013.increase its concentration in commercial loans while maintaining the residential loan portfolio.  The Company is focused on increasingopportunities for growth have come from the profitability ofCentral Vermont market where the balance sheet, improving expense efficiency, and prudently managing risk, particularly credit risk, in order to remain a well-capitalized bank in this challenging economic environment.

National economic data for the third quarter indicates that the economy has continued to expand at a moderate pace, although somewhat more slowly than earlier anticipated.  Improvements in the housing sector appear slow, possibly due to the rise in mortgage rates since spring.  Most of the housing activity is supported by several construction projects, in both the salesmunicipal and private sectors.  Furthermore, Central Vermont’s small but diverse base of existing homes, while new home sales declined.  Although employment has continuedmanufacturing companies continues to expand at a moderate pace, the national unemployment rate remains elevated.  The comments from the latest meeting of the FOMC retracted any movement toward a quantitative easing exit plan due to the fact that the outlook has not improved significantly enough and that tighter financial conditions are a concern.  Furthermore, uncertainty about the course of federal fiscal policy over the coming months, including the effects of the recent government shutdown or strains related to the debt ceiling debate, pose downside risks tobe the economic outlook.

More locally, according toleaders reporting stable employment levels throughout the State of Vermont Department of Labor, the Vermont seasonally adjusted unemployment rate for August was 4.6%.  This compares favorably to the annual 2012 rate of 5.0% and is well below the national average of 7.3%.  As of the prior month’s initial data, Vermont’s unemployment rate was tied for the fifth lowest in the country.  On a statewide basis job growth has been centered in the trade, transportation, utility and government sectors. Vermont’s construction sector is ranked one of the lowest for job growth, and with post-tropical storm Irene projects now complete, forecasts for construction jobs are less than optimistic. Federal spending cuts, i.e. sequestrations, are hampering the New England economy as a whole, but economists say that continued strength in the “Vermont” brand has helped recovery in the manufacturing sector. The Vermont housing market has continued to strengthen, and the tide is beginning to shift from a buyer’s market to a more level playing field.  The entire state experienced record early summer rain that made it tough on weather-dependent businesses, however early travel and tourism data indicates that the 2013 summer activity is slightly ahead of 2012.  In Central Vermont, the Company’s growth market, ongoing downtown revitalization and improvement projects are bringing energy and economic growth to the area.  Several workforce anchors in the region continue to provide stable operations and employment to the area including Green Mountain Coffee Roasters which employs an estimated 500 employees throughout Washington and Chittenden Counties and which has entered into a minimum five year agreement with Starbucks Coffee Company to manufacture, market, distribute and sell Starbuck’s single serve Keurig packs.region.  Technology, financial services and light manufacturing, particularly of specialty artisan foods, continue to be the economic leaders throughout Central Vermont.

A positive additionThe Company was able to Northern Vermont is a multi-phase expansion projectmaintain an allowance to average total loans coverage ratio of an Orleans County ski area, where construction of three hotels, a hockey arena, an indoor water park and a golf clubhouse has transformed1.09% on March 31, 2014 compared to 1.08% on March 31, 2013 while reducing the ski resort and golf courseprovision for loan losses to a year-round indoor and outdoor recreation and wedding destination resort.  This project has injected hundreds of millions of dollars of construction funding into the local economy over the last two years utilizing Federal EB5 program capital from foreign investors.  A second project upgraded snowmaking and will soon begin construction of new hotels at another local ski resort in Caledonia County.  It was recently announced that further investments of EB5 capital are intended to be utilized for several projects$135,000 in the region including a bio-tech manufacturing and research facility, a water-front hotel and conference center, and a major revitalization project for downtown Newport with construction scheduledfirst quarter of 2014 compared to begin$206,250 in the springsame period in 2013.  The lower provision was possible in spite of 2014.  Separate from the EB5 projects, it was announced recentlyincrease in the loan portfolio, due to improving trends in past dues and non-performing assets.  The Company continues to practice conservative credit standards and believes that a Vermont developer has committedthe reserve is sufficient to bringing a Wal-Mart Super Store to Orleans County.  Furthermore, the area recently received status as a foreign trade zone, propelling a major renovation project at the local airport, including an aviation flight school and small plane manufacturing plant in Newport. The projectscover losses that are underway have created jobsprobable and boosted economic activity in the area.estimable.

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

 
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On March 11, 2014, the Company's Board of Directors declared a quarterly cash dividend of $0.16 per common share, payable on May 1, 2014 to shareholders of record on April 15, 2014.  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 significant accounting policies, which are described in Note 1 (Significant Accounting Policies) to the Company’s audited consolidated financial statements in the December 31, 2012its 2013 Annual Report on Form 10-K, are fundamental to understanding the Company’s results of operations and financial condition because they require management to use estimates and assumptions that may affect the value of the Company’s assets or liabilities and financial results.  These policies are considered by management to be critical because they require subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.  The Company’s critical accounting policies govern:

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

These policies are described further in the Company’s December 31, 20122013 Annual Report on Form 10-K in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and in Note 1 (Significant Accounting Policies) to the audited consolidated financial statements.  There have been no material changes in the critical accounting policies described in the 20122013 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

The Company’s net income for the thirdfirst quarter of 20132014 was $1,354,933,$1,071,565, representing an increase of $87,582$29,787 or 6.9%2.9% over net income of $1,267,351$1,041,778 for the thirdfirst quarter of 2012.2013. This resulted in earnings per common share of $0.28$0.22 and $0.26,$0.21, respectively.  Net income for the first nine months of 2013 increased $381,663 or 11.7% to $3,635,055 compared to $3,253,392 for the same period in 2012.  Core earnings (net interest income) for the thirdfirst quarter of 20132014 increased $244,020$197,734 or 5.4%4.3%, compared to the thirdfirst quarter of 2012, and the nine months figures show an increase of $1,071,042 or 8.1% for 2013 compared to 2012.2013.  Despite continued pressure on the net interest margin and spread in this persistently low interest rate environment, the Company wasis pleased with these increases.  To help offset this pressure, the Company shifted assets from lower yielding taxable investments to loans.  Interest income decreased $174,945increased $56,227 or 3.0% for the third quarter of 2013 compared to 2012 and $30,807 or 0.2%1.0% for the first nine monthsquarter of 20132014 compared to 2012.2013 reflecting growth in the loan portfolio.  Although total deposits increased $13,448,012$18,345,471 or 2.9%4.0% year over year, interest expense on deposits, which is the major component of total interest expense, decreased $198,264$116,515 or 22.9% between quarterly periods and $461,276 or 17.5%15.1% for the nine month comparison periods, which are bothfirst quarter of 2014 compared to the first quarter of 2013.  This decrease is attributable to a decrease in the rates paid on interest-bearing deposit accounts.accounts, as rates paid on deposits continued to drop throughout the period.  The rate change on the Company’s junior subordinated debentures also hadhas now been in effect for a significant, favorable impact on the Company’sfull year, resulting in comparable debenture interest expense infigures for both the third quarter and nine month comparisonperiods with a decrease of $992 or 1.0% between periods.  The rate paid on these debentures repriced from a fixed rate of 7.56% through December 15, 2012, to a quarterly adjustable floating rate equal to the 3-month London Interbank Offered Rate (LIBOR) plus 2.85%, or 3.130%3.093% for the thirdfirst quarter of 2013.  This rate change decreased interest expense by $141,823 or 58.2%2014 compared to 3.158% for the thirdfirst quarter of 2013, compared to the third quarter of 2012, and $421,883 or 57.7% year over year.2013.   The Company recorded a provision for loan losses of $137,500$135,000 for the thirdfirst quarter of 2014 compared to $206,250 for the first quarter of 2013, and $463,750resulting in a decrease of $71,250 or 34.6%.  Non-interest income decreased $54,691 or 4.0% for the first nine monthsquarter of 20132014 compared to $249,999 for the thirdfirst quarter of 2012 and $750,0012013.  Non-interest expense increased $122,906 or 2.7%, from $4,589,290 for the first nine months of 2012, resulting in decreases of $112,499 or 45.0% and $286,251 or 38.2%, respectively.  Non-interest income reported modest increases in both periods with $10,208 or 0.7% for the third quarter of 2013 compared to the third quarter of 2012, and $11,249 or 0.3% year over year.  Non-interest expense decreased $81,427 or 1.8% for the third quarter in 2013 compared to $4,712,196 for the samefirst quarter in 2012, with figures of $4,471,596 and $4,553,023, respectively.  However, non-interest expense increased $57,980 or 0.4% for the nine month comparison periods with figures of $13,879,148 for 2013 and $13,821,168 for 2012.2014.  The section below labeled Non-Interest Income and Non-Interest Expense provides a more detailed discussion on the significant components of these two items.

Return on average assets, which is net income divided by average total assets, measures how effectively a corporation uses its assets to produce earnings.  Return on average equity, which is net income divided by average shareholders' equity, measures how effectively a corporation uses its equity capital to produce earnings.

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

For The Quarters Ended September 30, 2013  2012 
       
Return on Average Assets  0.96%  0.90%
Return on Average Equity  12.00%  11.85%
For The Quarters Ended March 31,
 
For The Nine Months Ended September 30,  2013   2012 
         2014  2013 
Return on Average Assets  0.86%  0.78%  0.76%  0.75%
Return on Average Equity  11.00%  10.35%  9.37%  9.71%
 
 
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The following table summarizes the earnings performance and certain balance sheet data of the Company for the 2013 and 2012 comparison periods.periods presented.
 
SELECTED FINANCIAL DATA (Unaudited)
Balance Sheet Data March 31,  December 31, 
  2014  2013 
       
Net loans $447,683,454  $435,354,440 
Total assets  583,127,748   573,667,404 
Total deposits  482,607,570   481,552,569 
Borrowed funds  12,000,000   0 
Total liabilities  536,504,554   527,531,427 
Total shareholders' equity  46,623,194   46,135,977 
  Three Months Ended March 31, 
  2014  2013 
         
Operating Data        
Total interest income $5,618,276  $5,562,049 
Total interest expense  793,290   934,797 
     Net interest income  4,824,986   4,627,252 
         
Provision for loan losses  135,000   206,250 
     Net interest income after provision for loan losses  4,689,986   4,421,002 
         
Non-interest income  1,313,501   1,368,192 
Non-interest expense  4,712,196   4,589,290 
     Income before income taxes  1,291,291   1,199,904 
Applicable income tax expense (1)  219,726   158,126 
         
     Net Income $1,071,565  $1,041,778 
         
Per Common Share Data        
         
Earnings per common share (2) $0.22  $0.21 
Dividends declared per common share $0.16  $0.14 
Book value per common share outstanding, period end $9.04  $8.57 
Weighted average number of common shares outstanding  4,872,589   4,816,588 
Number of common shares outstanding, period end  4,881,405   4,827,727 
(1) Applicable income tax expense assumes a 34% tax rate.

Balance Sheet Data September 30,  December 31, 
  2013  2012 
       
Net loans* $428,693,593  $413,734,575 
Total assets  564,094,499   575,738,245 
Total deposits  470,549,584   475,496,859 
Borrowed funds  8,325,000   6,000,000 
Total liabilities  518,841,185   532,385,670 
Total shareholders' equity  45,253,314   43,352,575 
*includes loans held-for-sale        
         
Nine Months Ended September 30,  2013   2012 
         
Operating Data        
Total interest income $16,974,033  $17,004,840 
Total interest expense  2,646,626   3,748,475 
     Net interest income  14,327,407   13,256,365 
         
Provision for loan losses  463,750   750,001 
     Net interest income after provision for loan losses  13,863,657   12,506,364 
         
Non-interest income  4,429,475   4,418,226 
Non-interest expense  13,879,148   13,821,168 
     Income before income taxes  4,413,984   3,103,422 
Applicable income tax expense (benefit)(1)  778,929   (149,970)
         
     Net Income $3,635,055  $3,253,392 
         
Per Common Share Data        
         
Earnings per common share $0.74  $0.65 
Dividends declared per common share $0.42  $0.42 
Book value per common shares outstanding $8.81  $8.42 
Weighted average number of common shares outstanding  4,831,084   4,759,383 
Number of common shares outstanding  4,854,617   4,796,998 
         
(1) Applicable income tax expense (benefit) includes the income tax effect, assuming a 34% tax rate, on securities 
(losses) gains which totaled ($5,521) and $140,971, for the nine months ended September 30, 2013 and 2012, 
respectively. 
(2) Computed based on the weighted average number of common shares outstanding during the periods presented.

INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME)

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

The Company’s tax-exempt interest income is entirely derived from its municipal investments, which comprised the entire held-to-maturity portfolio of $39,218,785$38,919,299 at September 30, 2013,March 31, 2014, and $50,065,653$42,380,968 at September 30, 2012.
March 31, 2013.
 
 
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The following table shows the reconciliation between reported net interest income and tax equivalent, net interest income for the nine month comparison periods of 20132014 and 2012.2013.

For the Nine Months Ended September 30, 2013  2012 
For the Three Months Ended March 31, 2014  2013 
            
Net interest income as presented $14,327,407  $13,256,365  $4,824,986  $4,627,252 
Effect of tax-exempt income  392,764   367,345   132,202   131,645 
Net interest income, tax equivalent $14,720,171  $13,623,710  $4,957,188  $4,758,897 
 
The following table presents average earning assets and average interest-bearing liabilities supporting earning assets.  Interest income (excluding interest on non-accrual loans) and interest expense are both expressed on a tax equivalent basis, both in dollars and as a rate/yield for the 20132014 and 20122013 comparison periods.

 For the Nine Months Ended September 30,  For the Three Months Ended March 31, 
 2013  2012  2014  2013 
       Average        Average        Average        Average 
 Average  Income/  Rate/  Average  Income/  Rate/  Average  Income/  Rate/  Average  Income/  Rate/ 
 Balance  Expense  Yield  Balance  Expense  Yield  Balance  Expense  Yield  Balance  Expense  Yield 
Interest-Earning Assets                                    
                                    
Loans (1) $422,756,037  $15,916,025   5.03% $399,953,037  $15,786,521   5.27% $445,692,728  $5,270,776   4.80% $417,364,812  $5,207,889   5.06%
Taxable investment securities  43,265,845   242,528   0.75%  62,357,637   439,642   0.94%  32,313,919   66,344   0.83%  42,498,605   77,202   0.74%
Tax-exempt investment securities  40,210,592   1,155,188   3.84%  37,882,741   1,080,426   3.81%  38,747,966   388,830   4.07%  42,489,415   387,192   3.70%
Sweep and interest earning accounts  3,477,139   7,933   0.31%  6,184,367   3,434   0.07%  1,928,158   1,244   0.26%  8,859,076   6,332   0.29%
Other investments (2)  4,118,042   45,123   1.46%  4,482,770   62,162   1.85%  4,019,850   23,284   2.35%  4,317,700   15,079   1.42%
Total $513,827,655  $17,366,797   4.52% $510,860,552  $17,372,185   4.54% $522,702,621  $5,750,478   4.46% $515,529,608  $5,693,694   4.48%
                                                
Interest-Bearing Liabilities                                                
                                                
NOW $113,210,431  $213,361   0.25% $105,668,556  $245,440   0.31%
Interest-bearing transaction accounts $117,104,159  $63,432   0.22% $120,349,667  $85,969   0.29%
Money market accounts  89,770,981   706,045   1.05%  78,214,169   577,481   0.99%  83,504,107   211,428   1.03%  93,554,420   258,784   1.12%
Savings deposits  68,720,917   74,530   0.15%  64,471,836   76,915   0.16%  72,259,754   22,633   0.13%  66,821,316   25,878   0.16%
Time deposits  124,344,086   1,181,533   1.27%  135,606,637   1,736,909   1.71%  122,080,087   359,762   1.20%  122,246,215   403,139   1.34%
Federal funds purchased and                                                
other borrowed funds  6,720,817   21,386   0.43%  23,461,496   231,603   1.32%  7,742,000   4,474   0.23%  2,161,256   7,767   1.46%
Repurchase agreements  29,122,873   95,408   0.44%  24,690,402   100,249   0.54%  27,451,077   16,598   0.25%  31,103,735   36,019   0.47%
Capital lease obligations  748,696   45,553   8.11%  809,263   49,185   8.10%  700,225   14,212   8.12%  764,486   15,498   8.11%
Junior subordinated debentures  12,887,000   308,810   3.20%  12,887,000   730,693   7.57%  12,887,000   100,751   3.17%  12,887,000   101,743   3.20%
Total $445,525,801  $2,646,626   0.79% $445,809,359  $3,748,475   1.12% $443,728,409  $793,290   0.73% $449,888,095  $934,797   0.84%
                                                
Net interest income     $14,720,171          $13,623,710          $4,957,188          $4,758,897     
Net interest spread (3)          3.73%          3.42%          3.73%          3.64%
Net interest margin (4)          3.83%          3.56%          3.85%          3.74%

(1)  Included in gross loans are non-accrual loans with an average balance of $4,502,878 and $4,901,781 for the three months ended March 31, 2014 and 2013, respectively.  Loans are stated before deduction of unearned discount and allowance for loans losses.
 
(2)  Included in other investments is the Company’s FHLBB Stock with an average balance of $3,044,700 and $3,342,550, respectively, for the three months of 2014 and 2013, and dividend payout rates of approximately 1.49% and 0.37%, respectively, per quarter.
(3)  Net interest spread is the difference between the average yield on average interest-earning assets and the average rate paid on average interest-bearing liabilities.
(1) Included in gross loans are non-accrual loans with an average balance of $4,298,002 and $6,804,857 for the nine months ended September 30, 2013 and 2012, respectively. Loans are stated before deduction of unearned discount and allowance for loans losses and include loans held-for-sale.
(2) Included in other investments is the Company’s FHLBB Stock with an average balance of $3,142,892 and $3,507,620, respectively, for the first nine months of 2013 and 2012, and dividend payout rates of approximately 0.38% and 0.52%, respectively, per quarter.
(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.
 
 
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The average volume of earninginterest-earning assets for the first ninethree months of 20132014 increased $2,967,103$7,173,013 or 0.6%1.4% compared to the same period of 2012,2013, while the average yield decreased two basis points.  The average volume of loans increased $22,803,000$28,327,916 or 5.7%6.8%, while the average yield decreased 2426 basis points.  Interest earned on the loan portfolio equaled 91.7% of total interest income for the first ninethree months of 20132014 and 90.9%91.5% for the 20122013 comparison period.  The average volume of the taxable investment portfolio (classified as available-for-sale) decreased $19,091,792$10,184,686 or 30.6%24.0% for the same period, andwhile the average yield decreased 19increased nine basis points.  The Company sold a portion of itsSales and maturities within the Company’s taxable investment portfolio to helphelped fund loan growth throughout 20122013 and into 2013 and to pay off a portion of its borrowings,2014, accounting for the decrease in these funds.  The average volume of the tax-exempt investment portfolio (classified as held-to-maturity) increased $2,327,851decreased $3,741,449 or 6.1%8.8% between periods, andwhile the average tax equivalent yield increased three37 basis points.  Interest earnedDuring the first quarter of 2014, the Company changed its pricing strategy on municipal investments, accounting for this increase in the average yield but also causing a decrease in the average volume of tax-exempt investments (which is presentedas well as in the table on a tax equivalent basis) comprised 6.7% of total interest income for the first nine months of 2013 compared to 6.2% for the same period in 2012.associated deposit product.

In comparison, the average volume of interest-bearing liabilities for the first ninethree months of 20132014 decreased $283,558$6,159,686 or 0.1%1.4% over the 20122013 comparison period, and the average rate paid on these liabilities decreased 3311 basis points.  The average volume of NOWinterest-bearing transaction accounts increased $7,541,875decreased $3,245,508 or 7.1%2.7% and the average volume of money market funds increased $11,556,812decreased $10,050,313 or 14.8%10.7%, whileand the average rate paid decreased sixseven basis points on NOWinterest-bearing transaction accounts and increased sixnine basis points on money market funds.  The average volume carried in the Company’s money market product, an insured cash sweep account (ICS) offered through Promontory Interfinancial Network, increased $3,634,939$1,628,647 or 10.3% year over year from $12,312,186$15,824,969 in 20122013 to $15,947,125$17,453,616 in 2013.  Although this product has brought2014, while the average volume in some new funds, most of the interest has come from the Company’s Certificate of Deposit Account Registry Service (CDARS) of Promontory Interfinancial Networknon-arbitrage borrowing account offered to municipal customers looking for alternativesdecreased $8,802,708 or 29.4%.  The decrease in these municipal deposits is due in part to placing their moneya change in time deposit accounts that are not as liquid.the pricing strategy mentioned above.  The average volume of time deposits decreased $11,262,551$166,128 or 8.3%0.14%, and the average rate paid on time deposits decreased 4414 basis points.  Interest paid on time deposits comprised 44.6%45.4% and 46.3%43.1%, respectively, of total interest expense for the first ninethree months of 20132014 and 2012.  The2013.  Increases are noted in the average volume of savings deposits, and of federal funds purchased and other borrowed funds decreased $16,740,679 or 71.4%with increases of $5,438,438 and the average rate paid decreased 89 basis points$5,580,744, respectively, for the first ninethree months of 20132014 compared to the same period in 2012.2013, while the average rate paid decreased three basis points on savings deposits and 123 basis points on federal funds purchased and other borrowed funds for the first three months of 2014 compared to the same period in 2013.  The decreaseincrease in the average volume was attributableof savings deposits is primarily due to matureda shift in customer deposits as it appears that customers may be waiting for more favorable rates from other interest-bearing accounts.  The Company drew down FHLBB advances totaling $15,000,000 in both short-term and long-term categories in February, 2014, and as well as prepayment on a borrowing scheduled to matureof March 31, 2014, $12,000,000 remained outstanding, accounting for the increase in 2015.the average balance of these funds.

The prolonged low interest rate environment has resulted in continued pressure on the Company’s net interest spread and margin.  The Company’s earning assets are being replaced and repricing to lower interest rates, while the opportunity to reduce rates further on non-maturing interest-bearing deposits is more limited, given the already low rates paid on deposits.  Between the ninethree month comparison periods of 20132014 and 2012,2013, the average yield on interest earninginterest-earning assets decreased two basis points, whileand the average rate paid on interest bearinginterest-bearing liabilities decreased 3311 basis points.  The decrease in interest expense was attributable in large part to the decrease in both volume and rate paid on time deposits.  The repricing of the junior subordinated debentures, which is discusseddecreases in the Resultsaverage volume of Operations, was another significant contributing factor tomost components of interest-bearing liabilities, with money market funds and time deposits noting the largest decrease in interest expense and intogether accounting for the average rate paid on interest-bearing liabilities.largest portion of interest expense.  The cumulative results of all these changes were increases of 31nine basis points in the net interest spread and 27eleven basis points in net interest margin.

 
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The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the first ninethree months of 20132014 and 20122013 resulting from volume changes in average assets and average liabilities and fluctuations in average rates earned and paid.
Changes in Interest Income and Interest Expense

 Variance  Variance     Variance  Variance    
 Due to  Due to  Total  Due to  Due to  Total 
 Rate (1)  Volume (1)  Variance  Rate (1)  Volume (1)  Variance 
Average Interest-Earning Assets                  
Loans $(770,143) $899,647  $129,504  $(290,552) $353,439  $62,887 
Taxable investment securities  (90,017)  (107,097)  (197,114)  9,986   (20,844)  (10,858)
Tax-exempt investment securities  8,365   66,397   74,762   39,186   (37,548)  1,638 
Sweep and interest earning accounts  10,776   (6,277)  4,499   (645)  (4,443)  (5,088)
Other investments  (13,056)  (3,983)  (17,039)  9,931   (1,726)  8,205 
Total $(854,075) $848,687  $(5,388) $(232,094) $288,878  $56,784 
                        
Average Interest-Bearing Liabilities                        
NOW $(49,582) $17,503  $(32,079)
Interest-bearing transaction accounts $(20,776) $(1,761) $(22,537)
Money market accounts  42,911   85,653   128,564   (21,831)  (25,525)  (47,356)
Savings deposits  (7,475)  5,090   (2,385)  (5,391)  2,146   (3,245)
Time deposits  (448,394)  (106,982)  (555,376)  (42,885)  (492)  (43,377)
Federal funds purchased and other borrowed funds  (156,376)  (53,841)  (210,217)  (23,384)  20,091   (3,293)
Repurchase agreements  (22,760)  17,919   (4,841)  (17,169)  (2,252)  (19,421)
Capital lease obligations  42   (3,674)  (3,632)  1   (1,287)  (1,286)
Junior subordinated debentures  (421,883)  0   (421,883)  (992)  0   (992)
Total $(1,063,517) $(38,332) $(1,101,849) $(132,427) $(9,080) $(141,507)
                        
Changes in net interest income $209,442  $887,019  $1,096,461  $(99,667) $297,958  $198,291 
 
(1) Items which have shown a year-to-year increase in volume have variances allocated as follows:
          Variance due to rate = Change in rate x new volume
          Variance due to volume = Change in volume x old rate
     Items which have shown a year-to-year decrease in volume have variances allocated as follows:
          Variance due to rate = Change in rate x old volume
          Variances due to volume = Change in volume x new rate
 
NON-INTEREST INCOME AND NON-INTEREST EXPENSE

Non-interest Income: Non-interest

The components of non-interest income increased slightly for the thirdperiods presented are as follows:

  Quarter Ended       
  March 31,  Change 
  2014  2013  $  % 
              
Service fees $646,813  $558,950  $87,863   15.72%
Income from sold loans  249,130   387,591   (138,461)  -35.72%
Other income from loans  144,400   143,313   1,087   0.76%
Income from CFSG Partners  79,811   63,595   16,216   25.50%
Rental income on OREO properties  48,537   38,650   9,887   25.58%
Exchange income  28,500   23,000   5,500   23.91%
SERP fair value adjustment  16,048   52,561   (36,513)  -69.47%
Other income  100,262   100,532   (270)  -0.27%
     Total non-interest income $1,313,501  $1,368,192  $(54,691)  -4.00%

33

Total non-interest income decreased $54,691 for the first quarter comparison periods andof 2014 versus the nine month comparison periodssame period last year, with the significant changes noted in the following.  Service fees increased $105,104 or 17.6%following:

●  Service fees increased $87,863 as a result of a change in the structure of various demand deposit accounts, including implementation of a paper statement fee late in the first half of 2013, accounting for $75,133 of this increase.

●  Income from sold loans decreased $138,461 which is attributable to a decrease in secondary market sales, as the pace of refinancing continued to slow.  Proceeds from sale of loans held-for-sale amounted to $8,069,687 for the first three months of 2013 compared to $4,922,980 for the first three months of 2014.

●  Income from the Company’s trust and investment management affiliate, Community Financial Services Group (CFSG Partners) increased $16,216 due in part to an increase in the customer base, as well as an increase in the market value for various investments

●  Rental income on OREO properties increased $9,887.  While rental of OREO properties is not a normal practice for the Company, it was deemed appropriate on a condominium unit in Stowe, Vermont to help offset expenses associated with this property while it is on the market for sale.  The bountiful snowfall this past winter season generated more of a demand for rental of this condominium unit.

●  The SERP fair value adjustment decreased $36,513 due to a decrease in the market value of the Company’s Supplemental Employee Retirement Program (SERP) investment account.

Non-interest Expense

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

  Quarter Ended       
  March 31,  Change 
  2014  2013  $  % 
              
Salaries and wages $1,650,000  $1,657,185  $(7,185)  -0.43%
Employee benefits  631,197   609,289   21,908   3.60%
Occupancy expenses, net  684,198   871,904   (187,706)  -21.53%
Other expenses                
     Computer outsourcing  104,055   0   104,055   100.00%
     Service contracts - administrative  109,114   0   109,114   100.00%
     Loss on limited partnerships  110,958   119,223   (8,265)  -6.93%
     FDIC Insurance  103,567   102,669   898   0.87%
     Telephone expense  81,239   115,384   (34,145)  -29.59%
     ATM Fees  93,736   107,902   (14,166)  -13.13%
     Other miscellaneous expenses  1,144,132   1,005,734   138,398   13.76%
          Total non-interest expense $4,712,196  $4,589,290  $122,906   2.68%
During the first quarter of 2014 the Company re-categorized some of its expense accounts for service contracts from occupancy expense to other expenses, which is reflected in the increase in other expense between periods.  Had the re-categorization been in effect during the first quarter of 2013, compared$180,000 would have shifted from occupancy expense to the same quarter in 2012 and $137,691 or 7.9%other expenses for the nine month comparison periods for 2013 and 2012.  During the first half of 2013, the Company changed the structure of various demand deposit accounts, including implementation of a different service fee, accounting for the increase in service fees.  These increases were offset by decreases of $105,197 and $146,492, respectively, for the third quarter and nine month periods in gains on sales of securities, reflecting gains of $99,676 for the third quarter of 2012 and $140,971 for the nine months period, compared to a loss of $5,521 for both periods in 2013.  Other income from loans decreased $42,625 or 17.3% for the third quarter of 2013, comparedwhich would have resulted in minimal change in occupancy expense between periods.  This would then have decreased the change in other expenses to the same period in 2012 and $130,003 or 19.5%approximately $100,000.

Total non-interest expense increased $122,906 for the first nine monthsquarter of 20132014 compared to the first nine months of 2012 due primarily to a decrease in residential real estate loan activity, including a decrease in secondary market sales. Income generated through documentation fees on residential real estate loans for the third quarter of 2013 was $53,353 compared to $95,423 forwith other significant changes noted in the third quarter of 2012 and $185,974 for the first nine months of 2013 compared to $283,297 for the same period in 2012.  Other Income increased in both comparison periods with an increase of $74,750 or 44.5% for the third quarter of 2013 compared to the third quarter of 2012 and $170,521 or 28.4% year over year.  Increases of $29,114 for the third quarter of 2013 compared to the same quarter in 2012 and $84,643 year over year from the Company’s trust and investment management affiliate, CFSG, together with $40,878 in rental income on OREO for the first nine months of 2013 helped to offset decreases in various components of other income in each of the comparison periods.  While rental of OREO properties is not a normal practice for the Company, it was deemed appropriate on a condominium unit in Stowe, Vermont to help offset expenses associated with this property while it is on the market for sale.
following:

●  Computer outsourcing increased $104,055.  The Company began outsourcing its data processing operations at the end of the fourth quarter of 2012, but due to incentive credits received for various functions, the Company did not incur data processing expenses until late in the second quarter of 2013.  Outsourcing of the core processing function has provided the opportunity for the existing information technology staff to take on additional duties and roles in response to regulatory and industry changes.

●  Service contracts – administrative increased $109,114 which was a direct result of the re-categorization mentioned above.

●  Telephone expense decreased $34,145 as the result of entering into a contract with a new vendor during the comparison periods.

 
3534
 
 
Non-interest Expense: Non-interest expense noted larger changes in the quarterly and nine month comparison periods with a decrease of $81,427 or 1.8% for the third quarter of 2013 comparedLosses related to the third quarter of 2012, while an increase of $57,980 or 0.4% is noted year over year.  The most significant increase was in salaries and wages with an increase of $63,413 or 4.1% for the third quarter of 2013 compared to the same quarter in 2012 and $353,601 or 7.8% for the first nine months of 2013 compared to the same period in 2012.  These increases were due in part to salary increases as well as additional staff in some areas such as commercial lending.  Employee benefits increased accordingly with increases totaling $1,281 or 0.3% and $45,801 or 2.7% for the respective third quarter and nine months comparison periods.  The amortization of the core deposit intangible associated with the LyndonBank acquisition decreased $17,042 or 20% for the third quarter of 2013 compared to the third quarter of 2012 with figures of $68,175 and $85,217, respectively.  For the nine month comparison period the amortization expense decreased $51,127 or 20% with figures of $204,525 for 2013 compared to $255,652 for 2012.

Other expenses decreased in both periods with decreases of $85,690 or 5.5% for the third quarter of 2013 compared to the third quarter of 2012, and $254,553 or 5.6% year over year.  The Company began outsourcing its data processing operations late in the fourth quarter of 2012, with related expenses amounting to $75,443 for the third quarter of 2013 and $99,824 for the first nine months of 2013.  Outsourcing of the core processing provided the opportunity for the existing information technology staff to take on additional duties and roles prescribed from regulatory and industry changes.  Expenses associated with the Company’s OREO properties increased $32,017 quarter over quarter and $91,839 year over year.  While these expenses remain higher in 2013, the Company is experiencing a decrease in collection and non-accrual loan expenses with decreases of $46,648 or 57.2% for the third quarter of 2013 compared to the same quarter of 2012, and $104,808 or 53.4% for the nine month comparison periods.  These increases were offset by a decrease in amortization associated with the Company’s limited partnerships. Amortization expense decreased $177,548 or 60.1% for the third quarter of 2013 compared to the third quarter of 2012 and $529,736 or 59.8% for the first nine months of 2013 compared to the same period in 2012.  This decrease between periods is attributable to the amortization in 2012 of two significant historic tax credits with no similar credits available during 2013.

Losses relating to various limited partnership investments for affordable housing in our market area constitute the largest portion of other expenses.  These losses for the thirdfirst quarter of 2014 and 2013 are included in the table above and 2012 amounted to $117,769$110,958 and $295,317, respectively and for the first nine months of 2013 and 2012 amounted to $356,215 and $885,951,$119,223, respectively.  These investments provide tax benefits, including tax credits, and are designed to provide an effective yield between 8% and 10%.  Losses relating to the Company’s New Market Tax Credit (NMTC) investment for the thirdfirst quarter of 20132014 were recorded as $25,347$36,822 compared to $9,918 for the third quarter of 2012 and $76,041$25,347 for the first nine monthsquarter of 2013, compared to $29,754 for the same period in 2012, with tax credits amounting to $28,174 for both quarters$33,809 and $84,521 for both year to date periods.$28,173, respectively.  The Company amortizes these investments under the effective yield method.

APPLICABLE INCOME TAXES

The provision for income taxes increased in both comparison periods for reasons discussed throughout this narrative including the non-interest income and non-interest expense section with expenses of $364,106$61,600 or 39.0% for the thirdfirst quarter of 2014 compared to the first quarter of 2013 compared to $3,534 for the third quarter of 2012, and $778,929 for the first nine months of 2013 compared to a benefit of $149,970 for the first nine months of 2012.  The increase in expense is due in part to an increase in net income before taxes of $448,154 for the third quarter and $1,310,562 for the first nine months of 2013, as well as thea decrease in tax credits, totaling $209,167with a provision of $219,726 and $158,126, respectively.  Net income before taxes was $1,291,291 for the thirdfirst quarter of 2014 and $534,865 year over year.$1,199,904 for the first quarter of 2013, with tax credits totaling $195,751 and $185,181, respectively.

CHANGES IN FINANCIAL CONDITION

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

  September 30, 2013  December 31, 2012  September 30, 2012 
Assets                  
 Loans (gross)* $433,211,277   76.80% $417,877,154   72.58% $409,094,645   72.79%
 Securities available-for-sale  35,452,071   6.28%  40,886,059   7.10%  47,008,818   8.36%
 Securities held-to-maturity  39,218,785   6.95%  41,865,555   7.27%  50,065,653   8.91%
*includes loans held-for-sale                        

36
  March 31, 2014  December 31, 2013  March 31, 2013 
Assets                  
 Loans $452,230,767   77.55% $439,908,926   76.68% $417,469,135   74.50%
 Securities available-for-sale  31,187,390   5.35%  35,188,602   6.13%  46,010,313   8.21%
 Securities held-to-maturity  38,919,299   6.67%  37,936,911   6.61%  42,380,968   7.56%
                         
Liabilities                        
 Time deposits $131,255,748   22.51% $120,951,539   21.08% $122,730,505   21.90%
 Savings deposits  74,187,411   12.72%  69,906,147   12.19%  68,232,421   12.18%
 Demand deposits  80,608,105   13.82%  82,156,154   14.32%  64,660,692   11.54%
 Interest-bearing transaction accounts  112,378,796   19.27%  126,578,052   22.06%  114,257,777   20.39%
 Money market accounts  84,177,510   14.44%  81,960,677   14.29%  94,380,704   16.84%
 Federal funds purchased  0   0.00%  0   0.00%  7,845,000   1.40%
 Short-term advances  6,000,000   1.03%  0   0.00%  0   0.00%
 Long-term advances  6,000,000   1.03%  0   0.00%  0   0.00%
 
  September 30, 2013  December 31, 2012  September 30, 2012 
Liabilities                  
 Time deposits $122,136,016   21.65% $121,526,064   21.11% $128,986,931   22.95%
 Savings deposits  70,668,274   12.53%  65,216,698   11.33%  66,204,831   11.78%
 Demand deposits  80,465,454   14.26%  72,956,097   12.67%  68,580,510   12.20%
 NOW  113,732,525   20.16%  128,824,165   22.38%  109,271,808   19.44%
 Money market accounts  83,547,315   14.81%  86,973,835   15.11%  84,057,492   14.96%
 Federal funds purchased  8,325,000   1.48%  0   0.00%  4,840,000   0.86%
 Long-term borrowings  0   0.00%  6,000,000   1.04%  12,010,000   2.14%

The Company's loan portfolio increased throughout the comparison periods with increases of $15,334,123$12,321,841 or 3.7%2.8%, from December 31, 20122013 to September 30, 2013,March 31, 2014, and $24,116,632$34,761,632 or 5.9%8.3%, year over year.  This increase is due in part to strong commercial loan growth during 20122013 and into the first ninethree months of 2013 as well as2014, primarily in commercial & industrial loans.  The Company set goals to increase its commercial loan portfolio, and with the help of a seasoned commercial lending team with a strong presence in the small business community, these goals are becoming a reality.  Most of the growth in the commercial loan portfolio has occurred in the Company’s decision to continue to hold some 10-15 year fixed rate residential mortgages in-house, rather than selling them into the secondary market, to further shift funds into loan assets in order to relieve pressure on the interest spread and margin.Washington County (Central Vermont) market.  Securities available-for-sale decreased $5,433,988$4,001,212 or 13.3%11.4% from December 31, 20122013 to September 30, 2013,March 31, 2014, and $11,556,747$14,822,923 or 24.6%32.2% year over year. During the second and third quarters of 20122013 as loan demand increased, securitiesthe Company used sales, calls and maturities from its available-for-sale were soldportfolio to help fund this loan growth.  Additionally, during the third quarter of 2013, the Company sold more investments from the same portfolio,growth contributing to the decrease in both periods.  Securities held-to-maturity decreased $2,646,770increased $982,388 or 6.3%2.6% during the first ninethree months of 2013, and $10,846,8682014, but decreased $3,461,669 or 21.7%8.2% year over year.  Held-to-maturity securities are made up of investments from the Company’s municipal customers in its servicingservice areas.  The Company is currently notchanged its pricing as aggressively as instrategy during the past for these investments, sofirst quarter of 2014, and as a result the portfolio has decreased over the past year.attracted fewer municipal accounts.

Total deposits decreased $4,947,275increased $1,055,001 or 1.0%0.2% from December 31, 20122013 to September 30, 2013 but increased $13,448,012March 31, 2014 and $18,345,471 or 2.9%4.0% year over year.  Time deposits increased $609,952$10,304,209 or 0.5%8.5% from December 31, 20122013 to September 30, 2013March 31, 2014, and $8,525,243 or 7.0% year to year due to a one-way CDARS balance but decreased $6,850,915 or 5.3% year to year.  Management believes this decrease in time deposits is partially attributable to the low rate environment as customers place their funds in non-maturing deposit accounts while searching for higher paying investments.of $10,000,140 at quarter-end.  Savings deposits increased throughout the comparison period, with increases of $5,451,576$4,281,264 or 8.4%6.1% year to date and $4,463,443$5,954,990 or 6.7%8.7% year to year.  Demand deposits increased $7,509,357decreased $1,548,049 or 10.3%1.9% during the first ninethree months of 2013, and $11,884,9442014, but increased $15,947,413 or 17.3%24.7% year to year. NOWInterest-bearing transaction accounts decreased $15,091,640$14,199,256 or 11.7%11.2% during the first ninethree months of 2013, but increased $4,460,7172014, and $1,878,981 or 4.1%1.6% year to year.  Business demand deposits increased $11,065,116 or 29.8% year to year, which coincides with the increase in commercial loans during the same period. The Company believes at least a portion of the increasedecrease in demand depositsinterest-bearing transaction accounts is attributable to customers holding on to moreshifting their funds into higher yielding time deposits, which accounts for a portion of their cash and waiting to see what happens with interest rates and the economyincrease in the coming months.those funds.  A decrease in government agency accounts in the amount of $7,517,128$16,553,150 or 22.8%40.7% and a decreasean increase of $4,727,437$3,547,206 or 19.4%19.6% in the account held by the Company’s affiliate, CFSG, accounted for most of the decrease in NOWinterest-bearing accounts during the first ninethree months of 2013.2014.  Money market accounts decreased $3,426,520increased $2,216,833 or 3.9%2.7% for the first ninethree months of 2014 but decreased $10,203,194 or 10.8% from March 31, 2013 and $510,177 or 0.6% is noted from September 30, 2012 to September 30, 2013.March 31, 2014.  The municipal money market accounts decreased $6,582,059increased $847,392 or 24.6%4.3% for the first ninethree months of 2013 which is related2014 but decreased $9,538,258 or 31.5% year to theyear, in conjunction with a decrease in municipal investments classified as held-to-maturity securities.  Regular money market accounts increased $1,757,804 or 3.8% for the first nine months of 2013, helping to offset a portion of the decrease in the municipal accounts.  Beginning late in the first quarter of 2013, the Company has borrowed overnight funds to help fund loan growth, during the first nine months of 2013 and to cover the temporary cyclical decrease in the municipal deposit accounts which has now rebounded resulting in a balance of $8,325,000$7,845,000 as of September 30,March 31, 2013, but as the year progressed these borrowings decreased and there were no balances outstanding as of December 31, 2013.  The substantial loan activity during the first three months of 2014 caused the Company paid off a $6,000,000 long-termto seek alternate funding sources resulting in FHLBB borrowing in Januaryadvances totaling $12,000,000 as of 2013 accounting for the $0 balance in long-term borrowings at September 30, 2013.March 31, 2014.

35
RISK MANAGEMENT

Interest Rate Risk and Asset and Liability Management - Management actively monitors and manages the Company’s interest rate risk exposure and attempts to structure the balance sheet to maximize net interest income while controlling its exposure to interest rate risk.  The Company's Asset/Liability Management Committee (ALCO) is made up of the Executive Officers and all the Vice Presidents of the Bank.  The ALCO formulates strategies to manage interest rate risk by evaluating the impact on earnings and capital of such factors as current interest rate forecasts and economic indicators, potential changes in such forecasts and indicators, liquidity and various business strategies.  The ALCO meets monthlyat 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.

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Interest rate risk represents the sensitivity of earnings to changes in market interest rates.  As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, thereby impacting net interest income (NII), the primary component of the Company’s earnings.  Fluctuations in interest rates can also have an impact on liquidity.  The ALCO uses an outside consultant to perform rate shock simulations to the Company's net interest income, as well as a variety of other analyses.  It is the ALCO’s function to provide the assumptions used in the modeling process.  Assumptions used in prior period simulation models are regularly tested by comparing projected NII with actual NII.  The ALCO utilizes the results of thisthe 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.  Furthermore, theThe 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 a flatteningnon-parallel changes in the yield curve as well. Thiscurve.   The results of this sensitivity analysis isare compared to the ALCO policy limits which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) shift upward and a 100 bp shift downward in interest rates.  The analysis also provides

Under the Company’s rate sensitivity modeling, in the current flat rate environment, NII levels are projected to be flat as the downward pressure on asset yields is projected to slow down as cash flow is replaced at equal yields.  Funding costs are expected to provide slight relief as longer-term funding is retired and replaced at current rates.  In a summaryrising 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 than projected, the expected benefit to rising rates would be reduced.  In a falling rate environment, NII is expected to trend in-line with the current rate environment scenario for the first year of the simulation as asset yield erosion is offset by decreasing funding costs.  Thereafter, net interest income is projected to experience sustained downward pressure as funding costs reach their assumed floors and asset yields continue to replace and reprice into the lower rate environment.

The following table summarizes the estimated impact on the Company's liquidity position. Furthermore, the analysis provides testingNII over a twelve month period, assuming a gradual parallel shift of the yield curve beginning March 31, 2014:

Rate ChangePercent Change in NII
Down 100 basis points-.80%
Up 200 basis points6.20%

The amounts shown in the table are well within the ALCO Policy limits.  However, those amounts do not represent a forecast and should not be relied upon as indicative of future results.  While assumptions used in previousthe ALCO process, including the interest rate simulation models by comparing the projected NII with actual NII.  The asset/liability simulation model provides management with an important tool for making sound economic decisions regarding the balance sheet.

The Company’s Asset/Liability Policy has been enhanced with a contingency funding plan to help management prepare for unforeseen liquidity restrictions to include hypothetical severe liquidity crises.

While assumptionsanalyses, are developed based upon current economic and local market conditions, the Company cannot provide any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

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

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The residential mortgage portfolio, continues to be the largest segmentincluding first mortgages and junior liens, accounts for 47.8% of the Company’s loan portfolio. The severity and depth of the latest recession and slow economic recoveryportfolio, down from 52.2% a year ago.  Post-recession, these segments saw the greatest degree of collection, foreclosure and foreclosure activity and losses in this segment of the portfolio.loss activity.  Delinquencies and losses, however, were not experienced to the extent of national peers as the Company maintains a mortgage loan portfolio of traditional mortgage products and had not engaged 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. While real estate values had declined in the Company’s market area, the sound underwriting standards historically employed by the Company mitigated the trends in defaults and property surrenders experienced elsewhere. Residential mortgages with loan-to-values exceeding 80% are generally covered by private mortgage insurance (“PMI”).  A 90% loan-to-value residential mortgage product without PMI is only available to borrowers with excellent credit and low debt-to-income ratios and has not been widely originated.  Junior lien home equity products make up approximately 20%21% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%.  The residential mortgage portfolio has had satisfactory performance in light of the depth of the latest recession and the slow recovery; portfolio performance improved through 2012throughout 2013 and into 2013.2014.

Risk in the Company’s commercial & industrial and commercial real estate loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the U.S. Small Business Administration and USDA Rural Development. At September 30, 2013,March 31, 2014, the Company had $26,299,484$24,935,592 in guaranteed loans with guaranteed balances of 20,898,326,19,799,898, compared to $24,676,611$25,150,175 in guaranteed loans with guaranteed balances of $19,787,843$20,044,091 at December 31, 20122013 and $26,929,217$26,733,172 in guaranteed loans with guaranteed balances of $21,510,648$21,394,673 at September 30, 2012.March 31, 2013.

The Company’s strategy is to continue growing the commercial & industrial and commercial real estate portfolios. Consistent with the strategic focus on commercial lending, both segments have seensaw solid growth during 2013. Growth2013 that has continued into 2014.  Commercial & industrial and commercial real estate loans together comprised 45.5% of the Company’s loan portfolio at March 31, 2013, growing to 48.3% at December 31, 2013 and 50.4% at March 31, 2014.  The increase in the residential mortgage first liensize of the commercial loan portfolio has also improved geographic diversification, with much of the Company continuing to hold rather than selling some of its 10 and 15 year fixed rate residential mortgage originations.growth in commercial loans occurring in central Vermont, the Company’s newest market.
 
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The following table reflects the composition of the Company's loan portfolio as a percentage of total loans as of the dates indicated:

 September 30, 2013  December 31, 2012  September 30, 2012 
 Total Loans  % of Total  Total Loans  % of Total  Total Loans  % of Total  March 31, 2014  December 31, 2013  March 31, 2013 
                                    
Commercial & industrial $55,500,735   12.81% $49,283,948   11.79% $47,484,639   11.61% $60,728,808   13.43% $55,619,285   12.64% $51,044,490   12.23%
Commercial real estate  147,280,787   34.00%  139,807,517   33.46%  136,016,554   33.25%  167,369,628   37.01%  156,935,803   35.67%  138,784,472   33.24%
1 - 4 family residential - 1st lien  175,737,499   40.57%  171,114,515   40.95%  168,541,410   41.20%  171,561,880   37.94%  172,847,074   39.30%  172,031,283   41.21%
1 - 4 family residential - Jr lien  45,279,400   10.45%  47,029,023   11.25%  46,029,238   11.25%  44,528,723   9.84%  45,687,405   10.39%  45,912,846   11.00%
Consumer  9,412,856   2.17%  10,642,151   2.55%  11,022,804   2.69%  8,041,728   1.78%  8,819,359   2.00%  9,696,044   2.32%
Total gross loans  433,211,277   100.00%  417,877,154   100.00%  409,094,645   100.00%
Total loans  452,230,767   100.00%  439,908,926   100.00%  417,469,135   100.00%
Deduct (add):                                                
Allowance for loan losses  4,799,431       4,312,080       4,115,230       4,837,578       4,854,915       4,493,384     
Unearned loan fees  (281,747)      (169,501)      (101,742)      (290,265)      (300,429)      (206,969)    
Loans held-for-sale  1,229,490       1,501,706       1,483,940     
  5,747,174       5,644,285       5,497,428       4,547,313       4,554,486       4,286,415     
Net loans $427,464,103      $412,232,869      $403,597,217      $447,683,454      $435,354,440      $413,182,720     
 
The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure. With the economic recovery continuing, the levels of both Group B (Management Involved) and Group C (Unacceptable Risk) loans (as defined in Note 5 to the Company’s unaudited interim consolidated financial statements) showed gradual improvement through 2012 and 2013 and thus the loan loss reserve factors for trends in delinquency and non-accrual loans and criticized and classified were gradually decreased. Alternatively, qualitative factors have been increased principally to account for growth in the loan portfolio.  During 2013 and into 2014, lower loan losses have beenwere offset by strong commercial loan volume, the deterioration of several commercial real estate loans and the migration of some past due residential loans to later stage delinquency, resulting in increases in the associated loan loss reserve qualitative factors.

Commercial and commercial real estate loans are generally placed on non-accrual status when there is deterioration in the financial position of the borrower, payment in full of principal and interest is not expected, and/or principal or interest has been in default for 90 days or more. However, such a loan need not be placed on non-accrual status if it is both well secured and in the process of collection.  Residential mortgages and home equity loans are considered for non-accrual status at 90 days past due and are evaluated on a case-by-case basis.  The Company obtains current property appraisals or market value analyses and considers the cost to carry and sell collateral in order to assess the level of specific allocations required. Consumer loans are generally not placed in non-accrual but are charged off by the time they reach 120 days past due. When a loan is placed in non-accrual status, the Company's policy is to reverse the accrued interest against current period income and to discontinue the accrual of interest until the borrower clearly demonstrates the ability and intention to resume normal payments, typically demonstrated by regular timely payments for a period of not less than six months.  Interest payments received on non-accrual or impaired loans are generally applied as a reduction of the loan principal balance.  Deferred taxes are calculated monthly, based on interest amounts that would have accrued through the normal accrual process.

The Company’s non-performing assets decreased $944,776$946,994 or 15.2%14.1% during the first ninethree months of 2013.2014. The improvement in non-performing loans is principally dueresulted in part from improved performance of three loans that were removed from non-accrual status, a short sale resolution to resolutionone real estate loan, and a $100,000 partial charge off of loans through foreclosure actions and collateral liquidations.a commercial real estate loan. Claims receivable on related government guarantees were $313,905$222,836 at September 30, 2013 asMarch 31, 2014 compared to $334,483$402,339 at June 30,March 31, 2013.

 
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As of the consolidated balance sheet dates, non-performing assets were made up of the following:

 September 30, 2013  December 31, 2012  March 31, 2014  December 31, 2013 
    Percent     Percent     Percent     Percent 
 Balance  of Total  Balance  of Total  Balance  of Total  Balance  of Total 
            
Loans past due 90 days or more and still accruing (1)          
Loans past due 90 days or more and still accruing            
Commercial & industrial $0   0.00% $21,902   0.32%
Commercial real estate $50,965   0.78% $53,937   0.87%  5,313   0.09%  5,313   0.08%
Residential real estate - 1st lien  344,193   5.30%  281,845   4.54%  557,640   9.63%  817,109   12.12%
Residential real estate - Jr lien  62,359   0.96%  41,434   0.67%  79,722   1.38%  56,040   0.83%
Consumer  8,755   0.13%  844   0.01%  0   0.00%  7,784   0.12%
Total  466,272   7.17%  378,060   6.09%  642,675   11.10%  908,148   13.47%
                                
Non-accrual loans (1)                                
Commercial & industrial  493,272   7.60%  596,777   9.61%  477,572   8.24%  527,105   7.82%
Commercial real estate  1,740,350   26.80%  1,892,195   30.48%  1,299,476   22.43%  1,403,541   20.82%
Residential real estate - 1st lien  1,999,274   30.79%  1,928,097   31.06%  2,047,423   35.34%  2,203,106   32.69%
Residential real estate - Jr lien  669,292   10.31%  338,383   5.45%  460,590   7.95%  593,125   8.80%
Total  4,902,188   75.50%  4,755,452   76.60%  4,285,061   73.96%  4,726,877   70.13%
                                
Other real estate owned  1,125,105   17.33%  1,074,705   17.31%  865,820   14.94%  1,105,525   16.40%
                                
Total $6,493,565   100.00% $6,208,217   100.00% $5,793,556   100.00% $6,740,550   100.00%

(1)  No commercial & industrial loans were past due 90 days or more and still accruing and no consumer loans were in non-accrual status as of the consolidated balance sheet dates.

As of the balance sheet dates, the Company was not contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans.

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.  The Non-Performing Assets table above includes TDR’s that are past due 90 days or more or in non-accrual status.  The remainder of the Company’s TDR’s consist of 13 residential mortgage loans, two commercial real estate loans and three commercial & industrial loans totaling $1,561,342 at March 31, 2014 compared to 10 residential mortgage loans, two commercial real estate loans and three commercial & industrial loans totaling $1,312,260 at December 31, 2013.

The Company’s OREO portfolio at September 30, 2013March 31, 2014 consisted of sixthree properties acquired through the normal foreclosure process.  OneAt December 31, 2013, the Company held three residential propertyand two commercial properties in its OREO portfolio and sold one of the commercial properties taken into the portfolio during the fourth quarter of 2013 and one commercial property were sold duringof the residential properties that the Bank has owned since 2012, resulting in a decrease in OREO of $239,705, to end the first quarter of 2013. During the second quarter of 2013, the OREO balance reached $2.2 million as the Company took possession of three commercial real estate properties and one residential property. During the third quarter the Company sold one commercial property and one residential property, and took possession of a parcel of raw land, resulting in a net decrease of $1,118,300 for the third quarter of 2013. Immediately following third quarter end, the Company closed on the sale of two more commercial real estate properties further reducing the2014 with an OREO portfolio to $885,205.of $865,820.

Allowance for loan losses and provisions - The Company maintains an allowance for loan losses (allowance) at a level that management believes is appropriate to absorb losses inherent in the loan portfolio (See Critical Accounting Policies). Although the Company, in establishing the allowance, considers the inherent losses in individual loans and pools of loans, the allowance is a general reserve available to absorb all credit losses in the loan portfolio.  No part of the allowance is segregated to absorb losses from any particular loan or classsegment of loans.

When establishing the allowance each quarter the Company applies a combination of historical loss factors and qualitative factors to loan classessegments including residential first and junior lien mortgages, commercial real estate, commercial and& industrial, and consumer loan portfolios. No changes were made to the allowance methodology during the first ninethree months of 2013.2014. The Company will shorten or lengthen its look back period for determining average portfolio historical loss rates as the economy either contracts or expands; during a period of economic contraction a shortening of the look back period may more conservatively reflect the current economic climate. The highest loss rates experienced for the look back period are applied to the various segments in establishing the allowance.

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

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

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The following table summarizes the Company's loan loss experience for the ninethree months ended September 30,March 31,

 2013  2012  2014  2013 
            
Loans outstanding, end of period* $433,211,277  $409,094,645 
Average loans outstanding during period* $422,756,037  $399,953,037 
Loans outstanding, end of period $452,230,767  $417,469,135 
Average loans outstanding during period $445,692,728  $417,364,812 
Non-accruing loans, end of period $4,902,188  $4,708,519  $4,285,061  $4,919,417 
Non-accruing loans, net of government guarantees $4,319,917  $3,118,286  $3,926,162  $3,718,022 
                
Allowance, beginning of period $4,312,080  $3,886,502  $4,854,915  $4,312,080 
Loans charged off:        
Loans charged off(1):        
Commercial & industrial  (61,614)  (159,309)  (16,680)  (17,935)
Commercial real estate  (124,849)  (57,878)  (100,000)  0 
Residential real estate - 1st lien  (7,009)  (239,600)
Residential real estate - Jr lien  0   (69,734)
Consumer loans  (36,655)  (69,437)  (51,528)  (17,226)
Total loans charged off  (230,127)  (595,958)  (168,208)  (35,161)
Recoveries:        
Recoveries(1):        
Commercial & industrial  2,117   20,498   112   200 
Commercial real estate  185,791   25,450 
Residential real estate - 1st lien  11,764   3,248   9,373   5,626 
Residential real estate - Jr lien  21,230   1,479   60   60 
Consumer loans  32,826   24,010   6,326   4,329 
Total recoveries  253,728   74,685   15,871   10,215 
Net loans charged off  23,601   (521,273)  (152,337)  (24,946)
Provision charged to income  463,750   750,001   135,000   206,250 
Allowance, end of period $4,799,431  $4,115,230  $4,837,578  $4,493,384 
                
Net charge offs to average loans outstanding  -0.006%  0.130%  0.034%  0.006%
Provision charged to income as a percent of average loans  0.110%  0.188%  0.030%  0.049%
Allowance to average loans outstanding  1.135%  1.029%  1.085%  1.077%
Allowance to non-accruing loans  97.904%  87.400%  112.894%  91.340%
Allowance to non-accruing loans net of government guarantees  111.100%  131.971%  123.214%  120.854%

*Includes loans held-for-sale(1)  There were no residential real estate 1st lien or Jr lien charge offs and there were no commercial real estate loan recoveries during the periods presented.

Net charge-offs increased from 2007 through 2011, peaking at $841,000 in 2011. Given the trend in losses, depth of the latestlast recession and the sluggish recovery, management increased its provisions for loan losses to $1.0 million in each of the years 2010 through 2012, compared to $625,004 for 2009. This increase was directionally consistent with the risk trends and growth of the loan portfolio.portfolio during the period.  Improving loan portfolio trends throughthroughout 2012 and into 2013, and several recoveries have resulted in a $286,251$330,000 or 38.2%33.0%, decrease to the provision for 2013, with total provision of $670,000 compared to $1,000,000 for 2012. The Company decreased its provision for 2014 resulting in a provision of $135,000 for the first nine monthsquarter of 2013; with total provisions year to date of $463,7502014 compared to $750,001$206,250 for the same period in 2012. While the2013, a decrease of $71,250 or 34.6%.  The Company’s allowance coverage of non-accruing loans has increased during 2013,as of the end of the first quarter of 2014 reflected an increase year over year as did the coverage of non-accruing loans net of government guarantees decreased.guarantees.  The decrease is the result of new non-accruing loans that are not guaranteed, replacing one large government guaranteed loan that was fully liquidated during the secondfirst quarter of 2013.2014 saw the $100,000 partial charge off of a commercial real estate loan, as well as higher than typical consumer loan charge offs.  The Company has an experienced collections department that continues to work actively with borrowers to resolve problem loans and manage the OREO portfolio, and management continues to monitor the loan portfolio closely.

Specific allocations to the allowance are made for certain impaired loans. Impaired loans are loans to a borrower that in aggregate are greater than $100,000 and that are in non-accrual status. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including interest and principal, according to the contractual terms of the loan agreement. The Company will review all the facts and circumstances surrounding non-accrual loans and on a case-by-case basis may consider loans below the threshold as impaired when such treatment is material to the financial statements.  See Note 5 to the accompanying unaudited interim consolidated financial statements for information on the recorded investment in impaired loans and their related allocations.  The $100,000 commercial real estate charge off taken during the first quarter of 2014 directly reduced the level of specific allocations carried on impaired loans.

39
The portion of the allowance termed "unallocated" is established to absorb inherent losses that exist as of the valuation date although not specifically identified through management's process for estimating credit losses.  While the allowance is described as consisting of separate allocated portions, the entire allowance is available to support loan losses, regardless of category.

41
Market Risk - In addition to credit risk in the Company’s loan portfolio and liquidity risk in its loan and deposit-taking operations, the Company’s business activities also generate market risk.  Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices.  Declining capital markets can result in fair value adjustments necessary to record decreases in the value of the investment portfolio for other-than-temporary-impairment.  The Company does not have any market risk sensitive instruments acquired for trading purposes.  The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. During times of recessionary periods, a declining housing market can result in an increase in loan loss reserves or ultimately an increase in foreclosures.  Interest rate risk is directly related to the different maturities and repricing characteristics of interest-bearing assets and liabilities, as well as to loan prepayment risks, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes vary by product.  The prolonged weak economy and disruption in the financial markets in recent years may heighten the Company’s market risk.  As discussed above under "Interest Rate Risk and Asset and Liability Management", the Company actively monitors and manages its interest rate risk through the ALCO process.

COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET ARRANGEMENTS

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and risk-sharing commitments on certain sold loans.  Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. During the first ninethree months of 2013,2014, the Company did not engage in any activity that created any additional types of off-balance sheet risk.

The Company generally requires collateral or other security to support financial instruments with credit risk. The Company's financial instruments whose contract amount represents credit risk were as follows:

 Contract or Notional Amount  Contract or Notional Amount 
 
September 30,
2013
  
December 31,
2012
  
March 31,
2014
  
December 31,
2013
 
            
Unused portions of home equity lines of credit $23,360,209  $21,120,077  $22,108,610  $21,961,527 
Other commitments to extend credit  47,221,934   45,551,282   42,176,179   41,230,202 
Residential construction lines of credit  2,597,864   1,138,872   1,413,471   2,010,417 
Commercial real estate and other construction lines of credit  12,599,285   1,762,424   12,078,640   15,592,702 
Standby letters of credit and commercial letters of credit  1,111,941   1,193,480   1,119,945   1,655,469 
Recourse on sale of credit card portfolio  280,500   352,000   276,650   276,650 
MPF credit enhancement obligation, net of liability recorded  1,546,211   2,035,858   1,544,335   1,543,211 
 
Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company sold its credit card portfolio during the third quarter of 2007, but retained a partial recourse obligation under the terms of the sale, based on total lines, not balances outstanding.  Based on historical losses, the Company does not expect any significant losses from this commitment.

In connection with its 2007 trust preferred securities financing, completed on October 31, 2007, the Company guaranteed the payment obligations under the $12,500,000 of capital securities of its subsidiary, CMTV Statutory Trust I.  The source of funds for payments by the Trust on its capital securities is payments made by the Company on its debentures issued to the Trust.  The Company's obligation under those debentures is fully reflected in the Company's balance sheet, in the gross amount of $12,887,000 for each of the comparison periods, of which $12,500,000 represents external financing.financing through the issuance to investors of capital securities by CMTV Statutory Trust I.

40

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.

42
Currently, the Company is not offering competitive rates to attract or retain “rate chasers”.  The Company however, recognizes that, at times, when loan demand exceeds deposit growth or the Company has other liquidity demands, it may be desirable to utilize alternative sources of deposit funding to augment retail deposits and borrowings.  One-way deposits purchased through the CDARS provide an alternative funding source when needed.  Such deposits are generally considered a form of brokered deposits.  TheDuring the first quarter of 2014, the Company hadutilized one-way depositsCDARS totaling $0$10,000,140 as a supplemental funding source.  There was no one-way CDARS balance at September 30, 2013 andeither December 31, 2012 and $2,061,461 at September 30, 2012.2013 or March 31, 2013.  In addition, two-way CDARS deposits allow the Company to provide FDIC deposit insurance to its customers in excess of account coverage limits by exchanging deposits with other CDARS members.  At September 30, 2013,March 31, 2014, the Company reported $1,101,465$1,104,521 in two-way CDARS deposits representing exchanged deposits with other CDARS participating banks, compared to $1,028,152$1,103,008 at December 31, 20122013 and $1,021,906$1,098,409 at September 30, 2012.March 31, 2013.  The balance in ICS deposits discussed above under “Changes in Financial Condition” was $14,927,159$17,208,334 at September 30, 2013,March 31, 2014, compared to $13,529,424$17,290,435 at December 31, 20122013 and $11,010,252$16,382,025 at September 30, 2012.March 31, 2013.

The Company has a Borrower-in-Custody (“BIC”) arrangement with the FRBB secured by eligible commercial loans, commercial real estate loans and home equity loans, resulting in an available line of $76,626,565, $71,345,734,$77,678,850, $74,929,216, and $70,635,875,$69,797,730, respectively, at September 30, 2013,March 31, 2014, December 31, 20122013 and September 30, 2012.March 31, 2013.  Credit advances in this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 75 basis points.  The Company had no outstanding advances against this line during any of the respective comparison periods.

The Company has an unsecured Federal Funds line with the FHLBB with an available balance of $500,000 at September 30, 2013,March 31, 2014, December 31, 20122013 and September 30 2012.March 31 2013.  Interest is chargeable at a rate determined daily approximately 25 basis points higher than the rate paid on federal funds sold.  In addition, at September 30, 2013,March 31, 2014, December 31, 20122013 and September 30, 2012,March 31, 2013, additional borrowing capacity of approximately $74,008,675, $72,591,692$71,201,419, $72,556,030 and $69,862,201,$73,807,775, respectively, was available through the FHLBB secured by the Company's qualifying loan portfolio (generally, residential mortgages).

The Company has an unsecured line with one of its correspondent banks with an available line of $3,000,000 at March 31, 2014, December 31, 2013 and March 31, 2013.  During the first quarter of 2014, the Company established an unsecured line with a different correspondent bank with an available line of $4,000,000 as of March 31, 2014.  There were no outstanding advances against either of these lines during any of the respective comparison periods.

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

  September 30,  December 31,  September 30, 
  2013  2012  2012 
Long-Term Advances         
FHLBB Community Investment Program advance, 7.67% fixed         
   rate, due November 16, 2012 $0  $0  $10,000 
FHLBB term advance, 1.71% fixed rate, due January 28, 2013  0   6,000,000   6,000,000 
FHLBB term advance, 2.72% fixed rate, due January 27, 2015  0   0   6,000,000 
  $0  $6,000,000  $12,010,000 
             
Overnight Borrowings            
Federal funds purchased (FHLBB),  0.3125%, 0.00% and 0.3125%  8,325,000   0   4,840,000 
             
     Total Borrowings $8,325,000  $6,000,000  $16,850,000 
  March 31,  December 31,  March 31, 
  2014  2013  2013 
Long-Term Advances         
FHLBB term borrowing, 0.23% fixed rate, due August 29, 2014 $6,000,000  $0  $0 
             
Short-Term Advances            
FHLBB term advance, 0.19% fixed rate, due May 2, 2014  6,000,000   0   0 
             
Overnight Borrowings            
Federal funds purchased (FHLBB), 0.35%  0   0   7,845,000 
             
     Total Advances and Overnight Borrowings $12,000,000  $0  $7,845,000 

41

The following table illustrates the changes in shareholders' equity from December 31, 20122013 to September 30, 2013:March 31, 2014:

Balance at December 31, 2012 (book value $8.13 per common share) $43,352,575 
Balance at December 31, 2013 (book value $8.96 per common share) $46,135,977 
Net income  3,635,055   1,071,565 
Issuance of stock through the Dividend Reinvestment Plan  523,678   173,946 
Dividends declared on common stock  (2,026,829)  (778,872)
Dividends declared on preferred stock  (60,938)  (20,313)
Change in unrealized gain on available-for-sale securities, net of tax  (170,227)  40,891 
Balance at September 30, 2013 (book value $8.81 per common share) $45,253,314 
Balance at March 31,2014 (book value $9.04 per common share) $46,623,194 

The primary sourceobjective of funds for the Company's paymentCompany’s capital planning process is to balance appropriately the retention of dividendscapital to itssupport operations and future growth, with the goal of providing shareholders is dividends paidan attractive return on their investment.  To that end, management monitors capital retention and dividend policies on an ongoing basis.

As described in more detail in the Company’s 2013 Annual Report on Form 10-K in Note 20 to the Company byaudited consolidated financial statements contained therein and under the Bank.  The Bank, as a national bank, is subject tocaption “LIQUIDITY AND CAPITAL RESOURCES” in the dividend restrictions set forth byManagement’s Discussion and Analysis section of such report, the Comptroller of the Currency ("OCC").  Under such restrictions, the Bank may not, without the prior approval of the OCC, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years.
43
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.  Failureagencies pursuant 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 Bankwhich they 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.items.   Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.  Prompt corrective action capital requirements are applicable to banks, but not bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).  The Company’s non-cumulative Series A preferred stock ($2.5 million liquidation preference) is includable without limitation in its Tier 1 capital.  In accordance with changes in the regulatory requirements for calculating capital ratios, beginning with the quarter ended March 31, 2011, the Company deducts the amount of goodwill, for purposes of calculating the amount of trust preferred junior subordinated debentures includable in Tier 1 capital.  Management believes, as of September 30, 2013, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of September 30, 2013March 31, 2014, the Bank was considered well capitalized under the regulatory capital framework for Prompt Corrective Action and the Company exceeded all applicable consolidated regulatory capital guidelines.

The regulatory capital ratios of the Company and its subsidiary as of September 30, 2013 and December 31, 2012 exceeded current regulatory guidelines and are presented in the following table.

              Minimum 
        Minimum  To Be Well 
        For Capital  Capitalized Under 
        Adequacy  Prompt Corrective 
  Actual  Purposes:  Action Provisions: 
  Amount  Ratio  Amount  Ratio  Amount  Ratio 
  (Dollars in Thousands) 
September 30, 2013 
Total capital (to risk-weighted assets) 
   Company $50,110   12.98% $30,896   8.00%  N/A   N/A 
   Bank $49,390   12.81% $30,850   8.00% $38,562   10.00%
  
Tier I capital (to risk-weighted assets) 
   Company $43,611   11.29% $15,448   4.00%  N/A   N/A 
   Bank $44,570   11.56% $15,425   4.00% $23,137   6.00%
  
Tier I capital (to average assets) 
   Company $43,611   7.98% $21,870   4.00%  N/A   N/A 
   Bank $44,570   8.16% $21,849   4.00% $27,311   5.00%
  
December 31, 2012: 
Total capital (to risk-weighted assets) 
   Company $47,385   12.57% $30,164   8.00%  N/A   N/A 
   Bank $46,796   12.44% $30,099   8.00% $37,623   10.00%
  
Tier I capital (to risk-weighted assets) 
   Company $40,724   10.80% $15,082   4.00%  N/A   N/A 
   Bank $42,440   11.28% $15,049   4.00% $22,574   6.00%
  
Tier I capital (to average assets) 
   Company $40,724   7.27% $22,416   4.00%  N/A   N/A 
   Bank $42,440   7.58% $22,387   4.00% $27,984   5.00%

 
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The Company intends to continuefollowing table shows the past policyCompany’s actual capital ratios and those of maintaining a strongits subsidiary, as well as applicable regulatory capital resource position to support its asset sizerequirements, as of March 31, 2014 and level of operations.  Consistent with that policy, management will continue to anticipate the Company's future capital needs and will adjust its dividend payment practices consistent with those needs.December 31, 2013:

From time
              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) 
March 31, 2014 
Total capital (to risk-weighted assets) 
   Company $51,801   12.85% $32,244   8.00%  N/A   N/A 
   Bank $51,278   12.74% $32,209   8.00% $40,261   10.00%
  
Tier I capital (to risk-weighted assets) 
   Company $45,704   11.34% $16,122   4.00%  N/A   N/A 
   Bank $46,396   11.52% $16,104   4.00% $24,156   6.00%
  
Tier I capital (to average assets) 
   Company $45,704   8.20% $22,284   4.00%  N/A   N/A 
   Bank $46,396   8.33% $22,266   4.00% $27,833   5.00%
  
December 31, 2013: 
Total capital (to risk-weighted assets) 
   Company $51,304   13.09% $31,365   8.00%  N/A   N/A 
   Bank $50,765   12.97% $31,314   8.00% $39,143   10.00%
  
Tier I capital (to risk-weighted assets) 
   Company $45,027   11.48% $15,682   4.00%  N/A   N/A 
   Bank $45,873   11.72% $15,657   4.00% $23,486   6.00%
  
Tier I capital (to average assets) 
   Company $45,027   8.04% $22,409   4.00%  N/A   N/A 
   Bank $45,873   8.20% $22,386   4.00% $27,983   5.00%

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

The Company's ability to pay dividends to its shareholders is largely dependent on the Company may make contributionsBank's ability to pay dividends to the capitalCompany.  In general, a national bank may not pay dividends that exceed net income for the current and preceding two years regardless of Community National Bank.  At present,statutory restrictions, as a matter of regulatory authorities have made no demand on the Company to make additional capital contributions.policy, banks and bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, they remain adequately capitalized.

In July 2013, the Federal Reserve Board adopted new rules implementing the Basel III capital standards, which significantly revise the regulatory capital standards for U.S. financial institutions, including community banks.  Among other things, the new capital rules, which take effect during a five year phase in period beginning in January 2014, revise the definition of various regulatory capital components and related calculation methods, add a new regulatory capital component (common equity tier 1 capital), increase the minimum required tier 1 capital, implement a new capital conservation buffer and restrict dividends and certain discretionary bonus payments when the buffer is not maintained.  The final rules as adopted did not include several proposals that were particularly troubling to the Company and other community banks, including proposed changes to risk-weighting of mortgage loan assets, the proposed mandatory inclusion of unrealized gains and losses on available-for-sale securities in regulatory capital and the proposed phase out of trust preferred securities from regulatory capital.  Management is evaluating the potential impact of the new capital rules on the Company and monitoring related regulatory developments.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

The Company's management of the credit, liquidity and market risk inherent in its business operations is discussed in Part 1, Item 2 of this report under the captions "RISK MANAGEMENT" and. “COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET ARRANGEMENTS” and “LIQUIDITY & CAPITAL RESOURCES”, which are incorporated herein by reference.  Management does not believe that there have been any material changes in the nature or categories of the Company's risk exposures from those disclosed in the Company’s 20122013 Annual Report on formForm 10-K.

ITEM 4. Controls and Procedures

Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”).  As of September 30, 2013,March 31, 2014, 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 September 30, 2013March 31, 2014 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.

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For this purpose, the term “disclosure controls and procedures” means controls and other procedures of the Company that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2013March 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

In the normal course of business the Company and its subsidiary are involved in litigation that is considered incidental to their business.  Management does not expect that any such litigation will be material to the Company's consolidated financial condition or results of operations.

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

The following table provides information as to purchases of the Company’s common stock during the quarter ended September 30, 2013,March 31, 2014, by the Company and by any affiliated purchaser (as defined in SEC Rule 10b-18):

             
           Maximum Number of 
        Total Number of  Shares That May Yet 
  
Total Number
of Shares
  
Average
Price Paid
  
Shares Purchased
as Part of Publicly
  
Be Purchased Under
the Plan at the End
 
For the period: Purchased(1)(2)  Per Share  Announced Plan  of the Period 
             
July 1 - July 31  0  $0.00   N/A   N/A 
August 1 - August 31  4,600   12.95   N/A   N/A 
September 1 - September 30  0   0.00   N/A   N/A 
     Total  4,600  $12.95   N/A   N/A 
 
           Maximum    
           Number of   
        Total Number  Shares That May 
        of Shares  Yet Be 
        Purchased   Purchased 
  Total Number  Average  as Part   Under the Plan 
  of Shares  Price Paid  of Publicly   at the End 
For the period: Purchased(1)(2)  Per Share  Announced Plan  of the Period 
             
January 1 - January 31  0  $0.00   N/A   N/A 
February 1 - February 28  1,489   13.75   N/A   N/A 
March 1 -March 31  407   13.75   N/A   N/A 
Total  1,896  $13.75   N/A   N/A 
(1)  All 4,6001,896 shares were purchased for the account of participants invested in the Company Stock Fund under the Company’s Retirement Savings Plan by or on behalf of the Plan Trustee, the Human Resources Committee of Community National Bank.  Such share purchases were facilitated through CFSG, which provides certain investment advisory services to the Plan.  Both the Plan Trustee and CFSG may be considered affiliates of the Company under Rule 10b-18.

(2)  Shares purchased during the period do not include fractional shares repurchased from time to time in connection with the participant's election to discontinue participation in the Company's Dividend Reinvestment Plan.

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ITEM 6. Exhibits

The following exhibits are filed with this report:
Exhibit 31.1 - Certification from the Chief Executive Officer of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification from the Chief Financial Officer of the Company pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification from the Chief Executive Officer of the Company pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
Exhibit 32.2 - Certification from the Chief Financial Officer of the Company pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*

Exhibit 101--The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 formatted in eXtensible Business Reporting Language (XBRL): (i) the unaudited consolidated balance sheets, (ii) the unaudited consolidated statements of income for the interim periods ended September 30, 2013 and 2012, (iii) the unaudited consolidated statements of comprehensive income, (iv) the unaudited consolidated statements of cash flows and (v) related notes.*  **
Exhibit 101-The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 formatted in eXtensible Business Reporting Language (XBRL): (i) the unaudited consolidated balance sheets, (ii) the unaudited consolidated statements of income for the interim periods ended March 31, 2014 and 2013, (iii) the unaudited consolidated statements of comprehensive income, (iv) the unaudited consolidated statements of cash flows and (v) related notes.*

*  This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

**  As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

 
4645
 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

COMMUNITY BANCORP.
 
DATED:  November 12, 2013May 13, 2014/s/ Stephen P. Marsh                     
 Stephen P. Marsh, Chairman, President 
 & Chief Executive Officer 
   
DATED:  November 12, 2013May 13, 2014/s/ Louise M. Bonvechio                 
 Louise M. Bonvechio,  Treasurer 
 (Principal Financial Officer) 

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