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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For fiscal year ended: December 31, 2003
[ ] 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: 0-18539
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.)
14-16 NORTH MAIN STREET, ANGOLA, NEW YORK 14006
- ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(716) 549-1000
---------------------------------------------------
Registrant's telephone number (including area code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.50 PER SHARE
--------------------------------------
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of The Act).
Yes [ ] No [X]
On June 30, 2003, the aggregate market value of the registrant's common stock,
$.50 par value, (the "Common Stock") held by nonaffiliates of the registrant was
approximately $42.4 million, based upon the closing price of a share of the
registrant's common stock as quoted by the Nasdaq National Market.
As of February 27, 2004, 2,476,227 shares of the registrant's Common Stock were
outstanding.
Page 1 of 112
Exhibit Index on Page 73
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement relating to the registrant's 2004
Annual Meeting of Shareholders, to be held on April 20, 2004, are incorporated
by reference into Part III of this Annual Report on Form 10-K where indicated.
2
TABLE OF CONTENTS
INDEX
PAGE
PART I
ITEM 1. BUSINESS ......................................................... 5
Evans Bancorp, Inc. ................................................... 5
Evans National Bank ................................................... 5
Forward Looking Statements ............................................ 6
Market Area ........................................................... 6
Average Balance Sheet Information ..................................... 7
Securities Activities ................................................. 8
Investment Policy ................................................... 8
Lending Activities .................................................... 10
General ............................................................. 10
Real Estate Loans ................................................... 10
Commercial Loans .................................................... 11
Installment Loans ................................................... 11
Student Loans ....................................................... 11
Other Loans ......................................................... 11
Loan Maturities ..................................................... 12
Loan Losses ......................................................... 13
Sources of Funds - Deposits ........................................... 14
General ............................................................. 14
Deposits ............................................................ 14
Federal Funds Purchased & Other Borrowed Funds ...................... 15
Securities Sold Under Agreements to Repurchase ...................... 15
Market Risk ........................................................... 15
Environmental Matters ................................................. 16
Competition ........................................................... 17
Regulation ............................................................ 17
Subsidiaries of the Bank .............................................. 19
M&W Agency, Inc ..................................................... 19
ENB Associates Inc .................................................. 20
Evans National Holding Corp ......................................... 20
Employees ............................................................. 20
ITEM 2. PROPERTIES ....................................................... 21
ITEM 3. LEGAL PROCEEDINGS ................................................ 21
ITEM 4. SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS .................................... 21
3
Page
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS .................................. 22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA ............................. 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................. 24
ITEM 7A.QUANTATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK ................................................ 39
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ......... 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES .......................... 72
ITEM 9A.CONTROLS AND PROCEDURES .......................................... 72
PART III
ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT ................................................... 72
ITEM 11.EXECUTIVE COMPENSATION ........................................... 72
ITEM 12.SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS .................................. 72
ITEM 13.CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS ............................................. 72
PART IV
ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES ........................... 72
ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K .......................................... 73
SIGNATURES ....................................................... 75
4
PART I
ITEM 1. BUSINESS
EVANS BANCORP, INC.
Evans Bancorp, Inc. (the "Company") was organized as a New York business
corporation and incorporated under the laws of the State of New York on October
28, 1988 for the purpose of becoming a bank holding company. The Company is
registered with the Federal Reserve Board as a bank holding company under the
Bank Holding Company Act of 1956, as amended. The Company conducts its business
through its wholly-owned subsidiary, Evans National Bank (the "Bank"), and the
Bank's subsidiaries, ENB Associates Inc. ("ENB"), M&W Agency, Inc. ("M&W"), and
Evans National Holding Corp. ("ENHC"). Unless the context otherwise requires,
the term "Company" refers to Evans Bancorp, Inc. and its subsidiary. The
Company's principal office is located at 14-16 North Main Street, Angola, New
York 14006 and its telephone number is (716)549-1000. The Company's common stock
is quoted on the Nasdaq National Market system under the symbol "EVBN."
The Bank is a nationally chartered bank founded in 1920 as a national banking
association and is currently regulated by the Office of the Comptroller of the
Currency. Prior to February 1995, the Bank was known as The Evans National Bank
of Angola. Its legal headquarters is located at 14-16 North Main Street, Angola,
New York 14006. The Bank's principal business is to provide a full range of
banking services to consumer and commercial customers in Erie, Chautauqua and
Cattaraugus Counties of Western New York.
The Bank serves its market through nine banking offices located in Amherst,
Angola, Derby, Evans, Forestville, Hamburg, Lancaster (as of January 2004),
North Boston and West Seneca, New York. The Bank's principal source of funding
is through deposits, which it reinvests in the community in the form of loans
and investments. The Bank offers deposit products, which include checking and
NOW accounts, passbook and statement savings and certificates of deposit.
Deposits are insured to the applicable limit by the Bank Insurance Fund ("BIF")
of the Federal Deposit Insurance Corporation ("FDIC"). The Bank offers a variety
of loan products to its customers including commercial loans, commercial and
residential mortgage loans, and consumer loans. The Bank is regulated by the
Office of the Comptroller of the Currency.
ENB, a wholly-owned subsidiary of the Bank, offers non-deposit investment
products, such as annuities and mutual funds, to the Bank's customers.
M&W Agency, Inc., a wholly-owned subsidiary of the Bank, is an insurance agency,
which sells various premium-based insurance policies on a commission basis. M&W
has offices located in Angola, Cattaraugus, Derby, Eden, Gowanda, Hamburg, North
Boston, Randolph, Silver Creek, South Dayton, and West Seneca, New York.
ENHC was incorporated in February 2002, as a subsidiary of the Bank. ENHC
operates as a real estate investment trust ("REIT"), which provides additional
flexibility and planning opportunities for the business of the Bank.
The Company operates in two reportable segments-banking activities and insurance
agency activities.
At December 31, 2003, the Bank had total assets of $334.7 million, total
deposits of $266.3 million and total stockholders' equity of $33.3 million.
5
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K may contain certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1993, 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", and
similar expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. 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 economic, competitive, regulatory, and other
factors affecting the Company's operations, markets, products and services, as
well as expansion strategies and other factors discussed elsewhere in this
report on Form 10-K, as well as in the Company's periodic reports filed with the
Securities and Exchange Commission. Many of these factors are beyond the
Company's control and difficult to predict. 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.
MARKET AREA
The Company's primary market area is located in Erie County, northern Chautauqua
County and northwestern Cattaraugus County, New York, which includes the towns
of Amherst, New York, Boston, New York, Cheektowaga, New York, Depew, New York,
Derby, New York, Evans, New York, Forestville, New York, Hamburg, New York,
Hanover, New York, Lancaster, New York, and West Seneca, New York. This market
area is the primary area where the Bank receives deposits and makes loans and
the M&W Agency sells insurance.
6
AVERAGE BALANCE SHEET INFORMATION
The table presents the significant categories of the assets and liabilities of
the Bank, interest income and interest expense, and the corresponding yields
earned and rates paid in 2003, 2002 and 2001. The assets and liabilities are
presented as daily averages. The average loan balances include both performing
and nonperforming loans. Interest income on loans does not include interest on
loans for which the Bank has ceased to accrue interest. Interest and yield are
not presented on a tax-equivalent basis.
2003 2002 2001
------------------------------- ---------------------------- ----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- ------ -------- -------- ------ -------- -------- ------
($000) ($000) ($000) ($000) ($000) ($000)
ASSETS
Interest-earning assets:
Loans, Net $167,145 $ 10,737 6.42% $145,676 $ 10,593 7.27% $135,436 $ 11,051 8.16%
Taxable securities 72,464 2,226 3.07% 48,902 2,554 5.22% 46,001 2,892 6.29%
Tax-exempt securities 52,658 2,288 4.35% 43,656 1,987 4.55% 33,040 1,571 4.75%
Time deposits-other banks 721 18 2.55% 146 5 3.34% -- -- --
Federal funds sold 5,017 61 1.21% 5,148 73 1.44% 3,214 133 4.14%
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total interest-earning assets 298,005 15,330 5.14% 243,528 15,212 6.25% 217,691 15,647 7.19%
Non interest-earning assets
Cash and due from banks 9,118 8,967 7,492
Premises and equipment, net 5,483 4,463 3,779
Other assets 13,743 8,315 8,130
-------- -------- --------
Total Assets $326,349 $265,273 $237,092
======== ======== ========
LIABILITIES & STOCKHOLDERS'
EQUITY
Interest-bearing liabilities:
NOW accounts $ 10,753 23 0.22% $ 9,678 44 0.45% $ 8,510 76 0.89%
Regular savings deposits 110,001 1,022 0.93% 75,741 841 1.11% 63,953 1,415 2.21%
Time deposits 99,775 2,819 2.83% 90,890 3,397 3.74% 86,005 4,516 5.25%
Fed funds purchased 933 29 3.08% -- -- -- -- -- --
Securities sold U/A to
repurchase 5,971 57 0.95% 3,989 67 1.69% 4,057 125 3.07%
FHLB advances 13,072 510 3.90% 8,627 447 5.18% 7,386 377 5.11%
M&W notes 827 24 2.89% 451 21 4.61% 363 28 7.73%
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total interest-bearing
liabilities 241,332 4,484 1.86% 189,376 4,817 2.54% 170,274 6,537 3.84%
Noninterest-bearing
liabilities:
Demand deposits 48,853 42,165 36,133
Other 4,299 4,889 4,437
-------- -------- --------
Total liabilities 294,484 236,430 210,844
Stockholders' equity 31,865 28,843 26,248
-------- -------- --------
Total Liabilities & Equity $326,349 $265,273 $237,092
======== ======== ========
Net interest earnings $ 10,846 $ 10,395 $ 9,110
======== ======== ========
Net yield on interest earning
assets 3.64% 4.27% 4.18%
In 2003, the Bank's interest income increased by $0.1 million from 2002,
compared to a decrease of $0.4 million in 2002 as compared to 2001. Interest
expense decreased by $0.3 million in 2003 from 2002 compared to a decrease of
$1.7 million in 2002 as compared to 2001.
7
SECURITIES ACTIVITIES
The primary objective of the Bank's securities portfolio is to provide liquidity
while maintaining safety of principal. Secondary objectives include investment
of funds in periods of decreased loan demand, interest sensitivity
considerations, providing collateral to secure local municipal deposits,
supporting local communities through the purchase of tax-exempt securities and
tax planning considerations. The Bank's Board of Directors is responsible for
establishing overall policy and reviewing performance.
The Bank's policy provides that acceptable portfolio investments include: U.S.
Government obligations, obligations of federal agencies, municipal obligations
(general obligations, revenue obligations, school districts and non-rated issues
from the Bank's general market area), banker's acceptances, certificates of
deposit, Industrial Development Authority Bonds, Public Housing Authority Bonds,
corporate bonds (each corporation limited to the Bank's legal lending limit),
collateral mortgage obligations, Federal Reserve stock and Federal Home Loan
Bank stock.
The Bank's investment policy is that in-state securities must be rated Moody's
BAA (or equivalent) at the time of purchase. Out-of-state issues must be rated
AA (or equivalent) at the time of purchase. Bonds or securities rated below A
are reviewed periodically to assure their continued credit worthiness. The
purchase of non-rated municipal securities is permitted, but limited to those
bonds issued by municipalities in the Bank's general market area which, in the
Bank's judgment, possess no greater credit risk than BAA (or equivalent) bonds.
The financial statements of the issuers of non-rated securities are reviewed by
the Bank and a credit file of the issuers is kept on each non-rated municipal
security with relevant financial information. In addition, the Bank's loan
policy permits the purchase of notes issued by various states and municipalities
which have not been rated by Moody's or Standard & Poors. The securities
portfolio of the Bank is priced on a monthly basis.
Statement of Financial Accounting Standard (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" promulgates accounting
treatment for investments in securities. All securities in the Bank's portfolio
are either designated as "held to maturity" or "available for sale."
Income from securities represented approximately 29.4% of total interest income
of the Company in 2003 as compared to 29.8% in 2002. At December 31, 2003, the
Bank's securities portfolio of $120.6 million consisted primarily of United
States ("U.S.") and federal agency obligations, state and municipal securities
and mortgage-backed securities issued by the Government National Mortgage
Association, Federal National Mortgage Association and Federal Home Loan
Mortgage Corp.
The following table summarizes the Bank's securities with those designated as
available for sale valued at fair value and securities designated as held to
maturity valued at amortized costs as of December 31, 2003 and 2002:
2003 2002
-------- --------
($000) ($000)
Available for Sale:
U.S. Treasury and other U.S. government agencies $ 62,426 $ 54,543
States and political subdivisions in the U.S. 52,527 47,240
FRB and FHLB Stock 1,854 1,248
-------- --------
Total Securities Designated as Available for Sale $116,807 $103,031
-------- --------
Held to Maturity:
U.S. Treasury and other U.S. government agencies $ 36 $ 37
States and political subdivisions in the U.S. 3,713 3,604
-------- --------
Total Securities Designated as Held to Maturity $ 3,749 $ 3,641
-------- --------
Total Securities $120,556 $106,672
======== ========
8
The following table sets forth the contractual maturities and weighted
average interest yields of the Bank's securities portfolio (yields on tax-exempt
obligations are not presented on a tax-equivalent basis) as of December 31,
2003:
Maturing
-------------------------------------------------------------------------------------
Within After One But After Five But After
One Year Within Five Years Within Ten Years Ten Years
------------------- ------------------- ------------------- -------------------
Amount Yield Amount Yield Amount Yield Amount Yield
($000) ($000) ($000) ($000)
CLASSIFIED AS AVAILABLE FOR
SALE AT FAIR VALUE:
U.S. Treasury and other U.S.
government agencies $ -- -- $ 12,058 3.35% $ 27,986 4.75% $ 22,382 4.95%
States and political subdivisions 1,927 4.90 5,046 4.68 26,053 4.58 19,501 4.77
-------- -------- -------- --------
Total Available for Sale $ 1,927 4.90% $ 17,104 3.75% $ 54,039 4.67% $ 41,883 4.87%
======== ======== ======== ========
CLASSIFIED AS HELD TO MATURITY
AT AMORTIZED COST:
U.S. Treasury and other U.S.
government agencies $ -- -- $ -- -- $ -- -- $ 36 --
States and political subdivisions 1,382 1.34 575 4.07 859 3.18 897 3.74
-------- -------- -------- --------
Total Held to Maturity 1,382 1.34 575 4.07 859 3.18 933 3.74
======== ======== ======== ========
Total Securities $ 3,309 3.37% $ 17,679 3.76% $ 54,898 4.65% $ 42,816 4.84%
======== ======== ======== ========
9
LENDING ACTIVITIES
GENERAL. The Bank has a loan policy which is approved by its Board of Directors
on an annual basis. The loan policy addresses the lending authorities of Bank
officers, charge off policies, desired portfolio mix, and loan approval
guidelines.
The Bank offers a variety of loan products to its customers including
residential and commercial real estate mortgage loans, commercial loans, and
installment loans. The Bank primarily extends loans to customers located within
the Western New York area. Income on loans represented approximately 70.0% of
the total interest income of the Company in 2003 and approximately 69.6% of
total interest income in 2002. The Bank's loan portfolio after unearned
discounts, loan origination costs and allowances for credit losses totaled
$185.5 million and $149.0 million at December 31, 2003 and December 31, 2002,
respectively. At December 31, 2003, the Bank had $2.5 million as an allowance
for loan losses which is approximately 1.35% of total loans. This compares with
approximately $2.1 million at December 31, 2002 which was approximately 1.42% of
total loans. The increase to the provision for loan losses to $0.5 million in
2003 from $0.4 million in 2002 reflects management's assessment of the portfolio
composition, of which higher risk commercial real estate loans have been an
increasing component, and its assessment of the New York State and local
economy. The net loan portfolio represented approximately 55.4% and 51.6% of the
Bank's total assets at December 31, 2003 and December 31, 2002, respectively.
REAL ESTATE LOANS. Approximately 84.8% of the Bank's loan portfolio at December
31, 2003 consisted of real estate loans or loans collateralized by mortgages on
real estate including residential mortgages, commercial mortgages and other
types of real estate loans. The Bank's real estate loan portfolio was $159.5
million at December 31, 2003, compared to $127.5 million at December 31, 2002.
The real estate loan portfolio increased approximately 25.1% in 2003 over 2002
compared to an increase of 4.3% in 2002 over 2001.
The Bank offers fixed rate residential mortgages with terms of ten to thirty
years with up to an 80% loan-to-value ratio. Fixed rate residential mortgage
loans outstanding totaled $18.4 million at December 31, 2003, which was
approximately 9.8% of total loans outstanding. In 1995, the Bank entered into a
contractual arrangement with the Federal National Mortgage Association (FNMA)
whereby mortgages can be sold to FNMA and the Bank retains the servicing rights.
In 2003, approximately $15.7 million of mortgages were sold to FNMA under this
arrangement compared to $11.6 million of mortgages sold in 2002. The Bank
currently retains the servicing rights on $30.9 million in mortgages sold to
FNMA. The Company has recorded no net servicing asset for such loans as it is
considered immaterial.
Since 1993, the Bank has offered adjustable rate residential mortgages with
terms of up to thirty years. Rates on these mortgages remain fixed for the first
three years and are adjusted annually thereafter. On December 31, 2003, the
Bank's outstanding adjustable rate mortgages were $2.2 million or 1.2% of total
loans. This balance did not include any construction mortgages.
The Bank also offers commercial mortgages with up to a 75% loan-to-value ratio
for up to fifteen years on a variable and fixed rate basis. Many of these
mortgages either mature or are subject to a rate call after three to five years.
The Bank's outstanding commercial mortgages were $104.0 million at December 31,
2003, which was approximately 55.3% of total loans outstanding. This balance
included $13.5 million in fixed rate and $90.4 million in variable rate loans,
which include rate calls.
The Bank also offers other types of loans collateralized by real estate such as
home equity loans. The Bank offers home equity loans at variable and fixed
interest rates with terms of up to fifteen years and up to an 80% loan-to-value
ratio. At December 31, 2003, the real estate loan portfolio included $26.9
million of home equity loans outstanding which represented approximately 14.3%
of its total loans outstanding. This balance included $18.3 million in variable
rate and $8.6 million in fixed rate loans.
The Bank also offers both residential and commercial real estate-construction
loans at up to an 80% loan-to-value ratio at fixed interest or adjustable
interest rates and multiple maturities. At December 31, 2003, fixed rate real
estate-construction loans outstanding were $0.4 million or 0.2% of the Bank's
loan portfolio, and adjustable rate construction loans outstanding were $4.7
million or 2.5% of the portfolio.
As of December 31, 2003, approximately $1.4 million or 0.9% of the Bank's real
estate loans were 30 to 90 days delinquent, and approximately $0.2 million or
0.1% of real estate loans were nonaccruing.
10
COMMERCIAL LOANS. The Bank offers commercial loans on a secured and unsecured
basis including lines of credit and term loans at fixed and variable interest
rates and multiple maturities. The Bank's commercial loan portfolio totaled
$24.3 million and $20.5 million at December 31, 2003 and December 31, 2002,
respectively. Commercial loans represented approximately 12.9% and 13.5% of the
Bank's total loans at December 31, 2003 and December 31, 2002, respectively.
As of December 31, 2003, none of the Bank's commercial loans were 30 to 90 days
past due and $0.04 million or 0.2% of its commercial loans were nonaccruing.
Commercial lending entails significant additional risk as compared with real
estate loans. Collateral, where applicable, may consist of inventory,
receivables, equipment and other business assets. Approximately seventy-three
percent of the Bank's commercial loans are variable rate which are tied to the
prime rate.
INSTALLMENT LOANS. The Bank's installment loan portfolio (which includes
personal loans and revolving credit card balances) totaled $2.6 million and $2.4
million at December 31, 2003 and December 31, 2002, respectively, representing
approximately 1.4% of the Bank's total loans at December 31, 2003 and 1.6% of
the Bank's total loans at December 31, 2002. Traditional installment loans are
offered at fixed interest rates with various maturities up to 60 months, on a
secured and unsecured basis. At December 31, 2003, the installment loan
portfolio included $0.2 million in fixed rate credit card balances at an
interest rate of 15.6% and $0.08 million in the variable rate option. As of
December 31, 2003, approximately $0.06 million or 2.2% of the Bank's installment
loans were 30-90 days past due.
STUDENT LOANS. During 2002, the Bank completed the sale of all direct student
loans and entered into an agreement whereby it facilitates the submission of
student loan applications to the Student Loan Marketing Association (SLMA) for a
fee. The loans are then originated and subsequently serviced by SLMA. This
change was made in order to enhance application response time, as well as Bank
profitability.
OTHER LOANS. Other loans totaled $1.2 at December 31, 2003 and $0.5 million at
December 31, 2002. Other loans consisted primarily of loans to municipalities,
hospitals, churches and non-profit organizations. These loans are at fixed or
variable interest rates with multiple maturities. Other loans also include
overdrafts, which totaled $0.8 million and $0.1 million December 31, 2003 and
2002, respectively.
The Bank's ability to lend larger amounts to any one borrower is subject to
regulation by the Comptroller of the Currency. The Bank continually monitors its
loan portfolio to review compliance with new and existing regulations.
11
The following table summarizes the major classifications of the Bank's loans
(net of deferred origination costs) as of the dates indicated.
December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Mortgage loans on real estate:
Residential 1-4 family $ 30,160 $ 26,712 $ 31,035 $ 33,375 $ 31,683
Commercial and multi-family 99,684 77,919 70,853 57,219 47,265
Construction 5,090 2,174 1,520 1,966 3,538
Second mortgages 6,274 6,919 8,188 7,648 7,851
Equity lines of credit 18,262 13,780 10,684 8,976 8,517
---------- ---------- ---------- ---------- ----------
Total mortgage loans 159,470 127,504 122,280 109,184 98,854
Commercial loans 24,282 20,460 16,338 14,783 14,186
Consumer installment loans:
Personal 2,277 2,054 2,759 2,994 2,365
Credit cards 292 298 334 483 364
Other 1,209 492 2,191 2,391 1,101
---------- ---------- ---------- ---------- ----------
Total consumer installment loans: 3,778 2,844 5,284 5,868 3,830
Net deferred loan origination costs 537 336 353 372 401
---------- ---------- ---------- ---------- ----------
Total Loans 188,067 151,144 144,255 130,207 117,271
Allowance for loan losses (2,539) (2,146) (1,786) (1,428) (838)
---------- ---------- ---------- ---------- ----------
Net loans $ 185,528 $ 148,998 $ 142,469 $ 128,779 $ 116,433
========== ========== ========== ========== ==========
LOAN MATURITIES AND SENSITIVITIES OF LOANS IN INTEREST RATES. The following
table shows the maturities of commercial and real estate construction loans
outstanding as of December 31, 2003 and the classification of loans due after
one year According to sensitivity to changes in interest rates.
($000)
0-1 Year 1-5 Years Over 5 Years Total
-------- --------- ------------ -------
Commercial $ 3,474 $ 10,406 $ 10,402 $24,282
Real estate construction 3,346 1,744 -- 5,090
------- -------- ------------ -------
$ 6,820 $ 12,150 $ 10,402 $29,372
======= ======== ============ =======
Loans maturing after one year with:
Fixed Rates $ 4,890 $ 132
Variable Rates 7,260 10,270
------- -------
$12,150 $10,402
======= =======
12
NON-ACCRUAL, PAST DUE AND RESTRUCTURED LOANS. The following table summarizes the
Bank's non-accrual and accruing loans 90 days or more past due as of December
31, for the dates listed below. The Bank had no restructured loans as of those
dates. Any loans classified for regulatory purposes as loss, doubtful,
substandard or special mention that have not been disclosed do not (i) represent
or result from trends or uncertainties which management reasonably expects will
materially impact future operating results, liquidity or capital resources, or
(ii) represent material credit about which management has serious doubts as to
the ability of such borrowers to comply with the loan repayment terms. See also
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Results of Operations - Allowance for Loan Losses."
At December 31,
----------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
($000)
Non-accruing loans:
One-to-four family $ - $ - $ - $ - $ -
Home equity - - - - -
Commercial real estate & multi family 256 1,104 545 1,071 1,532
Consumer - - - - -
Commercial business 40 93 179 124 193
------ ------ ------ ------ ------
Total $ 296 $1,197 $ 724 $1,195 $1,725
====== ====== ====== ====== ======
Accruing loans 90+ days past due 627 - 443 263 -
------ ------ ------ ------ ------
Total non-performing loans 923 1,197 1,167 1,458 1,725
====== ====== ====== ====== ======
Total non-performing loans to total assets 0.27% 0.36% 0.35% 0.44% 0.52%
====== ====== ====== ====== ======
Total non-performing loans to total loans 0.49% 0.79% 0.81% 1.13% 1.52%
====== ====== ====== ====== ======
The following table summarizes the Bank's allowance for loan losses and changes
in the allowance for loan losses by loan categories:
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR LOAN LOSSSES
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
($000)
BALANCE AT THE BEGINNING OF THE YEAR $ 2,146 $ 1,786 $ 1,428 $ 838 $ 729
CHARGE-OFFS
Commercial (54) (14) (24) (54) (26)
Real estate-mortgages (30) (42) (42) (48) (25)
Installment loans (11) (20) (14) (3) (19)
-------- -------- -------- -------- --------
TOTAL CHARGE-OFFS (95) (76) (80) (105) (70)
RECOVERIES
Commercial 7 2 11 - 1
Real estate-mortgages - - 1 1 -
Installment loans 1 14 6 5 8
-------- -------- -------- -------- --------
TOTAL RECOVERIES 8 16 18 6 9
-------- -------- -------- -------- --------
NET CHARGE-OFFS (87) (60) (62) (99) (61)
PROVISION FOR LOAN LOSSES 480 420 420 689 170
-------- -------- -------- -------- --------
BALANCE AT END OF YEAR $ 2,539 $ 2,146 $ 1,786 $ 1,428 $ 838
======== ======== ======== ======== ========
13
Management's provision for loan losses reflects the continued growth trend in
higher risk commercial loans and the Bank's assessment of the local and New York
State economic environment. Both the local and New York State economies have
lagged behind national prosperity which remains unsettled. Marginal job growth,
in conjunction with a declining population base, has left the Bank's market more
susceptible to potential credit problems. This is particularly true of
commercial borrowers. Commercial loans represent a segment of significant past
growth as well as concentration in the Company's commercial real estate
portfolio. Commercial real estate values may be susceptible to decline in an
adverse economy. Management believes that the reserve is also in accordance with
the regulations promulgated by the Office of the Comptroller of the Currency,
and is reflective of its assessment of the local environment as well as a
continued trend in commercial loans.
SOURCES OF FUNDS - DEPOSITS
GENERAL. Customer deposits represent the major source of the Bank's funds for
lending and other investment purposes. In addition to deposits, other sources of
funds include loan repayments, loan sales on the secondary market, interest and
dividends from investments, matured investments, and borrowings from the Federal
Reserve Bank and the Federal Home Loan Bank, and from the First Tennessee Bank,
which is a correspondent bank.
DEPOSITS. The Bank offers a variety of deposit products including checking,
passbook, statement savings, NOW accounts, certificates of deposit and jumbo
certificates of deposit. Deposits of the Bank are insured up to the limits
provided by the Federal Deposit Insurance Corporation ("FDIC"). At December 31,
2003, the Bank's deposits totaled $266.3 million consisting of the following (in
thousands):
Demand deposits $ 51,885
NOW accounts 11,464
Regular savings 105,599
Time deposits, $100,000 and over 35,648
Other time deposits 61,729
--------
Total $266,325
========
The following table shows daily average deposits and average rates paid on
significant deposit categories by the Bank:
2003 2002 2001
------------------- ------------------- -------------------
Average Weighted Average Weighted Average Weighted
Balance Average Balance Average Balance Average
($000) Rate ($000) Rate ($000) Rate
Demand deposits $ 48,853 0.00% $ 42,165 0.00% $ 36,133 0.00%
NOW accounts 10,753 0.22% 9,678 0.45% 8,510 0.89%
Regular savings 110,001 0.93% 75,741 1.11% 63,953 2.21%
Time deposits 99,775 2.83% 90,890 3.74% 86,005 5.25%
-------- -------- --------
Total $269,382 1.43% $218,474 1.96% $194,601 3.09%
======== ======== ========
14
FEDERAL FUNDS PURCHASED AND OTHER BORROWED FUNDS. Another source of the Bank's
funds for lending and investing activities at December 31, 2003 consisted of
short and long term borrowings from the Federal Home Loan Bank.
Other borrowed funds consisted of various advances from the Federal Home Loan
Bank with both fixed and variable interest rate terms ranging from 1.10% to
5.34%. The maturities of other borrowed funds are as follows (in thousands):
2004 $15,936
2005 1,518
2006 760
2007 145
2008 28
Thereafter 7,000
-------
Total $25,387
=======
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. The Bank enters into agreements
with depositors to sell to the depositors securities owned by the Bank and
repurchase the identical security, generally within one day. No physical
movement of the securities is involved. The depositor is informed the securities
are held in safekeeping by the Bank on behalf of the depositor. Securities sold
under agreements to repurchase totaled $5.5 million at December 31, 2003
compared to $6.5 million at December 31, 2002.
MARKET RISK
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 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 the future
periods under various interest rate scenarios using projected balances for
earning assets and interest-bearing liabilities. Management's philosophy toward
interest rate risk management is to limit the variability of net interest
income. The balances of financial instruments used in the projections are based
on expected growth from forecasted business opportunities, anticipated
prepayments of loans and investment securities and expected maturities of
investment securities, loans and deposits. Management supplements the modeling
technique described above with analysis of market values of the Company'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
computer model that considers the impact of ongoing lending and deposit
gathering 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, changes
in the pricing of loan and deposit products, modifying the composition of
interest-earning assets and interest-bearing liabilities, and other financial
instruments used for interest rate risk management purposes.
15
SENSITIVITY OF NET INTERESTINCOME
TO CHANGES IN INTERESTRATES
Calculated increase (decrease)
in projected annual net interest income
Changes in interest rates December 31, 2003 December 31, 2002
- ------------------------- ----------------- -----------------
($000) ($000)
+200 basis points $ 515 $ 311
- -200 basis points (1,390) (435)
Many assumptions were utilized by the Bank to calculate the impact that changes
in interest rates may have on 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 also assumed
immediate changes in rates including 100 and 200 basis point rate changes. In
the event that a 100 or 200 basis point rate change cannot be achieved, the
applicable rate changes are limited to lesser amounts such that interest rates
cannot be less than zero. These assumptions 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 above and
changes in such amounts are not considered significant to the Bank's projected
net interest income.
The following schedule sets forth the maturities of the Bank's time deposits as
of December 31, 2003:
Time Deposit Maturity Schedule
(in millions)
0-3 3-6 6-12 over
Mos. Mos. Mos. 12 Mos. Total
----- ----- ----- ------- -----
Time deposits - $100,000 and over $10.4 $ 2.2 $ 4.8 $ 18.3 $35.7
Other time deposits 7.6 6.8 16.2 31.1 61.7
----- ----- ----- ------- -----
Total time deposits $18.0 $ 9.0 $21.0 $ 49.4 $97.4
===== ===== ===== ======= =====
ENVIRONMENTAL MATTERS
To date, the Bank has not been required to perform any investigation or clean-up
activities, nor has it been subject to any environmental claims. There can be no
assurance, however, that this will remain the case in the future.
In the course of its business, the Bank has acquired and may acquire in the
future, property securing loans that are in default. There is a risk that the
Bank could be required to investigate and clean-up hazardous or toxic substances
or chemical releases at such properties after acquisition by the Bank, and may
be held liable to a governmental entity or third parties for property damage,
personal injury and investigation and clean-up costs incurred by such parties in
connection with such contamination. In addition, the owner or former owners of
contaminated sites may be subject to common law claims by third parties based on
damages and costs resulting from environmental contamination emanating from such
property.
16
COMPETITION
All phases of the Bank's business are highly competitive. The Bank competes
actively with local commercial banks as well as other commercial banks with
branches in the Bank's market area of Erie County, northern Chautauqua County,
and Northwestern Cattaraugus County, New York. The Bank considers its major
competition to be HSBC Bank USA and Manufacturers and Traders Trust Company,
both headquartered in Buffalo, New York. Other major competition consists of Key
Bank, N.A., and Fleet National Bank of New York, both headquartered in Albany,
New York, First Niagara Bank, headquartered in Lockport, New York and also
Community Bank, N.A., headquartered in DeWitt, New York. Additional competition
includes Charter One Bank, headquartered in Cleveland, Ohio and Citibank, NA,
headquartered in Rochester, New York. The Bank attempts to be generally
competitive with all financial institutions in its service area with respect to
interest rates paid on time and savings deposits, service charges on deposit
accounts, and interest rates charged on loans.
REGULATION
The operations of the Bank are subject to federal and state statutes applicable
to banks chartered under the banking laws of the United States, to members of
the Federal Reserve System and to banks whose deposits are insured by the
Federal Deposit Insurance Corporation ("the FDIC"). Bank operations are also
subject to regulations of the Comptroller of the Currency, the Federal Reserve
Board, the FDIC and the New York State Banking Department.
The primary supervisory authority of the Bank is the Comptroller of the
Currency, who regularly examines the Bank. The Comptroller of the Currency has
the authority under the Financial Institutions Supervisory Act to prevent a
national bank from engaging in an unsafe or unsound practice in conducting its
business.
Federal and state banking laws and regulations govern, among other things, the
scope of a bank's business, the investments a bank may make, the reserves
against deposits a bank must maintain, the loans a bank makes and collateral it
takes, the activities of a bank with respect to mergers and consolidations and
the establishment of branches. Branches may be established within the permitted
areas of New York State only after approval by the Comptroller of the Currency.
A subsidiary bank (such as the Bank) of a bank holding company is subject to
certain restrictions imposed by the Federal Reserve Act on any extensions of
credit to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries and on
taking such stock or securities as collateral for loans. The Federal Reserve Act
and Federal Reserve Board regulations also place certain limitations and
reporting requirements on extensions of credit by a bank to principal
shareholders of its parent holding company, among others, and to related
interests of such principal shareholders. In addition, such legislation and
regulations would affect the terms upon which any person becoming a principal
shareholder of a holding company may obtain credit from banks with which the
subsidiary bank maintains a correspondent relationship.
Federal law also prohibits acquisitions of control of a bank holding company
(such as the Company) without prior notice to certain federal bank regulators.
Control is defined for this purpose as the power, directly, or indirectly, to
direct the management or policies of the bank or bank holding company or to vote
25% or more of any class of voting securities of the bank holding company.
In addition to the restrictions imposed upon a bank holding company's ability to
acquire control of additional banks, federal law generally prohibits a bank
holding company from acquiring a direct or indirect interest in, or control of
5% or more of the outstanding voting shares of any company, and from engaging
directly or indirectly in activities other than that of banking, managing or
controlling banks or furnishing services to subsidiaries, except that a bank
holding company may engage in, and may own shares of companies engaged in
certain activities found by the Federal Reserve Board to be closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The Gramm-Leach-Bliley Act of 1999 modernized the laws regarding the financial
services industry by expanding considerably the powers of banks and bank holding
companies to sell financial products and services. The Act authorizes operating
subsidiaries of national banks to sell financial products without geographic
limitation, reforms the Federal Home Loan Bank system to increase access to loan
funding, protects banks from certain state insurance regulation considered
discriminatory and includes new provision in the area of privacy and customer
information. The Bank utilized the provisions of this Act to commence the
operations of M&W Agency, Inc. and ENB Associates Inc.
The USA Patriot Act imposes additional obligations on U.S. financial
institutions, including banks, to implement policies, procedures and controls,
which are reasonably designed to detect and report instances of money laundering
and the financing of terrorism.
17
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of the Bank. It cannot be predicted whether any such legislation will
be adopted or how such legislation would affect the business of the Bank. As a
consequence of the extensive regulation of commercial banking activities in the
United States, the Bank's business is particularly susceptible to being affected
by federal legislation and regulations that may increase the costs of doing
business.
Under the Federal Deposit Insurance Act, the Comptroller of the Currency
possesses the power to prohibit institutions regulated by it (such as the Bank)
from engaging in any activity that would be an unsafe and unsound banking
practice or would otherwise be in violation of law. Moreover, the Financial
Institutions and Interest Rate Control Act of 1978 ("FIRA") generally expanded
the circumstances under which officers or directors of a bank may be removed by
the institution's federal supervisory agency, restricts lending by a bank to its
executive officers, directors, principal shareholders or related interests
thereof, restricts management personnel of a bank from serving as directors or
in other management positions with certain depository institutions whose assets
exceed a specified amount or which have an office within a specified geographic
area, and restricts management personnel from borrowing from another institution
that has a correspondent relationship with their bank. Additionally, FIRA
requires that no person may acquire control of a bank unless the appropriate
federal supervisory agency has been given 60 days prior written notice and
within that time has not disapproved of the acquisition or extended the period
for disapproval.
Under the Community Reinvestment Act of 1977, the Comptroller of the Currency is
required to assess the record of all financial institutions regulated by it to
determine if these institutions are meeting the credit needs of the communities
(including low and moderate income neighborhoods) which they serve and to take
this record into account in its evaluation of any application made by any such
institutions for, among other things, approval of a branch or other deposit
facility, office relocation, a merger or an acquisition of bank shares.
The Company must give prior notice to the Federal Reserve Board of certain
purchases or redemptions of its outstanding equity securities. The Federal
Reserve Board has adopted capital adequacy guidelines for bank holding companies
(on a consolidated basis) substantially similar to those that apply to the Bank.
Under guidelines adopted in January 1989, bank holding companies with at least
$150 million in assets are required to maintain a ratio of qualifying total
capital to risk weighted assets of at least 8% effective December 31, 1993. For
bank holding companies with less than $150 million in assets, the
above-described ratio will not apply on a consolidated basis, but will apply on
a bank-only basis unless (i) the parent holding company is engaged in non-bank
activities involving significant leverage, or (ii) the parent holding company
has a significant amount of outstanding debt held by the general public. The
Federal Reserve Board has the discretionary authority to require higher capital
ratios.
In connection with the risk-based capital framework applicable to bank holding
companies described above, the Federal Reserve Board applies a risk-based
capital framework for Federal Reserve member banks, such as the Bank. The
framework requires banks to maintain minimum capital levels based upon a
weighting of their assets according to risk. Since December 31, 1992, Federal
Reserve member banks have been required to maintain a ratio of qualifying total
capital to risk-weighted assets of a minimum of 8%, and Tier 1 Capital to Assets
ratio of 4%. A minimum leverage ratio of 3% is required for banks with the
highest regulatory examination ratings and not contemplating or experiencing
significant growth or expansion. All other banks are required to maintain a
minimum leverage ratio of at least 1-2% above the stated minimum leverage ratio
of 3%.
A comparison of the Bank's capital ratios as of December 31, 2003 and December
31, 2002 with these minimum requirements is presented below:
Bank
--------------- Minimum
2003 2002 Requirements
---- ---- ------------
Total Risk-based Capital 13.9% 16.2% 8%
Tier 1 Risk-based Capital 12.7% 14.9% 4%
Tier 1 Capital 8.3% 9.3% 3%
As of December 31, 2003 and 2002, the Bank met all three capital requirements.
18
The following table shows consolidated operating and capital ratios for the
Company for the last three years:
2003 2002 2001
----- ----- -----
Return on Average Assets 1.25% 1.36% 1.09%
Return on Average Equity 12.77% 12.51% 9.82%
Dividend Payout Ratio 37.71% 36.18% 41.44%
Equity to Assets Ratio 9.96% 10.69% 10.84%
Sarbanes-Oxley Act. On July 30, 2002, the Sarbanes-Oxley Act for 2002 ("SOA")
was signed into law. The stated goals of the SOA are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the securities
laws.
The SOA includes very specific additional disclosure requirements and new
corporate governance rules, requires the SEC, the national securities exchanges
and the national securities associations to adopt and implement disclosure and
corporate governance standards, and mandates further studies of certain issues
by the SEC and the Comptroller General. The SOA represents significant federal
involvement in matters traditionally left to state regulatory systems, such as
the regulation of the accounting profession, and to state corporate law, such as
the relationship between a board of directors and management and between a board
of directors and its committees.
The SOA addresses, among other matters: audit committees; required reporting on
internal controls over financial reporting by management and auditors;
certification of financial statements by the Chief Executive Officer and the
Chief Financial Officer; the forfeiture of bonuses or other incentive-based
compensation and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial publication of
any financial statements that later require restatement; a prohibition on
insider trading during pension plan black out periods; disclosure of off-balance
sheet transactions; a prohibition on certain loans to directors and officers;
expedited filing requirements for Forms 4; the adoption of a code of ethics for
the issuer's principal executive officer and principal financial and accounting
officers, and disclosure of any change or waiver of such code; "real time"
filing of periodic reports; the formation of a public company accounting
oversight board; auditor independence; and various increased civil and criminal
penalties for violations of securities laws.
Some provisions of the SOA went into effect immediately (July 30, 2002), while
others required the SEC to adopt implementing rules within specified periods.
Nearly all of the implementing rules have been finalized by the SEC.
SUBSIDIARIES OF THE BANK
M&W AGENCY, INC. On September 1, 2000, the Company completed its acquisition of
the assets, business and certain liabilities of M&W Group, Inc., a retail
property and casualty insurance agency headquartered in Silver Creek, New York,
with offices located in Angola, New York, Derby, New York, Eden, New York,
Gowanda, New York, Hamburg, New York, North Boston, New York, South Dayton, New
York, Cattaraugus Counties, New York, Randolph, New York and West Seneca, New
York. The insurance agency acquired is operated through M&W Agency, Inc.
("M&W"), an operating subsidiary of the Bank.
M&W's legal headquarters are located at 265 Central Ave., Silver Creek, New York
14136. M&W is a full-service insurance agency offering personal, commercial and
financial services products. It also has a small consulting department. In 2003,
M&W acquired Frontier Claim Services, an insurance adjusting business, located
in Buffalo, New York. For the year ended December 31, 2003, M&W had a premium
volume of $23.2 million and net premium revenue of $3.5 million.
19
M&W's primary market area is Erie, Chautauqua and Cattaraugus counties. All
lines of personal insurance are provided including automobile, homeowners,
umbrellas, boats, recreational vehicles and landlord coverages. Commercial
insurance products are also provided, consisting of property, liability,
automobile, inland marine, workers compensation, umbrellas, bonds and crop
insurance. M&W also provides the following financial services products: life and
disability insurance, medicare supplements, long term care, annuities, mutual
funds, retirement programs and New York State Disability.
M&W has a small consulting division which does work almost exclusively with
school districts. The majority of the work is done in preparing specifications
for bidding and reviewing existing insurance programs. The majority of the
consulting accounts are located in Central and Eastern New York. In the personal
insurance area, the majority of M&W's competition comes from direct writers as
well as some small local agencies located in the same towns and villages in
which M&W has offices. In the commercial business segment, the majority of the
competition comes from larger agencies located in and around Buffalo, New York.
By offering the large number of carriers which it has available to its
customers, M&W has attempted to remain competitive in all aspects of their
business.
M&W is regulated by the New York State Insurance Department. It meets and
maintains all licensing and continuing education requirements required by the
State of New York.
ENB ASSOCIATES INC. ENB Associates Inc., a wholly-owned subsidiary of the Bank,
was established during the first quarter of 2000 and provides non-deposit
investment products, such as mutual funds and annuities, to Bank customers at
Bank branch locations. ENB Associates Inc. has an investment services agreement
with O'Keefe Shaw & Co., Inc., through which ENB can purchase and sell
securities to its customers.
EVANS NATIONAL HOLDING CORP. ENHC holds certain real estate loans and provides
management services. ENHC is operated as a real estate investment trust (REIT)
which provides additional flexibility and planning opportunities for the
business of the Bank.
Commencing in 2000, the Company operates in two reportable segments-banking and
insurance. For the years ended December 31, 1999 and prior, the Company
determined that its business was comprised of banking activity only. For
disclosure of segmented operations, See Item 8 "Consolidated Financial
Statements and Supplementary Data", of this Report on Form 10-K.
EMPLOYEES
As of December 31, 2003, the Company had no direct employees. As of December 31,
2003, the Bank employed 96 persons on a full-time basis and 9 on a part-time
basis. In addition, ENB Associates Inc. employed 1 person on a full-time basis.
M&W Agency, Inc. also employed 38 persons on a full-time basis and 1 on a
part-time basis.
OTHER INFORMATION
The Company's Internet address is www.evansbancorp.com. Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of The Exchange Act, are available through the Company's website as soon
as reasonably practical after filing such material with, or furnishing it to,
the Securities and Exchange Commission. We are providing the address of the
Company's internet site solely for the information of investors. We do not
intend the address to be an active link or to otherwise incorporate the contents
of the website into this Report on Form 10-K.
20
ITEM 2. PROPERTIES
The Company conducts its business from its main office and nine branch offices.
The main office is located at 14-16 North Main Street in Angola, New York. The
main office facility is 9,344 square feet and is owned by the Bank. This
facility is occupied by the Office of the President and Chief Executive Officer
as well as the Administration Division.
The Bank owns seven of its nine branch offices. The main office mentioned above
is owned by the Bank. A 3,900 square foot facility is located at 8599 Erie Road
in the Town of Evans. Another is a 1,530 square foot facility located at 25 Main
Street, Forestville, New York and the fourth is a 3,650 square foot branch
located at 6840 Erie Road, Derby, New York. A fifth is a 2,880 square foot
facility located at 7205 Boston State Rd, Boston, New York. The sixth is a 3,500
square foot facility located on land it is leasing at 3388 Sheridan Drive,
Amherst, New York. The seventh is a 3,500 square foot facility located on land
the Bank is leasing at 4979 Transit Road, Lancaster, New York.
The Bank also owns a building adjacent to its Derby branch location which houses
its loan division operations.
The Bank currently leases branch offices in Hamburg and West Seneca. The 3,000
square foot branch office at 5999 South Park Avenue, Hamburg, New York, is
occupied pursuant to a long-term lease. In September 1999, the Bank relocated
its West Seneca branch office to 3,864 square feet of space at 938 Union Road,
West Seneca, N.Y. 14224, which carries a long-term lease. In addition, the Bank
leases 726 square feet for a drive-thru facility.
The Bank operates in-school branch banking facilities in the West Seneca East
High School, 4760 Seneca Street, West Seneca, N.Y. 14224 and the West Seneca
West High School, 3330 Seneca Street, West Seneca, N.Y. The in-school branches
each have a cash dispensing style ATM located at the sites. There are no lease
payments required.
M&W leases the following offices from Millpine Enterprises, a partnership owned
by Mr. Robert Miller and his family: 265 Central Avenue, Silver Creek, New York;
5 Commercial Street, Angola, New York; 11 Main Street, Cattaraugus, New York;
213 Pine Street, South Dayton, New York. Each lease is dated September 1, 2000
and extends for a period of four years with three options to renew each for an
additional three year term.
M&W also leases an office located at 7 Bank Street, Randolph, New York on a
month to month basis.
In January 2002, M&W entered into a five year lease for the office at the site
of the former Eden Agency whose business it acquired on January 1, 2002. This
site is located at 8226 North Main Street, Eden, New York 14057. In January
2003, M&W entered into a three year lease for the office at the site for
Frontier Claims Services. This site is located at 1481 Harlem Road, Buffalo, New
York 14216. In October 2003, M&W entered into a month to month lease for the an
office located at 25 Buffalo Street, Gowanda, New York, 14070.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a party.
The nature of the Bank's business generates a certain amount of litigation
involving matters arising in the ordinary course of business. However, in the
opinion of management of the Bank, there are no proceedings pending to which the
Bank is a party or to which its property is subject, which, if determined
adversely to the Bank, would be material in relation to the Bank's financial
condition, nor are there any proceedings pending other than ordinary routine
litigation incident to the business of the Bank. In addition, no material
proceedings are pending or are known to be threatened or contemplated against
the Bank or its subsidiaries by governmental authorities or others.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth quarter of
the fiscal year covered by this report.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) MARKET. The Company's common stock is quoted on the Nasdaq National Market
system under the symbol: EVBN and has been traded on Nasdaq since July 9,
2001. The Company distributed a 5 percent stock dividend declared on
November 19, 2002 for shareholders of record on December 2, 2002 which was
distributed on January 29, 2003 and a 5 percent stock dividend declared on
September 16, 2003 for shareholders of record on October 14, 2003 which was
distributed on December 1, 2003. All share and per share data contained in
this Report on Form 10-K have been adjusted to reflect the stock dividends.
The following quotations reflect inter-dealer quotations that do not include
retail markups, markdowns or commissions and may not represent actual
transactions. The following table shows, for the periods indicated, the high and
low bid prices per share of the Company's common stock as reported on Nasdaq.
2003 2002
---------------- ----------------
QUARTER High Low High Low
- ------- ------ ------- ------ -------
FIRST $22.87 $ 19.48 $17.91 $ 16.37
SECOND $22.81 $ 19.68 $20.09 $ 16.28
THIRD $22.61 $ 20.00 $23.38 $ 14.74
FOURTH $24.30 $ 21.75 $22.27 $ 18.13
(b) HOLDERS. The approximate number of holders of record of the Company's
common stock at December 31, 2003 was 1,413.
(c) DIVIDENDS.
CASH DIVIDENDS.
The Company paid a cash dividend of $0.26 per share on April 2, 2002
to holders of record on March 12, 2002.
The Company paid a cash dividend of $0.28 per share on October 2, 2002
to holders of record on September 11, 2002.
The Company paid a cash dividend of $0.30 per share on April 1, 2003
to holders of record on March 11, 2003.
The Company paid a cash dividend of $0.32 per share on October 1, 2003
to holders of record on September 10, 2003.
The Company has declared a cash dividend of $0.33 per share payable on
April 6, 2004 to holders of record as of March 16, 2004.
All per share amounts have been adjusted to reflect the 5 percent
stock dividend paid on January 29, 2003 and the 5 percent stock
dividend paid on December 1, 2003.
The amount, if any, of future dividends will be determined by the
Company's Board of Directors and will depend upon the Company's
earnings, financial conditions and other factors considered by the
Board of Directors to be relevant. Banking regulations limit the
amount of dividends that may be paid without prior approval of the
Comptroller of the Currency. See Footnote 19 to the Consolidated
Financial Statements.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AND RATIO DATA)
AS OF AND FOR THE YEAR ENDED DECEMBER 31,
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
BALANCE SHEET DATA
Assets $ 334,677 $ 288,711 $ 248,722 $ 224,549 $ 198,788
Interest-earning assets 308,722 267,142 231,120 204,579 183,721
Investment securities 120,556 106,672 84,065 73,121 63,000
Loans, net 185,528 148,998 142,469 128,779 116,433
Deposits 266,325 239,507 204,260 186,701 169,949
Borrowings 25,388 8,111 9,661 4,409 5,000
Stockholders' equity 33,323 30,862 26,961 25,179 18,285
INCOME STATEMENT DATA
Net interest income $ 10,847 $ 10,396 $ 9,110 $ 8,580 $ 7,512
Non-interest income 7,666 5,474 4,528 3,648 1,343
Non-interest expense 12,740 10,650 9,531 7,535 6,050
Net income 4,069 3,606 2,579 3,223 2,027
PER SHARE DATA
Earnings per share - basic $ 1.66 $ 1.48 $ 1.06 $ 1.33 $ 0.87
Earnings per share - diluted 1.66 1.48 1.06 1.33 0.87
Cash dividends 0.62 0.54 0.44 0.38 0.34
Book value 13.63 12.59 11.08 10.38 7.81
PERFORMANCE RATIOS
Return on average assets 1.25% 1.36% 1.09% 1.53% 1.10%
Return on average equity 12.77 12.51 9.82 15.96 10.81
Net interest margin 3.64 4.27 4.18 4.39 4.40
Efficiency ratio 64.70 63.04 65.98 57.79 63.42
Dividend payout ratio 37.71 36.18 41.44 27.89 39.37
CAPITAL RATIOS
Tier I capital to average assets 8.30% 9.30% 9.60% 9.90% 10.10%
Equity to assets 9.96 10.69 10.84 11.21 9.20
ASSET QUALITY RATIOS
Total non-performing assets to total assets 0.27% 0.51% 0.66% 0.67% 1.11%
Total non-performing loans to total loans 0.49 0.79 0.81 1.13 1.52
Net charge-offs to average loans 0.05 0.04 0.04 0.08 0.05
Allowance for loan losses to total loans 1.35 1.42 1.24 1.10 0.71
Allowance for loan losses to non-performing loans 276.47 179.27 153.04 97.96 47.31
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Item 8 "Consolidated Financial Statements and
Supplementary Data" of this Report on Form 10-K for further information and
analysis.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
This discussion is intended to compare the performance of the Company for the
years ended December 31, 2003, 2002 and 2001. The review of the information
presented should be read in conjunction with the Consolidated Financial
Statements and Notes included in this Report on Form 10-K.
Evans Bancorp, Inc. (the "Company") is the holding company for Evans National
Bank (the "Bank"), its wholly-owned subsidiary, which is a nationally chartered
bank founded in 1920 and headquartered in Angola, New York. The Bank's principal
business is to provide a full range of banking services to consumer and
commercial customers in Erie, Chautauqua and Cattaraugus Counties of Western New
York. The Bank has three subsidiaries - ENB Associates Inc. and M&W Agency,
Inc., both wholly-owned subsidiaries, and Evans National Holding Corp. (which
the Bank owns 100% of the outstanding voting common shares). The Company
conducts its business through Evans National Bank and its subsidiaries. It does
not engage in any other substantial business activities.
The Company's financial objectives are focused on earnings growth and return on
average equity. Over the last five years, the Company's compounded annual net
income growth has been 14.77%, while return on average equity improved from
10.81% in 1999 to 12.77% in 2003. The compounded annual growth rate for gross
loans and deposits for the last five years were 11.07% and 13.07%, respectively.
To sustain future growth and to meet the Company's financial objectives, the
Company has defined a number of strategies. Five of the more important
strategies include:
- Expanding Bank market reach and penetration through de-novo branching
and potential acquisition;
- Continuing growth of non-interest income through insurance agency
internal growth and potential acquisition;
- Focusing on profitable customer segments;
- Leveraging technology to improve efficiency and customer service; and
- Maintaining a community based approach.
The Company's strategies are designed to direct tactical investment decisions
supporting its financial objectives. The Company's most significant revenue
source continues to be net interest income, defined as total interest income
less interest expense, which in 2003 accounted for approximately 67% of total
revenue. To produce net interest income and consistent earnings growth over the
long-term, the Company must generate loan and deposit growth at acceptable
economic spreads within its market of operation. To generate and grow loans and
deposits, the Company must focus on a number of areas including, but not limited
to, the economy, branch expansion, sales practices, customer and employee
satisfaction and retention, competition, evolving customer behavior, technology,
product innovation, interest rates, credit performance of its customers, and
vendor relationships.
The Company also considers non-interest income important to its continued
financial success. Fee income generation is partly related to the loan and
deposit operations, such as deposit service charges, as well as selling
financial products, such as: commercial and personal insurance through M&W
Agency, non-deposit investment products through ENB Associates Inc., and private
wealth management services through a strategic alliance with Mellon Financial
Services.
While the Company reviews and manages all customer segments, it has focused
increased efforts on four targeted segments: 1) high value consumers, 2) smaller
businesses with credit needs under $250,000, 3) medium-sized commercial
businesses with credit needs over $250,000 up to $4 million, and 4) commercial
real estate and construction-related businesses. These efforts have resulted in
material growth in the commercial and home equity loan portfolios as well as
core deposits over the last two years.
To support growth in targeted customer segments, the Bank has opened two
branches over the last two years with a third planned in mid 2004. With all new
and existing branches, totaling nine in January 2004, the Bank has strived to
maintain a local community based philosophy. The Bank has emphasized hiring
local branch and lending personnel with strong ties to the specific local
communities it enters and serves.
24
The Bank serves its market through nine banking offices located in Amherst, New
York, Angola, New York, Derby, New York, Evans, New York, Forestville, New York,
Hamburg, New York, Lancaster, New York, North Boston, New York and West Seneca,
New York. The Bank's principal source of funding is through deposits, which it
reinvests in the community in the form of loans and investments. Deposits are
insured to the applicable limit by the Bank Insurance Fund ("BIF") of the
Federal Deposit Insurance Corporation ("FDIC"). The Bank is regulated by the
Office of the Comptroller of the Currency ("OCC").
On March 11, 2000, ENB Associates Inc., a wholly-owned subsidiary of the Bank,
began the activity of providing non-deposit investment products, such as
annuities and mutual funds, to bank customers. Effective September 1, 2000, the
Company completed the acquisition of the assets, business and certain
liabilities of M&W Group, Inc., a retail property and casualty insurance agency
headquartered in Silver Creek, New York. The insurance agency acquired is
operated as M & W Agency, Inc., a wholly-owned subsidiary of the Bank. M & W
Agency, Inc. sells various premium-based insurance policies on a commission
basis. M & W Agency, Inc. operates offices located in Angola, New York,
Cattaraugus, New York, Derby, New York, Eden, New York, Gowanda, New York,
Hamburg, New York, North Boston, New York, Silver Creek, New York, South Dayton,
New York, Randolph, New York, and West Seneca, New York. Evans National Holding
Corp. ("ENHC") was incorporated in February 2002, as a subsidiary of the Bank.
ENHC is operated as a real estate investment trust ("REIT"), which will provide
additional flexibility and planning opportunities for the business of the Bank.
The Company operates in two reportable segments - banking activities and
insurance agency activities.
All share and per share information presented is stated after giving effect to a
5-for-4 stock split distributed on June 12, 2001, to shareholders of record on
May 25, 2001, a 5 percent stock dividend paid on January 29, 2003, to
shareholders of record on December 2, 2002, and a 5 percent stock dividend paid
on December 1, 2003 to shareholders of record on October 14, 2003.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES POLICIES
The Company's Consolidated Financial Statements are prepared in accordance with
accounting principles generally accepted in the United States of America 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 Financial Statements
and Notes. These estimates, assumptions and judgments are based on information
available as of the date of the Consolidated Financial Statements. Accordingly,
as this information changes, the 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.
The most significant accounting policies followed by the Company are presented
in Note 1 to the Consolidated Financial Statements. These policies, along with
the disclosures presented in the other financial statement notes and in this
financial review, provide information on how significant assets and liabilities
are valued in the financial statements and how those values are determined.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions and estimates underlying those
amounts, management has identified the determination of the allowance for loan
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.
The allowance for loan losses represents management's estimate of probable
credit losses in the loan portfolio. Determining the amount of the allowance for
loan losses is considered a critical accounting estimate because it requires
significant judgment 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 consolidated balance sheets. Note 1 to the Consolidated Financial Statements
describes the methodology used to determine the allowance for loan losses.
25
The amount of goodwill reflected in the Company's 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
and the use of estimates related to the growth assumptions and market multiples
used in the valuation model.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note 1 to the Consolidated Financial Statements discusses new accounting
policies adopted by the Company during fiscal 2003 and the expected impact of
accounting policies recently issued or proposed but not yet required to be
adopted. To the extent management believes the adoption of new accounting
standards materially affects the Company's financial condition, results of
operations, or liquidity, the impacts are discussed in the applicable section(s)
of this financial review and notes to the consolidated financial statements.
RESULTS OF OPERATIONS FOR YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31, 2002
Net interest income, the difference between interest income and fee income on
earning assets, such as loans and securities, and interest expense on deposits
and borrowings, provides the primary basis for the Bank's results of operations.
These results are also impacted by non-interest income, the provision for loan
losses, non-interest expense and income taxes. Net income of $4.1 million in
2003 consists of $3.7 million related to the Company's banking activities and
$0.4 million related to the Bank's insurance agency activities. The total net
income of $4.1 million or $1.66 per share, basic and diluted in 2003 compares to
$3.6 million or $1.48 per share, basic and diluted for 2002. All per share data
reflect the special 5 percent stock dividend paid on January 29, 2003 and the
special 5 percent stock dividend paid on December 1, 2003.
26
NET INTEREST INCOME
Net interest income is dependent on the amounts and yields earned on interest
earning assets as compared to the amounts of and rates paid on interest bearing
liabilities.
The following table segregates changes in interest earned and paid for the past
two years into amounts attributable to changes in volume and changes in rates by
major categories of assets and liabilities. The change in interest income and
expense due to both volume and rate has been allocated in the table to volume
and rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
2003 Compared to 2002 2002 Compared to 2001
Increase (Decrease) Due to Increase (Decrease) Due to
----------------------------- ----------------------------
All amounts in 000's
Volume Rate Total Volume Rate Total
------- ------- ------- ------- ------- -------
Interest earned on:
Loans $ 1,460 $(1,316) $ 144 $ 1,000 $(1,458) $ (458)
Taxable securities 956 (1,284) (328) 199 (538) (339)
Tax-exempt securities 394 (93) 301 481 (65) 416
Federal funds sold (1) (11) (12) 150 (209) (59)
Time deposits in other banks 15 (2) 13 5 -- 5
------- ------- ------- ------- ------- -------
Total interest-earning assets $ 2,824 $(2,706) $ 118 $ 1,835 $(2,270) $ (435)
======= ======= ======= ======= ======= =======
Interest paid on:
NOW accounts $ 2 $ (23) $ (21) $ 12 $ (44) $ (32)
Savings deposits 338 (157) 181 319 (893) (574)
Time deposits 258 (836) (578) 274 (1,393) (1,119)
Federal funds purchased &
other borrowings 245 (160) 85 72 (67) 5
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities $ 843 $(1,176) $ (333) $ 677 $(2,397) $(1,720)
======= ======= ======= ======= ======= =======
Net interest income, before the provision for loan losses, increased $0.5
million or 4.3% to $10.8 million in 2003, as compared to $10.4 million in 2002,
an increase of 14.1% from 2002 over 2001. This increase in 2003 is attributable
to the increase in average interest-earning assets of $54.5 million versus an
increase of $52.0 million in average interest-bearing liabilities over 2002.
This accounts, as indicated in the table above, for a net increase due to volume
of approximately $2.0 million in net interest income. The yield on
interest-earning assets decreased 111 basis points from 6.25% in 2002 to 5.14%
in 2003, while the cost of interest-bearing liabilities decreased 68 basis
points, from 2.54% in 2002 to 1.86% in 2003. These rate changes resulted in less
of a decrease in rate related changes on interest expense versus interest
income, or a net decrease in net interest income of approximately $1.5 million.
The Bank's net interest margin decreased from 4.27% during 2002 to 3.64% during
2003.
27
The decrease in net interest margin is due primarily to three factors: increased
competition from both a loan and deposit pricing perspective, a decrease in the
potential to adjust deposit rates significantly lower as a result of the
historically low interest rate environment, and a large amount of activity in
mortgage refinancing which led to an acceleration of amortization on investment
securities purchased at a premium that were backed by mortgages.
The Bank believes net interest margin will continue to be challenged in 2004 due
to two main factors. Banks, generally, are not only competing with each other
for available business, but with other providers of loan and investment
products, such as credit unions and insurance companies. A wealth of information
is easily obtained by consumers via the Internet, from television and through
print media. Competitors exist beyond the geographic trade area and banks
generally have increased business volumes by offering higher deposit rates and
lower loan rates, looking to other potential sources of income, such as fees and
service charges, to increase earnings.
In addition, as the Bank responds to competitive pricing for assets, the current
low interest rate environment will make it difficult to competitively adjust the
pricing of liabilities much further down. The historically low environment
provides the Bank a smaller interval to move rates on deposits to offset any
decrease in asset yield.
The Bank regularly monitors its exposure to interest rate risk. The proper
management of interest-sensitive funds will help protect the Bank's earnings
against extreme changes in interest rates. The Bank's Asset/Liability Management
Committee (ALCO) meets monthly for the purpose of evaluating the Bank's
short-range and long-range liquidity position and the potential impact on
capital and earnings as a result of changes in interest rates. The Bank has
adopted an asset/liability policy that specifies minimum limits for liquidity
and capital ratios. Ranges have been set for the negative impact acceptable on
net interest income and on the fair value of equity as a result of a shift in
interest rates. The asset/liability policy also includes guidelines for
investment activities and funds management. At its monthly meeting, the ALCO
reviews the Bank's status and formulates its strategy based on current economic
conditions, interest rate forecasts, loan demand, deposit volatility and the
Bank's earnings objectives.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents the amount charged against the Bank's
earnings to establish a reserve or allowance sufficient to absorb probable loan
losses based on management's evaluation of the loan portfolio. Factors
considered include the collectibility of individual loans, current loan
concentrations, charge-off history, delinquent loan percentages, input from
regulatory agencies and general economic conditions.
On a quarterly basis, management of the Bank meets to review the adequacy of the
allowance for loan losses. In making this determination, the Bank analyzes the
ultimate collectibility of the loans in its portfolio by incorporating feedback
provided by internal loan staff, an independent loan review function and
information provided by examinations performed by regulatory agencies.
The analysis of the allowance for loan losses is composed of three components:
specific credit allocation, general portfolio allocation and subjectively by
determined allocation. The specific credit allocation includes a detailed review
of the credit in accordance with SFAS No. 114 and No. 118, and allocation is
made based on this analysis. The general portfolio allocation consists of an
assigned reserve percentage based on the internal credit rating of the loan,
using the Company's historical loss experience.
The subjective portion of the allowance reflects management's current assessment
of the New York State and local economies. Both have lagged behind national
prosperity, which has continued to remain unsettled. Marginal job growth, in
conjunction with a declining population base, has left the Bank's market more
susceptible to potential credit problems. This is particularly true of
commercial borrowers. Commercial loans represent a segment of significant past
growth as well as concentration in the Bank's real estate portfolio. Commercial
real estate values may be susceptible to decline in an adverse economy.
Management believes that the Bank's loan loss reserve is in accordance with
regulations promulgated by the OCC, and is reflective of its assessment of the
local environment as well as a continued growth trend in commercial loans.
In 2003, the Company's provision for loan loss was $0.5 million as compared to
$0.4 million in 2002. Total non-performing loans amounted to $923,000 at
December 31, 2003, as compared to $1,197,000 at December 31, 2002.
28
The following table provides an analysis of the allowance for loan losses, the
total of charge-offs, non-performing loans and total allowance for loan losses
as a percentage of total loans outstanding for the three years ended December
31:
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
($000) ($000) ($000) ($000) ($000)
Balance, beginning of year $ 2,146 $ 1,786 $ 1,428 $ 838 $ 729
Provisions for loan losses 480 420 420 689 170
Recoveries 8 16 18 6 9
Loans charged off (95) (76) (80) (105) (70)
-------- -------- -------- -------- --------
Balance, end of year $ 2,539 $ 2,146 $ 1,786 $ 1,428 $ 838
======== ======== ======== ======== ========
Net Charge-offs to total loans 0.05% 0.05% 0.06% 0.08% 0.05%
Non-performing loans to total
loans 0.49% 0.79% 0.81% 1.13% 1.52%
Allowance for loan losses to
total loans 1.35% 1.42% 1.24% 1.10% 0.71%
An allocation of the allowance for loan losses by portfolio type over the past
five years follows:
Balance Percent Balance Percent Balance Percent
at of loans at of loans at of loans
12/31/2003 in each 12/31/2002 in each 12/31/2001 in each
Attributable category Attributable category Attributable category
to: to total to: to total to: to total
($000) loans: ($000) loans: ($000) loans:
------------ ------------ ------------ ------------ ------------ ------------
Real Estate Loans $ 1,619 85.1% $ 844 84.6% $ 455 85.0%
Commercial Loans 384 12.9 259 13.5 96 11.3
Consumer Loans 147 1.4 72 1.6 74 2.2
All other loans - 0.6 - 0.3 - 1.5
Unallocated 389 - 971 - 1,161 -
------------ ------------ ------------ ------------ ------------ ------------
Total $ 2,539 100.0% $ 2,146 100.0% $ 1,786 100.0%
============ ============ ============
Balance Percent Balance Percent
at of loans at of loans
12/31/2000 in each 12/31/1999 in each
Attributable category Attributable category
to: to total to: to total
($000) loans: ($000) loans:
------------ ------------ ------------ ------------
Real Estate Loans $ 600 84.1% $ 716 84.7%
Commercial Loans 96 11.4 50 12.1
Consumer Loans 66 2.7 56 2.3
All other loans - 1.8 - 0.9
Unallocated 666 - 16 -
------------ ------------ ------------ ------------
Total $ 1,428 100.0% $ 838 100.0%
============ ============
29
Both the total increase in allowance for loan losses and allocation of the
allowance to commercial loans are in response to the increase in total higher
risk commercial loans. Commercial real estate mortgages represent 62.5% or $99.7
million of total real estate mortgages at December 31, 2003, as compared to
61.1% or $77.9 million at December 31, 2002. Commercial real estate contains
mortgage loans to developers and owners of commercial real estate. Additionally,
commercial loans, which represent loans to a wide variety of businesses, small
and moderate across varying industries, comprises 12.9% of total loans or $24.3
million at December 31, 2003, as compared to 13.5% or $20.5 million at December
31, 2002. The increased allowance and allocation to commercial categories
addresses the Bank's strategic decision to continue growing this segment, as
well as the local economy, which has lagged the national economy. Commercial
loans are more susceptible to decreases in credit quality in cyclical downturns
and the larger individual balances of commercial loans expose the Bank to larger
losses. In addition, growth in the size of the commercial loan portfolio during
2003 required additional allowance to provide for probable losses in these
loans.
The allowance for loan losses is based on management's estimate, and ultimate
losses will vary from current estimates. Factors underlying the determination of
the allowance for loan losses are continually evaluated by management based on
changing market conditions and other known factors. Some factors underlying the
allocation of loan losses have changed in 2003 as a result of the evaluation of
underlying risk factors within each loan category. The underlying methodology to
determine the adequacy of the allowance for loan losses is consistent with prior
years.
NON-INTEREST INCOME
Total non-interest income increased approximately $2.2 million or 40.1% in 2003
over 2002. This compares to an increase of approximately $0.9 million from 2001
to 2002. Bank service charge income in 2003 increased approximately $0.7 million
over 2002 due to a concentrated effort on increasing fee income in late 2002 and
early 2003 and the rollout of the Bank's Safeguard Overdraft Service in early
2003. Income from the M&W Agency, Inc. in 2003 accounted for approximately $0.5
million of the increase in non-interest income. Income earned on bank-owned life
insurance increased approximately $0.4 million over 2002 as a result of a $6.2
million bank-owned life insurance purchase in February 2003.
The competitive interest rate environment resulted in prepayment fees collected
on refinanced loans totaling an additional $0.3 million in 2003. New mortgage
volume and refinancings also increased appraisal fees and premiums received on
residential mortgages sold to the Federal National Mortgage Association ("FNMA")
for approximately $0.1 million in 2003. ENB Associates also benefited from the
low interest rate environment as customers searched for higher yields in mutual
funds and annuities. ENB Associates' revenue increased $0.04 million in 2003 as
compared to 2002.
Additionally, the Bank grew its ATM network with the addition of six new offsite
locations during 2003. Also, the usage of the Bank's point-of-sale debit cards
has increased. Both data services have provided approximately an additional $0.2
million in fees in 2003 as compared to 2002.
Gains realized on the sale of assets, primarily sales of securities, totaled
approximately $0.3 million in 2003 versus an approximate $0.1 million gain
realized in 2002. During 2003, the Bank recognized losses on sales and write
downs in the carrying value of foreclosed real estate of $0.03 million versus
losses of $0.1 million in 2002.
NON-INTEREST EXPENSE
Total non-interest expense increased approximately $2.1 million or 19.6% in 2003
over 2002. In 2003, the ratio of non-interest expense to average assets was
3.90% compared to 4.01% in 2002 and 4.02% in 2001. Non-interest expense
categories include those most impacted by branch expansion and the operations of
the M&W Agency, Inc. and ENB Associates Inc.: salaries and benefits, occupancy,
advertising, and supplies, among others. Salary and benefit expense increased
23.1% in 2003. Of the $1.3 million increase in salary and benefit expense in
2003 over 2002, the Bank's operations contributed approximately $1.0 million and
M&W Agency contributed approximately $0.3 million. The addition of the Lancaster
branch, full operating year of the Amherst branch, increased loan staffing, M&W
Agency expansion and merit increases contributed to the increased salary costs.
M&W Agency acquired the business, assets and certain liabilities of the
Gutekunst Agency in the beginning of 2003, and completed a full year of
operations of Frontier Claim Services, Inc. which was acquired on January 1,
2003, which contributed to its increased salary and benefits.
Occupancy expense increased approximately $0.1 million or 8.7% from 2002 to
2003. M&W Agency's addition of the Frontier Claim Services, Inc. and a full year
operation of the Amherst branch location increased related occupancy expenses:
utilities, rent, and depreciation, among others. Professional services increased
$0.1 million or 15.4%. The Bank engaged an outside consulting firm for a revenue
enhancement project and attorneys to prepare and review new employee benefit
plans in 2003.
30
Miscellaneous other expenses increased $0.5 million or approximately 25.1% in
2003. Expenses associated with Internet banking, ATM expense, telephone and data
line costs, postage costs, maintenance on foreclosed properties, director fees
and correspondent bank service charges fall under miscellaneous expenses. Other
expenses have increased approximately $0.3 million due to a number of items
including costs associated with the Bank's conversion to a next generation item
processing data center environment, which have resulted in increased capacity,
capability and opportunity for future efficiencies.
PENSION
The Company maintains a qualified defined benefit pension plan, which covers
substantially all employees. Additionally, the Company has entered into
individual retirement agreements with certain current executives providing for
unfunded supplemental pension benefits. The Company's pension expense for all
pension plans, including the SERP, approximated $491,000 and $215,000 for the
years ended December 31, 2003, and December 31, 2002, respectively, and is
calculated based upon a number of actuarial assumptions, including an expected
long-term rate of return on our plan assets of 6.75% and compensation rate
increases of 4.75% in both 2003 and 2002. The increase is primarily due to a
change in benefit formula related to the SERP, which was changed in 2003 to
provide a benefit payment based on a percentage of final average earnings as
opposed to a fixed benefit under the superceded plan. Also, one additional
participant was added to the plan during 2003.
In developing our expected long-term rate of return assumption, we evaluated
input from our actuary in conjunction with our historical returns based on the
asset allocation of our portfolio. In evaluating compensation rate increases we
evaluated historical salary data as well as expected future increases. We will
continue to evaluate our actuarial assumptions, including our expected rate of
return and compensation rate increases at least annually, and will adjust as
necessary.
We base our determination of pension expense or income on a market-related
valuation of assets, which reduces year-to-year volatility. This market-related
valuation recognizes investment gains or losses over a three-year period from
the year in which they occur. Investment gains or losses for this purpose are
the difference between the expected return calculated using the market-related
value of assets and the actual return based on the market-related value of
assets. Since the market-related value of assets recognizes gains or losses over
a three-year period, the future value of assets will be impacted as previously
deferred gains or losses are recorded.
The discount rate utilized for determining future pension obligations is based
on a review of long-term bonds that receive one of the two highest ratings given
by a recognized rating agency. The discount rate determined on this basis has
decreased from 6.75% at September 30, 2002, for purposes of our defined benefit
pension plan and at December 31, 2002, for purposes of our SERP, both of which
are the measurement dates, to 6.25% for both plans at September 30, 2003 and
December 31, 2003, respectively.
TAXES
The provision for income taxes in 2003 of $1.2 million reflects an effective tax
rate of approximately 23.1%. This compares to $1.2 million or 24.9% in 2002 and
$1.1 million or 30.0% in 2001. There were three main factors for the decrease in
the effective tax rate in 2003 and 2002. The first was due to the establishment
of ENHC as a REIT. In addition to providing the flexibility and planning
opportunities for the Bank, it also provided state tax benefits. Life insurance
proceeds recorded in 2002 were tax exempt and contributed to a more favorable
tax position. Also, the additional bank-owned life insurance income earned in
2003 improved the Bank's effective tax rate. The Bank continues to maintain a
substantial investment in tax-advantaged municipal bonds, which contributes to
its favorable tax position.
RESULTS OF OPERATIONS FOR YEARS ENDED DECEMBER