EVANS BANCORP INC - Annual Report: 2007 (Form 10-K)

 

 

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Exact name of registrant as specified in its charter)

New York		16-1332767
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
14-16 North Main Street, Angola, New York		14006
(Address of principal executive offices)		(Zip Code)

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
Common Stock, Par Value $.50 per share		The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act. Yes o No þ

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

On June 29, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $44.6 million, based upon the closing sale price of a share of the registrant’s common stock on The NASDAQ Global Market.

As of March 10, 2008, 2,748,924 shares of the registrant’s common stock were outstanding.

Page 1 of 92
Exhibit Index on Page 85

 

 

Portions of the registrant’s Proxy Statement relating to the registrant’s 2008 Annual Meeting of Shareholders, to be held on April 24, 2008, which will be subsequently filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.

				Page
PART I
Item 1.		BUSINESS			5
Item 1A.		RISK FACTORS			21
Item 1B.		UNRESOLVED STAFF COMMENTS			23
Item 2.		PROPERTIES			23
Item 3.		LEGAL PROCEEDINGS			24
Item 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			24
PART II
Item 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES			24
Item 6.		SELECTED CONSOLIDATED FINANCIAL DATA			26
Item 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			27
Item 7A.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			42
Item 8.		CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			42
Item 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			80
Item 9A.		CONTROLS AND PROCEDURES			80
Item 9B.		OTHER INFORMATION			80

				Page
PART III
Item 10.		DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE			81
Item 11.		EXECUTIVE COMPENSATION			81
Item 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			81
Item 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE			81
Item 14.		PRINCIPAL ACCOUNTING FEES AND SERVICES			81
PART IV
Item 15.		EXHIBITS ,FINANCIAL STATEMENT SCHEDULES			82
		SIGNATURES			84
EX-23.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

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 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” and similar expressions identify such forward-looking statements. These forward-looking statements include statements regarding Evans Bancorp, Inc.’s (“the Company”) business plans, prospects, growth and operating strategies, statements regarding the asset quality of the Company’s loan and investment portfolios, and estimates of the Company’s risks and future costs and benefits.

These forward-looking statements are based largely on the expectations of the Company’s management and are subject to a number of risks and uncertainties, including but not limited to general economic conditions, either nationally or in the Company’s market areas, that are worse than expected; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company’s margins or reduce the fair value of financial instruments; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board (“FASB”) and the Public Company Accounting Oversight Board; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; and other factors discussed elsewhere in this Report on Form 10-K, as well as in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”). Many of these factors are beyond the Company’s control and are difficult to predict.

Because of these and other uncertainties, the Company’s actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation, to publicly update or revise forward-looking information, whether as a result of new, updated information, future events or otherwise.

Item 1. BUSINESS

EVANS BANCORP, INC.

Evans Bancorp, Inc. (the “Company”) is a New York business corporation which is registered as a financial holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The principal offices of the Company are located at 14-16 North Main Street, Angola, New York 14006 and its telephone number is (716) 926-2000. The Company was incorporated on October 28, 1988, but the continuity of its banking business is traced to the organization of the Evans National Bank of Angola on January 20, 1920. Except as the context otherwise requires, the Company and its direct and indirect subsidiaries are collectively referred to in this Report as the “Company.” The Company’s common stock is traded on the NASDAQ Global Market system under the symbol “EVBN.”

At December 31, 2007, the Company had consolidated total assets of $442.7 million, deposits of $325.8 million and stockholders’ equity of $43.3 million.

The Company’s primary business is the operation of its subsidiaries. It does not engage in any other substantial business activities. The Company has two direct wholly-owned subsidiaries: Evans National Bank (“Evans National Bank” or the “Bank”), which provides a full range of banking services to consumer and commercial customers in Western New York, and Evans National Financial Services, Inc. (“ENFS”), which owns 100% of the common stock of ENB Insurance Agency, Inc. (“ENBI”), which sells various premium-based insurance policies on a commission basis. At December 31, 2007, the Bank represented 97.2% and ENFS represented 2.8% of the consolidated assets of the Company. Further discussion of our segments is included in Note 17 to the Company’s Consolidated Financial Statements under Item 8 of this Report on Form 10-K.

Evans National Bank

The Bank is a nationally chartered bank that has its headquarters and full-service banking office at 14 North Main Street, Angola, New York, and a total of eleven full-service banking offices in Erie County and Chautauqua County, New York.

At December 31, 2007, the Bank had total assets of $430.2 million, security investments of $72.4 million, net loans of $319.6 million, deposits of $325.8 million and stockholders’ equity of $35.8 million compared to total assets of $461.5 million, security investments of $137.7 million, net loans of $285.4 million, deposits of $355.7 million and stockholders’ equity of $32.9 million at December 31, 2006. The Bank’s principal source of funding is 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. The Bank’s deposits are insured up to the maximum permitted by the Bank Insurance Fund (the “Insurance Fund”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers a variety of loan products to its customers, including commercial and consumer loans and commercial and residential mortgage loans.

As is the case with banking institutions generally, the Bank’s operations are significantly influenced by general economic conditions and by related monetary and fiscal policies of banking regulatory agencies, including the Federal Reserve Board (“FRB”) and FDIC. The Bank is also subject to the supervision, regulation and examination of the Office of the Comptroller of the Currency of the United States of America (the “OCC”).

Other Subsidiaries

In addition to the Bank, the Company has the following direct and indirect wholly-owned subsidiaries:

Evans National Leasing, Inc. (“Evans National Leasing” or “ENL”). ENL, a wholly-owned subsidiary of the Bank, provides direct financing leasing of commercial small-ticket general business equipment to companies located throughout the contiguous 48 United States.

Evans National Holding Corp. (“ENHC”). ENHC was incorporated in February 2002, and is a wholly-owned subsidiary of the Bank. ENHC operates as a real estate investment trust (“REIT”) that holds commercial real estate loans and residential mortgages, which provides additional flexibility and planning opportunities for the business of the Bank.

Evans National Financial Services, Inc. (“Evans National Financial Services” or “ENFS”). ENFS is located at One Grimsby Drive, Hamburg, New York. It was incorporated in September 2004, and is a wholly-owned subsidiary of the Company. ENFS’s primary business is to own the business and assets of the Company’s non-banking financial services segment subsidiaries.

ENB Insurance Agency, Inc. (“ENB Insurance Agency” or “ENBI”). ENBI, a wholly-owned subsidiary of ENFS, is an insurance agency which sells various premium-based insurance policies on a commission basis, including business and personal insurance, surety bonds, risk management, life, disability and long-term care coverage. ENBI has offices located in Erie, Niagara, Chautauqua, and Cattaraugus Counties in New York.

ENB Associates Inc. (“ENB Associates” or “ENB”). ENB, a wholly-owned subsidiary of ENBI, offers non-deposit investment products, such as annuities and mutual funds.

Frontier Claims Services, Inc. (“FCS”). FCS is a wholly-owned subsidiary of ENBI and provides claims adjusting services to various insurance companies.

The Company also has two special purpose entities: Evans Capital Trust I, a statutory trust formed on September 29, 2004 under the Statutory Trust Act, solely for the purpose of issuing and selling certain securities representing undivided beneficial interests in the assets of the trust, investing the proceeds thereof in certain debentures of the Company and engaging in those activities necessary, advisable or incidental thereto; and ENB Employers Insurance Trust, a Delaware trust company formed in February 2003 for the sole purpose of holding life insurance policies under the Bank’s bank-owned life insurance program.

The Company operates in two reportable segments – banking activities and insurance agency activities. See Note 17 to the Company’s Consolidated Financial Statements included under Item 8 of this Report on Form 10-K for more information on the Company’s reportable segments.

MARKET AREA

The Company’s primary market area is Erie County, Niagara County, northern Chautauqua County and northwestern Cattaraugus County, New York. This primary market area is the area where the Bank principally receives deposits and makes loans and ENBI sells insurance. Even though ENL conducts business outside of this defined market area, this activity is not deemed to expand the Company’s primary market.

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 2007, 2006 and 2005. The assets and liabilities are presented as daily averages. The average loan balances include both performing and non-performing loans. Interest income on loans does not include interest on loans for which the Bank has ceased to accrue interest. Securities are stated at fair value. Interest and yield are not presented on a tax-equivalent basis.

		2007												2006												2005
		Average								Yield/				Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
		(dollars in thousands)												(dollars in thousands)												(dollars in thousands)
Assets
Interest-earning assets:
Loans and leases, net		$	297,905			$	23,918				8.03	%		$	268,538			$	20,405				7.60	%		$	236,754			$	16,234				6.86	%
Taxable securities			68,453				2,919				4.26	%			104,368				4,209				4.03	%			124,774				4,663				3.74	%
Tax-exempt securities			38,923				1,683				4.32	%			44,044				1,881				4.27	%			45,751				1,933				4.23	%
Time deposits–other banks			—				—				—	%			—				—				—	%			215				3				1.40	%
Federal funds sold			6,448				317				4.92	%			1,097				49				4.47	%			4,462				113				2.53	%
Total interest-earning assets			411,729				28,837				7.00	%			418,047				26,544				6.35	%			411,956				22,946				5.57	%
Non interest-earning assets:
Cash and due from banks			11,454												12,066												11,183
Premises and equipment, net			8,568												8,194												8,215
Other assets			29,566												29,022												26,160
Total Assets		$	461,317											$	467,329											$	457,514
Liabilities & Stockholders’ Equity
Interest-bearing liabilities:
NOW		$	11,014				33				0.30	%		$	11,767				22				0.19	%		$	11,976				22				0.18	%
Regular savings deposits			88,685				1,061				1.20	%			88,522				926				1.05	%			94,841				804				0.85	%
Muni-vest savings			39,840				1,696				4.26	%			36,301				1,550				4.27	%			51,300				1,454				2.83	%
Time deposits			149,578				7,264				4.86	%			151,530				6,481				4.28	%			126,945				3,961				3.12	%
Other borrowed funds			29,655				1,164				3.93	%			46,304				1,800				3.89	%			49,939				1,616				3.23	%
Junior subordinated debentures			11,330				891				7.86	%			11,330				850				7.50	%			11,330				662				5.84	%
Securities sold under agreement to repurchase			6,694				53				0.79	%			8,493				68				0.80	%			6,467				50				0.77	%
Total interest-bearing liabilities			336,796				12,162				3.61	%			354,247				11,697				3.30	%			352,798				8,569				2.43	%
Non interest-bearing liabilities:
Demand deposits			73,577												67,046												62,186
Other			9,609												8,153												6,419
Total liabilities			419,982												429,446												421,403
Stockholders’ equity			41,335												37,883												36,111
Total Liabilities & Equity		$	461,317											$	467,329											$	457,514
Net interest earnings						$	16,675											$	14,847											$	14,377
Net yield on interest earning assets											4.05	%											3.55	%											3.49	%
Interest rate spread											3.39	%											3.05	%											3.14	%

SECURITIES ACTIVITIES

The primary objective of the Bank’s securities portfolio is to provide liquidity while preserving safety of principal. Secondary objectives include: the investment of funds during periods of decreased loan demand, interest rate 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 of the Bank’s investments.

Under the Bank’s policy, acceptable portfolio investments include: United States (“U.S.”) Government obligations, obligations of federal agencies or U.S. Government-sponsored enterprises, mortgage backed securities, 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), collateralized mortgage obligations, Federal Reserve stock and Federal Home Loan Bank stock.

The Bank’s general investment policy is that in-state securities must be rated at least Moody’s Baa (or equivalent) at the time of purchase. Out-of-state issues must be rated at least Moody’s Aa (or equivalent) at the time of purchase. Bonds or securities rated below A are reviewed periodically to assure their continued credit worthiness. While purchase of non-rated municipal securities is permitted, such purchases are limited to 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 & Poor’s. The securities portfolio of the Bank is priced on a monthly basis.

Pursuant to Statement of Financial Accounting Standard (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” which establishes accounting treatment for investments in securities, all securities in the Bank’s investment portfolio are either designated as “held to maturity” or “available for sale.”

Income from securities held in the Bank’s investment portfolio represented approximately 16.0% of total interest income of the Company in 2007 as compared to 22.9% in 2006 and 28.8% in 2005. At December 31, 2007, the Bank’s securities portfolio of $72.4 million consisted primarily of U.S. and federal agency obligations, state and municipal securities and mortgage-backed securities, including collateralized mortgage obligations (“CMO’s”), issued by the Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corp (“FHLMC”). The decrease in the securities portfolio from December 31, 2006 is a result of the Company’s strategy to restructure its balance sheet. The Company sold $45 million in securities in June 2007 while allowing other securities to mature. Management has the intent and ability to hold its investment securities until maturity. Correspondingly, the Company allowed certain municipal time deposits to roll off and priced down its muni-vest savings account with certain non-core municipal customers that resulted in the loss of those muni-vest accounts.

Available for sale securities with a total fair value of $65.8 million at December 31, 2007 were pledged as collateral to secure public deposits and for other purposes required or permitted by law.

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 cost as of December 31, 2007, 2006 and 2005:

		2007				2006				2005
		(in thousands)
Available for Sale:
Debt securities
U.S. government agencies		$	14,189			$	30,891			$	36,604
States and political subdivisions			35,658				38,438				42,463
Total debt securities		$	49,847			$	69,329			$	79,067
Mortgage-backed securities
FNMA		$	8,135			$	30,168			$	35,569
FHLMC			7,063				8,448				10,747
GNMA			—				1,044				1,334
CMO’s			1,587				20,629				24,509
Total mortgage-backed securities		$	16,785			$	60,289			$	72,159
FRB and Federal Home Loan Bank Stock			3,512				3,901				4,384
Total securities designated as available for sale		$	70,144			$	133,519			$	155,610
Held to Maturity:
U.S. government agencies		$	35			$	35			$	35
States and political subdivisions			2,231				4,176				4,307
Total securities designated as held to maturity		$	2,266			$	4,211			$	4,342
Total securities		$	72,410			$	137,730			$	159,952

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, 2007:

		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
		(dollars in thousands)
Available for Sale:
Debt Securities:
U.S. government agencies		$	7,336				3.40	%		$	4,852				4.20	%		$	—				—			$	2,000				7.40	%
States and political subdivisions			1,534				4.91	%			14,880				4.48	%			17,423				4.63	%			1,821				4.78	%
Total debt securities		$	8,870				3.66	%		$	19,732				4.42	%		$	17,423				4.63	%		$	3,821				6.15	%
Mortgage-backed Securities:
FNMA		$	—				—			$	935				5.02	%		$	1,197				5.04	%		$	6,003				5.25	%
FHLMC			1,996				3.25	%			2,329				3.96	%			1,541				4.90	%			1,197				5.65	%
CMO’s			—				—				232				4.25	%			—				—				1,356				4.47	%
Total mortgage-backed securities		$	1,996				—			$	3,496				4.26	%		$	2,738				4.95	%		$	8,556				5.18	%
Total available for sale		$	10,866				3.58	%		$	23,228				4.40	%		$	20,161				4.67	%		$	12,377				5.48	%
Held to Maturity:
U.S. government agencies		$	—				—			$	—				—			$	35				—			$	—				—
States and political subdivisions		$	173				4.44	%			828				3.81	%			476				4.56	%			754				3.70	%
Total held to maturity		$	173				4.44	%			828				3.81	%			511				4.24	%			754				3.70	%
Total securities		$	11,039				3.60	%		$	24,056				4.38	%		$	20,672				4.66	%			13,131				5.38	%

LENDING AND LEASING ACTIVITIES

General. The Bank has a loan and lease policy, which includes a loan and lease loss allowance policy, which is approved by its Board of Directors on an annual basis. The loan and lease policy governs the conditions under which loans and leases may be made, addresses the lending authorities of Bank officers, charge off policies and desired portfolio mix.

The Bank offers a variety of loan and lease products to its customers, including residential and commercial real estate mortgage loans, commercial loans, direct financing leases, and installment loans. The Bank primarily extends loans to customers located within the Western New York area, except for direct financing leases, which are originated in all 48 contiguous states. Interest income on loans and leases represented approximately 82.9% of the total interest income of the Company in 2007 and approximately 76.9% and 70.7% of total interest income in 2006 and 2005, respectively. The Bank’s loan and lease portfolio, after unearned discounts, loan origination costs and allowances for loan and lease losses, totaled $319.6 million and $285.4 million at December 31, 2007 and December 31, 2006, respectively. At December 31, 2007, the Bank had a $4.6 million allowance for loan losses which is approximately 1.41% of total loans and leases. This compares with approximately $3.7 million at December 31, 2006 which was approximately 1.29% of total loans and leases. The increase of the allowance for loan and lease losses of $0.9 million in 2007 reflects management’s assessment of the portfolio composition, of which higher risk commercial real estate loans comprise a significant component, the increase of higher risk leases and its assessment of the New York State and local economy. The net loan portfolio represented approximately 72.2% and 60.2% of the Company’s total assets at December 31, 2007 and December 31, 2006, respectively.

Real Estate Loans. Approximately 73.3% of the Bank’s loan and lease portfolio at December 31, 2007 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, compared to 76.1% at December 31, 2006. The Bank’s real estate loan portfolio was $237.5 million at December 31, 2007, compared to $220.0 million at December 31, 2006. The real estate loan portfolio increased approximately 8.0% in 2007 over 2006 compared to an increase of 5.2% in 2006 over 2005.

The Bank offers fixed rate residential mortgage loans with terms of 10 to 30 years with, typically, up to an 80% loan-to-value ratio. Fixed rate residential mortgage loans outstanding totaled $56.5 million at December 31, 2007, which was approximately 17.4% of total loans outstanding. In 1995, the Bank entered into a contractual arrangement with FNMA, pursuant to which the Bank sells mortgage loans to FNMA and the Bank retains the servicing rights as to those loans.

In 2007, the Bank sold approximately $2.9 million in mortgages to FNMA under this arrangement, compared to $2.6 million in mortgages sold in 2006. The Bank currently retains the servicing rights on $28.4 million in mortgages sold by the Bank to FNMA. The Company has recorded a net servicing asset for such loans of approximately $0.2 million at December 31, 2007. The Bank determines with each origination of a residential real estate loan which desired maturities, within the context of overall maturities in the loan portfolio, provide the appropriate mix to optimize the Bank’s ability to absorb the corresponding interest rate risk within the Bank’s tolerance ranges.

Since 1993, the Bank has offered adjustable rate residential mortgage loans with terms of up to 30 years. Rates on these mortgage loans remain fixed for a predetermined time and are adjusted annually thereafter. On December 31, 2007, the Bank’s outstanding adjustable rate residential mortgage loans were $12.1 million or 3.7% as compared to $8.7 million or 3.0% of total loans at December 31, 2006. This balance did not include any construction mortgage loans, which are discussed below.

The Bank also offers commercial mortgage loans with up to an 80% loan-to-value ratio for up to 20 years on a variable and fixed rate basis. Many of these mortgage loans either mature or are subject to a rate call after three to five years. The Bank’s outstanding commercial mortgage loans were $131.1 million at December 31, 2007, which was approximately 41.0% of total loans outstanding. This balance included $37.3 million in fixed rate and $93.8 million in variable rate mortgage loans, which include interest 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 15 years and up to an 80% loan-to-value ratio. At December 31, 2007, the real estate loan portfolio included $26.4 million of home equity loans outstanding, which represented approximately 8.1% of its total loans outstanding. This balance included $16.9 million in variable rate and $9.5 million in fixed rate loans.

The Bank does not have any sub-prime or Alt-A mortgages in its portfolio at December 31, 2007.

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, 2007, fixed rate real estate construction loans outstanding were $0.6 million or 0.2% of the Bank’s loan portfolio, and adjustable rate construction loans outstanding were $10.9 million or 3.3% of the portfolio.

As of December 31, 2007, approximately $4.3 million or 1.8% of the Bank’s real estate loans were 30 to 90 days delinquent, and approximately $0.1 million or 0.1% of real estate loans were non-accruing. The Bank also had one real estate loan for $0.2 million or 0.1% of real estate loans that was over 90 days past due and still accruing.

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 $34.6 million and $29.6 million at December 31, 2007 and 2006, respectively. Commercial loans represented approximately 10.7% and 10.2% of the Bank’s total loans at December 31, 2007 and 2006, respectively.

As of December 31, 2007, approximately $149 thousand or 0.4% of the Bank’s commercial loans were 30 to 90 days past due and $0.2 million or 0.6% of its commercial loans were non-accruing, the latter due primarily to one borrower.

Commercial lending entails significantly more risk than real estate loans. Collateral, where applicable, may consist of inventory, receivables, equipment and other business assets. Approximately 61.8% of the Bank’s commercial loans are at variable rates which are tied to the prime rate.

Installment Loans. The Bank’s consumer installment loan portfolio totaled $2.1 million and $3.1 million at December 31, 2007 and 2006, respectively, representing approximately 0.6% of the Bank’s total loans at December 31, 2007 and 1.1% of the Bank’s total loans at December 31, 2006. Traditional installment loans are offered at fixed interest rates with various maturities of up to 60 months, on a secured and unsecured basis. As of December 31, 2007, approximately $36 thousand or 1.7% of the Bank’s installment loans were 30 to 90 days past due.

Direct Financing Leases. Direct financing leases totaled $45.1 million and $31.7 million at December 31, 2007 and 2006, respectively, representing approximately 13.9% and 11.0% of the Bank’s total loans at December 31, 2007 and 2006, respectively. As of December 31, 2007, approximately $0.3 million or 0.7% of the Bank’s direct financing leases were 30-90 days past due.

The Bank’s lending limit to any one borrower is subject to regulation by the OCC. The Bank continually monitors its loan portfolio to review compliance with new and existing regulations.

The following table summarizes the major classifications of the Bank’s loans and leases (net of deferred origination costs) as of the dates indicated.

		December 31,
		2007				2006				2005				2004				2003
		(in thousands)
Mortgage loans on real estate:
Residential 1-4 family		$	68,553			$	57,702			$	48,580			$	38,491			$	30,160
Commercial and multi-family			131,146				123,701				123,727				107,392				99,684
Construction			11,446				11,848				9,270				8,188				5,090
Second mortgages			9,452				8,625				6,454				5,716				6,274
Home equity lines of credit			16,926				18,147				21,082				22,108				18,262
Total mortgage loans on real estate			237,523				220,023				209,113				181,895				159,470
Direct financing leases			45,078				31,742				16,945				4,546				—
Commercial loans			34,563				29,589				29,920				28,762				24,282
Consumer loans			2,083				3,101				2,747				2,832				2,569
Other			3,983				3,997				642				1,973				1,209
Net deferred loan and lease origination costs			881				654				654				590				537
Total loans and leases			324,111				289,106				260,021				220,598				188,067
Allowance for loan and lease losses			(4,555	)			(3,739	)			(3,211	)			(2,999	)			(2,539	)
Loans and leases, net		$	319,556			$	285,367			$	256,810			$	217,599			$	185,528

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, 2007 and the classification of such loans due after one year according to sensitivity to changes in interest rates.

						After One But
		Within				Within Five				After Five
		One Year				Years				Years				Total
		(in thousands)
Commercial		$	2,320			$	13,998			$	18,245			$	34,563
Real estate construction			5,133				5,057				1,256				11,446
		$	7,453			$	19,055			$	19,501			$	46,009
Loans maturing after one year with:
Fixed Rates						$	10,558			$	2,503
Variable Rates							8,497				16,998
						$	19,055			$	19,501

Non-accrual, Past Due and Restructured Loans and Leases. The following table summarizes the Bank’s non-accrual and accruing loans and leases 90 days or more past due as of the dates listed below. The Bank had no restructured loans or leases as of those dates. Any loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed do not represent or result from trends or uncertainties which management reasonably expects will materially impact the Company’s future operating results, liquidity or capital resources. See Part II, Item 7 of this Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Loan and Lease Losses,” for further information about the Company’s non-accrual, past due and restructured loans and leases.

		At December 31,
		2007				2006				2005				2004				2003
		(in thousands)
Non-accruing loans and leases:
Mortgage loans on real estate:
Residential 1-4 family		$	—			$	—			$	—			$	—			$	30
Commercial and multi-family			112				145				600				278				176
Construction			—				—				—				—				—
Second mortgages			—				—				—				—				50
Home Equity lines of credit			—				—				—				—				—
Total mortgage loans on real estate			112				145				600				278				256
Direct financing leases			215				—				—				2				—
Commercial loans			224				443				1,175				1,375				40
Consumer installment loans Other			—				—				—				—				—
Total non-accruing loans and leases		$	551			$	588			$	1,775			$	1,655			$	296
Accruing loans and leases 90+ days past due			163				74				95				151				627
Total non-performing loans and leases		$	714			$	662			$	1,870			$	1,806			$	923
Total non-performing loans and leases to total assets			0.16	%			0.15	%			0.41	%			0.42	%			0.27	%
Total non-performing loans and leases to total loans and leases			0.22	%			0.23	%			0.72	%			0.82	%			0.49	%

The following table summarizes the Bank’s allowance for loan and lease losses and changes in the allowance for loan and lease losses by categories:

ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES

		2007				2006				2005				2004				2003
		(in thousands)
BALANCE AT THE BEGINNING OF THE YEAR		$	3,739			$	3,211			$	2,999			$	2,539			$	2,146
CHARGE-OFFS:
Commercial			(153	)			(212	)			(417	)			(200	)			(54	)
Real estate mortgages			(5	)			—				(25	)			(6	)			(30	)
Direct financing leases			(1,048	)			(500	)			(108	)			—				—
Installment loans			(7	)			(44	)			(86	)			(9	)			(11	)
Overdrafted deposit accounts			(58	)			(42	)			(39	)			—				—
TOTAL CHARGE-OFFS			(1,271	)			(798	)			(675	)			(215	)			(95	)
RECOVERIES:
Commercial			26				53				—				48				7
Real estate mortgages			—				—				40				8				—
Direct financing leases			105				62				56				—				—
Installment loans			18				63				11				4				1
Overdrafted deposit accounts			21				20				11				—				—
TOTAL RECOVERIES			170				198				118				60				8
NET CHARGE-OFFS			(1,101	)			(600	)			(557	)			(155	)			(87	)
PROVISION FOR LOAN AND LEASE LOSSES			1,917				1,128				769				485				480
ADDITION OF ALLOWANCE FROM ACQUISITION			—				—				—				130				—
BALANCE AT END OF YEAR		$	4,555			$	3,739			$	3,211			$	2,999			$	2,539
RATIO OF NET CHARGE-OFFS TO AVERAGE NET LOANS AND LEASES OUTSTANDING			0.37	%			0.22	%			0.23	%			0.08	%			0.05	%

The increase in the allowance for loan and lease losses reflects the continued growth in higher risk commercial loans and direct financing leases, the downgrade of a small number of individual loans, and management’s assessment of the local and New York State economic environment. Both the local and New York State economies have lagged behind national economic growth in recent years. Marginal job growth, combined with a declining population base, has left the Bank’s primary market more susceptible to potential credit problems. This is particularly true of commercial borrowers. Recent national economic forecasts indicate a likelihood of slowed economic growth, with an increasing chance of a recession. Much of the economic turmoil in the national economy is due to the sub-prime mortgage credit crises. As the Company has no exposure to sub-prime lending, and the local real estate market has not experienced the same high levels of appreciation seen in high-growth parts of the country, the faltering sub-prime credit market has not affected the Company’s loan and lease portfolio and local real estate values have remained steady to slightly higher. However, management is closely monitoring the loan and lease portfolio for potential losses and heightened risk factors with customers. The Company maintains a robust loan review process to ensure that specific credits are appropriately reserved. In particular, management is monitoring the leasing portfolio for signs of weakness in a more challenging economic environment. Also, management is cognizant that commercial real estate values may be susceptible to decline in an adverse economy. Management believes that the provision for loan and lease losses is reflective of its assessment of the local environment, as well as the continued trend in commercial loan activity and balances outstanding.

SOURCES OF FUNDS – DEPOSITS

General. Customer deposits represent the primary source of the Bank’s funds for lending and other investment purposes. In addition to deposits, other sources of funds include loan and lease repayments, loan sales on the secondary market, interest and dividend income from investments, matured investments, and borrowings from the Federal Home Loan Bank (“FHLB”) and from correspondent banks First Tennessee Bank and M&T 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. Bank deposits of the Bank are insured up to the limits provided by the FDIC. At December 31, 2007, the Bank’s deposits totaled $325.8 million consisting of the following:

		(In thousands)
Demand deposits		$	69,268
NOW accounts			10,141
Regular savings			92,864
Muni-vest savings			24,530
Time deposits, $100,000 and over			51,128
Other time deposits			77,898
Total		$	325,829

The following table shows daily average deposits and average rates paid on significant deposit categories by the Bank (dollars in thousands):

		2007								2006								2005
						Weighted								Weighted								Weighted
		Average				Average				Average				Average				Average				Average
		Balance				Rate				Balance				Rate				Balance				Rate
Demand deposits		$	73,577				0.00	%		$	67,046				0.00	%		$	62,186				0.00	%
NOW accounts			11,014				0.30	%			11,767				0.19	%			11,976				0.18	%
Regular Savings			88,685				1.20	%			88,522				1.05	%			94,841				0.85	%
Muni-vest savings			39,840				4.26	%			36,301				4.27	%			51,300				2.83	%
Time deposits			149,578				4.86	%			151,530				4.28	%			126,945				3.12	%
Total		$	362,694				2.77	%		$	355,166				2.53	%		$	347,248				1.80	%

The following schedule sets forth the maturities of the Bank’s time deposits as of December 31, 2007:

		Time Deposit Maturity Schedule
		(in thousands)
		0-3				3-6				6-12				Over 12
		Mos.				Mos.				Mos.				Mos.				Total
Time deposits — $100,000 and over		$	14,671			$	5,205			$	14,492			$	16,760			$	51,128
Other time deposits			20,814				19,104				21,496				16,484				77,898
Total time deposits		$	35,485			$	24,309			$	35,988			$	33,244			$	129,026

Federal Funds Purchased and Other Borrowed Funds. Another source of the Bank’s funds for lending and investing activities at December 31, 2007 consisted of short and long term borrowings from the Federal Home Loan Bank.

Other borrowed funds consisted primarily of various advances from the Federal Home Loan Bank with both fixed and variable interest rate terms ranging from 3.02% to 3.61%. The maturities and weighted average rates of other borrowed funds at December 31, 2007 are as follows (dollars in thousands):

						Weighted
						Average
		Maturities				Rate
2008		$	33,980				3.62	%
2009			920				4.99	%
2010			112				6.00	%
2011			69				6.00	%
2012			—				—
Thereafter			13,000				3.46	%
Total		$	48,081				3.59	%

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 that the securities are held in safekeeping by the Bank on behalf of the depositor. Securities sold under agreements to repurchase totaled $3.8 million at December 31, 2007 compared to $9.0 million at December 31, 2006.

MARKET RISK

For information about, and a discussion of, the Company’s “Market Risk,” see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk” of this Report on Form 10-K.

ENVIRONMENTAL MATTERS

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 in a foreclosure action, and that the Bank 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.

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.

COMPETITION

All phases of the Company’s business are highly competitive. The Company competes actively with local, regional and national financial institutions, as well as with bank branches or insurance agency offices in the Company’s market area of Erie County, Niagara County, northern Chautauqua County, and northwestern Cattaraugus County, New York. These Western New York counties have a high density of financial institutions, many of which are significantly larger and have greater financial resources than the Company. The Company faces competition for loans, direct financing leases and deposits from other commercial banks, savings banks, savings and loan associations, mortgage banking companies, credit unions, insurance companies and other financial services companies. The Company faces additional competition for deposits and insurance business from non-depository competitors such as the mutual fund industry, securities and brokerage firms, and insurance companies and brokerages. The Company 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 and leases.

SUPERVISION AND REGULATION

Bank holding companies and banks are extensively regulated under both federal and state laws and regulations that are intended to protect depositors. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in the applicable law or regulation, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material adverse effect on the Company’s business, financial condition and results of operations.

Bank Holding Company Regulation (BHCA)

As a financial holding company registered under the BHCA, the Company and its non-banking subsidiaries are subject to regulation and supervision under the BHCA by the FRB. The FRB requires periodic reports from the Company, and is authorized by the BHCA to make regular examinations of the Company and its subsidiaries.

The Company is required to obtain the prior approval of the FRB before acquiring direct or indirect ownership or control of more than 5% of the voting shares of a bank or bank holding company. The FRB will not approve any acquisition, merger or consolidation that would have a substantial anti-competitive result, unless the anti-competitive effects of the proposed transaction are outweighed by a greater public interest in meeting the needs and convenience of the public.

The FRB also considers managerial, capital and other financial factors in acting on acquisition or merger applications. A bank holding company may not engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in any non-banking activity, unless such activity has been determined by the FRB to be closely related to banking or managing banks. The FRB has identified by regulation various non-banking activities in which a bank holding company may engage with notice to, or prior approval by, the FRB.

The FRB has enforcement powers over financial holding companies and their subsidiaries, among other things, to interdict activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative orders, or written agreements with a federal bank regulator. These powers may be exercised through the issuance of cease and desist orders, civil monetary penalties or other actions.

Bank holding companies and their subsidiary banks are also subject to the provisions of the Community Reinvestment Act (“CRA”). Under the terms of the CRA, the FRB (or other appropriate bank regulatory agency, in the case of the Bank, the OCC) is required, in connection with its examination of a bank, to assess such bank’s record in meeting the credit needs of the communities served by that bank, including low- and moderate-income neighborhoods. Furthermore, such assessment is taken into account in evaluating any application made by a bank holding company or a bank for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares.

Supervision and Regulation of Bank Subsidiaries

The Bank is a nationally chartered banking corporation subject to supervision, examination and regulation of the FRB, the FDIC and the OCC. These regulators have the power to enjoin “unsafe or unsound practices,” require affirmative action to correct any conditions resulting from any violation or practice, issue an administrative order that can be judicially enforced, direct an increase in capital, restrict the growth of a bank, assess civil monetary penalties, and remove a bank’s officers and directors.

The operations of the Bank are subject to numerous statutes and regulations. Such statutes and regulations relate to required reserves against deposits, investments, loans, mergers and consolidations, issuance of securities, payment of dividends, establishment of branches, and other aspects of the Bank’s operations. Various consumer laws and regulations also affect the operations of the Bank, including state usury laws, laws relating to fiduciaries, consumer credit and equal credit, fair credit reporting, and privacy of non-public financial information.

The Bank is subject to Sections 23A and 23B of the Federal Reserve Act and Regulation W thereunder, which govern certain transactions, such as loans, extensions of credit, investments and purchases of assets between member banks and their affiliates, including their parent holding companies. These restrictions limit the transfer from its subsidiaries, including the Bank, of funds to the Company in the form of loans, extensions of credit, investments or purchases of assets (collectively, “Transfers”), and they require that the Bank’s transactions with the Company be on terms no less favorable to the Bank than comparable transactions between the Bank and unrelated third parties. Transfers by the Bank to the Company are limited in amount to 10% of the Bank’s capital and surplus, and transfers to all affiliates are limited in the aggregate to 20% of the Bank’s capital and surplus. Furthermore, such loans and extensions of credit are also subject to various collateral requirements. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for acquisitions, and the payment of dividends, interest and operating expenses.

The Bank is prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Bank may not generally require a customer to obtain other services from the Bank or the Company, and may not require the customer to promise not to obtain other services from a competitor as a condition to an extension of credit. The Bank is also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal stockholders or any related interest

of such persons. Extensions of credit: (i) must be made on substantially the same terms (including interest rates and collateral) as, and following credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the Bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of the Bank or the imposition of a cease and desist order.

The deposits of the Bank are insured by the FDIC through the Insurance Fund to the extent provided by law. Under the FDIC’s risk-based insurance system, institutions insured through the Insurance Fund are currently assessed premiums based on eligible deposits and the institutions’ capital position and other supervisory factors. Legislation also provides for assessments against institutions insured through the Insurance Fund which will be used to pay certain financing corporation (“FICO”) obligations. In addition to any Insurance Fund assessments, banks insured through the Insurance Fund are expected to make payments for the FICO obligations based on eligible deposits each year. The assessment is determined quarterly.

Regulations promulgated by the FDIC pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 place limitations on the ability of certain insured depository institutions to accept, renew or rollover deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other depository institutions having the same type of charter in such depository institutions’ normal market area. Under these regulations, well-capitalized institutions may accept, renew or rollover such deposits without restriction, while adequately capitalized institutions may accept, renew or rollover such deposits with a waiver from the FDIC (subject to certain restrictions on payment of rates). Undercapitalized institutions may not accept, renew or rollover such deposits.

Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with: (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured institution in danger of default. “Default” is defined generally as the appointment of a conservator or receiver, and “in danger of Default” is defined generally as the existence of certain conditions indicating that a “default” is likely to occur in the absence of regulatory assistance.

The federal regulators have adopted regulations and examination procedures promoting the safety and soundness of individual institutions by specifically addressing, among other things: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate exposure; (v) asset growth; (vi) ratio of classified assets to capital; (vii) minimum earnings; and (viii) compensation and benefits standards for management officials.

The FRB, the OCC and other federal banking agencies have broad enforcement powers, including the power to terminate deposit insurance, and impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver for the assets of a regulated entity. Failure to comply with applicable laws, regulations and supervisory agreements could subject the Company or its subsidiaries, as well as officers, directors and other institution-affiliated parties of these organizations, to administrative sanctions and potential civil monetary penalties.

Capital Adequacy

The FRB, the FDIC and the OCC have adopted risk-based capital adequacy guidelines for bank holding companies and banks under their supervision. Under these guidelines, the so-called “Tier 1 capital” and “Total capital” as a percentage of risk-weighted assets and certain off-balance sheet instruments must be at least 4% and 8%, respectively.

The FRB, the FDIC and the OCC have also imposed a leverage standard to supplement their risk-based ratios. This leverage standard focuses on a banking institution’s ratio of Tier 1 capital to average total assets, adjusted for goodwill and certain other items. Under these guidelines, banking institutions that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and that have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total adjusted average assets of at least 3%.

Institutions not meeting these criteria, as well as institutions with supervisory, financial or operational weaknesses, along with those experiencing or anticipating significant growth, are expected to maintain a Tier 1 capital to total adjusted average assets ratio equal to at least 4%. As reflected in the following table, the risk-based capital ratios and leverage ratios of the Company and the Bank as of December 31, 2007 and 2006 exceeded the required capital ratios for classification as “well capitalized,” the highest classification under the regulatory capital guidelines.

Capital Components and Ratios at December 31,
(dollars in thousands)

		2007								2006
		Company				Bank				Company				Bank
Capital components
Tier 1 capital		$	44,224			$	39,103			$	40,489			$	37,847
Total risk-based capital			48,453				43,289				44,228				41,575
Risk-weighted assets and off-balance sheet instruments			338,016				334,494				316,763				315,456
Risk-based capital ratio
Tier 1 capital			13.1	%			11.7	%			12.9	%			12.0	%
Total risk-based capital			14.3	%			12.9	%			14.0	%			13.2	%
Leverage ratio			10.0	%			9.0	%			8.9	%			8.4	%

The federal banking agencies, including the FRB and the OCC, maintain risk-based capital standards in order to ensure that those standards take adequate account of interest rate risk, concentration of credit risk, the risk of non-traditional activities and equity investments in non-financial companies, as well as reflect the actual performance and expected risk of loss on certain multifamily housing loans. Bank regulators periodically propose amendments to the risk-based capital guidelines and related regulatory framework, and consider changes to the risk-based capital standards that could significantly increase the amount of capital needed to meet the requirements for the capital tiers described below. While the Company’s management studies such proposals, the timing of adoption, ultimate form and effect of any such proposed amendments on the Company’s capital requirements and operations cannot be predicted.

The federal banking agencies are required to take “prompt corrective action” in respect of depository institutions and their bank holding companies that do not meet minimum capital requirements, FDICIA established five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier, or that of its bank holding company, depends upon where its capital levels are in relation to various relevant capital measures, including a risk-based capital measure and a leverage ratio capital measure, and certain other factors.

Under the implementing regulations adopted by the federal banking agencies, a bank holding company or bank is considered “well capitalized” if it has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6% or greater; and (iii) a leverage ratio of 5% or greater; and is not subject to any order or written directive to meet and maintain a specific capital level for a capital measure. An “adequately capitalized” bank holding company or bank is defined as one that has: (i) a total risk-based capital ratio of 8% or greater; (ii) a Tier 1 risk-based capital ratio of 4% or greater; and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMELS rating of (1)). A bank holding company or bank is considered (A) “undercapitalized” if it has: (i) a total risk-based capital ratio of less than 8%; (ii) a Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with a composite CAMELS rating of (1)); (B) “significantly undercapitalized” if the bank has: (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1 risk-based capital ratio of less than 3%; or (iii) a leverage ratio of less than 3%; and (C) “critically undercapitalized” if the bank has a ratio of tangible equity to total assets equal to or less than 2%. The FRB may reclassify a “well capitalized” bank holding company or bank as “adequately capitalized” or subject an “adequately capitalized” or “undercapitalized” institution to the supervisory actions applicable to the next lower capital category if it determines that the bank holding company or bank is in an unsafe or unsound condition or deems the bank holding company or bank to be engaged in an unsafe or unsound practice and not to have corrected the deficiency. The Company and the Bank currently meet the definition of “well capitalized” institutions.

“Undercapitalized” depository institutions, among other things, are subject to growth limitations; are prohibited, with certain exceptions, from making capital distributions; are limited in their ability to obtain funding from a Federal Reserve Bank; and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan and provide appropriate assurances of performance. If a depository institution fails to submit an acceptable plan, including if the holding company refuses or is unable to make the guarantee described in the previous sentence, it is treated as if it is “significantly undercapitalized.” Failure to submit or implement an acceptable capital plan also is grounds for the appointment of a conservator or a receiver. “Significantly undercapitalized” depository institutions may be subject to a number of additional requirements and restrictions, including orders to sell sufficient voting stock to

become “adequately capitalized,” requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Moreover, the parent holding company of a “significantly undercapitalized” depository institution may be ordered to divest itself of the institution or of non-bank subsidiaries of the holding company. “Critically undercapitalized” institutions, among other things, are prohibited from making any payments of principal and interest on subordinated debt, and are subject to the appointment of a receiver or conservator.

Each federal banking agency prescribes standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares and other standards as they deem appropriate. The FRB and the OCC have adopted such standards.

Financial Services Modernization and Other Recent Legislation

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) facilitates the interstate expansion and consolidation of banking organizations by permitting bank holding companies that are adequately capitalized and managed to acquire banks located in states outside their home states, regardless of whether such acquisitions are authorized under the law of the host state. The Riegle-Neal Act also permits interstate mergers of banks, with some limitations, and the establishment of new branches on an interstate basis, provided that such actions are authorized by the law of the host state.

The Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) permits banks, securities firms and insurance companies to affiliate under a common holding company structure. In addition to allowing new forms of financial services combinations, the GLB Act clarifies how financial services conglomerates will be regulated by the different federal and state regulators. The GLB Act amended by the BHCA and expanded the permissible activities of certain qualifying bank holding companies, known as financial holding companies. In addition to engaging in banking and activities closely related to banking, as determined by the FRB by regulation or order, financial holding companies may engage in activities that are financial in nature or incidental to financial activities that are complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Under the GLB Act, all financial institutions, including the Company and the Bank, are required to develop privacy policies, restrict the sharing of non-public customer data with non-affiliated parties at the customer’s request, and establish procedures and practices to protect customer data from unauthorized access.

USA Patriot Act

The USA Patriot Act of 2001 (the “Patriot Act”) imposes additional obligations on U.S. financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to prevent, detect and report instances of money laundering and the financing of terrorism. In addition, provisions of the Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions. The Company and its impacted subsidiaries have approved policies and procedures that are believed to be compliant with the Patriot Act.

Sarbanes-Oxley Act of 2002

Since the enactment of the Sarbanes-Oxley Act of 2002 and the SEC’s implementing regulations of the same (collectively, the “Sarbanes-Oxley Act”), companies that have securities registered under the Exchange Act, including the Company, are subject to enhanced and more transparent corporate governance standards, disclosure requirements and accounting and financial reporting requirements. The Sarbanes-Oxley Act, among other things, (i) requires: the principal executive and principal financial officers of a public company to establish and maintain disclosure controls and procedures and internal controls over financial reporting for the company, and to evaluate the effectiveness of these controls and certify and report on their findings in the company’s periodic reports; a public company to establish and maintain audit committees, comprised solely of independent directors, which committee must be empowered to, among other things, engage, supervise and discharge the company’s auditors; that a public company’s financial statements be certified by the principal executive and principal financial officers of such company; increased and quicker public disclosure — real time — obligations by the company and its directors and officers, including disclosures of off-balance sheet transactions and accelerated reporting of transactions in company stock; (ii) prohibits personal loans to company directors and officers, except certain loans made by insured financial institutions on non-preferential terms and in compliance with other bank regulatory requirements; and (iii) creates or provides for various increased civil and criminal penalties for violations of the securities laws.

Monetary Policy and Economic Control

The commercial banking business is affected not only by general economic conditions, but also by the monetary policies of the FRB. Changes in the discount rate on member bank borrowing, availability of borrowing at the “discount window,” open market operations, the imposition of changes in reserve requirements against member banks’ deposits and assets of foreign branches and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the FRB. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and this use may affect interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks and are expected to continue to do so in the future. The monetary policies of these agencies are influenced by various factors, including inflation, unemployment, and short-term and long-term changes in the international trade balance and in the fiscal policies of the United States Government. Future monetary policies and the effect of such policies on the future business and earnings of the Company cannot be predicted.

SUBSIDIARIES OF THE COMPANY

Evans National Financial Services, Inc. ENFS, a wholly-owned subsidiary of the Company, is a holding company for the financial services business of the Company, including ENBI.

ENB Insurance Agency, Inc. ENBI, a retail property and casualty insurance agency, is a wholly-owned subsidiary of ENFS. ENBI is headquartered in Angola, New York, with offices located throughout Western New York. ENBI is a full-service insurance agency offering personal, commercial and financial services products. It also has a small consulting department. For the year ended December 31, 2007, ENBI had a premium volume of approximately $43.2 million and commission revenue of $6.5 million.

ENBI’s primary market area is Erie, Chautauqua, Cattaraugus and Niagara counties. All lines of personal insurance are provided, including automobile, homeowner’s, boat, recreational vehicle, landlord and umbrella coverages. Commercial insurance products are also provided, consisting of property, liability, automobile, inland marine, workers compensation, bonds, crop and umbrella insurance. ENBI 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.

ENBI has a small consulting division which works 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 ENBI’s competition comes from direct writers, as well as some small local agencies located in the same towns and villages in which ENBI 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, ENBI has attempted to remain competitive in all aspects of its business.

ENBI 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.

Frontier Claims Services, Inc. FCS, a wholly-owned subsidiary of ENBI, provides insurance adjusting services for insurance companies. FCS is located in Angola, New York.

ENB Associates Inc. ENB, a wholly-owned subsidiary of ENBI, provides non-deposit investment products, such as mutual funds and annuities, to Bank customers at Bank branch locations. ENB has an investment services agreement with O’Keefe Shaw & Co., Inc., through which ENB can purchase and sell securities to its customers.

Evans National Bank. The Bank is a wholly-owned subsidiary of the Company. The Bank’s business is described above.

Evans National Leasing, Inc. ENL, a wholly-owned subsidiary of the Bank, provides direct financing leasing of commercial small-ticket general business equipment to companies located throughout the contiguous 48 United States.

Evans National Holding Corp. ENHC, a wholly-owned subsidiary of the Bank, 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.

ENB Employers Insurance Trust. ENB Employers Insurance Trust is a Delaware trust company formed for the sole purpose of holding life insurance policies under the Bank’s bank-owned life insurance program.

Evans Capital Trust I. Evans Capital Trust I, a wholly-owned subsidiary of the Company, was organized solely to issue and sell certain securities representing undivided beneficial interests of the Trust and investing the proceeds thereof in certain debentures of the Company.

EMPLOYEES

As of December 31, 2007, the Company had no direct employees. As of December 31, 2007, the following table summarizes the employment rosters of the Company’s subsidiaries:

		Full Time				Part Time
Bank			122				14
ENL			11				—
ENBI			51				7
FCS			4				—
			188				21

The Company’s subsidiaries have good relationships with their employees.

AVAILABLE INFORMATION

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished by the Company pursuant to Section 13(a) or 15(d) of the Exchange Act, are available without charge on the Company’s website, www.evansbancorp.com — SEC filings section, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. The Company is providing the address to its Internet site solely for the information of investors. The Company does 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 or into any other report filed with or furnished to the SEC.

Item 1A. RISK FACTORS

The following factors identified by the Company’s management represent significant potential risks that the Company faces in its operations.

Direct Financing Leases Expose the Company to Increased Credit Risks.

At December 31, 2007, the Company’s portfolio of direct financing leases totaled $45.1 million, or 13.9% of total gross loans. The leasing portfolio increased $13.3 million, or 42.0%, from December 31, 2006. The leasing portfolio is the Company’s fastest-growing segment of its loan and lease portfolio and earns the highest yield compared to other loans that the Company offers. The Company plans to continue to emphasize the origination of direct financing leases. The Company is able to earn the relatively higher yield on these leases because of the higher amount of credit risk assumed in its leasing portfolio. This is reflected in the fact that the leases have the highest rate of charge-offs among the Company’s loan and lease portfolio. ENL commenced operations December 31, 2004, in conjunction with the acquisition of the M&C Leasing Company. As ENL is relatively young, the portfolio is still seasoning and the Company has little history to support a projection as to what a long-term run-rate of charge-offs will be. Also, the Company has not held the leasing portfolio through a full credit cycle and is unsure of the impact a worsening economy could have on this relatively riskier portfolio. Consequently, a further deterioration in the credit quality of the leasing portfolio could negatively impact earnings, as well as cause the Company to tighten lending standards to lessees, which could significantly slow the Company’s fastest-growing segment of the loan portfolio. This would also impinge future growth in net interest income as the fast-growing leasing portfolio has buttressed the Company’s overall net interest income growth since ENL’s inception.