Evans Bancorp - 10-Q quarterly report FY

 

(Mark One)

(Exact name of registrant as specified in its charter)

14 -16 North Main Street, Angola, New York 14006

(Address of principal executive offices)
(Zip Code)

(716) 926-2000

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed
since last report)

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

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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, $.50 par value 2,766,125 shares as of November 1, 2008

INDEX

EVANS BANCORP, INC. AND SUBSIDIARIES

PART I — FINANCIAL INFORMATION

ITEM I — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2008 AND DECEMBER 31, 2007
(in thousands, except share and per share amounts)

PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in thousands, except share and per share amounts)

PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in thousands, except share and per share amounts)

PART 1 — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in thousands, except share and per share amounts)

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PART I-FINANCIAL INFORMATION
ITEM I-FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in thousands)

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PART I-FINANCIAL INFORMATION
ITEM I-FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in thousands)

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PART 1 — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

8

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The common stock per share information is based upon the weighted average number of shares outstanding during each period, retroactively adjusted for stock dividends and stock splits. The Company’s potential dilutive securities included 2,698 and 2,664 dilutive shares for the three and nine month periods ended September 30, 2008, respectively. This compares with 305 and 705 for the three and nine month periods ended September 30, 2007, respectively.

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and not included in calculating diluted earnings per share. For the three and nine months periods ended September 30, 2008, there were approximately 109 thousand and 106 thousand shares, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive. For the three and nine months periods ended September 30, 2007, there were approximately 92 thousand and 74 thousand shares, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive.

The Company is comprised of two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three and nine month periods ended September 30, 2008 and 2007.

Three Months Ended
September 30, 2008
(in thousands)

Nine Months Ended
September 30, 2008
(in thousands)

Three Months Ended
September 30, 2007
(in thousands)

Nine Months Ended
September 30, 2007
(in thousands)

7. CONTINGENT LIABILITIES AND COMMITMENTS

The unaudited consolidated financial statements do not reflect various commitments and contingent liabilities, which arise in the normal course of business, and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities consist of commitments to extend

credit and standby letters of credit. A summary of the Bank’s commitments and contingent liabilities is as follows:

Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance of the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded on the Company’s unaudited consolidated balance sheets. Because these instruments have fixed maturity dates, and because they may expire without being drawn upon, they do not necessarily represent cash requirements of the Bank. The Bank has not incurred any losses on its commitments during the past two years.

Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The changes in the fair value of these commitments due to interest rate risk are not recorded on the consolidated balance sheets as the fair value of these derivatives are not considered material.

The Company is subject to possible litigation proceedings in the normal course of business. As of September 30, 2008, there were no claims pending against the Company that management considered to be material.

8. RECLASSIFICATIONS

Certain reclassifications have been made to the 2007 unaudited consolidated financial statements to conform with the presentation used in 2008.

9. NET PERIODIC BENEFIT COSTS

On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Company employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive the benefits already earned through January 31, 2008 at retirement, but will not be able to accrue any additional benefits. As a result, service cost will no longer be incurred.

The Bank used an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual experience and assumptions being different than those that are projected. The amortization method the Bank used recognized the prior service cost and net gains or losses over the average remaining service period of active employees. The freezing of the defined benefit pension plan was considered a curtailment. This resulted in the elimination of the unrecognized prior service cost and the unrecognized net loss. The elimination of those two components resulted in a $328 thousand gain in the first quarter of 2008.

The Bank also maintains a nonqualified supplemental executive retirement plan covering certain members of the Company’s senior management. The Bank uses an actuarial method of amortizing unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank uses recognizes the net gains or losses over the average remaining service period of active employees.

10. RECENT ACCOUNTING PRONOUNCEMENTS

FASB Staff Position No.157-3: Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. On October 10, 2008, FASB issued FSP No. 157-3 with the objective of clarifying the application of FASB Statement No. 157: Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. Effective immediately for the Company’s interim financial statements as of September 30, 2008, the implementation of FSP No. 157-3 did not have a material impact on our consolidated financial statements.

FASB Staff Position No. 133-1 and FIN 45-4: Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45. On September 12, 2008, FASB issued FAS 133-1 and FIN 45-4 with the objective of improving disclosures about credit derivatives by requiring more information about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives. It amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. The FSP also amends FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, to require an additional disclosure about the current status of the payment/performance risk of a guarantee. The provisions of the staff position that amends FAS 133 and FIN 45 are effective for reporting periods ending after November 15, 2008. The Company does not expect the staff position to have a material impact on its consolidated financial statements.

This Quarterly Report on Form 10-Q may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” and similar expressions identify such forward-looking statements. These forward-looking statements include statements regarding the Company’s business plans, prospects, growth and operating strategies, statements regarding the asset quality of the Company’s loan and investment portfolios, and estimates of the Company’s risks and future costs and benefits.

These forward-looking statements are based largely on the expectations of the Company’s management and are subject to a number of risks and uncertainties, including but not limited to general economic conditions, either

nationally or in the Company’s market areas, that are worse than expected; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company’s margins or reduce the fair value of financial instruments; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; and other factors discussed elsewhere in this Report on Form 10-Q, as well as in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”). Many of these factors are beyond the Company’s control and are difficult to predict.

Because of these and other uncertainties, the Company’s actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation, to publicly update or revise forward-looking information, whether as a result of new, updated information, future events or otherwise.

There have been historical disruptions in the financial system in recent weeks and many lenders and financial institutions have reduced or ceased to provided funding to borrowers, including other lending institutions. The availability of credit, confidence in the entire financial sector, and stability in financial markets have been adversely affected. Although the Company has not to date experienced any adverse effects, these disruptions are likely to have some impact on all institutions in the U.S. banking and financial industries.

In response to the financial crises affecting the overall banking system and financial markets, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. Under that act, the U.S. Treasury will have authority, among other things, to purchase up to $700 billion of mortgages, mortgage backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. As part of that program, the Department of the Treasury will purchase equity interests in a wide variety of eligible banks, thrifts and bank holding companies. Under this program, called the Troubled Asset Relief Program Capital Purchase Program (“TARP”), $250 billion of capital will be made available to U.S. financial institutions through the sale of preferred stock. The preferred stock would pay a 5% dividend for five years, which will increase to 9% after five years. In conjunction with its purchase of preferred stock, the Treasury will also receive warrants to purchase common stock with an aggregate market price equal to 15% of the amount invested in preferred stock. Participating institutions will be required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury continues to hold the institution’s equity under TARP.

Although both the Company and its subsidiary bank meet all applicable regulatory capital requirements and remain well capitalized, the Company will nonetheless evaluate the program to determine if participation would be advantageous for the Company and its common shareholders.

The actions described above, together with additional actions announced by the Treasury and other regulatory agencies continue to develop. It is not clear at this time what long term impact, EESA, TARP, other liquidity and funding initiatives of the Treasury and other bank regulatory agencies that have been previously announced, and any additional programs that may be initiated in the future will have on the financial markets and the financial services industry. The extreme levels of volatility and limited credit availability currently being experienced could continue to effect the U.S. banking

The Company’s Unaudited Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the Company’s Unaudited Consolidated Financial Statements and Notes. These estimates, assumptions and judgments are based on information available as of the date of the Unaudited Consolidated Financial

Statements. Accordingly, as this information changes, the Unaudited Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques. Refer to Note 3 in Item 1 of this report for further detail on fair value measurement.

Significant accounting policies followed by the Company are presented in Note 1 to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K. These policies, along with the disclosures presented in the other Notes to the Company’s Audited Consolidated Financial Statements contained in its Annual Report on Form 10-K and in this financial review, provide information on how significant assets and liabilities are valued in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses and valuation of goodwill to be the accounting areas that require the most subjective or complex judgments, and as such, could be most subject to revision as new information becomes available.

The allowance for loan and lease losses represents management’s estimate of probable losses in the Company’s loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the Unaudited Consolidated Balance Sheets. Note 1 to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K describes the methodology used to determine the allowance for loan and lease losses.

The amount of goodwill reflected in the Company’s Unaudited Consolidated Financial Statements is required to be tested by management for impairment on at least an annual basis. The test for impairment of goodwill on the identified reporting unit is considered a critical accounting estimate because it requires judgment on the part of management and the use of estimates related to the growth assumptions and market multiples used in the valuation model.

Total loans and leases grew to $384.5 at September 30, 2008, reflecting a $18.5 million or 5.1% increase from June 30, 2008 and a $60.4 million or 18.6% increase from December 31, 2007. Gross loans and leases are net of $10.9 million, $10.1 million and $9.7 million of unearned income on direct financing leases as of September 30, 2008, June 30, 2008 and December 31, 2007, respectively. Commercial loans and leases totaled $284.7 million at September 30, 2008, reflecting a $17.5 million or 6.6% increase from June 30, 2008 and a $56.3 million or 24.7% increase from December 31, 2007. Growth in commercial real estate loans of $9.3 million for the third fiscal quarter and $37.5 million for the year to date was largely responsible for the increase in commercial loans and leases from June 30, 2008 and December 31, 2007, respectively.

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The Company has no direct exposure to sub-prime lending, and as a result, the faltering sub-prime credit market has not affected the Company’s loan portfolio. Further, the local real estate market to date has not had the significant deterioration in values seen in high-growth parts of the United States as local real estate values have remained steady to slightly up. In contrast, some of the Bank’s larger competitors and the conduit markets are having capital adequacy and liquidity problems due to their exposure to sub-prime loans in their investment portfolio or lending activities in other parts of the United States. These problems have curtailed their lending activities somewhat and consequently created opportunities in the local commercial real estate market for smaller banks not experiencing the same issues such as the Bank. The increased opportunities have resulted in the Bank’s strong loan growth rates.

Direct finance leases increased $4.7 million or 9.2% from June 30, 2008 and $10.5 million or 23.3% from December 31, 2007. Direct finance leases are sold through a national channel of brokers with whom the Company has had long standing relationships and finance small commercial equipment. Direct leases carry a higher risk than the rest of the loan portfolio, but also provide a higher return. Management employs strict underwriting standards in selecting credits for this portion of the portfolio and has taken steps in an attempt to mitigate the leasing portfolio’s risk exposure in a potential economic recession. Actions taken to this effect include tightening credit standards, consolidating the broker network, and purchasing credit protection on certain leases late last year. The loan composition strategy is to maintain the direct lease portfolio at an optimum percentage of the loan portfolio that weights the risk involved in this type of credit.

Consumer loans totaled $98.9 million at September 30, 2008, reflecting a $1.0 million or 1.0% increase from June 30, 2008 and a $4.0 million or 4.2% increase from December 31, 2007. Real estate loans increased $0.3 million or 0.5% from June 30, 2008 and $1.6 million or 2.8% from December 31, 2007. While short-term interest rates have sharply decreased in 2008, long-term fixed rates have actually been gradually increasing. This, combined with the recent difficult and tumultuous economic environment, has put some downward pressure on the demand for consumer loans, resulting in lower growth rates in consumer loan balances.

The Bank continues to sell certain fixed rate residential mortgages originated below a designated interest rate level to the Federal National Mortgage Association (“FNMA”), while maintaining the servicing rights for those mortgages. During the three month period ended September 30, 2008, the Bank sold mortgages to FNMA totaling $0.4 million, as compared with $0.3 million during the three month period ended September 30, 2007. During the nine month period ended September 30, 2008, the Bank sold mortgages to FNMA totaling $1.8 million, as compared with $1.5 million during the nine month period ended September 30, 2007. At September 30, 2008, the Bank had a loan servicing portfolio principal balance of $27.7 million upon which it earns servicing fees, as compared with $28.1 million at June 30, 2008 and $28.4 million at December 31, 2007.

The following table presents selected information on the composition of the Company’s loan and lease portfolio in dollar amounts and in percentages as of the dates indicated.

Net loan and lease charge-offs were $550 thousand in the three month period ended September 30, 2008 as compared with $368 thousand in the second quarter of 2008 and $308 thousand in the three month period ended September 30, 2007. Net charge-offs were $1.3 million for the nine month period ended September 30, 2008, as compared with $841 thousand for the same period of 2007. The continued seasoning of the lease portfolio is responsible for the increase in net charge-offs. As has been the experience since the Company began originating small-ticket leases, the majority of charge-offs in the loan and lease portfolio have been leases. This is consistent with the risk/return nature of these credits in which the Company requires a higher rate of return. Management employs strict underwriting standards in selecting credits for this portion of the portfolio and has taken steps in an attempt to mitigate the leasing portfolio’s risk exposure in a potential economic recession. Actions taken to this effect include tightening credit standards and consolidation of the broker network.

Non-performing loans and leases, defined as accruing loans and leases greater than 90 days past due and non-accrual loans and leases, totaled 0.20% of total loans and leases outstanding at September 30, 2008 as compared with 0.12% at June 30, 2008 and 0.22% at December 31, 2007. The allowance for loan and lease losses totaled $5.1 million or 1.32% of total loans and leases outstanding at September 30, 2008 as compared with $5.1 million or 1.38% of total loans and leases outstanding as of June 30, 2008 and $4.6 million or 1.41% of total loans and leases at December 31, 2007.

The adequacy of the Company’s allowance for loan and lease losses is reviewed quarterly by the Company’s management with consideration given to loan and lease concentrations, charge-off history, delinquent loan and lease

percentages, and general economic conditions. Management believes the allowance for loan and lease losses is adequate for losses from existing loans and leases.

The following table sets forth information regarding non-performing loans and leases as of the dates specified.