Community Bancorp. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Community Bancorp., through Community National Bank, is a Vermont-based community banking organization serving northern Vermont and New Hampshire. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2020, with comparisons to the corresponding 2019 periods and December 31, 2019 balance-sheet data.
The reporting period was materially affected by COVID-19, the CARES Act Paycheck Protection Program (PPP), sharply lower interest rates, government stimulus payments and temporary borrower payment relief.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Total interest income | $8.1 million | $7.9 million | 2.3% increase |
| Interest expense | $1.1 million | $1.5 million | 30.4% decrease |
| Net interest income | $7.0 million | $6.4 million | 10.0% increase |
| Provision for loan losses | $362,499 | $412,499 | 12.1% decrease |
| Non-interest income | $1.9 million | $1.6 million | 21.5% increase |
| Non-interest expense | $5.1 million | $4.9 million | 5.0% increase |
| Net income | $2.9 million | $2.3 million | 27.3% increase |
| Earnings per common share | $0.54 | $0.43 | Increase |
| Net interest margin | 3.54% | 3.91% | Down 37 bps |
| Return on average assets | 1.36% | 1.28% | Increase |
| Return on average equity | 15.54% | 13.50% | Increase |
For the first nine months, net income was $7.6 million, or $1.43 per common share, compared with $6.5 million, or $1.23 per share, in 2019. Net interest income was $20.3 million versus $19.3 million; the provision for loan losses was $1.0 million versus $766,668; non-interest income was $5.1 million versus $4.4 million; and non-interest expense was $15.2 million versus $15.1 million. The nine-month net interest margin was 3.67%, compared with 3.98% in 2019.
Financial condition, liquidity and capital
- Total assets were $868.9 million, up 17.7% from $738.0 million at December 31, 2019.
- Total loans were $738.2 million, up 21.6%; net loans were $729.2 million. PPP loans totaled $100.3 million across 869 loans and were 100% guaranteed by the SBA.
- Total deposits were $743.0 million, up 20.8%, primarily from business checking, interest-bearing transaction, money market and savings account growth associated partly with PPP proceeds and government stimulus activity.
- Cash and cash equivalents were $51.5 million, compared with $48.6 million at year-end 2019. Nine-month operating cash flow was $8.9 million, while investing activities used $129.3 million, mainly because of net loan growth; financing activities provided $123.3 million, primarily through deposit growth.
- Borrowed funds were $2.8 million, repurchase agreements were $30.6 million and junior subordinated debentures were $12.9 million. The Company had no PPPLF advances.
- Available borrowing capacity included approximately $89.9 million through the FHLBB, $45.0 million through the Federal Reserve Bank borrowing arrangement and $21.5 million through correspondent-bank lines.
- Shareholders’ equity was $74.9 million, compared with $68.9 million at year-end, and book value per common share increased to $13.85 from $12.86.
- The Company and Bank exceeded applicable regulatory capital requirements. At September 30, 2020, the Bank’s common equity tier 1, total capital and Tier 1 leverage ratios were 13.72%, 14.97% and 8.98%, respectively, and the Bank was considered well capitalized.
Material changes versus prior periods
- Net income increased because lower funding costs, PPP processing-fee income and higher loan-sale activity more than offset lower asset yields and higher operating expenses.
- Interest expense declined following the Federal Reserve’s 150-basis-point reduction in short-term rates in March 2020. However, the average yield on interest-earning assets declined, and the Q3 net interest margin contracted 37 basis points.
- PPP SBA processing fees recognized were approximately $453,505 in Q3 and approximately $1.0 million year to date. The Company expects to earn approximately $3.6 million of related fees over the life of the PPP loans.
- Income from sold loans increased to $601,825 in Q3 and $1.1 million year to date, reflecting higher residential mortgage refinancing and home-purchase activity.
- Loan credit quality metrics were mixed. Non-performing assets declined to $5.4 million from $6.0 million at year-end, primarily because OREO was reduced to zero. Non-accrual loans increased to $4.6 million from $4.4 million, and loans past due 90 days or more and still accruing increased to $825,069 from $642,432.
- The allowance for loan losses increased to $6.8 million from $5.9 million. The nine-month provision increased 36.5% year over year, reflecting loan growth and additional qualitative factors related to COVID-19, municipal loans and certain purchased commercial loans.
- The Company granted qualifying COVID-19 short-term modifications to 435 borrowers involving approximately $110.5 million of principal. These modifications were generally not classified as troubled debt restructurings under applicable guidance.
- OREO declined from $966,738 at year-end to zero after the related properties were sold. Available-for-sale securities declined modestly to $45.2 million, while accumulated other comprehensive income increased to $1.0 million.
Outlook, commentary, risks and unusual items
Management stated that COVID-19 had a net positive effect on reported results in the short term because of lower funding costs, elevated mortgage activity and PPP fees, but expects longer-term effects could be adverse. The duration and economic consequences of the pandemic remained uncertain.
- Management expects future credit quality could deteriorate if unemployment, business restrictions or economic disruptions persist, potentially increasing delinquencies, non-accrual loans, charge-offs, provisions and capital pressure.
- Commercial and industrial loans and commercial real estate loans represented 64.8% of total loans excluding municipal and consumer categories, with significant exposure to sectors affected by COVID-19, including hotels and lodging, restaurants and bars, retail and breweries.
- The PPP portfolio creates compliance, documentation, SBA-guarantee and litigation risks. The SBA could deny or reduce guaranty coverage if loan origination, servicing or eligibility requirements were not satisfied.
- Management’s interest-rate modeling estimated a 0.5% increase in 12-month net interest income under a gradual 100-basis-point rate decline and a 3.5% increase under a gradual 200-basis-point increase. These scenarios are not forecasts.
- The $12.9 million of junior subordinated debentures bear interest at three-month LIBOR plus 2.85% and mature in 2037. LIBOR is expected to be phased out, creating uncertainty regarding the replacement benchmark and future interest costs.
- The Company had not adopted the CECL credit-loss model and did not intend to early adopt it. Adoption is expected to increase the allowance for credit losses and could reduce regulatory capital.
- The Board declared a quarterly common-stock dividend of $0.19 per share, payable November 1, 2020. Management reported no material litigation and concluded that disclosure controls were effective as of September 30, 2020.
Important facts for investors to verify
- Whether PPP borrowers receive forgiveness and whether any SBA guaranties are challenged, reduced or denied.
- The performance of the $110.5 million of COVID-19-modified loans after deferrals expire.
- Future trends in non-accrual loans, delinquencies, classified assets, charge-offs and the allowance for loan losses.
- The sustainability of PPP fee income, mortgage refinancing gains and unusually strong deposit growth.
- The effect of prolonged low interest rates on net interest margin, asset yields and funding costs.
- Exposure to commercial real estate, hospitality, restaurants, retail and other COVID-19-sensitive industries.
- The replacement benchmark and economic effect of the LIBOR phase-out on the junior subordinated debentures.
- The eventual impact of CECL adoption on earnings, allowance levels and regulatory capital ratios.