EVANS BANCORP INC - Quarter Report: 2020 September (Form 10-Q)

SUPPLEMENTAL DISCLOSURE OF NON-CASH

INVESTMENTS AND FINANCIAL ACTIVITIES:

Fair value of assets acquired in acquisition (non-cash)

Fair value of liabilities assumed in acquisition

evbn-20200930x10q

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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For quarterly period ended September 30, 2020

¨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.)

6460 Main St. Williamsville, NY 14221

(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 x 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 x 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 x
Non-accelerated filer ¨		Smaller reporting company x
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 x

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, 5,384,139 shares as of October 30, 2020.

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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, 2020 and December 31, 2019	1

	Unaudited Consolidated Statements of Income – Three months ended September 30, 2020 and 2019	2

	Unaudited Consolidated Statements of Income – Nine months ended September 30, 2020 and 2019	3

	Unaudited Consolidated Statements of Comprehensive Income – Three months ended September 30, 2020 and 2019	4

	Unaudited Consolidated Statements of Comprehensive Income – Nine months ended September 30, 2020 and 2019	4

	Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Three months ended September 30, 2020 and 2019	5

	Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Nine months ended September 30, 2020 and 2019	6

	Unaudited Consolidated Statements of Cash Flows - Nine months ended September 30, 2020 and 2019	7

	Notes to Unaudited Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	43

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	53

Item 4.	Controls and Procedures	54

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	55

Item 1A.	Risk Factors	55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55

Item 3.	Defaults Upon Senior Securities	55

Item 4.	Mine Safety Disclosure	55

Item 5.	Other Information	55

Item 6.	Exhibits	56

	Signatures	57

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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2020 AND DECEMBER 31, 2019
(in thousands, except share and per share amounts)
	September 30,		December 31,
	2020		2019
ASSETS
Cash and due from banks	$	15,386	$	10,577
Interest-bearing deposits at banks		88,249		28,280
Securities:
Available for sale, at fair value (amortized cost: $152,100 at September 30, 2020;		155,761		127,922
$127,217 at December 31, 2019)
Held to maturity, at amortized cost (fair value: $5,084 at September 30, 2020;		4,996		2,386
$2,392 at December 31, 2019)
Federal Home Loan Bank common stock, at cost		3,591		1,588
Federal Reserve Bank common stock, at cost		2,323		1,956
Loans, net of allowance for loan losses of $20,601 at September 30, 2020
and $15,175 at December 31, 2019		1,682,475		1,211,356
Properties and equipment, net of accumulated depreciation of $21,851 at September 30, 2020
and $20,682 at December 31, 2019		18,726		13,754
Goodwill and intangible assets		15,085		12,545
Bank-owned life insurance		33,817		29,418
Operating lease right-of-use asset		5,524		3,720
Other assets		31,060		16,728

TOTAL ASSETS	$	2,056,993	$	1,460,230

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand	$	442,536	$	263,717
NOW		215,492		140,654
Savings		799,739		587,142
Time		323,211		275,927
Total deposits		1,780,978		1,267,440

Securities sold under agreement to repurchase		4,414		2,425
Other borrowings		47,583		10,000
Operating lease liability		5,940		4,154
Other liabilities		24,278		16,428
Junior subordinated debentures		30,912		11,330
Total liabilities		1,894,105		1,311,777

STOCKHOLDERS' EQUITY:
Common stock, $0.50 par value, 10,000,000 shares authorized; 5,377,243
and 4,929,593 shares issued at September 30, 2020 and December 31, 2019,
respectively, and 5,376,742 and 4,929,283 outstanding at September 30, 2020
and December 31, 2019, respectively		2,691		2,467
Capital surplus		75,824		63,302
Treasury stock, at cost, 501 and 310 shares at September 30, 2020 and
December 31, 2019, respectively		-		-
Retained earnings		84,499		85,267
Accumulated other comprehensive income (loss), net of tax		(126)		(2,583)
Total stockholders' equity		162,888		148,453

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	2,056,993	$	1,460,230

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, 2020 AND 2019
(in thousands, except share and per share amounts)
	Three Months Ended September 30,
	2020		2019
INTEREST INCOME
Loans	$	16,847	$	15,645
Interest-bearing deposits at banks		26		159
Securities:
Taxable		825		993
Non-taxable		68		48
Total interest income		17,766		16,845
INTEREST EXPENSE
Deposits		1,641		3,038
Other borrowings		108		45
Junior subordinated debentures		375		141
Total interest expense		2,124		3,224
NET INTEREST INCOME		15,642		13,621
PROVISION (CREDIT) FOR LOAN LOSSES		1,881		(431)
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		13,761		14,052
NON-INTEREST INCOME
Deposit service charges		598		687
Insurance service and fees		3,217		3,225
Gain on sale of securities		667		-
Gain on loans sold		169		43
Bank-owned life insurance		170		160
Interchange fee income		481		438
Other		555		611
Total non-interest income		5,857		5,164
NON-INTEREST EXPENSE
Salaries and employee benefits		8,101		7,644
Occupancy		1,204		853
Advertising and public relations		503		231
Professional services		865		1,009
Technology and communications		1,365		1,057
Amortization of intangibles		136		112
FDIC insurance		290		-
Merger-related		524		-
Other		1,480		1,370
Total non-interest expense		14,468		12,276
INCOME BEFORE INCOME TAXES		5,150		6,940
INCOME TAX PROVISION		606		1,776
NET INCOME	$	4,544	$	5,164
Net income per common share-basic	$	0.85	$	1.05
Net income per common share-diluted	$	0.84	$	1.04
Weighted average number of common shares outstanding		5,376,851		4,918,740
Weighted average number of diluted shares outstanding		5,395,806		4,976,639

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, 2020 AND 2019
(in thousands, except share and per share amounts)
	Nine Months Ended September 30,
	2020		2019
INTEREST INCOME
Loans	$	47,497	$	45,149
Interest-bearing deposits at banks		223		564
Securities:
Taxable		2,758		2,736
Non-taxable		180		263
Total interest income		50,658		48,712
INTEREST EXPENSE
Deposits		6,471		8,883
Other borrowings		232		135
Junior subordinated debentures		604		431
Total interest expense		7,307		9,449
NET INTEREST INCOME		43,351		39,263
PROVISION FOR LOAN LOSSES		5,477		197
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		37,874		39,066
NON-INTEREST INCOME
Deposit service charges		1,623		1,822
Insurance service and fees		8,309		8,568
Gain on sale of securities		667		42
Gain on loans sold		359		105
Bank-owned life insurance		508		492
Loss on tax credit investment		(2,475)		-
Refundable state historic tax credit		1,857		-
Interchange fee income		1,270		1,299
Other		1,316		1,761
Total non-interest income		13,434		14,089
NON-INTEREST EXPENSE
Salaries and employee benefits		23,903		22,273
Occupancy		3,127		2,561
Advertising and public relations		895		612
Professional services		2,651		2,683
Technology and communications		3,928		3,049
Amortization of intangibles		400		336
FDIC insurance		751		357
Merger-related		5,958		-
Other		3,737		3,778
Total non-interest expense		45,350		35,649
INCOME BEFORE INCOME TAXES		5,958		17,506
INCOME TAX PROVISION		741		4,240
NET INCOME	$	5,217	$	13,266
Net income per common share-basic	$	1.01	$	2.71
Net income per common share-diluted	$	1.00	$	2.68
Weighted average number of common shares outstanding		5,179,386		4,889,029
Weighted average number of diluted shares outstanding		5,214,950		4,957,689

See Notes to Unaudited Consolidated Financial Statements

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EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019
(in thousands)
	Three Months Ended September 30,
		2020		2019

NET INCOME		$	4,544	$	5,164

OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX:
Unrealized gain (loss) on available-for-sale securities:
Unrealized (loss) gain on available-for-sale securities			(339)		523
Reclassification of gain on sale of securities			(494)		-
Total			(833)		523
Defined benefit pension plans:
Amortization of prior service cost			6		6
Amortization of actuarial loss			84		62
Total			90		68
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX			(743)		591
COMPREHENSIVE INCOME		$	3,801	$	5,755

See Notes to Unaudited Consolidated Financial Statements



EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019
(in thousands)
	Nine Month Ended September 30,
	2020		2019

NET INCOME	$	5,217	$	13,266

OTHER COMPREHENSIVE INCOME, NET OF TAX:
Unrealized gain on available-for-sale securities:
Unrealized gain on available-for-sale securities		2,684		3,328
Reclassification of gain on sale of securities		(494)		(31)
Total		2,190		3,297
Defined benefit pension plans:
Amortization of prior service cost		17		17
Amortization of actuarial loss		250		185
Total		267		202
OTHER COMPREHENSIVE INCOME, NET OF TAX		2,457		3,499
COMPREHENSIVE INCOME	$	7,674	$	16,765

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, 2020 AND 2019
(in thousands, except share and per share amounts)
							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
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
Balance, September 30, 2019	$	2,462	$	62,736	$	81,525	$	(1,854)	$	144,869

Balance, June 30, 2020	$	2,691	$	75,617	$	83,073	$	617	$	161,998
Net Income						4,544				4,544
Other comprehensive income								(743)		(743)
Cash dividends ($0.58 per common share)						(3,118)				(3,118)
Stock compensation expense				207						207
Balance, September 30, 2020	$	2,691	$	75,824	$	84,499	$	(126)	$	162,888

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, 2020 AND 2019
(in thousands, except share and per share amounts)
							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
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 22,120 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 29,058 shares in stock option exercises		16		499						515
Balance, September 30, 2019	$	2,462	$	62,736	$	81,525	$	(1,854)	$	144,869

Balance, December 31, 2019	$	2,467	$	63,302	$	85,267	$	(2,583)	$	148,453
Net Income						5,217				5,217
Other comprehensive income								2,457		2,457
Cash dividends ($1.16 per common share)						(5,985)				(5,985)
Stock compensation expense				668						668
Reissued 310 restricted shares										-
Issued 5,988 restricted shares, net of forfeitures		3		(3)						-
Issued 10,669 shares in Employee Stock Purchase Plan		5		206						211
Issued 8,017 shares in stock option exercises		4		130						134
Issued 422,475 shares in stock consideration		212		11,521						11,733
Balance, September 30, 2020	$	2,691	$	75,824	$	84,499	$	(126)	$	162,888

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, 2020 AND 2019
(in thousands)
	Nine Months Ended September 30,
		2020		2019
OPERATING ACTIVITIES:
Interest received	$	47,190	$	48,957
Fees received		12,462		13,404
Interest paid		(7,447)		(9,226)
Cash paid to employees and vendors		(41,580)		(36,888)
Income taxes paid		(1,957)		(1,586)
Proceeds from sale of loans held for sale		9,895		7,698
Originations of loans held for sale		(9,184)		(7,733)

Net cash provided by operating activities		9,379		14,626

INVESTING ACTIVITIES:
Available for sales securities:
Purchases		(76,311)		(46,893)
Proceeds from sales, maturities, calls, and payments		73,291		48,694
Held to maturity securities:
Purchases		(5,082)		(1,141)
Proceeds from maturities, calls, and payments		2,471		307
Cash paid for bank-owned life insurance		-		(360)
Additions to properties and equipment		(3,874)		(4,513)
Proceeds from sales of assets		-		185
Purchase of tax credit investment		(3,116)		-
Net cash used in acquisitions		(6,490)		-
Sale of other real estate		718		-
Net increase in loans		(204,679)		(62,823)

Net cash used in investing activities		(223,072)		(66,544)

FINANCING ACTIVITIES:
Proceeds from borrowings		20,274		4,275
Repayment of short-term borrowings		(13,646)		-
Net increase in deposits		274,365		43,748
Dividends paid		(2,867)		(2,528)
Issuance of common stock		345		852

Net cash provided by financing activities		278,471		46,347

Net increase in cash and cash equivalents		64,778		(5,571)

CASH AND CASH EQUIVALENTS:
Beginning of period		38,857		39,915
End of period	$	103,635	$	34,344

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, 2020 AND 2019
(in thousands)
	Nine Months Ended September 30,
		2020		2019

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

Net income	$	5,217	$	13,266

Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		2,107		1,505
Deferred tax benefit		(2,720)		(201)
Provision for loan losses		5,477		197
Loss on tax credit investment		2,475		-
Changes in refundable state historic tax credit		(1,857)		-
Net gain on sales of assets		(90)		(3)
Gain on sales of securities		(667)		(42)
Gain on loans sold		(359)		(105)
Stock compensation expense		668		692
Proceeds from sale of loans held for sale		9,895		7,698
Originations of loans held for sale		(9,184)		(7,733)
Changes in assets and liabilities affecting cash flow:
Other assets		(4,647)		(5,508)
Other liabilities		3,064		4,860

NET CASH PROVIDED BY OPERATING ACTIVITIES	$	9,379	$	14,626

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, 2020 AND 2019

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 Financial Accounting Standards Board (“FASB”) establishes changes to 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 adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.

The results of operations for the nine month period ended September 30, 2020 are not necessarily indicative of the results to be expected for the full year.

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus ("COVID-19") a global pandemic, and recommended containment and mitigation measures worldwide. Federal and state governments have taken unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which is causing a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and is prompting the need for additional aid and other forms of relief. Management is currently unable to determine the extent of the potential impacts to the Company’s financial condition or results of operations.

The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020. In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company has worked with customers directly affected by COVID-19 and offered short-term assistance in accordance with regulatory guidelines. Commercial borrowers needing assistance have been offered a 90-day principal and interest deferral. Commercial borrowers that originally requested a 90-day deferral can request an additional 90-day deferral by providing their financial information, including current year interim financial information and projections to show a need for the additional 90-day deferral. Consumers needing assistance have been offered a 90-day principal and interest deferral with an option to request an additional 90-day deferral. As of October 20, 2020, total deferrals amounted to $8 million compared with $407 million at June 30, 2020. While interest and fees will still accrue to income, should credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. The Company recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods. We continue to actively monitor developments related to COVID-19 and its impact to our business, customers, employees, counterparties, vendors, and service providers. During the third quarter of 2020, the Company identified a well-defined weakness in the hotel industry resulting in downgrades of the credit risk ratings for a majority of the loans to clients within that industry. As of September 30, 2020, the Company’s hotel loan portfolio was $81 million, or approximately 6.5%, of total commercial loans. During the first nine months of 2020, the most notable financial impacts to our results of operations was a higher provision for loan losses primarily reflecting the substantial increase in economic uncertainty and the resultant potential for increased credit losses in future periods as a consequence of the COVID-19 pandemic.

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, 2019 (“10-K”). There have been no significant changes to the Company’s significant accounting policies as disclosed in Note 1 to the 10-K, as supplemented by the disclosure in footnote 1 to the Consolidated Financial Statements in Part I of the Quarterly Report on Form 10-Q for the quarter ended June 30, 2020.

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2. ACQUISITIONS

On May 1, 2020, the Company completed the acquisition of FSB Bancorp, Inc., a Maryland corporation and the parent holding company of Fairport Savings Bank (“FSB”). On that date, FSB was merged into Evans Bank, a wholly owned banking subsidiary of the Company. At the time of closing, FSB had $321.7 million in total assets, including $272.1 million in net loans receivable and $21.4 million in securities, and $293.1 million in total liabilities, including $237.7 million in deposits and $50.6 million in borrowings. FSB operated 5 banking offices in New York at the date of acquisition. After application of the election, allocation and proration procedures contained in the merger agreement, the Company paid $17.1 million in cash and issued 422,475 shares of Evans Bancorp, Inc. common stock in exchange for all of the shares of common stock of FSB Bancorp, Inc. outstanding at the time of the acquisition. The $11.7 million fair value of the shares issued as part of the consideration paid for FSB was determined on the basis of the closing market price of the Company’s shares on April 30, 2020.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible were recorded at their fair values as of May 1, 2020 based on management’s best estimate using the information available as of the merger date. The application of the acquisition method of accounting resulted in the recognition of goodwill of $1.8 million and a core deposit intangible of $0.2 million. Accounting guidance provides that an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period, which runs through May 1, 2021, in the measurement period in which the adjustment amounts are determined. The acquirer must record in the financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the changes to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The Company will prepare tax returns related to the operation of the combined entities and the acquired entity and believes certain adjustments to income tax balances and goodwill may result upon completion of these returns.

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The Company recorded the assets acquired and liabilities assumed through the merger at fair value as summarized in the following table:


	As Recorded	Fair Value		As Recorded
	by FSB	Adjustments		at Acquisition
		(in thousands)
Cash and due from banks	$ 1,978	$ -		$ 1,978
Interest-bearing deposit at banks	9,339	-		9,339
Securities	21,371	106	(a)	21,477
FHLB Stock	2,614	-		2,614
Loans receivable	273,869	(2,484)	(b)	271,385
Allowance for loan losses	(1,706)	1,706	(c)	-
Premises and equipment	2,303	(56)	(d)	2,247
Intangible assets	-	166	(e)	166
Bank owned life insurance	3,891	-		3,891
Operating lease right-of-use asset	2,020	374	(f)	2,394
Other assets	6,033	1,640	(g)	7,673
Total assets acquired	$ 321,712	$ 1,452		$ 323,164

Deposits	237,688	1,485	(h)	239,173
Other borrowed funds	50,597	1,929	(i)	52,526
Operating lease liability	2,217	176	(j)	2,393
Other liabilities	2,557	(573)	(k)	1,984
Total liabilities assumed	$ 293,059	$ 3,017		$ 296,076

Net assets acquired				27,088
Purchase price				28,856
Goodwill recorded in merger				$ 1,768

Explanation of certain fair value related adjustments:

(a)Represents the fair value adjustments on investment securities.

(b)Represents the fair value adjustments on the net book value of loans, which includes an interest rate mark and credit mark adjustment and the write-off of deferred fees/costs and premiums.

(c)Represents the elimination of FSB’s allowance for loan losses.

(d)Represents the fair value adjustments to reflect the fair value of land and buildings and premises and equipment, which will be amortized on a straight-line basis over the estimated useful lives of the individual assets.

(e)Represents the intangible assets recorded to reflect the fair value of core deposits. The core deposit asset was recorded as an identifiable intangible asset and will be amortized on an accelerated basis over the estimated average life of the deposit base.

(f)Represents the fair value adjustments on operating lease right of use assets.

(g)Represents an adjustment to other assets acquired. The largest adjustment was to net deferred tax assets resulting from the fair value adjustments related to the acquired assets, liabilities assumed and identifiable intangible assets recorded.

(h)Represents fair value adjustments on time deposits, which will be treated as a reduction of interest expense over the remaining term of the time deposits.

(i)Represents the fair value adjustments on FHLB borrowings, which will be treated as a decrease to interest expense over the life of the borrowings.

(j)Represents the fair value adjustments on operating lease liabilities.

(k)Represents an adjustment to other liabilities assumed.

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The fair value of loans acquired from FSB were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. There was no carryover of FSB’s allowance for loan losses associated with the loans that were acquired, as the loans were initially recorded at fair value on the date of the FSB merger.

The core deposit intangible asset recognized is being amortized over its estimated useful life of approximately 10 years and the amortization is based on dollar weighted deposit runoff on an annualized basis.

Goodwill is not amortized for book purposes; however, it is reviewed at least annually for impairment and is not deductible for tax purposes.

The fair value of land and buildings was estimated using appraisals. Acquired equipment was not material. Buildings are amortized over their estimated useful lives of approximately 39 years. Improvements and equipment are amortized or depreciated over their estimated useful lives ranging up to 10 years.

The fair value of retail demand and interest bearing deposit accounts was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities.

Other borrowed funds include borrowings from the Federal Home Loan Bank (“FHLB”). The fair value of these borrowings was estimated by discounting the contractual future cash flows using FHLB rates offered of similar maturities.

Direct acquisition and other charges incurred in connection with the FSB merger were expensed as incurred and totaled $6.0 million for the nine months ended September 30, 2020. These expenses were recorded in merger-related expense on the consolidated statements of income.

The following table presents selected unaudited pro forma financial information reflecting the FSB merger assuming it was completed as of January 1, 2019. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the financial results of the combined companies had the FSB merger actually been completed at the beginning of the periods presented, nor does it indicate future results for any other interim or full year period. The unaudited pro forma information is based on the actual financial statements of the Company for the periods presented, and on the actual financial statements of FSB for the three and nine months ended September 30, 2020 and 2019 until the date of the FSB merger, at which time FSB’s results of operations were included in the Company’s financial statements.


		Three months ended September 30,				Nine months ended September 30,
		2020		2019		2020		2019
				(in thousands)
Net Interest Income	$	13,250	$	15,779	$	40,014	$	46,185
Non-Interest Income		5,857		5,718		14,023		15,441
Non-Interest Expense		13,944		14,764		42,905		43,026
Net Income		4,554		5,355		9,046		14,416

The unaudited supplemental pro forma information for the three and nine months ended September 30, 2020 and 2019 set forth above reflects adjustments related to (a) purchase accounting fair value adjustments; (b) amortization of core deposit; and (c) adjustments to interest income and expense due to amortization of premiums and accretion of discounts. Direct merger-related expenses incurred in the three and nine months periods ended September 30, 2020 are assumed to have occurred prior to January 1, 2019. Furthermore, the unaudited supplemental pro forma information does not reflect management’s estimate of any revenue enhancement opportunities or anticipated potential cost savings for periods that include data as of May 1, 2020 or earlier.

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3. SECURITIES

The amortized cost of securities and their approximate fair value at September 30, 2020 and December 31, 2019 were as follows:



	September 30, 2020
	(in thousands)

	Amortized		Unrealized				Fair
	Cost		Gains		Losses		Value

Available for Sale:
Debt securities:
U.S. government agencies	$	61,631	$	776	$	(128)	$	62,279
States and political subdivisions		7,375		175		(5)		7,545
Total debt securities		69,006		951		(133)		69,824

Mortgage-backed securities:
FNMA		24,305		750		(18)		25,037
FHLMC		4,066		120		-		4,186
GNMA		2,305		46		(1)		2,350
SBA		21,259		977		(34)		22,202
CMO		31,159		1,003		-		32,162
Total mortgage-backed securities		83,094		2,896		(53)		85,937

Total securities designated as available for sale	$	152,100	$	3,847	$	(186)	$	155,761

Held to Maturity:
Debt securities
States and political subdivisions	$	4,996	$	88	$	-	$	5,084
z
Total securities designated as held to maturity	$	4,996	$	88	$	-	$	5,084



	December 31, 2019
	(in thousands)

	Amortized		Unrealized				Fair
	Cost		Gains		Losses		Value

Available for Sale:
Debt securities:
U.S. government agencies	$	27,951	$	225	$	(21)	$	28,155
States and political subdivisions		3,289		69		(7)		3,351
Total debt securities		31,240		294		(28)		31,506

Mortgage-backed securities:
FNMA		34,395		330		(53)		34,672
FHLMC		15,390		137		(13)		15,514
GNMA		3,421		16		(24)		3,413
SBA		13,752		90		(70)		13,772
CMO		29,019		190		(164)		29,045
Total mortgage-backed securities		95,977		763		(324)		96,416

Total securities designated as available for sale	$	127,217	$	1,057	$	(352)	$	127,922

Held to Maturity:
Debt securities
States and political subdivisions	$	2,386	$	24	$	(18)	$	2,392

Total securities designated as held to maturity	$	2,386	$	24	$	(18)	$	2,392

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Available for sale securities with a total fair value of $128 million and $102 million at September 30, 2020 and December 31, 2019, 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, 2020 and December 31, 2019 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, 2020				December 31, 2019
	Amortized		Estimated		Amortized		Estimated
	cost		fair value		cost		fair value
			(in thousands)

Debt securities available for sale:

Due in one year or less	$	3,790	$	3,802	$	6,005	$	6,014
Due after one year through five years		7,768		7,971		6,481		6,626
Due after five years through ten years		23,959		24,658		18,754		18,866
Due after ten years		33,489		33,393		-		-
		69,006		69,824		31,240		31,506

Mortgage-backed securities
available for sale		83,094		85,937		95,977		96,416

Total	$	152,100	$	155,761	$	127,217	$	127,922

Debt securities held to maturity:

Due in one year or less	$	3,944	$	3,949	$	1,139	$	1,140
Due after one year through five years		564		597		712		732
Due after five years through ten years		45		48		54		54
Due after ten years		443		490		481		466
Total	$	4,996	$	5,084	$	2,386	$	2,392

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.

During the three months ended September 30, 2020, the Company received $23.3 million from the sale of investment securities. Gross realized gains from sales of investment securities for the three month and nine month periods ended September 30, 2020 were $0.7 million. There were no significant gross realized gains or losses from sales of investment securities for the three month and nine month periods ended September 30, 2019. Information regarding unrealized losses within the Company’s available for sale securities at September 30, 2020 and December 31, 2019 is summarized below. The securities are primarily U.S. government-guaranteed agency securities or municipal securities.

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	September 30, 2020

		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	$	27,432	$	(128)	$	-	$	-	$	27,432	$	(128)
States and political subdivisions		-		-		181		(5)		181		(5)
Total debt securities		27,432		(128)		181		(5)		27,613		(133)

Mortgage-backed securities:
FNMA		238		(1)		1,396		(17)		1,634		(18)
FHLMC		90		-		-		-		90		-
GNMA		156		(1)		-		-		156		(1)
SBA		-		-		1,406		(34)		1,406		(34)
CMO		-		-		-		-		-		-
Total mortgage-backed securities		484		(2)		2,802		(51)		3,286		(53)

Held to Maturity:
Debt securities:
States and political subdivisions		-		-		-		-		-		-

Total temporarily impaired
securities	$	27,916	$	(130)	$	2,983	$	(56)	$	30,899	$	(186)


	December 31, 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	$	1,976	$	(18)	$	3,997	$	(3)	$	5,973	$	(21)
States and political subdivisions		-		-		181		(7)		181		(7)
Total debt securities		1,976		(18)		4,178		(10)		6,154		(28)

Mortgage-backed securities:
FNMA		5,355		(38)		3,630		(15)		8,985		(53)
FHLMC		-		-		1,242		(13)		1,242		(13)
GNMA		2,091		(22)		770		(2)		2,861		(24)
SBA		5,171		(70)		-		-		5,171		(70)
CMO		5,706		(36)		8,911		(128)		14,617		(164)
Total mortgage-backed securities		18,323		(166)		14,553		(158)		32,876		(324)

Held to Maturity:
Debt securities:
States and political subdivisions		227		(1)		2,165		(17)		2,392		(18)

Total temporarily impaired
securities	$	20,526	$	(185)	$	20,896	$	(185)	$	41,422	$	(370)

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Management has assessed the securities available for sale in an unrealized loss position at September 30, 2020 and December 31, 2019 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 during the nine months ended September 30, 2020 and did not record any OTTI charges during 2019. 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.

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, 2020		December 31, 2019
Mortgage loans on real estate:	(in thousands)
Residential mortgages	$	364,598	$	158,572
Commercial and multi-family		702,624		645,036
Construction-Residential		6,761		1,067
Construction-Commercial		102,011		97,848
Home equities		84,863		69,351
Total real estate loans		1,260,857		971,874

Commercial and industrial loans		448,092		251,197
Consumer and other loans		412		1,926
Unaccreted yield adjustments*		(6,285)		1,534
Total gross loans		1,703,076		1,226,531

Allowance for loan losses		(20,601)		(15,175)

Loans, net	$	1,682,475	$	1,211,356

* Includes net premiums and discounts on acquired loans and net deferred fees and costs on loans originated, including $5.8 million of PPP fees at September 30, 2020.

The CARES Act established a loan program administered through the U.S. Small Business Administration (SBA), referred to as the paycheck protection program (“PPP”). PPP loans are 100% guaranteed by the SBA and are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Through September 30, 2020, the Company had originated 1,931 PPP loans totaling $203 million, included in commercial and industrial loans. PPP loans did not impact the Company’s allowance for loan loss as a result of the SBA guarantees. Fees collected from the SBA for these loans in the nine month period ended September 30, 2020 totaled $7.4 million. These fees are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness or sale of a PPP loan, unamortized fees are then recognized into interest income. As of September 30, 2020, no PPP loans had received SBA forgiveness.

In connection with the FSB acquisition, the Company acquired $271 million in total loans, primarily residential real estate. At September 30, 2020, the outstanding principal balance and carrying amount of acquired credit-impaired loans totaled $0.9 million and $0.8 million, respectively. The Company is not recording interest on the acquired credit-impaired loans due to the uncertainty of the cash flows relating to such loans. There were no valuation allowances for specifically identified impairment attributable to acquired credit-impaired loans at September 30, 2020. The Company did not have any acquired credit-impaired loans as of December 31, 2019.

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Also in connection with the FSB acquisition, the Company acquired a loan serving portfolio of $107 million in principal balances in which residential real estate loans were sold to FHLMC and the servicing rights are retained by the Company. No loans were sold to FHLMC by the Company during the three and nine month periods ending September 30, 2020 and 2019.

The Company also sells certain fixed rate residential mortgages to FNMA while maintaining the servicing rights for those mortgages. In the three and nine month periods ended September 30, 2020, the Company sold mortgages to FNMA totaling $7.2 million and $15.0 million, respectively. In the three and nine month periods ended September 30, 2019, the Company sold mortgages to FNMA totaling $3.0 million and $7.6 million, respectively.

At September 30, 2020 and December 31, 2019, the Company had loan servicing portfolio principal balances of $185 million and $76 million, respectively, upon which it earned servicing fees. The fair value of the mortgage servicing rights for that portfolio was $1.0 million and $0.6 million at September 30, 2020 and December 31, 2019, respectively. At September 30, 2020 there were no residential mortgages held for sale. At December 31, 2019 there were $0.7 million in residential mortgages held for sale.

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, 2019. 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, 2019. The accounting policy for loans acquired in a business combination is included in Note 1 of the Quarterly Report on Form 10-Q for the quarter ended June 30, 2020. There have been no significant changes to the Company’s significant accounting policies as disclosed in Note 1 to the 10-K, as supplemented in the Quarterly Report on Form 10-Q for the quarter ended June 30, 2020.

Credit Quality Indicators

The Company monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for the commercial mortgage and commercial and industrial 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

“Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” assets.

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.

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The Company continues to evaluate its loan portfolio in response to the economic impact of the COVID-19 pandemic on its clients. The increase in the watch category during the nine months ended September 30, 2020 was a result of the Company reclassifying all commercial loans that received a deferral into the watch or criticized categories. The Company will reassess the watch classification after the deferral’s termination dates and evidence of continuation of payments as contracted. During the third quarter of 2020, the Company identified a well-defined weakness in the hotel industry and classified the loans to clients within that industry as substandard. As of September 30, 2020, the Company’s hotel loan portfolio was $81 million, or approximately 6.5%, of total commercial loans. As a result, total criticized assets increased to $133 million at September 30, 2020 compared with $51 million at the end of the 2019.

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



September 30, 2020
(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	$	52,162	$	314,997	$	367,159	$	339,810
Watch		21,322		303,965		325,287		87,414
Special Mention		2,088		13,985		16,073		5,855
Substandard		26,439		69,677		96,116		15,013
Doubtful/Loss		-		-		-		-
Total	$	102,011	$	702,624	$	804,635	$	448,092


December 31, 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	$	73,646	$	451,297	$	524,943	$	165,255
Watch		13,380		171,277		184,657		68,665
Special Mention		8,359		15,725		24,084		7,631
Substandard		2,463		6,737		9,200		9,646
Doubtful/Loss		-		-		-		-
Total	$	97,848	$	645,036	$	742,884	$	251,197

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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, 2020
(in thousands)

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

Commercial and industrial	$	440,340	$	575	$	227	$	-	$	6,950	$	448,092
Residential real estate:
Residential		360,418		58		1,266		-		2,856		364,598
Construction		6,038		-		723		-		-		6,761
Commercial real estate:
Commercial		687,280		-		6,053		594		8,697		702,624
Construction		100,555		-		150		-		1,306		102,011
Home equities		82,864		929		11		-		1,059		84,863
Consumer and other		398		3		7		4		-		412
Total Loans	$	1,677,893	$	1,565	$	8,437	$	598	$	20,868	$	1,709,361

Note: Loan balances do not include $(6.3) million of unaccreted yield adjustments as of September 30, 2020.



December 31, 2019
(in thousands)

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

Commercial and industrial	$	245,658	$	705	$	-	$	-	$	4,834	$	251,197
Residential real estate:
Residential		153,630		2,616		888		-		1,438		158,572
Construction		865		-		202		-		-		1,067
Commercial real estate:
Commercial		630,016		3,482		5,879		-		5,659		645,036
Construction		92,667		2,886		720		-		1,575		97,848
Home equities		67,868		354		239		-		890		69,351
Consumer and other		1,907		15		4		-		-		1,926
Total Loans	$	1,192,611	$	10,058	$	7,932	$	-	$	14,396	$	1,224,997

Note: Loan balances do not include $1.5 million of unamortized yield adjustments as of December 31, 2019.

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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 three month periods ended September 30, 2020 and 2019.



September 30, 2020
	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan			(in thousands)
losses:
Beginning balance	$	5,260	$	11,625	$	233	$	1,147		489	$	18,754
Charge-offs		(124)		(5)		(14)		-		-		(143)
Recoveries		105		-		4		-		-		109
Provision (Credit)		(23)		1,843		(187)		218		30		1,881
Ending balance	$	5,218	$	13,463	$	36	$	1,365	$	519	$	20,601



September 30, 2019
	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan			(in thousands)
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

* Includes construction loans

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The following tables present the activity in the allowance for loan losses according to portfolio segment for the nine month periods ended September 30, 2020 and 2019:




Nine months ended September 30, 2020
				(in thousands)
	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Beginning balance	$	4,547	$	9,005	$	155	$	1,071	$	397	$	15,175
Charge-offs		(143)		(5)		(44)		(29)		(4)		(225)
Recoveries		141		11		22		-		-		174
Provision (Credit)		673		4,452		(97)		323		126		5,477
Ending balance	$	5,218	$	13,463	$	36	$	1,365	$	519	$	20,601

* Includes construction loans

Note: Loan balances do not include $(6.3) million of unaccreted yield adjustments as of September 30, 2020.



Nine months ended 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

* Includes construction loans

Note: Loan balances do not include $1.6 million of unamortized yield adjustments as of September 30, 2019.

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The following table presents the allocation of the allowance for loan losses according to portfolio segment summarized on the basis of the Company’s impairment methodology as of September 30, 2020 and December 31, 2020:



September 30, 2020
(in thousands)
	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Ending balance:
Loans acquired with deteriorated credit quality	$	-	$	-	$	-	$	-	$	-	$	-

Individually evaluated for impairment		1,103		154		-		-		-		1,257

Collectively evaluated for impairment		4,115		13,309		36		1,365		519		19,344
Total	$	5,218	$	13,463	$	36	$	1,365	$	519	$	20,601

Loans:
Ending balance:
Loans acquired with deteriorated credit quality	$	-	$	-	$	-	$	870	$	-	$	870

Individually evaluated for impairment		7,160		10,502		-		3,138		1,492		22,292

Collectively evaluated for impairment		440,932		794,133		412		367,351		83,371		1,686,199
Total	$	448,092	$	804,635	$	412	$	371,359	$	84,863	$	1,709,361

* Includes construction loans

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December 31, 2019
(in thousands)
	Commercial and Industrial		Commercial Real Estate Mortgages*		Consumer and Other		Residential Mortgages*		Home Equities		Total
Allowance for loan
losses:
Ending balance:
Individually evaluated for impairment	$	442	$	9	$	21	$	5	$	-	$	477

Collectively evaluated for impairment		4,105		8,996		134		1,066		397		14,698
Total	$	4,547	$	9,005	$	155	$	1,071	$	397	$	15,175

Loans:
Ending balance:
Individually evaluated for impairment	$	6,558	$	7,791	$	21	$	2,804	$	1,453	$	18,627

Collectively evaluated for impairment		244,639		735,093		1,905		156,835		67,898		1,206,370
Total	$	251,197	$	742,884	$	1,926	$	159,639	$	69,351	$	1,224,997

* Includes construction loans

Impaired Loans

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



			At September 30, 2020
		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	$	2,358		$	2,580	$	-	$	2,624	$	79	$	29
Residential real estate:
Residential		3,954			4,314		-		4,018		76		49
Construction		-			-		-		-		-		-
Commercial real estate:
Commercial		5,824			6,398		-		6,056		180		36
Construction		1,306			1,352		-		1,326		26		-
Home equities		1,492			1,714		-		1,565		41		16
Consumer and other		-			-		-		-		-		-
Total impaired loans	$	14,934		$	16,358	$	-	$	15,589	$	402	$	130

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		At September 30, 2020
		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	$	4,802	$	4,942	$	1,103	$	4,941	$	189	$	15
Residential real estate:
Residential		-		-		-		-		-		-
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		3,372		3,396		154		3,378		101		10
Construction		-		-		-		-		-		-
Home equities		-		-		-		-		-		-
Consumer and other		-		-		-		-		-		-
Total impaired loans	$	8,174	$	8,338	$	1,257	$	8,319	$	290	$	25


		At September 30, 2020
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
Total:		(in thousands)
Commercial and industrial	$	7,160	$	7,522	$	1,103	$	7,565	$	268	$	44
Residential real estate:
Residential		3,954		4,314		-		4,018		76		49
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		9,196		9,794		154		9,434		281		46
Construction		1,306		1,352		-		1,326		26		-
Home equities		1,492		1,714		-		1,565		41		16
Consumer and other		-		-		-		-		-		-
Total impaired loans	$	23,108	$	24,696	$	1,257	$	23,908	$	692	$	155

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		At December 31, 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	$	3,798	$	4,112	$	-	$	4,046	$	118	$	143
Residential real estate:
Residential		2,744		3,003		-		2,823		73		63
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		6,019		6,521		-		6,293		225		72
Construction		1,335		1,352		-		1,344		23		50
Home equities		1,453		1,687		-		1,525		64		30
Consumer and other		-		-		-		-		-		-
Total impaired loans	$	15,349	$	16,675	$	-	$	16,031	$	503	$	358


		At December 31, 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	$	2,760	$	2,808	$	442	$	2,764	$	109	$	63
Residential real estate:
Residential		60		62		5		61		3		1
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		197		197		4		197		8		4
Construction		240		246		5		242		8		9
Home equities		-		-		-		-		-		-
Consumer and other		21		23		21		22		-		1
Total impaired loans	$	3,278	$	3,336	$	477	$	3,286	$	128	$	78


		At December 31, 2019
		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Foregone		Interest Income Recognized
Total:		(in thousands)
Commercial and industrial	$	6,558	$	6,920	$	442	$	6,810	$	227	$	206
Residential real estate:
Residential		2,804		3,065		5		2,884		76		64
Construction		-		-		-		-		-		-
Commercial real estate:
Commercial		6,216		6,718		4		6,490		233		76
Construction		1,575		1,598		5		1,586		31		59
Home equities		1,453		1,687		-		1,525		64		30
Consumer and other		21		23		21		22		-		1
Total impaired loans	$	18,627	$	20,011	$	477	$	19,317	$	631	$	436

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Troubled debt restructurings

The following tables summarize the loans that were classified as troubled debt restructurings (“TDRs”) as of the dates indicated:



		September 30, 2020
		(in thousands)
		Total		Nonaccruing		Accruing		Related Allowance
Commercial and industrial	$	1,828	$	1,618	$	210	$	360
Residential real estate:
Residential		1,741		589		1,152		-
Construction		-		-		-		-
Commercial real estate:
Commercial and multi-family		3,463		2,965		498		-
Construction		-		-		-		-
Home equities		562		129		433		-
Consumer and other		-		-		-		-
Total TDR loans	$	7,594	$	5,301	$	2,293	$	360



		December 31, 2019
		(in thousands)
		Total		Nonaccruing		Accruing		Related Allowance
Commercial and industrial	$	2,052	$	328	$	1,724	$	26
Residential real estate:
Residential		1,815		449		1,366		-
Construction		-		-		-		-
Commercial real estate:
Commercial and multi-family		3,632		3,075		557		-
Construction		-		-		-		-
Home equities		738		175		563		-
Consumer and other		21		-		21		21
Total TDR loans	$	8,258	$	4,027	$	4,231	$	47

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.

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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In late March 2020, federal banking regulators issued guidance that modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders do not need to be identified as a TDR if the loan was current at the time a modification plan was implemented. The CARES Act also addressed COVID-19 related modifications and specified that such modifications made on loans that were current as of December 31, 2019 are not TDRs. As of September 30, 2020, the Company had applied this guidance and had made 381 modifications of commercial loans with principal balances totaling $368 million, and 298 modifications of consumer loans with principal balances totaling $37 million.

The following tables present TDR activity by the type of concession granted to the borrower for the three and nine month periods ended September 30, 2020 and 2019:


	Three months ended September 30, 2020					Three months ended September 30, 2019
	(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
Term-out line of credit	-		-		-	1		42		42
Residential Real Estate & Construction:
Extension of maturity and
interest rate reduction	1		97		97	3		307		307
Commercial Real Estate & Construction	-		-		-	-		-		-
Home Equities:
Extension of maturity and
interest rate reduction	-		-		-	1		110		110
Consumer and other loans	-		-		-	-		-		-
Other	-		-		-	-		-		-

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	Nine months ended September 30, 2020					Nine months ended September 30, 2019
	(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
Term-out line of credit	-		-		-	1		42		42
Residential Real Estate & Construction:
Combination of concessions	1		56		56	-		-		-
Extension of maturity and
interest rate reduction	1		97		97	3		307		307
Commercial Real Estate & Construction	-		-		-	-		-		-
Home Equities:
Extension of maturity and
interest rate reduction	-		-		-	3		390		390
Consumer and other loans	-		-		-	-		-		-

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, 2020 and 2019 were not material.

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5. GOODWILL

The following table presents changes to goodwill and intangible assets for the three and nine month periods ended September 30, 2020 and 2019:


	Goodwill		Core Deposit Intangibles		Other Intangibles
				(in thousands)
Balance at June 30, 2020	$	12,715	$	162	$	2,345
Amortization		-		(7)		(130)
Balance at September 30, 2020	$	12,715	$	155	$	2,215

Balance at June 30, 2019	$	10,520	$	-	$	2,248
Amortization		-		-		(111)
Balance at September 30, 2019	$	10,520	$	-	$	2,137

	Goodwill		Core Deposit Intangibles		Other Intangibles
				(in thousands)
Balance at December 31, 2019	$	10,520	$	-	$	2,025
Acquisition of Benefit Brokers of WNY, LLC		427		-		580
Acquisition of FSB		1,768		166		-
Amortization		-		(11)		(390)
Balance at September 30, 2020	$	12,715	$	155	$	2,215

Balance at December 31, 2018	$	10,520	$	-	$	2,472
Amortization		-		-		(335)
Balance at September 30, 2019	$	10,520	$	-	$	2,137

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6. SubordinateD Debt

On July 9, 2020, the Company entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers and institutional accredited investors pursuant to which the Company issued and sold $20.0 million in aggregate principal amount of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030 (the “2020 Notes”). The 2020 Notes were offered and sold by the Company to eligible purchasers in a private offering. Net of debt issuance costs, the Company received $19.5 million for the sale of the 2020 Notes. The Company intends to use the proceeds from the offering for general corporate purposes, organic growth and regulatory capital.

The 2020 Notes mature on July 15, 2030 and bear interest at a fixed annual rate of 6.00%, payable semi-annually in arrears, to but excluding July 15, 2025. From and including July 15, 2025 to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum initially equal to the then-current three-month Secured Overnight Financing Rate provided by the Federal Reserve Bank of New York plus 590 basis points, payable quarterly in arrears. The Company is entitled to redeem the 2020 Notes, in whole or in part, at any time on or after July 15, 2025, and to redeem the 2020 Notes at any time in whole upon certain other events. Any redemption of the 2020 Notes will be subject to prior regulatory approval to the extent required.

In connection with the issuance and sale of the 2020 Notes, the Company entered into Registration Rights Agreements with the purchasers of the 2020 Notes, pursuant to which the Company has agreed to take certain actions to provide for the exchange of the 2020 Notes for subordinated notes that are registered under the Securities Act of 1933, as amended, with substantially the same terms as the 2020 Notes. In connection with the Registration Rights Agreements, the Company filed a Registration Statement on Form S-4 with the Securities and Exchange Commission on September 3, 2020 and commenced an exchange offer on October 7, 2020. The exchange offer is expected to expire on November 9, 2020.

On October 1, 2004, Evans Capital Trust I, a statutory business trust wholly-owned by the Company (the “Trust”), issued $11.0 million in aggregate principal amount of floating rate preferred capital securities due November 23, 2034 (the “Capital Securities”) and $0.3 million of common securities (the “Common Securities”). The Capital Securities represent preferred undivided interests in the assets of the Trust. Under the Federal Reserve Board’s current risk-based capital guidelines, the Capital Securities are includable in the Company’s Tier 1 (Core) capital. The Common Securities are wholly-owned by the Company and are the only class of the Trust’s securities possessing general voting powers.

7. 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, 2020, the Company had an average of 18,955 and 35,564 dilutive shares outstanding, respectively. The Company had an average of 57,899 and 68,660 dilutive shares outstanding for the three and nine month periods ended September 30, 2019.

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, 2020, there was an average of 150,783 and 81,770 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, 2019, there was an average of 82,642 and 85,579 potentially anti-dilutive shares outstanding.

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8. OTHER COMPREHENSIVE INCOME

The following tables summarize the changes in the components of accumulated other comprehensive income during the three and nine month periods ended September 30, 2020 and 2019:


	Balance at June 30, 2020		Net Change		Balance at September 30, 2020
	(in thousands)
Net unrealized gain (loss) on investment securities	$	3,545	$	(833)	$	2,712
Net defined benefit pension plan adjustments		(2,928)		90		(2,838)
Total	$	617	$	(743)	$	(126)

	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 December 31, 2019		Net Change		Balance at September 30, 2020
	(in thousands)
Net unrealized gain on investment securities	$	522	$	2,190	$	2,712
Net defined benefit pension plan adjustments		(3,105)		267		(2,838)
Total	$	(2,583)	$	2,457	$	(126)


	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)

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	Three months ended September 30, 2020						Three months ended September 30, 2019
	(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 (loss) gain on investment
securities:
Unrealized (loss) gain on investment
securities	$	(455)	$	116	$	(339)	$	705	$	(182)	$	523
Reclassification from accumulated other
comprehensive income for gain on sale of securities		(667)		173		(494)		-		-		-
Net change		(1,122)		289		(833)		705		(182)		523

Defined benefit pension plan
adjustments:
Amortization of prior service cost		7		(1)		6		7		(1)		6
Amortization of actuarial loss		113		(29)		84		82		(20)		62
Net change		120		(30)		90		89		(21)		68

Other comprehensive (loss) income	$	(1,002)	$	259	$	(743)	$	794	$	(203)	$	591



	Nine months ended September 30, 2020						Nine months ended September 30, 2019
	(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	$	3,623	$	(939)	$	2,684	$	4,493	$	(1,165)	$	3,328
Reclassification from accumulated other
comprehensive income for gain on sale of securities		(667)		173		(494)		(42)		11		(31)
Net change		2,956		(766)		2,190		4,451		(1,154)		3,297

Defined benefit pension plan
adjustments:
Amortization of prior service cost		23		(6)		17		23		(6)		17
Amortization of actuarial loss		339		(89)		250		248		(63)		185
Net change		362		(95)		267		271		(69)		202

Other comprehensive income	$	3,318	$	(861)	$	2,457	$	4,722	$	(1,223)	$	3,499

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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, 2020 and 2019:




		Three months ended September 30,

		(in thousands)
					Supplemental Executive
	Pension Benefits				Retirement Plan

	2020		2019		2020		2019

Service cost	$	-	$	-	$	38	$	37
Interest cost		50		55		38		51
Expected return on plan assets		(81)		(70)		-		-
Amortization of prior service cost		-		-		7		7
Amortization of the net loss		25		24		88		58
Net periodic (benefit) cost	$	(6)	$	9	$	171	$	153




		Nine months ended September 30,

		(in thousands)
					Supplemental Executive
	Pension Benefits				Retirement Plan

	2020		2019		2020		2019

Service cost	$	-	$	-	$	116	$	109
Interest cost		151		165		114		151
Expected return on plan assets		(244)		(208)		-		-
Amortization of prior service cost		-		-		23		23
Amortization of the net loss		76		72		263		176
Net periodic (benefit) cost	$	(17)	$	29	$	516	$	459

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.

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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 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.

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.

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A disaggregation of the total insurance service and other fees for the three and nine months ended September 30, 2020 and 2019 is provided in the tables below:



		Three months ended September 30,
		2020		2019
		(in thousands)
Commercial property and casualty insurance commissions	$	1,439	$	1,382
Personal property and casualty insurance commissions		890		863
Employee benefits sales commissions		245		287
Profit sharing and contingent revenue		375		430
Wealth management and other financial services		164		142
Insurance claims services revenue		84		96
Other insurance-related revenue		20		25
Total insurance service and other fees	$	3,217	$	3,225



		Nine months ended September 30,
		2020		2019
	(in thousands)
Commercial property and casualty insurance commissions	$	3,261	$	3,267
Personal property and casualty insurance commissions		2,611		2,618
Employee benefits sales commissions		993		869
Profit sharing and contingent revenue		733		939
Wealth management and other financial services		407		405
Insurance claims services revenue		201		397
Other insurance-related revenue		103		73
Total insurance service and other fees	$	8,309	$	8,568

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11. 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, 2020 and December 31, 2019, respectively:


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

September 30, 2020
Securities available-for-sale:
US government agencies	$	-	$	62,279	$	-	$	62,279
States and political subdivisions		-		7,545		-		7,545
Mortgage-backed securities		-		85,937		-		85,937
Mortgage servicing rights		-		-		1,007		1,007

December 31, 2019
Securities available-for-sale:
US government agencies	$	-	$	28,155	$	-	$	28,155
States and political subdivisions		-		3,351		-		3,351
Mortgage-backed securities		-		96,416		-		96,416
Mortgage servicing rights		-		-		555		555

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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.

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.

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. 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)	2020		2019
Mortgage servicing rights - July 1	$	1,031	$	570
Losses included in earnings		(89)		(71)
Additions from loan sales & acquisition		65		28
Mortgage servicing rights - September 30	$	1,007	$	527


	Nine months ended September 30,
(in thousands)	2020		2019
Mortgage servicing rights - January 1	$	555	$	609
Losses included in earnings		(289)		(154)
Additions from loan sales & acquisition		741		72
Mortgage servicing rights - September 30	$	1,007	$	527

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


	September 30, 2020		December 31, 2019
Servicing fees	0.25	%	0.25	%
Discount rate	9.04	%	9.00	%
Prepayment rate (CPR)	9.59	%	8.21	%

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 September 30, 2020 and December 31, 2019:



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

September 30, 2020
Collateral dependent impaired loans	$	-	$	-	$	21,153	$	21,153

December 31, 2019
Collateral dependent impaired loans	$	-	$	-	$	15,735	$	15,735

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.

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 recorded investment of $22.3 million, with an allowance for loan loss of $1.1 million, at September 30, 2020 compared with $16.0 million and $0.3 million, respectively, at December 31, 2019.

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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, 2020				December 31, 2019
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
		(in thousands)				(in thousands)
Financial assets:
Level 1:
Cash and cash equivalents	$	103,635	$	103,635	$	38,857	$	38,857
Level 2:
Available for sale securities		155,761		155,761		127,922		127,922
FHLB and FRB stock		5,914		N/A		3,544		N/A
Level 3:
Held to maturity securities		4,996		5,084		2,386		2,392
Loans, net		1,682,475		1,757,480		1,211,356		1,222,386
Mortgage servicing rights		1,007		1,007		555		555

Financial liabilities:
Level 1:
Demand deposits	$	442,536	$	442,536	$	263,717	$	263,717
NOW deposits		215,492		215,492		140,654		140,654
Savings deposits		799,739		799,739		587,142		587,142
Level 2:
Securities sold under agreement to
repurchase		4,414		4,414		2,425		2,425
Other borrowed funds		47,583		48,336		10,000		9,997
Junior subordinated debentures		30,912		30,912		11,330		11,330
Level 3:
Time deposits		323,211		325,266		275,927		277,051

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12. 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, 2020 and 2019.




	Three months ended September 30, 2020
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	15,644	$	(2)	$	15,642
Provision for loan losses		1,881		-		1,881
Net interest income (expense) after
provision for loan losses		13,763		(2)		13,761
Insurance service and fees		162		3,055		3,217
Other non-interest income		2,636		4		2,640
Amortization expense		6		130		136
Other non-interest expense		12,372		1,960		14,332
Income before income taxes		4,183		967		5,150
Income tax provision		354		252		606
Net income	$	3,829	$	715	$	4,544




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

Net interest income (expense)	$	13,652	$	(31)	$	13,621
Provision for loan losses		(431)		-		(431)
Net interest income (expense) after
provision for loan losses		14,083		(31)		14,052
Insurance service and fees		130		3,095		3,225
Other non-interest income		1,777		162		1,939
Amortization expense		-		112		112
Other 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

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	Nine months ended September 30, 2020
		Banking		Insurance Agency
		Activities		Activities		Total
		(in thousands)

Net interest income (expense)	$	43,359	$	(8)	$	43,351
Provision for loan losses		5,477		-		5,477
Net interest income (expense) after
provision for loan losses		37,882		(8)		37,874
Insurance service and fees		395		7,914		8,309
Other non-interest income		5,121		4		5,125
Amortization expense		11		389		400
Other non-interest expense		38,917		6,033		44,950
Income before income taxes		4,470		1,488		5,958
Income tax provision		354		387		741
Net income	$	4,116	$	1,101	$	5,217




	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
Insurance service and fees		377		8,191		8,568
Other non-interest income		5,359		162		5,521
Amortization expense		-		336		336
Other 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

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13. 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,
	2020		2019
	(in thousands)

Commitments to extend credit	$	357,561	$	331,974
Standby letters of credit		3,641		4,309
Total	$	361,202	$	336,283

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 2020 or during 2019.

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.

14. RECENT ACCOUNTING PRONOUNCEMENTS

ASUs adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures. The following standard will be adopted in a future period. 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 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. Upon adoption, the Company would be required to recognize an allowance for credit losses on the FSB acquired portfolio, which has a balance of $249 million as of September 30, 2020. The amendments in CECL are effective for smaller reporting companies for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted. The Company intends to early adopt CECL effective January 1, 2022.

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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, 2019, as supplemented by the disclosures in Part II – Item 1A – Risk Factors - of the Quarterly Report for the Quarter ended March 31, 2020. 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.

Current Year Developments

Impact of Covid-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic, and recommended containment and mitigation measures worldwide. Federal and state governments have taken unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which is causing a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and is prompting the need for additional aid and other forms of relief.

Effects on Our Market Area – The Company’s commercial and consumer banking products and services are offered primarily in New York State, where governmental responses to the COVID-19 pandemic included an order that, subject to limited exceptions, all individuals stay at home and non‑essential businesses cease all activities, which led to a broad curtailment of economic activity beginning in March 2020. More recently, the local economy has begun to improve with the phased-in reopening of many impacted businesses, however most businesses are subject to restrictive health and safety guidelines, including occupancy limitations. New York State has issued travel restrictions, requiring travelers from most states and territories to quarantine for 14 days upon entering New York. Certain industries have been particularly hard-hit by the COVID-19 pandemic, including the travel and hotel industry. In addition, the New York State governor signed legislation on June 17, 2020 that expands mortgage forbearance available for those experiencing financial hardship during the crisis caused by the COVID-19 pandemic. The legislation applies to those who have mortgages with state-regulated financial institutions and is intended to be an expansion of the CARES Act’s mortgage forbearance provisions. The legislation provides up to one year of forbearance if the borrower’s hardship persists and provides flexible payment options.

Effects on Our Business – The Company currently expects that the COVID-19 pandemic and the specific developments referred to above could have a significant impact on our business. In particular, it is anticipated that a significant portion of the Company’s borrowers in the hotel industry will continue to endure significant economic distress, which has caused, and may continue to cause, them to draw on

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their existing lines of credit and adversely affect their ability to repay existing indebtedness, and may adversely impact the value of collateral. The Company has $81 million of loans outstanding with customers in the hotel industry, at September 30, 2020. These developments, together with economic conditions generally, are also expected to adversely impact the Company’s commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, and the value of certain collateral securing our loans. We continue to actively monitor developments related to COVID-19 and its impact to our business, customers, employees, counterparties, vendors, and service providers. During the first nine months of 2020, the most notable financial impacts to our results of operations was a higher provision for loan losses primarily reflecting the substantial increase in economic uncertainty and the resultant potential for increased credit losses in future periods as a consequence of the COVID-19 pandemic.

The Company’s Response – We have taken numerous steps in response to the COVID-19 pandemic, including the following:

The Company is actively working with loan customers and providing prudent loan modification terms, including the implementation of a customer payment deferral program to assist both consumers and business borrowers that may be experiencing financial hardship due to COVID-19 related challenges. Since the initial deferral period in the second quarter of 2020, the Company allowed customers to take a second 90 date deferral period, of which the majority have expired. As of October 20, 2020, the Company had $8 million in deferrals remaining which are expected to expire in the fourth quarter of 2020 and begin payment status.

The Company was proactive in providing updated guidance to its customers on the government’s PPP program as it was rolled out. Through September 30, 2020, the Bank had originated 1,931 PPP loans totaling $203 million. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Over $7 million of fees have been collected from the SBA for these loans. These fees are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness, unamortized fees are then recognized into interest income.

To assist customers experiencing financial hardship during this extraordinary time, the Company waived the following fees, effective March 20, 2020 through May 15, 2020:

oATM transactions fees charged by Evans for all customers

oAll early withdrawal fees on CDs

oMobile deposit fees for business customers

oMonthly fees to business customers for Deposit Express (Remote Capture)

The Company continues to promote its digital banking options. Customers are encouraged to utilize online and mobile banking tools, and our customer service and retail departments are fully staffed and available to assist customers remotely. All branches were closed to customer activity, except for drive-up and appointment only services, for a period of time. We continued to pay all employees according to their normal work schedule, even if their work has been reduced. No employees have been furloughed. We continue to provide the option to work from home to all employees whose job responsibilities can be effectively carried out remotely. Employees whose critical duties require their continued presence on-site are observing social distancing and cleaning protocols.

Acquisitions

On May 1, 2020, the Company completed its acquisition of FSB Bancorp, Inc., a Maryland corporation and the parent holding company of Fairport Savings Bank (together, “FSB”). FSB operated 5 banking offices in New York at the date of acquisition. This acquisition added total assets with a fair value of $323 million, including $271 million of loans (predominantly residential real estate loans) and $21 million of investment securities, and liabilities with a fair value of $296 million, including $239 million of deposits and $53 million in borrowed funds.

Subordinated Note Issuance

On July 9, 2020, the Company entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers and institutional accredited investors pursuant to which the Company issued and sold $20.0 million in aggregate principal amount of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030 (the “Notes”). The Notes were offered and sold by the Company to eligible purchasers in a private offering. The Company intends to use the proceeds from the offering for general corporate purposes, organic growth and regulatory capital.

The Notes mature on July 15, 2030 and bear interest at a fixed annual rate of 6.00%, payable semi-annually in arrears, to but excluding July 15, 2025. From and including July 15, 2025 to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum initially equal to the then-current three-month Secured Overnight Financing Rate provided by the Federal Reserve Bank of New York plus 590 basis points, payable quarterly in arrears. The Company is entitled to redeem the Notes, in whole or in part, at any time on or after July 15, 2025, and to redeem the Notes at any time in whole upon certain other events. Any redemption of the Notes will be subject to prior regulatory approval to the extent required.

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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 11 – “Fair Value Measurement” 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, 2019. 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. See Note 1 in Item 1 of this Quarterly Report on Form 10-Q for material updates to the Company’s significant accounting policies.

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 incurred 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, 2019 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.

At March 31, 2020, the Company performed a qualitative analysis to assess goodwill for impairment, which was solely contained in the Company’s insurance agency reporting unit and concluded that goodwill was not impaired. On May 1, 2020, the Company recognized an additional $1.8 million in goodwill in its banking reporting unit related to the acquisition of FSB. At September 30, 2020, the Company considered the on-going economic market disruption and the movement of the Company’s stock price in relation to other bank indexes as triggering events and has completed a qualitative analysis to assess whether or not goodwill was impaired. Management evaluated the goodwill associated with the insurance agency and determined the impacts from the market disruption does not materially impact the business performance of the reporting unit based on the nature of the insurance agency’s operations. Management determined

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the expected future financial performance of the banking reporting unit has not significantly changed as a result of the economic downturn. Management considered the length that its stock price has been under book value and an expectation of duration of the disruption and determined no impairment is required for the goodwill recorded at the Banking unit.

ANALYSIS OF FINANCIAL CONDITION

Loan Activity

Total gross loans were $1.7 billion at September 30, 2020, a $17 million or 1% increase from June 30, 2020 and a $477 million or 39% increase from December 31, 2019. The increase from the beginning of the year is primarily attributable to the acquisition of $271 million of FSB loans and the origination of $203 million of PPP loans.

Loans secured by real estate were $1.3 billion at September 30, 2020, reflecting a $12 million or 1% increase from June 30, 2020 and a $289 million or 30% increase from December 31, 2019. Residential real estate loans were $371 million at September 30, 2020, $6 million higher than at June 30, 2020, and $212 million higher than at December 31, 2019, reflecting the benefit of the acquired loan portfolio. Commercial real estate loans, including construction loans, which were $805 million at September 30, 2020, $5 million or 1% higher than the balance at June 30, 2020 and $62 million or 8% higher than the balance at December 31, 2019, also benefitted from the FSB acquisition. Commercial real estate is the largest part of the Company’s loan portfolio and has historically been the highest growth segment of the portfolio.

In the third quarter of 2020, residential mortgage originations were $34 million compared with the previous quarter’s originations of $25 million and $6 million in the third quarter of 2019. The Company originated $67 million in residential mortgages in the first nine months of 2020, compared to $19 million in the first nine months of 2019. The majority of the increase in residential mortgage originations is primarily due to the acquired FSB mortgage real estate division during the second quarter of 2020. Residential mortgages sold in the third quarter of 2020 equated to approximately 21% of the residential mortgages originated by the Company during the quarter, as compared with 15% in the second quarter of 2020 and 49% in the third quarter of 2019. Residential mortgages sold in the first nine months of 2020 were 27% of residential mortgages originated during the period, compared with 41% in the first nine months of 2019. 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 $448 million at September 30, 2020, representing a $8 million or 2% increase from June 30, 2020, and $197 million or 78% higher than at December 31, 2019. The increase from the beginning of the year is primarily the result of $203 million of PPP loans originated during the nine months ended September 30, 2020. 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

Non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $21 million, or 1.26% of total loans outstanding at September 30, 2020, compared with $20 million, or 1.17% of total loans outstanding, as of June 30, 2020 and $14 million, or 1.17% of total loans outstanding, as of December 31, 2019. The increase in non-performing loans during the first nine months of 2020 reflected $4.5 million of commercial real estate loans and $2.7 million of C&I loans that were moved to nonaccrual status.

Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $133 million at September 30, 2020, a $62 million increase from $71 million at June 30, 2020 and an $82 million increase from $51 million at December 31, 2019. The Company continues to evaluate its loan portfolio in response to the economic impact of the COVID-19 pandemic on its clients. During the third quarter of 2020, the Company identified a well-defined weakness in the hotel industry and classified an additional $65.5 million of the loans to clients within that industry as criticized. As of September 30, 2020, the Company’s hotel loan portfolio was $81 million, or approximately 6.5%, of total commercial loans. 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. 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 and are 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. Loans acquired in a business combination are recorded at fair value with no carry-over of an acquired entity’s previously established allowance for credit losses. The allowance for loan losses totaled $20.6 million or 1.21% of total loans outstanding at September 30, 2020, compared with $18.8 million or 1.11% of total loans outstanding as of June 30, 2020 and $15.2 million or 1.24% of total loans outstanding at December 31, 2019. The Company recorded $1.9 million in provision for loan losses during the third quarter of 2020, compared with a provision of $0.6 million in the second quarter of 2020, and a release of $0.4 million of allowance for loan losses in the third quarter of 2019. The third quarter of 2020 provision for loan losses reflects the increase in criticized loans. The

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release of provision during the third quarter of 2019 was the result of 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.

Investing Activities

Total investment securities were $161 million at September 30, 2020, compared with $170 million at June 30, 2020 and $130 million at December 31, 2019. The Company added $21 million of securities from the FSB acquisition during the second quarter of 2020, and subsequently sold $23 million of securities during the third quarter of 2020. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, were $88 million at September 30, 2020 compared to $110 million at June 30, 2020, and $28 million at December 31, 2019. 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. Average investment securities and interest-bearing cash were 14% of average interest-earning assets in the third and second quarters of 2020, compared with 12% in last year’s third quarter.

The Company’s highest concentration in its securities portfolio was in available for sale U.S. government sponsored mortgage-backed securities which comprised 53%, 70% and 74% of total investment securities at September 30, 2020, June 30, 2020 and December 31, 2019, respectively. The concentration in tax-advantaged debt securities issued by state and political subdivisions was 8%, 8% and 4% of the total securities portfolio at September 30, 2020, June 30, 2020, and December 31, 2019, respectively. The concentration in U.S. government-sponsored agency bonds was 39% of the total securities portfolio as of September 30, 2020 compared with 22% of the total securities portfolio at both June 30, 2020 and December 31, 2019.

The total net unrealized gain position of the available-for-sale investment portfolio was $3.7 million at September 30, 2020, compared with $4.8 million at June 30, 2020 and $0.7 million at December 31, 2019. The securities in an unrealized gain position at the end of the third quarter of 2020 generally reflect a decrease in market interest rates. 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 at September 30, 2020 were $1.8 billion, a $28 million or 2% decrease from June 30, 2020 but a $514 million or 41% increase from December 31, 2019. The Company acquired $239 million of deposits from the FSB acquisition during the second quarter of 2020. The growth in the first nine months of 2020 excluding the acquisition was primarily the result of an accumulation of liquidity by commercial customers in response to the pandemic, increases in consumer deposits from government stimulus payments and lower consumer spending, and deposits related to PPP loans. The increase in the first nine months of 2020 reflects increases in demand deposits of $179 million or 68%, consumer savings of $124 million or 37%, NOW deposits of $75 million or 53%, time deposits of $47 million or 17%, commercial savings of $47 million or 39%, and municipal savings of $42 million or 32%. Further discussion of deposit growth and changes in deposit mix are in the “Analysis of Results of Operations.” Average demand deposits were $431 million in the third quarter of 2020, an 8% increase from $400 million in the second quarter of 2020, and a 58% increase from $273 million in the fourth quarter of 2019.

The Company had $48 million in other borrowings at September 30, 2020. This represents long-term advances from the Federal Home Loan Bank of New York (“FHLBNY”) that were acquired in the FSB acquisition. At December 31, 2019 the Company had $10 million in other borrowings representing a single long-term advance with the FHLBNY that matured during the second quarter of 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, 2020.

During the third quarter of 2020, the Company entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers and institutional accredited investors pursuant to which the Company issued and sold $20.0 million in aggregate principal amount of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030 (the “Notes”). The Notes were offered and sold by the Company to eligible purchasers in a private offering. The Company intends to use the proceeds from the offering for general corporate purposes, organic growth and regulatory capital.

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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, 2020						Three months ended September 30, 2019
	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	$	1,671,338	$	16,847	4.01	%	$	1,202,634	$	15,645	5.16	%
Taxable securities		160,501		825	2.04	%		140,006		993	2.81	%
Tax-exempt securities		12,211		68	2.22	%		3,725		48	5.11	%
Interest bearing deposits at banks		106,154		26	0.10	%		24,661		159	2.56	%

Total interest-earning assets		1,950,204	$	17,766	3.62	%		1,371,026	$	16,845	4.87	%

Non interest-earning assets:

Cash and due from banks		14,482						14,522
Premises and equipment, net		17,756						12,850
Other assets		85,006						62,141

Total Assets	$	2,067,448					$	1,460,539

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW	$	221,343	$	103	0.19	%	$	134,008	$	151	0.45	%
Savings		799,082		654	0.33	%		591,585		1,346	0.90	%
Time deposits		337,967		884	1.04	%		281,798		1,541	2.17	%
Other borrowed funds		50,837		106	0.83	%		10,000		43	1.71	%
Junior subordinated debentures		29,582		375	5.04	%		11,317		141	4.94	%
Securities sold U/A to repurchase		4,507		2	0.18	%		3,917		2	0.20	%

Total interest-bearing liabilities		1,443,318	$	2,124	0.59	%		1,032,625	$	3,224	1.24	%

Noninterest-bearing liabilities:
Demand deposits		430,658						261,089
Other		29,644						22,231
Total liabilities	$	1,903,620					$	1,315,945

Stockholders' equity		163,828						144,594

Total Liabilities and Equity	$	2,067,448					$	1,460,539

Net interest income			$	15,642					$	13,621

Net interest margin					3.19	%					3.94	%

Interest rate spread					3.03	%					3.63	%

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	Nine months ended September 30, 2020						Nine months ended September 30, 2019
	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	$	1,475,973	$	47,497	4.30	%	$	1,179,875	$	45,149	5.12	%
Taxable securities		152,961		2,758	2.41	%		132,264		2,736	2.77	%
Tax-exempt securities		9,881		180	2.43	%		12,227		263	2.88	%
Interest bearing deposits at banks		79,247		223	0.38	%		32,202		564	2.34	%

Total interest-earning assets		1,718,062	$	50,658	3.94	%		1,356,568	$	48,712	4.80	%

Non interest-earning assets:

Cash and due from banks		14,523						13,845
Premises and equipment, net		15,818						11,318
Other assets		74,634						62,054

Total Assets	$	1,823,037					$	1,443,785

LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW	$	189,903	$	408	0.29	%	$	123,443	$	345	0.37	%
Regular savings		708,918		2,629	0.50	%		596,250		3,835	0.86	%
Time deposits		316,655		3,434	1.45	%		289,998		4,703	2.17	%
Other borrowed funds		32,369		227	0.94	%		10,014		130	1.74	%
Junior subordinated debentures		17,458		604	4.62	%		11,326		431	5.09	%
Securities sold U/A to repurchase		3,996		5	0.17	%		3,729		5	0.18	%

Total interest-bearing liabilities		1,269,299	$	7,307	0.77	%		1,034,760	$	9,449	1.22	%

Noninterest-bearing liabilities:
Demand deposits		370,915						249,157
Other		25,785						21,356
Total liabilities	$	1,665,999					$	1,305,273

Stockholders' equity		157,038						138,512

Total Liabilities and Equity	$	1,823,037					$	1,443,785

Net interest income			$	43,351					$	39,263

Net interest margin					3.37	%					3.87	%

Interest rate spread					3.17	%					3.58	%

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Net Income

Net income was $4.5 million, or $0.84 per diluted share, in the third quarter of 2020, compared with $0.5 million, or $0.09 per diluted share in the second quarter of 2020 and $5.2 million, or $1.04 per diluted share, in the third quarter of 2019. The Company’s third quarter 2020 results included a $1.9 million provision for loan loss primarily reflecting an increase in criticized loans due to the continued economic impact of COVID-19. In addition, the third quarter of 2020 included $0.5 million in one-time merger costs related to the acquisition of FSB resulting from the successful execution of the core system conversion during the quarter. Return on average equity was 11.09% for the third quarter of 2020, compared with 1.19% in the second quarter of 2020 and 14.29% in the third quarter of 2019.

Other Results of Operations – Quarterly Comparison

Net interest income of $15.6 million represented an increase of $0.7 million, or 5% from the second quarter of 2020, and $2.0 million, or 15% from the prior-year third quarter. The increase from both periods was primarily driven by higher average interest-earning assets as the Company recognized a full quarter of the impact of the FSB acquisition and PPP lending. The Company acquired approximately $271 million in total loans from FSB, largely consisting of residential real estate loans, during the second quarter of 2020. PPP loans, which carry a fixed rate of 1.00%, added $203 million in loan growth during 2020. Fees totaling $7.3 million were collected from the SBA for these loans during 2020. These fees are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness, unamortized fees are then recognized into interest income. The Company recognized $0.9 million of amortized PPP loan fees in interest income during the third quarter 2020 compared with $0.6 million during the second quarter of 2020. No PPP loan fees were included in interest income in the prior-year third quarter.

Third quarter net interest margin of 3.19% declined 17 basis points from the second quarter of 2020 and 75 basis points from the third quarter of 2019. The changes largely reflect the Federal Reserve’s decrease of the fed funds rate by 150 basis points during 2020, and changes in the mix of interest-earning assets, including increased interest earning cash balances, PPP loans and residential mortgages from FSB. The yield on loans decreased 21 and 115 basis points when compared with the second quarter of 2020 and third quarter of 2019, respectively. The cost of interest-bearing liabilities decreased to 0.59% compared with 0.65% in the second quarter of 2020 and 1.24% in the third quarter of 2019. The average cost of time deposits was 1.04% in the third quarter of 2020, compared with 1.40% in the second quarter of 2020 and 2.17% in the third quarter of 2019. Average time deposits comprised 19% of average total deposits during the third quarter of 2020, compared with 20% in the second quarter of 2020, and 22% in and the third quarter of 2019. The Company has brokered time deposits as part of its funding strategy. Average brokered time deposits were $26 million during the third quarter of 2020, $25 million in the second quarter of 2020, and $36 million in the third quarter of 2019.

Provision for loan losses was $1.9 million in the third quarter of 2020, compared with a provision of $0.6 million in the second quarter of 2020 and a release of $0.4 million of allowance for loan losses in the third quarter of 2019. The provision for loan losses during the third quarter of 2020 reflects the increase in criticized loans. The Company continues to evaluate its loan portfolio in response to the economic impact of the COVID-19 pandemic on its clients. During the third quarter of 2020, the Company identified a well-defined weakness in the hotel industry and classified the majority of the loans to clients within that industry as criticized. As of September 30, 2020, the Company’s hotel loan portfolio was $81 million, or approximately 6.5%, of total commercial loans. The release of provision during the third quarter of 2019 reflected 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. The Company has deferred the adoption of the Current Expected Credit Loss Impairment Model (CECL), as permitted by its classification as a Smaller Reporting Company by the Securities and Exchange Commission.

Non-interest income was $5.9 million in the third quarter of 2020, compared with $4.2 million in the second quarter of 2020 and $5.2 million in the prior year third quarter. Included in non-interest income during the third quarter of 2020 was a $0.7 million gain on sale of investment securities. There were no comparable gains in the second quarter of 2020 and the third quarter of 2019. In addition, insurance service and fee revenue increased $0.6 million from the previous quarter due to seasonally higher commercial lines insurance commissions and profit-sharing revenue.

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Non-interest expenses of $14.5 million in the third quarter of 2020 decreased 20% from the second quarter of 2020 but increased 18% from the prior-year period. The third quarter of 2020 included $0.5 million in merger-related expenses as a result of the core system conversion that was finalized during the quarter. In comparison, the second quarter of 2020 included $5.0 million in merger-related costs for system contract termination and deconversion expenses, severance costs, and legal and other professional service fees in connection with the FSB acquisition. Salaries and benefits costs of $8.1 million remained relatively flat compared with the second quarter of 2020 but increased 6% from last year’s third quarter. The increase in salaries and benefit costs from the prior-year period largely was due to the addition of personnel related to the FSB acquisition. Technology and communications expenses were $1.4 million in the third quarter of 2020, compared with $1.5 million in the second quarter of 2020 and $1.1 million in the third quarter of 2019. The increase from prior-year period was due to higher online banking activity, ATM card fees, and software costs, primarily as a result of the FSB acquisition. Professional services expense remained flat at $0.9 million during the third and second quarters of 2020 but decreased $0.1 million from last year’s third quarter. Professional service fees were elevated in the third quarter of 2019 due to higher legal and professional fees in response to certain data security matters.

The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 67.3% in the third quarter of 2020, 93.9% in the second quarter of 2020, and 65.4% in the third quarter of 2019. The Company’s non-GAAP efficiency ratio, excluding amortization expense, gains and losses from investment securities, and merger-related expenses, was 66.3% compared with 67.3% in the second quarter of 2020 and 64.8% in last year’s third quarter.

Income tax expense was $0.6 million, or an effective tax rate of 11.8%, for the third quarter of 2020 compared with 16.7% in the second quarter of 2020 and 25.6% in last year’s third quarter. Excluding the impact of a first quarter 2020 historic rehabilitation tax credit transaction, the effective tax rate was 25.6% and 25.9% in the third and second quarters of 2020, respectively.

Other Results of Operations – Year-to-Date Comparison

Net interest income was $43.4 million for the first nine months of 2020, a $4.1 million or 10% increase from the first nine months of 2019. The increase in net interest income is attributable to a $361 million or 27% increase in average interest-earning assets. The increase in average interest-earning assets reflects average loan growth of $296 million or 25% to $1.5 billion during the first nine months of 2020 compared to the first nine months of 2019. The Company acquired approximately $271 million in total loans from FSB, largely consisting of residential real estate, during the second quarter of 2020. In addition, PPP loans, which carry a fixed rate of 1.00%, added $203 million in loan growth during the first nine months of 2020. Fees totaling $7.3 million were collected from the SBA for these loans in the nine months ended September 30, 2020. These fees are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness, unamortized fees are then recognized into interest income. The Company recognized $1.5 million of amortized PPP loan fees in interest income during the nine months ended September 30, 2020. No PPP loan fees were included in interest income in the first nine months of 2019. The benefit from the increases in average interest-earning assets and PPP fees was partially offset by lower net interest margin.

The Company’s net interest margin of 3.37% in the first nine months of 2020 was 50 basis points lower than the margin in the first nine months of 2019. The yield on average interest-earning assets decreased 86 basis points from 4.80% to 3.94%. Average loan yields decreased 82 basis points from 5.12% to 4.30%, reflecting the Federal Reserve’s decrease of fed funds rate. The cost of interest-bearing liabilities was 0.77%, or 45 basis points lower in the first nine months of 2020 when compared with the first nine months of 2019. The rate paid on average time deposits decreased from 2.17% in the first nine months of 2019 to 1.45% during the first nine months of 2020.

The Company recorded $5.5 million in provision for loan losses in the nine-month period ended September 30, 2020, compared with a provision of $0.2 million in the nine-month period ended September 30, 2019. The increase in provision for loan losses during the first nine months of 2020 compared with the prior year period reflects an increase in criticized loans and additional reserves in response to economic trends and conditions and changes in credit quality standards as the economy continues to be impacted by the COVID-19 pandemic. During the third quarter of 2020, the Company identified a well-defined weakness in the hotel industry and classified the majority of the loans to clients within that industry as criticized. As of September 30, 2020, the Company’s hotel loan portfolio was $81 million, or approximately 6.5%, of total commercial loans. While the full impact of COVID-19 on future financial results is uncertain, the Company believes that the effects could have a material impact on the ability of some clients to meet their borrowing obligations. The provision for loan losses during the first nine months of 2019 reflected loan growth, offset by a decrease in non-performing loans, 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 2020 decreased $0.7 million from the prior year period to $13.4 million. The first nine months of 2020 included a $0.6 million net reduction of non-interest income related to an investment in an historic rehabilitation tax credit. There were no significant historic rehabilitation tax credits during the first nine months of 2019. Insurance service and fees revenue of $8.3 million decreased $0.3 million during the first nine months of 2020 compared with prior year period as a result of lower

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profit-sharing revenue and claims service revenues. Changes in the fair value of mortgage servicing rights decreased non-interest income by $0.2 million in first nine months of 2020 as compared to the first nine months of 2019. Deposit service charges revenue decreased $0.2 million during the first nine months of 2020 compared with the first nine months of 2019 as a result of lower consumer spending and the temporary suspension of certain fees to assist customers affected by COVID-19. Offsetting the decreases in non-interest income was a $0.7 million gain on sale of investment securities during the first nine months of 2020. There was no comparable gain on sale of investment securities during the first nine months of 2019.

Total non-interest expense increased to $45.4 million in the first nine months of 2020, 27% higher than the nine-month period ended September 30, 2019. The increase was mostly attributable to $6.0 million in merger-related expenses in connection with the FSB acquisition including system contract termination and deconversion charges, and legal and other professional services. Salaries and employee benefits costs were $23.9 million for the first nine months of 2020, a $1.6 million or 7% increase from $22.3 million in the prior year period. The year-over-year increase in salary and benefits expense reflects the addition of personnel related to the FSB acquisition and annual merit increases during 2020. Technology and communications expenses increased $0.9 million to $3.9 million, reflecting higher online banking activity, software costs primarily as a result of the FSB acquisition, and additional expenditures related to COVID-19.

The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 79.9% in the first nine months of 2020, compared with 66.8% during the prior-year period. The Company’s non-GAAP efficiency ratio, excluding amortization expense, gains and losses from investment securities, merger-related expenses and the impact of historic tax credit transactions, was 68.7% in the first nine months of 2020, compared with 66.2% during the prior-year period.

The Company recorded income tax expense of $0.7 million for the nine-month period ended September 30, 2020, compared with $4.2 million in the first nine months of 2019. The effective tax rate for the first nine months of 2020 was 12.4%, compared with 24.2% in the comparable 2019 period. Excluding the impact of the 2020 historic tax credit transaction, the effective tax rate was 25.7% for the first nine months of 2020.

CAPITAL

The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 7.82% at September 30, 2020, compared with 8.44% at June 30, 2020 and 10.33% at December 31, 2019. Book value per share was $30.29 at September 30, 2020, compared with $30.13 at June 30, 2020 and $30.12 at December 31, 2019.

On August 18, 2020, the Company declared a semi-annual cash dividend of $0.58 per share on the Company’s outstanding common stock. The dividend was paid on October 6, 2020 to shareholders of record as of September 15, 2019. For the full year of 2020, cash dividends totaled $1.16, up 12% over 2019.

The Company has also issued subordinated capital notes and junior subordinated debentures associated with trust preferred securities to provide liquidity and enhance regulatory capital ratios. The Company had $11.3 million of junior subordinated debentures associated with trust preferred securities outstanding at September 30, 2020 and December 31, 2019 which are considered Tier 1 capital and are includable in total regulatory capital. On July 9, 2020, the Company executed a private offering of $20 million in 6% fixed-to-floating rate subordinated notes due on July 15, 2030. During the third quarter of 2020, $15 million of the proceeds from the sale of the notes were moved to the Company’s Evans Bank, N.A. subsidiary as Tier 1 capital.

While we are currently classified as well capitalized, an extended economic recession brought about by COVID-19 could adversely impact our reported and regulatory capital ratios by credit losses. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s subsidiary bank’s capital deteriorates such that it is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt that was issued subsequent to September 30, 2020.

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 FHLBNY as its primary source of overnight funds and has long-term advance with FHLBNY. The Company acquired $53 million of FHLBNY long-term advances from the FSB acquisition during the second quarter of 2020. The Company had $10 million in long-term advances with FHLBNY at December 31, 2019, which matured in the second quarter of 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 core deposits along with the line usage’s impact on interest rate risk. The Company’s funding strategy has resulted in significant deposit growth, resulting in less usage of the FHLBNY

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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 $487 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, 2020, approximately 5% of the Bank’s securities had contractual maturity dates of one year or less and approximately 10% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprise 53% of the investment portfolio at September 30, 2020, 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, 2020, the Company had net short-term liquidity of $421 million as compared with $209 million at December 31, 2019. Available assets of $250 million, divided by public and purchased funds of $383 million, resulted in a long-term liquidity ratio of 65% at September 30, 2020, compared with 59% at December 31, 2019.

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.

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, 2020		December 31, 2019
Changes in interest rates

+200 basis points	$	(2,657)	$	(32)
+100 basis points		1,595		2,327

-100 basis points		NM		(2,455)
-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, 2020 (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, 2020 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, 2020 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 to the risk factors previously disclosed in the Company’s Annual Report on Form 10- K for the fiscal year ended December 31, 2019, as supplemented by the disclosure in Part II, Item 1A. Risk Factors included in the Quarterly report on Form 10-Q for the quarter ended March 31, 2020.

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

Issuer Purchases of Equity Securities



Period	Total Number of Shares Purchased ₍₁₎		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
July 2020:
July 1, 2020 - July 31, 2020		-	$	-	-
August 2020:
August 1, 2020 - August 31, 2020		-	$	-	-
September 2020:
September 1,2020 - September 30, 2020		-	$	-	-

Total:		-	$	-	-

(1)The total shares purchased in the period consist of shares constructively tendered to the Company by attestation in satisfaction of the exercise price due upon exercise of options issued pursuant to the Company’s 2019 Long-Term Incentive Plan. The “average price paid per share” reported in the table above, with respect to such shares, reflects the fair market value of the Company’s common stock on the exercise date, which was the closing sales price of the Company’s common stock as reported on the NYSE American on that date.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

(Not Applicable.)

ITEM 4 – MINE SAFETY DISCLOSURE

(Not Applicable.)

ITEM 5 – OTHER INFORMATION

(Not Applicable.)

ITEM 6 – EXHIBITS

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

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		EXHIBIT INDEX

Exhibit No.		Name

4.1		Indenture, dated as of July 9, 2020, by and between Evans Bancorp, Inc. and UMB Bank, National Association, as trustee (incorporated by reference to Exhibit 4.1 to Evans Bancorp, Inc.’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 9, 2020).

4.2		Form of 6.00% Fixed-to-Floating Rate Subordinated Note due 2030 of Evans Bancorp, Inc. (incorporated by reference to Exhibit 4.1 to Evans Bancorp, Inc.’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 9, 2020).

10.1		Form of Subordinated Note Purchase Agreement, dated as of July 9, 2020, by and between Evans Bancorp, Inc. and the several Purchasers (incorporated by reference to Exhibit 10.1 to Evans Bancorp, Inc.’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 9, 2020).

10.2		Form of Registration Rights Agreement, dated as of July 9, 2020, by and between Evans Bancorp, Inc. and the several Purchasers (incorporated by reference to Exhibit 10.2 to Evans Bancorp, Inc.’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 9, 2020).

10.3		Amendment Number One, dated as of September 21, 2020, to the Employment Agreement by and among Evans Bank, N.A., Evans Bancorp, Inc. and David J. Nasca, executed and delivered by Evans Bancorp, Inc. and Evans Bank on September 14, 2009 and effective as of September 9, 2009 (incorporated by reference to Exhibit 10.1 to Evans Bancorp, Inc.’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 25, 2020).

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, 2020, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets – September 30, 2020 and December 31, 2019; (ii) Unaudited Consolidated Statements of Income – Three months ended September 30, 2020 and 2019; (iii) Unaudited Consolidated Statements of Income – Nine months ended September 30, 2020 and 2019; (iv) Unaudited Statements of Consolidated Comprehensive Income – Three months ended September 30, 2020 and 2019; (v) Unaudited Statements of Consolidated Comprehensive Income – Nine months ended September 30, 2020 and 2019; (vi) Unaudited Consolidated Statements of Stockholders' Equity – Three months ended September 30, 2020 and 2019; (vii) Unaudited Consolidated Statements of Stockholders' Equity – Nine months ended September 30, 2020 and 2019; (viii) Unaudited Consolidated Statements of Cash Flows – Nine months ended September 30, 2020 and 2019; and (ix) Notes to Unaudited Consolidated Financial Statements.

104		The cover page from the Evans Bancorp, Inc’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline XBRL.

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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

November 5, 2020

/s/ David J. Nasca

David J. Nasca

President and CEO

(Principal Executive Officer)

DATE

November 5, 2020

/s/ John B. Connerton

John B. Connerton

Treasurer

(Principal Financial Officer and Principal Accounting Officer)