EVANS BANCORP INC - Quarter Report: 2019 September (Form 10-Q)

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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For quarterly period ended September 30, 2019

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

For the transition period from to ______

Commission file number 001-35021

EVANS BANCORP, INC.

(Exact name of registrant as specified in its charter)

New York 16-1332767

(State or other jurisdiction of (I.R.S. Employer

incorporation or organization) Identification No.)

One Grimsby Drive, Hamburg, NY 14075

(Address of principal executive offices) (Zip Code)

(716) 926-2000

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed

since last report)

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



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.50 par value	EVBN	NYSE American

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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


Large Accelerated Filer ☐		Accelerated Filer ☒
Non-accelerated Filer ☐		Smaller Reporting Company ☒
Emerging Growth Company ☐

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, $.50 par value, 4,923,879 shares as of October 30, 2019.

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INDEX

EVANS BANCORP, INC. AND SUBSIDIARIES



PART 1. FINANCIAL INFORMATION		PAGE

Item 1.	Financial Statements

	Unaudited Consolidated Balance Sheets – September 30, 2019 and December 31, 2018	1

	Unaudited Consolidated Statements of Income – Three months ended September 30, 2019 and 2018	2

	Unaudited Consolidated Statements of Income – Nine months ended September 30, 2019 and 2018	3

	Unaudited Consolidated Statements of Comprehensive Income – Three months ended September 30, 2019 and 2018	4

	Unaudited Consolidated Statements of Comprehensive Income – Nine months ended September 30, 2019 and 2018	4
	Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Three months ended September 30, 2019 and 2018	5
	Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Nine months ended September 30, 2019 and 2018	6

	Unaudited Consolidated Statements of Cash Flows - Nine months ended September 30, 2019 and 2018	7

	Notes to Unaudited Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	38

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47

Item 4.	Controls and Procedures	48

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	49

Item 1A.	Risk Factors	49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3.	Defaults Upon Senior Securities	49

Item 4.	Mine Safety Disclosure	49

Item 5.	Other Information	49

Item 6.	Exhibits	50

	Signatures	51

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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2019 AND DECEMBER 31, 2018
(in thousands, except share and per share amounts)
	September 30,		December 31,
	2019		2018
ASSETS
Cash and due from banks	$	19,587	$	13,997
Interest-bearing deposits at banks		14,757		25,918
Securities:
Available for sale, at fair value (amortized cost: $133,176 at September 30, 2019;		134,457		132,104
$135,274 at December 31, 2018)
Held to maturity, at amortized cost (fair value: $2,542 at September 30, 2019;		2,520		1,685
$1,674 at December 31, 2018)
Federal Home Loan Bank common stock, at cost		1,588		1,474
Federal Reserve Bank common stock, at cost		1,950		1,929
Loans, net of allowance for loan losses of $15,382 at September 30, 2019
and $14,784 at December 31, 2018		1,204,410		1,141,146
Properties and equipment, net of accumulated depreciation of $20,364 at September 30, 2019
and $19,416 at December 31, 2018		13,946		10,485
Goodwill and intangible assets		12,657		12,992
Bank-owned life insurance		29,254		28,403
Operating lease right-of-use asset (see Note 1)		3,862		-
Other assets		16,744		18,074

TOTAL ASSETS	$	1,455,732	$	1,388,207

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand	$	271,633	$	231,902
NOW		141,384		110,450
Savings		568,156		571,479
Time		277,633		301,227
Total deposits		1,258,806		1,215,058

Securities sold under agreement to repurchase		7,418		3,142
Other borrowings		10,000		10,000
Operating lease liability (see Note 1)		4,302		-
Other liabilities		19,007		17,031
Junior subordinated debentures		11,330		11,330
Total liabilities		1,310,863		1,256,561

STOCKHOLDERS' EQUITY:
Common stock, $.50 par value, 10,000,000 shares authorized; 4,920,381
and 4,852,868 shares issued at September 30, 2019 and December 31, 2018,
respectively, and 4,920,196 and 4,852,868 outstanding at September 30, 2019
and December 31, 2018, respectively		2,462		2,429
Capital surplus		62,736		61,225
Treasury stock, at cost, 185 and 0 shares at September 30, 2019 and
December 31, 2018, respectively		-		-
Retained earnings		81,525		73,345
Accumulated other comprehensive loss, net of tax		(1,854)		(5,353)
Total stockholders' equity		144,869		131,646

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,455,732	$	1,388,207

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands, except share and per share amounts)
	Three Months Ended September 30,
	2019		2018
INTEREST INCOME
Loans	$	15,645	$	13,676
Interest-bearing deposits at banks		159		63
Securities:
Taxable		993		805
Non-taxable		48		146
Total interest income		16,845		14,690
INTEREST EXPENSE
Deposits		3,038		2,412
Other borrowings		45		51
Junior subordinated debentures		141		141
Total interest expense		3,224		2,604
NET INTEREST INCOME		13,621		12,086
PROVISION FOR LOAN LOSSES		(431)		252
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		14,052		11,834
NON-INTEREST INCOME
Deposit service charges		687		571
Insurance service and fees		3,225		3,215
Loss on sale of securities		-		(98)
Gain on loans sold		43		6
Bank-owned life insurance		160		165
Loss on tax credit investment		-		(165)
Refundable state historic tax credit		-		150
Interchange fee income		438		413
Other		611		507
Total non-interest income		5,164		4,764
NON-INTEREST EXPENSE
Salaries and employee benefits		7,644		7,090
Occupancy		853		795
Advertising and public relations		231		258
Professional services		1,009		588
Technology and communications		1,057		874
Amortization of intangibles		112		112
FDIC insurance		-		295
Other		1,370		1,445
Total non-interest expense		12,276		11,457
INCOME BEFORE INCOME TAXES		6,940		5,141
INCOME TAX PROVISION		1,776		346
NET INCOME	$	5,164	$	4,795

Net income per common share-basic	$	1.05	$	0.99
Net income per common share-diluted	$	1.04	$	0.97
Weighted average number of common shares outstanding		4,918,740		4,824,318
Weighted average number of diluted shares outstanding		4,976,639		4,940,822

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands, except share and per share amounts)
	Nine Months Ended September 30,
	2019		2018
INTEREST INCOME
Loans	$	45,149	$	39,238
Interest-bearing deposits at banks		564		88
Securities:
Taxable		2,736		2,465
Non-taxable		263		512
Total interest income		48,712		42,303
INTEREST EXPENSE
Deposits		8,883		5,669
Other borrowings		135		509
Junior subordinated debentures		431		391
Total interest expense		9,449		6,569
NET INTEREST INCOME		39,263		35,734
PROVISION FOR LOAN LOSSES		197		1,678
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		39,066		34,056
NON-INTEREST INCOME
Deposit service charges		1,822		1,605
Insurance service and fees		8,568		7,132
Gain (loss) on sale of securities		42		(98)
Gain on loans sold		105		6
Bank-owned life insurance		492		514
Loss on tax credit investment		-		(165)
Refundable state historic tax credit		-		150
Interchange fee income		1,299		1,325
Other		1,761		1,720
Total non-interest income		14,089		12,189
NON-INTEREST EXPENSE
Salaries and employee benefits		22,273		20,192
Occupancy		2,561		2,280
Advertising and public relations		612		708
Professional services		2,683		1,867
Technology and communications		3,049		2,485
Amortization of intangibles		336		168
FDIC insurance		357		773
Other		3,778		3,388
Total non-interest expense		35,649		31,861
INCOME BEFORE INCOME TAXES		17,506		14,384
INCOME TAX PROVISION		4,240		2,479
NET INCOME	$	13,266	$	11,905

Net income per common share-basic	$	2.71	$	2.48
Net income per common share-diluted	$	2.68	$	2.41
Weighted average number of common shares outstanding		4,889,029		4,807,684
Weighted average number of diluted shares outstanding		4,957,689		4,933,485

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands)
	Three Months Ended September 30,
		2019		2018

NET INCOME		$	5,164	$	4,795

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gain (loss) on available-for-sale securities			523		(738)
Defined benefit pension plans:
Amortization of prior service cost			6		7
Amortization of actuarial loss			62		33
Total			68		40
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX			591		(698)
COMPREHENSIVE INCOME		$	5,755	$	4,097

See Notes to Unaudited Consolidated Financial Statements



EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands)
	Nine Month Ended September 30,
	2019		2018

NET INCOME	$	13,266	$	11,905

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gain (loss) on available-for-sale securities		3,297		(2,782)
Defined benefit pension plans:
Amortization of prior service cost		17		18
Amortization of actuarial loss		185		100
Total		202		118
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX		3,499		(2,664)
COMPREHENSIVE INCOME	$	16,765	$	9,241

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
THREE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands, except share and per share amounts)
							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
Balance, June 30, 2018	$	2,413	$	60,220	$	66,325	$	(5,383)	$	123,575
Net Income						4,795				4,795
Other comprehensive income								(698)		(698)
Cash dividends ($0.46 per common share)						(2,218)				(2,218)
Stock compensation expense				198						198
Issued 8,196 shares in stock option exercises		4		4						8
Balance, September 30, 2018	$	2,417	$	60,422	$	68,902	$	(6,081)	$	125,660

Balance, June 30, 2019	$	2,460	$	62,353	$	78,919	$	(2,445)	$	141,287
Net Income						5,164				5,164
Other comprehensive income								591		591
Cash dividends ($0.52 per common share)						(2,558)				(2,558)
Stock compensation expense				243						243
Issued 4,703 shares in stock option exercises		2		140						142
Reissued 2,261 shares in stock option exercises										-
Balance, September 30, 2019	$	2,462	$	62,736	$	81,525	$	(1,854)	$	144,869

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands, except share and per share amounts)
							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
Balance, December 31, 2017	$	2,394	$	59,444	$	59,921	$	(3,417)	$	118,342
Cumulative-effect adjustment due to change in accounting principle						1,496				1,496
Net Income						11,905				11,905
Other comprehensive income								(2,664)		(2,664)
Cash dividends ($0.92 per common share)						(4,420)				(4,420)
Stock compensation expense				597						597
Reissued 1,057 restricted shares										-
Issued 14,940 restricted shares, net of forfeitures		8		(8)						-
Issued 3,205 shares under Dividend Reinvestment Plan		2		142						144
Issued 3,898 shares in Employee Stock Purchase Plan		2		151						153
Issued 22,096 shares in stock option exercises		11		96						107
Balance, September 30, 2018	$	2,417	$	60,422	$	68,902	$	(6,081)	$	125,660

Balance, December 31, 2018	$	2,429	$	61,225	$	73,345	$	(5,353)	$	131,646
Net Income						13,266				13,266
Other comprehensive income								3,499		3,499
Cash dividends ($1.04 per common share)						(5,086)				(5,086)
Stock compensation expense				692						692
Reissued 500 restricted shares										-
Issued 20,757 restricted shares, net of forfeitures		12		(12)						-
Issued 3,866 shares under Dividend Reinvestment Plan		2		137						139
Issued 6,183 shares in Employee Stock Purchase Plan		3		195						198
Issued 32,516 shares in stock option exercises		16		499						515
Reissued 3,506 shares in stock option exercises										-
Balance, September 30, 2019	$	2,462	$	62,736	$	81,525	$	(1,854)	$	144,869

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands)
	Nine Months Ended September 30,
		2019		2018
OPERATING ACTIVITIES:
Interest received	$	48,957	$	42,157
Fees received		13,404		10,897
Interest paid		(9,226)		(6,221)
Cash paid to employees and vendors		(36,888)		(30,188)
Income taxes (paid) refund		(1,586)		475
Proceeds from sale of loans held for resale		7,698		409
Originations of loans held for resale		(7,733)		(1,686)

Net cash provided by operating activities		14,626		15,843

INVESTING ACTIVITIES:
Available for sales securities:
Purchases		(46,893)		(47,863)
Proceeds from sales, maturities, calls, and payments		48,694		54,476
Held to maturity securities:
Purchases		(1,141)		(156)
Proceeds from maturities, calls, and payments		307		4,120
Cash paid for bank-owned life insurance		(360)		-
Proceeds from bank-owned life insurance claims		-		675
Additions to properties and equipment		(4,513)		(757)
Proceeds from sales of assets		185
Proceeds from equity securities sales		-		1,960
Purchase of tax credit investment		-		(3,877)
Insurance agency acquisitions		-		(5,000)
Net increase in loans		(62,823)		(90,665)

Net cash used in investing activities		(66,544)		(87,087)

FINANCING ACTIVITIES:
Proceeds (repayments) from short-term borrowings, net		4,275		(84,560)
Net increase in deposits		43,748		164,394
Dividends paid		(2,528)		(2,202)
Issuance of common stock		852		404

Net cash provided by financing activities		46,347		78,036

Net increase (decrease) in cash and cash equivalents		(5,571)		6,792

CASH AND CASH EQUIVALENTS:
Beginning of period		39,915		21,330
End of period	$	34,344	$	28,122

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
(in thousands)
	Nine Months Ended September 30,
		2019		2018

RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:

Net income	$	13,266	$	11,905

Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		1,505		1,352
Deferred tax (benefit) expense		(201)		414
Provision for loan losses		197		1,678
Loss on tax credit investment		-		165
Refundable state historic tax credit received		-		2,101
Net gain on sales of assets		(3)		-
(Gain) loss on sales of securities		(42)		98
Gain on loans sold		(105)		(6)
Change in fair value of equity securities		-		(245)
Stock compensation expense		692		597
Proceeds from sale of loans held for resale		7,698		409
Originations of loans held for resale		(7,733)		(1,686)
Changes in assets and liabilities affecting cash flow:
Other assets		(5,508)		(3,262)
Other liabilities		4,860		2,323

NET CASH PROVIDED BY OPERATING ACTIVITIES	$	14,626	$	15,843

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2019 AND 2018

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies followed by Evans Bancorp, Inc. (the “Company”), a financial holding company, and its two direct, wholly-owned subsidiaries: (i) Evans Bank, National Association (the “Bank”), and the Bank’s subsidiaries, Evans National Leasing, Inc. (“ENL”), and Evans National Holding Corp. (“ENHC”); and (ii) Evans National Financial Services, LLC (“ENFS”), and ENFS’s subsidiary, The Evans Agency, LLC (“TEA”), and TEA’s subsidiaries, Frontier Claims Services, Inc. (“FCS”) and ENB Associates Inc. (“ENBA”), in the preparation of the accompanying interim unaudited consolidated financial statements conform with U.S. generally accepted accounting principles (“GAAP”) and with general practice within the industries in which it operates. Except as the context otherwise requires, the Company and its direct and indirect subsidiaries are collectively referred to in this report as the “Company.”

The results of operations for the three and nine month periods ended September 30, 2019 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018 (“10-K”). The Company’s significant accounting policies are disclosed in Note 1 to the 10-K.

The Financial Accounting Standards Board (“FASB”) establishes changes to U.S. GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB. ASUs listed below were adopted by the Company during its current fiscal year. ASUs not listed below did not have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.

On January 1, 2019, the Company adopted ASU 2016-02 Leases and all subsequent amendments (collectively, “ASU 2016-02”). The objective of this ASU is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements to meet that objective. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Under this new guidance, a lessee should recognize in the statement of financial position a liability to make lease payments and a right-of-use (“ROU”) asset representing its right to use the underlying asset for the lease term. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP.

ASU 2016-02 required a modified retrospective transition approach, applying the new standard to all leases existing at the date of initial application. The Company elected to use the effective date, January 1, 2019, as our date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification.

Under ASU 2016-02, leases are classified as finance or operating, with the classification affecting the pattern and classification of expense recognition in the income statement. The Company’s leases, consisting of property leases for certain of our bank branches and insurance agency offices, are classified as operating leases. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As these leases do not provide an implicit rate, we use our incremental borrowing rate in determining the present value of lease payments. Our lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

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ASU 2016-02 had an impact on the Company’s consolidated balance sheets, but did not have an impact on the consolidated statements of income or the consolidated statements of cash flows. The most significant impacts upon adoption on January 1, 2019 were the recognition of $4.3 million of ROU assets and $4.7 million of lease liabilities, including $0.4 million of liabilities that were reported in other liabilities in the Company’s December 31, 2018 consolidated balance sheet. ROU assets and lease liability were $3.9 million and $4.3 million, respectively, at September 30, 2019. Operating lease expenses during the three and nine month periods ended September 30, 2019 were $178 thousand and $535 thousand, respectively, and are included in other non-interest expense on the consolidated statement of income. Cash paid for amounts included in the measurement of lease liabilities during the three and nine month periods ended September 30, 2019 were $185 thousand and $553 thousand, respectively, and are included in cash flows from operating activities on the consolidated statement of cash flows. The weighted average discount rate related to the Company’s leases was 3.5% as of September 30, 2019. The weighted average remaining lease term related to the Company’s leases was 8.7 years as of September 30, 2019. Future minimum lease payments under non-cancellable leases as of September 30, 2019 were as follows:



		Year Ending December 31,
2019 (excluding the nine months ended September 30, 2019)	$	185
2020		748
2021		682
2022		694
2023		589
Thereafter		2,091
Total future minimum lease payments		4,989
Less imputed interest		687
Total	$	4,302

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2. SECURITIES

The amortized cost of securities and their approximate fair value at September 30, 2019 and December 31, 2018 were as follows:



	September 30, 2019
	(in thousands)

	Amortized		Unrealized				Fair
	Cost		Gains		Losses		Value

Available for Sale:
Debt securities:
U.S. government agencies	$	28,958	$	361	$	(14)	$	29,305
States and political subdivisions		3,723		70		(7)		3,786
Total debt securities	$	32,681	$	431	$	(21)	$	33,091

Mortgage-backed securities:
FNMA	$	35,678	$	455	$	(66)	$	36,067
FHLMC		16,506		122		(21)		16,607
GNMA		3,518		17		(13)		3,522
SBA		14,447		231		(43)		14,635
CMO		30,346		316		(127)		30,535
Total mortgage-backed securities	$	100,495	$	1,141	$	(270)	$	101,366

Total securities designated as available for sale	$	133,176	$	1,572	$	(291)	$	134,457

Held to Maturity:
Debt securities
States and political subdivisions	$	2,520	$	30	$	(8)	$	2,542

Total securities designated as held to maturity	$	2,520	$	30	$	(8)	$	2,542



	December 31, 2018
	(in thousands)

	Amortized		Unrealized				Fair
	Cost		Gains		Losses		Value

Available for Sale:
Debt securities:
U.S. government agencies	$	34,597	$	2	$	(671)	$	33,928
States and political subdivisions		22,168		69		(64)		22,173
Total debt securities	$	56,765	$	71	$	(735)	$	56,101

Mortgage-backed securities:
FNMA	$	27,747	$	21	$	(729)	$	27,039
FHLMC		14,645		11		(431)		14,225
GNMA		1,660		6		(36)		1,630
SBA		9,432		-		(299)		9,133
CMO		25,025		6		(1,055)		23,976
Total mortgage-backed securities	$	78,509	$	44	$	(2,550)	$	76,003

Total securities designated as available for sale	$	135,274	$	115	$	(3,285)	$	132,104

Held to Maturity:
Debt securities
States and political subdivisions	$	1,685	$	11	$	(22)	$	1,674

Total securities designated as held to maturity	$	1,685	$	11	$	(22)	$	1,674

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Available for sale securities with a total fair value of $91 million and $94 million at September 30, 2019 and December 31, 2018, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law.

The scheduled maturities of debt and mortgage-backed securities at September 30, 2019 and December 31, 2018 are summarized below. All maturity amounts are contractual maturities. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call premiums.




	September 30, 2019				December 31, 2018
	Amortized		Estimated		Amortized		Estimated
	cost		fair value		cost		fair value
		(in thousands)				(in thousands)

Debt securities available for sale:

Due in one year or less	$	4,000	$	3,986	$	5,074	$	5,075
Due after one year through five years		6,534		6,566		22,637		22,448
Due after five years through ten years		22,147		22,539		28,870		28,391
Due after ten years		-		-		184		187
		32,681		33,091		56,765		56,101

Mortgage-backed securities
available for sale		100,495		101,366		78,509		76,003

Total	$	133,176	$	134,457	$	135,274	$	132,104

Debt securities held to maturity:

Due in one year or less	$	1,124	$	1,125	$	693	$	693
Due after one year through five years		861		885		811		811
Due after five years through ten years		54		54		93		89
Due after ten years		481		478		88		81
Total	$	2,520	$	2,542	$	1,685	$	1,674

Contractual maturities of the Company’s mortgage-backed securities generally exceed ten years; however, the effective lives may be significantly shorter due to prepayments of the underlying loans and due to the nature of these securities.

Information regarding unrealized losses within the Company’s available for sale and held to maturity securities at September 30, 2019 and December 31, 2018 is summarized below. The securities are primarily U.S. government-guaranteed agency securities or municipal securities.

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	September 30, 2019

		Less than 12 months				12 months or longer				Total
		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
		Value		Losses		Value		Losses		Value		Losses
		(in thousands)
Available for Sale:
Debt securities:
U.S. government agencies	$	-	$	-	$	3,986	$	(14)	$	3,986	$	(14)
States and political subdivisions		-		-		181		(7)		181		(7)
Total debt securities	$	-	$	-	$	4,167	$	(21)	$	4,167	$	(21)

Mortgage-backed securities:
FNMA	$	3,386	$	(21)	$	6,181	$	(45)	$	9,567	$	(66)
FHLMC		3,046		(7)		1,300		(14)		4,346		(21)
GNMA		2,030		(10)		776		(3)		2,806		(13)
SBA		3,519		(43)		-		-		3,519		(43)
CMO		1,722		(13)		9,494		(114)		11,216		(127)
Total mortgage-backed securities	$	13,703	$	(94)	$	17,751	$	(176)	$	31,454	$	(270)

Held to Maturity:
Debt securities:
States and political subdivisions	$	496	$	(7)	$	423	$	(1)	$	919	$	(8)

Total temporarily impaired
securities	$	14,199	$	(101)	$	22,341	$	(198)	$	36,540	$	(299)


	December 31, 2018

		Less than 12 months				12 months or longer				Total
		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
		Value		Losses		Value		Losses		Value		Losses
		(in thousands)
Available for Sale:
Debt securities:
U.S. government agencies	$	9,931	$	(49)	$	21,144	$	(622)	$	31,075	$	(671)
States and political subdivisions		5,218		(15)		6,893		(49)		12,111		(64)
Total debt securities	$	15,149	$	(64)	$	28,037	$	(671)	$	43,186	$	(735)

Mortgage-backed securities:
FNMA	$	2,637	$	(21)	$	23,667	$	(708)	$	26,304	$	(729)
FHLMC		1,895		(25)		11,899		(406)		13,794		(431)
GNMA		-		-		926		(36)		926		(36)
SBA		-		-		9,133		(299)		9,133		(299)
CMO		-		-		23,127		(1,055)		23,127		(1,055)
Total mortgage-backed securities	$	4,532	$	(46)	$	68,752	$	(2,504)	$	73,284	$	(2,550)

Held to Maturity:
Debt securities:
States and political subdivisions	$	156	$	-	$	722	$	(22)	$	878	$	(22)

Total temporarily impaired
securities	$	19,837	$	(110)	$	97,511	$	(3,197)	$	117,348	$	(3,307)

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Management has assessed the securities available for sale in an unrealized loss position at September 30, 2019 and December 31, 2018 and determined the decline in fair value below amortized cost to be temporary. In making this determination, management considered the period of time the securities were in a loss position, the percentage decline in comparison to the securities’ amortized cost, and the financial condition of the issuer (primarily government or government-sponsored enterprises). In addition, management does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. Management believes the decline in fair value is primarily related to market interest rate fluctuations and not to the credit deterioration of the individual issuers.

The Company has not recorded any other-than-temporary impairment (“OTTI”) charges as of September 30, 2019 and did not record any OTTI charges during 2018. The credit worthiness of the Company’s securities portfolio is largely reliant on the ability of U.S. government sponsored agencies such as Federal Home Loan Bank (“FHLB”), Federal National Mortgage Association (“FNMA”), Government National Mortgage Association (“GNMA”), and Federal Home Loan Mortgage Corporation (“FHLMC”), and municipalities throughout New York State to meet their obligations. In addition, dysfunctional markets could materially alter the liquidity, interest rate, and pricing risk of the portfolio. The stable past performance is not a guarantee for similar performance of the Company’s securities portfolio in future periods.

3. FAIR VALUE MEASUREMENT

Fair value is defined in ASC Topic 820 “Fair Value Measurement” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

There are three levels of inputs to fair value measurement:


			Level 1 inputs are quoted prices for identical instruments in active markets;
			Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
			Level 3 inputs are unobservable inputs.

Observable market data should be used when available.

FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS

The following table presents, for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018, respectively:


(in thousands)		Level 1		Level 2		Level 3		Fair Value

September 30, 2019
Securities available-for-sale:
US government agencies	$	-	$	29,305	$	-	$	29,305
States and political subdivisions		-		3,786		-		3,786
Mortgage-backed securities		-		101,366		-		101,366
Mortgage servicing rights		-		-		527		527

December 31, 2018
Securities available-for-sale:
US government agencies	$	-	$	33,928	$	-	$	33,928
States and political subdivisions		-		22,173		-		22,173
Mortgage-backed securities		-		76,003		-		76,003
Mortgage servicing rights		-		-		609		609

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Securities available for sale

Fair values for securities are determined using independent pricing services and market-participating brokers. The Company’s independent pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, model processes, such as the Option Adjusted Spread model, are used to assess interest rate impact and develop prepayment scenarios. The models and the process take into account market convention. For each asset class, a team of evaluators gathers information from market sources and integrates relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The Company’s service provider may occasionally determine that it does not have sufficient verifiable information to value a particular security. In these cases the Company will utilize valuations from another pricing service.

Management believes that it has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of securities to enable management to maintain an appropriate system of internal control. On a quarterly basis, the Company reviews changes in the market value of its security portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on an annual basis, the Company has its entire security portfolio priced by a second pricing service to determine consistency with another market evaluator. If, during the Company’s review or when comparing with another servicer, a material difference between pricing evaluations were to exist, the Company would submit an inquiry to the service provider regarding the data used to value a particular security. If the Company determines it has market information that would support a different valuation than the initial evaluation it can submit a challenge for a change to that security’s valuation.

Securities available for sale are classified as Level 2 in the fair value hierarchy as the valuation provided by the third-party provider uses observable market data.

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Mortgage servicing rights

Mortgage servicing rights (“MSRs”) do not trade in an active, open market with readily observable prices. Accordingly, the Company obtains the fair value of the MSRs using a third-party pricing provider. The provider determines the fair value by discounting projected net servicing cash flows of the remaining servicing portfolio. The valuation model used by the provider considers market loan prepayment predictions and other economic factors which management considers to be significant unobservable inputs. The fair value of MSRs is mostly affected by changes in mortgage interest rates since rate changes cause the loan prepayment acceleration factors to increase or decrease. Management has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of MSRs to enable management to maintain an appropriate system of internal control. MSRs are classified within Level 3 of the fair value hierarchy as the valuation is model driven and primarily based on unobservable inputs.

The following table summarizes the changes in fair value for MSRs:


	Three months ended September 30,
(in thousands)	2019		2018
Mortgage servicing rights - July 1	$	570	$	635
Gains/(Losses) included in earnings		(71)		3
Additions from loan sales		28		4
Mortgage servicing rights - September 30	$	527	$	642


	Nine months ended September 30,
(in thousands)	2019		2018
Mortgage servicing rights - January 1	$	609	$	586
Gains/(Losses) included in earnings		(154)		52
Additions from loan sales		72		4
Mortgage servicing rights - September 30	$	527	$	642

Quantitative information about the significant unobservable inputs used in the fair value measurement of MSRs at the respective dates is as follows:


	September 30, 2019		December 31, 2018
Servicing fees	0.25	%	0.25	%
Discount rate	9.00	%	9.00	%
Prepayment rate (CPR)	8.62	%	6.52	%

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FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS

The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The following table presents for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a nonrecurring basis at September 30, 2019 and December 31, 2018:



(in thousands)		Level 1		Level 2		Level 3		Fair Value

September 30, 2019
Collateral dependent impaired loans	$	-	$	-	$	15,500	$	15,500

December 31, 2018
Collateral dependent impaired loans	$	-	$	-	$	20,590	$	20,590

Collateral dependent impaired loans

The Company evaluates and values impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral has a unique appraisal and management’s discount of the value is based on factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.

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The Company has an appraisal policy in which appraisals are obtained upon a commercial loan being downgraded on the Company’s internal loan rating scale to a special mention or a substandard depending on the amount of the loan, the type of loan and the type of collateral. All impaired commercial loans are graded substandard or worse on the internal loan rating scale. For consumer loans, the Company obtains appraisals when a loan becomes 90 days past due or is determined to be impaired, whichever occurs first. Subsequent to the downgrade or reaching 90 days past due, if the loan remains outstanding and impaired for at least one year more, management may require another follow-up appraisal. Between receipts of updated appraisals, if necessary, management may perform an internal valuation based on any known changing conditions in the marketplace such as sales of similar properties, a change in the condition of the collateral, or feedback from local appraisers. Collateral dependent impaired loans had a gross value of $16.0 million, with an allowance for loan loss of $0.5 million, at September 30, 2019 compared with $21.7 million and $1.1 million, respectively, at December 31, 2018.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The table below depicts the estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis.


	September 30, 2019				December 31, 2018
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
		(in thousands)				(in thousands)
Financial assets:
Level 1:
Cash and cash equivalents	$	34,344	$	34,344	$	39,915	$	39,915
Level 2:
Available for sale securities		134,457		134,457		132,104		132,104
FHLB and FRB stock		3,538		3,538		3,403		3,403
Level 3:
Held to maturity securities		2,520		2,542		1,685		1,674
Loans, net		1,204,410		1,214,285		1,141,146		1,131,891
Mortgage servicing rights		527		527		609		609

Financial liabilities:
Level 1:
Demand deposits	$	271,633	$	271,633	$	231,902	$	231,902
NOW deposits		141,384		141,384		110,450		110,450
Savings deposits		568,156		568,156		571,479		571,479
Level 2:
Securities sold under agreement to
repurchase		7,418		7,418		3,142		3,142
Other borrowed funds		10,000		9,981		10,000		9,854
Junior subordinated debentures		11,330		11,330		11,330		11,330
Level 3:
Time deposits		277,633		278,276		301,227		298,999

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4. LOANS AND THE ALLOWANCE FOR LOAN LOSSES

Loan Portfolio Composition

The following table presents selected information on the composition of the Company’s loan portfolio as of the dates indicated:


	September 30, 2019		December 31, 2018
Mortgage loans on real estate:	(in thousands)
Residential mortgages	$	160,112	$	158,404
Commercial and multi-family		632,786		592,507
Construction-Residential		890		113
Construction-Commercial		90,825		105,196
Home equities		69,771		70,546
Total real estate loans		954,384		926,766

Commercial and industrial loans		262,144		226,057
Consumer and other loans		1,684		1,520
Net deferred loan origination costs		1,580		1,587
Total gross loans		1,219,792		1,155,930

Allowance for loan losses		(15,382)		(14,784)

Loans, net	$	1,204,410	$	1,141,146

The Bank sells certain fixed rate residential mortgages to FNMA while maintaining the servicing rights for those mortgages. In the three month and nine month periods ended September 30, 2019, the Bank sold mortgages to FNMA totaling $3.0 million and $7.6 million, respectively, compared with $0.4 million mortgages sold during the three and nine month periods ended September 30, 2018., The Bank had a loan servicing portfolio principal balance of $74 million and $73 million at September 30, 2019 and December 31, 2018, respectively, upon which it earned servicing fees. The value of the mortgage servicing rights for that portfolio was $0.5 million and $0.6 million at September 30, 2019 and December 31, 2018, respectively. At September 30, 2019 and December 31, 2018 there were $0.5 million and $0.4 million in residential mortgages held for sale, respectively. The Company has never been contacted by FNMA to repurchase any loans due to improper documentation or fraud.

As noted in Note 1, these financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018. Disclosures related to the basis for accounting for loans, the method for recognizing interest income on loans, the policy for placing loans on nonaccrual status and the subsequent recording of payments and resuming accrual of interest, the policy for determining past due status, a description of the Company’s accounting policies and methodology used to estimate the allowance for loan losses, the policy for charging-off loans, the accounting policies for impaired loans, and more descriptive information on the Company’s credit risk ratings are all contained in the Notes to the Audited Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Unless otherwise noted in this Form 10-Q, the policies and methodology described in the Annual Report for the year ended December 31, 2018 are consistent with those utilized by the Company in the three and nine month periods ended September 30, 2019.

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Credit Quality Indicators

The Bank monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for its commercial mortgage and commercial and industrial (“C&I”) portfolios is the individual loan’s credit risk rating. The following list provides a description of the credit risk ratings that are used internally by the Bank when assessing the adequacy of its allowance for loan losses:

Acceptable or better

Watch

Special Mention

Substandard

Doubtful

Loss

The Company’s consumer loans, including residential mortgages and home equities, are not individually risk rated or reviewed in the Company’s loan review process. Unlike commercial customers, consumer loan customers are not required to provide the Company with updated financial information. Consumer loans also carry smaller balances. Given the lack of updated information after the initial underwriting of the loan and small size of individual loans, the Company uses delinquency status as the primary credit quality indicator for consumer loans. However, once a consumer loan is identified as impaired, it is individually evaluated for impairment.

The following tables provide data, at the class level, of credit quality indicators of certain loans for the dates specified:



September 30, 2019
(in thousands)
Corporate Credit Exposure – By Credit Rating	Commercial Real Estate Construction		Commercial and Multi-Family Mortgages		Total Commercial Real Estate		Commercial and Industrial
Acceptable or better	$	60,844	$	452,715	$	513,559	$	173,384
Watch		20,811		153,660		174,471		70,187
Special Mention		6,191		19,792		25,983		9,373
Substandard		2,979		6,619		9,598		9,200
Doubtful/Loss		-		-		-		-
Total	$	90,825	$	632,786	$	723,611	$	262,144




December 31, 2018
(in thousands)
Corporate Credit Exposure – By Credit Rating	Commercial Real Estate Construction		Commercial and Multi-Family Mortgages		Total Commercial Real Estate		Commercial and Industrial
Acceptable or better	$	65,932	$	466,294	$	532,226	$	155,687
Watch		30,628		109,409		140,037		57,366
Special Mention		-		10,583		10,583		4,105
Substandard		8,636		6,221		14,857		8,870
Doubtful/Loss		-		-		-		29
Total	$	105,196	$	592,507	$	697,703	$	226,057

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Past Due Loans

The following tables provide an analysis of the age of the recorded investment in loans that are past due as of the dates indicated:



September 30, 2019
(in thousands)

		Current							Non-accruing		Total
		Balance	30-59 days		60-89 days		90+ days		Loans		Balance

Commercial and industrial	$	256,920	$	173	$	806	$	-	$	4,245	$	262,144
Residential real estate:
Residential		158,290		-		285		-		1,537		160,112
Construction		890		-		-		-		-		890
Commercial real estate:
Commercial		627,253		-		-		-		5,533		632,786
Construction		89,228		-		-		-		1,597		90,825
Home equities		68,499		345		-		-		927		69,771
Consumer and other		1,672		12		-		-		-		1,684
Total Loans	$	1,202,752	$	530	$	1,091	$	-	$	13,839	$	1,218,212

Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2019.



December 31, 2018
(in thousands)

		Current							Non-accruing		Total
		Balance	30-59 days		60-89 days		90+ days		Loans		Balance

Commercial and industrial	$	217,625	$	6,173	$	565	$	-	$	1,694	$	226,057
Residential real estate:
Residential		154,063		2,546		332		-		1,463		158,404
Construction		113		-		-		-		-		113
Commercial real estate:
Commercial		582,016		4,546		-		-		5,945		592,507
Construction		95,204		1,027		329		-		8,636		105,196
Home equities		69,094		123		76		-		1,253		70,546
Consumer and other		1,514		5		1		-		-		1,520
Total Loans	$	1,119,629	$	14,420	$	1,303	$	-	$	18,991	$	1,154,343

Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of December 31, 2018.

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Allowance for loan losses

The following tables present the activity in the allowance for loan losses according to portfolio segment for the nine month periods ended September 30, 2019 and 2018:




September 30, 2019

(in thousands)	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Beginning balance	$	4,368	$	8,844	$	106	$	1,121	$	345	$	14,784
Charge-offs		(248)		(56)		(94)		-		-		(398)
Recoveries		786		-		13		-		-		799
Provision (Credit)		290		152		114		(325)		(34)		197
Ending balance	$	5,196	$	8,940	$	139	$	796	$	311	$	15,382

Allowance for loan
losses:
Ending balance:
Individually evaluated
for impairment	$	635	$	13	$	21	$	35	$	-	$	704
Collectively evaluated
for impairment		4,561		8,927		118		761		311		14,678
Total	$	5,196	$	8,940	$	139	$	796	$	311	$	15,382

Loans:
Ending balance:
Individually evaluated
for impairment	$	6,016	$	7,708	$	21	$	2,915	$	1,498	$	18,158
Collectively evaluated
for impairment		256,128		715,903		1,663		158,087		68,273		1,200,054
Total	$	262,144	$	723,611	$	1,684	$	161,002	$	69,771	$	1,218,212

* Includes construction loans

Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2019.

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September 30, 2018

(in thousands)	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Beginning balance	$	5,204	$	7,409	$	109	$	950	$	347	$	14,019
Charge-offs		(67)		(262)		(83)		(86)		(11)		(509)
Recoveries		18		-		6		-		1		25
Provision (Credit)		(574)		1,923		50		290		(11)		1,678
Ending balance	$	4,581	$	9,070	$	82	$	1,154	$	326	$	15,213

Allowance for loan
losses:
Ending balance:
Individually evaluated
for impairment	$	113	$	950	$	23	$	70	$	-	$	1,156
Collectively evaluated
for impairment		4,468		8,120		59		1,084		326		14,057
Total	$	4,581	$	9,070	$	82	$	1,154	$	326	$	15,213

Loans:
Ending balance:
Individually evaluated
for impairment	$	2,925	$	18,267	$	23	$	2,687	$	1,907	$	25,809
Collectively evaluated
for impairment		244,216		660,314		1,368		154,062		68,206		1,128,166
Total	$	247,141	$	678,581	$	1,391	$	156,749	$	70,113	$	1,153,975

* Includes construction loans

Note: Loan balances do not include $1.6 million in net deferred loan origination costs as of September 30, 2018.

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The following tables present the activity in the allowance for loan losses according to portfolio segment for the three month periods ended September 30, 2019 and 2018:



September 30, 2019
($ in thousands)	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Beginning balance	$	5,272	$	8,637	$	130	$	883	$	326	$	15,248
Charge-offs		(91)		(55)		(40)		-		-		(186)
Recoveries		747		-		4		-		-		751
Provision (Credit)		(732)		358		45		(87)		(15)		(431)
Ending balance	$	5,196	$	8,940	$	139	$	796	$	311	$	15,382



September 30, 2018
($ in thousands)	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Beginning balance	$	4,341	$	9,445	$	90	$	1,025	$	334	$	15,235
Charge-offs		-		(262)		(19)		-		-		(281)
Recoveries		5		-		2		-		-		7
Provision (Credit)		235		(113)		9		129		(8)		252
Ending balance	$	4,581	$	9,070	$	82	$	1,154	$	326	$	15,213

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Impaired Loans

The following tables provide data, at the class level, for impaired loans as of the dates indicated:



		At September 30, 2019
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
With no related allowance recorded:		(in thousands)
Commercial and industrial	$	3,096	$	3,346	$	-	$	3,269	$	62	$	92
Residential real estate:
Residential		2,576		2,805		-		2,652		105		50
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		5,914		6,389		-		6,188		180		30
Construction		1,353		1,353		-		1,353		6		50
Home equities		1,498		1,699		-		1,563		49		25
Consumer and other		-		-		-		-		-		-
Total impaired loans	$	14,437	$	15,592	$	-	$	15,025	$	402	$	247


		At September 30, 2019
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
With a related allowance recorded:		(in thousands)
Commercial and industrial	$	2,920	$	2,991	$	635	$	2,990	$	76	$	64
Residential real estate:
Residential		339		350		35		341		13		1
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		197		197		6		197		5		4
Construction		244		246		7		244		4		9
Home equities		-		-		-		-		-		-
Consumer and other		21		24		21		22		-		1
Total impaired loans	$	3,721	$	3,808	$	704	$	3,794	$	98	$	79

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		At September 30, 2019
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
Total:		(in thousands)
Commercial and industrial	$	6,016	$	6,337	$	635	$	6,259	$	138	$	156
Residential real estate:
Residential		2,915		3,155		35		2,993		118		51
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		6,111		6,586		6		6,385		185		34
Construction		1,597		1,599		7		1,597		10		59
Home equities		1,498		1,699		-		1,563		49		25
Consumer and other		21		24		21		22		-		1
Total impaired loans	$	18,158	$	19,400	$	704	$	18,819	$	500	$	326



		At December 31, 2018
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
With no related allowance recorded:		(in thousands)
Commercial and industrial	$	1,633	$	2,611	$	-	$	1,785	$	116	$	65
Residential real estate:
Residential		2,289		2,483		-		2,337		45		69
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		6,538		6,914		-		6,733		220		115
Construction		116		116		-		143		-		12
Home equities		1,887		2,058		-		1,952		71		43
Consumer and other		-		-		-		-		-		-
Total impaired loans	$	12,463	$	14,182	$	-	$	12,950	$	452	$	304

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		At December 31, 2018
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
With a related allowance recorded:		(in thousands)
Commercial and industrial	$	2,068	$	2,095	$	249	$	2,098	$	17	$	125
Residential real estate:
Residential		525		556		85		520		22		3
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		-		-		-		-		-		-
Construction		8,636		8,975		716		8,793		379		113
Home equities		-		-		-		-		-		-
Consumer and other		23		27		23		23		-		2
Total impaired loans	$	11,252	$	11,653	$	1,073	$	11,434	$	418	$	243


		At December 31, 2018
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
Total:		(in thousands)
Commercial and industrial	$	3,701	$	4,706	$	249	$	3,883	$	133	$	190
Residential real estate:
Residential		2,814		3,039		85		2,857		67		72
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		6,538		6,914		-		6,733		220		115
Construction		8,752		9,091		716		8,936		379		125
Home equities		1,887		2,058		-		1,952		71		43
Consumer and other		23		27		23		23		-		2
Total impaired loans	$	23,715	$	25,835	$	1,073	$	24,384	$	870	$	547

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Troubled debt restructurings

The following tables summarize the loans that were classified as troubled debt restructurings as of the dates indicated:



		September 30, 2019
		(in thousands)
		Total		Nonaccruing		Accruing		Related Allowance
Commercial and industrial	$	1,977	$	206	$	1,771	$	65
Residential real estate:
Residential		1,832		454		1,378		6
Construction		-		-		-		-
Commercial real estate:
Commercial and multi-family		3,854		3,276		578		-
Construction		-		-		-		-
Home equities		696		125		571		-
Consumer and other		21		-		21		21
Total TDR loans	$	8,380	$	4,061	$	4,319	$	92



		December 31, 2018
		(in thousands)
		Total		Nonaccruing		Accruing		Related Allowance
Commercial and industrial	$	2,282	$	275	$	2,007	$	154
Residential real estate:
Residential		1,617		266		1,351		14
Construction		-		-		-		-
Commercial real estate:
Commercial and multi-family		4,164		3,571		593		-
Construction		8,753		8,637		116		716
Home equities		756		122		634		-
Consumer and other		23		-		23		23
Total TDR loans	$	17,595	$	12,871	$	4,724	$	907

Any TDR that is placed on non-accrual is not reverted back to accruing status until the borrower makes timely payments as contracted for at least six months and future collection under the revised terms is probable. All of the Company’s restructurings were allowed in an effort to maximize its ability to collect on loans where borrowers were experiencing financial difficulty.

The reserve for a TDR is based upon the present value of the future expected cash flows discounted at the loan’s original effective interest rate or upon the fair value of the collateral less costs to sell, if the loan is deemed collateral dependent. This reserve methodology is used because all TDR loans are considered impaired. As of September 30, 2019, there were no commitments to lend additional funds to debtors owing on loans whose terms have been modified in TDRs.

The Company’s TDRs have various agreements that involve deferral of principal payments, or interest-only payments, for a period (usually 12 months or less) to allow the borrower time to improve cash flow or sell the property. Other common concessions leading to the designation of a TDR are lines of credit that are termed-out and/or extensions of maturities at rates that are less than the prevailing market rates given the risk profile of the borrower.

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The following tables show the data for TDR activity by the type of concession granted to the borrower for the three and nine month periods ended September 30, 2019 and 2018:


	Three months ended September 30, 2019					Three months ended September 30, 2018
	(Recorded Investment in thousands)					(Recorded Investment in thousands)
Troubled Debt Restructurings by Type of Concession	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment

Commercial and Industrial:
Extension of maturity	1	$	21	$	21	1	$	46	$	46
Term-out line of credit	1		42		42	-		-		-
Residential Real Estate & Construction:	-		-		-	-		-		-
Extension of maturity and
interest rate reduction	3		307		307	-		-		-
Commercial Real Estate & Construction:
Deferral of principal	-		-		-	1		8,768		8,768
Home Equities:			-		-	-		-		-
Extension of maturity and
interest rate reduction	1		110		110	-		-		-
Consumer and other loans	-		-		-	-		-		-



	Nine months ended September 30, 2019					Nine months ended September 30, 2018
	(Recorded Investment in thousands)					(Recorded Investment in thousands)
Troubled Debt Restructurings by Type of Concession	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment

Commercial and Industrial:
Extension of maturity	1	$	21	$	21	1	$	46	$	46
Term-out line of credit	1		42		42	1		29		29
Combination of concessions	-		-		-	1		63		63
Residential Real Estate & Construction:
Extension of maturity and
interest rate reduction	3		307		307	-		-		-
Commercial Real Estate & Construction:
Deferral of principal	-		-		-	1		8,768		8,768
Extension of maturity	-		-		-	1		181		181
Combination of concessions	-		-		-	1		154		154
Home Equities:
Deferral of principal	-		-		-	1		100		100
Extension of maturity and
interest rate reduction	3		390		390	-		-		-
Consumer and other loans	-		-		-	-		-		-

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The general practice of the Bank is to work with borrowers so that they are able to repay their loan in full. If a borrower continues to be delinquent or cannot meet the terms of a TDR and the loan is determined to be uncollectible, the loan will be charged-off to its collateral value. A loan is considered in default when the loan is 90 days past due. Loans which were classified as TDRs during the previous 12 months which defaulted during the nine month periods ended September 30, 2019 and 2018 were not material.

5. COMMON EQUITY AND EARNINGS PER SHARE DATA

The common stock per share information is based upon the weighted average number of shares outstanding during each period. For the three and nine month periods ended September 30, 2019, the Company had an average of 57,899 and 68,660 dilutive shares outstanding, respectively. The Company had an average of 116,504 and 125,801 dilutive shares outstanding for the three and nine month periods ended September 30, 2018.

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and not included in calculating diluted earnings per share. For the three and nine month periods ended September 30, 2019, there was an average of 82,642 and 85,579 potentially anti-dilutive shares outstanding, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive. For the three and nine month periods ended September 30, 2018 there were no anti-dilutive shares outstanding.

6. OTHER COMPREHENSIVE INCOME

The following tables summarize the changes in the components of accumulated other comprehensive income (loss) during the three and nine month periods ended September 30, 2019 and 2018:


	Balance at June 30, 2019		Net Change		Balance at September 30, 2019
	(in thousands)
Net unrealized gain on investment securities	$	426	$	523	$	949
Net defined benefit pension plan adjustments		(2,871)		68		(2,803)
Total	$	(2,445)	$	591	$	(1,854)

	Balance at June 30, 2018		Net Change		Balance at September 30, 2018
	(in thousands)
Net unrealized loss on investment securities	$	(3,093)	$	(738)	$	(3,831)
Net defined benefit pension plan adjustments		(2,290)		40		(2,250)
Total	$	(5,383)	$	(698)	$	(6,081)


	Balance at December 31, 2018		Net Change		Balance at September 30, 2019
	(in thousands)
Net unrealized (loss) gain on investment securities	$	(2,348)	$	3,297	$	949
Net defined benefit pension plan adjustments		(3,005)		202		(2,803)
Total	$	(5,353)	$	3,499	$	(1,854)


	Balance at December 31, 2017		Net Change		Balance at September 30, 2018
	(in thousands)
Net unrealized loss on investment securities	$	(1,049)	$	(2,782)	$	(3,831)
Net defined benefit pension plan adjustments		(2,368)		118		(2,250)
Total	$	(3,417)	$	(2,664)	$	(6,081)

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	Three months ended September 30, 2019						Three months ended September 30, 2018
	(in thousands)						(in thousands)
	Before-Tax Amount		Income Tax (Provision) Benefit		Net-of-Tax Amount		Before-Tax Amount		Income Tax (Provision) Benefit		Net-of-Tax Amount
Unrealized gain (loss) on investment
securities:
Unrealized gain (loss) on investment
securities	$	705	$	(182)	$	523	$	(1,002)	$	264	$	(738)

Defined benefit pension plan
adjustments:
Reclassifications from accumulated other
comprehensive income for gains
Amortization of prior service cost (a)	$	7	$	(1)	$	6	$	8	$	(1)	$	7
Amortization of actuarial loss (a)		82		(20)		62		43		(10)		33
Net change		89		(21)		68		51		(11)		40

Other comprehensive income (loss)	$	794	$	(203)	$	591	$	(951)	$	253	$	(698)

(a)

Included in net periodic pension cost, as described in Note 9 – “Net Periodic Benefit Costs”



	Nine months ended September 30, 2019						Nine months ended September 30, 2018
	(in thousands)						(in thousands)
	Before-Tax Amount		Income Tax (Provision) Benefit		Net-of-Tax Amount		Before-Tax Amount		Income Tax (Provision) Benefit		Net-of-Tax Amount
Unrealized gain (loss) on investment
securities:
Unrealized gain (loss) on investment
securities	$	4,451	$	(1,154)	$	3,297	$	(3,761)	$	979	$	(2,782)

Defined benefit pension plan
adjustments:
Reclassifications from accumulated other
comprehensive income for gains
Amortization of prior service cost (a)	$	23	$	(6)	$	17	$	24	$	(6)	$	18
Amortization of actuarial loss (a)		248		(63)		185		127		(27)		100
Net change		271		(69)		202		151		(33)		118

Other comprehensive income (loss)	$	4,722	$	(1,223)	$	3,499	$	(3,610)	$	946	$	(2,664)

(a)

Included in net periodic pension cost, as described in Note 9 – “Net Periodic Benefit Costs”

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7. SEGMENT INFORMATION

The Company comprises two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three and nine month periods ended September 30, 2019 and 2018.




	Three months ended September 30, 2019
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	13,652	$	(31)	$	13,621
(Credit) provision for loan losses		(431)		-		(431)
Net interest income (expense) after
provision for loan losses		14,083		(31)		14,052
Non-interest income		1,777		162		1,939
Insurance service and fees		130		3,095		3,225
Amortization expense		-		112		112
Non-interest expense		9,778		2,386		12,164
Income before income taxes		6,212		728		6,940
Income tax provision		1,587		189		1,776
Net income	$	4,625	$	539	$	5,164




	Three months ended September 30, 2018
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	12,118	$	(32)	$	12,086
Provision for loan losses		252		-		252
Net interest income (expense) after
provision for loan losses		11,866		(32)		11,834
Non-interest income		1,549		-		1,549
Insurance service and fees		148		3,067		3,215
Amortization expense		-		112		112
Non-interest expense		9,247		2,098		11,345
Income before income taxes		4,316		825		5,141
Income tax provision		116		230		346
Net income	$	4,200	$	595	$	4,795

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	Nine months ended September 30, 2019
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	39,360	$	(97)	$	39,263
Provision for loan losses		197		-		197
Net interest income (expense) after
provision for loan losses		39,163		(97)		39,066
Non-interest income		5,359		162		5,521
Insurance service and fees		377		8,191		8,568
Amortization expense		-		336		336
Non-interest expense		28,775		6,538		35,313
Income before income taxes		16,124		1,382		17,506
Income tax provision		3,880		360		4,240
Net income	$	12,244	$	1,022	$	13,266




	Nine months ended September 30, 2018
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	35,822	$	(88)	$	35,734
Provision for loan losses		1,678		-		1,678
Net interest income (expense) after
provision for loan losses		34,144		(88)		34,056
Non-interest income		5,057		-		5,057
Insurance service and fees		449		6,683		7,132
Amortization expense		-		168		168
Non-interest expense		26,436		5,257		31,693
Income before income taxes		13,214		1,170		14,384
Income tax provision		2,159		320		2,479
Net income	$	11,055	$	850	$	11,905

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8. CONTINGENT LIABILITIES AND COMMITMENTS

The unaudited consolidated financial statements do not reflect various commitments and contingent liabilities, which arise in the normal course of business, and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities consist of commitments to extend credit and standby letters of credit. A summary of the Bank’s commitments and contingent liabilities is as follows:



	September 30,		December 31,
	2019		2018
	(in thousands)

Commitments to extend credit	$	347,081	$	290,785
Standby letters of credit		4,432		3,379
Total	$	351,513	$	294,164

Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance by the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded on the Company’s unaudited consolidated balance sheets. Because these instruments have fixed maturity dates, and because they may expire without being drawn upon, they do not necessarily represent cash requirements of the Bank. The Bank did not incur any losses on its commitments and did not record a reserve for its commitments during the first nine months of 2019 or during 2018.

Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of GAAP. The changes in the fair value of these commitments, due to interest rate risk, are not recorded on the consolidated balance sheets as the fair value of these derivatives is not considered to be material.

9. NET PERIODIC BENEFIT COSTS

On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Bank employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive, at retirement, the benefits already earned through January 31, 2008, but have not accrued any additional benefits since then. As a result, service cost is no longer incurred.

The Bank uses an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank used recognized the prior service cost and net gains or losses over the average remaining service period of active employees.

The Bank also maintains a nonqualified supplemental executive retirement plan covering certain members of the Company’s senior management. The Bank uses an actuarial method of amortizing unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank uses recognizes the net gains or losses over the average remaining service period of active employees.

The following table presents the net periodic cost for the Bank’s defined benefit pension plan and supplemental executive retirement plan for the three and nine month periods ended September 30, 2019 and 2018:

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		Three months ended September 30,
		(in thousands)

					Supplemental Executive
	Pension Benefits				Retirement Plan

	2019		2018		2019		2018

Service cost	$	-	$	-	$	37	$	47
Interest cost		55		51		51		34
Expected return on plan assets		(70)		(78)		-		-
Amortization of prior service cost		-		-		7		8
Amortization of the net loss		24		21		58		22
Net periodic cost (benefit)	$	9	$	(6)	$	153	$	111




		Nine months ended September 30,
		(in thousands)

					Supplemental Executive
	Pension Benefits				Retirement Plan

	2019		2018		2019		2018

Service cost	$	-	$	-	$	109	$	141
Interest cost		165		153		151		102
Expected return on plan assets		(208)		(234)		-		-
Amortization of prior service cost		-		-		23		24
Amortization of the net loss		72		63		176		64
Net periodic cost (benefit)	$	29	$	(18)	$	459	$	331

The components of net periodic benefit cost other than the service cost component are included in the line item “other expense” in the income statement.

10. REVENUE RECOGNITION OF NON-INTEREST INCOME

A description of the Company’s material revenue streams in non-interest income accounted for under ASC 606 follows:

Insurance Service and Fees: Insurance services revenue relates to various revenue streams from services provided by TEA and the Bank:

TEA earns commission revenue from selling commercial and personal property and casualty (“P&C”) insurance as well as employee benefits (“EB”) solutions to commercial customers.

TEA has agreements with various insurance companies to sell policies to customers on behalf of the carriers. The performance obligation for TEA is to sell annual P&C policies to commercial customers and consumers. This performance obligation is met when a new policy is sold or when an existing policy renews. The policies are generally one year terms. In the agreements with the respective insurance companies, a commission rate is agreed upon. The commission is recognized at the time of the sale of the policy or when a policy renews.

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TEA has signed contracts with insurance carriers that enable TEA to sell benefit plans to commercial customers on behalf of the insurance carriers. The performance obligation for TEA is to sell the plans to commercial customers. After the initial sale when the customer signs an agreement to purchase the offered benefit plan, the performance obligation is met each month when a customer continues utilizing benefit plans from the carrier. The customer does not commit to a specific length of time with the carrier. In the agreements with the respective insurance companies, a commission rate is agreed upon. Revenue is recognized each month when the customer continues with the benefit plan sold by TEA.

TEA also earns contingent profit sharing revenue. The insurance companies measure the loss ratio for TEA’s customers and pay TEA according to how profitable TEA customers are.

TEA has signed written agreements with insurance carriers that document payouts to TEA based on the loss ratios of its customers. The performance obligation for TEA is to maintain a customer base with loss ratios below the agreed upon thresholds. In the contracts with the insurance companies, payout rates based on loss ratios are documented. The consideration is variable as loss ratios vary based on customer experience. TEA’s performance obligation is over the course of the year as its customers’ performance with insurance carriers is measured throughout the year as losses occur. Due to the variable nature of contingent profit sharing revenue, TEA will accrue contingent profit sharing revenue throughout the year based on recent historical results. As loss events occur and overall performance becomes known to TEA, accrual adjustments will be made until the cash is ultimately received.

Financial services commission revenue from the Bank related to wealth management such as life insurance, annuities, and mutual funds sales is also included in the “insurance service and fees” line of the income statement.

The Company earns wealth management fees from its contracts with customers for certain financial services. Fees that are transaction-based are recognized at the point in time that the transaction is executed. Other related services provided include financial planning services and the fees the Bank earns are recognized when the services are rendered.

Insurance claims services revenue is recorded at FCS.

FCS has signed agreements with insurance companies to perform claims services including investigative and adjustment services related to residential and commercial lines. The performance obligation is for FCS to investigate the insurance claims and inspecting the damage to determine the extent of the insurance company’s liability. FCS is paid based on time and materials expended to investigate the claim. The rates paid are determined in the agreement between FCS and the respective insurance companies. Upon completion of its claims inspection work, FCS bills the insurance company for services rendered and recognizes the revenue earned.

A disaggregation of the total insurance service and other fees for the three and nine month periods ended September 30, 2019 and 2018 is provided in the tables below:



		Three months ended September 30,
		2019		2018
		(in thousands)
Commercial property and casualty insurance commissions	$	1,382	$	1,330
Personal property and casualty insurance commissions		863		917
Employee benefits sales commissions		287		241
Profit sharing and contingent revenue		430		486
Wealth management and other financial services		142		151
Insurance claims services revenue		96		65
Other insurance-related revenue		25		25
Total insurance service and other fees	$	3,225	$	3,215

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		Nine months ended September 30,
		2019		2018
	(in thousands)
Commercial property and casualty insurance commissions	$	3,267	$	2,665
Personal property and casualty insurance commissions		2,618		2,249
Employee benefits sales commissions		869		664
Profit sharing and contingent revenue		939		790
Wealth management and other financial services		405		462
Insurance claims services revenue		397		234
Other insurance-related revenue		73		68
Total insurance service and other fees	$	8,568	$	7,132

11. RECENT ACCOUNTING PRONOUNCEMENTS

Note 1 contains details on the impact of accounting pronouncements adopted during the nine months ended September 30, 2019. The following standards will be adopted in future periods. ASUs not listed below are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.

ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Both financial institutions and users of their financial statements expressed concern that current GAAP restricts the ability to record credit losses that are expected, but do not yet meet the “probable” threshold. The main objective of this ASU (commonly known as the Current Expected Credit Loss Impairment Model, or CECL, in the industry) is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in CECL replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The life of loan loss concept presents complexities that can decrease capital, and add both volatility to the allowance for loan losses estimates and additional costs. Changes in expectations of future economic conditions will play a large role in CECL and can significantly affect the credit loss estimate. The Company is developing its approach for determining expected credit losses under the new guidance, including the licensing of new software and the development of processes to track loan performance. The total impact of CECL to the Company’s financial statements is unknown but may be material. On October 16, 2019, the FASB affirmed its decision to amend the effective date for the amendments in CECL for smaller reporting companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is allowed for fiscal years beginning after December 15, 2018. The Company intends to early adopt CECL effective January 1, 2021. Implementation of CECL will be a significant project for the Company through the projected implementation date of January 1, 2021.

ASU 2018-13, Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement – The amendments in this ASU modify the disclosure requirements on fair value measurements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Adoption of this ASU will impact the Company’s disclosures but will not impact the Company’s financial condition, results of operations or cash flows.

ASU 2018-14, Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans – The amendments in this ASU remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. The amendments in this ASU are effective for fiscal years ending after December 15, 2020. Adoption of this ASU will impact the Company’s disclosures but will not impact the Company’s financial condition, results of operations or cash flows.

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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” and similar expressions identify such forward-looking statements. These forward-looking statements include statements regarding the Company’s business plans, prospects, growth and operating strategies, statements regarding the asset quality of the Company’s loan and investment portfolios, and estimates of the Company’s risks and future costs and benefits.

These forward-looking statements are based largely on the expectations of the Company’s management and are subject to a number of risks and uncertainties, including but not limited to: general economic conditions, either nationally or in the Company’s market areas, that are worse than expected; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company’s margins or reduce the fair value of financial instruments; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees, monetary policy, and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; loan losses in excess of the Company’s allowance for loan losses; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; the impact of such changes in accounting pronouncements and practices being greater than anticipated; the ability to realize the benefit of deferred tax assets; changes in tax policies, rates and regulations of federal, state and local tax authorities; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; and other factors discussed elsewhere in this Quarterly Report on Form 10-Q, as well as in the Company’s periodic reports filed with the SEC, in particular the “Risk Factors” discussed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Many of these factors are beyond the Company’s control and are difficult to predict.

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

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

The Company’s Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q are prepared in accordance with U.S. GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the Company’s Unaudited Consolidated Financial Statements and Notes. These estimates, assumptions, and judgments are based on information available as of the date of the Unaudited Consolidated Financial Statements. Accordingly, as this information changes, the Unaudited Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques. Refer to Note 3 – “Fair Value Measurements” to the Company’s Unaudited Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q for further detail on fair value measurement.

Significant accounting policies followed by the Company are presented in Note 1 – “Organization and Summary of Significant Accounting Policies” to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K for the year ended December 31, 2018. These policies, along with the disclosures presented in the other Notes to the Company's Audited Consolidated Financial Statements contained in its Annual Report on Form 10-K and in this financial review, provide information on how significant assets and liabilities are presented in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.

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

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable losses in the Company’s loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s Unaudited Consolidated Balance Sheets. Note 1 to the Audited Consolidated Financial Statements included in Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 describes the methodology used to determine the allowance for loan losses.

Goodwill

The amount of goodwill reflected in the Company’s Unaudited Consolidated Financial Statements is required to be tested by management for impairment on at least an annual basis. The test for impairment of goodwill on the identified reporting unit is considered a critical accounting estimate because it requires judgment on the part of management and the use of estimates related to the growth assumptions and market multiples used in the valuation model. The goodwill impairment testing is performed annually as of December 31. No impairment charges were incurred in the most recent test and the fair value of the tested reporting unit substantially exceeded its carrying value. There were no triggering events in the nine-month period ended September 30, 2019 that resulted in an interim impairment test.

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ANALYSIS OF FINANCIAL CONDITION

Loan Activity

Total gross loans were $1.2 billion at September 30, 2019, a $7 million or 1% increase from June 30, 2019 and a $64 million or 6% increase from December 31, 2018.

Loans secured by real estate were $954 million at September 30, 2019, reflecting a $12 million or 1% increase from $942 million at June 30, 2019 and a $27 million or 3% increase from $927 million at December 31, 2018. Commercial real estate loans, including construction loans, were $724 million at September 30, 2019, $13 million or 2% higher than the $711 million balance at the end of the second quarter of 2019 and $26 million or 4% higher than the $698 million balance at the end of the fourth quarter of 2018. Commercial real estate is the largest part of the Company’s loan portfolio and has historically been the highest growth segment of the portfolio. The market for commercial real estate in the Company’s footprint in Western New York has been strong in recent years. The demand, along with the Company’s dedicated resources to commercial real estate lending, led to 7% annualized growth rate in the third quarter of 2019.

Residential mortgage originations were $6 million in the third and second quarters of 2019, compared with $14 million in last year’s third quarter. The Company originated $19 million in residential mortgages in the first nine months of 2019, compared to $35 million in the first nine months of 2018. The decrease in residential mortgage originations is attributable to reduced staffing in 2019. Residential mortgages sold in the third quarter of 2019 equated to approximately 49% of the residential mortgages originated by the Company during the quarter, as compared with 43% in the second quarter of 2019 and 3% in the third quarter of 2018. Residential mortgages sold in the first nine months of 2019 were 41% of residential mortgages originated during the period compared with 1% in the first nine months of 2018. Management decides to keep or sell residential mortgage loans at the time of origination based on interest rate risk management and the risk-adjusted return of alternative investment sources such as mortgage-backed securities.

The Company has also focused on growth opportunities in commercial and industrial (“C&I”) lending as a way to diversify its overall loan portfolio. The C&I portfolio was $262 million at September 30, 2019, representing a $6 million or 2% decrease from $268 million at June 30, 2019 but a $36 million or 16% increase from $226 million at December 31, 2018. The increase in C&I balances during the first nine months of 2019 equates to a 21% annualized growth rate. C&I lending is a critical component of the Company’s strategy as C&I relationships can often include core deposits.

Credit Quality of Loan Portfolio

Total non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $14 million, or 1.13% of total loans outstanding at September 30, 2019, compared with $11 million, or 0.91% of total loans outstanding, as of June 30, 2019 and $19 million, or 1.64% of total loans outstanding, as of December 31, 2018. The increase in non-performing loans compared with the second quarter of 2019 reflects $2.3 million related to a single C&I relationship that was changed to nonaccrual status during the third quarter of 2019. The decrease in non-performing loans compared with December 31, 2018 is due to a payoff of a single commercial construction loan of $8 million that was in nonaccrual status.

Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $54 million at September 30, 2019, a $11 million increase from $43 million at June 30, 2019 and $16 million increase from $38 million at December 31, 2018. The increase in criticized loans in the third quarter of 2019 includes $8 million in commercial real estate loans and $3 million in C&I loans that were downgraded to criticized during the quarter. In comparison to December 31, 2018, the increase includes $20 million in commercial real estate loans and $9 million in C&I loans that were downgraded to criticized in the first nine months of 2019, offset by paydowns of $13 million including the paydown of a single commercial construction loan of $8 million. The level of criticized loans can fluctuate as new information is constantly received on the Company’s borrowers and their financial circumstances change over time. As noted in Note 4 to the Company’s Unaudited Financial Statements included in Part I of this Quarterly Report on Form 10-Q, internal risk ratings are the credit quality indicators used by the Company’s management to determine the appropriate allowance for loan losses for commercial credits. “Special mention” and “substandard” loans are weaker credits with a higher risk of loss categorized as “criticized” credits rather than “pass” or “watch” credits.

The Company maintains an allowance for loan losses that in management’s judgment appropriately reflects losses inherent in the loan portfolio. The allowance for loan losses totaled $15.4 million at September 30, 2019, $15.2 million at June 30, 2019, and $14.8 million at December 31, 2018. At the end of September 30, 2019 and June 30, 2019 the allowance for loan losses was 1.26% of total loans outstanding, compared with 1.28% of total loans outstanding as of December 31, 2018. The Company released $0.4 million in allowance for loan losses in the third quarter of 2019, compared to $0.1 million in provision for loan losses in the second quarter of 2019, and $0.3 million provision for loan loss in last year’s third quarter. The release of allowance for loan losses in the third quarter of 2019 reflects a decrease in net loan charge-offs due to a single commercial loan recovery of $0.7 million, partially offset by an increase in non-performing loans.

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Investing Activities

Total investment securities were $137 million at September 30, 2019 and June 30, 2019 compared with $134 million at December 31, 2018. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, decreased to $15 million at September 30, 2019 from $46 million at June 30, 2019 and $26 million at December 31, 2018. The primary objectives of the Company’s investment portfolio are to provide liquidity, provide collateral to secure municipal deposits, and maximize income while preserving safety of principal. With the flattened yield curve there is a reduced advantage to purchasing longer-term investment securities. Average investment securities and interest-bearing cash were 12% of average interest-earning assets in the third quarter of 2019 and 2018, compared with 13% in the second quarter of 2019.

The Company’s highest concentration in its securities portfolio was in available-for-sale U.S. government sponsored mortgage-backed securities at 74% of total investment securities at September 30, 2019 compared with 70% at June 30, 2019 and 57% at December 31, 2018. The concentration in tax-advantaged debt securities issued by state and political subdivisions and U.S. government-sponsored agency bonds was 5% and 21%, respectively, of the total securities portfolio at September 30, 2019, compared with 4% and 26% at June 30, 2019 and 18% and 25% at December 31, 2018.

The total net unrealized gain position of the available-for-sale investment portfolio was $1.3 million and $0.6 million at September 30, 2019 and June 30, 2019, respectively, compared with a net unrealized loss position of $3.2 million at December 31, 2018. The changes in unrealized gains and losses during 2019 resulted primarily from a rebalancing of the investment portfolio. The securities in an unrealized loss position at the end of the third quarter of 2019 reflect differences in market interest rates rather than a reduction in credit concerns. Management believes that the credit quality of the securities portfolio as a whole is strong.

The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. The Company has no direct exposure to subprime mortgages, nor does the Company hold private mortgage-backed securities, credit default swaps, or FNMA or FHLMC preferred stock investments in its investment portfolio.

Funding Activities

Total deposits were $1.26 billion at September 30, 2019 compared with $1.28 billion at June 30, 2019. Total deposits increased $44 million or 4% from $1.22 billion at December 31, 2018. The increase during the first nine months of 2019 reflects growth in demand deposits of $40 million, NOW deposits (interest-bearing checking accounts) of $31 million, offset by a $24 million decrease in time deposits and a $3 million decrease in savings deposits. Further discussion of deposit growth and changes in deposit mix are in the “Analysis of Results of Operations.”

The Company had $10 million in other borrowings at September 30, 2019 and December 31, 2018. This represents a single $10 million long-term advance with the FHLBNY scheduled to mature in 2020. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with deposits along with the line usage’s impact on interest rate risk. There were no overnight borrowings at September 30, 2019.

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ANALYSIS OF RESULTS OF OPERATIONS

Average Balance Sheet

The following tables present the significant categories of the assets and liabilities of the Company, interest income and interest expense, and the corresponding yields earned and rates paid for the periods indicated. The assets and liabilities are presented as daily averages. The average loan balances include both performing and non-performing loans. Investments are included at book value. Yields are presented on a non-tax-equivalent basis.




	Three months ended September 30, 2019						Three months ended September 30, 2018
	Average		Interest				Average		Interest
	Outstanding		Earned/		Yield/		Outstanding		Earned/		Yield/
	Balance		Paid		Rate		Balance		Paid		Rate
	(dollars in thousands)						(dollars in thousands)
ASSETS
Interest-earning assets:
Loans, net	$	1,202,634	$	15,645	5.16	%	$	1,127,173	$	13,676	4.81	%
Taxable securities		140,006		993	2.81	%		120,004		805	2.66	%
Tax-exempt securities		3,725		48	5.11	%		25,118		146	2.31	%
Interest bearing deposits at banks		24,661		159	2.56	%		12,641		63	1.98	%

Total interest-earning assets		1,371,026	$	16,845	4.87	%		1,284,936	$	14,690	4.54	%

Non interest-earning assets:

Cash and due from banks		14,522						14,095
Premises and equipment, net		12,850						10,428
Other assets		62,141						62,879

Total Assets	$	1,460,539					$	1,372,338

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW	$	134,008	$	151	0.45	%	$	115,417	$	79	0.27	%
Savings		591,585		1,346	0.90	%		581,484		1,023	0.70	%
Time deposits		281,798		1,541	2.17	%		274,275		1,310	1.89	%
Other borrowed funds		10,000		43	1.71	%		11,035		50	1.80	%
Junior subordinated debentures		11,317		141	4.94	%		11,330		141	4.94	%
Securities sold U/A to repurchase		3,917		2	0.20	%		3,384		1	0.12	%

Total interest-bearing liabilities		1,032,625	$	3,224	1.24	%		996,925	$	2,604	1.04	%

Noninterest-bearing liabilities:
Demand deposits		261,089						233,393
Other		22,231						17,045
Total liabilities	$	1,315,945					$	1,247,363

Stockholders' equity		144,594						124,975

Total Liabilities and Equity	$	1,460,539					$	1,372,338

Net interest income			$	13,621					$	12,086

Net interest margin					3.94	%					3.73	%

Interest rate spread					3.63	%					3.50	%

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	Nine months ended September 30, 2019						Nine months ended September 30, 2018
	Average		Interest				Average		Interest
	Outstanding		Earned/		Yield/		Outstanding		Earned/		Yield/
	Balance		Paid		Rate		Balance		Paid		Rate
	(dollars in thousands)						(dollars in thousands)
ASSETS
Interest-earning assets:
Loans, net	$	1,179,875	$	45,149	5.12	%	$	1,097,814	$	39,238	4.78	%
Taxable securities		132,264		2,736	2.77	%		124,487		2,465	2.65	%
Tax-exempt securities		12,227		263	2.88	%		29,106		512	2.35	%
Interest bearing deposits at banks		32,202		564	2.34	%		6,582		88	1.79	%

Total interest-earning assets		1,356,568	$	48,712	4.80	%		1,257,989	$	42,303	4.50	%

Non interest-earning assets:

Cash and due from banks		13,845						13,902
Premises and equipment, net		11,318						10,469
Other assets		62,054						58,875

Total Assets	$	1,443,785					$	1,341,235

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW	$	123,443	$	345	0.37	%	$	116,736	$	233	0.27	%
Regular savings		596,250		3,835	0.86	%		570,182		2,617	0.61	%
Time deposits		289,998		4,703	2.17	%		227,929		2,819	1.65	%
Other borrowed funds		10,014		130	1.74	%		38,052		499	1.75	%
Junior subordinated debentures		11,326		431	5.09	%		11,330		391	4.61	%
Securities sold U/A to repurchase		3,729		5	0.18	%		6,892		10	0.19	%

Total interest-bearing liabilities		1,034,760	$	9,449	1.22	%		971,121	$	6,569	0.90	%

Noninterest-bearing liabilities:
Demand deposits		249,157						232,082
Other		21,356						15,634
Total liabilities	$	1,305,273					$	1,218,837

Stockholders' equity		138,512						122,398

Total Liabilities and Equity	$	1,443,785					$	1,341,235

Net interest income			$	39,263					$	35,734

Net interest margin					3.87	%					3.80	%

Interest rate spread					3.58	%					3.60	%

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Net Income

Net income was $5.2 million, or $1.04 per diluted share, in the third quarter of 2019, compared with $4.4 million, or $0.88 per diluted share, in the second quarter of 2019 and $4.8 million, or $0.97 per diluted share, in last year’s third quarter. The increase over comparative periods reflects higher net interest income due to loan growth and a decrease in loan loss provision, partially offset by an increase in non-interest expense. Return on average equity was 14.29% for the third quarter of 2019, compared with 12.71% in the second quarter of 2019 and 15.35% in the third quarter of 2018.

Other Results of Operations – Quarterly Comparison

Net interest income increased $0.5 million, or 4%, from the second quarter of 2019, and $1.5 million, or 13%, from the prior-year third quarter to $13.6 million in the third quarter of 2019. The increases were driven by growth in the commercial loan portfolio, partially offset by an increase in interest expense. Average commercial loans, including commercial real estate and commercial and industrial loans, were $983 million, up $18 million from the 2019 second quarter and $65 million from the 2018 third quarter. The third quarter of 2019 also included $0.2 million of interest related to the recovery of a single commercial loan that was charged-off in a previous period.

Third quarter net interest margin of 3.94%. When excluding the interest related to the recovery, net interest margin was 3.89%, an increase of 2 basis points from the 2019 second quarter and 16 basis points from the third quarter of 2018. The modest increase from the linked quarter resulted from changes in the mix of interest earning assets reflecting the utilization of cash to achieve loan growth, while the change from the prior year reflects increased yields on loans, offset by higher funding costs, reflecting higher interest rates and competitive deposit market pricing. Excluding the interest related to the recovery, the yield on loans increased 30 basis points when compared with the third quarter of 2018. The cost of interest-bearing liabilities was 1.24% in the third quarter of 2019, compared with 1.23% in the second quarter of 2019 and 1.04% in the third quarter of 2018.

The Company released $0.4 million of allowance for loan losses in the third quarter of 2019. Provision for loan losses was $0.1 million in the second quarter of 2019 and $0.3 million in the third quarter of 2018. The release of allowance for loan losses during the third quarter of 2019 reflects a decrease in net loan charge-offs due to the single commercial loan recovery of $0.7 million, partially offset by an increase in non-performing loans.

Non-interest income was $5.2 million in the third quarter of 2019, compared with $4.7 million in the second quarter of 2019 and $4.8 million in the prior year third quarter. The increase in non-interest income compared with the prior quarter is primarily due to seasonally higher insurance revenue. Other income in the third quarter of 2019 includes $0.2 million of insurance proceeds related to legal and professional fees incurred to respond to a data security incident and related matters.

Non-interest expenses of $12.3 million in the third quarter of 2019 increased 7% from the prior-year period and 1% from the second quarter of 2019. The most significant component of the increase was higher salaries and employee benefit costs as a result of severance and the addition of strategic personnel hires to support the Company’s continued growth. Salaries and employee benefits costs were $7.6 million in the third quarter of 2019, an increase of 8% from last year’s third quarter.

Professional services fees was relatively flat compared to the second quarter of 2019, but was $0.4 million higher than last year’s third quarter. The increase in professional service fees includes $0.2 million related to legal and professional fees incurred to respond to a data security incident and related matters, plus incremental project costs designed to enhance technology and continue to be prepared to respond to future threats which impact the banking industry at large. The increase from the prior year period also includes $0.1 million of broker commissions related to our employee benefits insurance business, and generally higher legal and accounting expenses.

Technology and communications expenses were $1.1 million in the third quarter and second quarter of 2019, an increase of $0.2 million from the last year’s third quarter. The increase in technology and communications was due to higher software costs and volume related ATM card fees and online banking activity.

The third quarter of 2019 FDIC insurance expense was offset by the application of the FDIC’s small bank assessment credit.

The Company’s efficiency ratio improved to 64.8% compared with 67.5% in the second quarter of 2019 and 66.9% in last year’s third quarter.

Income tax expense was $1.8 million, or an effective tax rate of 25.6%, for the third quarter of 2019 compared with 22.1% in the second quarter of 2019 and 6.7% in the third quarter of 2018. Last year’s third quarter income taxes were reduced by $0.7 million due to a change in estimate of when certain state historic tax credits will be taxable for federal purposes. Historic tax credit transactions lowered the effective tax rate by 13.8% in the third quarter of 2018.

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Other Results of Operations – Year-to-Date Comparison

Net interest income was $39.3 million for the first nine months of 2019, a $3.5 million or 10% increase from the first nine months of 2018. The increase in net interest income is attributable to a $99 million or 8% increase in average interest-earning assets and $0.2 million of interest related to the recovery of a single commercial loan that was previously written-off. The increase in average interest-earning assets reflects average loan growth of $82 million or 7% to $1.2 billion during the first nine months of 2019 compared to the first nine months of 2018. Most of the growth was in commercial loans, including $46 million in average commercial real estate loans and $15 million in average C&I loans. Additionally, average interest-bearing deposits at banks increased $26 million during the first nine months of 2019 compared to the first nine months of 2018.

The Company’s net interest margin of 3.87% in the first nine months of 2019 was 7 basis points higher than the first nine months of 2018. The yield on average interest-earning assets increased 30 basis points from 4.50% to 4.80%. Average loan yields increased 34 basis points from 4.78% to 5.12%, reflecting the benefit of variable loan re-pricing as short-term interest rates rise. The cost of interest-bearing liabilities was 1.22%, or 32 basis points higher in the first nine months of 2019 when compared with the first nine months of 2018. In reaction to the competitive deposit market the Company has increased promotional pricing on certain deposit products, primarily time deposits. The rate paid on average time deposits increased from 1.65% in the first nine months of 2018 to 2.17% during the first nine months of 2019. The higher overall cost of interest-bearing liabilities also reflects a shift in the Company’s funding mix as the average balance of higher cost time deposits increased. Average time deposits were 28% of total interest-bearing liabilities in the nine-month period ended September 30, 2019, compared with 23% in the first nine months of 2018.

The Company recorded $0.2 million in provision for loan losses in the first nine months period ended September 30, 2019, compared with $1.7 million in the nine-month period ended September 30, 2018. The decrease in provision for loan losses during the first nine months of 2019 compared with the prior year period reflects a decrease in non-performing loans during the current year period, primarily due to the paydown of a single commercial construction loan of $8 million, and a decrease in net loan charge-offs due to the single commercial loan recovery of $0.7 million.

Non-interest income for the first nine months of 2019 increased $1.9 million from the prior year period to $14.1 million. The increase was a result of higher insurance service and fees revenue of $1.4 million resulting from the 2018 acquisition of Richardson and Stout, Inc., and higher deposit service charges of $0.2 million.

Total non-interest expense increased to $35.6 million in the first nine months of 2019, 12% higher than the nine-month period ended September 30, 2018. The increase was mostly attributable to an increase in salaries and employee benefits costs. Salaries and employee benefits costs were $22.3 million for the first nine months of 2019, a $2.1 million or 10% increase from $20.2 million in the prior year period. The year-over-year increase in salary and benefits expense reflects severance and strategic personnel hires to support the Company’s growth. Professional services expenses increased $0.8 million to $2.7 million, primarily due to $0.2 million related to legal and professional fees incurred to respond to a data security incident and related matters, $0.2 million of broker commissions related to our employee benefits insurance business and generally higher legal and accounting expenses. Technology and communications expenses increased $0.6 million to $3.0 million, reflecting higher software costs and volume relating to ATM card fees and online banking activity. FDIC insurance was $0.4 million lower in the first nine months of 2019 when compared to the first nine months of 2018 as a result of lower non-performing assets and the FDIC’s small bank assessment credit.

The Company’s efficiency ratio for the first nine months of 2019 was 66.2%, compared with 66.0% during the prior-year period. The slight increase in the ratio reflects the increase in non-interest expenses, partially offset by the increase in net interest income and non-interest income.

The Company recorded income tax expense of $4.2 million for the nine-month period ended September 30, 2019, compared with $2.5 million in the first nine months of 2018. The effective tax rate for the first nine months of 2019 was 24.2%, compared with 17.2% in the comparable 2018 period. The impact of the historic tax credits on the effective tax rate for the first nine months of 2018 was 5.0%. Income taxes for the first nine months of 2018 were reduced by $0.7 million due to a change in estimate of when certain state historic tax credits will be taxable for federal purposes.

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CAPITAL

The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 10.11% at September 30, 2019, compared with 9.99% at June 30, 2019 and 9.73% at December 31, 2018. Book value per share increased to $29.44 at September 30, 2019, compared with $28.74 at June 30, 2019, and $27.13 at December 31, 2018.

On August 22, 2019, the Company declared a semi-annual cash dividend of $0.52 per share on the Company’s outstanding common stock. The dividend was paid on October 2, 2019 to shareholders of record as of September 11, 2019. For the full year of 2019, cash dividends totaled $1.04, up 13% over 2018.

LIQUIDITY

The Bank utilizes cash flows from the investment portfolio and federal funds sold balances to manage the liquidity requirements related to loan demand and deposit fluctuations. The Bank also has many borrowing options. The Company uses the Federal Home Loan Bank of New York as its primary source of overnight funds and also has one long-term advance with FHLBNY. The Company had $10 million in borrowed funds at FHLBNY at September 30, 2019 and December 31, 2018. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with core deposits along with the line usage’s impact on interest rate risk. The Company’s funding strategy has resulted in significant time deposit growth, resulting in less usage of the FHLBNY overnight line of credit. The Company has pledged sufficient collateral in the form of residential and commercial real estate loans at FHLBNY that meets FHLB collateral requirements. As a member of the FHLB, the Bank is able to borrow funds at competitive rates. Advances of up to $280 million can be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. The Bank also has the ability to purchase up to $18 million in federal funds from its correspondent banks. By placing sufficient collateral in safekeeping at the Federal Reserve Bank, the Bank could borrow at the discount window. The Bank’s liquidity needs also can be met by more aggressively pursuing time deposits, or accessing the brokered time deposit market, including the Certificate of Deposit Account Registry Service (“CDARS”) network.

Cash flows from the Bank’s investment portfolio are laddered, so that securities mature at regular intervals, to provide funds from principal and interest payments at various times as liquidity needs may arise. Contractual maturities are also laddered, with consideration as to the volatility of market prices. At September 30, 2019, approximately 4% of the Bank’s securities had contractual maturity dates of one year or less and approximately 9% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprise 74% of the investment portfolio at September 30, 2019, provide consistent cash flows for the Bank.

The Company’s primary source of liquidity is dividends from the Bank. Additionally, the Company has access to capital markets as a funding source.

Management, on an ongoing basis, closely monitors the Company’s liquidity position for compliance with internal policies and believes that available sources of liquidity are adequate to meet funding needs in the normal course of business. As part of that monitoring process, management calculates the 90-day liquidity each month by analyzing the cash needs of the Bank. Included in the calculation are liquid assets and potential liabilities. Management stresses the potential liabilities calculation to ensure a strong liquidity position. Included in the calculation are assumptions of some significant deposit run-off as well as funds needed for loan closings and investment purchases. In the Company’s internal stress test at September 30, 2019, the Company had net short-term liquidity of $202 million as compared with $249 million at December 31, 2018. Available assets of $154 million, divided by public and purchased funds of $292 million, resulted in a long-term liquidity ratio of 53% at September 30, 2019, compared with 63% at December 31, 2018.

Management does not anticipate engaging in any activities, either currently or in the long term, for which adequate funding would not be available and which would therefore result in significant pressure on liquidity.

The Company believes that the Bank maintains a sufficient level of U.S. government and government agency securities and New York State municipal bonds that can be pledged as collateral for municipal deposits.

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ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Additional information responsive to this Item is contained in the Liquidity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, which information is incorporated herein by reference.

Market risk is the risk of loss from adverse changes in market prices and/or interest rates of the Bank’s financial instruments. The primary market risk that the Company is exposed to is interest rate risk. The core banking activities of lending and deposit-taking expose the Bank to interest rate risk, which occurs when assets and liabilities reprice at different times and by different amounts as interest rates change. As a result, net interest income earned by the Bank is subject to the effects of changing interest rates. The Bank measures interest rate risk by calculating the variability of net interest income in future periods under various interest rate scenarios using projected balances for interest-earning assets and interest-bearing liabilities. Management’s philosophy toward interest rate risk management is to limit the variability of net interest income to changes in net interest rates. The balances of financial instruments used in the projections are based on expected growth from forecasted business opportunities, anticipated prepayments of loans, and expected maturities of investment securities, loans, and deposits. Management supplements the modeling technique described above with analysis of market values of the Bank’s financial instruments and changes to such market values given changes in the interest rates.

The Bank’s Asset-Liability Committee, which includes members of senior management, monitors the Bank’s interest rate sensitivity with the aid of a model that considers the impact of ongoing lending and deposit taking activities, as well as interrelationships in the magnitude and timing of the repricing of financial instruments, including the effect of changing interest rates on expected prepayments and maturities. When deemed prudent, management has taken actions, and intends to do so in the future, to mitigate exposure to interest rate risk through the use of on- or off-balance sheet financial instruments. Possible actions include, but are not limited to, changing the pricing of loan and deposit products, and modifying the composition of interest-earning assets and interest-bearing liabilities, and reliance on other financial instruments used for interest rate risk management purposes.

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The following table demonstrates the possible impact of changes in interest rates on the Bank’s net interest income over a 12-month period of time:

SENSITIVITY OF NET INTEREST INCOME TO CHANGES IN INTEREST RATES



	Calculated increase (decrease)
	in projected annual net interest income
	(in thousands)

		September 30, 2019		December 31, 2018
Changes in interest rates

+200 basis points	$	(51)	$	1,598
+100 basis points		2,153		2,825

-100 basis points		(2,292)		(3,026)
-200 basis points		NM		NM

Many assumptions were utilized by management to calculate the impact that changes in interest rates may have on the Bank’s net interest income. The more significant assumptions related to the rate of prepayments of mortgage-related assets, loan and deposit volumes and pricing, and deposit maturities. The Bank assumed immediate changes in rates including 200 basis point rate changes. In the 200 basis point rate reduction scenario, the applicable rate changes may be limited to lesser amounts such that interest rates are not less than zero. The assumptions in the Company’s projections are inherently uncertain and, as a result, the Bank cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly due to the timing, magnitude, and frequency of interest rate changes in market conditions and interest rate differentials (spreads) between maturity/repricing categories, as well as any actions such as those previously described, which management may take to counter such changes. In light of the uncertainties and assumptions associated with the process, the amounts presented in the table and changes in such amounts are not considered significant to the Bank’s projected net interest income.

ITEM 4 - CONTROLS AND PROCEDURES

DISCLOSURE CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2019 (the end of the period covered by this Report). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that as of September 30, 2019 the Company’s disclosure controls and procedures were effective.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

No changes in the Company’s internal control over financial reporting were identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business.

In the opinion of management, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if determined adversely, would have a material effect on the Company’s results of operations or financial condition.

ITEM 1A – RISK FACTORS

There have been no material changes in risk factors relating to the Company to those disclosed in response to Item 1A. Part I of Form 10-K for the year ended December 31, 2018.

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

In the third quarter of 2019, the Company did not purchase shares of its common stock.

Issuer Purchases of Equity Securities



Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that may yet be Purchased Under the Plans or Programs (1)
July 2019:
July 1, 2019 - July 31, 2019		-	$	-	-	100,000
August 2019:
August 1, 2019 - August 31, 2019		-	$	-	-	100,000
September 2019:
September 1, 2019 - September 30, 2019		-	$	-	-	100,000

Total:		-	$	-	-	100,000

(1)

On October 17, 2017, the Board of Directors authorized the Company to repurchase up to 100,000 shares of the Company’s common stock (the “2017 Repurchase Program”). The 2017 Repurchase Program expires 24 months after its adoption and may be suspended or discontinued by the Board of Directors at any time. The maximum number of shares that may be purchased under the 2017 Repurchase Program as of September 30, 2019 was 100,000.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

(Not Applicable.)

ITEM 4 – MINE SAFETY DISCLOSURE

(Not Applicable.)

ITEM 5 – OTHER INFORMATION

(Not Applicable.)

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ITEM 6 – EXHIBITS

The following exhibits are filed as a part of this report:


		EXHIBIT INDEX

Exhibit No.		Name


31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


31.2		Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


32.1		Certification of Principal Executive Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




32.2		Certification of Principal Financial Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




101		The following materials from Evans Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets – September 30, 2019 and December 31, 2018; (ii) Unaudited Consolidated Statements of Income – Three months ended September 30, 2019 and 2018; (iii) Unaudited Consolidated Statements of Income – Nine months ended September 30, 2019 and 2018; (iv) Unaudited Statements of Consolidated Comprehensive Income – Three months ended September 30, 2019 and 2018; (v) Unaudited Statements of Consolidated Comprehensive Income – Nine months ended September 30, 2019 and 2018; (vi) Unaudited Consolidated Statements of Stockholders' Equity – Nine months ended September 30, 2019 and 2018; (vii) Unaudited Consolidated Statements of Cash Flows – Nine months ended September 30, 2019 and 2018; and (viii) Notes to Unaudited Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Evans Bancorp, Inc.

DATE

October 31, 2019

/s/ David J. Nasca

David J. Nasca

President and CEO

(Principal Executive Officer)

DATE

October 31, 2019

/s/ John B. Connerton

John B. Connerton

Treasurer

(Principal Financial Officer and Principal Accounting Officer)