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EVBN > SEC Filings for EVBN > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for EVANS BANCORP INC


3-May-2013

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, 2012. 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.

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, 2012. 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, 2012, 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 month period ended March 31, 2013 that resulted in an interim impairment test.

ANALYSIS OF FINANCIAL CONDITION

Loan and Lease Activity

Total loans and leases grew to $588.1 million at March 31, 2013, reflecting a $5.2 million or 0.9% increase from $582.9 million at December 31, 2012. Since March 31, 2012, the loan portfolio has grown $8.4 million, or 1.4%.

Loans secured by real estate were $479.1 million at March 31, 2013, an increase of $1.0 million or 0.2% from December 31, 2012. The Company's commercial real estate portfolio has historically been the fastest growing part of the portfolio. However, with rates at all-time lows, several customers have decided to pay off their loans before maturity, despite prepayment penalties, and re-finance their loans at lower rates with other institutions. Financial institutions are generally healthier after enduring a difficult credit cycle during the recession. In addition, banks are experiencing higher liquidity levels with loan demand relatively weak while deposit growth remains steady. These circumstances have converged into an environment of stiff competition for loans over the past year, making loan growth difficult. Commercial and multi-family loans decreased 0.6% from $323.8 million at December 31, 2012 to $321.8 million at March 31, 2013.

With commercial real estate loan growth slowing and investment yields at all-time lows, the Company retained more of its originated residential mortgages during the first quarter of 2013, selling fewer loans to FNMA than it has in the past. Residential mortgages increased to $74.7 million at March 31, 2013, a $6.6 million, or 9.7% increase from $68.1 million at December 31, 2012. Residential mortgage originations increased to $8.6 million in the three month period ended March 31, 2013, compared with $7.3 million in the three month period ended March 31, 2012.

The Bank sells certain fixed rate residential mortgages to FNMA, while maintaining the servicing rights for those mortgages. During the three month period ended March 31, 2013, the Bank sold mortgages to FNMA totaling $0.8 million, compared with $6.2 million during the three month period ended March 31, 2012. At March 31, 2013, the Bank had a loan servicing portfolio principal balance of $70.4 million upon which it earns servicing fees, as compared with $73.7 million at December 31, 2012. The value of the mortgage servicing rights for that portfolio was $0.5 million at March 31, 2013 and December 31, 2012. Residential mortgage loans held-for-sale were $0.4 million at March 31, 2013 and $0.9 million at December 31, 2012. 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. Declining line of credit usage and loan payoffs had resulted in a decrease in C&I balances during 2012. In 2013, line of credit usage increased such that C&I balances increased 6.0% in the first quarter of 2013, from $100.0 million at December 31, 2012 to $106.0 million at March 31, 2013.

The leasing portfolio continued to roll-off under the Company's 2009 decision to exit the direct financing leasing business. Direct financing leases were $0.9 million at March 31, 2013, compared with $1.6 million at December 31, 2012.


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 $8.0 million, or 1.37% of total loans and leases outstanding, at March 31, 2013, compared with $8.2 million, or 1.41%, of total loans and leases outstanding at December 31, 2012.

While non-performing loans and leases were flat in the quarter, "special mention" and "substandard" commercial credits increased from $10.0 million and $5.9 million, respectively, at December 31, 2012 to $13.2 million and $7.4 million at March 31, 2013. As noted in Note 4 to these Unaudited Financial Statements, internal risk ratings are the credit quality indicators used by the Company's management to determine the appropriate allowance for loan and lease losses for commercial credits. Special mention and substandard loans are weaker credits with a higher risk of loss than "pass" or "watch" credits. While there were several upgrades and downgrades as part of the risk rating balances increasing, there were two loans driving the overall increase - a $6.5 million commercial real estate loan was downgraded to special mention and a $1.0 million commercial real estate loan was downgraded to substandard. While management increased the allowance for loan and lease losses as a result of the increased risk inherent in the downgrades, it should be noted that the loans are not impaired and management continues to expect to collect full principal and interest as contracted.

The allowance for loan and lease losses totaled $10.2 million, or 1.73% of total loans and leases outstanding as of March 31, 2013, compared with $9.7 million or 1.67% at December 31, 2012. The increase in the allowance over the prior year end resulted from a $0.5 million provision for loan and lease losses recorded during the first quarter of 2013, and minimal net charge-offs of less than $0.1 million during the quarter. The provision for loan and lease losses resulted from the increase in special mention and substandard loans discussed above. The net charge-off ratio in the first quarter of 2013 equated to 0.02% of average net loans and leases. This compares with a 0.32% ratio in the first quarter of 2012.

The coverage ratio of the allowance for loan and lease losses to non-performing loans and leases increased from 118% at December 31, 2012 to 126% at March 31, 2013 as the allowance for loan and lease losses increased while non-performing loans and leases decreased during the first quarter of 2013.

Investing Activities

Total securities were $95.3 million at March 31, 2013, compared with $95.8 million at December 31, 2012. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, increased from $78.1 million at December 31, 2012 to $88.1 million at March 31, 2013. Interest-bearing cash increased as deposit growth outpaced loan growth in the first quarter. Securities and interest-bearing deposits at correspondent banks made up 23.5% of the Bank's total average interest earning assets in the first quarter of 2013, compared with 18.4% in the first 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 35.7% at March 31, 2013, compared with 32.9% at December 31, 2012. The concentration in U.S. government-sponsored agency bonds was 29.5% of the portfolio at March 31, 2013, compared with 29.6% of the portfolio at December 31, 2012. U.S. government-sponsored mortgage-backed securities comprised 30.8% of the securities portfolio at March 31, 2013, compared with 33.7% at December 31, 2012.

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. While interest rates remained near historic lows, long-term rates were slightly higher at March 31, 2013 when compared with December 31, 2012. As a result, the net unrealized gain position of the available-for-sale investment portfolio decreased from $4.0 million at December 31, 2012 to $3.6 million at March 31, 2013.

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 $90.1 million at March 31, 2013, as compared with $68.0 million at December 31, 2012, 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 March 31, 2013 were $698.3 million, reflecting a $19.3 million or 2.8% increase from December 31, 2012. The growth was driven by seasonal inflows of municipal deposits. The growth in municipal deposits in the first quarter totaled $20.1 million and was spread across several deposit categories:
demand ($2.8 million), NOW ($5.1 million), and savings ($12.2 million). It is expected that the Company's municipal deposits will decline through the rest of the year due to normal seasonal fluctuations.

The Company's retail deposit growth vehicle for the last three years has been its 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 demonstrate a deep relationship with the Bank as evidenced by regular use of their debit card, use of direct deposit, and electronic statements. However, the growth in NOW and savings deposits slowed in the first quarter as the Better Checking and Better Savings products begin to mature and the Company continued to lower rates on selected deposit products given the Company's current excess liquidity and declining net interest margin in this extended low rate environment.

Time deposits were $110.5 million at March 31, 2013, an increase of $1.6 million, or 1.4%, from December 31, 2012. Time deposit rates remain near historic lows, resulting in balance declines or low growth for the past three years, as customers have preferred liquid savings deposits.

Other borrowings, which typically include the Bank's overnight line of credit and other advances with the FHLBNY, were $12.0 million at March 31, 2013 and $19.0 million at December 31, 2012 as a $7.0 million advance with FHLBNY matured and was not replaced. The Company's deposit growth has outpaced its loan growth this year and remains in an overall liquid position. Therefore, the Company has not needed to replace or add to its wholesale borrowings.


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 and lease balances include both performing and non-performing loans and leases. Investments are included at amortized cost. Yields are presented on a non-tax-equivalent basis.

                                 Three Months Ended                      Three Months Ended
                                   March 31, 2013                          March 31, 2012
                           Average       Interest                  Average        Interest
                         Outstanding      Earned/     Yield/     Outstanding      Earned/     Yield/
                           Balance         Paid        Rate        Balance          Paid       Rate
                               (dollars in thousands)                  (dollars in thousands)
ASSETS
Interest-earning
assets:
Loans and leases, net    $   575,953      $  7,252    5.04  %    $   568,863       $ 7,508    5.28  %
Taxable securities            63,974           417    2.61  %         70,928           545    3.07  %
Tax-exempt securities         34,146           269    3.15  %         34,411           306    3.56  %
Interest bearing
deposits at banks             78,426            18    0.09  %         23,271             9    0.15  %

Total
interest-earning
assets                       752,499      $  7,956    4.23  %        697,473       $ 8,368    4.80  %

Non interest-earning
assets:

Cash and due from
banks                         14,376                                  11,470
Premises and
equipment, net                11,219                                  10,417
Other assets                  35,719                                  36,720

Total Assets             $   813,813                             $   756,080

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing
liabilities:
NOW                      $    67,836      $    113    0.67  %    $    55,116       $   139    1.01  %
Regular savings              380,783           327    0.34  %        348,166           585    0.67  %
Time deposits                110,209           450    1.63  %        112,079           518    1.85  %
Other borrowed funds          17,989           153    3.40  %         22,000           181    3.29  %
Junior subordinated
debentures                    11,330            79    2.79  %         11,330            87    3.07  %
Securities sold U/A
to repurchase                 14,374             8    0.22  %          9,182             6    0.26  %

Total
interest-bearing
liabilities                  602,521      $  1,130    0.75  %        557,873       $ 1,516    1.09  %

Noninterest-bearing
liabilities:
Demand deposits              122,359                                 114,783
Other                         12,856                                  13,418
Total liabilities        $   737,736                             $   686,074

Stockholders' equity          76,077                                  70,006

Total Liabilities and
Equity                   $   813,813                             $   756,080

Net interest earnings                   $    6,826                               $   6,852

Net interest margin                                   3.63  %                                 3.93  %

Interest rate spread                                  3.48  %                                 3.71  %


Net Income

Net income decreased to $1.8 million, or $0.43 per diluted share, in the first quarter of 2013, down 23.7% from net income of $2.4 million, or $0.58 per diluted share, in the first quarter of 2012. The decline in net income reflected a $0.7 million year-over-year increase in the provision for loan and lease losses. Return on average equity was 9.55% for the first quarter of 2013 compared with 13.59% in the first quarter of 2012.

Other Results of Operations - Quarterly Comparison

Net interest income was $6.8 million for the 2013 first quarter, down 0.4% when compared with the first quarter of 2012, and down 3.9% when compared with the fourth quarter of 2012. The performance of net interest income has been driven by slow growth in the loan portfolio and a declining net interest margin. Average net loans and leases of $576.0 million in the first quarter of 2013 were $7.1 million, or 1.2% higher than last year's first quarter, but $9.5 million, or 1.6% lower than the average balance in the fourth quarter of 2012.

The Company's net interest margin decreased to 3.63% for the first quarter of 2013, down from the fourth quarter 2012 margin of 3.78% and down from 3.93% in the first quarter of 2012. The decrease in the net interest margin is a result of the continued declining interest rate environment. When compared with last year's first quarter, the Company was able to only partially offset the 57 basis point decrease in yield on interest-earning assets through re-pricing its interest bearing liabilities by 34 basis points. The contribution of interest-free funds declined by 7 basis points in the first quarter of 2013 when compared with the first quarter of 2012.

The Company's loan and investment portfolios continue to re-price into lower yields, as evidenced by a decrease in yield on interest-earning assets of 25 basis points from the fourth quarter of 2012.

The provision for loan and lease losses increased to $0.5 million in the first quarter of 2013 from a reserve release of ($0.2) million in the prior year's first quarter. The first quarter of 2012 benefitted from a release of $0.4 million in leasing reserves after continued improvement in the leasing portfolio's performance, compared with less than $0.1 million in leasing reserve release in the first quarter of 2013. The provision for loan losses (excluding leases) increased from $0.2 million in the first quarter of 2012 to $0.5 million in first quarter of 2013 due to the increase in special mention and substandard loans, as discussed in the "Credit Quality of the Loan Portfolio" section of the "Analysis of Financial Condition," above, in this Management's Discussion and Analysis.

Non-interest income, which represented 32.7% of total revenue in the first quarter of 2013, increased 0.7%, or $22 thousand, to $3.3 million when compared with the first quarter of 2012. Insurance agency revenue of $2.0 million was up $54 thousand, or 2.8%, when compared with the 2012 first quarter due mostly to an increase in commercial lines revenue. Service charges on deposits increased 10.6% to $0.5 million due to more competitive pricing and the acquisition of commercial deposit customers. These positive variances were somewhat offset by decreases in premiums on loans sold and a lower mortgage servicing rights value due to fewer loans being sold to FNMA.

Total non-interest expense was $7.1 million in the first quarter of 2013, an increase of 2.4%, from $6.9 million in the first quarter of 2012. The largest component of the increase was in occupancy expense and salaries and employee benefits expense. The increase in occupancy expense of $0.1 million can be attributed to a write-off of software which is no longer going to be utilized. The increase in salaries and benefits expense of $0.1 million, or 1.8%, reflects merit salary increases for employees.

As a result of the increase in non-interest expense and lack of growth in revenue, the efficiency ratio increased to 69.20% for the first quarter of 2013 from 67.10% for the first quarter of 2012.

Income tax expense for the quarter ended March 31, 2013, was $0.8 million, representing an effective tax rate of 30.4% compared with an effective tax rate of 31.7% in the first quarter of 2012. The decrease in tax rate in the first quarter was primarily due to the recognition of a previously unrecognized tax benefit related to the expiration of a statute from the 2009 tax year.

CAPITAL

The Company consistently maintains regulatory capital ratios measurably above the federal "well capitalized" standard, including a Tier 1 leverage ratio of 9.87% and 9.69% at March 31, 2013 and December 31, 2012, respectively. Book value per share of the Company's common stock was $18.26 at March 31, 2013, compared with $17.94 at December 31, 2012. Tangible book value per share (a non-GAAP measure) at March 31, 2013 was $16.26, compared with $15.92 at December 31, 2012. The increase in both book value and tangible book value per share is a result of the Company's $1.8 million in net income.

Tangible book value per share is a non-GAAP financial measure. [The Company calculates tangible book value per share by dividing tangible book value by the number of common shares outstanding, as compared to GAAP book value per share, which the Company calculates by dividing GAAP book value by the number of common shares outstanding.] Management believes that this information is consistent with treatment by bank regulatory agencies, which exclude intangible assets from the calculation of risk-based capital


ratios. Accordingly, management believes that this non-GAAP financial measure provides information that is important to investors and that is useful in . . .

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