EVANS BANCORP INC - Annual Report: 2009 (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 Each 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 Act. Yes o No þ

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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. þ

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 (Do not check if a smaller reporting company)		Smaller reporting company þ

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

On June 30, 2009, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $35.7 million, based upon the closing sale price of a share of the registrant’s common stock on The NASDAQ Global Market.

As of March 5, 2010, 2,827,894 shares of the registrant’s common stock were outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement relating to the registrant’s 2010 Annual Meeting of Shareholders, to be held on April 22, 2010, 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.

TABLE OF CONTENTS

INDEX

		Page
PART I
Item 1. BUSINESS			5
Item 1A. RISK FACTORS			26
Item 1B. UNRESOLVED STAFF COMMENTS			30
Item 2. PROPERTIES			30
Item 3. LEGAL PROCEEDINGS			31
Item 4. (REMOVED AND RESERVED)			31
PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES			31
Item 6. SELECTED FINANCIAL DATA			33
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			33
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			54
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			55
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			98
Item 9A. CONTROLS AND PROCEDURES			98
Item 9B. OTHER INFORMATION			98

PART III
		Page
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE			99
Item 11. EXECUTIVE COMPENSATION			99
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			99
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE			99
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES			99
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES			100
SIGNATURES			101
EX-21.1
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 the business plans, prospects, growth and operating strategies of Evans Bancorp, Inc. (the “Company”), 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 Annual 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, NY 14006 and its telephone number is (716) 926-2000. The Company’s administrative office is located at One Grimsby Drive in Hamburg, NY. This facility is occupied by the Office of the President and Chief Executive Officer of the Company, as well as the Administrative and Loan Divisions of Evans Bank. 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 under the symbol “EVBN.”

At December 31, 2009, the Company had consolidated total assets of $619.4 million, deposits of $499.5 million and stockholders’ equity of $46.0 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: (1) Evans Bank, N.A. (“Evans Bank” or the “Bank”), which provides a full range of banking services to consumer and commercial customers in Western New York; and (2) Evans National Financial Services, Inc., which owns 100% of the common stock of The Evans Agency, Inc. (“TEA”), which sells various premium-based insurance policies on a commission basis. At December 31, 2009, the Bank represented 98.1% and ENFS represented 1.9% of the consolidated assets of the Company. Further discussion of our segments is included in Note 19 to the Company’s Consolidated Financial Statements included under Item 8 of this Annual Report on Form 10-K.

Evans Bank

The Bank is a nationally chartered bank that has its headquarters and a full-service banking office at 14 North Main Street, Angola, NY, and a total of 13 full-service banking offices in Erie County and Chautauqua County, NY.

At December 31, 2009, the Bank had total assets of $607.7 million, investment securities of $79.0 million, net loans of $482.6 million, deposits of $499.5 million and stockholders’ equity of $40.4 million, compared to total assets of $516.4 million, security investments of $75.8 million, net loans of $401.6 million, deposits of $404.0 million and stockholders’ equity of $40.2 million at December 31, 2008. 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, savings accounts, 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 leases 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”).

The Evans Agency, Inc.

TEA, a retail property and casualty insurance agency, is a wholly-owned subsidiary of Evans Financial Services. TEA is headquartered in Angola, NY, with offices located throughout Western New York. TEA 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, 2009, TEA had a premium volume of approximately $37.6 million and total revenue of $7.2 million.

TEA’s primary market area is Erie, Chautauqua, Cattaraugus and Niagara counties. Most 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. TEA 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.

TEA 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.

Other Subsidiaries

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

Evans National Leasing, Inc. (“ENL”). ENL, a wholly-owned subsidiary of the Bank, provided direct financing leasing of commercial small-ticket general business equipment to companies located throughout the contiguous 48 United States. The Company announced in April 2009 that it was exiting the leasing business. After attempts to sell the leasing portfolio, management has decided to service it through to maturity.

Evans National Holding Corp. (“ENHC”). ENHC, a wholly-owned subsidiary of the Bank, operates as a real estate investment trust that holds commercial real estate loans and residential mortgages, providing additional flexibility and planning opportunities for the business of the Bank.

Suchak Data Systems (“SDS”). The Company acquired SDS on December 31, 2008. SDS, a wholly-owned subsidiary of the Bank, serves the data processing needs of financial institutions with customized solutions and consultative services. SDS hosts the Bank’s core and primary banking systems and provides product development and programming services. SDS’s products and services for its other customers include core and online banking systems, check imaging, item processing, and automated teller machine (“ATM”) services.

Evans National Financial Services, Inc. (“ENFS”). ENFS 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 Associates Inc. (“ENBA”). ENBA, a wholly-owned subsidiary of TEA, offers non-deposit investment products, such as annuities and mutual funds.

Frontier Claims Services, Inc. (“FCS”). FCS is a wholly-owned subsidiary of TEA 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 (“BOLI”) program.

The Company operates in two operating segments — banking activities and insurance agency activities. See Note 19 to the Company’s Consolidated Financial Statements included under Item 8 of this Annual Report on Form 10-K for more information on the Company’s operating segments.

ACQUISITIONS

On July 24, 2009, the Bank entered into a definitive purchase and assumption agreement with the FDIC under which the Bank assumed approximately $51.0 million in liabilities, consisting almost entirely of deposits and accrued interest, and purchased substantially all of the assets, of Waterford Village Bank, a community bank located in Williamsville, NY (“Waterford”). Total assets purchased (before fair value adjustments) amounted to approximately $47.2 million, including a loan portfolio of approximately $42.0 million. Under the terms of the purchase agreement, the FDIC made an initial payment of $4.6 million to the Bank, which includes the bid price of a $0.8 million discount and approximately $3.8 million for Waterford’s capital shortfall at the initial closing. The final settlement will be determined on March 31, 2010. All of the purchased loans and foreclosed real estate acquired by the Bank under the purchase agreement were covered by a loss sharing agreement between the FDIC and the Bank which was included in the purchase agreement. Under this loss sharing agreement, the FDIC agreed to bear 80% of loan and foreclosed real estate losses up to $5.6 million and 95% of losses that exceed $5.6 million. Reimbursable losses are based on the book value of the relevant loans and foreclosed assets as determined by the FDIC as of the date of the acquisition.

MARKET AREA

The Company’s primary market area is Erie County, Niagara County, northern Chautauqua County and northwestern Cattaraugus County, NY. This primary market area is the area where the Bank principally receives deposits and makes loans and TEA 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.

The table below 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 2009, 2008 and 2007. 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.

		2009												2008												2007
		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		$	439,710			$	27,416				6.24	%		$	357,210			$	26,328				7.37	%		$	297,905			$	23,918				8.03	%
Taxable securities			40,594				1,608				3.96	%			32,168				1,309				4.07	%			68,453				2,919				4.26	%
Tax-exempt securities			40,242				1,676				4.16	%			34,584				1,490				4.31	%			38,923				1,683				4.32	%
Federal funds sold			1,188				1				0.08	%			1,531				24				1.57	%			6,448				317				4.92	%
Total interest-earning assets			521,734				30,701				5.88	%			425,493				29,151				6.85	%			411,729				28,837				7.00	%
Non interest-earning assets:
Cash and due from banks			12,337												12,592												11,454
Premises and equipment, net			9,547												8,662												8,568
Other assets			32,886												30,037												29,566
Total Assets		$	576,504											$	476,784											$	461,317
Liabilities & Stockholders’ Equity
Interest-bearing liabilities:
NOW		$	11,514				41				0.36	%		$	11,793				80				0.68	%		$	11,014				33				0.30	%
Regular savings deposits			197,178				2,226				1.13	%			113,266				1,801				1.59	%			88,685				1,061				1.20	%
Muni-vest savings			33,266				209				0.63	%			23,459				494				2.11	%			39,840				1,696				4.26	%
Time deposits			142,893				4,368				3.06	%			144,040				5,713				3.97	%			149,578				7,264				4.86	%
Other borrowed funds			32,758				843				2.57	%			35,876				1,110				3.09	%			29,655				1,164				3.93	%
Junior subordinated debentures			11,330				399				3.52	%			11,330				644				5.68	%			11,330				891				7.86	%
Securities sold under agreement to repurchase			5,331				21				0.39	%			5,151				41				0.80	%			6,694				53				0.79	%
Total interest-bearing liabilities			434,270				8,107				1.87	%			344,915				9,883				2.87	%			336,796				12,162				3.61	%
Non interest-bearing liabilities:
Demand deposits			85,181												75,551												73,577
Other			12,013												10,972												9,609
Total liabilities			531,464												431,438												419,982
Stockholders’ equity			45,040												45,346												41,335
Total Liabilities & Equity		$	576,504											$	476,784											$	461,317
Net interest earnings						$	22,594											$	19,268											$	16,675
Net yield on interest earning assets											4.33	%											4.53	%											4.05	%
Interest rate spread											4.01	%											3.98	%											3.39	%

SECURITIES ACTIVITIES

The primary objectives of the Bank’s securities portfolio are to provide liquidity and maximize income while preserving safety of principal. Secondary objectives include: providing collateral to secure local municipal deposits, the investment of funds during periods of decreased loan demand, interest rate sensitivity considerations, 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 by Moody’s at least Aa (or equivalent) at the time of purchase. Bonds or securities rated below A are reviewed periodically to ensure 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. The securities portfolio of the Bank is priced on a monthly basis.

Pursuant to FASB Accounting Standards Codification (“ASC”) 320, “Investments — 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 10.7% of total interest income of the Company in 2009 as compared with 9.6% in 2008 and 16.0% in 2007. At December 31, 2009, the Bank’s securities portfolio of $79.0 million consisted primarily of state and municipal securities, mortgage-backed securities issued by the Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corp (“FHLMC”), and U.S. and federal agency obligations. The Bank did not hold any FNMA or FHLMC perpetual preferred stock or trust-preferred securities at December 31, 2009. The decrease in the securities portfolio income from 2007 to 2008 was a result of the Company’s strategy to restructure its balance sheet. The Company sold $45.0 million of available-for-sale securities in June 2007 while allowing other securities to mature. 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 which resulted in the loss of those muni-vest accounts. The increase in the securities portfolio income from 2008 to 2009 was a result of assets purchased with the strong deposit growth in 2009, particularly in the muni-vest savings deposits. The Company’s core municipal customers retained higher balances at the Bank instead of bidding out longer-term time deposits. Municipal time deposits are typically put out to bid for multiple banks, resulting in a loss of that deposit business when the Bank is not the winning bidder. Management has the intent and ability to hold the Company’s investment securities until recovery or maturity. The Company did not have the intent to sell and it is not considered more likely than not that the Company will be required to sell any individual security in a loss position as of December 31, 2009 before recovery of its cost basis.

Available for sale securities with a total fair value of $65.2 million at December 31, 2009 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, 2009, 2008 and 2007:

		2009				2008				2007
		(in thousands)
Available for Sale:
Debt securities
U.S. government agencies		$	12,884			$	17,902			$	14,189
States and political subdivisions			37,730				35,436				35,658
Total debt securities		$	50,614			$	53,338			$	49,847
Mortgage-backed securities
FNMA		$	8,779			$	8,165			$	8,135
FHLMC			11,527				7,587				7,063
GNMA			378				—				—
CMO’s			981				1,149				1,587
Total mortgage-backed securities		$	21,665			$	16,901			$	16,785
FRB and Federal Home Loan Bank Stock			3,575				3,565				3,512
Total securities designated as available for sale		$	75,854			$	73,804			$	70,144
Held to Maturity:
U.S. government agencies		$	35			$	35			$	35
States and political subdivisions			3,129				1,916				2,231
Total securities designated as held to maturity		$	3,164			$	1,951			$	2,266
Total securities		$	79,018			$	75,755			$	72,410

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, 2009:

		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		$	1,008				4.25	%		$	828				3.13	%		$	3,950				4.30	%		$	7,098				5.58	%
States and political subdivisions			3,928				4.38	%			15,567				4.29	%			12,881				4.55	%			5,354				4.41	%
Total debt securities		$	4,936				4.36	%		$	16,395				4.23	%		$	16,831				4.49	%		$	12,452				5.07	%
Mortgage-backed Securities:
FNMA		$	50				4.50	%		$	524				5.04	%		$	3,568				5.01	%		$	4,637				4.81	%
FHLMC			64				5.00	%			3,708				3.20	%			1,441				5.02	%			6,314				5.45	%
GNMA			—				—				—								—								378				5.00	%
CMO’s			—				—				—				—				75				4.25	%			906				4.50	%
Total mortgage-backed securities		$	114				4.78	%		$	4,232				3.43	%		$	5,084				5.00	%		$	12,235				5.12	%
Total available for sale		$	5,050				4.37	%		$	20,627				4.06	%		$	21,915				4.61	%		$	24,687				5.10	%
Held to Maturity:
U.S. government agencies		$	—				—			$	—				—			$	35				—			$	—				—
States and political subdivisions			1,539				2.47	%			524				3.78	%			390				4.64	%			676				3.69	%
Total held to maturity		$	1,539				2.47	%		$	524				3.78	%		$	425				4.26	%		$	676				3.69	%
Total securities		$	6,589				3.92	%		$	21,151				4.06	%		$	22,340				4.60	%		$	25,363				5.06	%

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 authority of Bank officers, documentation, appraisal policy, charge off policies and desired portfolio mix.

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. Until it announced that it was exiting the direct financing leasing business in April 2009, ENL originated direct financing leases in all 48 contiguous states. The lease portfolio’s largest presence is in New York (17.7% of the portfolio), California (12.4%), Texas (7.9%), and Florida (7.3%). No other state had more than 4.0% of the total portfolio. Interest income on loans and leases represented approximately 89.3% of the total interest income of the Company in 2009 and approximately 90.4% and 82.9% of total interest income in 2008 and 2007, respectively. The Bank’s loan and lease portfolio, net of the allowances for loan and lease losses, totaled $482.6 million and $401.6 million at December 31, 2009 and December 31, 2008, respectively. The portfolio was bolstered by the $41.0 million in loans acquired in the purchase and assumption of Waterford from the FDIC on July 24, 2009, of which $39.0 million remained on the balance sheet at December 31, 2009. At December 31, 2009, the Bank had a $7.0 million allowance for loan and lease losses which is approximately 1.42% of total loans and leases. This compares with approximately $6.1 million at December 31, 2008 which was approximately 1.49% of total loans and leases. The $0.9 million increase in the allowance for loan and lease losses reflects management’s assessment of the risks inherent in the portfolio composition as well as the economic conditions. The United States was in a recession in 2009 and the recovery in 2010 is expected to be slow. The troubled economy resulted in a significant increase in net charge-offs in the direct financing lease portfolio in 2009. While the Company’s remaining commercial and consumer portfolios did not experience significant charge-offs in 2009, the economic recession put those portfolios at increased risk as well, as evidenced by the increase in non-performing loans. Also, a higher allowance is necessary because the loan portfolio was larger at December 31, 2009 than at the previous year-end due to strong growth in 2009, as discussed in more detail below. The net loan portfolio represented approximately 77.9% and 75.9% of the Company’s total assets at December 31, 2009 and December 31, 2008, respectively.

Real Estate Loans. Approximately 78.8% of the Bank’s total loan and lease portfolio at December 31, 2009 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 $385.8 million at December 31, 2009, compared with $296.2 million at December 31, 2008. The real estate loan portfolio increased by approximately 30.2% in 2009 over 2008 compared with an increase of 24.7% in 2008 over 2007. The real estate portfolio includes $34.4 million in real estate loans at December 31, 2009 that were acquired in the Waterford transaction.

Overall, residential real estate loans increased $14.0 million, or 21.0%, from $66.8 million at December 31, 2008 to $80.8 million at December 31, 2009. $11.8 million of the increase is attributable to the Waterford acquisition.

The Bank offers fixed rate residential mortgage loans with terms of 10 to 30 years with, typically, up to an 80% loan-to-value (“LTV”) ratio. Fixed rate residential mortgage loans outstanding totaled $65.4 million at December 31, 2009, which was approximately 13.5% of total loans and leases outstanding, compared with $54.8 million and 13.4%, respectively, at December 31, 2008. The Bank has a contractual arrangement with FNMA, pursuant to which the Bank sells certain mortgage loans to FNMA and the Bank retains the servicing rights to those loans.

In 2009, the Bank sold $16.2 million in mortgages to FNMA under this arrangement, compared with $3.5 million in mortgages sold in 2008. The growth in mortgage sales is attributable to the 142% increase in mortgage originations in 2009. Historically low interest rates resulted in the Bank selling the majority of new loans in an effort to mitigate the interest rate risk of holding long-term fixed rate loans in portfolio. Originations increased from $12.4 million in 2008 to $30.1 million in 2009. Historically low interest rates and Federal homebuyer tax credits fueled a high level of consumer demand in 2009. Much of the increased activity at the Bank and in the market in general was refinancing activity, in which customers replace their mortgage loans with a loan with a lower interest rate. The refinancing activity led to low organic balance growth.

The Bank currently retains the servicing rights on $37.4 million in mortgages sold to FNMA. The Company has recorded a net servicing asset for such loans of $0.3 million and $0.1 million at December 31, 2009 and 2008, respectively. The Bank determines with each origination of residential real estate loans 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 Company’s tolerance ranges.

The Bank offers 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. At December 31, 2009, the Bank’s outstanding adjustable rate residential mortgage loans were $15.4 million or 3.2% of total loans and leases outstanding as compared with $12.0 million or 2.9% of total loans and leases at December 31, 2008. 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% LTV 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 $241.1 million at December 31, 2009, which was 49.3% of total loans and leases outstanding, compared with $180.4 million and 44.3%, respectively, at December 31, 2008. $16.1 million of the $60.7 million in growth in commercial mortgages can be attributed to the Waterford acquisition. The rest of the growth is attributable to the Bank’s loan officers continuing to capitalize on opportunities available in the market. The Bank believes that it employs some of the most talented and well-connected loan officers in Western New York, and that the strong relationships with customers in the local community that have been fostered over the years have resulted in significant loan production in 2008 and 2009. The balance at December 31, 2009 included $78.1 million in fixed rate and $163.0 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% LTV ratio. At December 31, 2009, the real estate loan portfolio included $43.4 million of home equity loans outstanding, which represented 8.9% of total loans and leases outstanding, compared with $31.3 million and 7.7% at December 31, 2008, respectively. $4.7 million of the $12.1 million in growth is attributable to the Waterford acquisition. The rest of the growth is attributable to strong consumer demand for historically low-rate variable-rate home equity loans. This balance included $36.3 million in variable rate loans and $7.1 million in fixed rate loans.

The Bank also offers both residential and commercial real estate construction loans at up to an 80% LTV ratio at fixed interest or adjustable interest rates and multiple maturities. At December 31, 2009, fixed rate real estate construction loans outstanding totaled $5.1 million or 1.0% of total loans and leases outstanding, and adjustable rate construction loans outstanding totaled $15.3 million or 3.1% of total loans and leases outstanding. At December 31, 2008, fixed rate real estate construction loan outstanding totaled $4.8 million, or 1.2% of total loans and leases outstanding, and adjustable rate construction loans outstanding totaled $13.0 million, or 3.2% of total loans and leases outstanding.

As of December 31, 2009, $4.3 million or 1.1% of the Bank’s real estate loans were 30 to 90 days delinquent, and $4.3 million or 1.1% of real estate loans were non-accruing. The Bank also had $4.1 million, or 1.1% of real estate loans that were over 90 days past due and still accruing. As of December 31, 2008, $2.8 million or 0.9% of the Bank’s real estate loans was 30 to 90 days delinquent, and $2.3 million or 0.8% of real estate loans were non-accruing. There were no real estate loans that were 90 days past due and still accruing at December 31, 2008. The reasons for the increase, and the Bank’s treatment of these loans, are discussed in greater detail below under “Non-accrual, Past Due, and Restructured Loans and Leases.”

Direct Financing Leases. Direct financing leases totaled $31.5 million and $58.6 million at December 31, 2009 and 2008, respectively, representing 6.4% and 14.4% of the Bank’s total loans and leases outstanding at December 31, 2009 and 2008, respectively. As of December 31, 2009, $0.3 million or 0.9% of the Bank’s direct financing leases were 30 to 90 days past due, compared with $1.2 million and 2.1% at December 31, 2008. In addition, $2.9 million, or 9.2%, were non-accruing at December 31, 2009, compared with $0.8 million, or 1.4% at December 31, 2008. $1.7 million, or 5.5%, of direct financing leases were restructured in troubled debt restructurings at December 31, 2009, $0.7 million of which are non-accruing. At December 31, 2008, there were $1.9 million, or 3.2% of leases restructured in troubled debt restructurings, $0.1 million of which were non-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 $60.3 million and $46.1 million at December 31, 2009 and 2008, respectively. $3.1 million of the $14.2 million in growth is attributable to the Waterford acquisition. The rest of the growth is attributable to good results achieved through the Bank’s community-focused and relationship-based lending approach in the local market. Commercial loans represented 12.3% and 11.3% of the Bank’s total loans at December 31, 2009 and 2008, respectively.

As of December 31, 2009, $647 thousand or 1.1% of the Bank’s commercial loans were 30 to 90 days past due and $1.4 million or 2.3% of its commercial loans were non-accruing. As of December 31, 2008, $350 thousand or 0.8% of the

Bank’s commercial loans were 30 to 90 days past due and $0.3 million or 0.6% of its commercial loans were non-accruing. The Bank also had one commercial loan for $144 thousand or 0.3% of commercial loans that was over 90 days past due and still accruing at December 31, 2009.

Collateral for commercial loans, where applicable, may consist of inventory, receivables, equipment and other business assets. At December 31, 2009, 62.7% of the Bank’s commercial loans were at variable rates which are tied to the prime rate.

Consumer Installment Loans. The Bank’s consumer installment loan portfolio totaled $3.0 million and $1.8 million at December 31, 2009 and 2008, respectively, representing 0.6% and 0.5% of the Bank’s total loans and leases outstanding at December 31, 2009 and 2008, respectively. 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, 2009, $104 thousand or 3.5% of the Bank’s installment loans were 30 to 90 days past due. In addition $197 thousand or 6.7% were non-accruing. As of December 31, 2008, $15 thousand or 0.8% of the Bank’s installment loans were 30 to 90 days past due and none were on non-accrual.

Other Loans. Other loans totaled $8.5 million and $4.2 million at December 31, 2009 and December 31, 2008, respectively. Other loans consisted primarily of loans to municipalities, hospitals, churches and non-profit organizations, at fixed or variable interest rates with multiple maturities. Other loans also includes overdrafts, which totaled $0.2 million at December 31, 2009 and $0.4 million at December 31, 2008.

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,
		2009				2008				2007				2006				2005
				(in thousands)
Mortgage loans on real estate:
Residential 1-4 family		$	80,775			$	66,750			$	68,553			$	57,702			$	48,580
Commercial and multi-family			241,101				180,388				131,146				123,701				123,727
Construction			20,444				17,814				11,446				11,848				9,270
Second mortgages			7,813				8,918				9,452				8,625				6,454
Home equity lines of credit			35,633				22,347				16,926				18,147				21,082
Total mortgage loans on real estate			385,766				296,217				237,523				220,023				209,113
Direct financing leases			31,486				58,639				45,078				31,742				16,945
Commercial loans			60,345				46,077				34,563				29,589				29,920
Consumer installment loans			2,957				1,831				2,083				3,101				2,747
Other			8,489				4,152				3,983				3,997				642
Net deferred loan and lease origination costs			525				797				881				654				654
Total loans and leases			489,568				407,713				324,111				289,106				260,021
Allowance for loan and lease losses			(6,971	)			(6,087	)			(4,555	)			(3,739	)			(3,211	)
Loans and leases, net		$	482,597			$	401,626			$	319,556			$	285,367			$	256,810

Loan Maturities and Sensitivities of Loans to Changes in Interest Rates. The following table shows the maturities of commercial loans and real estate construction loans outstanding as of December 31, 2009 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		$	4,496			$	24,005			$	31,844			$	60,345
Real estate construction			16,227				4,217				—				20,444
		$	20,723			$	28,222			$	31,844			$	80,789
Loans maturing after one year with:
Fixed Rates						$	16,372			$	5,052
Variable Rates							11,850				26,792
						$	28,222			$	31,844

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. See Part II, Item 7 of this Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Allowance for Loan and Lease Losses,” and Part II, Item 8 of this Annual Report on Form 10-K “Financial Statements and Supplementary Data — Note 4 of the Notes to Consolidated Financial Statements” for further information about the Company’s non-accrual, past due and restructured loans and leases.

		At December 31,
		2009				2008				2007				2006				2005
		(in thousands)
Non-accruing loans and leases:
Mortgage loans on real estate:
Residential 1-4 family		$	1,076			$	50			$	—			$	—			$	—
Commercial and multi-family			2,713				1,787				112				145				600
Construction			417				417				—				—				—
Second mortgages			—				—				—				—				—
Home equity lines of credit			128				—				—				—				—
Total mortgage loans on real estate			4,334				2,254				112				145				600
Direct financing leases			2,905				791				215				—				—
Commercial loans			1,400				263				224				443				1,175
Consumer installment loans			197				—				—				—				—
Other			—				123				—				—				—
Total non-accruing loans and leases		$	8,836			$	3,431			$	551			$	588			$	1,775
Accruing loans and leases 90+ days past due			4,112				148				163				74				95
Total non-performing loans and leases		$	12,948			$	3,579			$	714			$	662			$	1,870
Total non-performing loans and leases to total assets			2.09	%			0.68	%			0.16	%			0.15	%			0.41	%
Total non-performing loans and leases to total loans and leases			2.64	%			0.88	%			0.22	%			0.23	%			0.72	%

The Bank had $2.2 million and $1.9 million in loans and leases that were restructured in a troubled debt restructuring at December 31, 2009 and 2008, respectively, in addition to the non-accruing loans and leases in the table above. These restructurings were allowed in an effort to maximize the Bank’s ability to collect on loans and leases where borrowers were experiencing financial issues. The general practice of the Bank is to work with borrowers so that they are able to

pay back their loan or lease in full. If a borrower continues to be delinquent after a troubled debt restructuring, the loan or lease will be placed in nonaccrual or charged off.

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:

		2009				2008				2007				2006				2005
		(in thousands)
BALANCE AT THE BEGINNING OF THE YEAR		$	6,087			$	4,555			$	3,739			$	3,211			$	2,999
CHARGE-OFFS:
Commercial			(285	)			—				(153	)			(212	)			(417	)
Real estate mortgages			(34	)			(1	)			(5	)			—				(25	)
Direct financing leases			(9,483	)			(2,149	)			(1,048	)			(500	)			(108	)
Consumer installment loans			(8	)			(4	)			(7	)			(44	)			(86	)
Overdrafted deposit accounts			(48	)			(51	)			(58	)			(42	)			(39	)
TOTAL CHARGE-OFFS			(9,858	)			(2,205	)			(1,271	)			(798	)			(675	)
RECOVERIES:
Commercial			9				36				26				53				—
Real estate mortgages			—				—				—				—				40
Direct financing leases			211				170				105				62				56
Consumer installment loans			1				2				18				63				11
Overdrafted deposit accounts			21				21				21				20				11
TOTAL RECOVERIES			242				229				170				198				118
NET CHARGE-OFFS			(9,616	)			(1,976	)			(1,101	)			(600	)			(557	)
PROVISION FOR LOAN AND LEASE LOSSES			10,500				3,508				1,917				1,128				769
BALANCE AT END OF YEAR		$	6,971			$	6,087			$	4,555			$	3,739			$	3,211
RATIO OF NET CHARGE-OFFS TO AVERAGE NET LOANS AND LEASES OUTSTANDING			2.19	%			0.55	%			0.37	%			0.22	%			0.23	%
RATIO OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO TOTAL LOANS AND LEASES			1.42	%			1.49	%			1.41	%			1.29	%			1.23	%

Much of the economic turmoil in the national economy began with the sub-prime mortgage credit crisis. As the Company does not engage in sub-prime lending, the faltering sub-prime credit market has not directly affected the Company’s loan and lease portfolio. Also, local real estate values have remained steady to slightly higher. However, the recessionary economy has impacted the Company’s commercial real estate, commercial loan, and in particular, its national leasing portfolio as the Company’s customers struggle to deal with the difficult economic conditions. Management is closely monitoring the Company’s loan and lease portfolio for potential losses and heightened risk factors related to our customers. The increase in the allowance for loan and lease losses in 2009 reflects management’s assessment of the risk inherent in the portfolio composition as well as the economic conditions. The United States has been in recession throughout 2008 and 2009, and any possible recovery in 2010 is expected to happen at a slow pace.

The troubled economy resulted in a significant increase in net charge-offs in the direct financing lease portfolio during 2009. The $9.3 million in net leasing charge-offs included a mark-to-market adjustment of $7.1 million on the total portfolio after the Company initially announced its intention to sell the portfolio during the second quarter of 2009. The Company later decided to service the portfolio through maturity. As a result, the Company adjusts the carrying value of total leases as charge-offs and recoveries of specific leases are realized. The book value of the leasing portfolio was $4.2 million lower than the principal value as of December 31, 2009.

ENL did business with customers all over the United States, including states that previously had fast-growing economies such as California and Florida. While ENL did not lend to sub-prime borrowers, small-ticket commercial equipment

leasing is a riskier type of lending than traditional commercial and consumer real estate lending. Leases typically yield higher rates because of the higher credit risk. Often the collateral securing the leases does not have significant recoverable value and the lessees are generally small businesses which are less able to withstand disruptions like the recent economic recession than larger, more established businesses. Management expects the leasing portfolio to continue to be sensitive to economic conditions while the portfolio runs off at approximately $1.5 million per month in 2010. While the Company’s remaining commercial and consumer portfolios did not experience increased charge-offs in 2009, an economic recession puts those portfolios at increased risk as well. While charge-offs in those portfolios remained lower, non-performing loans and leases increased substantially year-over-year.

The Company maintains a robust loan review process to ensure that specific credits are appropriately reserved. In particular, management continues to monitor the leasing portfolio closely 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 allowance for loan and lease losses is reflective of its assessment of the 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 are insured up to the limits provided by the FDIC. At December 31, 2009, the Bank’s deposits totaled $499.5 million consisting of the following:

	(In thousands)
Demand deposits		$	87,855
NOW accounts			15,619
Regular savings			229,609
Muni-vest savings			23,418
Time deposits, $100,000 and over			59,301
Other time deposits			83,706
Total		$	499,508

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

		2009								2008								2007
						Weighted								Weighted								Weighted
		Average				Average				Average				Average				Average				Average
		Balance				Rate				Balance				Rate				Balance				Rate
Demand deposits		$	85,181				0.00	%		$	75,551				0.00	%		$	73,577				0.00	%
NOW accounts			11,514				0.36	%			11,793				0.68	%			11,014				0.30	%
Regular Savings			197,178				1.13	%			113,266				1.59	%			88,685				1.20	%
Muni-vest savings			33,266				0.63	%			23,459				2.11	%			39,840				4.26	%
Time deposits			142,893				3.06	%			144,040				3.97	%			149,578				4.86	%
Total		$	470,032				1.46	%		$	368,109				2.20	%		$	362,694				2.77	%

The following schedule sets forth the maturities of the Bank’s time deposits as of December 31, 2009:

		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		$	17,401			$	7,621			$	5,012			$	29,267			$	59,301
Other time deposits			11,649				15,992				16,417				39,648				83,706
Total time deposits		$	29,050			$	23,613			$	21,429			$	68,915			$	143,007

Federal Funds Purchased and Other Borrowed Funds. Another source of the Bank’s funds for lending and investing activities at December 31, 2009 consisted of short and long term borrowings from the Federal Home Loan Bank.

Other borrowed funds consisted primarily of various advances from the FHLB with both fixed and variable interest rate terms ranging from 0.32% to 3.55%. The maturities and weighted average rates of other borrowed funds at December 31, 2009 are as follows (dollars in thousands):

						Weighted
						Average
		Maturities				Rate
2010		$	19,202				0.35%
2011			5,068				3.12%
2012			3,000				2.52%
2013			10,000				3.28%
2014			9,000				3.53%
Thereafter			—				—
Total		$	46,270				2.05%

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 $5.5 million at December 31, 2009 compared to $6.3 million at December 31, 2008. Balances can vary day to day based on customer needs.

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 Annual 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 and insurance agency offices in the Company’s primary

market area of Erie County, Niagara County, northern Chautauqua County, and northwestern Cattaraugus County, NY. 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 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. In the personal insurance area, the majority of TEA’s competition comes from direct writers, as well as some small local agencies located in the same towns and villages in which TEA has offices. In the commercial business segment, the majority of the competition comes from larger agencies located in and around Buffalo, NY. By offering the large number of carriers which it has available to its customers, TEA has attempted to remain competitive in all aspects of its business.

As an approximate indication of the Company’s competitive position, in the Buffalo metropolitan area, where 12 of the Company’s 13 banking offices are located, the Bank had the seventh most deposits according to the FDIC’s annual deposit market share report as of June 30, 2009 with 1.4% of the total market’s deposits of $32.7 billion. By comparison, the market leaders, M&T Bank and HSBC Bank USA, have 67.5% of the metropolitan area’s deposits combined. 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.

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 and investors. 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. Under Regulation Y, a bank holding company must serve as a source of financial and managerial strength for its subsidiary banks and must not conduct its operations in an unsafe or unsound manner.

The Company is required to obtain the prior approval of the FRB before acquiring all or substantially all of the assets of, or 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 by 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 any affiliate (including 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 those prevailing at the time for, and following credit underwriting procedures that are not less stringent than those applicable to, 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. The Bank has elected to participate in the FDIC’s temporary Transaction Account Guarantee Program, established in 2008. Under this program, all non-interest bearing transaction accounts and certain low-interest NOW checking accounts at participating FDIC-insured institutions are fully guaranteed by the FDIC for the entire amount on deposit. This coverage is in addition to, and separate from, the coverage provided under the FDIC’s general deposit insurance rules, and a surcharge is added to a participating institution’s current insurance assessment in order to fully cover all transaction accounts. The program is scheduled to remain in effect until June 30, 2010. Interest-bearing savings accounts and certificates of deposit are not covered accounts under the program, but are insured up to $250,000 through December 31, 2013. At the expiration of these programs, it is expected that the FDIC insurance limits will return to $100,000 on all deposits at eligible institutions.

As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, insured institutions. It may also prohibit an insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC.

The FDIC has adopted a risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based on their examination ratings and capital ratios. Pursuant to the

Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), as amended by the Helping Families Save Their Home Act of 2009, the FDIC has established and implemented a plan to restore the reserve ratio for the Deposit Insurance Fund to 1.15% by December 31, 2013. In order to implement the restoration plan, the FDIC changed both its risk-based assessment system and its base assessment rates.

For the first quarter of 2009 only, the FDIC raised the base annual assessment rate for institutions in Risk Category I to between 12 and 14 basis points while the base annual assessment rates for institutions in Risk Categories II, III and IV were increased to 17, 35 and 50 basis points, respectively. For the quarter beginning April 1, 2009 the FDIC set the base annual assessment rate for institutions in Risk Category I to between 12 and 16 basis points and the base annual assessment rates for institutions in Risk Categories II, III and IV at 22, 32 and 45 basis points, respectively. An institution’s assessment rate could be lowered by as much as five basis points based on the ratio of its long-term unsecured debt to deposits or, for smaller institutions, based on the ratio of certain amounts of Tier 1 capital to adjusted assets. The assessment rate may be adjusted for Risk Category I institutions that have a high level of brokered deposits and have experienced higher levels of asset growth (other than through acquisitions) and could be increased by as much as ten basis points for institutions in Risk Categories II, III and IV whose ratio of brokered deposits to deposits exceeds 10%. Reciprocal deposit arrangements like CDARS^® are treated as brokered deposits for Risk Category II, III and IV institutions but not for institutions in Risk Category I. An institution’s base assessment rate would also be increased if the institution’s ratio of secured liabilities (including FHLB advances and repurchase agreements) to deposits exceeds 25%. The maximum adjustment for secured liabilities for institutions in Risk Categories I, II, III and IV would be 8, 11, 16 and 22.5 basis points, respectively, provided that the adjustment may not increase an institution’s base assessment rate by more than 50%.

The FDIC imposed a special assessment equal to five basis points of assets less Tier 1 capital as of June 30, 2009, payable on September 30, 2009, and reserved the right to impose additional special assessments. In November, 2009, instead of imposing an additional special assessment, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. Payment of the prepaid assessment, along with the payment of institutions’ regular quarterly assessment, was due on December 30, 2009. For purposes of estimating the future assessments, each institution’s base assessment rate in effect on September 30, 2009 will be used, increased by three basis points beginning in 2011, and the assessment base will be increased at a 5% annual growth rate. The prepaid assessment will be applied against actual quarterly assessments until exhausted. Any funds remaining after June 30, 2013 will be returned to the institution. If the prepayment would impair an institution’s liquidity or otherwise create significant hardship, it may apply for an exemption. Requiring this prepaid assessment does not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system.

In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), a mixed-ownership Federal government corporation established to recapitalize the Federal Savings and Loan Insurance Corporation. The current annualized assessment rate is 1.06 basis points, or approximately .265 basis points per quarter. These assessments will continue until the Financing Corporation bonds mature in 2019.

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, in the opinion of the appropriate banking agency, a “default” is likely to occur in the absence of regulatory assistance.

In addition to the forgoing, 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. Federal Reserve Board’s regulations, for example, generally require a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution.

Dividends paid by the Bank have been the Company’s primary source of operating funds and are expected to be for the foreseeable future. Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. Under OCC regulations, the Bank may not pay a dividend, without prior OCC approval, if the total amount of all dividends declared during the calendar year, including the proposed dividend, exceed the sum of its retained net income to date during the calendar year and its retained net income over the preceding two years. As of December 31, 2009, approximately $2.0 million was available for the payment of dividends without prior OCC approval. The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. As indicated below, the Bank is currently in compliance with these requirements.

Because the Company is a legal entity separate and distinct from the Bank, the Company’s right to participate in the distribution of assets of the Bank in the event of the Bank’s liquidation or reorganization would be subject to the prior claims of the Bank’s creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of unsecured, non-deposit creditors, including a parent bank holding company (such as the Company) or any shareholder or creditor thereof.

The FRB, the OCC and other federal banking agencies have broad enforcement powers, including the power to terminate deposit insurance, to impose substantial fines and other civil and criminal penalties, and to 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, 2009 and 2008 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)

		2009								2008
		Company				Bank				Company				Bank
Capital components
Tier 1 capital		$	47,203			$	45,008			$	44,829			$	43,436
Total risk-based capital			53,166				50,949				50,139				48,726
Risk-weighted assets and off-balance sheet instruments			476,017				474,265				424,014				422,425
Risk-based capital ratio
Tier 1 capital			9.9	%			9.5	%			10.6	%			10.3	%
Total risk-based capital			11.2	%			10.7	%			11.8	%			11.5	%
Leverage ratio			7.8	%			7.5	%			9.0	%			8.8	%

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. The Federal Deposit Insurance Act 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 it 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 it 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. As of December 31, 2009, the Company and the Bank met 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.

Regulation of Insurance Agency Subsidiary

TEA 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.

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 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 Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism 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 and are implementing policies and procedures that the Company believes are 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 control over financial reporting for the company, and to evaluate the effectiveness of these controls and procedures and certify and report on their findings in the company’s periodic reports; a public company to establish and maintain an audit committee, 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 — of obligations of 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.

Emergency Economic Stabilization Act of 2008

There were historical disruptions in the financial system in late 2008 and many lenders and financial institutions reduced or ceased to provide funding to borrowers, including other lending institutions. The availability of credit, confidence in the entire financial sector, and stability in financial markets was adversely affected. These disruptions have had some impact on all institutions in the U.S. banking and financial industries.

In response to the financial crises affecting the overall banking system and financial markets, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. Under EESA, the U.S. Treasury was granted the authority, among other things, to purchase up to $700 billion of mortgages, mortgage backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. As part of that program, the U.S. Treasury purchased equity interests in a wide variety of eligible banks, thrifts and bank holding companies. Under this program, called the Troubled Asset Relief Program Capital Purchase Program (“TARP”), $250 billion of capital was made available to U.S. financial institutions through the purchase of preferred stock. The preferred stock would pay a 5% dividend for five years, which would increase to 9% after five years. In conjunction with its purchase of preferred stock, the Treasury would also receive warrants to purchase common stock with an aggregate market price equal to 15% of the amount invested in preferred stock. Participating institutions are required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury continues to hold the institution’s equity under TARP.

Management evaluated the program to determine whether participation would be advantageous for the Company and its common shareholders. On December 17, 2008, the Company announced that the Company had elected not to participate in the program by a unanimous vote of the Board of Directors. Factors driving this decision included the lack of exposure to the troubled assets for which the program was originally designed, including subprime mortgages and mortgage-backed securities tied to subprime mortgages, dividend restrictions, uncertainty around the management and changing government parameters of TARP, and the difficulty in providing adequate return to shareholders with the new capital as the Bank was already experiencing high levels of lending activity without the capital from TARP.

Consumer Laws and Regulations

In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include, but are not limited to, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, Federal Financial Privacy Laws, Interagency Guidelines Establishing Information Security Standards, the Right to Financial Privacy Act, and the Fair and Accurate Credit Transactions Reporting Act. These laws and regulations regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.

On November 12, 2009, the Federal Reserve announced an amendment to Regulation E, which implements the Electronic Funds Transfer Act, that limits the ability of a financial institution to assess an overdraft fee for paying ATM and one-time debit card transactions that overdraw a consumer’s account, unless the consumer affirmatively consents, or opts in, to the institution’s payment of overdrafts for these transactions. Before opting in, the consumer must be provided a notice that explains the financial institution’s overdraft services, including the fees associated with the service, and the consumer’s choices. To ensure that consumers have a meaningful choice, the final rules prohibit financial institutions from discriminating against consumers who do not opt in. The final rules require institutions to provide consumers who do not opt in with the same account terms, conditions, and features (including pricing) that they provide to consumers who do opt in. For consumers who do not opt in, the institution would be prohibited from charging overdraft fees for any overdrafts it pays on ATM and one-time debit card transactions. The amendment is effective July 1, 2010. The Company is working toward being in compliance with these final rules by July 1, 2010 and studying the impact of the change in rules on the Company’s overall financial performance.

EMPLOYEES

As of December 31, 2009, the Company had no direct employees. As of December 31, 2009, the following table summarizes the employment rosters of the Company’s subsidiaries:

		Full Time				Part Time
Bank			130				17
ENL			7				—
SDS			8				—
TEA			55				4
FCS			4				—
			204				21

Management believes that 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 Annual 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.

The Company’s Business May Be Adversely Affected by Conditions in the Financial Markets and Economic Conditions Generally.

Since December 2007, the United States has been in a recession. Business activity across a wide range of industries and regions has been greatly reduced and local governments and many businesses are in serious difficulty due to rising unemployment, the lack of consumer spending, a faltering housing market, and reduced liquidity in the credit markets. Since mid-2007, and particularly during the second half of 2008, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities. In 2009, there was some recovery in the value of some asset classes, but the economy remains weak with high unemployment, lower property values, and low consumer confidence.

The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and leases and the value of collateral securing those loans and leases, is highly dependent upon the business environment in the markets where the Company operates, in Western New York and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, declines in housing and real estate valuations, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; natural disasters; or a combination of these or other factors.

Overall, during 2009, the business environment has been adverse for many households and businesses in the United States and worldwide. It is expected that the business environment in Western New York, the United States and worldwide will be slow to recover from the 2008-2009 recession. There can be no assurance that these conditions will improve in the near term. Such conditions could materially adversely affect the credit quality of the Company’s loans and leases, and therefore, the Company’s results of operations and financial condition.

National Direct Financing Lease Portfolio Exposes the Company to Increased Credit Risks.

At December 31, 2009, the book value of the Company’s national portfolio of direct financing leases originated through ENL was $31.5 million, or 6.4% of total loans and leases outstanding. The $31.5 million book value represents $35.7 million in lease principal balance, net of the remaining mark of $4.2 million. $2.9 million of those leases were in non-accrual status at December 31, 2009. There was no allowance for lease losses associated with this portfolio at December 31, 2009 as there has been no additional deterioration in credit quality since the portfolio was written down in the second quarter of 2009. Due to the increasing credit risks, poor performance in the portfolio, the lack of strategic fit with the Company’s community banking philosophy, and with the intention of reallocating capital back to its core business, management announced its exit from the national leasing business in April 2009. The Company still faces the challenge of collecting the remainder of the portfolio, which puts the Company at risk for future losses. In 2009, the provision for lease losses was $6.8 million, net charge-offs, including the mark-to-market adjustment of $7.1 million, were $9.3 million, and the entire goodwill balance of $2.0 million was written off. The portfolio balance peaked at December 31, 2008 at $58.6 million, or 14.4% of total loans and leases. Most of the Company’s leases are small-ticket general business equipment leases originated through brokers. With 1,897 active leases, the average balance per lease at December 31, 2009 was $19 thousand. In many cases, the collateral for the leases has a low market value and, with lessees in other states far from the Company’s primary market area, is difficult to retrieve in the case of a delinquent customer. Also, the lessees tend to be small businesses, which have a more difficult time withstanding a poor economic environment than larger and more established middle market customers. In addition, the leasing portfolio is exposed to certain states that have experienced higher-than-average credit issues and property devaluation such as California and Florida. These risks are reflected in the fact that the leases in those states have the highest rate of charge-offs among the Company’s lease portfolio.

While management believes that the losses in the leasing portfolio will be less in 2010 as the book value of the portfolio is already down 46.3% from last year end, there remains significant risk of future losses in the portfolio due to the nature of the customers, collateral, and geography of the business and its heightened sensitivity to the continued adverse

economic factors. Continued weakness in the lease portfolio could have a material adverse effect on the Company’s business, financial condition, and results of operations.

Commercial Real Estate and Commercial Business Loans Expose the Company to Increased Credit Risks.

At December 31, 2009, the Company’s portfolio of commercial real estate loans totaled $241.1 million, or 49.3% of total loans and leases outstanding and the Company’s portfolio of commercial business loans totaled $60.3 million, or 12.3% of total loans and leases outstanding. The Company plans to continue to emphasize the origination of commercial loans as they generally earn a higher rate of interest than other loan products offered by the Bank. Commercial loans generally expose a lender to greater risk of non-payment and loss than one-to four-family residential mortgage loans because repayment of commercial real estate and business loans often depends on the successful operations and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to four-family residential mortgage loans. Also, many of the Company’s commercial borrowers have more than one commercial real estate or business loan outstanding with the Company. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Company to a significantly greater risk of loss compared to an adverse development with respect to a one-to four-family residential mortgage loan. Commercial real estate loans in non-accrual status at December 31, 2009 were $2.7 million, compared with $1.8 million at December 31, 2008. There were also $4.0 million in commercial real estate loans that were still accruing interest at December 31, 2009, but were over 90 days past due. Management believes that these loans are well secured and in the process of collection. Commercial loans in nonaccrual status at December 31, 2009 were $1.4 million, compared with $0.3 million at December 31, 2008.

Continuing Concentration of Loans in the Company’s Primary Market Area May Increase the Company’s Risk.

Unlike larger banks that are more geographically diversified, the Company provides banking and financial services to customers located primarily in western New York State. Therefore, the Company’s success depends primarily on the general economic conditions in western New York State. The Company’s business lending and marketing strategies focus on loans to small- to medium-sized businesses in this geographic region. Moreover, the Company’s assets are heavily concentrated in mortgages on properties located in western New York State. Accordingly, the Company’s business and operations are vulnerable to downturns in the economy of western New York State. The concentration of the Company’s loans in this geographic region subjects the Company to the risk that a downturn in the economy or recession in this region could result in a decrease in loan originations and increases in delinquencies and foreclosures, which would more greatly affect the Company than if the Company’s lending were more geographically diversified. In addition, the Company may suffer losses if there is a decline in the value of properties underlying the Company’s mortgage loans which would have a material adverse impact on the Company’s operations. The Company has not seen this type of deterioration in the current credit cycle.

In the Event the Company’s Allowance for Loan and Lease Losses is Not Sufficient to Cover Actual Loan and Lease Losses, the Company’s Earnings Could Decrease.

The Company maintains an allowance for loan and lease losses in order to capture the probable losses inherent in its loan and lease portfolio. There is a risk that the Company may experience significant loan and lease losses which could exceed the allowance for loan and lease losses. In determining the amount of the Company’s recorded allowance, the Company makes various assumptions and judgments about the collectibility of its loan and lease portfolio, including the creditworthiness of its borrowers, the effect of changes in the local economy on the value of the real estate and other assets serving as collateral for the repayment of loans, the effects on the Company’s loan and lease portfolio of current economic indicators and their probable impact on borrowers, and the Company’s loan quality reviews. In addition, bank regulators periodically review the Company’s loan and lease portfolio and credit underwriting procedures, as well as its allowance for loan and lease losses, and may require the Company to increase its provision for loan and lease losses or recognize further loan and lease charge-offs. At December 31, 2009, the Company had a net loan portfolio of approximately $482.6 million and the allowance for loan and lease losses was approximately $7.0 million, which represented 1.42% of the total amount of gross loans and leases. If the Company’s assumptions and judgments prove to be incorrect or bank regulators require the Company to increase its provision for loan and lease losses or recognize further loan and lease charge-offs, the Company may have to increase its allowance for loan and lease losses or loan and lease charge-offs which could have an adverse effect on the Company’s operating results and financial condition. There can be no assurances that the Company’s allowance for loan and lease losses will be adequate to protect the Company against loan and lease losses that it may incur.

Changes in Interest Rates Could Adversely Affect the Company’s Business, Results of Operations and Financial Condition.

The Company’s results of operations and financial condition are significantly affected by changes in interest rates. The Company’s results of operations depend substantially on its net interest income, which is the difference between the interest income earned on its interest-earning assets and the interest expense paid on its interest-bearing liabilities. Because the Company’s interest-bearing liabilities generally re-price or mature more quickly than its interest-earning assets, an increase in interest rates generally would tend to result in a decrease in its net interest income.

Changes in interest rates also affect the value of the Company’s interest-earning assets, and in particular, the Company’s securities portfolio. Generally, the value of securities fluctuates inversely with changes in interest rates. At December 31, 2009, the Company’s securities available for sale totaled $75.9 million. Net unrealized gains on securities available for sale, net of tax, amounted to $1.0 million and are reported as a separate component of stockholders’ equity. Decreases in the fair value of securities available for sale, therefore, could have an adverse effect on stockholders’ equity or earnings.

The Company also is subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, the Company is subject to reinvestment risk to the extent that it is unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans.

The Company May Be Adversely Affected by the Soundness of Other Financial Institutions

Financial services institutions are interrelated as a result of counterparty relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry. The most important counterparty for the Company, in terms of liquidity, is the Federal Home Loan Bank of New York (“FHLBNY”). The Company uses FHLBNY as its primary source of overnight funds and also has several long-term advances with FHLBNY. At December 31, 2009, the Company had a total of $46.1 million in borrowed funds with FHLBNY. The Company has placed sufficient collateral in the form of commercial and residential real estate loans at FHLBNY. As a member of the Federal Home Loan Bank System, the Bank is required to hold stock in FHLBNY. The Bank held FHLBNY stock with a fair value of $2.7 million as of December 31, 2009. The Bank’s FHLBNY stock average yield in 2009 was 4.6%.

There are 12 branches of the FHLB, including New York. Several members have warned that they have either breached risk-based capital requirements or that they are close to breaching those requirements. To conserve capital, some FHLB branches are suspending dividends, cutting dividend payments, and not buying back excess FHLB stock that members hold. FHLBNY has stated that they expect to be able to continue to pay dividends, redeem excess capital stock, and provide competitively priced advances in the future. The most severe problems in FHLB have been at some of the other FHLB branches. Nonetheless, the 12 FHLB branches are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB branch cannot meet its obligations to pay its share of the system’s debt, other FHLB branches can be called upon to make the payment.

Systemic weakness in the FHLB could result in higher costs of FHLB borrowings, reduced value of FHLB stock, and increased demand for alternative sources of liquidity that are more expensive, such as brokered time deposits, the discount window at the Federal Reserve, or lines of credit with correspondent banks First Tennessee and M&T Bank.

Strong Competition Within the Company’s Market Area May Limit its Growth and Profitability.

Competition in the banking and financial services industry is intense. The Company competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally within the Company’s market area and elsewhere. Many of these competitors (whether regional or national institutions) have substantially greater resources and lending limits than the Company does, and may offer certain services that the Company does not or cannot provide. The Company’s profitability depends upon its continued ability to successfully compete in this market area.

Expansion of the Company’s Branch Network May Adversely Affect its Financial Results.

The Company has increased its retail branch network from eight branches to thirteen branches by opening de novo branches in five of the last seven years. In addition, the Company plans on opening another branch in 2010, and its

strategy is to continue to grow its branch network through de novo branching and acquisitions. The Company can not assure that its branch expansion strategy will be accretive to earnings or that it will be accretive to earnings within a reasonable period of time. Numerous factors contribute to the performance of a new branch, such as suitable location, qualified personnel, and an effective marketing strategy. Additionally, it takes time for a new branch to gather sufficient loans and deposits to generate income sufficient to cover its operating expenses. Difficulties the Company experiences in implementing its growth strategy may have a material adverse effect on the Company’s financial condition and results of operations.

The Company Operates in a Highly Regulated Environment and May Be Adversely Affected By Changes in Laws and Regulations.

The Company is subject to regulation, supervision and examination by the OCC, FRB, and by the FDIC, as insurer of its deposits. Such regulation and supervision govern the activities in which a bank and its holding company may engage and are intended primarily for the protection of the deposit insurance funds and depositors. Regulatory requirements affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a bank, the imposition of deposit insurance premiums and other assessments, the classification of assets by a bank and the adequacy of a bank’s allowance for loan and lease losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material adverse impact on the Bank, the Company and its business, financial condition and results of operations.

Lack of System Integrity or Credit Quality Related to Funds Settlement could Result in a Financial Loss.

The Bank settles funds on behalf of financial institutions, other businesses and consumers and receives funds from clients, card issuers, payment networks and consumers on a daily basis for a variety of transaction types. Transactions facilitated by the Bank include debit card, credit card and electronic bill payment transactions, supporting consumers, financial institutions and other businesses. These payment activities rely upon the technology infrastructure that facilitates the verification of activity with counterparties and the facilitation of the payment. If the continuity of operations or integrity of processing were compromised this could result in a financial loss to the Bank, and therefore the Company, due to a failure in payment facilitation. In addition, the Bank may issue credit to consumers, financial institutions or other businesses as part of the funds settlement. A default on this credit by a counterparty could result in a financial loss to Bank, and therefore to the Company.

Financial Services Companies Depend on the Accuracy and Completeness of Information about Customers and Counterparties.

In deciding whether to extend credit or enter into other transactions, the Company may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. The Company may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. While management generally engages only third parties that it knows or believes to be reputable, reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause the Company to enter into unfavorable transactions, which could have a material adverse effect on the Company’s financial condition and results of operations.

The Company May Not be Able to Attract and Retain Skilled Personnel.

The Company’s success depends, in large part, on its ability to attract and retain skilled personnel. Competition for the best people in most activities engaged in by the Company can be intense, and the Company may not be able to hire sufficiently skilled people or to retain them despite its best efforts to be an employer of choice. The loss of services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

Loss of Key Employees May Disrupt Relationships with Certain Customers.

The Company’s business is primarily relationship-driven in that many of the Company’s key employees have extensive customer relationships. Loss of a key employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While management believes that the Company’s relationships with its key business producers are good, the Company cannot guarantee that all of its key personnel will remain with the organization. Loss of such key personnel, should they enter into an employment relationship with one of the Company’s competitors, could result in the loss of some of the Company’s

customers. Such losses could have a material adverse effect on the Company’s business, financial condition and results of operations.

Because the Nature of the Financial Services Business Involves a High Volume of Transactions, the Company Faces Significant Operational Risks.

The Company operates in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from the Company’s operations, including but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation.

The Company’s Information Systems may Experience an Interruption or Breach in Security.

The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in the Company’s customer relationship management, general ledger, deposit, loan, and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of its information systems, there can be no assurance that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of the Company’s information systems could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.

The Potential for Business Interruption Exists Throughout the Company’s Organization.

Integral to the Company’s performance is the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and the vast array of associates and key executives in the Company’s day-to-day and ongoing operations. Failure by any or all of these resources subjects the Company to risks that may vary in size, scale and scope. This includes, but is not limited to, operational or technical failures, ineffectiveness or exposure due to interruption in third party support as expected, as well as the loss of key individuals or failure on the part of key individuals to perform properly. Although management has established policies and procedures to address such failures, the occurrence of any such event could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on its financial condition and results of operations.

Item 1B. UNRESOLVED STAFF COMMENTS

None.

Item 2. PROPERTIES

The Bank conducts its business from its administrative office and 13 branch offices as of December 31, 2009. The Bank’s administrative office is located at One Grimsby Drive in Hamburg, NY. The administrative office facility is 26,000 square feet and is owned by the Bank. This facility is occupied by the Office of the President and Chief Executive Officer of the Company, as well as the Administrative and Loan Divisions of the Bank. The Bank also owns a building on Erie Road in Derby, NY that formerly housed its Loan Division.

The Bank has 13 branch locations. The Bank owns the building and land for five locations. The Bank owns the building but leases the land for four locations. Three other locations are leased. The remaining branch location is currently owned by the FDIC as Receiver in charge of Waterford Village Bank. The Company has informed the FDIC of its intention to purchase the location and expects to close on that purchase in March 2010.

The Bank also owns the headquarters for SDS at Baseline Road in Grand Island, NY.

TEA operates from its headquarters a 9,300 square foot office located at 16 North Main Street, Angola, NY, which is owned by the Bank. TEA has 14 retail locations. TEA leases 11 of the locations. The Bank owns two of the locations and TEA owns the remaining building.

The Company owned $9.3 million in properties and equipment, net of depreciation at December 31, 2009, compared with $9.9 million at December 31, 2008.

Item 3. LEGAL PROCEEDINGS