United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 2019
☐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.)
One Grimsby Drive, Hamburg, NY 14075
(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:
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Title of each class |
Trading Symbol(s) |
Name of each exchange on which registered |
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Common Stock, $0.50 par value |
EVBN |
NYSE American |
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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 ☒ 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 ☒ 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.
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Large Accelerated Filer ☐ |
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Accelerated Filer ☒ |
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Non-accelerated Filer ☐ |
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Smaller Reporting Company ☒ |
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Emerging Growth Company ☐ |
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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 ☒
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, 4,923,879 shares as of October 30, 2019.
EVANS BANCORP, INC. AND SUBSIDIARIES
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PART 1. FINANCIAL INFORMATION |
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Item 1. |
Financial Statements |
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Unaudited Consolidated Balance Sheets – September 30, 2019 and December 31, 2018 |
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Unaudited Consolidated Statements of Income – Three months ended September 30, 2019 and 2018 |
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Unaudited Consolidated Statements of Income – Nine months ended September 30, 2019 and 2018 |
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Unaudited Consolidated Statements of Cash Flows - Nine months ended September 30, 2019 and 2018 |
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Item 2. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Item 3. |
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Item 4. |
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PART II. OTHER INFORMATION |
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Item 1. |
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Item 1A. |
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Item 2. |
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Item 3. |
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Item 4. |
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Item 5. |
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Item 6. |
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EVANS BANCORP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2019 AND 2018
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 subsidiaries, Frontier Claims Services, Inc. (“FCS”) and 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 results of operations for the three and nine month periods ended September 30, 2019 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, 2018 (“10-K”). The Company’s significant accounting policies are disclosed in Note 1 to the 10-K.
The Financial Accounting Standards Board (“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. ASUs listed below were adopted by the Company during its current fiscal year. ASUs not listed below did not have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
On January 1, 2019, the Company adopted ASU 2016-02 Leases and all subsequent amendments (collectively, “ASU 2016-02”). The objective of this ASU is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements to meet that objective. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Under this new guidance, a lessee should recognize in the statement of financial position a liability to make lease payments and a right-of-use (“ROU”) asset representing its right to use the underlying asset for the lease term. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP.
ASU 2016-02 required a modified retrospective transition approach, applying the new standard to all leases existing at the date of initial application. The Company elected to use the effective date, January 1, 2019, as our date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification.
Under ASU 2016-02, leases are classified as finance or operating, with the classification affecting the pattern and classification of expense recognition in the income statement. The Company’s leases, consisting of property leases for certain of our bank branches and insurance agency offices, are classified as operating leases. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As these leases do not provide an implicit rate, we use our incremental borrowing rate in determining the present value of lease payments. Our lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
9
ASU 2016-02 had an impact on the Company’s consolidated balance sheets, but did not have an impact on the consolidated statements of income or the consolidated statements of cash flows. The most significant impacts upon adoption on January 1, 2019 were the recognition of $4.3 million of ROU assets and $4.7 million of lease liabilities, including $0.4 million of liabilities that were reported in other liabilities in the Company’s December 31, 2018 consolidated balance sheet. ROU assets and lease liability were $3.9 million and $4.3 million, respectively, at September 30, 2019. Operating lease expenses during the three and nine month periods ended September 30, 2019 were $178 thousand and $535 thousand, respectively, and are included in other non-interest expense on the consolidated statement of income. Cash paid for amounts included in the measurement of lease liabilities during the three and nine month periods ended September 30, 2019 were $185 thousand and $553 thousand, respectively, and are included in cash flows from operating activities on the consolidated statement of cash flows. The weighted average discount rate related to the Company’s leases was 3.5% as of September 30, 2019. The weighted average remaining lease term related to the Company’s leases was 8.7 years as of September 30, 2019. Future minimum lease payments under non-cancellable leases as of September 30, 2019 were as follows:
10
2. SECURITIES
The amortized cost of securities and their approximate fair value at September 30, 2019 and December 31, 2018 were as follows:
11
Available for sale securities with a total fair value of $91 million and $94 million at September 30, 2019 and December 31, 2018, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law.
The scheduled maturities of debt and mortgage-backed securities at September 30, 2019 and December 31, 2018 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.
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.
Information regarding unrealized losses within the Company’s available for sale and held to maturity securities at September 30, 2019 and December 31, 2018 is summarized below. The securities are primarily U.S. government-guaranteed agency securities or municipal securities.
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Management has assessed the securities available for sale in an unrealized loss position at September 30, 2019 and December 31, 2018 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 has not recorded any other-than-temporary impairment (“OTTI”) charges as of September 30, 2019 and did not record any OTTI charges during 2018. The credit worthiness of the Company’s securities portfolio is largely reliant on the ability of U.S. government sponsored agencies such as Federal Home Loan Bank (“FHLB”), Federal National Mortgage Association (“FNMA”), Government National Mortgage Association (“GNMA”), and 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 of the Company’s securities portfolio in future periods.
3. 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:
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Level 1 inputs are quoted prices for identical instruments in active markets; |
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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 |
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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 September 30, 2019 and December 31, 2018, respectively:
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Securities available for sale
Fair values for securities are determined using independent pricing services and market-participating brokers. The Company’s independent pricing service 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 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, model processes, such as the Option Adjusted Spread model, are used 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 Company’s service provider may occasionally 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.
Management believes that it has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of securities to enable management to maintain an appropriate system of internal control. On a quarterly basis, the Company reviews changes in the market value of its security portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on an annual basis, the Company has its entire security portfolio priced by a second pricing service to determine consistency with another market evaluator. If, during the Company’s review or when comparing with another servicer, a material difference between pricing evaluations were to exist, the Company would submit an inquiry to the 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 the initial 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.
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Mortgage servicing rights
Mortgage servicing rights (“MSRs”) do not trade in an active, open market with readily observable prices. Accordingly, the Company obtains the fair value of the MSRs using a third-party pricing provider. The provider determines the fair value by discounting projected net servicing cash flows of the remaining servicing portfolio. The valuation model used by the provider considers market loan prepayment predictions and other economic factors which management considers to be significant unobservable inputs. The fair value of MSRs is mostly affected by changes in mortgage interest rates since rate changes cause the loan prepayment acceleration factors to increase or decrease. Management has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of MSRs to enable management to maintain an appropriate system of internal control. MSRs are classified within Level 3 of the fair value hierarchy as the valuation is model driven and primarily based on unobservable inputs.
The following table summarizes the changes in fair value for MSRs:
Quantitative information about the significant unobservable inputs used in the fair value measurement of MSRs at the respective dates is as follows:
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September 30, 2019 |
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December 31, 2018 |
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Servicing fees |
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0.25 |
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0.25 |
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Discount rate |
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9.00 |
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9.00 |
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Prepayment rate (CPR) |
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8.62 |
% |
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6.52 |
% |
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FINANCIAL INSTRUMENTS 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 at September 30, 2019 and December 31, 2018:
Collateral dependent impaired loans
The Company evaluates and values 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 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. 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.
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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 $16.0 million, with an allowance for loan loss of $0.5 million, at September 30, 2019 compared with $21.7 million and $1.1 million, respectively, at December 31, 2018.
FAIR VALUE OF FINANCIAL INSTRUMENTS
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.
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4. LOANS AND THE ALLOWANCE FOR LOAN LOSSES
Loan Portfolio Composition
The following table presents selected information on the composition of the Company’s loan portfolio as of the dates indicated:
The Bank sells certain fixed rate residential mortgages to FNMA while maintaining the servicing rights for those mortgages. In the three month and nine month periods ended September 30, 2019, the Bank sold mortgages to FNMA totaling $3.0 million and $7.6 million, respectively, compared with $0.4 million mortgages sold during the three and nine month periods ended September 30, 2018., The Bank had a loan servicing portfolio principal balance of $74 million and $73 million at September 30, 2019 and December 31, 2018, respectively, upon which it earned servicing fees. The value of the mortgage servicing rights for that portfolio was $0.5 million and $0.6 million at September 30, 2019 and December 31, 2018, respectively. At September 30, 2019 and December 31, 2018 there were $0.5 million and $0.4 million in residential mortgages held for sale, respectively. The Company has never been contacted by FNMA to repurchase any loans due to improper documentation or fraud.
As noted in Note 1, these 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, 2018. Disclosures related to the basis for accounting for loans, the method for recognizing interest income on loans, the policy for placing loans on nonaccrual status and the subsequent recording of payments and resuming accrual of interest, the policy for determining past due status, a description of the Company’s accounting policies and methodology used to estimate the allowance for loan losses, the policy for charging-off loans, the accounting policies for impaired loans, and more descriptive information on the Company’s credit risk ratings are all contained in the Notes to the Audited Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Unless otherwise noted in this Form 10-Q, the policies and methodology described in the Annual Report for the year ended December 31, 2018 are consistent with those utilized by the Company in the three and nine month periods ended September 30, 2019.
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Credit Quality Indicators
The Bank monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for its commercial mortgage and commercial and industrial (“C&I”) 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:
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Acceptable or better |
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Watch |
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Special Mention |
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Substandard |
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Doubtful |
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Loss |
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 provide data, at the class level, of credit quality indicators of certain loans for the dates specified:
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Past Due Loans
The following tables provide an analysis of the age of the recorded investment in loans that are past due as of the dates indicated:
Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2019.
Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of December 31, 2018.
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Allowance for loan losses
The following tables present the activity in the allowance for loan losses according to portfolio segment for the nine month periods ended September 30, 2019 and 2018:
* Includes construction loans
Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2019.
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* Includes construction loans
Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2018.
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The following tables present the activity in the allowance for loan losses according to portfolio segment for the three month periods ended September 30, 2019 and 2018:
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Impaired Loans
The following tables provide data, at the class level, for impaired loans as of the dates indicated:
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Troubled debt restructurings
The following tables summarize the loans that were classified as troubled debt restructurings as of the dates indicated:
Any TDR that is placed on non-accrual is not reverted back to accruing status until the borrower makes timely payments as contracted for at least six months and future collection under the revised terms is probable. All of the Company’s restructurings were allowed in an effort to maximize its ability to collect on loans where borrowers were experiencing financial difficulty.
The reserve for a TDR is based upon the present value of the future expected cash flows discounted at the loan’s original effective interest rate or upon the fair value of the collateral less costs to sell, if the loan is deemed collateral dependent. This reserve methodology is used because all TDR loans are considered impaired. As of September 30, 2019, there were no commitments to lend additional funds to debtors owing on loans whose terms have been modified in TDRs.
The Company’s TDRs have various agreements that involve deferral of principal payments, or interest-only payments, for a period (usually 12 months or less) to allow the borrower time to improve cash flow or sell the property. Other common concessions leading to the designation of a TDR are lines of credit that are termed-out and/or extensions of maturities at rates that are less than the prevailing market rates given the risk profile of the borrower.
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The following tables show the data for TDR activity by the type of concession granted to the borrower for the three and nine month periods ended September 30, 2019 and 2018:
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The general practice of the Bank is to work with borrowers so that they are able to repay their loan in full. If a borrower continues to be delinquent or cannot meet the terms of a TDR and the loan is determined to be uncollectible, the loan will be charged-off to its collateral value. A loan is considered in default when the loan is 90 days past due. Loans which were classified as TDRs during the previous 12 months which defaulted during the nine month periods ended September 30, 2019 and 2018 were not material.
5. 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 and nine month periods ended September 30, 2019, the Company had an average of 57,899 and 68,660 dilutive shares outstanding, respectively. The Company had an average of 116,504 and 125,801 dilutive shares outstanding for the three and nine month periods ended September 30, 2018.
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and not included in calculating diluted earnings per share. For the three and nine month periods ended September 30, 2019, there was an average of 82,642 and 85,579 potentially anti-dilutive shares outstanding, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive. For the three and nine month periods ended September 30, 2018 there were no anti-dilutive shares outstanding.
6. OTHER COMPREHENSIVE INCOME
The following tables summarize the changes in the components of accumulated other comprehensive income (loss) during the three and nine month periods ended September 30, 2019 and 2018:
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Included in net periodic pension cost, as described in Note 9 – “Net Periodic Benefit Costs” |
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(a) |
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Included in net periodic pension cost, as described in Note 9 – “Net Periodic Benefit Costs” |
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7. 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 and nine month periods ended September 30, 2019 and 2018.
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8. 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:
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September 30, |
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December 31, |
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2019 |
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2018 |
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(in thousands) |
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Commitments to extend credit |
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$ |
347,081 |
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$ |
290,785 |
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Standby letters of credit |
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4,432 |
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3,379 |
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Total |
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$ |
351,513 |
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$ |
294,164 |
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 nine months of 2019 or during 2018.
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.
9. 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 and nine month periods ended September 30, 2019 and 2018:
34
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.
10. 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:
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TEA earns commission revenue from selling commercial and personal property and casualty (“P&C”) insurance as well as employee benefits (“EB”) 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.
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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.
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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.
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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.
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Insurance claims services revenue is recorded at FCS. |
FCS has signed agreements with insurance companies to perform claims services including investigative and adjustment services related to residential and commercial lines. The performance obligation is for FCS to investigate the insurance claims and inspecting the damage to determine the extent of the insurance company’s liability. FCS is paid based on time and materials expended to investigate the claim. The rates paid are determined in the agreement between FCS and the respective insurance companies. Upon completion of its claims inspection work, FCS bills the insurance company for services rendered and recognizes the revenue earned.
A disaggregation of the total insurance service and other fees for the three and nine month periods ended September 30, 2019 and 2018 is provided in the tables below:
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11. RECENT ACCOUNTING PRONOUNCEMENTS
Note 1 contains details on the impact of accounting pronouncements adopted during the nine months ended September 30, 2019. The following standards will be adopted in future periods. ASUs not listed below are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Both financial institutions and users of their financial statements expressed concern that current GAAP restricts the ability to record credit losses that are expected, but do not yet meet the “probable” threshold. The main objective of this ASU (commonly known as the Current Expected Credit Loss Impairment Model, or CECL, in the industry) 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 in current GAAP 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. The life of loan loss concept presents complexities that can decrease capital, and add both volatility to the allowance for loan losses estimates and additional costs. Changes in expectations of future economic conditions will play a large role in CECL and can significantly affect the credit loss estimate. The Company is developing its approach for determining expected credit losses under the new guidance, including the licensing of new software and the development of processes to track loan performance. The total impact of CECL to the Company’s financial statements is unknown but may be material. On October 16, 2019, the FASB affirmed its decision to amend the effective date for the amendments in CECL for smaller reporting companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is allowed for fiscal years beginning after December 15, 2018. The Company intends to early adopt CECL effective January 1, 2021. Implementation of CECL will be a significant project for the Company through the projected implementation date of January 1, 2021.
ASU 2018-13, Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement – The amendments in this ASU modify the disclosure requirements on fair value measurements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Adoption of this ASU will impact the Company’s disclosures but will not impact the Company’s financial condition, results of operations or cash flows.
ASU 2018-14, Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans – The amendments in this ASU remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. The amendments in this ASU are effective for fiscal years ending after December 15, 2020. Adoption of this ASU will impact the Company’s disclosures but will not impact the Company’s financial condition, results of operations or cash flows.
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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; loan losses in excess of the Company’s allowance for loan 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, 2018. 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.
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, 2018. 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.
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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 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 Losses
The allowance for loan losses represents management’s estimate of probable losses in the Company’s loan portfolio. Determining the amount of the allowance for loan 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, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan 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, 2018 describes the methodology used to determine the allowance for loan 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 performed annually as of December 31. No impairment charges were incurred in the most recent test and the fair value of the tested reporting unit substantially exceeded its carrying value. There were no triggering events in the nine-month period ended September 30, 2019 that resulted in an interim impairment test.
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ANALYSIS OF FINANCIAL CONDITION
Loan Activity
Total gross loans were $1.2 billion at September 30, 2019, a $7 million or 1% increase from June 30, 2019 and a $64 million or 6% increase from December 31, 2018.
Loans secured by real estate were $954 million at September 30, 2019, reflecting a $12 million or 1% increase from $942 million at June 30, 2019 and a $27 million or 3% increase from $927 million at December 31, 2018. Commercial real estate loans, including construction loans, were $724 million at September 30, 2019, $13 million or 2% higher than the $711 million balance at the end of the second quarter of 2019 and $26 million or 4% higher than the $698 million balance at the end of the fourth quarter of 2018. Commercial real estate is the largest part of the Company’s loan portfolio and has historically been the highest growth segment of the portfolio. The market for commercial real estate in the Company’s footprint in Western New York has been strong in recent years. The demand, along with the Company’s dedicated resources to commercial real estate lending, led to 7% annualized growth rate in the third quarter of 2019.
Residential mortgage originations were $6 million in the third and second quarters of 2019, compared with $14 million in last year’s third quarter. The Company originated $19 million in residential mortgages in the first nine months of 2019, compared to $35 million in the first nine months of 2018. The decrease in residential mortgage originations is attributable to reduced staffing in 2019. Residential mortgages sold in the third quarter of 2019 equated to approximately 49% of the residential mortgages originated by the Company during the quarter, as compared with 43% in the second quarter of 2019 and 3% in the third quarter of 2018. Residential mortgages sold in the first nine months of 2019 were 41% of residential mortgages originated during the period compared with 1% in the first nine months of 2018. Management decides to keep or sell residential mortgage loans at the time of origination based on interest rate risk management and the risk-adjusted return of alternative investment sources such as mortgage-backed securities.
The Company has also focused on growth opportunities in commercial and industrial (“C&I”) lending as a way to diversify its overall loan portfolio. The C&I portfolio was $262 million at September 30, 2019, representing a $6 million or 2% decrease from $268 million at June 30, 2019 but a $36 million or 16% increase from $226 million at December 31, 2018. The increase in C&I balances during the first nine months of 2019 equates to a 21% annualized growth rate. C&I lending is a critical component of the Company’s strategy as C&I relationships can often include core deposits.
Credit Quality of Loan Portfolio
Total non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $14 million, or 1.13% of total loans outstanding at September 30, 2019, compared with $11 million, or 0.91% of total loans outstanding, as of June 30, 2019 and $19 million, or 1.64% of total loans outstanding, as of December 31, 2018. The increase in non-performing loans compared with the second quarter of 2019 reflects $2.3 million related to a single C&I relationship that was changed to nonaccrual status during the third quarter of 2019. The decrease in non-performing loans compared with December 31, 2018 is due to a payoff of a single commercial construction loan of $8 million that was in nonaccrual status.
Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $54 million at September 30, 2019, a $11 million increase from $43 million at June 30, 2019 and $16 million increase from $38 million at December 31, 2018. The increase in criticized loans in the third quarter of 2019 includes $8 million in commercial real estate loans and $3 million in C&I loans that were downgraded to criticized during the quarter. In comparison to December 31, 2018, the increase includes $20 million in commercial real estate loans and $9 million in C&I loans that were downgraded to criticized in the first nine months of 2019, offset by paydowns of $13 million including the paydown of a single commercial construction loan of $8 million. 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. As noted in Note 4 to the Company’s Unaudited Financial Statements included in Part I of this Quarterly Report on Form 10-Q, internal risk ratings are the credit quality indicators used by the Company’s management to determine the appropriate allowance for loan losses for commercial credits. “Special mention” and “substandard” loans are weaker credits with a higher risk of loss categorized as “criticized” credits rather than “pass” or “watch” credits.
The Company maintains an allowance for loan losses that in management’s judgment appropriately reflects losses inherent in the loan portfolio. The allowance for loan losses totaled $15.4 million at September 30, 2019, $15.2 million at June 30, 2019, and $14.8 million at December 31, 2018. At the end of September 30, 2019 and June 30, 2019 the allowance for loan losses was 1.26% of total loans outstanding, compared with 1.28% of total loans outstanding as of December 31, 2018. The Company released $0.4 million in allowance for loan losses in the third quarter of 2019, compared to $0.1 million in provision for loan losses in the second quarter of 2019, and $0.3 million provision for loan loss in last year’s third quarter. The release of allowance for loan losses in the third quarter of 2019 reflects a decrease in net loan charge-offs due to a single commercial loan recovery of $0.7 million, partially offset by an increase in non-performing loans.
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Investing Activities
Total investment securities were $137 million at September 30, 2019 and June 30, 2019 compared with $134 million at December 31, 2018. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, decreased to $15 million at September 30, 2019 from $46 million at June 30, 2019 and $26 million at December 31, 2018. 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. With the flattened yield curve there is a reduced advantage to purchasing longer-term investment securities. Average investment securities and interest-bearing cash were 12% of average interest-earning assets in the third quarter of 2019 and 2018, compared with 13% in the second quarter of 2019.
The Company’s highest concentration in its securities portfolio was in available-for-sale U.S. government sponsored mortgage-backed securities at 74% of total investment securities at September 30, 2019 compared with 70% at June 30, 2019 and 57% at December 31, 2018. The concentration in tax-advantaged debt securities issued by state and political subdivisions and U.S. government-sponsored agency bonds was 5% and 21%, respectively, of the total securities portfolio at September 30, 2019, compared with 4% and 26% at June 30, 2019 and 18% and 25% at December 31, 2018.
The total net unrealized gain position of the available-for-sale investment portfolio was $1.3 million and $0.6 million at September 30, 2019 and June 30, 2019, respectively, compared with a net unrealized loss position of $3.2 million at December 31, 2018. The changes in unrealized gains and losses during 2019 resulted primarily from a rebalancing of the investment portfolio. The securities in an unrealized loss position at the end of the third quarter of 2019 reflect differences in market interest rates rather than a reduction in credit concerns. 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 were $1.26 billion at September 30, 2019 compared with $1.28 billion at June 30, 2019. Total deposits increased $44 million or 4% from $1.22 billion at December 31, 2018. The increase during the first nine months of 2019 reflects growth in demand deposits of $40 million, NOW deposits (interest-bearing checking accounts) of $31 million, offset by a $24 million decrease in time deposits and a $3 million decrease in savings deposits. Further discussion of deposit growth and changes in deposit mix are in the “Analysis of Results of Operations.”
The Company had $10 million in other borrowings at September 30, 2019 and December 31, 2018. This represents a single $10 million long-term advance with the FHLBNY scheduled to mature in 2020. 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 no overnight borrowings at September 30, 2019.
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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 balances include both performing and non-performing loans. Investments are included at book value. Yields are presented on a non-tax-equivalent basis.
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Net Income
Net income was $5.2 million, or $1.04 per diluted share, in the third quarter of 2019, compared with $4.4 million, or $0.88 per diluted share, in the second quarter of 2019 and $4.8 million, or $0.97 per diluted share, in last year’s third quarter. The increase over comparative periods reflects higher net interest income due to loan growth and a decrease in loan loss provision, partially offset by an increase in non-interest expense. Return on average equity was 14.29% for the third quarter of 2019, compared with 12.71% in the second quarter of 2019 and 15.35% in the third quarter of 2018.
Other Results of Operations – Quarterly Comparison
Net interest income increased $0.5 million, or 4%, from the second quarter of 2019, and $1.5 million, or 13%, from the prior-year third quarter to $13.6 million in the third quarter of 2019. The increases were driven by growth in the commercial loan portfolio, partially offset by an increase in interest expense. Average commercial loans, including commercial real estate and commercial and industrial loans, were $983 million, up $18 million from the 2019 second quarter and $65 million from the 2018 third quarter. The third quarter of 2019 also included $0.2 million of interest related to the recovery of a single commercial loan that was charged-off in a previous period.
Third quarter net interest margin of 3.94%. When excluding the interest related to the recovery, net interest margin was 3.89%, an increase of 2 basis points from the 2019 second quarter and 16 basis points from the third quarter of 2018. The modest increase from the linked quarter resulted from changes in the mix of interest earning assets reflecting the utilization of cash to achieve loan growth, while the change from the prior year reflects increased yields on loans, offset by higher funding costs, reflecting higher interest rates and competitive deposit market pricing. Excluding the interest related to the recovery, the yield on loans increased 30 basis points when compared with the third quarter of 2018. The cost of interest-bearing liabilities was 1.24% in the third quarter of 2019, compared with 1.23% in the second quarter of 2019 and 1.04% in the third quarter of 2018.
The Company released $0.4 million of allowance for loan losses in the third quarter of 2019. Provision for loan losses was $0.1 million in the second quarter of 2019 and $0.3 million in the third quarter of 2018. The release of allowance for loan losses during the third quarter of 2019 reflects a decrease in net loan charge-offs due to the single commercial loan recovery of $0.7 million, partially offset by an increase in non-performing loans.
Non-interest income was $5.2 million in the third quarter of 2019, compared with $4.7 million in the second quarter of 2019 and $4.8 million in the prior year third quarter. The increase in non-interest income compared with the prior quarter is primarily due to seasonally higher insurance revenue. Other income in the third quarter of 2019 includes $0.2 million of insurance proceeds related to legal and professional fees incurred to respond to a data security incident and related matters.
Non-interest expenses of $12.3 million in the third quarter of 2019 increased 7% from the prior-year period and 1% from the second quarter of 2019. The most significant component of the increase was higher salaries and employee benefit costs as a result of severance and the addition of strategic personnel hires to support the Company’s continued growth. Salaries and employee benefits costs were $7.6 million in the third quarter of 2019, an increase of 8% from last year’s third quarter.
Professional services fees was relatively flat compared to the second quarter of 2019, but was $0.4 million higher than last year’s third quarter. The increase in professional service fees includes $0.2 million related to legal and professional fees incurred to respond to a data security incident and related matters, plus incremental project costs designed to enhance technology and continue to be prepared to respond to future threats which impact the banking industry at large. The increase from the prior year period also includes $0.1 million of broker commissions related to our employee benefits insurance business, and generally higher legal and accounting expenses.
Technology and communications expenses were $1.1 million in the third quarter and second quarter of 2019, an increase of $0.2 million from the last year’s third quarter. The increase in technology and communications was due to higher software costs and volume related ATM card fees and online banking activity.
The third quarter of 2019 FDIC insurance expense was offset by the application of the FDIC’s small bank assessment credit.
The Company’s efficiency ratio improved to 64.8% compared with 67.5% in the second quarter of 2019 and 66.9% in last year’s third quarter.
Income tax expense was $1.8 million, or an effective tax rate of 25.6%, for the third quarter of 2019 compared with 22.1% in the second quarter of 2019 and 6.7% in the third quarter of 2018. Last year’s third quarter income taxes were reduced by $0.7 million due to a change in estimate of when certain state historic tax credits will be taxable for federal purposes. Historic tax credit transactions lowered the effective tax rate by 13.8% in the third quarter of 2018.
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Other Results of Operations – Year-to-Date Comparison
Net interest income was $39.3 million for the first nine months of 2019, a $3.5 million or 10% increase from the first nine months of 2018. The increase in net interest income is attributable to a $99 million or 8% increase in average interest-earning assets and $0.2 million of interest related to the recovery of a single commercial loan that was previously written-off. The increase in average interest-earning assets reflects average loan growth of $82 million or 7% to $1.2 billion during the first nine months of 2019 compared to the first nine months of 2018. Most of the growth was in commercial loans, including $46 million in average commercial real estate loans and $15 million in average C&I loans. Additionally, average interest-bearing deposits at banks increased $26 million during the first nine months of 2019 compared to the first nine months of 2018.
The Company’s net interest margin of 3.87% in the first nine months of 2019 was 7 basis points higher than the first nine months of 2018. The yield on average interest-earning assets increased 30 basis points from 4.50% to 4.80%. Average loan yields increased 34 basis points from 4.78% to 5.12%, reflecting the benefit of variable loan re-pricing as short-term interest rates rise. The cost of interest-bearing liabilities was 1.22%, or 32 basis points higher in the first nine months of 2019 when compared with the first nine months of 2018. In reaction to the competitive deposit market the Company has increased promotional pricing on certain deposit products, primarily time deposits. The rate paid on average time deposits increased from 1.65% in the first nine months of 2018 to 2.17% during the first nine months of 2019. The higher overall cost of interest-bearing liabilities also reflects a shift in the Company’s funding mix as the average balance of higher cost time deposits increased. Average time deposits were 28% of total interest-bearing liabilities in the nine-month period ended September 30, 2019, compared with 23% in the first nine months of 2018.
The Company recorded $0.2 million in provision for loan losses in the first nine months period ended September 30, 2019, compared with $1.7 million in the nine-month period ended September 30, 2018. The decrease in provision for loan losses during the first nine months of 2019 compared with the prior year period reflects a decrease in non-performing loans during the current year period, primarily due to the paydown of a single commercial construction loan of $8 million, and a decrease in net loan charge-offs due to the single commercial loan recovery of $0.7 million.
Non-interest income for the first nine months of 2019 increased $1.9 million from the prior year period to $14.1 million. The increase was a result of higher insurance service and fees revenue of $1.4 million resulting from the 2018 acquisition of Richardson and Stout, Inc., and higher deposit service charges of $0.2 million.
Total non-interest expense increased to $35.6 million in the first nine months of 2019, 12% higher than the nine-month period ended September 30, 2018. The increase was mostly attributable to an increase in salaries and employee benefits costs. Salaries and employee benefits costs were $22.3 million for the first nine months of 2019, a $2.1 million or 10% increase from $20.2 million in the prior year period. The year-over-year increase in salary and benefits expense reflects severance and strategic personnel hires to support the Company’s growth. Professional services expenses increased $0.8 million to $2.7 million, primarily due to $0.2 million related to legal and professional fees incurred to respond to a data security incident and related matters, $0.2 million of broker commissions related to our employee benefits insurance business and generally higher legal and accounting expenses. Technology and communications expenses increased $0.6 million to $3.0 million, reflecting higher software costs and volume relating to ATM card fees and online banking activity. FDIC insurance was $0.4 million lower in the first nine months of 2019 when compared to the first nine months of 2018 as a result of lower non-performing assets and the FDIC’s small bank assessment credit.
The Company’s efficiency ratio for the first nine months of 2019 was 66.2%, compared with 66.0% during the prior-year period. The slight increase in the ratio reflects the increase in non-interest expenses, partially offset by the increase in net interest income and non-interest income.
The Company recorded income tax expense of $4.2 million for the nine-month period ended September 30, 2019, compared with $2.5 million in the first nine months of 2018. The effective tax rate for the first nine months of 2019 was 24.2%, compared with 17.2% in the comparable 2018 period. The impact of the historic tax credits on the effective tax rate for the first nine months of 2018 was 5.0%. Income taxes for the first nine months of 2018 were reduced by $0.7 million due to a change in estimate of when certain state historic tax credits will be taxable for federal purposes.
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CAPITAL
The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 10.11% at September 30, 2019, compared with 9.99% at June 30, 2019 and 9.73% at December 31, 2018. Book value per share increased to $29.44 at September 30, 2019, compared with $28.74 at June 30, 2019, and $27.13 at December 31, 2018.
On August 22, 2019, the Company declared a semi-annual cash dividend of $0.52 per share on the Company’s outstanding common stock. The dividend was paid on October 2, 2019 to shareholders of record as of September 11, 2019. For the full year of 2019, cash dividends totaled $1.04, up 13% over 2018.
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 Federal Home Loan Bank of New York as its primary source of overnight funds and also has one long-term advance with FHLBNY. The Company had $10 million in borrowed funds at FHLBNY at September 30, 2019 and December 31, 2018. 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 time 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. Advances of up to $280 million can be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. The Bank also has 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. 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 September 30, 2019, approximately 4% of the Bank’s securities had contractual maturity dates of one year or less and approximately 9% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprise 74% of the investment portfolio at September 30, 2019, 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 90-day liquidity 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 September 30, 2019, the Company had net short-term liquidity of $202 million as compared with $249 million at December 31, 2018. Available assets of $154 million, divided by public and purchased funds of $292 million, resulted in a long-term liquidity ratio of 53% at September 30, 2019, compared with 63% at December 31, 2018.
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.
46
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.
47
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
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|
Calculated increase (decrease) |
||||
|
|
|
in projected annual net interest income |
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|
|
(in thousands) |
||||
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|
|
|
|
|
|
|
|
|
|
|
September 30, 2019 |
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|
December 31, 2018 |
|
Changes in interest rates |
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
+200 basis points |
|
$ |
(51) |
|
$ |
1,598 |
|
+100 basis points |
|
|
2,153 |
|
|
2,825 |
|
|
|
|
|
|
|
|
|
-100 basis points |
|
|
(2,292) |
|
|
(3,026) |
|
-200 basis points |
|
|
NM |
|
|
NM |
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 September 30, 2019 (the end of the period covered by this Report). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that as of September 30, 2019 the Company’s disclosure controls and procedures were effective.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes in the Company’s internal control over financial reporting were identified 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 September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
48
PART II - OTHER INFORMATION
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.
There have been no material changes in risk factors relating to the Company to those disclosed in response to Item 1A. Part I of Form 10-K for the year ended December 31, 2018.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In the third quarter of 2019, the Company did not purchase shares of its common stock.
Issuer Purchases of Equity Securities
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|
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|
|
|
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 (1) |
||
|
July 2019: |
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|
|
|
|
|
|
|
|
|
|
July 1, 2019 - July 31, 2019 |
|
|
- |
|
$ |
- |
|
- |
|
100,000 |
|
August 2019: |
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|
|
|
|
|
|
|
|
|
|
August 1, 2019 - August 31, 2019 |
|
|
- |
|
$ |
- |
|
- |
|
100,000 |
|
September 2019: |
|
|
|
|
|
|
|
|
|
|
|
September 1, 2019 - September 30, 2019 |
|
|
- |
|
$ |
- |
|
- |
|
100,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
|
- |
|
$ |
- |
|
- |
|
100,000 |
|
|
(1) |
|
On October 17, 2017, the Board of Directors authorized the Company to repurchase up to 100,000 shares of the Company’s common stock (the “2017 Repurchase Program”). The 2017 Repurchase Program expires 24 months after its adoption 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 2017 Repurchase Program as of September 30, 2019 was 100,000. |
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
(Not Applicable.)
ITEM 4 – MINE SAFETY DISCLOSURE
(Not Applicable.)
(Not Applicable.)
49
The following exhibits are filed as a part of this report:
50
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
October 31, 2019
|
|
|
/s/ David J. Nasca |
|
David J. Nasca |
|
President and CEO |
|
(Principal Executive Officer) |
DATE
October 31, 2019
|
|
|
/s/ John B. Connerton |
|
John B. Connerton |
|
Treasurer |
|
(Principal Financial Officer and Principal Accounting Officer) |
51
Certification
I, David J. Nasca, certify that:
1. I have reviewed this report on Form 10-Q of Evans Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: October 31, 2019
/s/ David J. Nasca
David J. Nasca
President and Chief Executive Officer
(Principal Executive Officer)
Certification
I, John B. Connerton, certify that:
1. I have reviewed this report on Form 10-Q of Evans Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: October 31, 2019
/s/ John B. Connerton
John B. Connerton
Treasurer
(Principal Financial Officer and Principal Accounting Officer)
CERTIFICATION OF PRINCIPAL EXECUTIVE AND FINANCIAL OFFICERS
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, David J. Nasca, the President and Chief Executive Officer of Evans Bancorp, Inc., certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) the Quarterly Report of Evans Bancorp, Inc. on Form 10-Q for the fiscal quarter ended September 30, 2019 fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and (2) the information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Evans Bancorp, Inc.
Date: October 31, 2019
|
|
|
|
By: |
/s/ David J. Nasca |
|
Name: |
David J. Nasca |
|
Title: |
President and Chief Executive Officer |
|
|
(Principal Executive Officer) |
CERTIFICATION OF PRINCIPAL EXECUTIVE AND FINANCIAL OFFICERS
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, John B. Connerton, the Treasurer of Evans Bancorp, Inc., certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) the Quarterly Report of Evans Bancorp, Inc. on Form 10-Q for the fiscal quarter ended September 30, 2019 fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and (2) the information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Evans Bancorp, Inc.
Date: October 31, 2019
|
|
|
|
By: |
/s/ John B. Connerton |
|
Name: |
John B. Connerton |
|
Title: |
Treasurer |
|
|
(Principal Financial Officer and Principal Accounting Officer) |