Business Context and Reporting Period
Community Bancorp., headquartered in Derby, Vermont, is the holding company for Community National Bank. The unaudited Form 10-Q covers the quarter and nine months ended September 30, 2022, with comparisons to the respective 2021 periods and to December 31, 2021. The company is a smaller reporting company and non-accelerated filer.
Financial Condition and Performance
| Metric | Q3 2022 | Q3 2021 | Change |
|---|
| Total interest income | $9.4 million | $9.2 million | Up 2.4% |
| Net interest income | $8.4 million | $8.5 million | Down 1.3% |
| Provision for loan losses | $125,000 | $89,167 | Up 40.2% |
| Non-interest income | $1.5 million | $1.7 million | Down 9.9% |
| Non-interest expense | $5.3 million | $5.5 million | Down 3.5% |
| Net income | $3.6 million | $3.7 million | Down 2.4% |
| Earnings per common share | $0.66 | $0.69 | Down $0.03 |
| Net interest margin | 3.46% | 3.86% | Down 40 bps |
| Return on average assets | 1.41% | 1.54% | Down 13 bps |
| Return on average equity | 19.06% | 17.87% | Up 119 bps |
| Metric | Nine months 2022 | Nine months 2021 | Change |
|---|
| Net interest income | $23.8 million | $23.8 million | Essentially flat |
| Provision for loan losses | $1.3 million | $624,165 | Up $700,835 |
| Non-interest income | $4.9 million | $5.0 million | Down 3.8% |
| Non-interest expense | $16.2 million | $16.2 million | Up 0.4% |
| Net income | $9.0 million | $9.8 million | Down 7.5% |
| Earnings per common share | $1.67 | $1.82 | Down $0.15 |
| Net interest margin | 3.33% | 3.64% | Down 31 bps |
- Total assets were $1.027 billion at September 30, 2022, up 0.8% from year-end 2021.
- Total loans were $724.2 million, up 5.0%; net loans were $716.2 million. Commercial and industrial loans increased by approximately $20.0 million and commercial real estate loans by approximately $23.3 million.
- Available-for-sale securities were $187.2 million, up 2.7%. The portfolio had $28.6 million of unrealized losses, primarily attributable to higher interest rates rather than issuer credit deterioration.
- Deposits were $903.0 million, up 2.7% from December 31, 2021, led by increases in savings and money-market balances.
- Cash and cash equivalents declined to $73.9 million from $110.4 million, reflecting deployment into loans and securities. Nine-month operating cash flow was $10.9 million, while investing activities used $67.6 million and financing activities provided $20.2 million.
- Total debt and similar funding included $1.3 million of borrowed funds, $32.3 million of repurchase agreements and $12.9 million of junior subordinated debentures. Available borrowing capacity included $112.8 million through the FHLBB, $62.6 million through the Federal Reserve Bank of Boston borrowing arrangement and $20.5 million through correspondent-bank lines.
- Shareholders’ equity declined to $69.5 million from $84.8 million. Accumulated other comprehensive loss increased to $22.6 million, primarily from after-tax unrealized losses on available-for-sale securities. Book value per common share fell to $12.56 from $15.48.
- Management stated that the company and bank exceeded applicable regulatory capital requirements. The bank’s September 30, 2022 ratios included 13.80% common equity tier 1, 13.80% tier 1 risk-based, 15.05% total risk-based and 9.08% tier 1 leverage.
- The common dividend increased to $0.23 per share for the quarter, payable November 1, 2022.
Material Changes Versus Prior Comparable Period
- Profitability weakened despite higher total interest income. Rising deposit and funding costs, lower loan yields and lower non-interest income reduced earnings.
- Net interest margin contracted because average asset yields declined while rates paid on certain deposits and other liabilities increased. Management reported that recent Federal Reserve rate increases were putting pressure on deposit pricing.
- PPP-related fee income largely ran off: the PPP portfolio declined to approximately $1.1 million at September 30, 2022, from $12.2 million at December 31, 2021 and $92.6 million in February 2021. This reduced a prior source of net interest income.
- The nine-month provision for loan losses more than doubled, driven principally by a $667,474 write-down on a single non-performing commercial real estate loan and growth in commercial lending.
- Non-accruing loans increased to $8.6 million, or 1.19% of loans, from $5.9 million, or 0.86%, at year-end 2021. Management attributed approximately $2.7 million of the increase to one business relationship under close monitoring.
- Net charge-offs were $603,170 for the first nine months of 2022 versus $13,343 in the prior-year period. The allowance for loan losses increased to $8.4 million, equal to 1.16% of loans, from $7.7 million, or 1.12%.
- Comprehensive loss was $3.5 million in the third quarter and $12.4 million for the first nine months, despite positive net income, because of securities-market losses recognized in accumulated other comprehensive income.
Outlook, Risks, Contingencies and Unusual Items
- No formal earnings or revenue guidance was provided. Management expects the rising-rate environment to have a positive effect on net interest income for the remainder of 2022 because the balance sheet is asset-sensitive, but higher-than-expected deposit repricing could reduce that benefit. The filing’s interest-rate model estimated a 0.1% increase in 12-month net interest income under a 200-basis-point increase and a 1.2% decrease under a 100-basis-point decline; these are scenarios, not forecasts.
- CECL accounting becomes effective January 1, 2023. Based on a September 30, 2022 parallel calculation, management expected an immaterial effect on retained earnings and regulatory capital, although updated forecasts could produce a different transition adjustment.
- The company’s $12.9 million of junior subordinated debentures use three-month LIBOR plus 2.85% and mature in 2037. LIBOR is scheduled to cease after June 30, 2023. The company expects limited exposure beyond these debentures but cannot yet quantify the effect on interest expense.
- Key credit risks include commercial real estate and commercial lending concentrations, higher non-accrual loans, potential deterioration from inflation or recession, and possible additional losses associated with a portfolio of 322 COVID-related modified loans totaling $89.6 million. None were in deferral status at September 30, 2022, but management noted elevated future default risk.
- Other disclosed risks include deposit outflows, interest-rate volatility, geographic concentration in northern New England, cybersecurity and operational risks, competition, labor availability, changing regulation and the continuing effects of COVID-19.
- Management does not expect ordinary-course litigation to be material. No new types of off-balance-sheet risk were created during the first nine months; commitments include lending commitments, standby letters of credit and risk-sharing commitments on certain sold loans.
- Disclosure controls were judged effective, and the filing reported no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the increase in non-accrual loans, including the relationship cited by management, results in additional charge-offs or provisions.
- The ultimate credit impact of the commercial real estate portfolio and the single loan written down by $667,474.
- The January 1, 2023 CECL transition adjustment and its effect on capital ratios.
- Deposit pricing, deposit retention and the resulting effect on net interest margin as interest rates continue to change.
- The magnitude of the securities portfolio’s unrealized losses and whether any losses become realized or are considered other-than-temporary.
- The replacement benchmark and eventual interest cost for the LIBOR-linked junior subordinated debentures.
- Future performance of the 322 remaining COVID-related modified loans with aggregate principal balances of $89.6 million.
- Availability and terms of the company’s secured and unsecured liquidity facilities if loan growth continues or deposits decline.
