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EVBN > SEC Filings for EVBN > Form 10-Q on 1-Nov-2013All Recent SEC Filings

Show all filings for EVANS BANCORP INC

Form 10-Q for EVANS BANCORP INC


1-Nov-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


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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 as of 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 nine month period ended September 30, 2013 that resulted in an interim impairment test.

ANALYSIS OF FINANCIAL CONDITION

Loan and Lease Activity

Total loans and leases grew to $625.6 million at September 30, 2013, a $17.8 million, or 2.9%, increase from total loans and leases of $607.8 million at June 30, 2013, and a $42.7 million, or 7.3%, increase from $582.9 million at December 31, 2012.

Loans secured by real estate were $506.6 million at September 30, 2013, reflecting a $15.2 million, or 3.1%, increase from $491.4 million at June 30, 2013, and a $28.6 million or 6.0% increase from December 31, 2012. The Company's commercial real estate portfolio has historically been the fastest growing part of the portfolio, however, the largest year-to-date growth of $21.8 million, or 31.9%, was experienced in the Company's residential mortgage portfolio. In the third quarter of 2013, residential mortgages increased $9.6 million, or 12.0%, since June 30, 2013. Commercial construction and commercial and multi-family loans increased $5.3 million, or 1.5%, since June 30, 2013, and $7.0 million, or 2.0%, since December 31, 2012.

The Company continued to retain more of its originated residential mortgages during the third quarter of 2013, selling fewer loans to FNMA than it has in the past. Residential mortgages increased to $90.0 million at September 30, 2013, reflecting a $9.6 million, or 12.0%, increase from June 30, 2013. Residential mortgage originations increased to $12.8 million and $31.0 million in the three and nine month periods ended September 30, 2013, respectively, compared with $9.0 million and $24.1 million in the three and nine month periods ended September 30, 2012, respectively.

The Bank sells certain fixed rate residential mortgages to FNMA, while maintaining the servicing rights for those mortgages. In the three month period ended September 30, 2013, the Bank did not sell any mortgages to FNMA, as compared with $6.0 million during the three month period ended September 30, 2012. During the nine month period ended September 30, 2013, the Bank sold mortgages to FNMA totaling $0.8 million, as compared with $17.1 million sold for the nine month period ended September 30, 2012. At September 30, 2013, the Bank had a loan servicing portfolio principal balance of $65.8 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 September 30, 2013 and December 31, 2012. At September 30, 2013, there were no residential mortgage loans held-for-sale, compared with $0.9 million at December 31, 2012. The Company had no commercial loans held-for-sale at September 30, 2013 and 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. Declining line of credit usage and loan payoffs had resulted in a decrease in C&I balances during 2012. In the third quarter of 2013, C&I balances increased $4.8 million or 4.3% from $112.3 million at June 30, 2013 to $117.1 million at September 30, 2013. On a year-to-date basis, C&I loans increased $17.1 million or 17.1% from $100.0 million at December 31, 2012.


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The leasing portfolio continued to roll-off under the Company's 2009 decision to exit the direct financing leasing business. At September 30, 2013, there was no net book value for direct financing leases, due to a $0.3 million direct financing lease receivable and an offsetting $0.3 million mark-to-market balance. Direct financing leases were $0.3 million at June 30, 2013, and $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 $14.3 million, or 2.29% of total loans and leases outstanding, as of September 30, 2013, compared with $13.5 million, or 2.21% of total loans and leases outstanding, at June 30, 2013, and $8.2 million, or 1.41%, of total loans and leases outstanding at December 31, 2012. The year-to-date increase of $6.1 million, or 73.9%, in non-performing loans and leases is due to a single commercial mortgage credit relationship that moved into non-accrual status in the second quarter of 2013. Management believes that this commercial mortgage loan is well-secured by collateral value, and was successfully restructured with a new borrower in the current quarter.

In the third quarter of 2013, commercial credits graded as "special mention" and "substandard" increased $7.3 million from $21.5 million at June 30, 2013 to $28.8 million at September 30, 2013, primarily due to an increase in commercial and multi-family mortgages classified as "special mention" during the third quarter. "Special mention" and "substandard" commercial credits have increased $12.8 million from $16.0 million as of December 31, 2012, primarily due to a $7.9 million downgrade to of a well-secured commercial mortgage to "substandard" in the second quarter of 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. As of September 30, 2013, $17.0 million, or 92.1%, of the $18.4 million "substandard" credits were identified as impaired, and thus, individually evaluated for specific reserves.

The allowance for loan and lease losses totaled $10.9 million, or 1.74% of total loans and leases outstanding as of September 30, 2013, compared with $10.3 million, or 1.69% of total loans and leases outstanding as of June 30, 2013, and $9.7 million or 1.67% at December 31, 2012. The $1.2 million increase in the allowance from December 31, 2012 resulted from a $0.6 million provision in the third quarter of 2013 due to the termination of a loss share agreement with the FDIC, a $0.8 million provision for loan and lease losses recorded during the first nine months of 2013, and minimal net charge-offs of less than $0.2 million during the first nine months of the year. The net charge-off (recovery) ratio in the third quarter of 2013 equated to 0.09% ratio of average net loans and leases, compared with a ratio of 0.31% in the third quarter of 2012.

The third quarter coverage ratio of the allowance for loan and lease losses to non-performing loans and leases of 76.1% remained consistent with the prior quarter of 76.2%, and decreased from 118% at December 31, 2012, due to the increase in non-performing loans and leases in the first nine months of 2013, as discussed above.

Investing Activities

Total securities were $96.3 million at September 30, 2013, compared with $96.5 million at June 30, 2013, and $95.8 million at December 31, 2012, respectively. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, decreased to $42.7 million at September 30, 2013 from $59.8 million at June 30, 2013 and $78.1 million at December 31, 2012. Interest-bearing cash decreased in the third quarter due to loan growth and bank-owned life insurance purchases. Securities and interest-bearing deposits at correspondent banks made up 20.1% of the Bank's total average interest earning assets in the third quarter, compared with 23.0% and 20.0% in the second quarter of 2013 and third quarter of 2012, respectively.

The Company's highest concentration in its securities portfolio was in tax-advantaged debt securities issued by state and political subdivisions with 34.8% at September 30, 2013, compared with 33.7% at June 30, 2013 and 32.9% at December 31, 2012. The concentration in U.S. government-sponsored agency bonds was 29.5% of the total securities portfolio at September 30, 2013, compared with 30.5% at June 30, 2013 and 29.6% at December 31, 2012. U.S. government-sponsored mortgage-backed securities comprised 31.8% of the securities portfolio at September 30, 2013, compared with 32.0% and 33.7% at June 30, 2013 and December 31, 2012, respectively.

Management believes that the credit quality of the securities portfolio as a whole is strong as the portfolio has no individual securities in a significant unrealized loss position. While interest rates have been near historic lows, long-term rates increased in the third and second quarters of 2013, compared to the first quarter of 2013 and fourth quarter of 2012. As a result, the net unrealized gain position of the available-for-sale investment portfolio decreased from $4.0 million and $1.3 million at December 31, 2012 and June 30, 2013, respectively, to $1.1 million at September 30, 2013.


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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 $75.5 million at September 30, 2013, as compared with $77.0 million at June 30, 2013 and $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 September 30, 2013 were $702.6 million, compared with $692.4 million and $679.0 million at June 30, 2013 and December 31, 2012, respectively, reflecting a 1.5% increase from second quarter 2013 and a 3.5% increase from fourth quarter 2012. The increase in deposit balances since the second quarter of 2013 and the fourth quarter of 2012 was driven by growth in non-interest bearing demand deposit products. Demand deposits have increased $7.6 million, or 5.7%, and $17.0 million, or 13.8%, since June 30, 2013 and December 31, 2012, respectively.

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 three quarters of 2013 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.

In the third quarter of 2013, time deposits slightly increased to $112.3 million from $112.1 million at June 30, 2013, and increased $3.4 million, or 3.1%, 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 $9.0 million at September 30, 2013 and June 30, 2013, and $19.0 million at December 31, 2012. In the first quarter of 2013, a $7.0 million advance with FHLBNY matured and was not replaced, in addition to a $3.0 million maturity of an FHLBNY advance in the second quarter of 2013. The Company remains in an overall liquid position, and therefore has not needed to replace or add to its wholesale borrowings.


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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
                                 September 30, 2013                      September 30, 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    $   604,283      $  7,445    4.93  %    $   590,200       $ 7,567    5.13  %
Taxable securities            61,157           402    2.63  %         64,923           450    2.77  %
Tax-exempt securities         35,892           263    2.93  %         34,424           277    3.22  %
Interest bearing
deposits at banks             55,102            39    0.28  %         48,619            15    0.12  %

Total
interest-earning
assets                       756,434      $  8,149    4.31  %        738,166       $ 8,309    4.50  %

Non interest-earning
assets:

Cash and due from
banks                         14,525                                  10,941
Premises and
equipment, net                11,236                                  10,901
Other assets                  36,700                                  35,934

Total Assets             $   818,895                             $   795,942

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing
liabilities:
NOW                      $    66,926      $     80    0.48  %    $    62,283       $   161    1.03  %
Regular savings              379,306           282    0.30  %        374,170           494    0.53  %
Time deposits                111,774           444    1.59  %        108,179           451    1.67  %
Other borrowed funds           9,012            80    3.55  %         19,000           164    3.45  %
Junior subordinated
debentures                    11,330            82    2.89  %         11,330            88    3.11  %
Securities sold U/A
to repurchase                 14,348             7    0.20  %          9,553             6    0.25  %

Total
interest-bearing
liabilities                  592,696      $    975    0.66  %        584,515       $ 1,364    0.93  %

Noninterest-bearing
liabilities:
Demand deposits              135,491                                 124,590
Other                         12,323                                  13,186
Total liabilities        $   740,510                             $   722,291

Stockholders' equity          78,385                                  73,651

Total Liabilities and
Equity                   $   818,895                             $   795,942

Net interest earnings                   $    7,174                               $   6,945

Net interest margin                                   3.79  %                                 3.76  %

Interest rate spread                                  3.65  %                                 3.57  %


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                                 Nine Months Ended                        Nine Months Ended
                                September 30, 2013                       September 30, 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                     $   588,640      $ 21,974    4.98  %    $   578,003       $ 22,596     5.21  %
Taxable securities           63,047         1,223    2.59  %         67,852          1,452     2.85  %
Tax-exempt
securities                   35,351           799    3.01  %         34,145            879     3.43  %
Interest bearing
deposits at banks            69,323           103    0.20  %         36,959             39     0.14  %

Total
interest-earning
assets                      756,361      $ 24,099    4.25  %        716,959       $ 24,966     4.64  %

Non interest-earning
assets:

Cash and due from
banks                        14,308                                  11,239
Premises and
equipment, net               11,280                                  10,586
Other assets                 35,933                                  36,315

Total Assets            $   817,882                             $   775,099

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing
liabilities:
NOW                     $    68,149      $    279    0.55  %    $    59,266       $    451     1.01  %
Regular savings             381,871           883    0.31  %        361,528          1,583     0.58  %
Time deposits               111,205         1,344    1.61  %        109,844          1,460     1.77  %
Other borrowed funds         12,517           325    3.46  %         20,548            517     3.35  %
Junior subordinated
debentures                   11,330           243    2.86  %         11,330            261     3.07  %
Securities sold U/A
to repurchase                14,484            22    0.20  %          9,261             16     0.23  %

Total
interest-bearing
liabilities                 599,556      $  3,096    0.69  %        571,777       $  4,288     1.00  %

Noninterest-bearing
liabilities:
Demand deposits             128,782                                 118,524
Other                        12,057                                  13,020
Total liabilities       $   740,395                             $   703,321

Stockholders' equity         77,487                                  71,778

Total Liabilities
and Equity              $   817,882                             $   775,099

Net interest
earnings                               $   21,003                               $   20,678

Net interest margin                                  3.70  %                                   3.85  %

Interest rate spread                                 3.56  %                                   3.64  %


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Net Income

Net income was $2.4 million in the third quarter of 2013, a 14.7% increase from $2.1 million in the third quarter of 2012. The improvement in net income reflects a combination of higher net interest income, lower non-interest expense and increased fee income, partially offset by an increase in the provision for loan and lease losses. Return on average equity increased to 12.50% for the third quarter of 2013, compared with 11.60% in the third quarter of 2012.

For the nine months ended September 30, 2013, the Company recorded net income of $6.2 million, or $1.47 per diluted share, a 3.0% increase from net income of $6.0 million, or $1.45 per diluted share, in the same period in 2012. The return . . .

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