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EVBN > SEC Filings for EVBN > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for EVANS BANCORP INC

Form 10-Q for EVANS BANCORP INC


2-Nov-2012

Quarterly Report


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 general economic conditions, either nationally or in the Company's market areas, that are worse than expected; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company's margins or reduce the fair value of financial instruments; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees, 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; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; changes in consumer spending, borrowing and saving habits; changes in the Company's organization, compensation and benefit plans; and other factors discussed elsewhere in this 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, 2011. 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.

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. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques. Refer to Note 3 - "Fair Value Measurements" to the Company's Unaudited Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q for further detail on fair value measurement.


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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, 2011. 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.

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

Allowance for Loan and Lease Losses

The allowance for loan and lease losses represents management's estimate of probable losses in the Company's loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the Company's Unaudited Consolidated Balance Sheets. Note 1 to the Audited Consolidated Financial Statements included in Item 8 in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, describes the methodology used to determine the allowance for loan and lease losses.

Goodwill

The amount of goodwill reflected in the Company's Unaudited Consolidated Financial Statements is required to be tested by management for impairment on at least an annual basis. The test for impairment of goodwill on the identified reporting unit is considered a critical accounting estimate because it requires judgment on the part of management and the use of estimates related to the growth assumptions and market multiples used in the valuation model. The goodwill impairment testing is typically performed annually on December 31st. No impairment charges were incurred in the most recent test and the fair value of the tested reporting unit substantially exceeded its fair value. There were no triggering events in the three and nine month periods ended September 30, 2012 that resulted in an interim impairment test.

ANALYSIS OF FINANCIAL CONDITION

Loan and Lease Activity

Total loans and leases grew to $598.6 million at September 30, 2012, reflecting a $0.7 million or 0.1% increase from June 30, 2012 and a $15.2 million or 2.6% increase from December 31, 2011. The national direct financing lease portfolio declined $0.9 million during the third quarter to $2.4 million at September 30, 2012 as the Company had ceased lease originations in the second quarter of 2009 and is winding down the portfolio and exiting this business line.

Core loans, defined as total loans less leases, were $596.2 million at September 30, 2012, a $1.6 million, or 0.3% increase from $594.6 million at June 30, 2012 and an $18.8 million, or 3.3% increase from December 31, 2011. The large amount of loans closed in the fourth quarter of 2011 left the Company's loan pipeline relatively lighter to start 2012. The Company re-filled the pipeline in the first quarter and early second quarter and was able to generate significant loan closings in the second quarter, with the highest level of growth driven by commercial and multi-family real estate loans. Loan balances in the third quarter were relatively flat as demand has been relatively soft and the marketplace remains extremely competitive. Compared with core loan balances of $560.8 million at September 30, 2011, the growth rate over the past twelve months has been 6.3%.

Loans secured by real estate were $485.3 million at September 30, 2012, an increase of $2.8 million or 0.6% from June 30, 2012, and $20.1 million or 4.3% from December 31, 2011. The strongest growth was in commercial real estate construction loans, which increased $3.8 million or 11.9% in the third quarter of 2012. Year-to-date, growth in commercial real estate construction was $7.7 million, or 27.6%. Commercial real estate lending has long been an area of strength of the Bank and its loan officers and the historical strong performance has continued in 2012.


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Residential mortgages increased to $70.4 million at September 30, 2012 from $69.3 million at June 30, 2012, but decreased from $73.6 million at December 31, 2011. The Company has sold the majority of its originated residential mortgage loans as long-term fixed rate mortgage loan rates remain near all-time historic lows. This, along with prepayments from existing customers re-financing their homes, has resulted in the decrease in residential mortgage balances in 2012. Residential mortgage originations increased to $9.0 million and $24.1 million in the three and nine month periods ended September 30, 2012, respectively, compared with $6.0 million and $23.6 million in the three and nine month periods ended September 30, 2011, respectively.

The Bank sells certain fixed rate residential mortgages to FNMA, while maintaining the servicing rights for those mortgages. During the three and nine month periods ended September 30, 2012, the Bank sold mortgages to FNMA totaling $6.0 million and $17.1 million, respectively, as compared with $2.6 million and $15.8 million sold during the three and nine month periods ended September 30, 2011, respectively. At September 30, 2012, the Bank had a loan servicing portfolio principal balance of $70.5 million upon which it earns servicing fees, as compared with $68.4 million at June 30, 2012 and $62.4 million at December 31, 2011. The value of the mortgage servicing rights for that portfolio was $0.4 million at September 30, 2012, June 30, 2012 and December 31, 2011. Residential mortgage loans held-for-sale were $2.7 million at September 30, 2012, compared with $1.0 million at June 30, 2012 and $3.6 million at December 31, 2011. The Company has never been contacted by FNMA to repurchase any loans due to improper documentation or fraud.

The Company continues to focus on commercial and industrial ("C&I") lending as a way to diversify its loan portfolio, which has historically experienced strong growth rates in real estate loans. However, the Company faces the headwinds of a low growth economy and a very competitive local market. Line of credit commitments and line of credit usage decreased in the third quarter, resulting in C&I balances declining to $106.8 million at September 30, 2012, compared with $107.8 million at June 30, 2012, and $109.5 million at December 31, 2011.

Leasing Portfolio

As noted above, management made the strategic decision in April 2009 to exit the national direct financing lease business and market the portfolio for sale. This decision resulted in the classification of the leasing portfolio as held-for-sale and the portfolio being marked to its market value at September 30, 2009. The mark-to-market adjustment was $7.2 million. At September 30, 2009, management determined to keep the lease portfolio and service it to maturity, terminated its plans to actively market the portfolio for sale, and the portfolio was placed back into held-for-investment at the revised carrying amount as of September 30, 2009. The difference between the principal value and the carrying value, initially created by the mark-to-market adjustment at September 30, 2009, reduces over time as individual leases deteriorate, become uncollectible, and are written off. The allowance for lease losses was zero at September 30, 2009 when the portfolio was classified as held-for-sale and reported at its fair market value. With the portfolio classified as held-for-investment at September 30, 2012, the portfolio has been evaluated in accordance with the Company's normal credit review policies in determining the appropriate allowance for lease losses. During the third quarter of 2012, a net of $4 thousand in leases were written off and the difference between the principal value and carrying value of the leasing portfolio remained the same at $0.1 million at September 30, 2012 when compared with June 30, 2012. Non-performing leases of $0.3 million at September 30, 2012 declined from $0.4 million at June 30, 2012 and $1.2 million at December 31, 2011. There were no new leases placed in nonaccrual in the third quarter. With both performing and non-performing lease balances declining, management determined that the allowance for leasing losses should decrease by $0.1 million in the third quarter of 2012, following a $0.2 million decrease in the second quarter of 2012 and a $0.4 million decrease in the first quarter of 2012. The following table illustrates the write-off and allowance activity related to the leasing portfolio over the past five quarters.


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($ in thousands)

                                                               2012                                                2011
                                        September 30,          June 30,          March 31,         December 31,          September 30,
Leasing Principal Balance              $         2,526        $    3,445        $     4,953        $       6,509        $         8,467
Mark                                               (86 )             (90 )             (441 )               (488 )                 (684 )

Leasing Carrying Value                 $         2,440        $    3,355        $     4,512        $       6,021        $         7,783

Mark-to-Market Adjustment              $            90        $      441        $       488        $         684        $           779
Net Write-Offs                                      (4 )            (351 )              (47 )               (196 )                  (95 )

Remaining Mark                         $            86        $       90        $       441        $         488        $           684


                                                                          For the three months ended
                                                               2012                                                2011
                                        September 30,          June 30,          March 31,         December 31,          September 30,
Allowance for lease losses             $           367        $      583        $       994        $       1,229        $         1,471
Provision for leases                              (132 )            (216 )             (411 )               (235 )                 (242 )
Leasing net charge-offs                             -                 -                  -                    -                      -

Allowance for lease losses             $           235        $      367        $       583        $         994        $         1,229

Total mark plus allowance              $           321        $      457        $     1,024        $       1,482        $         1,913
Mark + allowance/leasing principal
balance                                          12.71 %           13.27 %            20.67 %              22.77 %                22.59 %

Credit Quality of Loan Portfolio

Total non-performing loans and leases, defined as accruing loans and leases greater than 90 days past due and non-accrual loans and leases, totaled $9.4 million, or 1.57% of total loans and leases outstanding, at September 30, 2012, compared with $11.0 million, or 1.84%, at June 30, 2012 and $15.2 million, or 2.60% of total loans and leases outstanding at December 31, 2011. There were several reasons for the decline in non-performing loans and leases during the past three quarters.

In the first six months of 2012, certain construction loans that were formerly more than 90 days past their maturity dates were converted to permanent loans and remain performing as of September 30, 2012 ($1.4 million). The non-performing leasing portfolio continued to improve and run off ($0.7 million). Other reasons for the decline in non-performing loans and leases included charge-offs ($0.6 million), pay-offs and pay-downs ($0.9 million), and improved performance justifying a return to performing status ($0.5 million).

In the third quarter of 2012, non-performing loans and leases continued to decline. The Company had two non-accruing loans pay off, including two commercial real estate loans for $0.5 million and $0.3 million. The Company partially charged off $0.4 million of a $2.1 million commercial and industrial relationship that was risk rated a 7 on the Company internal risk rating scale and had previously been reserved for. The Company also charged off $0.1 million of a home equity loan. The leasing portfolio continued its run-off in the third quarter with non-accruing leases declining by $0.2 million. The remaining net $0.2 million decrease is from payments on non-accruing loans that remain in the portfolio.

The allowance for loan and lease losses totaled $10.2 million, or 1.71% of total loans and leases outstanding as of September 30, 2012, compared with $10.7 million or 1.78% at June 30, 2012, and $11.5 million or 1.97% at December 31, 2011. The decrease in the allowance over the prior year end resulted from a $0.8 million release of reserves on the leasing portfolio and net charge-offs of $1.4 million in the nine month period ended September 30, 2012, partially offset by a $0.8 million provision for loan losses. The provision for loan losses resulted from the charge-off of three loans that exceeded the reserve associated with those loans at the time of the charge-offs, as well as the loan growth through the first nine months of 2012. The $0.5 million in net charge-offs in the third quarter of 2012 equates to a 0.31% annualized ratio as a percentage of average net loans and leases. This compares with a 0.30% ratio in the second quarter of 2012 and 0.09% in the third quarter of 2011. For the nine months ended September 30, 2012, the $1.4 million in net charge-offs equated to 0.31% of average net loans and leases, compared with $1.4 million in net charge-offs for a ratio of 0.35% in the first nine months of 2011.


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The coverage ratio of the allowance for loan and lease losses to non-performing loans and leases increased from 76% at December 31, 2011 to 97% at June 30, 2012 and 108% at September 30, 2012. There are two factors that significantly influence these ratios. The first factor is the covered loan portfolio acquired in the Waterford transaction which are covered by an FDIC loss-sharing agreement that guarantees 80% of any losses incurred in the portfolio up to $5.6 million, and 95% of losses beyond that threshold. The second factor is the leasing portfolio, which carries significantly higher risk, but also has the remaining mark to consider as depicted in the table above. The following table depicts the allowance and non-performing ratios by segregating the covered and non-covered loan portfolios and the leasing portfolio as of the following dates:

                                                                                September 30, 2012
                                                                                 ($ in thousands)
                                                                                                                                   Allowance
                                                                                          Allowance                                 for loan
                                                                                          for loan                                 and lease
                                                                                          and lease                                 losses/
                                                   Allowance                               losses/          Non-performing            Non-
                                                   for loan                                 Total             loans and            performing
                                                   and lease        Non-performing        loans and          leases/Total          loans and
                                     Balance        losses         loans and leases        leases          loans and leases          leases
Non-covered loans                   $ 573,636     $     9,860     $            7,245            1.72 %                  1.26 %          136.09 %
Covered loans                          22,540             113                  1,915            0.50 %                  8.50 %            5.90 %
Leases                                  2,440             235                    255            9.63 %                 10.45 %           92.16 %

Total                               $ 598,616     $    10,208     $            9,415            1.71 %                  1.57 %          108.42 %

                                                                               December 31, 2011
                                                                                ($ in thousands)
                                                                                                                                  Allowance
                                                                                         Allowance                                 for loan
                                                                                         for loan                                 and lease
                                                                                         and lease                                 losses/
                                                  Allowance                               losses/          Non-performing            Non-
                                                  for loan                                 Total             loans and            performing
                                                  and lease        Non-performing        loans and          leases/Total          loans and
                                    Balance        losses         loans and leases        leases          loans and leases          leases
Non-covered loans                  $ 550,955     $    10,400     $           11,488            1.89 %                  2.09 %           90.53 %
Covered loans                         26,429             101                  2,528            0.38 %                  9.57 %            4.00 %
Leases                                 6,021             994                  1,160           16.51 %                 19.27 %           85.69 %

Total                              $ 583,405     $    11,495     $           15,176            1.97 %                  2.60 %           75.74 %

Investing Activities

Total securities were $95.9 million at September 30, 2012, compared with $96.8 million at June 30, 2012 and $103.8 million at December 31, 2011.
Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks, increased from $3.2 million at December 31, 2011 to $31.4 million at June 30, 2012 and $52.7 million at September 30, 2012. Interest-bearing cash has increased as deposit growth outpaced loan growth. Securities and interest-bearing deposits at correspondent banks made up 20.0 % of the Bank's total average interest earning assets in the third quarter of 2012, compared with 19.6% in the second quarter of 2012.

The Company's highest concentration in its securities portfolio is in tax-advantaged debt securities issued by state and political subdivisions with 33.1% at September 30, 2012, compared with 31.1% at December 31, 2011. The concentration in U.S. government-sponsored agency bonds was 25.6% of the portfolio at September 30, 2012, compared with 29.1% of the portfolio at December 31, 2011.

The credit quality of the securities portfolio as a whole is believed to be strong as the portfolio has no individual securities in a significant unrealized loss position. Despite interest rates remaining near historic lows, the net unrealized gain position of the investment portfolio increased from $4.1 million at December 31, 2011 and $4.0 million at June 30, 2012 to $4.6 million at September 30, 2012.


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The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. Available-for-sale securities with a total fair value of $74.9 million at September 30, 2012, as compared with $76.7 million at December 31, 2011, were pledged as collateral to secure public deposits and for other purposes required or permitted by law. 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 September 30, 2012 were $672.7 million, reflecting an $18.8 million or 2.9% increase from June 30, 2012 and a $56.5 million, or 9.2%, increase from December 31, 2011. Total demand deposits at September 30, 2012 were $126.3 million, reflecting a $10.0 million or 8.6% increase from June 30, 2012, and an $8.2 million or 7.0% increase from December 31, 2011. Demand deposit balances fluctuate day-to-day based on the high volume of transactions normally associated with the demand product, and therefore average demand deposit growth is a valuable measure of sustained growth. Average demand deposits of $124.6 million during the three month period ended September 30, 2012 was 8.3% higher than the second quarter of 2012, and 12.2% higher than the prior year's third quarter. Most of the Company's growth in the past year in demand deposits has come from commercial customers.

The Company's retail deposit growth vehicle continues to be the complementary Better Checking and Better Savings products, which are included in the NOW and regular savings deposit categories, respectively, on the Company's balance sheet. The Better Checking product is unique in the Bank's Western New York footprint as it pays a premium interest rate as a reward to customers who . . .

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