COMMUNITY BANCORP /VT 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Period Ended March 31, 2022 The following discussion analyzes the consolidated financial condition of Community Bancorp. and its wholly-owned subsidiary, Community National Bank, as of March 31, 2022 and December 31, 2021, and its consolidated results of operations for the three-month interim period and one year period presented. The Company is considered a “smaller reporting company” and a “non-accelerated filer” under the disclosure rules of the SEC. Accordingly, the Company has elected to provide its audited statements of income, comprehensive income, cash flows and changes in shareholders’ equity for a two year, rather than a three year, period and intends to provide smaller reporting company scaled disclosures where management deems it appropriate. The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 2021 Annual Report on Form 10-K filed with the SEC. Please refer to Note 1 in the accompanying audited consolidated financial statements for a listing of acronyms and defined terms used throughout the following discussion. FORWARD-LOOKING STATEMENTS This Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, regarding the results of operations, financial condition and business of the Company and its subsidiary. Words used in the discussion below such as “believes,” “expects,” “anticipates,” “intends,” “estimates,” “projects”, “plans,” “assumes”, “predicts,” “may”, “might”, “will”, “could”, “should” and similar expressions, indicate that management of the Company is making forward-looking statements. Forward-looking statements are not guarantees of future performance. They necessarily involve risks, uncertainties and assumptions. Examples of forward looking statements included in this discussion include, but are not limited to, statements regarding the potential effects of the COVID-19 pandemic on our business, financial condition, results of operations and prospects; the 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 management’s general outlook for the future performance of the Company or the local or national economy. Although forward-looking statements are based on management’s expectations and estimates as of the date they are made, many of the factors that could influence or determine actual results are unpredictable and not within the Company’s control. Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities: · general economic or business conditions, either nationally, regionally or locally, deteriorate, resulting in a decline in credit quality or a diminished demand for the Company’s products and services; · competitive pressures increase among financial service providers in the Company’s northern New England market area or in the financial services industry generally, including competitive pressures from non-bank financial service providers, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; · interest rates change in such a way as to negatively affect the Company’s net income, asset valuations or margins; · changes in laws or government rules, including the rules of the federal Consumer Financial Protection Bureau, or the way in which courts or government agencies interpret or implement those laws or rules, increase our costs of doing business, causing us to limit or change our product offerings or pricing, or otherwise adversely affect the Company’s business; · changes in federal or state tax laws or policy; · changes in the level of nonperforming assets and charge-offs; · changes in applicable accounting policies, practices and standards, including, without limitation, implementation of pending changes to the measurement of credit losses in financial statements under U.S. GAAP pursuant to the CECL model; · changes in consumer and business spending, borrowing and savings habits; · reductions in deposit levels, which necessitate increased borrowings to fund loans and investments; · the geographic concentration of the Company’s loan portfolio and deposit base; · losses due to the fraudulent or negligent conduct of third parties, including the Company’s service providers, customers and employees; 28 Table of Contents · cybersecurity risks could adversely affect the Company’s business, financial performance or reputation and could result in financial liability for losses incurred by customers or others due to data breaches or other compromise of the Company’s information security systems; · higher-than-expected costs are incurred relating to information technology or difficulties arise in implementing technological enhancements; · management’s risk management measures may not be completely effective; · changes in the United States monetary and fiscal policies, including the interest rate policies of the FRB and its regulation of the money supply; · adverse changes in the credit rating of U.S. government debt; · the planned phase out of three month LIBOR by June 30, 2023, which could adversely affect the Company’s interest costs in future periods on its $12,887,000 in principal amount of Junior Subordinated Debentures due December 12, 2037, which currently bear interest at a variable rate, adjusted quarterly, equal to 3-month LIBOR, plus 2.85%; · continuing the effects of COVID-19 and emerging variants of the virus on our Company, the communities where we have branches and loan production offices, the State of Vermont and the national and global economies and overall stability of the financial markets; · the continuing effects of government and regulatory responses to the COVID-19 pandemic; · operational and internal system failures due to changes in normal business practices, including remote working for Company staff; · increased cybercrime and payment system risk due to increase usage by customers of online and other remote banking channels; · the impact of inflation on the Company’s customers and on its financial results and performance; and · the ongoing challenges to find qualified workers to maintain a stable workforce. Readers are cautioned not to place undue reliance on such statements as they speak only as of the date they are made. The Company does not undertake, and disclaims any obligation, to revise or update any forward-looking statements to reflect the occurrence or anticipated occurrence of events or circumstances after the date of this Report, except as required by applicable law. The Company claims the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995. NON-GAAP FINANCIAL MEASURES Under SEC Regulation G, public companies making disclosures containing financial measures that are not in accordance with GAAP must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure, as well as a statement of the company’s reasons for utilizing the non-GAAP financial measure. The SEC has exempted from the definition of non-GAAP financial measures certain commonly used financial measures that are not based on GAAP. However, three non-GAAP financial measures commonly used by financial institutions, namely tax-equivalent net interest income and tax-equivalent net interest margin (as presented in the tables in the section labeled Interest Income Versus Interest Expense (NII)) and core earnings (as defined and discussed in the Results of Operations section), have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G. We are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G. Management believes that these non-GAAP financial measures are useful in evaluating the Company’s financial performance and facilitate comparisons with the performance of other financial institutions. However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP. OVERVIEW The Company’s consolidated assets on March 31, 2022 were $1,005,190,870 compared to $1,019,105,799 at December 31, 2021, a decrease of 1.4%. Significant changes in the asset base were a decrease of $25.9 million, or 23.5%, in cash and cash equivalents, which was partially offset by an increase in net loans of $6.4 million, or 0.9%, and an increase in the available for sale investment portfolio of $3.4 million. The decrease in cash also reflects deposit runoff, primarily in business and municipal accounts, in the first quarter. The increase in the loan portfolio was primarily attributable to an increase of $7.8 million in commercial & industrial loans and $6.1 million in CRE loans, which was partially offset by a $7.0 million decrease in PPP loan balances. Total deposits on March 31, 2022 were $877,300,445 compared to $879,399,953 on December 31, 2021, a decrease of $2.1 million, or 0.2%, reflecting the combined effect of decreases in core deposits (demand deposit accounts, non-interest bearing) of $5.8 million, or 2.8%, and a decrease in interest-bearing transaction accounts of $7.1 million, or 2.7%, partially offset by an increase in money market funds totaling $1.0 million, or 0.8%, and an increase in savings accounts of $9.6 million, or 5.7%. 29 Table of Contents Consolidated net income for the first three months of 2022 decreased $620,159, or 20.5% compared to the same period in 2021. A $927,248 decrease in the amortization of PPP loan processing fees from the SBA was partially offset by an increase of $407,954 in investment income from the Company’s debt securities portfolio and adjustments to interest income totaling $177,000, which is primarily from loans coming out of non-accrual status. Also contributing to the offset was a decrease of $54,257 in interest expense on savings and money market deposits, and a decrease of $103,849 in interest expense from time deposits. These changes and other significant changes are discussed in the appropriate income sections of this MD&A. Total interest income decreased $365,364, or 4.2%, year over year, due to the changes discussed in the previous paragraph related to PPP loan processing fees and investment and loan income. The investment portfolio has increased considerably year over year accounting for the increase in investment income. The amortization of the SBA PPP fees was $295,769 for the first three months of 2022, compared to $1.2 million for the same period in 2021. Those processing fees represented 73.2% and 92.9%, respectively, of the total of fees on loans of $404,326 for the first three months of 2022, and $1.3 million for the first three months of 2021. Total interest expense decreased $161,106, or 18.9%, for the first three months of 2022 compared to the same period in 2021. A decrease in time deposits year over year is a contributing factor to the decrease in interest expense, as well as the prolonged low interest rate environment that prevailed throughout 2021 and most of the first quarter of 2022. Please refer to the interest rate sensitivity discussion in the Interest Rate Risk and Asset and Liability Management section for more information on the impact that the actions of the FRB’s FOMC in regulating interest rates, and changes in the yield curve could have on net interest income. The provision for loan losses for the first quarter of 2022 was $862,500 compared to $267,497 for the same quarter of 2021, resulting in an increase of $595,003, or 222.4%, between periods. This increase to the provision was driven primarily by a write-down on a non-performing CRE loan totaling $667,474 during March 2022. Please refer to the ALL and provisions discussion in the Credit Risk section for more information. Equity capital decreased to $77.4 million, with a book value per share of $14.08 as of March 31, 2022, compared to equity capital of $84.8 million and a book value of $15.48 as of December 31, 2021. This decrease in equity is directly related to the increase of unrealized losses in the investment portfolio, reflecting rising bond rates, which resulted in an increase of $8,744,637, net of tax, in the accumulated other comprehensive loss in the shareholders’ equity portion of the balance sheet. This position is considered temporary and does not impact the Company’s regulatory capital ratios. On March 16, 2022, the Company’s Board of Directors declared a quarterly cash dividend of $0.23 per common share, payable on May 1, 2022 to shareholders of record on April 15, 2022. As of March 31, 2022, all of the Company’s capital ratios, and those of our subsidiary Bank, were in excess of applicable regulatory requirements. While we believe that we have sufficient capital to withstand an economic downturn from any headwinds related to inflation or recessionary periods, should one occur, our equity capital and regulatory capital ratios could be adversely impacted, including as a result of credit losses and other adverse impacts of the pandemic or government monetary policy. CRITICAL ACCOUNTING POLICIES The Company’s consolidated financial statements are prepared according to U.S. GAAP. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities in the consolidated financial statements and related notes. The SEC has defined a company’s critical accounting policies as those that are most important to the portrayal of the Company’s financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Because of the significance of these estimates and assumptions, there is a high likelihood that materially different amounts would be reported for the Company under different conditions or using different assumptions or estimates. Management evaluates on an ongoing basis its judgment as to which policies are considered to be critical. The Company’s critical accounting policies govern: · the ALL; · OREO; · OTTI of debt securities; · valuation of residential MSRs; and · the carrying value of goodwill. These policies are described in the Company’s 2021 Annual Report on Form 10-K in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and in Note 1 (Significant Accounting Policies) to the audited consolidated financial statements. There were no material changes during the first three months of 2022 in the Company’s critical accounting policies. 30 Table of Contents RESULTS OF OPERATIONS Net income for the first three months of 2022 was $2,405,542 or $0.44 per common share, compared to $3,025,701 or $0.57 per common share for the same period of 2021. Core earnings (NII) for the first three months of 2022 were $7.6 million compared to $7.8 million for the same period in 2021. As noted in the Overview, the decrease year over year is attributable to a decrease in the amortization of fees from administering PPP loans. Over the past year, the portfolio of PPP loans has decreased, as these loans are forgiven and paid in full by the SBA. The PPP loan portfolio balance decreased from $92.6 million at the end of February 2021 to $12.2 million at December 31, 2021 and then to $5.1 million as of March 31, 2022. As these loans are paid in full, the unamortized fees are taken to income, resulting in a decrease in income year over year. Interest paid on deposits, which is the major component of total interest expense, decreased $153,284, or 21.7% in 2022, driven in part by a decrease in time deposits. 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 tables show these ratios annualized, as well as other equity ratios, for the comparison periods presented. Three Months Ended March 31, 2022 2021 Return on average assets 0.97 % 1.33 % Return on average equity 11.76 % 15.75 % Dividend payout ratio (1) 52.27 % 38.60 % Average equity to average assets 8.24 % 8.48 % (1) Dividends declared per common share divided by earnings per common share. INTEREST INCOME VERSUS INTEREST EXPENSE (NET INTEREST INCOME) The largest component of the Company’s operating income is NII, which is the difference between interest earned on loans and investments and the interest paid on deposits and other sources of funds (i.e., borrowings). The Company’s level of net interest income can fluctuate over time due to changes in the level and mix of earning assets and sources of funds (volume), and changes in the yield earned and costs of funds (rate). A portion of the Company’s income from loans to local municipalities is not subject to income taxes. Because the proportion of tax-exempt items in the Company’s balance sheet 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. The Company’s corporate tax rate is 21%; therefore, to equalize tax-free and taxable income in the comparison, we divide the tax-free income by 79%, with the result that every tax-free dollar is equivalent to $1.27 in taxable income for the periods presented. The Company’s tax-exempt interest income of $236,043 and $258,761 for the three months ended March 31, 2022 and 2021, respectively, was derived from loans to local municipalities of $48.7 million and $52.2 million, and tax-exempt municipal investments of $2.2 million and $0, at March 31, 2022 and 2021, respectively. The following tables show the reconciliation between reported NII and tax equivalent NII for the comparison periods presented. Three Months Ended March 31, 2022 2021 Net interest income as presented $ 7,558,230 $ 7,762,488 Effect of tax-exempt income 62,745 68,785 Net interest income, tax equivalent $ 7,620,975 $ 7,831,273 31 Table of Contents The following tables present the daily average interest-earning assets and the daily average interest-bearing liabilities supporting earning assets for the respective comparison periods. Interest income (excluding interest on non-accrual loans) is expressed on a tax equivalent basis, both in dollars and as a rate/yield for the comparison periods presented. Three Months Ended March 31, 2022 2021 Average Average Average Income/ Rate/ Average Income/ Rate/ Balance Expense Yield Balance Expense Yield Interest-Earning Assets Loans (1) $ 693,001,033 $ 7,547,035 4.42 % $ 720,584,311 $ 8,322,081 4.68 % Taxable investment securities 185,794,633 656,277 1.43 % 71,633,125 265,112 1.50 % Tax-exempt investment securities 2,232,280 13,859 2.52 % 0 0 0.00 % Sweep and interest-earning accounts 69,778,429 80,660 0.47 % 79,995,338 87,883 0.45 % Other investments (2) 1,779,400 16,460 3.75 % 1,833,550 10,619 2.35 % Total $ 952,585,775 $ 8,314,291 3.54 % $ 874,046,324 $ 8,685,695 4.03 % Interest-Bearing Liabilities Interest-bearing transaction accounts $ 258,739,985 $ 160,078 0.25 % $ 214,680,380 $ 146,518 0.28 % Money market funds 130,743,524 127,680 0.40 % 120,918,163 168,105 0.56 % Savings deposits 173,158,450 23,440 0.05 % 144,612,956 37,273 0.10 % Time deposits 106,635,720 240,761 0.92 % 111,327,106 353,348 1.29 % Borrowed funds 1,301,144 2 0.00 % 2,530,789 12 0.00 % Repurchase agreements 28,847,413 21,040 0.30 % 37,312,342 35,442 0.39 % Finance lease obligations 3,823,091 21,963 2.30 % 1,679,688 14,929 3.56 % Junior subordinated debentures 12,887,000 98,352 3.10 % 12,887,000 98,795 3.11 % Total $ 716,136,327 $ 693,316 0.39 % $ 645,948,424 $ 854,422 0.54 % Net interest income $ 7,620,975 $ 7,831,273 Net interest spread (3) 3.15 % 3.49 % Net interest margin (4) 3.24 % 3.63 % (1) Included in gross loans are non-accrual loans with average balances of $5,736,827 and $4,087,346 for the three months ended March 31, 2022 and 2021, respectively. Loans are stated before deduction of unearned discount and ALL, less loans held-for-sale and include tax-exempt loans to local municipalities with average balances of $49,022,025 and $52,232,117 for the three months ended March 31, 2022 and 2021, respectively. (2) Included in other investments is the Company’s FHLBB Stock with average balances of $714,250 and $768,400, respectively, with a dividend rate of approximately 2.66% and 1.54%, respectively, for the three months ended March 31, 2022 and 2021, respectively. (3) Net interest spread is the difference between the average yield on average interest-earning assets and the average rate paid on average interest-bearing liabilities. (4) Net interest margin is net interest income divided by average earning assets. The average volume of interest-earning assets for the three-month period ended March 31, 2022 increased 9.0% compared to the three-month period ended March 31, 2021. The average yield on interest-earning assets decreased 49 basis points for 2022 versus 2021. The average volume of loans decreased 3.8% for the first three months of 2022 versus the same period in 2021, and the average yield on loans decreased 26 basis points to 4.42% for 2022 compared to 4.68% for 2021. The decrease in the yield in 2022 was due primarily to the decrease in PPP fees year over year as discussed in the Overview. The decrease in the average volume of loans is attributable to the forgiveness and payoff of PPP loans by the SBA between periods. Interest earned on the loan portfolio as a percentage of total interest income decreased to 90.8% for the first three months of 2022, compared to 95.8% for the same period in 2021. 32 Table of Contents The average volume of the taxable investment portfolio (classified as AFS) increased 159.4% for the three-month period ended March 31, 2022 compared the same period last year, while the average yield decreased seven basis points. The increase in average volume is due primarily to management’s effort to continue to grow the investment portfolio incrementally as the balance sheet grows in order to provide additional liquidity and pledge quality assets. The average volume of the tax-exempt investment portfolio (classified as AFS) for the three-month period ended March 31, 2022 was $2.2 million, with a tax equivalent yield of 2.52%. The Company began investing in these tax-exempt bonds during December 2021. The average volume of sweep and interest-earning accounts, which consists primarily of an interest-bearing account at the FRBB, decreased 12.8% for the three-month ended March 31, 2022 compared to the same period in 2021. This decrease in volume is attributable to a need to fund investment and loan growth and also to a decrease in customer deposit accounts. The average yield on these funds increased two basis points during the first three months of 2022 versus the same period in 2021. The average volume of interest-bearing liabilities for the three-month period ended March 31, 2022 increased 10.9% compared to the same period in 2021. The average rate paid on interest-bearing liabilities decreased 15 basis points during 2022 compared to 2021. Although year to date volume shows an overall decrease in deposit accounts, most of the funds deposited through PPP loan proceeds and stimulus funds remained on deposit throughout 2021. The average volume of interest-bearing transaction accounts increased 20.5% during the three-month period ended March 31, 2022 compared to the same period of 2021, reflecting strong deposit growth throughout 2021. The average rate paid on these accounts decreased three basis points between comparison periods. The average volume of money market accounts increased 8.1% during the three-month period ended March 31, 2022 compared to the same period of 2021, while the average rate paid on these deposits decreased 16 basis points. The average volume of savings accounts increased 19.7% for the three-month period ended March 31, 2022 compared to the same period in 2021, while the average rate paid on these accounts decreased five basis points. The average volume of time deposits decreased 4.2% during the three-month period ended March 31, 2022 compared to the same period in 2021, and the average rate paid decreased 37 basis points. Interest paid on time deposits as a percentage of total interest expense was 34.7% and 41.4%, respectively for the three-month periods ended March 31, 2022 and 2021. The decrease in the average volume of time deposits between periods reflects the maturity of brokered deposits in January and April of 2021 that had not been replaced as of March 31, 2022. Management still considers the brokered deposit market to be a beneficial source of funding to help smooth out the fluctuations in core deposit balances without the need to disrupt deposit pricing in the Company’s local markets. These funds can be obtained relatively quickly on an as-needed basis, making them a valuable alternative to traditional term borrowings from the FHLBB. Refer to the “Liquidity and Capital Resources” section for more discussion on this topic. The average volume of borrowed funds decreased $1.2 million, or 48.6% for the three-month period ended March 31, 2022 compared to the same period in 2021 and, for both periods, consisted of only JNE funds at zero percent interest. The average volume of repurchase agreements decreased 22.7% for the three-month period ended March 31, 2022 compared to the same period in 2021 and the average rate paid decreased nine basis points. In summary, between the three-month periods ended March 31, 2022 and 2021, the average yield on interest-earning assets decreased 49 basis points and the average rate paid on interest-bearing liabilities decreased 15 basis points. Net interest spread decreased 34 basis points for the three-month period of 2022 versus 2021 and net interest margin decreased 39 basis points between periods. 33 Table of Contents The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the interim periods presented for 2022 and 2021 resulting from volume changes in daily average assets and daily average liabilities and fluctuations in average rates earned and paid. Three Months Ended March 31, Variance Variance Due to Due to Total Rate (1) Volume (1) Variance Average Interest-Earning Assets Loans $ (474,426 ) $ (300,620 ) $ (775,046 ) Taxable investment securities (31,076 ) 422,241 391,165 Tax-exempt investment securities 13,859 0 13,859 Sweep and interest-earning accounts 4,617 (11,840 ) (7,223 ) Other investments 6,342 (501 ) 5,841 Total $ (480,684 ) $ 109,280 $ (371,404 ) Average Interest-Bearing Liabilities Interest-bearing transaction accounts $ (16,859 ) $ 30,419 $ 13,560 Money market funds (53,992 ) 13,567 (40,425 ) Savings deposits (20,872 ) 7,039 (13,833 ) Time deposits (101,945 ) (10,642 ) (112,587 ) Borrowed funds (10 ) 0 (10 ) Repurchase agreements (8,140 ) (6,262 ) (14,402 ) Finance lease obligations (11,781 ) 18,815 7,034 Junior subordinated debentures (443 ) 0 (443 ) Total $ (214,042 ) $ 52,936 $ (161,106 ) Changes in net interest income $ (266,642 ) $ 56,344 $ (210,298 ) (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 34 Table of Contents NON-INTEREST INCOME AND NON-INTEREST EXPENSE Non-interest Income The components of non-interest income for the periods presented were as follows: Three Months Ended March 31, Change 2022 2021 Income Percent Service fees $ 862,887 $ 788,623 $ 74,264 9.42 % Income from sold loans 203,842 185,006 18,836 10.18 % Other income from loans 271,260 183,274 87,986 48.01 % Other income Income from CFS Partners 225,870 306,986 (81,116 ) -26.42 % Other miscellaneous income 122,570 108,342 14,228 13.13 % Total non-interest income $ 1,686,429 $ 1,572,231 $ 114,198 7.26 % Total non-interest income increased $114,198, or 7.3%, for the first three months of 2022 compared to the same period in 2021, with significant changes noted in the following: · The increase in service fees during the comparison period is mostly due to an increase in interchange income of $21,686, or 5% and overdraft charges of $53,280, or 29.3%, year over year. · The increase in income from sold loans is due to a higher volume of loans sold into the secondary market during the first three months of 2022 versus 2021. · An increase in CRE loan volume in 2022 resulted in a significant increase in documentation fees collected at origination, accounting for the increase in other income from loans when comparing the two periods. · Income from CFS Partners decreased between periods due in part to the impact of mark-to-market adjustments to CFS Partners equity portfolio during the first two months of 2022. The capital markets rebounded during March, but not enough to offset the decrease during the first two months. · Included in Other miscellaneous income for the first three months of 2022 is income totaling $23,400 associated with a renegotiated contract with the Company’s check printing vendor. 35 Table of Contents Non-interest Expense The components of non-interest expense for the periods presented were as follows: Three Months Ended March 31, Change 2022 2021 Expense Percent Salaries and wages $ 2,040,000 $ 1,975,003 $ 64,997 3.29 % Employee benefits 772,052 831,210 (59,158 ) -7.12 % Occupancy expenses, net 753,364 744,720 8,644 1.16 % Other expenses Directors Fees 143,857 129,104 14,753 11.43 % Telephone expense 34,571 32,125 2,446 7.61 % Audit fees 100,728 89,232 11,496 12.88 % Consultant services 64,887 78,789 (13,902 ) -17.64 % FDIC insurance 89,984 82,857 7,127 8.60 % Collection & non-accruing loan expense 36,000 11,600 24,400 210.34 % ATM fees 140,890 128,946 11,944 9.26 % Electronic banking expense 67,578 52,382 15,196 29.01 % State deposit tax 240,478 206,933 33,545 16.21 % Other miscellaneous expenses 969,199 1,002,150 (32,951 ) -3.29 % Total non-interest expense $ 5,453,588 $ 5,365,051 $ 88,537 1.65 % Total non-interest expense increased $88,537, or 1.7%, for the first three months of 2022 compared to the same period in 2021, with significant changes noted in the following: · The increase in salaries and wages is due to normal salary increases. · The decrease in employee benefits in was attributable to a decrease in health insurance claims year over year. · The increase in directors’ fees is attributable to a change to the Director’s fee schedule as well as an additional Director for 2022 whose quarterly compensation totaled $10,056. · Telephone expense increased due to a one-time fee charged in February 2022. · An increase was budgeted for audit fees in anticipation of increased audit services due to the Company surpassing the $1.0 billion asset size. · The decrease in consultant services year over year is attributable in part to recruitment of a senior management position in 2021. · FDIC insurance increased due primarily to an increase in assets as well as an increase in the assessment multiplier year over year. · Collection & non-accruing loan expense is higher year over year due to expenses associated with a commercial property in the Company’s non-accruing loan portfolio. · ATM fees increased due to the ongoing cost to support the upgraded and enhanced technology utilized for deposit automation. The use of deposit automation replaces a manual process for required monitoring of cash deposits as well as providing fraud detection measures at ATMs. · State deposit tax increased year over year due primarily to the increase in deposits throughout 2021. The calculation is based on an average of month-end deposit totals over a 12 month period. · The components of other miscellaneous expense are made up of several categories including outsourcing expense and service contracts – administration, but none with changes year over year greater than 5%. 36 Table of Contents APPLICABLE INCOME TAXES The provision for income taxes decreased $153,441, or 22.7%, for the first three months of 2022 compared to the same period in 2021 and is proportional to the decrease in income before income taxes totaling $773,600 year over year. Tax credits related to limited partnership investments amounted to $96,237 and $117,015, respectively, for the first three months of 2022 and 2021. Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $67,092 and $90,762, respectively, for the first three months of 2022 and 2021. These investments provide tax benefits, including tax credits, and are designed to provide a targeted effective annual yield between 7% and 10%. CHANGES IN FINANCIAL CONDITION The following table reflects the composition of the Company’s major categories of assets and liabilities as a percentage of total assets or liabilities and shareholders’ equity, as the case may be, as of the balance sheet dates: March 31, 2022 December 31, 2021 Assets Loans $ 696,293,182 69.27 % $ 689,988,533 67.71 % AFS securities 185,755,566 18.48 % 182,342,459 17.89 % Liabilities Demand deposits 203,661,459 20.26 % 209,465,151 20.55 % Interest-bearing transaction accounts 258,401,561 25.71 % 265,513,937 26.05 % Money market funds 130,731,075 13.01 % 129,728,954 12.73 % Savings deposits 177,994,875 17.71 % 168,390,905 16.52 % Time deposits 106,511,475 10.60 % 106,301,006 10.43 % Long-term advances 1,300,000 0.13 % 1,300,000 0.13 % The following table reflects the changes in the composition of the Company’s major categories of assets and liabilities between the balance sheet dates, as disclosed in the table above: Change in Volume Percentage Change Assets Loans $ 6,304,649 0.91 % AFS securities 3,413,107 1.87 % Liabilities Demand deposits (5,803,692 ) -2.77 % Interest-bearing transaction accounts (7,112,376 ) -2.68 % Money market funds 1,002,121 0.77 % Savings deposits 9,603,970 5.70 % Time deposits 210,469 0.20 % The increase in the loan portfolio during the first three months of 2022 was attributable to increases totaling $13.9 million in commercial & industrial and CRE loans, which was partially offset by payoffs of certain PPP loans through SBA’s forgiveness program totaling $7.0 million. The SBA PPP program ended during the second quarter of 2021, so this portfolio will continue to decrease throughout the remainder of 2022 either through pay downs or payoffs initiated on behalf of SBA’s forgiveness program, or by regular amortization as borrowers begin to make scheduled monthly payments. The increase in the securities AFS portfolio is attributable to the purchase of $19.1 million in securities AFS during the first three months of 2022, consisting of $7.2 million in US Treasuries, $3.8 million in Tax-exempt municipal bonds, and $8.1 million in MBS. These purchases were reduced in part by maturities and calls exercised amounting to $291,500, as well as principal payments on MBS totaling $4.2 million, and by an increase of $11.1 million in unrealized losses arising during the first quarter of 2022 and reflected in OCI. In management’s view, the size of the securities AFS portfolio is appropriate and proportional to the overall asset base, as this portfolio serves an important role in the Company’s liquidity position. 37 Table of Contents Most of the fluctuation in demand deposits is due to a decrease during the first quarter of 2022 in business checking accounts of $7.1 million, or 4.4%, which the Company believes primarily reflects the outflow of funds as customers are starting to spend some of the funds generated through the PPP loans. The decrease in interest-bearing transaction accounts consists of a decrease of $10.8 million, or 25.7%, in municipal deposit accounts, as well as a decrease of $6.1 million, or 8.6%, in ICS deposit accounts, which was partially offset by an increase of $8.1 million, or 7.0%, in consumer interest-bearing transaction accounts. The increase in savings deposits of $9.6 million, or 5.7%, is likely attributable in part to parked funds as customers await more favorable rates for time deposits, as well as deposits of stimulus payments and tax credits from the U.S. Government. Interest Rate Risk and Asset and Liability Management - Management actively monitors and manages the Company’s interest rate risk exposure and attempts to structure the balance sheet to maximize net interest income while controlling its exposure to interest rate risk. The Company’s ALCO is made up of the Executive Officers and certain Vice Presidents of the Bank representing major business lines. The ALCO formulates strategies to manage interest rate risk by evaluating the impact on earnings and capital of such factors as current interest rate forecasts and economic indicators, potential changes in such forecasts and indicators, liquidity and various business strategies. The ALCO meets at least quarterly to review financial statements, liquidity levels, yields and spreads to better understand, measure, monitor and control the Company’s interest rate risk. In the ALCO process, the committee members apply policy limits set forth in the Asset Liability, Liquidity and Investment policies approved and periodically reviewed by the Company’s Board of Directors. The ALCO’s methods for evaluating interest rate risk include an analysis of the effects of interest rate changes on net interest income and an analysis of the Company’s interest rate sensitivity “gap”, which provides a static analysis of the maturity and repricing characteristics of the entire balance sheet. The ALCO Policy also includes a contingency funding plan to help management prepare for unforeseen liquidity restrictions, including hypothetical severe liquidity crises. Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, thereby impacting NII, the primary component of the Company’s earnings. Fluctuations in interest rates can also have an impact on liquidity. The ALCO uses an outside consultant to perform rate shock simulations to the Company’s net interest income, as well as a variety of other analyses. It is the ALCO’s function to provide the assumptions used in the modeling process. Assumptions used in prior period simulation models are regularly tested by comparing projected NII with actual NII. The ALCO utilizes the results of the simulation model to quantify the estimated exposure of NII and liquidity to sustained interest rate changes. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-earning assets and interest-bearing liabilities reflected on the Company’s balance sheet. The model also simulates the balance sheet’s sensitivity to a prolonged flat rate environment. All rate scenarios are simulated assuming a parallel shift of the yield curve; however further simulations are performed utilizing non-parallel changes in the yield curve. The results of this sensitivity analysis are compared to the ALCO policy limits which specify a maximum tolerance level for NII exposure over a 1-year horizon, assuming no balance sheet growth, given a 200 bp shift upward and a 100 bp shift downward in interest rates. Under the Company’s interest rate sensitivity modeling, with the continued asset sensitive balance sheet, in a rising rate environment NII is expected to trend upward as the short-term asset base (cash and adjustable rate loans) quickly cycle upward while the retail funding base (deposits) lags the market. If rates paid on deposits have to be increased more and/or more quickly than projected due to competitive pressures, the expected benefit to rising rates would be reduced. In a falling rate environment, NII is expected to trend slightly downward compared with the current rate environment scenario for the first year of the simulation as asset yield erosion is not fully offset by decreasing funding costs. Thereafter, net interest income is projected to experience sustained downward pressure as funding costs reach their assumed floors and asset yields continue to reprice into the lower rate environment. Management expects that the rising rate environment will have a positive impact to the Company’s NII in 2022. The following table summarizes the estimated impact on the Company’s NII over a twelve month period, assuming a gradual parallel shift of the yield curve beginning March 31, 2022: Rate Change Percent Change in NII Down 100 bps -1.2 % Up 200 bps 0.9 % The estimated amounts shown in the table are within the ALCO Policy limits. However, those amounts do not represent a forecast and should not be relied upon as indicative of future results. The ALCO model also provides alternate scenarios including a sustained flat, or inverted yield curve. While assumptions used in the ALCO process, including the interest rate simulation analyses, are developed based upon current economic and local market conditions, and expected future conditions, the Company cannot provide any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. As the market rates continue to increase, the impact of a falling rate environment is more pronounced, and the possibility more plausible than during the last several years of near zero short rates. 38 Table of Contents As of March 31, 2022, the Company had outstanding $12,887,000 in principal amount of Junior Subordinated Debentures due December 15, 2037, which bear a quarterly floating rate of interest equal to the 3-month London Interbank Offered Rate (LIBOR), plus 2.85%. During 2017, the Financial Conduct Authority (FCA) in the United Kingdom that administers LIBOR announced that LIBOR will be phased out, with an expected target date of December 31, 2021 for the phase out. On March 5, 2021, the FCA announced firm target dates for the phase out of various LIBOR settings, including a phase out date of June 30, 2023 for 3-month LIBOR for U.S. dollar deposits. Under the terms of the Indenture, if 3-month LIBOR is not available, the Trustee may obtain substitute quotations from four leading banks in the London interbank market for their offered rate to prime banks in the London market for U.S. dollar deposits having a three month maturity; if at least two such quotations are provided, the quarterly rate on the Debentures will be the arithmetic mean of such quotations. If fewer than two such quotations are received, the Trustee will request substitute quotations from four major New York City banks for their offered rate to leading European banks for loans in U.S. dollars; if at least two such quotations are provided, the quarterly rate on the Debentures will be the arithmetic mean of such quotations. The Debenture Trustee has not yet informed the Company as to how it intends to proceed. Aside from the Debentures, the Company does not have any other exposures to the phase out of LIBOR. The Company has not generally utilized LIBOR as an interest rate benchmark for its variable rate commercial, residential or other loans and does not utilize derivatives or other financial instruments tied to LIBOR for hedging or investment purposes. Accordingly, management expects that the Company’s exposure to the phase out of LIBOR will be limited to the effect on the interest rate paid on its Debentures, but cannot predict the magnitude of the impact on the Company’s interest expense at this time. 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 interests, loans to industry segments, and the geographic distribution of commercial real estate loans. Loans are reviewed periodically by an independent loan review firm to help ensure accuracy of the Company’s internal risk ratings and compliance with various internal policies, procedures and regulatory guidance. Residential mortgages represented 30.8% of the Company’s loan balances as of March 31, 2022, compared to 31.3% at December 31, 2021, a level that has historically been on a gradual annual decline in recent years, consistent with the Company’s strategic shift to commercial lending. The Company maintains a residential mortgage loan portfolio of traditional mortgage products and does not engage in higher risk loans such as option adjustable rate mortgage products, high loan-to-value products, interest only mortgages, subprime loans and products with deeply discounted teaser rates. Residential mortgages with loan-to-values exceeding 80% are generally covered by PMI. A 90% loan-to-value residential mortgage product without PMI is only available to borrowers with excellent credit and low debt-to-income ratios and has not been widely originated. As of March 31, 2022, junior lien home equity products made up 17.6% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%. The Company also originates some home equity loans greater than 80% under an insured loan program with stringent underwriting criteria. Consistent with the strategic focus on commercial lending, the commercial & industrial and CRE loan portfolios have seen solid growth over recent years. Commercial & industrial and CRE loans together comprised 68.7% of the Company’s loan portfolio at March 31, 2022, compared to 68.1% at December 31, 2021. Those percentages included the Company’s portfolio of PPP loans, which have been steadily decreasing, and totaled $5.1 million at March 31, 2022, compared to $12.2 million at December 31, 2021. Growth in the CRE portfolio in recent years has been principally driven by new loan volume in Chittenden County and northern Windsor County around the White River Junction, I91-I93 interchange area. Credits in the Chittenden County market are being managed by two commercial lenders out of the Company’s Burlington loan production office that know the area well , while Windsor County is being served by a commercial lender from the St. Johnsbury office with previous lending experience serving the greater White River Junction area. The Company has a loan production office in Lebanon, New Hampshire to provide a presence in the greater White River Junction area including Grafton County, New Hampshire. Larger transactions continue to be centrally underwritten and monitored through the Company’s commercial credit department. The types of CRE transactions driving the growth have been a mix of construction, land and development, multifamily, and other non-owner occupied CRE properties including hotels, retail, office, and industrial properties. The largest components of the $308.3 million CRE portfolio at March 31, 2022 were $105.6 million in owner-occupied CRE and $110.0 million in non-owner occupied CRE. Risk in the Company’s commercial & industrial and CRE loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the SBA and RD. At March 31, 2022, the Company had $36.8 million in guaranteed loans with guaranteed balances of $28.8 million, compared to $42.9 million in guaranteed loans with guaranteed balances of $35.4 million at December 31, 2021. PPP loans are included in these totals, all of which carry a 100% guarantee through the SBA, subject to borrower eligibility requirements. 39 Table of Contents The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure. Commercial & industrial and CRE loans are generally placed on non-accrual status when there is deterioration in the financial position of the borrower, payment in full of principal and interest is not expected, and/or principal or interest has been in default for 90 days or more. However, such a loan need not be placed on non-accrual status if it is both well secured and in the process of collection. Residential mortgages and home equity loans are considered for non-accrual status at 90 days past due and are evaluated on a case-by-case basis. The Company obtains current property appraisals or market value analyses and considers the cost to carry and sell collateral in order to assess the level of specific allocations required. Consumer loans are generally not placed in non-accrual but are charged off by the time they reach 120 days past due. When a loan is placed in non-accrual status, the Company reverses the accrued interest against current period income and discontinues the accrual of interest until the borrower clearly demonstrates the ability and intention to resume normal payments, typically demonstrated by regular timely payments for a period of not less than six months. Interest payments received on non-accrual or impaired loans are generally applied as a reduction of the loan book balance. The Company’s TDRs are principally a result of extending loan repayment terms to relieve cash flow difficulties. The Company has only infrequently reduced interest rates below the current market rate. The Company has not forgiven principal or reduced accrued interest within the terms of original restructurings. Management evaluates each TDR situation on its own merits and does not foreclose the granting of any particular type of concession. The Company’s TDRs that were past due 90 days or more or in non-accrual status as of the dates presented: March 31, 2022 December 31, 2021 Number of Principal Number of Principal Loans Balance Loans Balance Commercial & industrial 5 $ 58,448 6 $ 71,128 Commercial real estate 5 2,968,472 5 3,642,073 Residential real estate - 1st lien 13 1,239,113 12 977,961 Residential real estate - Jr lien 1 40,263 1 41,901 Total 24 $ 4,306,296 24 $ 4,733,063 The remaining TDRs were performing in accordance with their modified terms as of the dates presented and consisted of the following: March 31, 2022 December 31, 2021 Number of Principal Number of Principal Loans Balance Loans Balance Commercial real estate 1 $ 9,496 2 $ 41,228 Residential real estate - 1st lien 31 2,460,459 31 2,473,767 Residential real estate - Jr lien 1 3,213 1 3,537 Total 33 $ 2,473,168 34 $ 2,518,532 As of the balance sheet dates, the Company evaluates whether it is contractually committed to lend additional funds to debtors with impaired, non-accrual or modified loans. The Company is contractually committed to lend on one SBA guaranteed line of credit to a borrower whose lending relationship was previously restructured. ALL and provisions - The Company maintains an ALL at a level that management believes is appropriate to absorb losses inherent in the loan portfolio as of the measurement date (See Note 5 to the accompanying unaudited interim consolidated financial statements). Although the Company, in establishing the ALL, considers the inherent losses in individual loans and pools of loans, the ALL is a general reserve available to absorb all credit losses in the loan portfolio. No part of the ALL is segregated to absorb losses from any particular loan or segment of loans. When establishing the ALL each quarter, the Company applies a combination of historical loss factors to loan segments, including residential first and junior lien mortgages, CRE, commercial & industrial, and consumer loan portfolios, other than the municipal loans as there has never been a loss recorded in that loan segment. The Company applies numerous qualitative factors to each segment of the loan portfolio. Those factors include the levels of and trends in delinquencies and non-accrual loans, criticized and classified assets, volumes and terms of loans, and the impact of any loan policy changes. Experience, ability and depth of lending personnel, levels of policy and documentation exceptions, national and local economic trends, the competitive environment, and concentrations of credit are also factors considered. 40 Table of Contents Specific allocations to the ALL are made for certain impaired loans. Impaired loans include all troubled debt restructurings regardless of amount, and all loans to a borrower that in aggregate are greater than $100,000 and that are in non-accrual status. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including interest and principal, according to the contractual terms of the loan agreement. The Company reviews 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 following table summarizes the Company’s credit risk ratios for the balance sheet dates presented: March 31, December 31, 2022 2021 ALL to total loans outstanding 1.13 % 1.12 % ALL $ 7,890,648 $ 7,710,256 Loans outstanding $ 696,293,182 $ 689,988,533 Non-accruing loans to loans outstanding 0.78 % 0.86 % Non-accruing loans $ 5,414,963 $ 5,940,629 Loans outstanding $ 696,293,182 $ 689,988,533 ALL to non-accruing loans 145.72 % 129.79 % ALL $ 7,890,648 $ 7,710,256 Non-accruing loans $ 5,414,963 $ 5,940,629 The provision for loan losses for the first quarter ended March 31, 2022 was $862,500, compared to $267,497 for the same period in 2021. The $595,003 year over year increase was driven primarily by a write-down on a single non-performing loan, which is in foreclosure, totaling $667,474. The first quarter ALL analysis indicates that the reserve balance of $7.9 million at March 31, 2022 is sufficient to cover losses that are probable and estimable as of the measurement date, with an unallocated reserve of $90,276. Management believes the reserve balance continues to be directionally consistent with the overall risk profile of the Company’s loan portfolio and credit risk appetite. The portion of the ALL termed “unallocated” is established to absorb inherent losses that exist as of the measurement date although not specifically identified through management’s process for estimating credit losses. While the ALL is described as consisting of separate allocated portions, the entire ALL is available to support loan losses, regardless of category. Due to the charge off activity during the first quarter of 2022, the unallocated reserves are lower than historical levels. It is expected that the provision would be increased in future periods, if loan growth or additional charge-offs warrants an increase. The adequacy of the ALL is reviewed quarterly by the risk management committee of the Board and then presented to the full Board for approval. 41 Table of Contents Net charge-offs during the period to average loan outstanding were as follows: For the Three Months Ended March 31, 2022 2021 Commercial & industrial -0.01 % -0.01 % Net charge-off during the period $ (17,650 ) $ (14,086 ) Average amount outstanding $ 120,804,935 $ 177,158,060 Commercial real estate -0.22 % 0.00 % Net (charge-off) recovery during the period $ (667,474 ) $ 7,000 Average amount outstanding $ 304,057,825 $ 280,029,141 Municipal 0.00 % 0.00 % Net charge-off during the period $ 0 $ 0 Average amount outstanding $ 49,022,024 $ 52,232,117 Residential real estate - 1st lien 0.00 % 0.00 % Net recovery during the period $ 1,210 $ 1,567 Average amount outstanding $ 182,305,338 $ 170,036,028 Residential real estate - Jr lien 0.01 % 0.00 % Net recovery during the period $ 2,276 $ 528 Average amount outstanding $ 33,230,645 $ 37,317,509 Consumer -0.01 % -0.07 % Net charge-off during the period $ (470 ) $ (2,703 ) Average amount outstanding $ 3,580,266 $ 3,811,456 Total loans -0.10 % 0.00 % Net charge-off during the period $ (682,108 ) $ (7,694 ) Average amount outstanding $ 693,001,033 $ 720,584,311 In addition to credit risk in the Company’s loan portfolio and liquidity risk in its loan and deposit-taking operations, the Company’s business activities also generate market risk. Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Declining capital markets can result in fair value adjustments necessary to record decreases in the value of the investment portfolio for other-than-temporary-impairment. The Company does not have any market risk sensitive instruments acquired for trading purposes. The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. During recessionary periods, a declining housing market can result in an increase in loan loss reserves or ultimately an increase in foreclosures. Interest rate risk is directly related to the different maturities and repricing characteristics of interest-bearing assets and liabilities, as well as to loan prepayment risks, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes vary by product. As discussed above under “Interest Rate Risk and Asset and Liability Management”, the Company actively monitors and manages its interest rate risk through the ALCO process. COMMITMENTS, CONTINGENCIES AND OFF-BALANCE-SHEET ARRANGEMENTS The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and risk-sharing commitments on certain sold loans. Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. During the first three months of 2022, the Company did not engage in any activity that created any additional types of off-balance sheet risk. 42 Table of Contents LIQUIDITY AND CAPITAL RESOURCES Managing liquidity risk is essential to maintaining both depositor confidence and stability in earnings. Liquidity management refers to the ability of the Company to adequately cover fluctuations in assets and liabilities. Meeting loan demand (assets) and covering the withdrawal of deposit funds (liabilities) are two key components of the liquidity management process. The Company’s principal sources of funds are deposits, amortization and prepayment of loans and securities, maturities of investment securities, sales of loans available-for-sale, and earnings and funds provided from operations. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities, reduces the Company’s exposure to rollover risk on deposits and limits reliance on volatile short-term borrowed funds. Short-term funding needs arise from declines in deposits or other funding sources and from funding requirements for loan commitments. The Company’s strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds. The Company recognizes that, at times, when loan demand exceeds deposit growth or the Company has other liquidity demands, it may be desirable to utilize alternative sources of deposit funding to augment retail deposits and borrowings. One-way deposits acquired through the CDARS program provide an alternative funding source when needed. At March 31, 2022 and December 31, 2021, the Company had no one-way CDARS outstanding. In addition, two-way (reciprocal) CDARS deposits, as well as reciprocal ICS money market and demand deposits, allow the Company to provide FDIC deposit insurance to its customers in excess of account coverage limits by exchanging deposits with other participating FDIC-insured financial institutions. At March 31, 2022 and December 31, 2021, the Company reported $3.6 million in reciprocal CDARS deposits. The balance in ICS reciprocal money market deposits was $17.2 million at March 31, 2022, compared to $15.3 million at December 31, 2021, and the balance in ICS reciprocal demand deposits as of those dates was $64.6 million and $70.8 million, respectively. The Company had two blocks of DTC Brokered CDs totaling $2.3 million and $1.4 million with maturities in January, 2021 and April, 2021, respectively. These blocks were not replaced, leaving no DTC Brokered CDs outstanding at December 31, 2021 or March 31, 2022. Although wholesale deposit funding through DTC is an important supplemental source of liquidity that has proven efficient, flexible and cost-effective when compared with other borrowing methods, the growth in deposits during 2021 has reduced the Company’s need for supplementary funding sources in the near term. At March 31, 2022 and December 31, 2021, borrowing capacity of $95.3 million and $100.2 million, respectively, was available through the FHLBB, secured by the Company’s qualifying loan portfolio (generally, residential mortgage and commercial loans), reduced by outstanding advances and by collateral pledges securing FHLBB letters of credit collateralizing public unit deposits. The Company also has an unsecured Federal Funds credit line with the FHLBB with an available balance of $500,000 and no outstanding advances during any of the respective comparison periods. Interest is chargeable at a rate determined daily, approximately 25 bps higher than the rate paid on federal funds sold. The Company has a BIC arrangement with the FRBB secured by eligible commercial & industrial loans, CRE loans and home equity loans, resulting in an available credit line of $65.1 million and $52.3 million, respectively, at March 31, 2022 and December 31, 2021. Credit advances under this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 40 bps. The Company had no outstanding advances through this facility at March 31, 2022 or December 31, 2021. The following table reflects the Company’s outstanding FHLBB and FRBB advances against the respective lines as of the dates indicated: March 31, December 31, 2022 2021 Long-Term Advances(1) FHLBB term advance, 0.00%, due September 22, 2023 $ 200,000 $ 200,000 FHLBB term advance, 0.00%, due November 12, 2025 300,000 300,000 FHLBB term advance, 0.00%, due November 13, 2028 800,000 800,000 $ 1,300,000 $ 1,300,000 (1) All long-term advances are pursuant to the JNE program, through which the FHLBB provides a subsidy, funded by the FHLBB’s earnings, to write down interest rates to zero percent on advances that finance qualifying loans to small businesses. JNE advances must support small business in New England that create and/or retain jobs, or otherwise contribute to overall economic development activities. The Company has unsecured lines of credit with two correspondent banks with aggregate available borrowing capacity totaling $20.5 million as of the balance sheet dates presented in this quarterly report. The Company had no outstanding advances against these credit lines as of the balance sheet dates presented. 43 Table of Contents The following table illustrates the changes in shareholders’ equity from December 31, 2021 to March 31, 2022: Balance at December 31, 2021 (book value $15.48 per common share) $ 84,760,268 Net income 2,405,542 Issuance of common stock through the DRIP 272,683 Dividends declared on common stock (1,236,880 ) Dividends declared on preferred stock (12,188 ) Change in AOCI on AFS securities, net of tax (8,744,637 ) Balance at March 31, 2022 (book value $14.08 per common share) $ 77,444,788 The primary objective of the Company’s capital planning process is to balance appropriately the retention of capital to support operations and future growth, with the goal of providing shareholders an attractive return on their investment. To that end, management monitors capital retention and dividend policies on an ongoing basis. As described in more detail in Note 23 to the audited consolidated financial statements contained in the Company’s 2021 Annual Report on Form 10-K and under the caption “LIQUIDITY AND CAPITAL RESOURCES” in the MD&A section of that report, the Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies pursuant to which they must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. As of March 31, 2022, the Bank was considered well capitalized under the standard regulatory capital framework for Prompt Corrective Action and the Company exceeded currently applicable consolidated regulatory guidelines for capital adequacy. While we believe that the Company has sufficient capital to withstand an extended economic downturn in the wake of the COVID-19 pandemic, our regulatory capital ratios could be adversely impacted by future credit losses and other operational impacts related to COVID-19 or emerging variants of the virus. 44 Table of Contents The following table shows the Company’s actual capital ratios and those of its subsidiary, as well as currently applicable regulatory capital requirements, as of the dates indicated. Minimum Minimum Minimum For Capital To Be Well For Capital Adequacy Purposes Capitalized Under Adequacy with Conservation Prompt Corrective Actual Purposes: Buffer(1): Action Provisions(2): Amount Ratio Amount Ratio Amount Ratio Amount Ratio (Dollars in Thousands) March 31, 2022 Common equity tier 1 capital (to risk-weighted assets) Company $ 88,669 14.06 % $ 28,388 4.50 % $ 44,159 7.00 % N/A N/A Bank $ 88,070 13.97 % $ 28,369 4.50 % $ 44,129 7.00 % $ 40,977 6.50 % Tier 1 capital (to risk-weighted assets) Company $ 88,669 14.06 % $ 37,851 6.00 % $ 53,622 8.50 % N/A N/A Bank $ 88,070 13.97 % $ 37,825 6.00 % $ 53,585 8.50 % $ 50,433 8.00 % Total capital (to risk-weighted assets) Company $ 96,556 15.31 % $ 50,468 8.00 % $ 66,239 10.50 % N/A N/A Bank $ 95,952 15.22 % $ 50,433 8.00 % $ 66,194 10.50 % $ 63,042 10.00 % Tier 1 capital (to average assets) Company $ 88,669 8.88 % $ 39,952 4.00 % N/A N/A N/A N/A Bank $ 88,070 8.82 % $ 39,935 4.00 % N/A N/A $ 49,919 5.00 % December 31, 2021: Common equity tier 1 capital (to risk-weighted assets) Company $ 87,240 14.25 % $ 27,548 4.50 % $ 42,853 7.00 % N/A N/A Bank $ 86,654 14.17 % $ 27,522 4.50 % $ 42,812 7.00 % $ 39,754 6.50 % Tier 1 capital (to risk-weighted assets) Company $ 87,240 14.25 % $ 36,731 6.00 % $ 52,036 8.50 % N/A N/A Bank $ 86,654 14.17 % $ 36,696 6.00 % $ 51,986 8.50 % $ 48,928 8.00 % Total capital (to risk-weighted assets) Company $ 94,894 15.50 % $ 48,975 8.00 % $ 64,279 10.50 % N/A N/A Bank $ 94,301 15.42 % $ 48,928 8.00 % $ 64,218 10.50 % $ 61,160 10.00 % Tier 1 capital (to average assets) Company $ 87,240 8.79 % $ 39,719 4.00 % N/A N/A N/A N/A Bank $ 86,654 8.73 % $ 39,698 4.00 % N/A N/A $ 49,622 5.00 % (1) Conservation Buffer is calculated based on risk-weighted assets and does not apply to calculations of average assets. (2) Applicable to banks, but not bank holding companies. The Company’s ability to pay dividends to its shareholders is largely dependent on the Bank’s ability to pay dividends to the Company. In general, a national bank may not pay dividends that exceed net income for the current and preceding two years regardless of statutory restrictions, as a matter of regulatory policy, banks and bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, they remain adequately capitalized. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk Omitted, in accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 and 34-83550. 45 Table of Contents