Table of Contents
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended March 31, 2023
¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to ______
Commission file number 001-35021
EVANS BANCORP, INC.
(Exact name of registrant as specified in its charter)
New York 16-1332767
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6460 Main St. Williamsville, NY 14221
(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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.50 par value
EVBN
NYSE American
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x
Smaller reporting company x
Emerging growth company ¨
If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
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, 5,462,763 shares as of April 28, 2023.
INDEX
EVANS BANCORP, INC. AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION
PAGE
Item 1.
Financial Statements
Unaudited Consolidated Balance Sheets – March 31, 2023 and December 31, 2022
1
Unaudited Consolidated Statements of Income – Three months ended March 31, 2023 and 2022
2
Unaudited Consolidated Statements of Comprehensive (Loss) Income – Three months ended March 31, 2023 and 2022
3
Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Three months ended March 31, 2023 and 2022
4
Unaudited Consolidated Statements of Cash Flows – Three months ended March 31, 2023 and 2022
5
Notes to Unaudited Consolidated Financial Statements
7
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
27
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
34
Item 4.
Controls and Procedures
35
PART II. OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
36
Defaults Upon Senior Securities
37
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
Signatures
38
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
UNAUDITED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2023 AND DECEMBER 31, 2022
(in thousands, except share and per share amounts)
March 31,
December 31,
2023
2022
ASSETS
Cash and due from banks
$
12,272
16,796
Interest-bearing deposits at banks
3,832
6,258
Securities:
Available for sale, at fair value and net of valuation allowance
365,929
364,326
(amortized cost: $424,935 at March 31, 2023; $428,216 at December 31, 2022)
Held to maturity, at amortized cost and net of valuation allowance
3,707
6,949
(fair value: $3,613 at March 31, 2023; $6,809 at December 31, 2022)
Federal Home Loan Bank common stock, at cost
5,364
10,437
Federal Reserve Bank common stock, at cost
3,080
3,074
Loans, net of allowance for credit losses of $21,523 at March 31, 2023
and $19,438 at December 31, 2022
1,637,053
1,652,931
Properties and equipment, net of accumulated depreciation of $11,482 at March 31, 2023
and $11,596 at December 31, 2022
16,520
16,999
Goodwill
12,702
Intangible assets
1,127
1,227
Bank-owned life insurance
42,050
41,826
Operating lease right-of-use asset
4,537
4,392
Other assets
40,097
40,593
TOTAL ASSETS
2,148,270
2,178,510
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand
483,958
493,710
NOW
268,283
273,359
Savings
807,532
801,943
Time
290,141
202,667
Total deposits
1,849,914
1,771,679
Securities sold under agreement to repurchase
9,264
7,147
Other borrowings
79,637
193,001
Operating lease liability
4,856
4,723
Other liabilities
15,247
16,892
Subordinated debt
31,101
31,075
Total liabilities
1,990,019
2,024,517
STOCKHOLDERS' EQUITY:
Common stock, $0.50 par value, 10,000,000 shares authorized; 5,564,449 and 5,544,339 shares issued at
March 31, 2023 and December 31, 2022, respectively, and 5,462,763 and 5,437,048 shares outstanding at
March 31, 2023 and December 31, 2022, respectively.
2,787
2,775
Capital surplus
81,210
81,031
Treasury stock, at cost, 101,686 and 107,291 shares at March 31, 2023 and
December 31, 2022, respectively
(3,656)
(3,891)
Retained earnings
123,533
123,356
Accumulated other comprehensive income (loss), net of tax
(45,623)
(49,278)
Total stockholders' equity
158,251
153,993
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
See Notes to Unaudited Consolidated Financial Statements
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2023 AND 2022
Three Months Ended March 31,
INTEREST INCOME
Loans
20,886
15,724
96
70
Taxable
2,294
1,677
Non-taxable
89
46
Total interest income
23,365
17,517
INTEREST EXPENSE
Deposits
4,015
568
1,499
47
526
401
Total interest expense
6,040
1,016
NET INTEREST INCOME
17,325
16,501
PROVISION FOR CREDIT LOSSES
(654)
221
NET INTEREST INCOME AFTER
17,979
16,280
NON-INTEREST INCOME
Deposit service charges
613
692
Insurance service and fees
2,429
2,299
224
154
Interchange fee income
493
492
Other
354
794
Total non-interest income
4,113
4,431
NON-INTEREST EXPENSE
Salaries and employee benefits
9,413
9,470
Occupancy
1,173
1,180
Advertising and public relations
156
179
Professional services
883
872
Technology and communications
1,356
1,174
Amortization of intangibles
100
FDIC insurance
350
270
1,071
1,215
Total non-interest expense
14,502
14,460
INCOME BEFORE INCOME TAXES
7,590
6,251
INCOME TAX PROVISION
1,790
1,503
NET INCOME
5,800
4,748
Net income per common share-basic
1.07
0.86
Net income per common share-diluted
1.06
Weighted average number of common shares outstanding
5,444,352
5,494,782
Weighted average number of diluted shares outstanding
5,475,790
5,547,548
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gain (loss) on available-for-sale securities:
3,635
(16,705)
Defined benefit pension plans:
Amortization of prior service cost
-
Amortization of actuarial loss
20
50
Total
55
3,655
(16,650)
COMPREHENSIVE INCOME (LOSS)
9,455
(11,902)
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Accumulated
Common
Capital
Retained
Comprehensive
Treasury
Stock
Surplus
Earnings
Loss
Balance, December 31, 2021
2,744
78,795
108,024
(5,671)
183,892
Net Income
Other comprehensive loss
Cash dividends ($0.62 per common share)
(3,406)
Stock compensation expense
333
Issued 18,244 restricted shares, net of forfeitures
9
(9)
Issued 18,831 shares in stock option exercises
277
286
Balance, March 31, 2022
2,762
79,396
109,366
(22,321)
169,203
Balance, December 31, 2022
Cumulative effect of change in accounting principle— credit losses
(2,026)
Beginning balance after cumulative effect adjustment
121,330
151,967
Other comprehensive income
Cash dividends ($0.66 per common share)
(3,597)
306
Reissued 6,228 restricted shares
(235)
235
Issued 12,421 shares in stock option exercises
6
114
120
Issued 12,671 restricted shares, net of forfeitures
(6)
Balance, March 31, 2023
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
OPERATING ACTIVITIES:
Interest received
23,428
17,088
Fees received
5,640
5,142
Interest paid
(5,409)
(1,094)
Cash paid to employees and vendors
(18,409)
(18,781)
Income taxes paid
(4,967)
(1,200)
Proceeds from sale of loans held for sale
4,828
2,957
Originations of loans held for sale
(4,800)
(2,815)
Net cash provided by operating activities
311
1,297
INVESTING ACTIVITIES:
Available for sales securities:
Purchases
(109,990)
Proceeds from sales, maturities, calls, and payments
8,400
7,726
Held to maturity securities:
(309)
(412)
Proceeds from maturities, calls, and payments
3,551
560
Additions to properties and equipment
(364)
(226)
Proceeds from sales of assets
370
Net decrease (increase) in loans
13,898
(31,622)
Net cash used in investing activities
25,546
(133,964)
FINANCING ACTIVITIES:
Repayments from long-term borrowings, net
(8,685)
(5,888)
(Repayments) proceeds from short-term borrowings, net
(102,484)
2,364
Net increase in deposits
78,242
49,795
Issuance of common stock
Net cash (used in) provided by financing activities
(32,807)
46,557
Net (decrease) increase in cash and cash equivalents
(6,950)
(86,110)
CASH AND CASH EQUIVALENTS:
Beginning of period
23,054
244,785
End of period
16,104
158,675
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization
387
497
Deferred tax expense
252
262
Provision for credit losses
Loss on sales of assets
31
Gain on loans sold
(26)
(43)
Changes in assets and liabilities affecting cash flow:
(7,199)
303
1,386
(5,166)
NET CASH PROVIDED BY OPERATING ACTIVITIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTH PERIOD ENDED MARCH 31, 2023 AND 2022
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies followed by Evans Bancorp, Inc. (the “Company”), a financial holding company, and its two direct, wholly-owned subsidiaries: (i) Evans Bank, National Association (the “Bank”), and the Bank’s subsidiaries, Evans National Leasing, Inc. (“ENL”), and Evans National Holding Corp. (“ENHC”); and (ii) Evans National Financial Services, LLC (“ENFS”), and ENFS’s subsidiary, The Evans Agency, LLC (“TEA”), and TEA’s subsidiary ENB Associates Inc. (“ENBA”), in the preparation of the accompanying interim unaudited consolidated financial statements conform with U.S. generally accepted accounting principles (“GAAP”) and with general practice within the industries in which it operates. Except as the context otherwise requires, the Company and its direct and indirect subsidiaries are collectively referred to in this report as the “Company.”
The Financial Accounting Standards Board (“FASB”) establishes changes to GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB.
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments which requires an allowance for credit losses be deducted from the amortized cost basis of financial assets to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset considering relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. In estimating expected losses in the loan portfolio, borrower-specific financial data and macro-economic assumptions are utilized to project losses over a reasonable and supportable forecast period. Assumptions and judgment are applied to measure amounts and timing of expected future cash flows, collateral values and other factors used to determine the borrowers’ abilities to repay obligations. Subsequent to the forecast period, the Company utilizes longer-term historical loss experience to estimate losses over the remaining contractual life of the loans. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for the accounting policy for determining the Allowance for Credit Losses.
Prior to January 1, 2023, the allowance for credit losses represented the amount that in management’s judgment reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. Based on portfolio composition, then current economic conditions, and reasonable and supportable forecasts of future conditions, the Company recognized an increase to the allowance for credit losses of $2.7 million upon adoption of the standard as of January 1, 2023 as compared with the allowance for credit losses recognized on its consolidated balance sheet at December 31, 2022. The $2.7 million increase was recognized as a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
All other ASUs adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
The results of operations for the three month period ended March 31, 2023 are not necessarily indicative of the results to be expected for the full year.
The accompanying unaudited consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “10-K”). Except for the changes to the measurement of credit losses to financial instruments disclosed above, there have been no significant changes to the Company’s significant accounting policies as disclosed in Note 1 to the 10-K.
2. SECURITIES
The amortized cost of securities and their approximate fair value at March 31, 2023 and December 31, 2022 were as follows:
March 31, 2023
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for Sale:
Debt securities:
U.S. treasuries and government agencies
165,479
(22,417)
143,062
States and political subdivisions
23,452
(1,286)
22,168
Total debt securities
188,931
(23,703)
165,230
Mortgage-backed securities:
FNMA
75,087
(11,677)
63,411
FHLMC
46,435
(6,042)
40,393
GNMA
39,740
(6,698)
33,042
SBA
21,905
(2,099)
19,806
CMO
52,837
(8,790)
44,047
Total mortgage-backed securities
236,004
(35,306)
200,699
Total securities designated as available for sale
424,935
(59,009)
Held to Maturity:
Debt securities
(94)
3,613
Total securities designated as held to maturity
December 31, 2022
165,495
(24,814)
140,682
23,480
(1,662)
21,822
188,975
(26,476)
162,504
75,921
(12,819)
63,102
46,922
(6,695)
40,227
40,039
(6,580)
33,459
22,556
(2,419)
20,137
53,803
(8,906)
44,897
239,241
(37,419)
201,822
428,216
(63,895)
(140)
6,809
Available for sale securities with a total fair value of $290 million and $226 million were pledged as collateral to secure public deposits and for other purposes required or permitted by law at March 31, 2023 and December 31, 2022, respectively.
The scheduled maturities of debt and mortgage-backed securities at March 31, 2023 are summarized below. All maturity amounts are contractual maturities. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call premiums.
Estimated
cost
fair value
Debt securities available for sale:
Due in one year or less
6,846
6,806
Due after one year through five years
91,456
85,576
Due after five years through ten years
61,639
52,446
Due after ten years
28,990
20,402
Mortgage-backed securities
available for sale
Debt securities held to maturity:
2,900
2,887
395
412
356
Contractual maturities of the Company’s mortgage-backed securities generally exceed ten years; however, the effective lives may be significantly shorter due to prepayments of the underlying loans and due to the nature of these securities.
There were no gross realized gains or losses from sales of investment securities for the three month periods ended March 31, 2023 or 2022.
As described in note 1, on January 1, 2023 the Company adopted amended accounting guidance that requires an allowance for credit losses be deducted from the amortized cost basis of financial assets, including investment securities held to maturity, to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset. The Company estimated no allowance for credit losses for its investment securities classified as held-to-maturity at January 1, 2023 or March 31, 2023, as the portfolio of held-to-maturity securities consists entirely of states and political subdivisions investments.
Management has assessed the securities available for sale in an unrealized loss position at March 31, 2023 and December 31, 2022 and determined the decline in fair value below amortized cost to be temporary. In making this determination, management considered the period of time the securities were in a loss position, the percentage decline in comparison to the securities’ amortized cost, and the financial condition of the issuer (primarily government or government-sponsored enterprises). In addition, management does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. Management believes the decline in fair value is primarily related to market interest rate fluctuations and not to the credit deterioration of the individual issuers. The Company holds no securities backed by sub-prime or Alt-A residential mortgages or commercial mortgages and also does not hold any trust-preferred securities.
The Company did not record any other-than-temporary impairment charges during the three month periods ended March 31, 2023 and 2022. The creditworthiness of the Company’s portfolio is largely reliant on the ability of U.S. government agencies such as the Federal Home Loan Bank (“FHLB”), Federal National Mortgage Association (“FNMA”), and the Federal Home Loan Mortgage Corporation (“FHLMC”), and municipalities throughout New York State to meet their obligations. In addition, dysfunctional markets could materially alter the liquidity, interest rate, and pricing risk of the portfolio. The stable past performance is not a guarantee for similar performance going forward.
Information regarding unrealized losses within the Company’s available for sale securities at March 31, 2023 and December 31, 2022 is summarized below.
Less than 12 months
12 months or longer
11,835
(165)
130,227
(22,252)
142,062
1,589
(60)
18,717
(1,226)
20,306
13,424
(225)
148,944
(23,478)
162,368
630
(22)
62,722
(11,655)
63,352
7,838
(251)
32,511
(5,791)
40,349
6,005
(290)
27,037
(6,408)
6,954
(149)
37,093
(8,641)
21,427
(712)
179,169
(34,594)
200,596
(13)
726
(81)
Total temporarily impaired
securities
37,738
(950)
328,839
(58,153)
366,577
(59,103)
68,292
(5,929)
71,389
(18,885)
139,681
19,540
(1,645)
418
(17)
19,958
87,832
(7,574)
71,807
(18,902)
159,639
23,242
(3,081)
39,860
(9,738)
11,927
(790)
28,300
(5,905)
10,763
(1,298)
22,696
(5,282)
16,996
(1,971)
3,141
(448)
11,288
(673)
33,609
(8,233)
74,216
(7,813)
127,606
(29,606)
6,627
(118)
182
168,675
(15,505)
199,595
(48,530)
368,270
(64,035)
3. LOANS AND THE ALLOWANCE FOR CREDIT LOSSES
Loan Portfolio Composition
The following table presents selected information on the composition of the Company’s loan portfolio as of the dates indicated:
Mortgage loans on real estate:
Residential mortgages
437,416
440,123
Commercial and multi-family
772,061
778,714
Construction-Residential
3,472
3,626
Construction-Commercial
123,878
117,403
Home equities
80,673
82,414
Total real estate loans
1,417,500
1,422,280
Commercial and industrial loans
241,041
250,069
Consumer and other loans
604
572
Unaccreted yield adjustments*
(569)
(552)
Total gross loans
1,658,576
1,672,369
Allowance for credit losses
(21,523)
(19,438)
Loans, net
* Includes net premiums and discounts on acquired loans and net deferred fees and costs on loans originated.
The outstanding principal balance and the carrying amount of acquired credit-impaired loans totaled $0.8 million and $0.7 million at March 31, 2023 and December 31, 2022. There were no valuation allowances for specifically identified impairment attributable to acquired credit-impaired loans at March 31, 2023 or December 31, 2022. The Company is not recording interest on the acquired credit-impaired loans due to the uncertainty of the cash flows relating to such loans.
There were $607 million and $495 million in residential and commercial mortgage loans pledged to FHLBNY to serve as collateral for potential borrowings as of March 31, 2023 and December 31, 2022, respectively.
At March 31, 2023, the Company’s FHLMC loan servicing portfolio had $58 million in principal balances of residential real estate loans that were sold to FHLMC and the servicing rights are retained by the Company. No loans were sold to FHLMC by the Company during the three month periods ending March 31, 2023 and 2022.
The Company may also sell certain fixed rate residential mortgages to FNMA while maintaining the servicing rights for those mortgages. At March 31, 2023, the Company’s FNMA loan servicing portfolio was $57 million in principal balances. In the three month period ended March 31, 2023, the Company sold $1.3 million residential mortgages to FNMA. The Company did not sell any mortgages to FNMA in the three month period ended March 31, 2022.
At March 31, 2023 and December 31, 2022, the Company had loan servicing portfolio principal balances of $115 million and $116 million, respectively, upon which it earned servicing fees. The fair value of the mortgage servicing rights for that portfolio was $1.1 million at March 31, 2023 and December 31, 2022.
There were no residential mortgages held for sale at March 31, 2023 and December 31, 2022.
Credit Quality Indicators
The Company monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for the commercial mortgage and commercial and industrial portfolios is the individual loan’s credit risk rating. The following list provides a description of the credit risk ratings that are used internally by the Bank when assessing the adequacy of its allowance for loan losses:
Acceptable or better
Watch
Special Mention
Substandard
Doubtful
Loss
“Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” assets.
The Company’s consumer loans, including residential mortgages and home equities, are not individually risk rated or reviewed in the Company’s loan review process. Unlike commercial customers, consumer loan customers are not required to provide the Company with updated financial information. Consumer loans also carry smaller balances. Given the lack of updated information after the initial underwriting of the loan and small size of individual loans, the Company uses delinquency status as the primary credit quality indicator for consumer loans. However, once a consumer loan is identified as impaired, it is individually evaluated for impairment.
The following tables summarize amortized cost of loans by year of origination and internally assigned credit grades:
Term Loans Amortized Cost Basis by Origination Year
As of March 31, 2023
Three months ended March 31, 2023
2021
2020
2019
Prior
Revolving Loans Amortized Cost Basis
Risk rating
Pass
2,555
43,132
24,725
12,475
10,580
10,162
103,071
206,700
Special Mention
9,062
447
4,503
1,329
1,417
6,903
23,661
Substandard
71
4,036
152
1,715
1,380
3,338
10,692
Doubtful/Loss
52,265
29,208
17,130
13,624
12,959
113,312
241,053
Current period gross writeoffs
Commercial real estate mortgages
10,003
201,796
184,437
92,391
70,404
275,966
6,163
841,160
1,262
410
6,178
10,250
6,987
25,087
5,499
336
7,741
17,241
30,817
203,058
190,346
98,905
88,395
300,194
897,064
Consumer and other
Payment performance
Performing
86
249
26
23
40
135
596
Nonperforming
15
30
74,388
105,951
73,201
18,829
158,100
436,720
147
169
57
167
3,331
3,871
74,535
106,120
73,258
18,996
161,431
440,591
2,947
3,342
699
690
709
2,399
68,039
78,825
443
2,403
68,482
79,272
The amortized cost of criticized assets of $93 million included $29 million of loans in the Company’s hotel loan portfolio at March 31, 2023 and December 31, 2022.
Past Due Loans
The following tables provide an analysis of the age of the amortized cost of loans that are past due as of the dates indicated:
Current
Non-accruing
Balance
30-59 days
60-89 days
90+ days
Commercial and industrial
236,523
2,010
2,520
Residential real estate:
Residential
428,354
4,663
233
437,121
Construction
3,305
165
3,470
Commercial real estate:
Commercial
758,478
599
6,628
565
6,561
772,831
108,061
5,958
1,648
8,566
124,233
78,189
595
41
592
Total Loans
1,613,502
13,994
6,902
2,213
21,965
246,412
684
139
2,625
250,095
434,393
1,105
472
3,738
439,708
3,502
771,871
1,083
75
6,648
779,677
107,369
8,765
117,782
79,320
759
206
563
80,948
652
657
1,643,519
3,185
891
2,435
22,339
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments which requires an allowance for credit losses be deducted from the amortized cost basis of financial assets to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset. In determining the allowance for credit losses, accruing loans with similar risk characteristics are generally evaluated collectively. The Company utilizes discounted cash flow models considering relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount to project principal balances over the remaining contractual lives of the loan portfolios and to determine estimated credit losses through a reasonable and supportable forecast period. The models have been statistically developed based on historical correlations of credit losses with prevailing economic metrics, including unemployment and gross domestic product. The Company utilizes a reasonable and supportable forecast period of one year. Subsequent to this forecast period the Company reverts, on a straight-line basis over a one-year period, to historical loss experience to inform its estimate of losses for the remaining contractual life of each portfolio. Model forecasts may be adjusted for inherent limitations or biases that have been identified through independent validation and back-testing of model performance to actual realized results. The Company also considered the impact of qualitative factors, including portfolio concentrations, changes in underwriting practices, imprecision in its economic forecasts, geopolitical conditions and other risk factors that might influence its loss estimation process.
The Company also estimates losses attributable to specific troubled credits identified through both normal and targeted credit review processes and includes all loans on nonaccrual status. The amounts of specific losses are determined through a loan-by-loan analysis. Such loss estimates are typically based on expected future cash flows, collateral values and other factors that may impact the borrower’s ability to pay. To the extent that those loans are collateral-dependent, they are evaluated based on recent estimations of the fair value of the loan’s collateral. In those cases where current appraisals may not yet be available, prior appraisals are utilized with adjustments, as deemed necessary, for estimates of subsequent declines in values as determined by line of business and/or loan workout personnel. Those adjustments are reviewed and assessed for reasonableness by the Company’s credit risk personnel. Accordingly, for real estate collateral securing larger nonaccrual commercial loans and commercial real estate loans, estimated collateral values are based on current
appraisals and estimates of value. For non-real estate loans, collateral is assigned a discounted estimated liquidation value and, depending on the nature of the collateral, is verified through field exams or other procedures. In assessing collateral, real estate and non-real estate values are reduced by an estimate of selling costs. Charge-offs are based on recent indications of value from external parties that are generally obtained shortly after a loan becomes nonaccrual. Loans to consumers that file for bankruptcy are generally charged-off to estimated net collateral value shortly after the Company is notified of such filings. When evaluating individual home equity loans and lines of credit for charge off and for purposes of estimating losses in determining the allowance for credit losses, the Company gives consideration to the required repayment of any first lien positions related to collateral property.
Prior to 2023, the allowance for credit losses represented the amount that in management’s judgment reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. A description of the methodologies used by the Company to estimate its allowance for credit losses prior to January 1, 2023 is included in note 4 of Notes to Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
The following table presents the activity in the allowance for credit losses according to portfolio segment for the three month period ended March 31, 2023.
Commercial and Industrial
Commercial Real Estate Mortgages*
Consumer and Other
Residential Mortgages*
Home Equities
Allowance for credit losses:
Beginning balance
4,980
11,595
153
2,102
608
19,438
Adoption of new accounting
standard
324
1,145
(147)
1,618
(205)
2,735
Beginning balance after
cumulative effect adjustment
5,304
12,740
3,720
403
22,173
Charge-offs
(30)
Recoveries
Provision
(67)
(186)
24
(342)
(83)
Ending balance
5,267
12,554
3,378
320
21,523
*Includes construction loans
Prior to the adoption of ASU 2016-13 on January 1, 2023, the Company calculated the allowance for loan losses using the incurred loss methodology. The following table presents the activity in the allowance for loan losses by segment for the three month period ended March 31, 2022.
Three months ended March 31, 2022
3,309
12,367
54
2,127
581
18,438
(24)
(40)
(64)
17
386
(88)
(10)
(91)
3,688
12,279
44
2,117
490
18,618
* Includes construction loans
The following tables present the allowance for credit losses and recorded investment on loans by segment as of March 31, 2023 and December 31, 2022.
Allowance for credit
losses:
Ending balance:
Individually evaluated for impairment
212
29
276
Collectively evaluated for impairment
12,342
3,343
291
21,247
Loans:
2,582
17,869
4,244
826
25,521
238,459
878,070
436,644
79,847
1,633,624
895,939
440,888
1,659,145
Loans acquired with deteriorated credit quality
251
28
77
11,344
2,074
531
19,082
687
2,697
18,144
4,020
949
25,810
247,372
877,973
439,042
81,465
1,646,424
896,117
443,749
1,672,921
The Company’s reserve for off-balance sheet credit exposures was not material at March 31, 2023 and upon adoption of ASU 2016-13,
Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.
Nonaccrual Loans
The following tables provide amortized costs, at the class level, for nonaccrual loans as of the dates indicated:
Three Months Ended
January 1, 2023
Amortized Cost with Allowance
Amortized Cost without Allowance
Amortized Cost
Interest Income Recognized
151
8
1,301
7,265
Total nonaccrual loans
1,481
20,484
March 31, 2022
January 1, 2022
93
4,619
4,712
4,919
3,114
3,417
3,020
171
6,010
6,181
5,758
1,536
836
2,372
2,942
108
529
637
755
2,211
15,108
17,319
17,394
81
Modifications to Borrowers Experiencing Financial Difficulty
The Company adopted Accounting Standards Update (“ASU”) 2022-02, Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty.
The table below details the amortized cost of gross loans held for investment made to borrowers experiencing financial difficulty that were modified during the three months ended March 31, 2023:
Term Extension
Total Class of Receivable
%
104
0
The financial impacts of residential mortgage loan modifications made to borrowers experiencing financial difficulty during the three months ended March 31, 2023 were maturity extensions ranging from 159 months to 164 months.
The Company has not committed to lend any additional amounts to the borrowers included in the previous table.
As of March 31, 2023, the Company did not have any loans made to borrowers experiencing financial difficulty that were modified during the first quarter of 2023 that subsequently defaulted. Payment default is defined as movement to nonperforming status, foreclosure or charge-off, whichever occurs first.
The Company closely monitors the performance of loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The payment status of all loans modified to borrowers experiencing financial difficulties during the first quarter of 2023 was current as of March 31, 2023.
Troubled debt restructurings
Information on loan modifications prior to the adoption of ASU 2022-02 on January 1, 2023 is presented in accordance with the applicable accounting standards in effect at that time. During the three months ended March 31, 2022, the Company modified only one loan that was determined to be a troubled debt restructuring, a Home Equity loan with an outstanding balance of $38 thousand that included extension of maturity and interest rate reduction concessions.
4. COMMON EQUITY AND EARNINGS PER SHARE DATA
The common stock per share information is based upon the weighted average number of shares outstanding during each period. For the three month period ended March 31, 2023 and 2022, the Company had an average of 31,438 and 52,766 dilutive shares outstanding, 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 month period ended March 31, 2023 and 2022 there was an average of 53,910 and 21,560 potentially anti-dilutive shares outstanding, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive.
5. OTHER COMPREHENSIVE INCOME
The following tables summarize the changes in the components of accumulated other comprehensive income during the three month period ended March 31, 2023 and 2022:
Balance at December 31, 2022
Net Change
Balance at March 31, 2023
Net unrealized (loss) gain on investment securities
(47,348)
(43,713)
Net defined benefit pension plan adjustments
(1,930)
(1,910)
Balance at December 31, 2021
Balance at March 31, 2022
Net unrealized gain (loss) on investment securities
(3,160)
(19,865)
(2,511)
(2,456)
Before-Tax Amount
Income Tax (Provision) Benefit
Net-of-Tax Amount
Unrealized gain (loss) on investment
securities:
4,884
(1,249)
(22,537)
5,832
Defined benefit pension plan
adjustments:
(3)
(7)
68
(18)
Net change
76
(21)
Other comprehensive income (loss)
4,911
(1,256)
(22,461)
5,811
6. NET PERIODIC BENEFIT COSTS
On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Bank employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive, at retirement, the benefits already earned through January 31, 2008, but have not accrued any additional benefits since then. As a result, service cost is no longer incurred.
The Bank uses an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual expense 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 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.
The following table presents the net periodic cost for the Bank’s defined benefit pension plan and supplemental executive retirement plan for the three month period ended March 31, 2023 and 2022:
Three months ended March 31,
Supplemental Executive
Pension Benefits
Retirement Plan
Service cost
33
Interest cost
62
Expected return on plan assets
Amortization of the net loss
Net periodic (benefit) cost
22
(20)
98
116
The components of net periodic benefit cost other than the service cost component are included in the line item “other expense” in the income statement.
7. REVENUE RECOGNITION OF NON-INTEREST INCOME
A description of the Company’s material revenue streams in non-interest income accounted for under ASC 606 follows:
Insurance Service and Fees: Insurance services revenue relates to various revenue streams from services provided by TEA and the Bank:
TEA earns commission revenue from selling commercial and personal property and casualty (“P&C”) insurance as well as employee benefits solutions to commercial customers.
TEA has agreements with various insurance companies to sell policies to customers on behalf of the carriers. The performance obligation for TEA is to sell annual P&C policies to commercial customers and consumers. This performance obligation is met when a new policy is sold or when an existing policy renews. The policies are generally one year terms. In the agreements with the respective insurance companies, a commission rate is agreed upon. The commission is recognized at the time of the sale of the policy or when a policy renews.
TEA has signed contracts with insurance carriers that enable TEA to sell benefit plans to commercial customers on behalf of the insurance carriers. The performance obligation for TEA is to sell the plans to commercial customers. After the initial sale when the customer signs an agreement to purchase the offered benefit plan, the performance obligation is met each month when a customer continues utilizing benefit plans from the carrier. The customer does not commit to a specific length of time with the carrier. In the agreements with the respective insurance companies, a commission rate is agreed upon. Revenue is recognized each month when the customer continues with the benefit plan sold by TEA.
TEA also earns contingent profit sharing revenue. The insurance companies measure the loss ratio for TEA’s customers and pay TEA according to how profitable TEA customers are.
TEA has signed written agreements with insurance carriers that document payouts to TEA based on the loss ratios of its customers. The performance obligation for TEA is to maintain a customer base with loss ratios below the agreed upon thresholds. In the contracts with the insurance companies, payout rates based on loss ratios are documented. The consideration is variable as loss ratios vary based on customer experience. TEA’s performance obligation is over the course of the year as its customers’ performance with insurance carriers is measured throughout the year as losses occur. Due to the variable nature of contingent profit sharing revenue, TEA will accrue contingent profit sharing revenue throughout the year based on recent historical results. As loss events occur and overall performance becomes known to TEA, accrual adjustments will be made until the cash is ultimately received.
Financial services commission revenue from the Bank related to wealth management such as life insurance, annuities, and mutual funds sales is also included in the “insurance service and fees” line of the income statement.
The Company earns wealth management fees from its contracts with customers for certain financial services. Fees that are transaction-based are recognized at the point in time that the transaction is executed. Other related services provided include financial planning services and the fees the Bank earns are recognized when the services are rendered.
A disaggregation of the total insurance service and other fees for the three months ended March 31, 2023 and 2022 is provided in the tables below:
Commercial property and casualty insurance commissions
889
788
Personal property and casualty insurance commissions
739
723
Employee benefits sales commissions
194
234
Profit sharing and contingent revenue
427
Wealth management and other financial services
127
141
Other insurance-related revenue
53
43
Total insurance service and other fees
8. FAIR VALUE MEASUREMENT
Fair value is defined in ASC Topic 820 “Fair Value Measurement” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
There are three levels of inputs to fair value measurement:
Level 1 inputs are quoted prices for identical instruments in active markets;
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
Level 3 inputs are unobservable inputs.
Observable market data should be used when available.
FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS
The following table presents, for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a recurring basis as of March 31, 2023 and December 31, 2022, respectively:
Level 1
Level 2
Level 3
Fair Value
Securities available-for-sale:
US treasuries and government agencies
Securities available for sale
Fair values for available for sale securities are determined using independent pricing services and market-participating brokers. The Company utilizes a third-party for these pricing services. The third-party utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the third-party service provider’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, our third-party pricing service provider uses model processes, such as the Option Adjusted Spread model, to assess interest rate impact and develop prepayment scenarios. The models and the process take into account market convention. For each asset class, a team of evaluators gathers information from market sources and integrates relevant credit information, perceived
market movements and sector news into the evaluated pricing applications and models. The third-party, at times, may determine that it does not have sufficient verifiable information to value a particular security. In these cases the Company will utilize valuations from another pricing service.
On a quarterly basis the Company reviews changes, as submitted by our third-party pricing service provider, in the market value of its securities portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on a quarterly basis the Company has its entire securities portfolio priced by a second pricing service to determine consistency with another market evaluator. If, on the Company’s review or in comparing with another servicer, a material difference between pricing evaluations were to exist, the Company may submit an inquiry to our third-party pricing service provider regarding the data used to value a particular security. If the Company determines it has market information that would support a different valuation than our third-party service provider’s evaluation it can submit a challenge for a change to that security’s valuation.
Securities available for sale are classified as Level 2 in the fair value hierarchy as the valuation provided by the third-party provider uses observable market data.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The following table presents for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a nonrecurring basis March 31, 2023 and December 31, 2022:
Collateral dependent impaired loans
1,200
1,170
Impaired loans
Collateral dependent loans carried at fair value have been partially charged-off or receive specific allocations of the allowance for credit losses. The Company evaluates and values collateral dependent impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral value has a unique appraisal and management’s discount of the value is based on factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which ranges from 10%-50%. Fair value is estimated based on the value of the collateral securing these loans. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.
The Company has an appraisal policy in which appraisals are obtained upon a commercial loan being downgraded on the Company’s internal loan rating scale to a special mention or a substandard depending on the amount of the loan, the type of loan and the type of collateral. All impaired commercial loans are graded substandard or worse on the internal loan rating scale. For consumer loans, the Company obtains appraisals when a loan becomes 90 days past due or is determined to be impaired, whichever occurs first. Subsequent to the downgrade or reaching 90 days past due, if the loan remains outstanding and impaired for at least one year more, management may require another follow-up appraisal. Between receipts of updated appraisals, if necessary, management may perform an internal valuation based on any known changing conditions in the marketplace such as sales of similar properties, a change in the condition of the collateral, or feedback from local appraisers. Collateral dependent impaired loans had a gross value of $1.5 million, with an allowance for credit loss of $0.3 million, at March 31, 2023 compared with $1.5 million and $0.4 million, respectively, at December 31, 2022.
The table below depicts the estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis.
Carrying
Amount
Financial assets:
Level 1:
Cash and cash equivalents
Level 2:
Available for sale securities
FHLB and FRB stock
8,444
N/A
13,511
Level 3:
Held to maturity securities
1,565,824
1,564,641
Financial liabilities:
Demand deposits
NOW deposits
Savings deposits
Securities sold under agreement to
repurchase
Other borrowed funds
79,293
192,443
30,035
30,263
Time deposits
286,883
199,910
9. SEGMENT INFORMATION
The Company comprises two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three month period ended March 31, 2023 and 2022.
Banking
Insurance Agency
Activities
Net interest income
Net interest income after
provision for credit losses
123
2,306
Other non-interest income
1,684
Amortization expense
95
Other non-interest expense
12,557
1,845
14,402
Income before income taxes
7,224
366
Income tax provision
1,707
83
5,517
283
2,160
2,132
12,502
1,858
14,360
6,044
207
1,449
4,595
10. 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
422,843
376,167
Standby letters of credit
3,027
3,673
425,870
379,840
Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance by 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 did not incur any losses on its commitments and did not record a reserve for its commitments during the first three months of 2023 or during 2022.
Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of GAAP. 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 is not considered to be material.
11. RECENT ACCOUNTING PRONOUNCEMENTS
The FASB establishes changes to U.S. GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB. Effective January 1, 2023 the Company adopted both ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses of Financial Instruments and ASU 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures. Excluding those ASUs, the Company did not adopt any accounting pronouncements during its current fiscal year that had a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures. There have been no accounting standards that have been recently issued but not yet required to be adopted as of March 31, 2023 that management expects will have a material impact on the Company’s financial condition, results of operations, cash flows or disclosures.
ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments – The Company adopted this ASU (commonly known as the Current Expected Credit Loss Impairment Model, or CECL) effective January 1, 2023. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in CECL replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for further details regarding the Company’s accounting policy for determining the Allowance for Credit Losses under this new accounting standard.
Upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments, the Company recognized a $2.7 million increase in the allowance for credit losses as of January 1, 2023 with a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
ASU 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures – The Company adopted this ASU effective January 1, 2023. This ASU eliminates the accounting guidance for troubled debt restructurings ("TDRs") in ASC 310-40, "Receivables - Troubled Debt Restructurings by Creditors" for entities that have adopted the CECL model introduced by ASU 2016-13. ASU 2022-02 also requires that public business entities disclose current-period gross charge-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, "Financial Instruments—Credit Losses—Measured at Amortized Cost". The adoption of ASU 2022-02 did not have a material impact on the Company’s financial condition, results of operations or cash flows, but did affect the financial statement disclosures.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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: adverse changes in general economic conditions, either nationally or in the Company’s market areas; 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, monetary policy, 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; credit losses in excess of the Company’s allowance for credit losses; 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; the impact of such changes in accounting pronouncements and practices being greater than anticipated; the ability to realize the benefit of deferred tax assets; changes in tax policies, rates and regulations of federal, state and local tax authorities; 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 Quarterly Report on Form 10-Q, as well as in the Company’s periodic reports filed with the SEC, in particular the “Risk Factors” discussed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and this Quarterly Report on Form 10-Q. 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, except to the extent required by law.
The Discussion and Analysis of Financial Condition and Results of Operations that follows includes comparisons to the quarter ended March 31, 2022 as well as the trailing quarter ended December 31, 2022.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The Company’s Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q are prepared in accordance with U.S. GAAP 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.
Significant accounting policies followed by the Company are presented in Note 1 – “Organization and Summary of Significant Accounting Policies” to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K for the year ended December 31, 2022. 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 presented in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for the accounting policy for determining the Allowance for Credit Losses (“ACL”).
The more significant areas in which management of the Company applies critical assumptions and estimates includes the allowance for credit losses.
Allowance for Credit Losses
The ACL on loans is management’s estimate of expected lifetime credit losses on loans carried at amortized cost. The ACL on loans is established through a provision for credit losses recognized in the Consolidated Statements of Income. Additionally, the ACL on loans is reduced by charge-offs on loans and increased by recoveries of amounts previously charged-off. At March 31, 2023 the ACL on loans totaled $21.5 million, compared to $22.2 million recorded upon adoption of ASU 2016-13 at January 1, 2023. A significant portion of our ACL is allocated to the commercial portfolio (both commercial real estate and commercial and industrial (“C&I”) loans). As of March 31, 2023 and January 1, 2023, the ACL allocated to the total commercial portfolio was $17.8 million and $18.0 million, respectively.
Management employs a process and methodology to estimate the ACL on loans that evaluates both quantitative and qualitative factors. The methodology for evaluating quantitative factors consists of two basic components; pooling loans into portfolio segments for loans that share similar risk characteristics and identifying individually analyzed loans that do not share similar risk characteristics with loans that are pooled into portfolio segments.
For pooled loan portfolio segments, the Company utilizes a discounted cash flow (“DCF”) methodology to estimate credit losses over the expected life of the loan. The methodology incorporates a probability of default and loss given default framework. Loss given default is estimated based on historical credit loss experience. Probability of default is estimated utilizing a regression model that incorporates econometric factors. The model utilizes forecasted econometric factors with a one-year reasonable and supportable forecast period and one-year straight-line reversion period in order to estimate the probability of default for each loan portfolio segment. The DCF methodology combines the probability of default, the loss given default, prepayment speeds and the remaining life of the loan to estimate a reserve for each loan.
The ACL for individually analyzed loans is measured using a DCF method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan was collateral dependent, at the fair value of the collateral.
Quantitative loss factors are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates. Qualitative loss factors are applied to each portfolio segment with the amounts determined by historical loan charge-offs of a peer group of similar-sized regional banks.
Because the methodology is based upon historical experience and trends, current economic data, reasonable and supportable forecasts, as well as management’s judgment, factors may arise that result in different estimations. Deteriorating conditions or assumptions could lead to further increases in the ACL on loans; conversely, improving conditions or assumptions could lead to further reductions in the ACL on loans.
In estimating the ACL on loans, management considers the sensitivity of the model and significant judgments and assumptions that could result in an amount that is materially different from management’s estimate. Given the concentration of ACL allocation to the total commercial portfolio and the significant judgments made by management in deriving the qualitative loss factors, management analyzed the impact that changes in judgments could have. The result was an ACL allocated to the total commercial loan portfolio that ranged between $13.4 million and $28.2 million at March 31, 2023. The sensitivity and related range of impact is a hypothetical analysis and is not intended to represent management’s judgments or assumptions of qualitative loss factors that were utilized at March 31, 2023 in estimation of the ACL on loans recognized on the Consolidated Balance Sheet.
If the assumptions underlying the determination of the ACL prove to be incorrect, the ACL may not be sufficient to cover actual loan losses and an increase to the ACL may be necessary to allow for different assumptions or adverse developments. In addition, a problem with one or more loans could require a significant increase to the ACL.
ANALYSIS OF FINANCIAL CONDITION
Loan Activity
Total gross loans were $1.7 billion at March 31, 2023 and December 31, 2022 compared with $1.6 billion at March 31, 2022. Loans secured by real estate were $1.4 billion at March 31, 2023, December 31, 2022 and March 31, 2022. Residential real estate loans, including construction loans, were $441 million at March 31, 2023, $3 million or less than 1% lower than at December 31, 2022, but $18 million or 4% higher than at March 31, 2022. The increase in residential real estate loans from March 31, 2022 reflects management’s decision to retain the majority of residential mortgages within our loan portfolio. Commercial real estate loans, including construction loans, were $895 million at March 31, 2023, $1 million or less than 1% lower than at December 31, 2022, but $36 million or 4% higher than the balance at March 31, 2022. Commercial real estate is the largest part of the Company’s loan portfolio and has historically been the highest growth segment of the portfolio.
In the first quarter of 2023, residential mortgage originations were $8 million compared with the previous quarter’s originations of $15 million and $22 million in the first quarter of 2022. The decrease in residential mortgage originations as compared to the prior year was primarily due to the impact of the rising interest rate environment. The Company sold $1 million of residential mortgages during the first three months of 2023 compared with $3 million during the year earlier period. The Company did not sell any residential mortgages during the fourth quarter of 2022. Management decides to keep or sell residential mortgage loans at the time of origination based on interest rate risk management practices and the risk-adjusted return of alternative investment sources such as mortgage-backed securities.
The Company has also focused on growth opportunities in C&I lending as a way to diversify its overall loan portfolio. The C&I portfolio was $241 million at March 31, 2023, representing a $9 million or 4% decrease from December 31, 2022. When compared with last year’s first quarter, commercial and industrial loans increased $8 million or 4%, excluding Paycheck Protection Program loan balances.
Credit Quality of Loan Portfolio
Non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $24 million, or 1.45% of total loans outstanding at March 31, 2023, compared with $25 million, or 1.48% of total loans outstanding, as of December 31, 2022 and $21 million, or 1.29% of total loans outstanding, as of March 31, 2022.
Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $90 million at March 31, 2023, a $3 million decrease from $93 million at December 31, 2022, and a $20 million decrease from $110 million at March 31, 2022. The level of criticized loans can fluctuate as new information is constantly received on the Company’s borrowers and their financial circumstances change over time. Internal risk ratings are the credit quality indicators used by management to monitor credit risk in its commercial loan portfolio. “Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” credits rather than “pass” or “watch” credits.
Prior to January 1, 2023, the allowance for credit losses represented the amount that in management’s judgment reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. Based on portfolio composition, then current economic conditions, and reasonable and supportable forecasts of future conditions, the Company recognized an increase to the allowance for credit losses of $2.7 million upon adoption of the new credit loss accounting standard, ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, as of January 1, 2023 as compared with the allowance for credit losses recognized on its consolidated balance sheet at December 31, 2022. The $2.7 million increase was recognized as a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
The Company recorded a $0.7 million release of allowance during the three months ended March 31, 2023, primarily due to lower loan balances, a benefit from the reduction in rate of increases in home prices in the Company’s market and lower specific reserves on individually analyzed loans.
Prior to the adoption of ASU 2016-13, loans acquired in a business combination were recorded at fair value with no carry-over of an acquired entity’s previously established allowance for credit losses. Acquired loans that previously did not have an allowance valuation totaled $129 million at January 1, 2023. Upon adoption of the new ACL accounting standard these loans contributed $1 million to the allowance for credit losses. The allowance for credit losses totaled $21.5 million or 1.30% of total loans outstanding at March 31, 2023, compared with $19.4 million, or 1.16% of total loans outstanding as of December 31, 2022 and $18.6 million, or 1.16% of total loans outstanding at March 31, 2022. The increase in the percentage of allowance for credit losses to total loans outstanding from both comparative periods was the result of the adoption of the new accounting standard.
Investing Activities
Total investment securities were $370 million at March 31, 2023, compared with $371 million at December 31, 2022 and $389 million at March 31, 2022. The decreases reflect changes in unrealized gains and losses on investment securities. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, were $4 million at March 31, 2023 compared to $6 million at December 31, 2022, and $147 million at March 31, 2022. The primary objectives of the Company’s investment portfolio are to provide liquidity, provide collateral to secure municipal deposits, and maximize income while preserving safety of principal. Average investment securities and interest-bearing cash were 19% of average interest-earning assets in both the first quarter of 2023 and fourth quarter of 2022 and 26% in the first quarter of 2022.
The Company’s highest concentration in its securities portfolio was in available for sale U.S. government sponsored mortgage-backed securities which were 54% of total investment securities at March 31, 2023 and December 31, 2022, and 56% of total investment securities at March 31, 2022. Tax-advantaged debt securities issued by state and political subdivisions were 2%, 3% and 2% of the total securities portfolio at March 31, 2023, December 31, 2022, and March 31, 2022, respectively.
The total net unrealized loss position of the available-for-sale investment portfolio was $59 million at March 31, 2023, compared with $64 million at December 31, 2022 and $27 million at March 31, 2022. The securities in an unrealized loss position generally reflect an increase in market interest rates. Management believes that the credit quality of the securities portfolio as a whole is strong.
The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. The Company has no direct exposure to subprime mortgages, nor does the Company hold private mortgage-backed securities, credit default swaps, or FNMA or FHLMC preferred stock investments in its investment portfolio.
Funding Activities
Total deposits at March 31, 2023 were $1.8 billion, a $78 million or 4% increase from December 31, 2022, but a $137 million or 7% decrease from March 31, 2022. The increase from the fourth quarter of 2022 reflects an increase in time deposits of $87 million or 43%, municipal savings deposits of $52 million or 31%, and commercial savings of $15 million or 8%, partially offset by a decrease in consumer savings of $62 million or 14%, demand deposits of $9 million or 2%, and NOW deposits of $5 million or 2%. The decrease from March 31, 2022 largely reflects deposit decreases in consumer savings of $163 million or 42%, commercial savings of $51 million or 26%, demand deposits of $45 million or 9%, municipal savings of $30 million or 13%, and brokered deposits of $2 million or 29%. Offsetting those decreases were higher consumer time deposits of $143 million or 51% and NOW deposits of $11 million or 4%. Average demand deposits were $504 million in the first quarter of 2023, a 3% decrease from $519 million in the fourth quarter of 2022, and a 2% decrease from $512 million in the first quarter of 2022.
The Company had $11 million in long-term Federal Home Loan Bank of New York (“FHLBNY”) advances at March 31, 2023, compared with $20 million at December 31, 2022 and $27 million at March 31, 2022. This represents long-term advances from the FHLBNY that were acquired in the FSB acquisition. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with deposits along with the line usage’s impact on interest rate risk. There were $69 million in overnight borrowings with the FHLBNY at March 31, 2023.
ANALYSIS OF RESULTS OF OPERATIONS
Average Balance Sheet
The following tables present the significant categories of the assets and liabilities of the Company, interest income and interest expense, and the corresponding yields earned and rates paid for the periods indicated. The assets and liabilities are presented as daily averages. The average loan balances include both performing and non-performing loans. Interest income on loans does not include interest on loans for which the Bank has ceased to accrue interest. Investments are included at book value. Yields are presented on a non-tax-equivalent basis.
Average
Interest
Outstanding
Earned/
Yield/
Paid
Rate
(dollars in thousands)
Interest-earning assets:
1,641,162
5.16
1,566,716
4.07
Taxable securities
370,798
2.51
347,123
1.96
Tax-exempt securities
11,531
3.13
10,807
1.73
Interest bearing deposits at banks
9,824
3.97
178,729
0.16
Total interest-earning assets
2,033,315
4.66
2,103,375
3.38
Non interest-earning assets:
13,302
Premises and equipment, net
16,900
17,698
100,240
79,316
Total Assets
2,167,251
2,213,691
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
260,242
482
0.75
252,965
56
0.09
796,793
1,860
0.95
1,024,447
344
0.14
257,733
1,673
2.63
156,534
168
0.44
134,719
1,496
4.50
29,280
45
0.62
31,086
6.86
30,984
5.25
Securities sold U/A to repurchase
7,248
0.17
4,890
Total interest-bearing liabilities
1,487,821
1.65
1,499,100
0.27
Noninterest-bearing liabilities:
503,945
512,118
20,487
20,897
2,012,253
2,032,115
Stockholders' equity
154,998
181,576
Total Liabilities and Equity
Net interest margin
3.46
3.18
Interest rate spread
3.01
3.11
Net income was $5.8 million, or $1.06 per diluted share, in the first quarter of 2023, compared with $6.0 million, or $1.10 per diluted share, in the fourth quarter of 2022 and $4.7 million, or $0.86 per diluted share, in last year’s first quarter. The change from the prior quarter was largely due to a reduction in net interest income in the current period, partially offset by a release of allowance for credit losses. The change from prior year period reflected higher net interest income and a reduction in provision for credit losses in the current period, partially offset by lower non-interest income.
Return on average equity was 14.97% for the first quarter of 2023, compared with 16.07% in the fourth quarter of 2022 and 10.46% in the first quarter of 2022.
Other Results of Operations – Quarterly Comparison
Net interest income decreased $1.9 million, or 10%, from the sequential fourth quarter due to higher interest expense, given the cost increase of interest-bearing liabilities as a result of competitive pricing on deposits. When compared to the first quarter of 2022 net interest income increased $0.8 million, or 5%, resulting from a 128 basis point increase in yields on interest-earning assets and higher average loan and investment balances. The increase in rates paid on interest-bearing liabilities and yields on interest-earning assets resulted from the 450 basis point increase in the federal funds rate.
First quarter net interest margin of 3.46% decreased 31 basis points from the fourth quarter of 2022 but increased 28 basis points from the first quarter of 2022. The yield on loans increased 28 basis points compared with the fourth quarter of 2022 and 109 basis points when compared to the first quarter of 2022. The cost of interest-bearing liabilities increased to 1.65% compared with 0.86% in the fourth quarter of 2022 and 0.27% in the first quarter of 2022.
The $0.7 million release of allowance in the current quarter was largely due to lower loan balances, a reduction in the rate of increases in home prices in the Company’s market and lower specific reserves on individually analyzed loans.
Non-interest income was $4.1 million in the first quarter of 2023, compared with $4.5 million in the fourth quarter of 2022 and $4.4 million in the prior year first quarter. Included in the fourth quarter of 2022 was a $0.2 million gain on the sale of an asset that was acquired in foreclosure as well as $0.2 million of revenue recognized relating to rent payments received on the acquired asset. The decrease from last year’s first quarter was primarily due to decreases in mortgage servicing rights and loan fees. Insurance service and fee revenue, increased 10% over the fourth quarter and was up 6% from last year’s first quarter, due to higher profit sharing revenue and commissions from higher premiums and new commercial lines insurance business.
Non-interest expenses of $14.5 million in the first quarter of 2023 decreased $0.4 million or 3% when compared with the fourth quarter of 2022 and were relatively flat from last year’s first quarter. Salaries and employee benefits were down slightly as merit increases and strategic hires were offset by lower incentive accruals of $0.6 million. FDIC insurance expense increased $0.1 million from both comparative periods, reflecting changes to the FDIC’s assessment rate schedule intended to raise the reserve ratio of the Deposit Insurance Fund. Other expenses decreased from the sequential fourth quarter primarily due to lower loan fees of $0.3 million and expenses relating to a foreclosed property of $0.1 million in the fourth quarter.
The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 67.6% in the first quarter of 2023, 62.9% in the fourth quarter of 2022, and 69.1% in the first quarter of 2022.
Income tax expense was $1.8 million, for an effective tax rate of 23.6%, in the first quarter of 2023 compared with 23.0% in the fourth quarter of 2022 and 24.0% in last year’s first quarter.
CAPITAL
The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 9.13% at March 31, 2023 and December 31, 2022, compared with 8.57% at March 31, 2022.
On February 22, 2023, the Company declared a cash dividend of $0.66 per common share, which was paid on April 4, 2023. The semi-annual dividend represented a $0.02, or 3%, increase from the previous semi-annual dividend paid in October 2022.
Book value per share was $28.97 at March 31, 2023, compared with $28.32 at December 31, 2022 and $30.65 at March 31, 2022. Reflected in the book value changes are the Federal Reserve’s aggressive interest rate hikes that have resulted in significant unrealized losses on investment securities, which reduced book value per share at March 31, 2023 by $4.37 when compared with the last year’s
first quarter. Such unrealized gains and losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available-for-sale.
The Company has also issued subordinated capital notes and junior subordinated debentures associated with trust preferred securities to provide liquidity and enhance regulatory capital ratios. The Company had $11.3 million of junior subordinated debentures associated with trust preferred securities outstanding at March 31, 2023 and December 31, 2022 which are considered Tier 1 capital and are includable in total regulatory capital. On July 9, 2020, the Company executed a private offering of $20 million of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030. During 2020, $15 million of the proceeds from the sale of the Notes were moved to the Company’s Evans Bank, N.A. subsidiary as Tier 1 capital.
While we are currently classified as well capitalized, an extended economic recession could adversely impact our reported and regulatory capital ratios. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s subsidiary bank’s capital deteriorates such that it is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt that was issued.
LIQUIDITY
The Bank utilizes cash flows from the investment portfolio and federal funds sold balances to manage the liquidity requirements related to loan demand and deposit fluctuations. The Bank also has many borrowing options. The Company uses the FHLBNY as its primary source of overnight funds and has long-term advance with FHLBNY. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with core deposits along with the line usage’s impact on interest rate risk. The Company’s funding strategy has resulted in significant deposit growth, resulting in less usage of the FHLBNY overnight line of credit. The Company has pledged sufficient collateral in the form of residential and commercial real estate loans at FHLBNY that meets FHLB collateral requirements. As a member of the FHLB, the Bank is able to borrow funds at competitive rates. As of March 31, 2023, advances of up to $404 million could be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. As of March 31, 2023, the Bank also had the ability to purchase up to $18 million in federal funds from its correspondent banks. By placing sufficient collateral in safekeeping at the Federal Reserve Bank, the Bank could borrow at the discount window. Furthermore, the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments. The Bank’s liquidity needs also can be met by more aggressively pursuing time deposits, or accessing the brokered time deposit market, including the Certificate of Deposit Account Registry Service (“CDARS”) network.
Cash flows from the Bank’s investment portfolio are laddered, so that securities mature at regular intervals, to provide funds from principal and interest payments at various times as liquidity needs may arise. Contractual maturities are also laddered, with consideration as to the volatility of market prices. At March 31, 2023, approximately 3% of the Bank’s securities had contractual maturity dates of one year or less and approximately 26% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprise 54% of the investment portfolio at March 31, 2023, provide consistent cash flows for the Bank.
The Company’s primary source of liquidity is dividends from the Bank. Additionally, the Company has access to capital markets as a funding source.
Management, on an ongoing basis, closely monitors the Company’s liquidity position for compliance with internal policies and believes that available sources of liquidity are adequate to meet funding needs in the normal course of business. As part of that monitoring process, management calculates the Company’s 90-day liquidity ratio each month by analyzing the cash needs of the Bank. Included in the calculation are liquid assets and potential liabilities. Management stresses the potential liabilities calculation to ensure a strong liquidity position. Included in the calculation are assumptions of some significant deposit run-off as well as funds needed for loan closings and investment purchases. In the Company’s internal stress test at March 31, 2023, the Company had net short-term liquidity of $433 million as compared with $209 million at December 31, 2022. Available assets of $375 million, divided by public and purchased funds of $505 million, resulted in a long-term liquidity ratio of 74% at March 31, 2023, compared with 75% at December 31, 2022.
Management does not anticipate engaging in any activities, either currently or in the long term, for which adequate funding would not be available and which would therefore result in significant pressure on liquidity.
The Company believes that the Bank maintains a sufficient level of U.S. government and government agency securities and New York State municipal bonds that can be pledged as collateral for municipal deposits.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Additional information responsive to this Item is contained in the Liquidity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, which information is incorporated herein by reference.
Market risk is the risk of loss from adverse changes in market prices and/or interest rates of the Bank’s financial instruments. The primary market risk that the Company is exposed to is interest rate risk. The core banking activities of lending and deposit-taking expose the Bank to interest rate risk, which occurs when assets and liabilities reprice at different times and by different amounts as interest rates change. As a result, net interest income earned by the Bank is subject to the effects of changing interest rates. The Bank measures interest rate risk by calculating the variability of net interest income in future periods under various interest rate scenarios using projected balances for interest-earning assets and interest-bearing liabilities. Management’s philosophy toward interest rate risk management is to limit the variability of net interest income to changes in net interest rates. The balances of financial instruments used in the projections are based on expected growth from forecasted business opportunities, anticipated prepayments of loans, and expected maturities of investment securities, loans, and deposits. Management supplements the modeling technique described above with analysis of market values of the Bank’s financial instruments and changes to such market values given changes in the interest rates.
The Bank’s Asset-Liability Committee, which includes members of senior management, monitors the Bank’s interest rate sensitivity with the aid of a model that considers the impact of ongoing lending and deposit taking activities, as well as interrelationships in the magnitude and timing of the repricing of financial instruments, including the effect of changing interest rates on expected prepayments and maturities. When deemed prudent, management has taken actions, and intends to do so in the future, to mitigate exposure to interest rate risk through the use of on- or off-balance sheet financial instruments. Possible actions include, but are not limited to, changing the pricing of loan and deposit products, and modifying the composition of interest-earning assets and interest-bearing liabilities, and reliance on other financial instruments used for interest rate risk management purposes.
The following table demonstrates the possible impact of changes in interest rates on the Bank’s net interest income over a 12-month period of time:
SENSITIVITY OF NET INTEREST INCOME TO CHANGES IN INTEREST RATES
Calculated increase (decrease)
in projected annual net interest income
Changes in interest rates
+200 basis points
(2,734)
(2,867)
+100 basis points
528
770
-100 basis points
(679)
(962)
-200 basis points
(1,588)
(2,661)
Many assumptions were utilized by management to calculate the impact that changes in interest rates may have on the Bank’s net interest income. The more significant assumptions related to the rate of prepayments of mortgage-related assets, loan and deposit volumes and pricing, and deposit maturities. The Bank assumed immediate changes in rates including 200 basis point rate changes. In the 200 basis point rate reduction scenario, the applicable rate changes may be limited to lesser amounts such that interest rates are not less than zero. The assumptions in the Company’s projections are inherently uncertain and, as a result, the Bank cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly due to the timing, magnitude, and frequency of interest rate changes in market conditions and interest rate differentials (spreads) between maturity/repricing categories, as well as any actions such as those previously described, which management may take to counter such changes. In light of the uncertainties and assumptions associated with the process, the amounts presented in the table and changes in such amounts are not considered significant to the Bank’s projected net interest income.
ITEM 4 - CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2023 (the end of the period covered by this Report). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2023.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Effective January 1, 2023, Evans Bancorp, Inc. adopted the CECL accounting standard. The Company designed new controls and modified existing controls as part of its adoption. These additional controls over financial reporting included controls over model creation and design, model governance, assumptions, and expanded controls over loan level data.
Except for the change in controls relating to the adoption of the CECL accounting standard, there were no other changes in the Company’s internal control over financial reporting in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended March 31, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business.
In the opinion of management, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if determined adversely, would have a material effect on the Company’s results of operations or financial condition.
ITEM 1A – RISK FACTORS
Other than the risk factors set forth below, there have been no material changes to the risk factors previously disclosed in Item 1A. Part I of the Company’s Annual Report on Form 10- K for the fiscal year ended December 31, 2022.
Recent Negative Developments Affecting the Banking Industry, and Resulting Media Coverage, May Erode Customer Confidence in the Banking System
The March 2023 high-profile bank failures involving Silicon Valley Bank and Signature Bank have generated significant market volatility among publicly traded bank holding companies and, in particular, community banks like the Company. These market developments have negatively impacted customer confidence in the safety and soundness of community banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations. While the Department of the Treasury, the Federal Reserve, and the FDIC have made statements ensuring that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in community banks and the banking system more broadly.
A Lack of Liquidity Could Adversely Affect the Company’s Financial Condition and Results of Operations and Result in Regulatory Restrictions
The Company must maintain sufficient funds to respond to the needs of depositors and borrowers. Deposits have traditionally been the Company’s primary source of funds for use in lending and investment activities and are emphasized due to the relatively lower cost of these funds. The Company also receives funds from loan repayments, investment maturities and income on other interest-earning assets, as well as borrowings. If the Company is required to rely more heavily on more expensive funding sources to support liquidity and future growth, its revenues may not increase proportionately to cover its increased costs, which would adversely affect its operating margins, profitability and growth prospects. Alternatively, the Company may need to sell a portion of its investment securities portfolio to raise funds, which, as discussed below, could result in a loss.
Any decline in funding could adversely impact the Company’s ability to originate loans, invest in securities, pay expenses, or fulfill obligations such as repaying its borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on its liquidity, business, financial condition and results of operations. A lack of liquidity could also attract increased regulatory scrutiny and potential restraints imposed by regulators. Depending on the capitalization status and regulatory treatment of depository institutions, including whether an institution is subject to a supervisory prompt corrective action directive, regulatory restrictions and prohibitions may include restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits.
Rising Interest Rates Have Decreased the Value of the Company’s Securities Portfolio, and the Company Would Realize Losses if it Were Required to Sell Such Securities to Meet Liquidity Needs
As a result of inflationary pressures and the resulting rapid increases in interest rates over the last year, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company’s, resulting in unrealized losses embedded in the securities portfolios. While the Company does not currently intend to sell these securities, if the Company were required to sell such securities to meet liquidity needs, it may incur losses, which could impair the Company’s capital, financial condition, and results of operations and require the Company to raise additional capital on unfavorable terms, thereby negatively impacting its profitability. While the Company has taken actions to maximize its funding sources, there is no guarantee that such actions will be successful or sufficient in the event of sudden liquidity needs. Furthermore, while the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments, there is no guarantee that such programs will be effective in addressing liquidity needs as they arise.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
January 1, 2023 - January 31, 2023
Repurchase program(1)
187,932
Employee transactions(2)
215
37.68
February 1, 2023 - February 28, 2023
7,130
39.99
March 1, 2023 - March 31, 2023
Total:
7,345
39.92
(1)On February 25, 2021, the Board of Directors authorized the Company to repurchase up to 300,000 shares of the Company’s common stock (the “2021 Repurchase Program”). The 2021 Repurchase program does not expire and may be suspended or discontinued by the Board of Directors at any time. The maximum number of shares that may be purchased under the 2021 Repurchase Program as of March 31, 2023 was 187,932.
(2)The total shares purchased in the period consist of shares constructively tendered to the Company by attestation in satisfaction of the exercise price due upon exercise of options issued pursuant to the Company’s 2019 Long-Term Incentive Plan. The “average price paid per share” reported in the table above, with respect to such shares, reflects the fair market value of the Company’s common stock on the exercise date, which was the closing sales price of the Company’s common stock as reported on the NYSE American on that date.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
(Not Applicable.)
ITEM 4 – MINE SAFETY DISCLOSURE
ITEM 5 – OTHER INFORMATION
ITEM 6 – EXHIBITS
The following exhibits are filed as a part of this report:
EXHIBIT INDEX
Exhibit No.
Name
3.1
Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3a to the Company’s Registration Statement on Form S-4 (Registration No. 33-25321), as filed on November 7, 1988). (Filed on paper – hyperlink is not required pursuant to Rule 105 of Regulation S-T)
3.1.1
Certificate of Amendment to the Company’s Certificate of Incorporation (incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997, as filed on May 14, 1997). (Filed on paper – hyperlink is not required pursuant to Rule 105 of Regulation S-T)
3.2
Amended and Restated Bylaws of the Company, effective as of January 24, 2023 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on January 30, 2023)
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Principal Executive Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Principal Financial Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
The following materials from Evans Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets – March 31, 2023 and December 31, 2022; (ii) Unaudited Consolidated Statements of Income – Three months ended March 31, 2023 and 2022; (iii) Unaudited Statements of Consolidated Comprehensive Income – Three months ended March 31, 2023 and 2022; (iv) Unaudited Consolidated Statements of Stockholders' Equity – Three months ended March 31, 2023 and 2022; (v) Unaudited Consolidated Statements of Cash Flows – Three months ended March 31, 2023 and 2022; and (vi) Notes to Unaudited Consolidated Financial Statements.
The cover page from the Evans Bancorp, Inc’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, formatted in Inline XBRL.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Evans Bancorp, Inc.
DATE
May 02, 2023
/s/ David J. Nasca
David J. Nasca
President and CEO
(Principal Executive Officer)
/s/ John B. Connerton
John B. Connerton
Treasurer
(Principal Financial Officer and Principal Accounting Officer)