EVANS BANCORP INC - Annual Report: 2010 (Form 10-K)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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

Commission file number: 001-35021

EVANS BANCORP, INC.

(Exact name of registrant as specified in its charter)

New York		16-1332767
(State or other jurisdiction of 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		NYSE-Amex

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

None

(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

* Registrant has not yet been phased into the interactive data requirements

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No þ

On June 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $41.0 million, based upon the closing sale price of a share of the registrant’s common stock on The NASDAQ Global Market.

As of March 1, 2011, 4,086,160 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 2011 Annual Meeting of Shareholders, to be held on April 28, 2011, 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

PART I
		Page
Item 1. BUSINESS		5
Item 1A. RISK FACTORS		15
Item 1B. UNRESOLVED STAFF COMMENTS		20
Item 2. PROPERTIES		20
Item 3. LEGAL PROCEEDINGS		20
Item 4. (REMOVED AND RESERVED)		20
PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES		21
Item 6. SELECTED FINANCIAL DATA		23
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		23
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		55
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		56
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE		106
Item 9A. CONTROLS AND PROCEDURES		106
Item 9B. OTHER INFORMATION		106
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE		107
Item 11. EXECUTIVE COMPENSATION		107
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS		107

		Page
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE		107
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES		107
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES		108
SIGNATURES		109
EX-10.18
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 including the risk factors described in Item 1A, 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 NYSE-Amex under the symbol “EVBN.”

At December 31, 2010, the Company had consolidated total assets of $671.5 million, deposits of $544.5 million and stockholders’ equity of $63.1 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. (“ENFS”), 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, 2010, the Bank represented 98.4% and ENFS represented 1.6% of the consolidated assets of the Company. Further discussion of our segments is included in Note 18 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, 2010, the Bank had total assets of $660.6 million, investment securities of $93.3 million, net loans of $517.6 million, deposits of $544.5 million and stockholders’ equity of $56.0 million, compared to 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 at December 31, 2009. The Bank offers deposit products, which include checking and NOW accounts, savings accounts, and certificates of deposit, as its principal source of funding. 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 National 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. For the year ended December 31, 2010, TEA had total revenue of $7.0 million.

TEA’s primary market area is Erie, Chautauqua, Cattaraugus and Niagara counties. Most lines of personal insurance are provided, including automobile, homeowners, boat, recreational vehicle, landlord, and umbrella coverage. 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.

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 attempting to sell the leasing portfolio, management decided to service it through to maturity in approximately 2014.

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”). SDS, a wholly-owned subsidiary of the Bank, serves the data processing needs of financial institutions with customized solutions and consulting 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 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 Delaware 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 18 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.

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.

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.

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, internet 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 Erie County, NY, 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, 2010 with 1.7% of the total market’s deposits of $29.8 billion. By comparison, the market leaders, M&T Bank and HSBC Bank USA, have 69.6% 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. Because the Company is a public company with shares traded on the NYSE-Amex, it is subject to regulation by the Securities and Exchange Commission, as well as the listing standards required by NYSE-Amex. 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 there under, 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. Under Section 343 of the Dodd-Frank Act, the FDIC provides full deposit insurance coverage for noninterest-bearing transactions accounts beginning December 31, 2010 for a two year period. Previously, the Bank had 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 were 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 was added to a participating institution’s current insurance assessment in order to fully cover all transaction accounts. The program ended on December 31, 2010. Interest-bearing savings accounts and certificates of deposit are insured up to $250,000.

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 insured 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. 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 1.02 basis points, or approximately .255 basis points per quarter. These assessments will continue until the Financing Corporation bonds mature in 2019. Pursuant to the Dodd-Frank Act, the deposit insurance assessment base has been redefined to reflect consolidated total assets less average tangible equity. The result is that larger financial institutions, which have more assets leveraged with non-deposit wholesale funds, will pay a greater percentage of the aggregate insurance assessment and smaller banks will pay less than they would have. Evans Bank is expected to benefit from this provision.

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, 2010, approximately $2.7 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, 2010 and 2009 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)

		2010								2009
		Company				Bank				Company				Bank
Capital components
Tier 1 capital		$	65,559			$	63,797			$	47,203			$	45,008
Total risk-based capital			71,889				70,110				53,166				50,949
Risk-weighted assets and off-balance sheet instruments			502,327				500,967				476,017				474,265
Risk-based capital ratio
Tier 1 capital			13.1	%			12.7	%			9.9	%			9.5	%
Total risk-based capital			14.3	%			14.0	%			11.2	%			10.7	%
Leverage ratio			9.9	%			9.7	%			7.8	%			7.5	%

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, 2010, 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.

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 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, and uncertainty around the management and changing government parameters of 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 implemented 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 is prohibited from charging overdraft fees for any overdrafts it pays on ATM and one-time debit card transactions. The amendment was effective July 1, 2010.

Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law by President Obama on July 21, 2010. It is widely regarded as the most sweeping change to financial regulation since the Great Depression. The law is intended to achieve the following objectives: promote robust supervision and regulation of financial firms; establish comprehensive supervision of financial markets; protect consumers and investors from financial abuse; provide the government with the tools to manage a financial crisis; and raise international regulatory standards and improve international cooperation. The Dodd-Frank Act requires more than 60 studies to be conducted and more than 200 regulations to be written over the next one to two years. The true impact of the legislation will be unknown until these are complete. The Dodd-Frank Act is organized around sixteen titles:

	I.		Financial Stability — creates a new oversight regulator, the Financial Stability Oversight Council. The council of regulators will monitor the financial system for systemic risk and will determine which entities pose significant systemic risk. One of the key provisions of this title is the so-called Collins Amendment, which imposes a stricter application of risk-based capital requirements for bank holding companies than currently employed. Under the Collins Amendment, certain depository institutions will not be permitted to include trust preferred securities issued after May 19, 2010 in Tier 1 capital. For depository institutions with greater than $15 billion in assets, trust preferred securities issued before May 19, 2010 will be phased out as a component of Tier 1 Capital over three years beginning January 1, 2013. Evans Bancorp has $11.3 million in trust preferred securities included in Tier 1 Capital, but with an asset size of $671 million, is well under the $15 billion exemption threshold.
	II.		Orderly Liquidation Authority — establishes a framework for the liquidation by the FDIC of large institutions that pose systemic risk.
	III.		Transfer of Powers to the OCC, FDIC, and the FRB — merges the Office of Thrift Supervision (“OTS”) into the OCC. The OTS regulatory responsibilities will be spread among other regulators. As a nationally chartered bank regulated by the FRB, FDIC, and OCC, Evans Bank is not impacted by the abolishment of the OTS. This title includes a number of deposit insurance reforms. The first redefines the deposit insurance assessment base to reflect consolidated total assets less average tangible equity. The result is that larger financial institutions, which have more assets leveraged with non-deposit wholesale funds, will pay a greater percentage of the aggregate insurance assessment and smaller banks will pay less than they would have. Evans Bank is expected to benefit from this provision. This title also increases the minimum reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35%, but exempts institutions with assets less than $10 billion from the cost of the increase. The title also permanently increases deposit insurance coverage to $250,000 and fully covers non-interest bearing transactions accounts through 2012.
	IV.		Regulation of Advisers to Hedge Funds and Others — requires most advisors to private funds to register with the SEC.
	V.		Insurance — establishes the Federal Insurance Office, housed in the Office of the Treasury. It is to review the insurance industry and study for Congress the federal regulation of insurance.
	VI.		Improvements to Regulation of Bank and Savings Associations Holding Companies and Depository Institutions — this title implements the so-called Volcker Rule. The rule limits the ability of certain bank and bank-related entities to engage in proprietary trading or investing in hedge funds and private equity funds to 3 percent of the entity’s Tier 1 capital. This provision does not have a material impact on Evans Bank as it does not engage in proprietary trading and has immaterial investments in any private funds.
	VII.		Wall Street Transparency and Accountability — imposes exchange trading for derivatives contracts and imposes new capital and margin requirements and various reporting obligations on Over the Counter (“OTC”) swap dealers and major OTC swap participants. This title has no impact on the Company.
	VIII.		Payment, Clearing, and Settlement Provision — allows for a systemic approach to certain financial market payment, clearing, and settlement systems. Designations as systemically important will be made by the Financial Stability Oversight Council.

	IX.		Investor Protections and Improvement to the Regulation of Securities — has a number of provisions intended to protect investors, including for example: risk retention requirements for certain asset-backed securities; reforms to regulation of credit ratings agencies; establishing an Investor Advisory Committee and an Office of Investor Advocate, and requiring the SEC to study whether a fiduciary duty standard of care for broker-dealers providing personalized investment advice to a retail customer should be created. The are several corporate governance procedures established in this title, including: proxy access requirements for shareholders; disclosure about the failure to separate the role of the chair of the board of directors and chief executive officer; shareholder voting on executive compensation; the establishment of an independent compensation committee; executive compensation disclosures and claw backs. In addition, the Federal Reserve is required to issue regulations regarding incentive-based pay practices for institutions with more than $1 billion in assets. This title also provides that companies with a public market capitalization under $75 million are permanently exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act (“SOX”), which requires that public companies receive an opinion from their external auditors as to the effectiveness of their internal controls over financial reporting. Under this provision, Evans Bancorp would be exempt from SOX 404(b) as it has a public market capitalization of $58.2 million as of December 31, 2010. However, the Audit Committee of the Board of Directors and the Company’s management have decided to continue to voluntarily comply with SOX 404(b) as they believe it is in the best interest of the Company. This title also requires the SEC to conduct a study of companies with market capitalization between $75 million and $250 million to determine how the SEC could reduce the burden of complying with the internal control audit requirements.
	X.		Bureau of Consumer Financial Protection — establishes the Bureau of Consumer Financial Protection (“BCFP”), an independent entity housed with the Federal Reserve. The title gives the BCFP the authority to prohibit practices that it finds to be unfair, deceptive, or abusive in addition to requiring certain disclosures. An important provision of this title limits interchange fees for debit card transactions to an amount established as reasonable under regulations to be issued by the Federal Reserve. Cards issued by banks with less than $10 billion in assets are exempt from this requirement. Despite being exempt from this provision, management expects the Bank to be impacted by this provision because the Bank will likely have to match the reduced rates being offered by larger competitors. This could result in the loss of hundreds of thousands of dollars of revenue.
	XI.		Federal Reserve System Revisions — gives the Government Accountability Office (“GAO”) authority to conduct a one-time audit of the Federal Reserve emergency lending during the credit crisis and gives the GAO other auditing responsibilities over the Federal Reserve.
	XII.		Improving Access to Mainstream Financial Institutions — is intended to provide alternatives to payday loans. This title is intended to encourage low and moderate income individuals to create accounts in insured depository institutions and it creates a program to provide low-cost loans of $2,500 or less.
	XIII.		Pay It Back Act — reduces the TARP funds authorized under EESA from $700 billion to $475 billion.
	XIV.		Mortgage Reform and Anti-Predatory Lending Act — places new regulations on mortgage originators and imposes new disclosure requirements and appraisal reforms, including: the creation of a mortgage originator duty of care; the establishment of certain underwriting requirements so that at the time of origination the consumer has a reasonable ability to repay the loan; the creation of document requirements intended to eliminate “no document” and “low document” loans; the prohibition of steering incentives for mortgage originators; a prohibition on yield spread premiums and prepayment penalties in some cases; and a provision that allows borrowers to assert as a foreclosure defense a contention that the lender violated the anti-steering restrictions or the reasonable repayment requirements.
	XV.		Miscellaneous Provisions
	XVI.		Section 1256 Contracts — adds a new provision to the Internal Revenue Code involving futures, swaps, and option contracts.

EMPLOYEES

As of December 31, 2010, the Company had no direct employees. As of December 31, 2010, the following table summarizes the employment rosters of the Company’s subsidiaries using full-time equivalent employees (“FTE”):

		2010				2009				2008				2007				2006
Bank			156				139				138				129				123
ENL			4				7				12				11				9
SDS			8				8				10				—				—
TEA			52				57				58				55				48
FCS			4				4				4				4				4
			224				215				222				199				184

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.

The United States was in an economic recession from December 2007-June 2009, according to the U.S. National Bureau of Economic Research. While the recession is technically over, economic growth has been muted and the unemployment rate remains high at 9.4% (per the U.S. Department of Labor) as of December 31, 2010. 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 the high unemployment rate, the lack of consumer spending, and a faltering housing market. 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 and 2010, 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 2010, 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 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, 2010, the book value of the Company’s national portfolio of direct financing leases originated through ENL was $15.5 million, or 2.9% of total loans and leases outstanding. The portfolio balance had peaked at December 31, 2008 at $58.6 million, or 14.4% of total loans and leases. The $15.5 million book value represents $17.0 million in lease principal balance, net of the remaining mark of $1.5 million. $2.9 million of those leases were in non-accrual status at December 31, 2010. The allowance for lease losses associated with this portfolio at December 31, 2010 is $1.5 million. 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. In 2009, the provision for lease losses was $6.8 million and the entire goodwill balance associated with the leasing business of $2.0 million was written off. The Company still faces the challenge of collecting the remainder of the portfolio, which puts the Company at risk for future losses. Despite the book value of the portfolio declining from $31.5 million to $15.5 million, non-accruing leases remained at $2.9 million on December 31, 2010, a consistent level from December 31, 2009. As a result of the continued poor credit performance, management provided an additional $1.5 million for leasing losses in 2010. Most of the Company’s leases are small-ticket general business equipment leases originated through brokers. With 1,146 active leases, the average balance per lease at December 31, 2010 was $14 thousand. In many cases, the collateral for the leases has a low market value and, with some lessees in other states far from the Company’s primary market area, is difficult to retrieve in the case of a defaulted customer. Also, the lessees tend to be small businesses, which have a more difficult time withstanding the 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 problems 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 2011 as the book value of the portfolio is already down 51% 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, 2010, the Company’s portfolio of commercial real estate loans totaled $293.7 million, or 55.6% of total loans and leases outstanding and the Company’s portfolio of commercial and industrial (“C&I”) loans totaled $91.4 million, or 17.3% 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 C&I loans often depends on the successful operations and the income stream of the borrowers. Commercial mortgages are collateralized by real property while C&I loans are typically secured by business assets such as equipment and accounts receivable. 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 C&I 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, 2010 were $6.6 million, compared with $2.7 million at December 31, 2009. C&I loans in nonaccrual status at December 31, 2010 were $2.2 million, compared with $1.8 million at December 31, 2009. Further increases in the delinquency levels of commercial real estate and C&I loans could result in an increase in non-performing loans and provision for loan and lease losses.

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 (“WNY”). Therefore, the Company’s success depends primarily on the general economic conditions in WNY. The Company’s business lending and marketing strategies focus on loans to small and medium-sized businesses in this geographic region. Moreover, the Company’s assets are heavily concentrated in mortgages on properties located in WNY. Accordingly, the Company’s business and operations are vulnerable to downturns in the economy of WNY. 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.

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 collectability 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, 2010, the Company had a net loan portfolio of approximately $517.6 million and the allowance for loan and lease losses was approximately $10.4 million, which represented 1.97% 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, 2010, the Company’s securities available for sale totaled $91.2 million. Net unrealized gains on securities available for sale, net of tax, amounted to $0.8 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, 2010, the Company had a total of $35.6 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 $2.4 million as of December 31, 2010. The Bank’s FHLBNY stock average yield in 2010 was 5.2%.

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 eight years. In addition, the Company plans on opening another branch in 2011, and its strategy is to continue to grow its branch network through de novo branching and acquisitions. The Company cannot 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, particularly through the new rules and regulations expected to be established by the Dodd-Frank Act, 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, pandemics, 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.

Environmental Factors May Create Liability

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.

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, 2010. 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 six locations. The Bank owns the building but leases the land for four locations. Three other locations are leased.

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 $10.8 million in properties and equipment, net of depreciation at December 31, 2010, compared with $9.3 million at December 31, 2009.

Item 3. LEGAL PROCEEDINGS

The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, in the opinion of management of the Company, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if determined adversely, would have a material effect on the Company’s results of operations or financial condition.

Item 4. (REMOVED AND RESERVED).

PART II

Item 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information. Until December 24, 2010, the Company’s common stock was traded on the Nasdaq Global Select Market. The common stock is now listed on NYSE-Amex under the symbol EVBN.

The following table shows, for the periods indicated, the high and low sales prices per share of the Company’s common stock for fiscal 2010 and 2009.

		2010								2009
QUARTER		High				Low				High				Low
FIRST		$	16.64			$	11.23			$	16.39			$	9.31
SECOND		$	15.60			$	12.25			$	15.50			$	12.00
THIRD		$	13.75			$	12.11			$	14.65			$	11.80
FOURTH		$	14.49			$	13.01			$	13.05			$	10.36

Holders. The approximate number of holders of record of the Company’s common stock at March 1, 2011 was 1,374.

Cash Dividends. The Company paid the following cash dividends on shares of the Company’s common stock during fiscal 2009 and 2010:

	•		A cash dividend of $0.41 per share on April 1, 2009 to holders of record on March 9, 2009.
	•		A cash dividend of $0.20 per share on October 15, 2009 to holders of record on September 21, 2009.
	•		A cash dividend of $0.20 per share on April 27, 2010 to holders of record on April 6, 2010.
	•		A cash dividend of $0.20 per share on October 6, 2010 to holders of record on September 13, 2010.

The amount and type (cash or stock), if any, of future dividends will be determined by the Company’s Board of Directors and will depend upon the Company’s earnings, financial conditions and other factors considered by the Board of Directors to be relevant. The Bank pays a dividend to the Company to provide funds for: debt service on the junior subordinated debentures, a portion of the proceeds of which were contributed to the Bank as capital; dividends the Company pays; treasury stock repurchases; and other Company expenses. There are various legal limitations with respect to the Bank’s ability to supply funds to the Company. In particular, under Federal banking law, the prior approval of the FRB and OCC may be required in certain circumstances, prior to the payment of dividends by the Company or the Bank. See Note 20 to the Company’s Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information concerning contractual and regulatory restrictions on the payment of dividends.

PERFORMANCE GRAPH

The following Performance Graph compares the Company’s cumulative total stockholder return on its common stock for a five-year period (December 31, 2005 to December 31, 2010) with the cumulative total return of the NASDAQ Bank Index and NASDAQ Market Index. The comparison for each of the periods assumes that $100 was invested on December 31, 2005 in each of the Company’s common stock, the stocks included in the NASDAQ Bank Index and the stocks included in the NASDAQ Market Index, and that all dividends were reinvested without commissions. This table does not forecast future performance of the Company’s stock.

Compare 5-Year Cumulative Total Return Among
Evans Bancorp, Inc.,
NASDAQ Market Index and NASDAQ Bank Index

		Period Ending
Index		12/31/05				12/31/06				12/31/07				12/31/08				12/31/09				12/31/10
Evans Bancorp, Inc.			100.00				98.34				81.75				82.06				65.05				84.11
NASDAQ Composite			100.00				110.39				122.15				73.32				106.57				125.91
NASDAQ Bank			100.00				113.82				91.16				71.52				59.87				68.34

In accordance with and to the extent permitted by applicable law or regulation, the information set forth above under the heading “Performance Graph” shall not be incorporated by reference into any future filing under the Securities Act, as amended, or the Exchange Act and shall not be deemed to be “soliciting material” or to be “filed” with the SEC under the Securities Act or the Exchange Act.

Item 6.		SELECTED FINANCIAL DATA

		As of and for the year ended December 31,
(Dollars in thousands except per share data)		2010				2009				2008				2007				2006
Balance Sheet Data
Assets		$	671,523			$	619,444			$	528,974			$	442,729			$	473,894
Interest-earning assets			611,141				562,219				477,496				392,235				426,836
Investment securities			93,332				79,018				75,755				72,410				137,730
Loans and leases, net			517,554				482,597				401,626				319,556				285,367
Deposits			544,457				499,508				403,953				325,829				355,749
Borrowings			52,226				63,146				66,512				63,236				60,559
Stockholders’ equity			63,064				45,959				45,919				43,303				39,543
Income Statement Data
Net interest income		$	24,495			$	22,594			$	19,268			$	16,675			$	14,847
Non-interest income			12,633				14,067				11,677				8,843				10,773
Non-interest expense			26,107				26,057				20,440				19,182				17,728
Net income			4,840				707				4,908				3,368				4,921
Per Share Data
Earnings per share — basic		$	1.34			$	0.25			$	1.78			$	1.23			$	1.81
Earnings per share — diluted			1.34				0.25				1.78				1.23				1.80
Cash dividends			0.40				0.61				0.78				0.71				0.68
Book value			15.45				16.34				16.57				15.74				14.46
Performance Ratios
Return on average assets			0.75	%			0.12	%			1.03	%			0.73	%			1.05	%
Return on average equity			8.35				1.57				10.82				8.15				12.99
Net interest margin			4.16				4.33				4.53				4.05				3.55
Efficiency ratio *			67.90				63.16				63.87				66.65				67.37
Dividend payout ratio			29.85				244.00				43.82				57.72				37.57
Capital Ratios
Tier I capital to average assets			9.93	%			7.80	%			9.02	%			10.04	%			8.90	%
Equity to assets			9.39				7.42				8.68				9.78				8.34
Asset Quality Ratios
Total non-performing assets to total assets			2.07	%			2.10	%			0.69	%			0.16	%			0.15	%
Total non-performing loans and leases to total loans and leases			2.64				2.64				0.88				0.22				0.23
Net charge-offs to average loans and leases			0.10				2.19				0.55				0.37				0.22
Allowance for loan and lease losses to total loans and leases			1.97				1.42				1.49				1.41				1.29

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Consolidated Financial Statements and Supplementary Data,” of this Report on Form 10-K for further information and analysis of changes in the Company’s financial condition and results of operations.

Item 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

This discussion is intended to compare the performance of the Company for the years ended December 31, 2010, 2009 and 2008. The review of the information presented should be read in conjunction with Part I, Item 1: “Business” and Part II, Item 6: “Selected Financial Data” and Item 8: “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

The Company is a financial holding company registered under the BHCA. The Company currently conducts its business through its two direct wholly-owned subsidiaries: the Bank and the Bank’s subsidiaries, ENL and ENHC; and ENFS and

its subsidiaries, TEA and ENBA. The Company does not engage in any other substantial business. Unless the context otherwise requires, the term “Company” refers collectively to Evans Bancorp, Inc. and its subsidiaries.

Summary

The Company’s financial objectives are focused on market share growth, earnings growth, and return on average equity. The Company rebounded from one of the most difficult years in its history in 2009 to a more normal level of profitability in 2010. The Company earned $4.8 million, or $1.34 per diluted share, in 2010, a sharp increase from $0.7 million, or $0.25 per diluted share, in 2009, but less than the $4.9 million, or $1.78 per diluted share, earned in 2008. Return on average equity was 8.35% in 2010, compared with 1.57% in 2009 and 10.82% in 2008. 2009 was impacted by significant deterioration in the Company’s national leasing portfolio that resulted in a $2.0 million goodwill impairment charge and $6.8 million in provision for lease losses. The Company experienced some improvement in the second half of 2009 with the FDIC-assisted acquisition of Waterford Village Bank (“Waterford”) and carried that momentum through 2010. In May of 2010, the Company conducted a successful capital raise, which resulted in $13.4 million in net proceeds. The increase in capital levels bolstered the Company’s balance sheet and gave the Company the capacity to pursue significant organic loan growth and the flexibility to pursue any attractive acquisition opportunities that might arise. When excluding the leasing portfolio, which is running off after management discontinued the Bank’s leasing business, gross core loans increased $54.4 million, or 11.9%, to $512.5 million from December 31, 2009 to December 31, 2010. This growth was achieved in the headwinds of a competitive and slow-growth Western New York market in the middle of an economic recovery from a deep recession.

Non-performing loans and leases increased $1.0 million from $12.9 million at December 31, 2009 to $13.9 million at December 31, 2010. The ratio of non-performing loans and leases to total loans and leases remained flat at 2.64% year over year. While non-performing loans are at their highest level in the past five years, the Company’s charge-off rate in 2010 of 0.10% remains low compared with the rest of the banking industry. Despite the Company’s significant growth in its core loan portfolio over the past three years and an increase in non-performing loans related to the difficult economic environment, the Company has managed to keep losses of its core loan portfolio at low levels.

Significant Factors in 2010 Performance

Net interest income increased 8.4% in 2010 compared with 2009. The increase was a result of balance sheet growth, including a full year of the acquired Waterford loan portfolio. Net interest margin declined from 4.33% in 2009 to 4.16% in 2010. The Company’s net interest margin remains above average compared with the rest of the banking industry, but has declined two years in a row due to assets re-pricing to lower rates while there is less opportunity to re-price liabilities as many of the sources of the Company’s funding have already re-priced. Included in the asset re-pricing impact is the roll-off of higher-rate direct financing leases.

The provision for loan and lease losses declined from $10.5 million to $3.9 million, mostly due to the deterioration in the leasing portfolio in 2009. While the Company still incurred $1.5 million in provision for leasing losses in 2010, the provision related to this portfolio in 2009 was $6.8 million. The leasing portfolio is $15.5 million at December 31, 2010, compared with $31.5 million at December 31, 2009. Management expects the portfolio to reduce by a little more than half again in 2011. As a result, the leasing portfolio’s impact on the Company’s performance should continue to decrease as time passes. Nevertheless, the credit quality of the portfolio remains poor with nearly 19% of leases in non-performing status as of December 31, 2010 and additional future provisioning remains possible. The provision for loan losses also decreased, from $3.7 million in 2009 to $2.4 million in 2010. While non-performing loans increased $1.0 million in 2010, they increased $7.2 million in 2009. Also, the economy improved from recessionary to slow growth. While the economy is not strong, it is better than the environment in 2009 and as a result the increase in the allowance for loan losses due to qualitative economic factors was not as severe.

After a solid performance in 2009, TEA struggled in 2010 with a decrease in revenue of 2.8% and a decrease in net income of 25.9%. The soft insurance market that has persisted since about 2005 continued through 2010. Insurers rely on their surplus to underwrite new business. The surplus is the amount of capital they maintain in excess of the reserves they have posted to pay for insured losses. Enhanced surplus capacity allows the insurance company to take on more risk and earn more premiums. The property and casualty insurance industry has steadily increased its surplus capacity since the events of September 11, 2001. The insurance industry has been able to grow surplus capacity to record levels in part through the returns they were able to achieve from their investment activities. The enhanced return on their investments enabled the carriers to write more business and further invest those premiums. In their efforts to grow market share and invest the premiums, insurers have reduced rates over the past few years. Thus, there has been a soft insurance market, characterized by falling premium rates, with many readily available insurance products. In contrast, a hard market is one in which insurance rates rise and coverage is more difficult to find. The insurance industry generally cycles between soft and hard markets. TEA would benefit from a return to a hardening market, and management expects

that TEA will continue to struggle to grow revenue until a harder market returns. A relatively benign Atlantic hurricane season limited catastrophe losses in 2010 and insurance capacity and competition remained strong. Barring a significant market-changing event, consensus forecasts call for conditions to generally remain favorable to buyers in 2011.

Non-interest expenses were flat at $26.1 million from 2009 to 2010. When excluding the goodwill impairment charge of $2.0 million in 2009, non-interest expenses increased 8.4%, or $2.0 million. The primary factor causing the increase is the increase in salaries and benefits expense of $2.1 million as the Company continues to invest in people that will drive new business such as commercial loan officers and other financial services sales people, along with the requisite support staff. In conjunction with the Company’s successful capital raise, management believes it is setting the foundation for a period of robust organic growth in the near future.

Significant Factors in 2009 Performance

The first six months of 2009 were extremely difficult for the Company. The Company’s national leasing portfolio deteriorated very quickly as non-performing leases jumped from $0.8 million to $1.6 million from December 31, 2008 to March 31, 2009 and net leasing charge-offs from $0.7 million in the fourth quarter of 2008 to $1.6 million in the first quarter of 2009. As the deterioration heightened, management evaluated ENL’s place as part of the Company. At the end of the first quarter, management decided that given the high level of credit risk associated with the leasing portfolio and its sensitivity to the recessionary economy, coupled with ENL’s national footprint and lack of integration into the Bank’s Western New York community banking model, exiting the national leasing business was the appropriate business decision. The portfolio’s deterioration and management’s decision resulted in a write-off at March 31, 2009 of the full $2.0 million in goodwill attributable to ENL. The Company had a $3.3 million provision for loan and lease losses in the first quarter, with $2.9 million attributable to the leasing portfolio. In the second quarter, the leasing portfolio continued to deteriorate. At the end of the second quarter, the Company announced it would to attempt to sell the portfolio and marked the portfolio to market as of June 30, 2009. The total mark-to-market adjustment and net charge-offs related to leasing in the second quarter were $7.7 million. With $3.8 million previously reserved, the provision for lease losses was $3.9 million in the second quarter. With an additional $1.7 million in provision for loan losses in the quarter, the end result was a $1.9 million net loss in the second quarter of 2009.

The high level of risk in the leasing business stems from the low liquidity value of the collateral and the nature of the customers, often small businesses which are less likely to be able to withstand disruptions in the business cycle such as an economic recession than are larger, more established business with greater resources and experience. ENL conducted business with customers through brokers all over the United States, including states that previously had fast-growing economies such as California and Florida, which now are among those states with the worst economies.

The Company returned to solid profitability in the second half of 2009. Despite the losses absorbed from ENL, the Company’s capital position was still robust enough to earn regulatory approval for the purchase of certain assets and assumption of certain liabilities of Waterford Village Bank (“Waterford”) on July 24, 2009. The Company had a winning bid in the FDIC-assisted transaction of negative $0.8 million. In the transaction, the Company acquired $41.0 million in loans and deposits of $51.2 million. After making the appropriate purchase accounting marks to fair value, the Company took a gain on the bargain purchase of $0.7 million. All of the loans and foreclosed real estate purchased by the Bank under the Purchase and Assumption agreement with the FDIC are covered by a loss sharing agreement between the FDIC and the Bank. 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.

The Company announced in October 2009 that, after going through a lengthy due diligence process with several potential buyers of the leasing portfolio, the bids did not reflect the Company’s estimate of the fair value of the portfolio. As a result, management decided to retain the portfolio and will service it until maturity.

Strong balance sheet growth and a favorable interest rate environment allowed the Company’s net interest income to grow by 17.3% during 2009 to $22.6 million. Total net loans and leases grew 20.2%, or $81.0 million, despite $27.1 million in pay-downs and write-downs in the leasing portfolio. Total deposits grew $95.6 million, or 23.7%. Net interest margin declined 20 basis points to 4.33%, but remained high when compared to peers and historical performance. The Company benefited from a steep yield curve and low deposit rates.

Strategy

To sustain future growth and to meet the Company’s financial objectives, the Company has defined a number of strategies. Five of the more important strategies are:

	•		Growing the business to achieve better scale and leverage investments in the banking and insurance agency business for enhanced profitability;
	•		Continuing growth of non-interest income through insurance agency internal growth, financial services revenues, and potential acquisitions;
	•		Utilizing segmented market approach to develop deeper relationships and strengthen earnings power;
	•		Leveraging technology to improve efficiency and customer service; and
	•		Maintaining a community based focus.

The Company’s strategies are designed to direct tactical investment decisions supporting its financial objectives. While the Company intends to focus its efforts on the pursuit of these strategies, there can be no assurance that the Company will successfully implement these strategies or that the strategies will produce the desired results. The Company’s most significant revenue source continues to be net interest income, defined as total interest income less interest expense. Net interest income accounted for approximately 66% of total revenue in 2010. To produce net interest income and consistent earnings growth over the long-term, the Company must generate loan and deposit growth at acceptable margins within its market area. To generate and grow loans and deposits, the Company must focus on a number of areas including, but not limited to, branch expansion, sales practices, customer and employee satisfaction and retention, competition, evolving customer behavior, technology, product innovation, interest rates, credit performance of its customers and vendor relationships.

The Company also considers non-interest income important to its continued financial success. Fee income generation is partly related to the Company’s loan and deposit operations, such as deposit service charges, as well as to its financial products, such as commercial and personal insurance sold through TEA and non-deposit investment products sold through ENBA. Improved performance in non-interest income can help increase capital ratios because most of the non-interest income is generated without recording assets on the balance sheet. The Company has and will continue to face challenges in increasing its non-interest income as the regulatory environment changes. For example, recent regulation has resulted in an industry-wide decline in overdraft deposit service charges. It is also expected that the new regulations stemming from the Dodd-Frank Act will force banks to drastically reduce interchange fees on debit cards. Management is closely studying these developments and their impact on the Company’s profitability, including the development of strategies to mitigate their impact.

While the Company reviews and manages all customer units, it has focused increased efforts on targeted segments in its community such as (1) smaller businesses with smaller credit needs but rich in deposits; (2) middle market commercial businesses; (3) commercial real estate and construction-related lending; and (4) retail customers. The overarching goal is to cross-sell between our insurance, financial services and banking lines of business to deepen our relationships with all of our customers. The Company believes that these efforts resulted in growth in the commercial loan portfolio and core deposits during fiscal 2010 and 2009.

To support growth in targeted customer units, the Bank opened one de-novo branch per year from 2004-2006, and opened another in August 2008. The Bank also acquired a new branch location in Clarence, NY in connection with the Waterford transaction in July 2009. The Bank is planning to open another branch in 2011, with the goal to open 1-2 more in the next 3 years. With all new and existing branches, the Company has strived to maintain a local community based philosophy. The Bank has emphasized hiring local branch and lending personnel with strong ties to the specific local communities it enters and serves.

In addition, the Bank acquired SDS on December 31, 2008. The Company believes that this acquisition has enabled the Bank to drive the strategic direction of its information technology platform by augmenting its resources and increasing its in-house capabilities in order to expand its operational flexibility, create scalability and mitigate risk as the Company grows. Additionally, SDS provides the opportunity to utilize proprietary technology as a strategic advantage for potential mergers and acquisitions of other financial institutions. SDS’s products and services include core and online banking systems, check imaging, item processing and ATM services.

The Bank serves its market through 13 banking offices in Western New York, located in Amherst, Angola, Buffalo, Clarence, Derby, Evans, Forestville, Hamburg, Lancaster, North Boston, West Seneca, and Tonawanda. The Company’s principal source of funding is through deposits, which it reinvests in the community in the form of loans and investments. Deposits are insured up to the maximum permitted by the Insurance Fund of the FDIC. The Bank is regulated by the OCC.

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

The Company’s Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the industries in which it operates. Application of these

principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the Company’s Consolidated Financial Statements and Notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements. Accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported.

Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. These policies, along with the disclosures presented in the other Notes to the Company’s Consolidated Financial Statements contained in this Annual Report on Form 10-K and in this financial review, provide information on how significant assets and liabilities are valued in the Company’s Consolidated Financial Statements and how those values are determined.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses and valuation of goodwill to be the accounting areas that require the most subjective or complex judgments, and as such, could be most subject to revision as new information becomes available.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses represents management’s estimate of probable losses in the Bank’s loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s consolidated balance sheets.

On a quarterly basis, management of the Bank meets to review and determine the adequacy of the allowance for loan and lease losses. In making this determination, the Bank’s management analyzes the ultimate collectability of the loans and leases in its portfolio by incorporating feedback provided by the Bank’s internal loan and lease staff, an independent internal loan and lease review function and information provided by examinations performed by regulatory agencies.

The analysis of the allowance for loan and lease losses is composed of two components: specific credit allocation and general portfolio allocation. The specific credit allocation includes a detailed review of each impaired loan and allocation is made based on this analysis. Factors may include the appraisal value of the collateral, the age of the appraisal, the type of collateral, the performance of the loan to date, the performance of the borrower’s business based on financial statements, and legal judgments involving the borrower. The general portfolio allocation consists of an assigned reserve percentage based on the historical loss experience and other quantitative and qualitative factors of the loan or lease category.

The general portfolio allocation is segmented into pools of loans with similar characteristics. Separate pools of loans include loans pooled by loan grade and by portfolio segment. The Company does not have sufficient meaningful data to perform a traditional loss migration analysis and thus has implemented alternative procedures. Loans graded a 5 or worse (“criticized loans”) that exceed a material balance threshold are evaluated by the Company’s credit department to determine if the collateral for the loan is worth less than the loan. All of these “shortfalls” are added together and divided by the respective loan pool to calculate the quantitative factor applied to the respective pool. These loans are not considered impaired because the cash flow of the customer and the payment history of the loan suggest that it is not probable that the Company will be unable to collect the full amount of principal and interest as contracted and are thus still accruing interest. Also included in the criticized pool are certain nonaccrual loans that did not have any measureable impairment (i.e. the collateral value exceeds the loan carrying value but the full collectability of principal and interest as contracted are in doubt) but the collateral valuation had sufficient risk such that a reserve was appropriate. These

particular loans are considered to have common characteristics based on the timing and reliability of appraisals or other valuation, timing of the a third-party’s inspection of the collateral, liquidity of collateral, borrowers financial condition, historical losses on similar loans and other factors as appropriate for the loan type, or other factors. As a result, management maintains reserves on these loans in the criticized loan pool in accordance with loan policy and regulatory guidance.

Loans that are graded 4 or better (“non-criticized loans”) are reserved in separate loan pools in the general portfolio allocation. A weighted average 5-year historical charge-off ratio by portfolio segment is calculated and applied against these loan pools.

For both the criticized and non-criticized loan pools in the general portfolio allocation, additional qualitative factors are applied. The qualitative factors applied to the general portfolio allocation reflect management’s evaluation of various conditions. The conditions evaluated include the following: industry and regional conditions; seasoning of the loan and lease portfolio and changes in the composition of and growth in the loan and lease portfolio; the strength and duration of the business cycle; existing general economic and business conditions in the lending areas; credit quality trends in non-accruing loans and leases; timing of the identification of downgrades; historical loan and lease charge-off experience; and the results of bank regulatory examinations. Due to the nature of the loans, the criticized loan pools carry significantly higher qualitative factors than the non-criticized pools.

Direct financing leases are segregated from the rest of the loan portfolio in determining the appropriate allowance for that portfolio segment. Unlike the loan portfolio, the Company does have sufficient historical loss data to perform a migration analysis for non-accruing leases. Management periodically updates this analysis by examining the non-accruing lease portfolio at different points in time and studying what percentage of the non-accruing portfolio ends up being charged off. There are selected large leases in non-accruing status which carry different characteristics than the rest of the portfolio. The Company has more information on these particular lessees. The underwriting for these leases was different due to the size of the leases and the subsequent servicing of these leases was also more intensive. Due to the elevated level of information on these leases, the Company is able to specifically analyze these leases and allocate an appropriate specific reserve based on the information available including cash flow, payment history, and collateral value. These selected large leases are not considered when performing the migration analysis. All of the remaining leases not in nonaccrual are allocated a reserve based on several factors including: delinquency and nonaccrual trends, charge-off trends, and national economic conditions.

For further discussion on the allowance for loan and lease loss, please see Note 1 and Note 3 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Goodwill and Intangible Assets

The amount of goodwill reflected in the Company’s Consolidated Financial Statements is required to be tested by management for impairment on at least an annual basis. The test for impairment of goodwill in an identified reporting unit is considered a critical accounting estimate because it requires judgment on the part of management and the use of estimates related to the growth assumptions and market multiples used in the valuation model. As of December 31, 2010, TEA had $8.1 million in goodwill. The banking and ENL reporting units do not have any more goodwill after the ENL reporting unit’s goodwill was determined to be impaired in 2009 and the entire $2.0 million balance was written down to zero. All of the goodwill at TEA stems from the acquisition of various insurances agencies, not the purchase of diverse companies in which goodwill was subjectively allocated to different reporting units. Therefore, total market capitalization reconciliation was not performed because not all of the reporting units had goodwill. As a result, such an analysis would not be meaningful.

Management valued TEA, the reporting unit with goodwill, using cash flow modeling and earnings multiple techniques. When using the cash flow models, management considered historical information, the operating budget for 2011, economic and insurance market cycles, and strategic goals in projecting net income and cash flows for the next five years. The fair value calculated substantially exceeded the book value of TEA. The value based on a multiple to earnings before interest, taxes, depreciation, and amortization (“EBITDA”) was averaged with the value as determined by the cash flow model to calculate the fair value. The multiple used was based on data from a third party consulting service. The firm’s services include searching, valuing, structuring, and negotiating the acquisition of insurance agencies. The valuation using the EBITDA model was higher, likely a result of conservative growth assumptions used by the Company in the cash flow model as well as an implied control premium in the multiple.

While the fair values determined in the impairment tests were substantially higher than the carrying value for TEA, the risk of a future impairment charge still exists. Management used growth rates that are achievable over the long run through both soft and hard insurance cycles. A soft insurance market has persisted for several years, resulting in a

decrease in revenue of 2.8%, a decrease in EBITDA of 15.6%, and a decrease in net income of 25.9% at TEA in 2010 compared with 2009. A continued soft insurance market over the long term could result in lower than projected revenue and profitability growth rates and result in depressed pricing multiples in the acquisition marketplace. A persistent soft insurance market is the biggest risk to the Company’s valuation model.

For further discussion of the Company’s accounting for goodwill and other intangible assets, see Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS

Note 1 to the Company’s Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K discusses new accounting policies adopted by the Company during fiscal 2010. Below are accounting policies recently issued or proposed but not yet required to be adopted. To the extent management believes the adoption of new accounting standards materially affects the Company’s financial condition, results of operations, or liquidity, the impacts are discussed below.

Accounting Standards Update (“ASU”) No. 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts, a consensus of the FASB Emerging Issues Task Force (Issue No. 10-A), modifies Step 1 of the goodwill impairment test under FASB Accounting Standards Codification (“ASC”) Topic 350, Intangibles — Goodwill and Other, for reporting units with zero or negative carrying amounts to require an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are adverse qualitative factors, including the examples provided in FASB ASC paragraph 350-20-35-30, in determining whether an interim goodwill impairment test between annual test dates is necessary. On adoption of this ASU, goodwill impairment that results from this requirement to perform Step 2 of the goodwill impairment test would be recognized as cumulative effect adjustment to beginning retained earnings in the period of adoption. The ASU is effective for fiscal year, and interim periods within those years, beginning after December 15, 2010 for a public entity. An impairment charge recorded on adoption may require disclosure for 2010 calendar year-end registrants. The Company adopted the ASU as of January 1, 2011. The Company has one reporting unit with goodwill — TEA, its insurance agency subsidiary. As the carrying amount of that reporting unit is greater than zero, adoption of this ASU did not impact the Company.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2010 AND DECEMBER 31, 2009

Net Income

Net income of $4.8 million in 2010 consisted of $4.1 million related to the Company’s banking activities and $0.7 million in net income related to the Company’s insurance agency activities. The total net income of $4.8 million or $1.34 per basic and diluted share in 2010 compares with $0.7 million or $0.25 per basic and diluted share for 2009.

Supplemental Reporting of Non-GAAP Results of Operations

In accordance with GAAP, included in the computation of net income for years ended December 31, 2010, 2009, and 2008, are gains and losses on the sale of securities and acquisition-related amortization and gains. To provide investors with greater visibility of the Company’s operating results, the Company uses “net operating income,” which excludes items that management believes to be non-operating in nature. Specifically, “net operating income” excludes gains and losses on the sale and call of securities and acquisition-related items such as amortization expense of acquisition intangibles, goodwill impairment, and the gain on bargain purchase. This non-GAAP information is being disclosed because management believes this non-GAAP financial measure provides investors with information useful in understanding the Company’s financial performance, its performance trends, and financial position. While the Company’s management uses this non-GAAP measure in its analysis of the Company’s performance, this information should not be viewed as a substitute for financial results determined in accordance with GAAP or considered to be more important than financial results determined in accordance with GAAP, nor is it necessarily comparable with non-GAAP measures which may be presented by other companies.

When net income is adjusted for what management considers “non-operating” items, “net operating” income was $5.4 million in 2010, compared with $2.1 million for 2009, and $5.3 million in 2008. Diluted net operating earnings per share for 2010 was $1.49 compared with $0.74 in 2009 and $1.93 in 2008. The reconciliation of net operating income and diluted net operating earnings per share to net income and diluted earnings per share can be found in the following table.

Reconciliation of GAAP Net Income to Non-GAAP Net Operating Income

		Year ended December 31,
(in thousands, except per share)		2010				2009				2008
GAAP Net Income		$	4,840			$	707			$	4,908
Gain on sale and call of securities*			(5	)			(11	)			(6	)
Goodwill impairment charge*			—				1,210				—
Amortization of intangibles*			549				568				418
Gain on bargain purchase*			—				(409	)			—
Net operating income^		$	5,384			$	2,065			$	5,320
GAAP diluted earnings per share		$	1.34			$	0.25			$	1.78
(Gain) loss on sale of securities*			—				—				—
Goodwill impairment charge*			—				0.43				—
Amortization of intangibles*			0.15				0.21				0.15
Gain on bargain purchase*			—				(0.15	)			—
Diluted net operating earnings per share^		$	1.49			$	0.74			$	1.93

Net Interest Income

Net interest income, the difference between interest income and fee income on earning assets, such as loans and securities, and interest expense on deposits and borrowings, provides the primary basis for the Company’s results of operations.

Net interest income is dependent on the amounts and yields earned on interest earning assets as compared to the amounts of and rates paid on interest bearing liabilities.

AVERAGE BALANCE SHEET INFORMATION

The following table presents the significant categories of the assets and liabilities of the Bank, interest income and interest expense, and the corresponding yields earned and rates paid in 2010, 2009 and 2008. 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.

		2010												2009												2008
		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		$	494,366			$	28,102				5.68	%		$	439,710			$	27,416				6.24	%		$	357,210			$	26,328				7.37	%
Taxable securities			50,149				1,740				3.47	%			40,594				1,608				3.96	%			32,168				1,309				4.07	%
Tax-exempt securities			39,330				1,566				3.98	%			40,242				1,676				4.16	%			34,584				1,490				4.31	%
Federal funds sold			4,642				9				0.19	%			1,188				1				0.08	%			1,531				24				1.57	%
Total interest-earning assets			588,487				31,417				5.34	%			521,734				30,701				5.88	%			425,493				29,151				6.85	%
Non interest-earning assets:
Cash and due from banks			13,281												12,337												12,592
Premises and equipment, net			10,054												9,547												8,662
Other assets			35,059												32,886												30,037
Total Assets		$	646,881											$	576,504											$	476,784
Liabilities & Stockholders’ Equity
Interest-bearing liabilities:
NOW		$	24,981				251				1.00	%		$	11,514				41				0.36	%		$	11,793				80				0.68	%
Regular savings deposits			237,939				1,648				0.69	%			197,178				2,226				1.13	%			113,266				1,801				1.59	%
Muni-vest savings			30,005				145				0.48	%			33,266				209				0.63	%			23,459				494				2.11	%
Time deposits			142,360				3,616				2.54	%			142,893				4,368				3.06	%			144,040				5,713				3.97	%
Other borrowed funds			31,721				909				2.87	%			32,758				843				2.57	%			35,876				1,110				3.09	%
Junior subordinated debentures			11,330				333				2.94	%			11,330				399				3.52	%			11,330				644				5.68	%
Securities sold under agreement to repurchase			7,531				20				0.27	%			5,331				21				0.39	%			5,151				41				0.80	%
Total interest-bearing liabilities			485,867				6,922				1.42	%			434,270				8,107				1.87	%			344,915				9,883				2.87	%
Non interest-bearing liabilities:
Demand deposits			92,072												85,181												75,551
Other			11,006												12,013												10,972
Total liabilities			588,945												531,464												431,438
Stockholders’ equity			57,936												45,040												45,346
Total Liabilities & Equity		$	646,881											$	576,504											$	476,784
Net interest earnings						$	24,495											$	22,594											$	19,268
Net yield on interest earning assets											4.16	%											4.33	%											4.53	%
Interest rate spread											3.92	%											4.01	%											3.98	%

The following table segregates changes in interest earned and paid for the past two years into amounts attributable to changes in volume and changes in rates by major categories of assets and liabilities. The change in interest income and expense due to both volume and rate has been allocated in the table to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

		2010 Compared to 2009												2009 Compared to 2008
		Increase (Decrease) Due to												Increase (Decrease) Due to
										(in thousands)
		Volume				Rate				Total				Volume				Rate				Total
Interest earned on:
Loans and leases		$	3,232				($2,546	)		$	686			$	5,518				($4,430	)		$	1,088
Taxable securities			348				(216	)			132				335				(36	)			299
Tax-exempt securities			(37	)			(73	)			(110	)			237				(51	)			186
Federal funds sold			6				2				8				(4	)			(19	)			(23	)
Total interest-earning assets		$	3,549				($2,833	)		$	716			$	6,086				($4,536	)		$	1,550
Interest paid on:
NOW accounts		$	82			$	128			$	210				($2	)			($37	)			($39	)
Savings deposits			398				(976	)			(578	)			1,056				(630	)			426
Muni-vest			(19	)			(45	)			(64	)			152				(437	)			(285	)
Time deposits			(16	)			(736	)			(752	)			(45	)			(1,300	)			(1,345	)
Fed funds purchased and other borrowings			29				(30	)			(1	)			(96	)			(437	)			(533	)
Total interest-bearing liabilities		$	474				($1,659	)			($1,185	)		$	1,065				($2,841	)			($1,776	)

Net interest income increased by $1.9 million, or 8.4%, to $24.5 million in 2010 from $22.6 million in 2009. As indicated in the preceding table, interest-earning asset and interest-bearing liability volume positively impacted net interest income by $3.1 million, while rates earned and paid on those respective assets and liabilities negatively impacted net interest income by $1.2 million. Overall, the increase in the volume of loans and investment securities and the benefit of lower rates paid on interest-bearing liabilities was partially offset by lower rates earned on interest-earning assets, particularly loans and leases.

During 2008, the FRB aggressively cut interest rates and reduced its target overnight rate by 200 basis points over the first 8 months. This rate cut activity accelerated in the fourth quarter of 2008 because of the continuing financial turmoil and by the end of 2008 the target overnight rate had been cut to between 0.00% and 0.25%. These actions by the FRB, along with its program to purchase mortgage-backed securities, kept market interest rates at or near all-time lows for all of 2009. Rates continued to remain low during 2010, as the global economy continued to struggle. This interest rate environment resulted in lower interest yields earned on assets as well as lower rates paid on liabilities.

Low interest rates helped support loan demand. The impact on net interest income from loan volume was also affected by the acquisition of Waterford’s loan portfolio of $41.0 million in July 2009. A full year of balances of the former Waterford portfolio contributed to the increase in average loans and leases in 2010 compared with 2009. Total loan growth continued to be driven by commercial loan growth, which increased by 12.7%, from a $336.5 million average balance in 2009 to a $379.1 million average balance in 2010. Consumer loans increased 13.1% from $109.0 million average balance in 2009 to $123.2 million in 2010. Investment securities volume positively impacted net interest income by $0.3 million as the Company used the proceeds from raising capital from the sale of its common stock to purchase investments.

On the funding side, the Company has been successful in attracting new deposit customers, with most of that success coming in the premium-rate Better Checking, Better Savings, and business money market accounts. Better Checking is a NOW product and the impact of its premium rate is evidenced in the table above as the only deposit category that paid a higher rate in 2010 versus 2009. Better Savings and business money market are savings deposit products and while overall savings rates dropped because of the low rate environment, they did not drop as much as loan rates. While these products have put some pressure on the net interest margin, the Company expects to benefit in the long term from the deeper relationships that these core deposits products provide. In order to get the premium rates, customers have to have multiple products with the Company and demonstrate its core relationship with the Bank through required transaction activity in checking accounts.

Net interest spread, or the difference between yield on interest-earning assets and rate on interest-bearing liabilities, declined to 3.92% in 2010, compared with 4.01% in 2009. The yield on interest-earning assets decreased 54 basis points from 5.88% in 2009 to 5.34% in 2010, and the cost of interest-bearing liabilities decreased 45 basis points, from 1.87%

in 2009 to 1.42% in 2010. Net interest spread remained wide as the yield curve, or the difference between long-term rates and short-term rates, remained fairly steep throughout 2010. Banks traditionally benefit from a steep yield curve because the duration of interest-earnings assets is typically longer than the duration of interest-bearing liabilities. Another effect of the difference in the duration of assets and liabilities is that after the Company’s spread widened in 2008 because it was able to re-price its liabilities faster than its assets, its spread has declined two years in a row as assets continue to re-price while liabilities have already re-priced with less ability for any further re-pricing.

The Company’s net interest margin decreased from 4.33% in 2009 to 4.16% in 2010, reflecting the changes to the net interest spread. In the future, it should be noted that several factors could put pressure on the Company’s net interest margin, including increases in interest rates, flattening of the yield curve, and increased pricing competition for loans and deposits.

The Bank regularly monitors its exposure to interest rate risk. Management believes that the proper management of interest-sensitive funds will help protect the Bank’s earnings against extreme changes in interest rates. The Bank’s Asset/Liability Management Committee (“ALCO”) meets monthly for the purpose of evaluating the Bank’s short-term and long-term liquidity position and the potential impact on capital and earnings of changes in interest rates. The Bank has adopted an asset/liability policy that specifies minimum limits for liquidity and capital ratios. This policy includes setting ranges for the negative impact acceptable on net interest income and on the fair value of equity as a result of a shift in interest rates. The asset/liability policy also includes guidelines for investment activities and funds management. At its monthly meetings, ALCO reviews the Bank’s status and formulates its strategies based on current economic conditions, interest rate forecasts, loan demand, deposit volatility and the Bank’s earnings objectives.

Provision for Loan and Lease Losses

The Company’s provision for loan and lease losses decreased $6.6 million from $10.5 million in 2009 to $3.9 million in 2010. Most of the decrease was due to the significant credit issues experienced in the Company’s national lease portfolio during 2009, as described in the “Overview” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K. The provision for lease losses decreased $5.3 million from $6.8 million in 2009 to $1.5 million in 2010. The provision for loan losses also decreased, going from $3.7 million in 2009 to $2.4 million in 2010. Management continued to identify and provision for impaired loans and increases in criticized loan pools. However, the increases in impaired loans and criticized loans were not as substantial in 2010, resulting in a lower loan loss provision. Another reason for the lower provision is that while the economy remained stagnant, it did stabilize somewhat, particularly expectations of future economic growth. By comparison, the economy deteriorated throughout 2009. While the non-performing loans and leases to total loans and leases ratio was flat at 2.64% at December 31, 2010 and December 31, 2009, the ratio increased substantially from 0.88% at December 31, 2008 to 2.64% at December 31, 2009. The increase in non-performing loans and leases during 2009 was a contributing factor to the higher provision for loan and lease losses during 2009.

Trends in non-performing loans and charge-offs are the best indicators of credit quality and provide context for the movement in the provision for loan and lease losses. Trends in those two important credit quality indicators are presented and discussed in the next section. A description of how the allowance for loan and lease losses is determined along with tabular data depicting the key factors in calculating the allowance is in Part II, Item 8 of this Annual Report on Form 10-K “Financial Statements and Supplementary Data — Notes 1 and 3 of the Notes to Consolidated Financial Statements.”

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 8 of this Annual Report on Form 10-K “Financial Statements and Supplementary Data — Note 3 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,
		2010				2009				2008				2007				2006
						(in thousands)
Non-accruing loans and leases:
Mortgage loans on real estate:
Residential mortgages		$	696			$	978			$	—			$	—			$	—
Commercial and multi-family			5,724				2,328				1,291				112				145
Construction-residential			186				—				—				—				—
Construction-commercial			850				417				417				—				—
Home equities			256				181				51				—				—
Total mortgage loans on real estate			7,712				3,904				1,759				112				145
Direct financing leases			2,930				2,905				791				215				—
Commercial loans			2,203				1,784				758				224				443
Consumer loans			276				243				—				—				—
Other			—				—				123				—				—
Total non-accruing loans and leases		$	13,121			$	8,836			$	3,431			$	551			$	588
Accruing loans and leases 90+ days past due			806				4,112				148				163				74
Total non-performing loans and leases		$	13,927			$	12,948			$	3,579			$	714			$	662
Total non-performing loans and leases to total assets			2.07	%			2.09	%			0.68	%			0.16	%			0.15	%
Total non-performing loans and leases to total loans and leases			2.64	%			2.64	%			0.88	%			0.22	%			0.23	%

Non-performing loans and leases increased from $12.9 million at December 31, 2009 to $13.9 million at December 31, 2010. Non-accruing loans and leases increased $4.3 million from $8.8 million at December 31, 2009 to $13.1 million at December 31, 2010. In the fourth quarter of 2010, the non-accruing portfolio spiked to $13.1 million due to two primary factors. First, a large commercial mortgage relationship for $3.5 million was moved into nonaccrual. Management ordered a new appraisal for the underlying collateral and recorded a provision for loan losses for the $0.3 million shortfall between the appraised value of the underlying collateral (adjusted for projected selling and carrying costs) and the loan value. Second, the Company’s two largest remaining direct financing leases for a total of $0.5 million were placed into nonaccrual in the fourth quarter. Management believes that these two leases contain significantly different risk characteristics than the remaining leasing portfolio. One of the leases is with a local borrower with whom Bank management has a developed relationship and a restructuring plan is in place. The second lease is with a large public company that recently declared bankruptcy. The Company is considered a secured creditor in the bankruptcy. Most of the leases in the Company’s portfolio are with small businesses throughout the country, obtained through a broker network. While the two large leases have characteristics of troubled credits and are classified as nonaccrual, management does not believe these two leases have similar characteristics as compared with the remaining lease portfolio. Management believes appropriate reserves have been established on an individual basis for the two leases.

The increase in non-accruing loans and leases was partially offset by a decrease in loans and leases 90+ days past due and still accruing interest. This category decreased from $4.1 million at December 31, 2009 to $0.8 million at December 31, 2010. Management considers these loans well secured and in the process of collection, and still believes that the Company will collect the full value of principal and interest as contracted. Last year’s balance included two large commercial mortgages for $3.7 million which were both performing and current at December 31, 2010 after being extended during 2010. The extension did not involve lowering the interest rate or monthly payment on the loans. Neither borrower is considered to be in financial difficulty. Therefore, these loans are not considered troubled debt restructurings.

The Bank had $2.5 million in loans and leases, of which $1.3 were in non-accrual status, that were restructured in a troubled debt restructuring at December 31, 2010, compared with $2.2 million in loans and leases, with $0.9 million in non-accrual status, at December 31, 2009. Those loans and leases that are in accruing status have shown evidence of performance for at least six months as of December 31, 2010 and 2009. 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 loans and leases that were classified as troubled debt restructurings:

		December 31,
		2010				2009
		(in thousands)
Commercial and industrial		$	166			$	121
Residential real estate:
Residential			—				—
Construction			—				—
Commercial real estate:
Commercial and multi-family			139				144
Construction			—				—
Home equities			68				229
Direct financing leases			2,155				1,736
Consumer			—				18
Other			—				—
Total troubled restructured loans and leases		$	2,528			$	2,248

Allowance for Loan and Lease Losses

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

ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES

		2010				2009				2008				2007				2006
										(in thousands)
BALANCE AT THE BEGINNING OF THE YEAR		$	6,971			$	6,087			$	4,555			$	3,739			$	3,211
CHARGE-OFFS:
Residential mortgages			—				—				—				—				(6	)
Commercial and multi-family			—				—				—				—				—
Construction-residential			—				—				—				—				—
Construction-commercial			(104	)			—				—				—				—
Home equities			—				—				(1	)			(5	)			—
Direct financing leases			—				(9,483	)			(2,149	)			(1,048	)			(500	)
Commercial loans			(388	)			(319	)			—				(154	)			(212	)
Consumer loans			(4	)			—				(2	)			(5	)			(35	)
Other			(53	)			(56	)			(53	)			(59	)			(45	)
TOTAL CHARGE-OFFS			(549	)			(9,858	)			(2,205	)			(1,271	)			(798	)
RECOVERIES:
Residential mortgages			—				—				—				1				—
Commercial and multi-family			—				—				—				—				—
Construction-residential			—				—				—				—				—
Construction-commercial			30				—				—				—				—
Home equities			1				—				—				—				—
Direct financing leases			—				211				170				105				62
Commercial loans			4				9				36				26				53
Consumer loans			—				—				2				17				63
Other			24				22				21				21				20
TOTAL RECOVERIES			59				242				229				170				198
NET CHARGE-OFFS			(490	)			(9,616	)			(1,976	)			(1,101	)			(600	)
PROVISION FOR LOAN AND LEASE LOSSES			3,943				10,500				3,508				1,917				1,128
BALANCE AT END OF YEAR		$	10,424			$	6,971			$	6,087			$	4,555			$	3,739
RATIO OF NET CHARGE-OFFS TO AVERAGE NET LOANS AND LEASES OUTSTANDING			0.10	%			2.19	%			0.55	%			0.37	%			0.22	%
RATIO OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO TOTAL LOANS AND LEASES			1.97	%			1.42	%			1.49	%			1.41	%			1.29	%

An allocation of the allowance for loan and lease losses by portfolio type over the past five years follows (dollars in thousands):

		Balance				Percent				Balance				Percent				Balance				Percent				Balance				Percent								Percent
		at				of loans in				at				of loans in				at				of loans in				at				of loans in				Balance				of loans in
		12/31/2010 Attributable				each category to				12/31/2009 Attributable				each category to				12/31/2008 Attributable				each category to				12/31/2007 Attributable				each category to				at 12/31/2006				each category to
		to:				total loans:				to:				total loans:				to:				total loans				to:				total loans				Attributable to:				total loans
Residential Mortgages*		$	548				13.5	%		$	559				14.2	%		$	238				13.9	%		$	237				17.4	%		$	129				16.9	%
Commercial Mortgages*			4,252				55.6	%			3,324				53.5	%			1,646				48.0	%			1,379				43.5	%			1,425				46.1	%
Home Equities			540				10.1	%			495				10.2	%			256				9.7	%			216				11.1	%			138				11.9	%
Commercial Loans			3,435				17.3	%			2,387				14.9	%			1,289				13.4	%			1,276				13.1	%			889				12.7	%
Consumer Loans			29				0.6	%			57				0.8	%			60				0.6	%			72				1.0	%			95				1.4	%
Direct financing leases			1,471				2.9	%			—				6.4	%			2,449				14.4	%			1,215				13.9	%			905				11.0	%
Unallocated			149				—	%			149				—	%			149				—	%			160				—	%			158				—	%
Total		$	10,424				100.0	%		$	6,971				100.0	%		$	6,087				100.0	%		$	4,555				100.0	%		$	3,739				100.0	%