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Item 2. Management’s Discussion and Analysis

2023-05-12 compared with 2022-11-14 · 208 added, 270 removed, 328 unchanged (59% of the section changed)

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FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Period Ended September 30, 2022

Period Ended March 31, 2023

The following discussion analyzes the consolidated financial condition of Community Bancorp.

and its wholly-owned subsidiary, Community National Bank, as of September 30, 2022 and December 31, 2021, and its consolidated results of operations for the three- and nine-month interim periods and one year period presented.

and its wholly-owned subsidiary, Community National Bank, as of March 31, 2023 and December 31, 2022, 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.

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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.

Certain amounts presented below pertaining to the 2021 comparison periods have been reclassified to conform to current year presentation.

FORWARD-LOOKING STATEMENTS

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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;

Examples of forward looking statements included in this discussion include, but are not limited to, statements regarding 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.

credit risk expectations relating to the Company's loan portfolio and off-balance sheet commitments;

and management's general outlook for the future performance of the Company and 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.

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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;

the impact of inflation on the Company’s customers and on its financial results and performance;

the impact of inflation and slowing economic growth on the Company’s customers and on its financial results and performance;

changes in the United States monetary and fiscal policies, including the interest rate policies of the FRB and its regulation of the money supply;

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 applicable accounting policies, practices and standards;

the geographic concentration of the Company’s loan portfolio and deposit base;

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%;

reductions in deposit levels, which necessitate increased borrowings to fund loans and investments;

changes in the level of nonperforming assets and charge-offs;

reductions in deposit levels, which necessitate increased borrowings to fund loans and sale of investment securities;

increases in the level of nonperforming assets and charge-offs;

changes in federal or state tax laws or policy;

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;

regulatory responses to recent high profile bank failures increase our costs of operation, including through regulatory compliance changes and higher FDIC deposit insurance assessments to replenish the Bank Insurance Fund (BIF);

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;

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changes in consumer and business spending, borrowing and savings habits;

the continuing 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;

increased cybercrime and payment system risk due to increased usage by customers of online, mobile and other remote banking channels;

the ongoing challenges to find qualified workers to maintain a stable workforce;

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However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.

The Company’s consolidated assets on September 30, 2022 were $1,026,884,950 compared to $1,019,105,799 at December 31, 2021, an increase of 0.8%.

Significant changes in the asset base were due to an increase in net loans of $34.0 million, or 5.0%, and an increase in the available-for-sale investment portfolio of $4.9 million, or 2.7%, which was partially offset by a decrease of $36.5 million, or 33.0%, in cash and cash equivalents.

The Company’s consolidated assets on March 31, 2023 were $1.03 billion compared to $1.06 billion at December 31, 2022, a decrease of 2.4%.

Significant changes in the asset base were due to a decrease of $33.5 million, or 47.1%, in cash and cash equivalents, which was partially offset by an increase in net loans of $9.5 million, or 1.3%.

This demonstrates the Company’s efforts to deploy cash into higher earning assets.

The increase in the loan portfolio was primarily attributable to an increase of $20.0 million in commercial & industrial loans and $23.3 million in CRE loans, which was partially offset by an $11.1 million decrease in PPP loans and $7.8 million in municipal loan balances.

Total deposits on September 30, 2022 were $903,041,149 compared to $879,399,953 on December 31, 2021, an increase of $23.6 million, or 2.7%.

Savings accounts increased $11.5 million, or 6.8%, followed by money market funds with an increase of $7.9 million, or 6.1%.

Consolidated net income for the third quarter of 2022 decreased $88,696, or 2.4% to $3.6 million compared to $3.7 million in the third quarter of 2021.

Income for the first nine months of 2022 decreased $734,109 to $9.0 million compared to $9.7 million in the same period of 2021.

Year over year, a $3.2 million decrease in PPP loan processing fees from the SBA and an increase of $700,835 in provision for loan losses was partially offset by an increase of $1.4 million in interest income from the Company’s debt securities portfolio and an increase in interest income from loans totaling $1.58 million, which includes interest adjustments of approximately $286 thousand for loans coming out of non-accrual status.

Also contributing to the offset was a decrease of $74,979 in interest expense on savings and money market deposits, and a decrease of $226,062 in interest expense on time deposits.

These changes and other significant changes are discussed in the appropriate income sections of this MD&A.

Total interest income increased $221,392 or 2.4%, for the third quarter of 2022, compared to the same quarter in 2021, and increased $166,388, or 0.6%, 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.

Negatively impacting interest income for the three- and nine-month comparison periods was the amortization of the SBA PPP fees in the amount of $36,182 for the third quarter of 2022, compared to $1.6 million for the same quarter in 2021, and $469,929 for the first nine months of 2022, compared to $3.7 million for the same period in 2021.

Total interest expense increased $329,895, or 45.3%, for the third quarter of 2022, compared to the same quarter in 2021, and increased $153,139, or 6.5%, for the first nine months of 2022 compared to the same period in 2021.

The recent increases in the fed funds rate have put more pressure on deposit pricing, resulting in an increase in the Company’s money market and time deposit rates.

The increase in the loan portfolio was primarily attributable to an increase of $5.9 million in commercial & industrial loans, $5.23 million in CRE loans and $1.8 million in municipal loans, which was partially offset by a decrease of $1.9 million in residential junior lien loans and $0.8 million in purchased BHG loans.

Total deposits on March 31, 2023 were $888.5 million compared to $923.0 million on December 31, 2022, a decrease of $34.4 million, or 3.7% and an increase of $11.2 million, or 1.28%, compared to March 31, 2022.

Year to date, demand and interest-bearing transaction accounts decreased in total by $29.9 million or 5.9%, followed by a decrease of $7.6 million, or 5.4% in money market funds.

This was offset minimally by an increase of $3.6 million, or 3.6% in time deposits.

An increase of $5.0 million, or 15.1%, in repurchase agreements is also noted since year end and $9.3 million, or 32.4%, since March 31, 2022.

A decline in deposits in the first quarter is a normal occurrence for the Company primarily due to normal seasonal outflows.

Pricing pressures as depositors look for alternative products with higher interest rates in the current rate environment has resulted in deposit outflows as well.

Total interest income increased $2.5 million, or 30.5%, for the first three months of 2023 compared to the same period in 2022.

The increase in the loan portfolio, coupled with the increases in the fed funds rate throughout 2022 and in the first quarter of 2023 help to support the year over year increase in interest income.

Total interest expense increased $1.6 million, or 224.1%, for the first three months of 2023 compared to the same period in 2022.

The recent increases in the fed funds rate have put more pressure on competitive deposit pricing, resulting in an increase in the Company’s money market and time deposit rates.

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 third quarter of 2022 was $125,000 compared to $89,167 for the same quarter of 2021, resulting in an increase of $35,833, or 40.2%, between periods.

The provision for loan losses for the first nine months of 2022 was $1.3 million compared to $624,165 for the same period in 2021, resulting in an increase of $700,835, or 112.3%, 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, as well as increases to the reserve due to the increase in the commercial loan portfolios, both secured and unsecured.

Please refer to the ALL and provisions discussion in the Credit Risk section for more information.

Equity capital decreased to $69.5 million, with a book value per share of $12.56 as of September 30, 2022, compared to $84.8 million and a book value of $15.48 as of December 31, 2021.

This decrease in equity capital is directly related to the increase of unrealized losses in the investment portfolio, reflecting rising bond rates, which resulted in an increase of $21.4 million, 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 September 7, 2022, the Company's Board of Directors declared a quarterly cash dividend of $0.23 per common share, payable on November 1, 2022 to shareholders of record on October 15, 2022.

As of September 30, 2022, all of the Company’s capital ratios, and those of our subsidiary Bank, were in excess of applicable regulatory requirements.

The provision for credit losses for the quarter ended March 31, 2023 was determined under ASU No.

2016-13, Measurement of Credit Losses on Financial Instruments, commonly referenced as the Current Expected Credit Losses, or CECL, which the Company adopted effective January 1, 2023.

The provision for credit losses for the first three months of 2023 was $286,526 compared to $862,500 for the same period in 2022, a decrease of $575,974, or 66.8%.

This decrease 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 Note 5 of the unaudited consolidated financial statements as well as the ACL and provisions discussion in the Credit Risk section of this MD&A.

Consolidated net income for the first three months of 2023 increased $933,219 to $3.3 million compared to $2.4 million in the same period of 2022.

Year over year, a $2.5 million increase in interest income was offset in part by an increase of $1.6 million in interest expense, but a decrease of $575,974 in the provision for credit losses between periods resulted in an increase of $1.6 million in net interest income after provision for credit losses.

These changes, along with other significant changes in non-interest income and non-interest expense are discussed in the appropriate sections of this MD&A.

Equity capital increased to $79.7 million, with a book value per share of $14.33 as of March 31, 2023, compared to $75.2 million and a book value of $13.55 as of December 31, 2022.

This increase in equity capital is partially related to the decrease of unrealized losses in the investment portfolio of $2.7 million, net of tax, in accumulated other comprehensive loss in the shareholders’ equity portion of the balance sheet.

This position is considered by management as temporary and does not impact the Company’s regulatory capital ratios.

On March 15, 2023, the Company's Board of Directors declared a quarterly cash dividend of $0.23 per common share, payable on May 1, 2023 to shareholders of record on April 15, 2023.

As of March 31, 2023, 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, deteriorating economic conditions, or government monetary policy.

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The Company’s critical accounting policies govern:

OTTI of debt securities;

credit losses on debt securities;

valuation of residential MSRs;

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These policies are described in the Company’s 2022 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 nine months of 2022 in the Company’s critical accounting policies.

With the exception of the ACL policy, there were no material changes during the first three months of 2023 in the Company’s critical accounting policies.

ACL - Management believes that the calculation of the ACL is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements.

In estimating the ACL, management has adopted a methodology consistent with ASU No.

2016-13 that requires that expected credit losses for financial assets held at the reporting date that are accounted for at amortized cost be measured and recognized based on historical experience and current and reasonably supportable forecasted conditions to reflect the full amount of expected credit losses over the life of the loans at the measurement date.

Further consideration is given to qualitative factors, including changes in current economic indicators and their probable impact on borrowers and collateral, trends in delinquent and non-performing loans, trends in criticized and classified assets, levels of exceptions, the impact of competition in the market, concentrations of credit risk in a variety of areas, including portfolio product mix, the level of loans to individual borrowers and their related interests, loans to industry segments and the geographic distribution of CRE loans.

Management’s estimates used in calculating the ACL may increase or decrease based on changes in these factors, which in turn will affect the amount of the Company’s provision for credit losses charged against current period income.

This evaluation is inherently subjective and actual results could differ significantly from these estimates under different assumptions, judgments or conditions.

A modified version of these requirements applies to debt securities classified as available for sale, which eliminates OTTI impairment analysis and requires that if a decline in the fair value of debt securities AFS are deemed by management to be the result of credit losses rather than other factors, the credit losses on those securities will be recorded through an allowance for credit losses rather than a write-down of the security.

The Company’s securities portfolio is evaluated for impairment on a quarterly basis.

RESULTS OF OPERATIONS

Net income for the third quarter of 2022 was $3,610,506 or $0.66 per common share compared to $3,699,202 or $0.69 per common share for the same quarter of 2021.

Net income for the first nine months of 2022 was $9,037,200 or $1.67 per common share, compared to $9,771,309 or $1.82 per common share for the same period of 2021.

Core earnings (NII) for the third quarter of 2022 were $8.37 million compared to $8.48 million for the same quarter in 2021 and $23.77 million for the first nine months of 2022 compared to $23.76 million for the same period in 2021.

As noted in the Overview, the moderate changes in NII in both periods primarily reflect the decrease in the amortization of fees from administering PPP loans, which enhanced NII in 2021.

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 $1.1 million as of September 30, 2022.

As these loans are paid in full, the unamortized fees are taken into income, resulting in a decrease in income year over year.

Interest paid on deposits, which is the major component of total interest expense, increased $243,656, or 41.0% between the third quarter comparison periods and $44,737, or 2.3%, year over year, driven primarily by the increases in the fed funds rate during 2022.

The Company’s net income for the first three months of 2023 was $3.3 million or $0.61 per common share, compared to $2.4 million or $0.44 per common share for the same period of 2022.

Core earnings (NII) were $8.5 million for the first three months of 2023 compared to $7.6 million for the same period in 2022.

Interest and fees on loans, the major component of interest income, increased $1.9 million, or 25.2% for the first three months of 2023 compared to the same period in 2022.

Interest paid on deposits, which is the major component of total interest expense, increased $1.3 million, or 234.2%, year over year, driven primarily by the increases in the fed funds rate during 2022 and the first quarter of 2023.

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

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The following tables show these ratios annualized, as well as other equity ratios monitored by management, for the comparison periods presented.

Three Months Ended September 30,

Return on average assets

Return on average equity

Dividend payout ratio (1)

Average equity to average assets

Nine Months Ended September 30,

Three Months Ended March 31

Return on average assets

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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 $284,618 and $246,627 for the three months ended September 30, 2022 and 2021, respectively, and $777,314 and $759,855 for the nine months ended September 30, 2022 and 2021, respectively, was derived from loans to local municipalities of $40.2 million and $53.8 million, and tax-exempt municipal investments of $10.3 million and $0, at September 30, 2022 and 2021, respectively.

The Company’s tax-exempt interest income of $291,954 and $224,094 for the three months ended March 31, 2023 and 2022, respectively, was derived from loans to local municipalities of $36.5 million and $48.7 million, and tax-exempt municipal investments of $11.6 million and $4.3 million, at March 31, 2023 and 2022, respectively.

The following tables show the reconciliation between reported NII and tax equivalent NII for the comparison periods presented.

Three Months Ended September 30,

Net interest income as presented

Effect of tax-exempt income

Net interest income, tax equivalent

Nine Months Ended September 30,

Three Months Ended March 31,

Net interest income as presented

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Interest income (excluding interest on non-accrual loans) is expressed on a tax equivalent basis, both in dollars and as a yield/rate for the comparison periods presented.

Three Months Ended September 30,

Interest-Earning Assets

$ 717,692,703

$ 705,990,188

Taxable investment securities

Tax-exempt investment securities

Sweep and interest-earning accounts

Other investments (2)

$ 969,456,859

$ 879,464,364

Interest-Bearing Liabilities

Interest-bearing transaction accounts

$ 252,413,763

$ 217,633,391

Money market funds

Savings deposits

Time deposits

Borrowed funds

Repurchase agreements

Finance lease obligations

Junior subordinated debentures

$ 729,951,827

$ 660,361,589

Net interest income

Net interest spread (3)

Net interest margin (4)

Included in gross loans are non-accrual loans with average balances of $7,337,588 and $3,803,807 for the three months ended September 30, 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 $39,007,717 and $52,546,634 for the three months ended September 30, 2022 and 2021, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $712,800 and $769,000 for the three months ended September 30, 2022 and 2021, respectively, with a dividend rate of approximately 3.72% and 1.52%, respectively, per quarter.

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.

Net interest margin is net interest income divided by average earning assets.

Nine Months Ended September 30,

Interest-Earning Assets

Net interest income, net interest spread and net interest margin are also expressed on a tax equivalent basis.

Three Months Ended March 31,

Average Assets

Loans, net (1)

$ 746,342,447

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Other investments (2)

Total interest-earning assets

Cash and due from banks

Premises and equipment

$ 1,030,252,842

$ 1,006,411,597

Interest-Bearing Liabilities

Average Liabilities and Shareholders' Equity

Interest-bearing transaction accounts

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Junior subordinated debentures

Total interest-bearing liabilities

Noninterest bearing deposits

Other liabilities

Total liabilities

Shareholders' equity

Total liabilities and shareholders' equity

$ 1,030,252,842

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Net interest margin (4)

Included in gross loans are non-accrual loans with average balances of $5,375,840 and $3,945,577 for the nine months ended September 30, 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 $45,161,639 and $52,105,647 for the nine months ended September 30, 2022 and 2021, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $713,278 and $768,734, respectively, with a dividend rate of approximately 3.38% and 1.52%, respectively, for the nine months ended September 30, 2022 and 2021, respectively.

Included in net loans are non-accrual loans with average balances of $8,220,394 and $5,736,827 for the three months ended March 31 2023 and 2022, respectively.

Loans are stated net of unearned discount and ACL, and include loans held-for-sale and tax-exempt loans to local municipalities with average balances of $35,177,595 and $49,022,025 for the three months ended March 31 2023 and 2022, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $713,330 and $714,250, respectively, with a dividend rate of approximately 6.67% and 2.66%, respectively, for the three months ended March 31 2023 and 2022, respectively.

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.

Net interest margin is net interest income divided by average earning assets.

The average volume of interest-earning assets for the three- and nine-month periods ended September 30, 2022 increased 10.2% and 9.5%, respectively, compared to the same periods last year, while the average yield on interest-earning assets decreased 29 bps and 32 bps, respectively.

The average volume of loans increased 1.7% over the three-month comparison period and decreased 1.9% over the nine-month comparison period of 2022 versus 2021, while the average yield on loans decreased 42 bp and 23 bps, respectively.

The $286 thousand in income for loans coming out of non-accrual status, discussed in the Overview, translates to an increase of five bps in the nine-month comparison period for 2022.

Loans accounted for 74.0% and 73.1%, respectively, of the average interest-earning asset portfolio for the three- and nine-month periods ended September 30, 2022 compared to 80.3% and 81.6%, respectively, for the same periods last year.

Interest earned on the loan portfolio as a percentage of total interest income was 86.7% and 88.7%, respectively for the three- and nine-month periods in 2022 compared to 95.3% and 95.5%, respectively for the same periods in 2021.

The average volume of the taxable investment portfolio (classified as AFS) increased 100.0% and 112.6% during the three- and nine-month periods ended September 30, 2022, compared to the same periods last year, and the average yield increased 33 bps and 23 bps, respectively, between periods.

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- and nine-month periods ended September 30, 2022 was $9.1 million and $5.6 million, respectively, with a tax equivalent yield of 3.75% and 3.39%, respectively.

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 27.5% and 7.7%, respectively, for the three- and nine-month comparison periods ended September 30, 2022 compared to the same period in 2021.

The decrease in average volume is attributable to the funding of investment and loan growth.

The average yield on these funds increased 198 bps and 72 bps for the three- and nine-month periods ended September 30, 2022 versus the same periods in 2021.

The average volume of interest-bearing liabilities for the three- and nine-month periods ended September 30, 2022 increased 10.7% in both periods, compared to the same periods in 2021, while the average rate paid on interest-bearing liabilities increased 14 bps and decreased two bps, respectively.

The average volume of interest-bearing transaction accounts increased 16.0% and 18.9%, respectively for the three- and nine-month periods ended September 30, 2022 compared to the same periods of 2021.

The average rate paid on these accounts increased 36 bps and 14 bps, respectively, between comparison periods.

The average volume of money market accounts increased 9.3% and 6.8%, respectively for the three- and nine-month periods ended September 30, 2022 compared to the same periods of 2021, while the average rate paid on these deposits increased 10 bps and decreased six bps, respectively.

The average volume of savings accounts increased 8.5% and 14.0%, respectively, for the three- and nine-month periods ended September 30, 2022 compared to the same periods in 2021, while the average rate paid on these accounts decreased four bps in both comparison periods.

The average volume of time deposits decreased 1.2% and 2.6%, respectively, for the three- and nine-month periods ended September 30, 2022 compared to the same periods in 2021, and the average rate paid decreased 13 bps and 25 bps, respectively.

Interest paid on time deposits as a percentage of total interest expense was 21.7% and 27.9%, respectively, for the three and nine-month periods ended September 30, 2022, compared to 36.7% and 39.3%, respectively, for the same comparison periods in 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 September 30, 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.

The average volume of interest-earning assets for the three-month period ended March 31, 2023 increased 2.8% compared to the same period last year, while the average yield on interest-earning assets increased 96 bps.

The average volume of loans increased 8.9% over the three-month comparison period of 2023 versus 2022, and the average yield on loans increased 66 bps.

Loans accounted for 76.8% of the average interest-earning asset portfolio for the three-month period ended March 31, 2023 compared to 72.5% for the same period last year.

Interest earned on the loan portfolio as a percentage of total interest income was 86.9% for the first three months of 2023 compared to 90.8% for the same period in 2022.

The average volume of the taxable investment portfolio (classified as AFS) decreased 2.2% during the three-month period ended March 31, 2023, compared to the same period last year, and the average yield increased 68 bps between periods.

The average volume of the tax-exempt investment portfolio (classified as AFS) increased $9.2 million, or 5.0% for the three-month period ended March 31, 2023 and the tax equivalent yield increased 154 bps between periods.

The Company began investing in these tax-exempt bonds during December 2021, and currently carries an average volume of $11.5 million as of March 31, 2023.

The average volume of sweep and interest-earning accounts, which consists primarily of an interest-bearing account at the FRBB, decreased 56.3% for the three-month comparison period ended March 31, 2023 compared to the same period in 2022.

The decrease in average volume is attributable to the funding of investments in 2022 and loan growth throughout 2022 and into 2023.

The average yield on these funds increased 391 bps for the three-month period ended March 31, 2023 versus the same period in 2022.

The average volume of interest-bearing liabilities for the three-month period ended March 31, 2023 increased 3.8%, compared to the same period in 2022, and the average rate paid on interest-bearing liabilities increased 84 bps.

The average volume of interest-bearing transaction accounts increased 8.2% for the three-month period ended March 31, 2023 compared to the same period of 2022 and the average rate paid on these accounts increased 115 bps between comparison periods.

Interest paid on interest-bearing transaction accounts as a percentage of total interest expense was 42.9% for the three-month period ended March 31, 2023, compared to 23.1% for the same comparison period in 2022.

The average volume of money market accounts increased 3.7% for the three-month period ended March 31, 2023 compared to the same period of 2022, and the average rate paid on these deposits increased 114 bps.

The average volume of savings accounts decreased 1.1% for the three-month period ended March 31, 2023 compared to the same period in 2022, while the average rate paid on these accounts increased two bps year over year.

The average volume of time deposits decreased 4.1% for the three-month period ended March 31, 2023 compared to the same period in 2022, while the average rate paid increased 41 bps.

Historically, the average volume of time deposits included brokered deposits, which provided an alternate source of funding, but as the Company’s retail deposits increased over the last two years, the need for these funds diminished.

Management still considers the brokered deposit market to be a beneficial source of funding in appropriate circumstances 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 43.5% and 45.3% for the three- and nine-month periods ended September 30, 2022 compared to the same periods in 2021 and, for all periods, consisted of only JNE funds at zero percent interest.

The average volume of repurchase agreements increased 41.3% and 2.5%, respectively, for the three- and nine-month periods ended September 30, 2022 compared to the same periods in 2021 and the average rate paid increased 26 bps and six bps, respectively, between comparison periods.

In summary, between the three- and nine-month periods ended September 30, 2022 and 2021, the average yield on interest-earning assets decreased 29 bps and 32 bps, respectively, and the average rate paid on interest-bearing liabilities increased 14 bps and decreased two bps, respectively.

Net interest spread decreased 43 bps and 30 bps for the three- and nine-month periods of 2022 versus 2021 and net interest margin decreased 40 and 31 bps, respectively, between periods.

The average volume of borrowed funds increased 23.8% for the three-month period ended March 31, 2023 compared to the same period in 2022.

In 2022, borrowed funds consisted of only JNE funds at zero percent interest, however, during the first three months of 2023, as the Company’s balance at FRBB decreased, the need for overnight borrowings increased for a short period of time in February.

The average volume of repurchase agreements increased 25.3% for the three-month period ended March 31, 2023 compared to the same period in 2022 and the average rate paid increased 118 bps between comparison periods.

In summary, between the three-month periods ended March 31, 2023 and 2022, the average yield on interest-earning assets increased 96 bps and the average rate paid on interest-bearing liabilities increased 84 bps.

Net interest spread increased 12 bps for the first three months of 2023 versus 2022 and net interest margin increased 32 bps between periods, reflecting the rising interest rate environment.

The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the interim periods presented for 2023 and 2022 resulting from volume changes in daily average assets and daily average liabilities and fluctuations in average rates earned and paid.

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31

Average Interest-Earning Assets

$ (1,189,407 )

$ (1,645,141 )

Taxable investment securities

22 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

Income from sold loans

3 unchanged sentences

Total non-interest income

Total non-interest income decreased $168,983, or 9.9% for the third quarter of 2022 and $189,023, or 3.8%, for the first nine months of 2022 compared to the same periods 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 overdraft charges of $31,752, or 39.9%, between the third quarter comparison periods and $162,459, or 27.8%, year over year.

The decrease in income from sold loans is due in part to a lower volume of loans sold into the secondary market during the first nine months of 2022 versus 2021, as well as lower points and premiums on these loans in 2022.

An increase in CRE loan volume in 2022 resulted in a significant increase in documentation fees collected at origination as well as commercial rate lock fees collected accounting for the increase in other income from loans when comparing both comparison 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 2022, reflecting general stock market conditions.

Included in Other miscellaneous income for 2022 is income totaling $23,400 associated with a renegotiated contract with the Company’s check printing vendor, helping to offset decreases in other components of this category.

Total non-interest income increased $72,348, or 4.3%, for the first three months of 2023 compared to the same period in 2022, with significant changes noted in the following:

The decrease in income from sold loans is due primarily to a lower volume of loans sold into the secondary market during the first three months of 2023 versus 2022, as the rising interest rate environment has adversely affected residential mortgage lending activity.

An increase in CRE loan volume in 2023 resulted in a significant increase in documentation fees collected at origination as well as commercial rate lock fees collected, accounting for the increase in other income from loans for the first three months of 2023 versus 2022.

Income from CFS Partners increased between periods due in part to the late rebound of market prices during the latter part of the first quarter of 2023.

CFS Partners has a small portion of its equity capital invested in the stock market, and as a result is sensitive to general stock market conditions.

Included in other miscellaneous income for 2022 is a one-time payment totaling $23,400 associated with a renegotiated contract with the Company’s check printing vendor, accounting for a portion of the decrease for the first three months of 2023 versus 2022.

Non-interest Expense

1 unchanged sentence

Three Months Ended

Nine Months Ended

September 30,

Salaries and wages

3 unchanged sentences

Service contracts - administrative

Directors fees

FDIC insurance

Collection & non-accruing loan expense

Electronic banking expense

State deposit tax

1 unchanged sentence

Total non-interest expense

Total non-interest expense decreased $190,948, or 3.5% for the third quarter of 2022 and increased $62,657, or 0.4%, for the first nine months of 2022 compared to the same periods in 2021, with significant changes noted in the following:

The increase in salaries and wages in the nine month comparison period is due to normal salary increases.

The decrease in employee benefits was attributable to a decrease in health insurance claims year over year under the Company’s self-funded health insurance plan.

The decrease in occupancy expenses is primarily attributable to a write down of $63,125 at maturity of a capital lease during the third quarter of 2021.

The increase in service contracts - administrative is due to a combination of an increase in pricing for contracts that are based on asset size and inflationary adjustment factors that are higher than historical increase adjustments.

The increase in directors’ fees is attributable to a change to the Director’s fee schedule as well as an additional Director for 2022.

The increase in audit fees reflects increased audit services due to the Company surpassing the $1.0 billion asset size.

FDIC insurance decreased for the third quarter due to a decrease in the assessment multiplier, while the modest increase year over year is due primarily to an increase in assets.

Collection & non-accruing loan expense is lower in both periods due to the recoupment of expenses associated with properties 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.

The increase in electronic banking expense is attributable to a new mobile banking platform which includes security enhancements and other technical upgrades.

State deposit tax increased year over year due primarily to the increase in deposits throughout 2021.

Total non-interest expense increased $426,114, or 7.8% for the first three months of 2023 compared to the same period in 2022, with significant changes noted in the following:

In addition to normal salary increases, the increase in salaries and wages year over year is attributable to new hires in the area of commercial lending as well as the hiring of a new Executive Officer during the last quarter of 2022.

Also contributing to the increase was a one-time salary adjustment in November of 2022 of $2,000 to all employees below vice president status that impacted the year over year comparison by $57,500.

The increase in service contracts - administrative is due to a combination of an increase in pricing for contracts that transaction based and inflationary adjustment factors that are higher than historical increase adjustments.

The increase in audit fees reflects increased audit services due to additional audit requirements required by FDICIA due to the Company surpassing $1.0 billion asset size.

The Company increased the 2023 monthly accrual for FDIC insurance in anticipation of an increase in the assessment multiplier, as announced by the FDIC in late 2022.

Collection & non-accruing loan expense is lower year over year due to a decrease of expenses associated with properties in the Company’s non-accruing loan portfolio.

ATM fees are based on increased customer activity as well as annual contractual price adjustments.

State deposit tax increased year over year due primarily to the increase in deposits.

The calculation is based on an average of month-end deposit totals over a 12 month period.

APPLICABLE INCOME TAXES

The provision for income taxes decreased $33,675, or 3.9%, for the third quarter of 2022 compared to the same quarter in 2021, and decreased $205,157, or 9.2%, for the first nine months of 2022 compared to the same period in 2021 and is proportional to the decrease in income before income taxes totaling $122,371 for the third quarter of 2022 versus 2021 and $939,266 year over year.

Tax credits related to limited partnership investments amounted to $99,958 and $117,015, respectively, for the third quarter of 2022 and 2021, and $292,437 and $351,045, respectively, for the first nine months of 2022 and 2021.

Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $67,353 and $90,762, respectively, for the third quarters of 2022 and 2021, and $201,537 and $272,286, respectively, for the first nine months of 2022 and 2021.

The provision for income taxes increased $254,124, or 48.6%, for the first three months of 2023 compared to the same period in 2022 and is proportional to the increase in income before income taxes totaling $1.2 million.

Tax credits related to limited partnership investments amounted to $67,128 and $96,237, respectively, for the first three months of 2023 and 2022.

Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $67,128 and $67,092, respectively, for the first three months of 2023 and 2022.

These investments provide tax benefits, including tax credits, and are designed to provide a targeted effective annual yield between 7% and 10%.

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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:

September 30, 2022

March 31, 2023

December 31, 2022

9 unchanged sentences

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

Volume Change

AFS securities

Demand deposits

(15,782,440 )

Interest-bearing transaction accounts

(14,072,666 )

Money market funds

1 unchanged sentence

Time deposits

The increase in the loan portfolio during the first nine months of 2022 was attributable to increases totaling $43.3 million in commercial & industrial and CRE loans, which was partially offset by payoffs of certain PPP loans through SBA’s forgiveness program totaling $11.1 million and maturities of certain municipal loans totaling $7.8 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 maturities within the municipal loan portfolio are cyclical, generally occurring on June 30.

As a result of competition from area financial institutions, the Company lost the bids on renewal of a portion of the matured municipal loans.

The increase in the securities AFS portfolio is attributable to the purchase of $47.5 million in securities AFS during the first nine months of 2022, consisting of $9.1 million in US treasury securities, $10.9 million in tax-exempt municipal bonds, $1.6 million in ABS, $7.4 million in CMO, and $18.5 million in MBS.

These purchases were reduced in part by maturities and calls exercised amounting to $3.0 million, as well as principal payments on various portfolios totaling $12.0 million, and by an increase of $27.1 million in unrealized losses arising during the first nine months of 2022, which is reflected in OCI.

The increase in the loan portfolio during the first three months of 2023 was attributable to increases totaling $13.0 million in commercial & industrial CRE and municipal loans, which was partially offset by decreases of $0.8 million in purchased BHG loans, $1.9 million in residential junior lien loans and $0.6 million in consumer loans.

The Company has experienced strong loan activity among its commercial customers, but only minimal consumer loan activity.

There were no securities AFS purchased during the first three months of 2023.

The change in the securities AFS portfolio is attributable to maturities amounting to $0.6 million, as well as principal payments on various securities totaling $3.1 million.

These changes were almost totally offset by a decrease of $3.4 million in unrealized losses arising during the first three months of 2023, which is 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.

The increase in interest-bearing transaction accounts consists of an increase of $11.7 million, or 9.9%, in consumer interest-bearing transaction accounts, which includes Health Savings Accounts and the deposit account of the Company’s trust and asset management affiliate, CFSG.

This was partially offset by a decrease of $3.2 million, or 7.6%, in municipal deposit accounts and a decrease of $4.1 million, or 5.8% in the ICS deposit accounts.

The increase in savings deposits of $11.5 million, or 6.8%, 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.

The decrease in the demand deposit accounts was entirely made up of business DDAs.

The decrease in interest-bearing transaction accounts consists of a decrease of $13.1 million, or 10.6%, in consumer interest-bearing transaction accounts, a decrease of $11.6 million, or 28.8%, in municipal deposit accounts and a decrease of $11.0 million, or 12.9% in ICS deposit accounts.

These decreases were partially offset by a combined increase of $21.6 million, or 48.7% in health savings accounts and the deposit account of the Company’s trust and asset management affiliate, CFSG.

The decrease in money market funds was driven by decreases of $6.5 million, or 21.9% in ICS accounts and $4.6 million, or 4.5% in retail money market funds.

These decreases were partially offset by an increase in municipal accounts of $3.5 million or 39.6%.

The increase in time deposits is attributable to customer response to periodic certificate of deposit specials that have been offered.

CERTAIN TIME DEPOSITS

Increments of maturity of time CDs of $250,000 or more outstanding on March 31, 2023 are summarized as follows:

3 months or less

Over 3 through 6 months

Over 6 through 12 months

Over 12 months

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.

17 unchanged sentences

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.

Under the Company’s interest rate sensitivity modeling, with the continued asset sensitive balance sheet, in a rising rate environment NII initially trends 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.

1 unchanged sentence

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 current rising rate environment will have a positive impact to the Company’s NII for the remainder of 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 September 30, 2022:

Percent Change in NII

The current rising rate environment has had a positive impact to the Company’s NII however market expectations for higher deposit rates are applying increasing pressure to the spread between interest income and interest expense.

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, 2023:

Percent Change

The estimated amounts shown in the table above are within the ALCO Policy limits.

3 unchanged sentences

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-term rates.

As of September 30, 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%.

As of March 31, 2023, 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%.

As previously announced by the Financial Conduct Authority in the United Kingdom, the entity that administers LIBOR, 3-month LIBOR for U.S.

1 unchanged sentence

The Indenture governing the terms of the Company’s Debentures contains detailed fallback provisions in the event 3-month LIBOR is not available, empowering the Trustee to obtain substitute quotations from other leading banks.

However, under the federal Adjustable Interest Rate (LIBOR) Act enacted in March 2022 (the “LIBOR Act”), fallback provisions like those in the Company’s Indenture that are based on a “determining person” (such as an indenture trustee) obtaining quotations of interbank lending or deposit rates are deemed “ineffective” and will be replaced as a matter of law, without need to amend contract documents, with a benchmark interest rate that will be identified in final regulations to be promulgated by the Federal Reserve.

The Federal Reserve has issued proposed regulations and has indicated that it will issue final regulations prior to the June 30, 2023 LIBOR phase out date.

As required under the LIBOR Act, any Federal Reserve-identified benchmark rate specified in the final regulations will be based on the Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York and will include an appropriate “tenor spread adjustment” to reflect historical spreads between LIBOR and SOFR.

The replacement rate for ineffective fallback provisions will take effect on the first London banking day after June 30, 2023.

The Indenture Trustee has indicated informally that it views the fallback provisions in the Indenture as ineffective under the LIBOR Act, and that it intends to provide written guidance on the transition from LIBOR prior to June 30, 2023, following the Federal Reserve’s adoption of final regulations.

However, under the federal Adjustable Interest Rate (LIBOR) Act enacted in March 2022 (the “LIBOR Act”), fallback provisions like those in the Company’s Indenture that are based on a “determining person” (such as an indenture trustee) obtaining quotations of interbank lending or deposit rates are deemed “ineffective” and will be replaced as a matter of law, without need to amend contract documents, with a benchmark interest rate identified in regulations promulgated by the Federal Reserve.

As required under the LIBOR Act, the Federal Reserve-identified benchmark rates specified in the final regulations for various tenors of LIBOR are based on the Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York and each includes an appropriate “tenor spread adjustment” to reflect historical spreads between LIBOR and SOFR.

The replacement benchmark rate for ineffective fallback provisions will take effect on the first London banking day after June 30, 2023, (the “LIBOR Replacement Date”).

The Indenture Trustee has informed the Company that it views the fallback provisions in the Indenture as ineffective under the LIBOR Act, and that, absent either an amendment to the Indenture and related Debenture documents to adopt a new interest rate or a change in applicable law, effective on and after the LIBOR Replacement Date, 3-month LIBOR will be replaced by 3-month CME SOFR, as adjusted by a spread adjustment factor of 0.26161 percent, in accordance with the LIBOR Act and FRB regulations.

The Company does not intend to seek an amendment of the Indenture or other Debenture documents.

Accordingly, as of the LIBOR Replacement Date, the Debentures will bear interest at a quarterly floating rate equal to 3-month CME SOFR, as adjusted by a spread adjustment of 0.26161 percent, plus 2.85%.

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 with certainty the magnitude of the impact on the Company’s interest expense at this time.

Accordingly, management expects that the Company’s exposure to the phase out of LIBOR will be limited to the effect on the interest rate paid on its Debentures.

Credit Risk - As a financial institution, one of the primary risks the Company manages is credit risk, the risk of loss stemming from borrowers’ failure to repay loans or inability to meet other contractual obligations.

4 unchanged sentences

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 31.3% of the Company’s loan balances as of September 30, 2022 and December 31, 2021.

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 mortgage loans represented 30.4% of the Company’s loan balances at March 31, 2023, compared to 31.2% at December 31, 2022.

The Company maintains a residential mortgage loan portfolio of traditional mortgage products and does not offer higher risk loan products, 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-value ratios 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 September 30, 2022, junior lien home equity products made up 14.9% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%.

As of March 31, 2023, junior lien home equity products made up 13.8% 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 67.1% of the Company’s loan portfolio at September 30, 2022, compared to 68.1% at December 31, 2021.

Those percentages included the Company’s portfolio of PPP loans, which has been steadily decreasing, and totaled $1.1 million at September 30, 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 who 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 $324.3 million CRE portfolio at September 30, 2022 were $102.4 million in owner-occupied CRE and $124.9 million in non-owner occupied CRE.

Commercial & industrial, purchased, CRE and municipal loans collectively comprised 69.1% of the Company’s loan portfolio at March 31, 2023, compared to 68.4% at December 31, 2022.

The largest components of the CRE portfolio were $99.4 million in owner-occupied CRE and $139.0 million in non-owner occupied CRE at March 31, 2023.

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 September 30, 2022, the Company had $31.9 million in guaranteed loans with guaranteed balances of $23.8 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.

At March 31, 2023, the Company had $26.2 million in guaranteed loans with guaranteed balances of $17.0 million, compared to $27.0 million in guaranteed loans with guaranteed balances of $18.3 million at December 31, 2022.

PPP loans with outstanding balances of $116,299 and $199,664 at March 31, 2023 and December 31, 2022, respectively, are included in these totals, all of which carry a 100% guarantee through the SBA, subject to borrower eligibility requirements.

The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure.

6 unchanged sentences

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 following table shows the Company’s TDRs that were past due 90 days or more or in non-accrual status as of the balance sheet dates:

September 30, 2022

December 31, 2021

Commercial & industrial

Commercial real estate

Residential real estate - 1st lien

Residential real estate - Jr lien

The remaining TDRs were performing in accordance with their modified terms as of the balance sheet dates and consisted of the following:

September 30, 2022

December 31, 2021

Commercial real estate

Residential real estate - 1st lien

Residential real estate - Jr lien

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 most loan segments, including residential first and junior lien mortgages, CRE, commercial & industrial, and consumer loan portfolios, but excluding the municipal loan and purchased loan portfolios as there has never been a loss recorded in either of those loan segments.

The Company applies numerous qualitative factors to each segment of the loan portfolio.

Those factors include the levels of and trends in delinquencies and non-accrual loans, criticized and classified assets, volumes and terms of loans, and the impact of any loan policy changes.

Experience, ability and depth of lending personnel, levels of policy and documentation exceptions, national and local economic trends, the competitive environment, and concentrations of credit are also factors considered.

Specific allocations to the ALL are made for certain impaired loans.

Impaired loans include all troubled debt restructurings regardless of amount, and all loans to a borrower that in aggregate are greater than $100,000 and that are in non-accrual status.

A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including interest and principal, according to the contractual terms of the loan agreement.

The Company 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.

Provision for Credit Losses

The provision for credit losses was made up of the following components for the periods indicated:

Three Months Ended

Provision for credit losses on loans

Provision for credit losses on OBS credit exposure

Provision for credit losses

ACL and provisions – As stated in Note 2 of the accompanying notes to the Company’s unaudited interim consolidated financial statements, effective January 1, 2023, the Company was required to recognize credit losses under the guidance of ASU No.

2016-13, Financial Instruments—Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments , The new guidance, which is referred to as the current expected credit loss, or CECL model, requires that expected credit losses for financial assets held at the reporting date that are accounted for at amortized cost be measured and recognized based on historical experience and current and reasonably supportable forecasted conditions to reflect the full amount of expected credit losses over the life of the loans.

The adjustment from the adoption of CECL amounted to $549,113, net of tax and was recorded as an adjustment to retained earnings and will affect calculation of regulatory capital ratios.

Changes in forecasts used in the model could produce different results, quarter to quarter.

The Company’s board of directors has approved an ACL policy that provides guidance in maintaining an adequate methodology for establishing, estimating and maintaining allowances for credit losses under ASC 326.

The policy creates a measurement model to establish a proper ACL based on current expected credit losses rather than incurred losses.

The Company maintains an ACL 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 ACL, considers the inherent losses in individual loans and pools of loans, the ACL is a general reserve available to absorb all credit losses in the loan portfolio.

No part of the ACL is segregated to absorb losses from any particular loan or segment of loans.

When establishing the ACL each quarter, the Company applies a combination of significant key assumptions and methodologies, as discussed in the ACL section under Critical Accounting Policies in this MD&A, and also presented in Note 5 of the accompanying unaudited interim consolidated financial statements.

The following table summarizes the Company’s credit risk ratios for the balance sheet dates presented:

September 30,

ALL to total loans outstanding

ACL to total loans outstanding

Loans outstanding

6 unchanged sentences

$ 748,548,608

ALL to non-accruing loans

ACL to non-accruing loans

Non-accruing loans

The provision for loan losses for the nine months ended September 30, 2022 was $1.3 million, compared to $624,165 for the same period in 2021.

The $700,835 year over year increase was driven in part by an increase in the commercial loan volume as well as a write-down totaling $667,474, on a single non-performing loan, currently in foreclosure.

The increase of $2.7 million in non-accruing loans is attributable to one business relationship, which the Company is monitoring closely.

The third quarter ALL analysis indicates that the reserve balance of $8.4 million at September 30, 2022 is sufficient to cover losses that are probable and estimable as of the measurement date, with an unallocated reserve of $258,555.

The provision for credit losses for the three months ended March 31, 2023 was $286,526, compared to $862,500 for the same period in 2022.

The $575,974 year over year decrease was driven in part by a write-down totaling $667,474, on a single non-performing loan, in March of 2022.

The first quarter ACL analysis indicates that the reserve balance of $9.3 million at March 31, 2023 is sufficient to cover expected credit losses that are probable and estimable as of the measurement date.

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.

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.

As stated in Note 2 of the accompanying notes to the Company’s unaudited interim consolidated financial statements, effective January 1, 2023, the Company will be required to recognize credit losses under the guidance of ASU No.

2016-13, Financial Instruments—Credit Losses (Topic 326):

Any adjustments from the adoption of CECL will be recorded as an adjustment to retained earnings and will affect calculation of regulatory capital ratios.

Based on a parallel calculation as of September 30, 2022 the required adjustment would have an immaterial impact to retained earnings and regulatory capital.

Changes in forecasts used in the model could produce different results, quarter to quarter, including as of the January 1, 2023 effective date for the transition to CECL.

Net charge-offs during the periods presented to average loan outstanding were as follows:

For the Nine Months Ended September 30,

Net charge-offs during the period to average loan outstanding:

While the ACL is described as consisting of separate allocated portions, the entire ACL is available to support loan losses, regardless of category.

The adequacy of the ACL is presented to the full Board for approval quarterly.

Net recoveries (charge-offs) during the periods presented to average loans outstanding were as follows:

For the Three Months Ended March 31

Commercial & industrial

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$ 111,436,341

Purchased loans

Net charge-offs during the period

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Commercial real estate

Net (charge-offs) recoveries during the period

Net recoveries (charge-offs) during the period

Average amount outstanding

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Average amount outstanding

Net charge-offs during the period

Net recoveries (charge-offs) during the period

Average amount outstanding

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$ 693,001,033

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.

In addition to credit risk in the Company’s loan and investment portfolios and its off-balance sheet commitments, 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.

Declining capital markets and changes in interest rates can result in fair value adjustments to asset valuations or the need to create a related reserve or allowance.

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.

The Company’s market risk arises primarily from interest rate risk inherent in its lending, deposit taking and investment activities.

During recessionary periods, a declining housing market can result in an increase in loan loss reserves or ultimately an increase in foreclosures.

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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 nine months of 2022, the Company did not engage in any activity that created any additional types of off-balance sheet risk.

During the first three months of 2023, the Company did not engage in any activity that created any additional types of off-balance sheet risk.

With the adoption of ASU 2016-13 (CECL), the Company is required to establish an allowance for expected credit losses on OBS credit exposures.

Expected credit losses are estimated by management over the contractual period during which the Company is exposed to credit risk under a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company.

The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life.

Upon adoption of ASU 2016-13, the Company recorded an adjustment to retained earnings of $451,704 to reflect an allowance for credit losses for unfunded commitments.

The allowance for credit losses for OBS credit exposures is presented in the "Accrued interest and other liabilities" line of the consolidated balance sheets.

There were no changes to the allowance for credit losses for OBS credit exposures during the three months ended March 31, 2023.

LIQUIDITY AND CAPITAL RESOURCES

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One-way deposits acquired through the CDARS program provide an alternative funding source when needed.

At September 30, 2022 and December 31, 2021, the Company had no one-way CDARS outstanding.

At March 31, 2023 and December 31, 2022, 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, enhance the Company’s ability to retain larger deposit balances by allowing the Company to provide FDIC deposit insurance to its customers in excess of account coverage limits through the exchange of deposits with other participating FDIC-insured financial institutions.

At September 30, 2022 and December 31, 2021, the Company reported $3.1 million and $3.6 million, respectively, in reciprocal CDARS deposits.

The balance in ICS reciprocal money market deposits was $15.6 million at September 30, 2022, compared to $15.3 million at December 31, 2021, and the balance in ICS reciprocal demand deposits as of those dates was $66.7 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 the balance sheet dates presented in this quarterly report.

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 and 2022 has reduced the Company’s need for supplementary funding sources in the near term.

At September 30, 2022 and December 31, 2021, borrowing capacity of $112.8 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.

At March 31, 2023 and December 31, 2022, the Company reported $2.8 million in reciprocal CDARS deposits.

The balance in ICS reciprocal money market deposits was $23.0 million at March 31, 2023, compared to $29.5 million at December 31, 2022, and the balance in ICS reciprocal demand deposits as of those dates was $74.3 million and $85.3 million, respectively.

At March 31, 2023 and December 31, 2022, borrowing capacity of $110.3 million and $112.3 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 $62.6 million and $52.3 million, respectively, at September 30, 2022 and December 31, 2021.

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 $52.8 million and $56.1 million, respectively, at March 31, 2023 and December 31, 2022.

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 500 bps.

The Company had no outstanding advances through this facility at September 30, 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:

September 30,

The Company had no outstanding advances through this facility at March 31, 2023 or December 31, 2022.

As of March 31, 2023, the Company had additional potential borrowing capacity, subject to pledging of required collateral, under the FRB’s Term Funding Program, which was established in March 2023 to provide banks with an additional source of liquidity.

The Company did not have any advances under the Term Funding Program at March 31, 2023.

The following table reflects the Company’s outstanding advances under the FHLBB’s JNE program as of the dates indicated:

Long-Term Advances(1)

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FHLBB term advance, 0.00%, due November 13, 2028

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.

(1) Under the JNE program, 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.

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The Company had no outstanding advances against these credit lines as of the balance sheet dates presented.

The following table illustrates the changes in shareholders' equity from December 31, 2021 to September 30, 2022:

Management believes that the combination of high levels of potentially liquid assets, unencumbered securities, cash flows from operations, and additional borrowing capacity are sufficient to meet the Company’s liquidity and capital needs.

The following table illustrates the changes in shareholders' equity from December 31, 2022 to March 31, 2023:

Balance at December 31, 2022 (book value $13.55 per common share)

Cumulative change in accounting principle (Note 2)

Issuance of common stock through the DRIP

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Change in AOCI on AFS securities, net of tax

(21,392,376 )

Balance at September 30, 2022 (book value $12.56 per common share)

Balance at March 31 2023 (book value $14.33 per common share)

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.

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Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

As of September 30, 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.

As of March 31, 2023, 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, our regulatory capital ratios could be adversely impacted by future credit losses and other operational impacts of deteriorating economic conditions and inflation.

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.

The calculations as of March 31, 2023 reflect adoption of ASU 2016-13 (CECL), including the beginning period cumulative effect adjustment of $549,113, which reduced retained earnings.

Adequacy Purposes

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(Dollars in Thousands)

September 30, 2022

March 31, 2023

Common equity tier 1 capital

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(2) Applicable to banks, but not bank holding companies.

Reflects recalculation of the Company’s previously reported common equity tier I capital ratio.

The previously reported calculation for December 31, 2021 and prior annual and interim periods incorrectly included the Company’s outstanding preferred stock and trust preferred securities in the equity component of the calculation.

The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company.

5 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis