United States
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

		For quarterly period ended March 31, 2011

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

Commission file number 001-35021

EVANS BANCORP, INC.

(Exact name of registrant as specified in its charter)

New York		16-1332767
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

14 -16 North Main Street, Angola, New York		14006
(Address of principal executive offices)		(Zip Code)

(716) 926-2000

Not applicable

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

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, $.50 par value: 4,100,319 shares as of April 22, 2011

 

 

INDEX

EVANS BANCORP, INC. AND SUBSIDIARIES

		PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Consolidated Balance Sheets — March 31, 2011 and December 31, 2010			1
Unaudited Consolidated Statements of Income — Three months ended March 31, 2011 and 2010			2
Unaudited Consolidated Statements of Stockholders’ Equity — Three months ended March 31, 2011 and 2010			3
Unaudited Consolidated Statements of Cash Flows — Three months ended March 31, 2011 and 2010			4
Notes to Unaudited Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			31
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41
Item 4. Controls and Procedures			42
PART II. OTHER INFORMATION
Item 6. Exhibits			42
SIGNATURES			43
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2011 AND DECEMBER 31, 2010
(in thousands, except share and per share amounts)

		March 31,				December 31,
		2011				2010
ASSETS
Cash and due from banks		$	13,553			$	13,467
Interest-bearing deposits at banks			17,567				255
Securities:
Available for sale, at fair value (cost: $93,940 at March 31, 2011; $86,096 at December 31, 2010)			95,468				87,422
Held to maturity, at amortized cost (fair value: $2,221 at March 31, 2011; $2,130 at December 31, 2010)			2,235				2,140
FHLB and FRB common stock, at amortized cost and fair value			3,165				3,770
Loans and leases, net of allowance for loan and lease losses of $10,482 in 2011 and $10,424 in 2010			521,147				517,554
Properties and equipment, net of depreciation of $12,368 in 2011 and $12,054 in 2010			10,609				10,841
Goodwill			8,101				8,101
Intangible assets			1,038				1,168
Bank-owned life insurance			12,493				12,389
Other assets			14,335				14,416
TOTAL ASSETS		$	699,711			$	671,523
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits:
Demand		$	99,444			$	98,016
NOW			43,457				32,683
Regular savings			263,854				249,410
Muni-vest			34,804				22,000
Time			143,588				142,348
Total deposits			585,147				544,457
Securities sold under agreement to repurchase			4,807				5,227
Other short-term borrowings			39				13,669
Other liabilities			12,055				11,776
Junior subordinated debentures			11,330				11,330
Long-term borrowings			22,000				22,000
Total liabilities			635,378				608,459
CONTINGENT LIABILITIES AND COMMITMENTS
STOCKHOLDERS’ EQUITY:
Common stock, $.50 par value, 10,000,000 shares authorized; 4,094,147 and 4,081,960 shares issued and outstanding, respectively,			2,047				2,041
Capital surplus			40,720				40,660
Retained earnings			21,895				20,836
Accumulated other comprehensive loss, net of tax			(329	)			(473	)
Total stockholders’ equity			64,333				63,064
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	699,711			$	671,523

See Notes to Unaudited Consolidated Financial Statements

PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(in thousands, except share and per share amounts)

		Three Months Ended March 31,
		2011				2010
INTEREST INCOME
Loans and leases		$	7,152			$	6,941
Interest bearing deposits at banks			4				—
Securities:
Taxable			486				403
Non-taxable			371				402
Total interest income			8,013				7,746
INTEREST EXPENSE
Deposits			1,420				1,350
Other borrowings			215				238
Junior subordinated debentures			81				80
Total interest expense			1,716				1,668
NET INTEREST INCOME			6,297				6,078
PROVISION FOR LOAN AND LEASE LOSSES			488				1,214
NET INTEREST INCOME AFTER
PROVISION FOR LOAN AND LEASE LOSSES			5,809				4,864
NON-INTEREST INCOME
Bank charges			386				511
Insurance service and fees			2,089				2,246
Data center income			239				234
Net gain (loss) on sales and calls of securities			—				(6	)
Gain on loans sold			52				10
Bank-owned life insurance			103				108
Other			592				599
Total non-interest income			3,461				3,702
NON-INTEREST EXPENSE
Salaries and employee benefits			3,904				3,608
Occupancy			777				771
Repairs and maintenance			159				182
Advertising and public relations			130				102
Professional services			402				414
Technology and communications			235				225
Amortization of intangibles			130				231
FDIC insurance			229				226
Other			639				692
Total non-interest expense			6,605				6,451
INCOME BEFORE INCOME TAXES			2,665				2,115
INCOME TAX PROVISION			790				668
NET INCOME		$	1,875			$	1,447
Net income per common share-basic		$	0.46			$	0.51
Net income per common share-diluted		$	0.46			$	0.51
Cash dividends per common share		$	0.20			$	0.20
Weighted average number of common shares outstanding			4,085,509				2,818,147
Weighted average number of diluted shares outstanding			4,096,170				2,823,559

See Notes to Unaudited Consolidated Financial Statements

PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(in thousands, except share and per share amounts)

														Accumulated
														Other
		Common				Capital				Retained				Comprehensive
		Stock				Surplus				Earnings				(Loss) Income				Total
Balance, January 1, 2010		$	1,407			$	27,279			$	17,381			$	(108	)		$	45,959
Comprehensive income:
Net Income											1,447								1,447
Unrealized gain on available-for-sale, net of reclassification of loss of ($4) (after tax) securities, net of tax effect of ($8)															25				25
Amortization of prior service cost and net loss net of tax effect of ($13)															20				20
Total comprehensive income																			1,492
Cash dividends ($0.20 per common share)											(565	)							(565	)
Stock options expense							49												49
Issued 14,620 restricted shares			7				(7	)											—
Balance, March 31, 2010		$	1,414			$	27,321			$	18,263			$	(63	)		$	46,935
Balance, January 1, 2011		$	2,041			$	40,660			$	20,836			$	(473	)		$	63,064
Comprehensive income:
Net Income											1,875								1,875
Unrealized gain on available-for-sale securities, net of tax effect of ($78)															124				124
Amortization of prior service cost and net loss net of tax effect of ($11)															20				20
Total comprehensive income																			2,019
Cash dividends ($0.20 per common share)											(816	)							(816	)
Excess tax benefit from stock-based compensation							9												9
Stock options expense							57												57
Issued 12,260 restricted shares			6				(6	)											—
Balance, March 31, 2011		$	2,047			$	40,720			$	21,895			$	(329	)		$	64,333

See Notes to Unaudited Consolidated Financial Statements

PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(in thousands)

		Three Months Ended
		March 31,
		2011				2010
OPERATING ACTIVITIES:
Interest received		$	7,654			$	7,679
Fees received			3,590				3,765
Interest paid			(1,829	)			(1,805	)
Cash paid to employees and vendors			(5,985	)			(5,079	)
Income taxes paid			(299	)			(1,021	)
Proceeds from sale of loans held for resale			7,285				1,998
Originations of loans held for resale			(9,779	)			(2,817	)
Net cash provided by operating activities			637				2,720
INVESTING ACTIVITIES:
Available for sales securities:
Purchases			(10,029	)			(38,305	)
Proceeds from maturities and calls			2,655				29,254
Held to maturity securities:
Purchases			(135	)			—
Proceeds from maturities and calls			39				—
Additions to properties and equipment			(82	)			(214	)
Increase in loans, net of repayments			(2,327	)			(9,725	)
Net cash used in investing activities			(9,879	)			(18,990	)
FINANCING ACTIVITIES:
Proceeds from borrowings			—				2,795
Repayments of borrowings			(14,050	)			(61	)
Net increase in deposits			40,690				11,332
Net cash provided by financing activities			26,640				14,066
Net increase (decrease) in cash and equivalents			17,398				(2,204	)
CASH AND CASH EQUIVALENTS:
Beginning of period			13,722				12,983
End of period		$	31,120			$	10,779
		(continued)

(in thousands)

		Three Months Ended
		March 31,
		2011				2010
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Net income		$	1,875			$	1,447
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			379				420
Deferred tax expense (benefit)			86				(31	)
Provision for loan and lease losses			488				1,214
Net gain on sales of securities			—				6
Premium on loans sold			(52	)			(10	)
Stock options expense			57				49
Proceeds from sale of loans held for resale			7,285				1,998
Originations of loans held for resale			(9,779	)			(2,817	)
Changes in assets and liabilities affecting cash flow:
Other assets			1,461				(490	)
Other liabilities			(1,163	)			934
NET CASH PROVIDED BY OPERATING ACTIVITIES		$	637			$	2,720

See Notes to Unaudited Consolidated Financial Statements

PART I-FINANCIAL INFORMATION

ITEM 1-FINANCIAL STATEMENTS

EVANS BANCORP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2011 AND 2010

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”), Evans National Holding Corp. (“ENHC”) and Suchak Data Systems, Inc. (“SDS”); and (ii) Evans National Financial Services, Inc. (“ENFS”), and ENFS’s subsidiary, The Evans Agency, Inc. (“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 accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the Company’s financial position and results of operations for the interim periods have been made. Certain reclassifications have been made to the 2010 unaudited consolidated financial statements to conform to the presentation used in 2011.

The results of operations for the three month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010. The Company has evaluated subsequent events for potential recognition and/or disclosure through the date of filing.

2. SECURITIES

The amortized cost of securities and their approximate fair value at March 31, 2011 and December 31, 2010 were as follows:

		March 31, 2011
						(in thousands)
						Unrealized
		Amortized												Fair
		Cost				Gains				Losses				Value
Available for Sale:
Debt securities:
U.S. government agencies		$	24,057			$	572			$	(69	)		$	24,560
States and political subdivisions			37,800				730				(107	)			38,423
Total debt securities		$	61,857			$	1,302			$	(176	)		$	62,983
Mortgage-backed securities:
FNMA		$	13,162			$	266			$	(57	)		$	13,371
FHLMC			9,667				139				(6	)			9,800
GNMA			6,720				76				(13	)			6,783
CMO’S			2,534				19				(22	)			2,531
Total mortgage-backed securities		$	32,083			$	500			$	(98	)		$	32,485
Total securities designated as available for sale		$	93,940			$	1,802			$	(274	)		$	95,468
Held to Maturity:
Debt securities
U.S. government agencies			—				—				—				—
States and political subdivisions			2,235				19				(33	)			2,221
Total securities designated as held to maturity		$	2,235			$	19			$	(33	)		$	2,221
Total securities		$	96,175			$	1,821			$	(307	)		$	97,689

		December 31, 2010
						(in thousands)
						Unrealized
		Amortized												Fair
		Cost				Gains				Losses				Value
Available for Sale:
Debt securities:
U.S. government agencies		$	23,130			$	609			$	(95	)		$	23,644
States and political subdivisions			35,796				726				(225	)			36,297
Total debt securities		$	58,926			$	1,335			$	(320	)		$	59,941
Mortgage-backed securities:
FNMA		$	10,207			$	320			$	(65	)		$	10,462
FHLMC			9,541				79				(53	)			9,567
GNMA			4,763				38				—				4,801
CMO’S			2,659				11				(19	)			2,651
Total mortgage-backed securities		$	27,170			$	448			$	(137	)		$	27,481
Total securities designated as available for sale		$	86,096			$	1,783			$	(457	)		$	87,422
Held to Maturity:
Debt securities
U.S. government agencies			—				—				—				—
States and political subdivisions			2,140				22				(32	)			2,130
Total securities designated as held to maturity		$	2,140			$	22			$	(32	)		$	2,130
Total securities		$	88,236			$	1,805			$	(489	)		$	89,552

Available for sale securities with a total fair value of $91.4 million and $65.6 million at March 31, 2011 and December 31, 2010, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law.

The Company uses the Federal Home Loan Bank of New York (“FHLBNY”) as its primary source of overnight funds and also has several long-term advances with FHLBNY. The Company had a total of $22.0 million and $35.6 million in borrowed funds with FHLBNY at March 31, 2011 and December 31, 2010, respectively. The Company has placed sufficient collateral in the form of residential and commercial real estate loans at FHLBNY that meet FHLB collateral requirements. As a member of the Federal Home Loan Bank (“FHLB”) System, the Bank is required to hold stock in FHLBNY. The Bank held $1.8 million and $2.4 million in FHLBNY stock as of March 31, 2011 and December 31, 2010, respectively, at fair value.

The scheduled maturities of debt and mortgage-backed securities at March 31, 2011 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.

		Amortized				Estimated
		cost				fair value
		(in thousands)
Debt securities available for sale:
Due in one year or less		$	2,882			$	2,905
Due after one year through five years			19,539				19,957
Due after five years through ten years			23,063				23,448
Due after ten years			16,373				16,673
			61,857				62,983
Mortgage-backed securities available for sale			32,083				32,485
		$	93,940			$	95,468
Debt securities held to maturity:
Due in one year or less		$	879			$	878
Due after one year through five years			446				448
Due after five years through ten years			280				290
Due after ten years			630				605
Mortgage-backed securities available for sale		$	2,235			$	2,221

Information regarding unrealized losses within the Company’s available for sale securities at March 31, 2011 and December 31, 2010, is summarized below. The securities are primarily U.S. government-guaranteed agency securities or municipal securities. All unrealized losses are considered temporary and related to market interest rate fluctuations.

		March 31, 2011
		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(in thousands)
Available for Sale:
Debt securities:
U.S. government agencies		$	3,731			$	(69	)		$	—			$	—			$	3,731			$	(69	)
States and political subdivisions			6,709				(104	)			305				(3	)			7,014				(107	)
Total debt securities		$	10,440			$	(173	)		$	305			$	(3	)		$	10,745			$	(176	)
Mortgage-backed securities:
FNMA		$	4,413			$	(57	)		$	—			$	—			$	4,413			$	(57	)
FHLMC			3,730				(6	)			—				—				3,730				(6	)
GNMA			2,046				(13	)			—				—				2,046				(13	)
CMO’S			1,982				(22	)			—				—				1,982				(22	)
Total mortgage-backed securities		$	12,171			$	(98	)		$	—			$	—			$	12,171			$	(98	)
Held To Maturity:
Debt securities:
States and political subdivisions		$	997			$	(6	)		$	466			$	(27	)		$	1,463			$	(33	)
Total temporarily impaired securities		$	23,608			$	(277	)		$	771			$	(30	)		$	24,379			$	(307	)

		December 31, 2010
		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(in thousands)
Available for Sale:
Debt securities:
U.S. government agencies		$	3,705			$	(95	)		$	—			$	—			$	3,705			$	(95	)
States and political subdivisions			9,144				(225	)			—				—				9,144				(225	)
Total debt securities		$	12,849			$	(320	)		$	—			$	—			$	12,849			$	(320	)
Mortgage-backed securities:
FNMA		$	3,113			$	(65	)		$	—			$	—			$	3,113			$	(65	)
FHLMC			7,897				(53	)			—				—				7,897				(53	)
CMO’S			2,011				(19	)			—				—				2,011				(19	)
Total mortgage-backed securities		$	13,021			$	(137	)		$	—			$	—			$	13,021			$	(137	)
Held To Maturity:
Debt securities:
States and political subdivisions		$	—			$	—			$	—			$	—			$	—			$	—
Total temporarily impaired securities		$	25,870			$	(457	)		$	—			$	—			$	25,870			$	(457	)

In regard to municipal securities, the Company’s general investment policy is that in-state securities must be rated at least Moody’s Baa (or equivalent) at the time of purchase. Out-of-state issues must be rated by Moody’s at least Aa (or equivalent) at the time of purchase. The Company did not own any out-of-state municipal bonds at March 31, 2011 or December 31, 2010. Bonds rated below A are reviewed periodically to ensure their continued credit worthiness. While purchase of non-rated municipal securities is permitted, such purchases are limited to bonds issued by municipalities in the Company’s general market area which, in the Company’s judgment, possess no greater credit risk than Baa (or equivalent) bonds. The financial statements of the issuers of non-rated securities are reviewed by the Bank and a credit file of the issuers is kept on each non-rated municipal security with relevant financial information.

Although concerns have been raised in the marketplace recently about the health of municipal bonds, the Company has not experienced any credit troubles in this portfolio and does not believe any credit troubles are imminent. Aside from the non-rated municipal securities to local municipalities discussed above that are considered held-to-maturity, all of the Company’s available-for-sale municipal bonds are investment-grade government obligation (“G.O.”) bonds. G.O. bonds are considered safer than revenue bonds because they are backed by the full faith and credit of the government while revenue bonds rely on the revenue produced by a particular project. All of the Company’s municipal bonds are to municipalities in NY. There has never been a default of a NY G.O. in the history of the state. Historical performance does not guarantee future performance, but it does indicate that the risk of loss on default of a G.O. municipal bond for the Company is relatively low.

Management has assessed the securities available for sale in an unrealized loss position at March 31, 2011 and December 31, 2010 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 charges in 2011 or 2010, the gross unrealized losses amounted to less than 0.5% of the total fair value of the securities portfolio at March 31, 2011 and December 31, 2010, and the gross unrealized loss position decreased by $0.2 million from December 31, 2010 to March 31, 2011. Nevertheless, it remains possible that there could be deterioration in the asset quality of the securities portfolio in the future. The credit worthiness of the Company’s portfolio is largely reliant on the ability of U.S. government sponsored agencies such as 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 relatively stable past performance is not a guarantee for similar performance of the Company’s securities portfolio going forward.

3. FAIR VALUE MEASUREMENTS

The Company follows the provisions of ASC Topic 820, “Fair Value Measurements and Disclosures.” Those provisions relate to financial assets and liabilities carried at fair value and fair value disclosures related to financial assets and liabilities. ASC Topic 820 defines fair value and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined 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 measurements:

•		Level 1, meaning the use of quoted prices for identical instruments in active markets;
•		Level 2, meaning the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable; and
•		Level 3, meaning the use of 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 at March 31, 2011 and December 31, 2010:

		Level 1				Level 2				Level 3				Fair Value
March 31, 2011
Securities available-for-sale:
U.S. government agencies		$	—			$	24,560			$	—			$	24,560
States and political subdivisions			—				38,423				—				38,423
Mortgage-backed securities			—				32,485				—				32,485
Mortgage servicing rights			—				—				435				435
December 31, 2010
Securities available-for-sale:
U.S. government agencies		$	—			$	23,644			$	—			$	23,644
States and political subdivisions			—				36,297				—				36,297
Mortgage-backed securities			—				27,481				—				27,481
Mortgage servicing rights			—				—				388				388

Securities available for sale

Fair values for securities are determined using independent pricing services and market-participating brokers. The pricing service and brokers use a variety of techniques to arrive at fair value including market maker bids, quotes, and pricing models. Inputs to their pricing models include recent trades, benchmark interest rates, spreads, and actual and projected cash flows. Management obtains a single market quote or price estimate for each security. 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 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 uses a combination of market and income valuation methodologies. All assumptions are market driven. Therefore, mortgage servicing rights 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 items measured at fair value (Level 3) on a recurring basis using significant unobservable inputs:

Mortgage servicing rights — December 31, 2010		$	388
Gains included in earnings			4
Mortgage originations			43
Mortgage servicing rights — March 31, 2011		$	435

FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS

The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The following table presents for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a nonrecurring basis at March 31, 2011 and December 31, 2010:

		Level 1				Level 2				Level 3				Fair Value
March 31, 2011
Impaired loans		$	—			$	—			$	8,813			$	8,813
December 31, 2010
Impaired loans		$	—			$	—			$	7,787			$	7,787

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. Fair value is estimated based on the value of the collateral securing these loans. 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 loan being downgraded on the Company’s internal loan rating scale to a 5 (special mention) or a 6 (substandard) depending on the amount of the loan, the type of loan and the type of collateral. All impaired loans are either graded a 6 or 7 on the internal loan rating scale. Subsequent to the downgrade, 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. Impaired loans had a gross value of $10.2 million, with a valuation allowance of $1.4 million, at March 31, 2011, compared with a gross value of $9.3 million, with a valuation allowance of $1.5 million, at December 31, 2010.

FAIR VALUE OF FINANCIAL INSTRUMENTS

At March 31, 2011 and December 31, 2010, 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, were as follows:

		March 31, 2011								December 31, 2010
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
		(in thousands)								(in thousands)
Financial assets:
Cash and cash equivalents		$	31,120			$	31,120			$	13,722			$	13,722
Available for sale securities			95,468				95,468				87,422				87,422
Held to maturity securities			2,235				2,221				2,140				2,130
FHLB and FRB stock			3,165				3,165				3,770				3,770
Loans and leases, net			521,147				530,764				517,554				535,338
Mortgage servicing rights			435				435				388				388
Financial liabilities:
Deposits		$	585,147			$	585,082			$	544,457			$	544,889
Other borrowed funds and securities sold under agreements to repurchase			26,846				27,871				40,896				41,710
Junior subordinated debentures			11,330				11,330				11,330				11,330

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value.

Cash and Cash Equivalents. For these short-term instruments, the carrying amount is a reasonable estimate of fair value. “Cash and Cash Equivalents” includes interest-bearing deposits at other banks.

Securities available for sale. Fair values for available-for-sale securities are determined using independent pricing

services and market-participating brokers. The pricing service and brokers use a variety of techniques to arrive at fair value including market maker bids, quotes, and pricing models. Inputs to their pricing models include recent trades, benchmark interest rates, spreads, and actual and projected cash flows. Management obtains a single market quote or price estimate for each security. These quoted prices reflect current information based on orderly transactions. These are considered Level 2 inputs under ASC 820.

Securities held to maturity. The Company holds certain municipal bonds as held-to-maturity. These bonds are generally small in dollar amount and are issued only by certain local municipalities within the Company’s market area. The original terms are negotiated directly and on an individual basis consistent with our loan and credit guidelines. These bonds are not traded on the open market and management intends to hold the bonds to maturity. The fair value of held-to-maturity securities is estimated by discounting the future cash flows using the current rates at which similar agreements would be made with municipalities with similar credit ratings and for the same remaining maturities.

FHLB and FRB stock. The carrying value of FHLB and FRB stock approximate fair value.

Loans and Leases, net. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, net of the appropriate portion of the allowance for loan losses. For variable rate loans, the carrying amount is a reasonable estimate of fair value. This fair value calculation is not necessarily indicative of the exit price, as defined in ASC 820.

Mortgage servicing rights. Mortgage servicing rights 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 uses a combination of market and income valuation methodologies. All assumptions are market driven.

Deposits. The fair value of demand deposits, NOW accounts, muni-vest accounts and regular savings accounts is the amount payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.

Other Borrowed Funds and Securities Sold Under Agreement to Repurchase. The fair value of the short-term portion of other borrowed funds approximates its carrying value. The fair value of the long-term portion of other borrowed funds is estimated using a discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Junior Subordinated Debentures. The carrying amount of Junior Subordinated Debentures is a reasonable estimate of fair value due to the fact that they bear a floating interest rate that adjusts on a quarterly basis.

Commitments to extend credit and standby letters of credit. As described in Note 7 — “Contingent Liabilities and Commitments” to these Unaudited Consolidated Financial Statements, the Company was a party to financial instruments with off-balance sheet risk at March 31, 2011 and December 31, 2010. Such financial instruments consist of commitments to extend permanent financing and letters of credit. If the options are exercised by the prospective borrowers, these financial instruments will become interest-earning assets of the Company. If the options expire, the Company retains any fees paid by the counterparty in order to obtain the commitment or guarantee. The fair value of commitments is estimated based upon fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate commitments, the fair value estimation takes into consideration an interest rate risk factor. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements. The fair value of these off-balance sheet items at March 31, 2011 and December 31, 2010 approximates the recorded amounts of the related fees, which are not considered material.

4. LOANS, LEASES, AND THE ALLOWANCE FOR LOAN AND LEASE LOSSES

Loans

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are reported at their outstanding unpaid principal balances adjusted for unamortized deferred fees or costs. Interest income is accrued on the unpaid principal balance and is recognized using the interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the effective yield method of accounting.

Loans become past due when the payment date has been missed. If payment has not been received within 30 days, then the loan is delinquent. Delinquent loans are placed into three categories; 30-59 days past due, 60-89 days past due, or 90+ days past due. Loans 90 or more days past due are considered non-performing.

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. If the credit is not well secured and in the process of collection, the loan is placed on non-accrual status and is subject to charge-off if collection of principal or interest is considered doubtful.

All interest due but not collected for loans that are placed on non-accrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cost-recovery method, until it again qualifies for an accrual basis. Any cash receipts on non-accrual loans reduce the carrying value of the loans. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current, the adverse circumstances which resulted in the delinquent payment status are resolved, and payments are made in a timely manner for a period of time sufficient to reasonably assure their future dependability.

The Bank considers a loan impaired when, based on current information and events, it is probable that it will be unable to collect principal or interest due according to the contractual terms of the loan. Commercial mortgage, commercial and industrial (“C&I”), and large balance leases (greater than $100,000) are identified for evaluation and individually considered impaired. These loans and leases are assessed for any impairment. Loan impairment is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Consumer loans and smaller balance leases are collectively evaluated for impairment. Since these loans and leases are not individually identified and evaluated, they are not considered impaired loans.

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

	•		1-3-Pass: Risk Rated 1-3 loans are loans with a slight risk of loss. The loan is secured by collateral of sufficient value to cover the loan by an acceptable margin. The financial statements of the company demonstrate sufficient net worth and repayment ability. The company has established an acceptable credit history with the bank and typically has a proven track record of performance. Management is experienced, and has an at least average ability to manage the company. The industry has an average or less than average susceptibility to wide fluctuations in business cycles.
			This risk rating includes all accruing consumer loans, including residential mortgages and home equities, that are less than 60 days past due.
	•		4-Watch: Although generally acceptable, a higher degree of risk is evident in these watch credits. Obligor assessment factors may have elements which reflect marginally acceptable conditions warranting more careful review and analysis and monitoring.
			The obligor’s balance sheet reflects generally acceptable asset quality with some elements weak or marginally acceptable. Liquidity may be somewhat strained, but is at an acceptable level to support operations. Obligor may be fully leveraged with ratios higher than industry averages. High leverage is negatively impacting the company, leaving it vulnerable to adverse change. Inconsistent or declining capability to service existing debt requirements evidenced by debt service coverage temporarily below or near acceptable level. The margin of collateral may be adequate, but declining or fluctuating in value. Company management may be unproven, but capable. Rapid expansion or acquisition may increase leverage or reduce cash flow.

			Negative industry conditions or weaker management could also be characteristic. Proper consideration should be given to companies in a high growth phase or in development business segments that may not have achieve sustainable earnings.
			Obligors demonstrate sufficient financial flexibility to react to and positively address the root cause of the adverse financial trends without significant deviations from their current business strategy. The rating is also used for borrowers that have made significant progress in resolving their financial weaknesses.
	•		5-O.A.E.M. (Other Assets Especially Mentioned): Special Mention (“SM”) — A special mention asset has potential weaknesses that warrant management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. SM assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
			SM assets have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the institution’s position at some future date. These assets pose elevated risk, but their weakness does not yet justify a substandard classification. Borrowers may be experiencing adverse operating trends (declining revenues or margins) or an ill proportioned balance sheet (e.g. increasing inventory without an increase in sales, high leverage, tight liquidity).
			Adverse economic or market conditions, such as interest rate increases or the entry of a new competitor, may also support a special mention rating.
			Nonfinancial reasons for rating a credit exposure special mention include management problems, pending litigation, an ineffective loan agreement or other material structural weakness, and any other significant deviation from prudent lending practices.
			The SM rating is designed to identify a specific level of risk and concern about asset quality. Although an SM asset has a higher probability of default than a pass asset, its default is not imminent.
			This risk rating includes the pool of consumer loans, including residential mortgages and home equities, that are 60-89 days past due.
	•		6-Substandard: A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
			Substandard assets have a high probability of payment default, or they have other well-defined weaknesses. They require more intensive supervision by bank management.
			Substandard assets are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk subsidies. For some substandard assets, the likelihood of full collection of interest and principal may be in doubt; such assets should be placed on non-accrual. Although substandard assets in the aggregate will have distinct potential for loss, an individual asset’s loss potential does not have to be distinct for the asset to be rated substandard. These loans are periodically reviewed and tested for impairment.
			This risk rating includes the pool of consumer loans, including residential mortgages and home equities, that are 90 or more days past due or in non-accrual status.
	•		7-Doubtful: An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

			A doubtful asset has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification of loss is deferred.
			Doubtful borrowers are usually in default, lack adequate liquidity or capital, and lack the resources necessary to remain an operating entity. Pending events can include mergers, acquisitions, liquidations, capital injections, the perfection of liens on additional collateral, the valuation of collateral, and refinancing.
			Generally, pending events should be resolved within a relatively short period and the ratings will be adjusted based on the new information. Because of high probability of loss, non-accrual accounting treatment is required for doubtful assets.
	•		8-Loss: Assets classified loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the assets have absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be achieved in the future.
			With loss assets, the underlying borrowers are often in bankruptcy, have formally suspended debt repayments, or have otherwise ceased normal business operations. Once an asset is classified loss, there is little prospect of collecting either its principal or interest. When access to collateral, rather than the value of the collateral, is a problem, a less severe classification may be appropriate. However, management should not maintain an asset on the balance sheet if realizing its value would require long-term litigation or other lengthy recovery efforts. Losses are to be recorded in the period an obligation becomes uncollectible.

Leases

The Bank’s leasing operations consists principally of the leasing of various types of small ticket commercial equipment. The Company follows ASC Topic 840, “Leases,” for all of its direct financing leases. The net investment in direct financing leases is the sum of all minimum lease payments and estimated residual values, less unearned income, net of the remaining mark. In the third quarter of 2009, the Company announced its intention to sell the leasing portfolio. As a result, the Company classified the leasing portfolio as held-for-sale and marked the portfolio down to its fair market value as of June 30, 2009. As of September 30, 2009, management decided to service the portfolio to maturity and transferred it to held-for-investment. The carrying value of the leasing portfolio amounted to $12.4 million and $15.5 million at March 31, 2011 and December 31, 2010, respectively. The CQI used for leases are delinquency and accruing status. The leasing CQI’s are discussed in more detail in the Credit Quality Indicators section of this footnote.

Loan and Lease Portfolio Composition

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

		March 31, 2011				December 31, 2010
		(in thousands)
Mortgage loans on real estate:
Residential Mortgages		$	69,815			$	69,958
Commercial and multi-family			274,138				261,371
Construction-Residential			1,412				1,320
Construction-Commercial			25,397				32,332
Home equities			53,736				53,120
Total real estate loans			424,498				418,101
Direct financing leases			12,449				15,475
Commercial loans			92,120				91,445
Consumer loans			1,996				2,458
Other			302				252
Net deferred loan origination costs			264				247
Total gross loans			531,629				527,978
Allowance for loan losses			(10,482	)			(10,424	)
Loans, net		$	521,147			$	517,554

Residential Mortgages: The Company originates adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage. These loans are collateralized by owner-occupied properties located in the Company’s market area. They are amortized over 10 to 30 years. Loans on one-to-four-family residential real estate are mostly originated in amounts of no more than 80% of appraised value or have private mortgage insurance. Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling.

Due to the lack of foreclosure activity and absence of any ongoing litigation, the Company has no accrual for loss contingencies or potential costs associated with foreclosure-related activities.

The Bank sells certain fixed rate residential mortgages to FNMA, while maintaining the servicing rights for those mortgages. During the three month period ended March 31, 2011, the Bank sold mortgages to FNMA totaling $7.3 million, as compared with $2.0 million sold during the three month period ended March 31, 2010. At March 31, 2011, the Bank had a loan servicing portfolio principal balance of $49.8 million upon which it earns servicing fees, as compared with $44.2 million at December 31, 2010. The value of the mortgage servicing rights for that portfolio was $0.4 million at March 31, 2011 and December 31, 2010. Residential mortgage loans held-for-sale were $1.4 million at March 31, 2011, compared with $2.9 million at December 31, 2010. The Company has never been contacted by FNMA to repurchase any loans due to improper documentation or fraud.

Commercial and Multi-Family Mortgages: Commercial real estate loans are made to finance the purchases of real estate with completed structures or in the midst of being constructed. These commercial real estate loans are secured by first liens on the real estate, which may include apartments, hotels, retail stores or plazas, healthcare facilities, and other non-owner-occupied facilities. These loans are less risky than commercial and industrial loans, since they are secured by real estate and buildings. The Company offers commercial mortgage loans with up to an 80% LTV ratio for up to 20 years on a variable and fixed rate basis. Many of these mortgage loans either mature or are subject to a rate call after three to five years. The Company’s underwriting analysis includes credit verification, independent appraisals, a review of the borrower’s financial condition, and the underlying cash flows. These loans are typically originated in amounts of no more than 80% of the appraised value of the property. Construction loans have a unique risk, because they are secured by an incomplete dwelling.

Home Equities: The Company originates home equity lines of credit and second mortgage loans (loans secured by a second lien position on owner-occupied one-to-four-family residential real estate). These loans carry a higher risk than first mortgage residential loans as they are in a second position relating to collateral. Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower’s financial condition,

and personal cash flows. A security interest, with title insurance when necessary, is taken in the underlying real estate.

Direct Financing Leases: From January 2005 to April 2009 the Company originated direct financing leases of commercial small-ticket general business equipment to companies located throughout the United States. These leases carry a high risk of loss. As a result of the increase in credit risks, poor performance in the portfolio, the lack of strategic fit with the Company’s community banking philosophy, and with the intention of reallocating capital back to its core business, management announced its exit from the national leasing business in April 2009. As a result of management’s decision to sell the portfolio a mark-to-market adjustment of $7.2 million was made on June 30, 2009. The mark was charged off against the allowance. The portfolio was subsequently placed back into held-for-investment as of September 30, 2009 after management determined that a greater value for the portfolio would be realized by keeping it and servicing it to maturity rather than selling it. The portfolio was re-classified as held-for-investment using the same $7.2 million mark. Since that time, leases that are determined to have zero value have been applied to the remaining mark, rather than charged off through the allowance. There is an allowance for lease losses for $1.5 million at March 31, 2011.

Commercial and Industrial Loans: These loans generally include term loans and lines of credit. Such loans are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition of real estate, expansion and improvements) and equipment purchases. As a general practice, a collateral lien is placed on equipment or other assets owned by the borrower. These loans carry a higher risk than commercial real estate loans by the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable. To reduce the risk, management also attempts to secure real estate as collateral and obtain personal guarantees of the borrowers. To further reduce risk and enhance liquidity, these loans generally carry variable rates of interest, re-pricing in three- to five-year periods, and have a maturity of ten years or less. Lines of credit generally carry floating rates of interest (e.g., prime plus a margin).

Consumer Loans: The Company funds a variety of consumer loans, including direct automobile loans, recreational vehicle loans, boat loans, aircraft loans, home improvement loans, and personal loans (collateralized and uncollateralized). Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging up to five years, based upon the nature of the collateral and the size of the loan. The majority of consumer loans are underwritten on a secured basis using the underlying collateral being financed. A minimal amount of loans are unsecured, which carry a high risk of loss.

Other Loans: These loans include $0.1 million and $0.3 million at March 31, 2011 and December 31, 2010, respectively, of overdrawn deposit accounts classified as loans.

Net loan commitment fees or costs for commitment periods greater than one year are deferred and amortized into fee income or other expense on a straight-line basis over the commitment period.

Credit Quality Indicators

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

		March 31, 2011
Corporate Credit		(in thousands)
Exposure — By		Commercial Real				Commercial Real				Total Commercial
Credit Rating		Estate Construction				Estate Other				Real Estate				Commercial
3		$	19,441			$	222,248			$	241,689			$	61,931
4			2,211				36,929				39,140				19,329
5			2,276				5,442				7,718				5,090
6			1,469				9,519				10,988				4,847
7			—				—				—				923
Total		$	25,397			$	274,138			$	299,535			$	92,120