EVANS BANCORP, INC. 10-Q
Table of Contents

 
 
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 June 30, 2008
     
o   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 0-18539
EVANS BANCORP, INC.
(Exact name of registrant as specified in its charter)
     
New York   16-1332767
     
(State of 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
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed
since last report)
     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 is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
     Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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 2,755,274 shares as of August 1, 2008
 
 

 


 

INDEX
EVANS BANCORP, INC. AND SUBSIDIARIES
         
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    27  
 EX-10.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

 


Table of Contents

1
PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2008 AND DECEMBER 31, 2007
(in thousands, except share and per share amounts)
                 
    June 30,     December 31,  
    2008     2007  
ASSETS
               
Cash and due from banks
  $ 16,031     $ 12,335  
Interest-bearing deposits at banks
    653       269  
Securities:
               
Available for sale, at fair value
    64,978       70,144  
Held to maturity, at amortized cost
    2,079       2,266  
Loans and leases, net of allowance for loan and lease losses of $5,059 in 2008 and $4,555 in 2007
    360,961       319,556  
Properties and equipment, net
    8,512       8,366  
Goodwill
    10,046       10,046  
Intangible assets
    2,180       2,507  
Bank-owned life insurance
    10,968       10,760  
Other assets
    8,331       6,480  
 
           
 
               
TOTAL ASSETS
  $ 484,739     $ 442,729  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
LIABILITIES
               
Deposits:
               
Demand
  $ 76,947     $ 69,268  
NOW
    16,691       10,141  
Regular savings
    107,845       92,864  
Muni-vest
    17,952       24,530  
Time
    152,025       129,026  
 
           
Total deposits
    371,460       325,829  
 
               
Securities sold under agreement to repurchase
    4,342       3,825  
Other short-term borrowings
    23,083       33,980  
Other liabilities
    10,877       10,361  
Junior subordinated debentures
    11,330       11,330  
Long-term borrowings
    18,349       14,101  
 
           
 
               
Total liabilities
    439,441       399,426  
 
           
 
               
CONTINGENT LIABILITIES AND COMMITMENTS
               
 
               
STOCKHOLDERS’ EQUITY:
               
Common stock, $.50 par value; 10,000,000 shares authorized; 2,759,700 and 2,756,731 shares issued, respectively, and 2,755,274 and 2,751,698 shares outstanding, respectively
    1,380       1,378  
Capital surplus
    26,459       26,380  
Retained earnings
    17,573       15,612  
Accumulated other comprehensive (loss) income, net of tax
    (39 )     16  
Less: Treasury stock, at cost (4,426 and 5,033 shares, respectively)
    (75 )     (83 )
 
           
Total stockholders’ equity
    45,298       43,303  
 
           
 
               
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 484,739     $ 442,729  
 
           
See Notes to Unaudited Consolidated Financial Statements

 


Table of Contents

2
PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2008 AND 2007
in thousands, except share and per share amounts)
                 
    Three Months Ended  
    June 30  
    2008     2007  
INTEREST INCOME
               
Loans and leases
  $ 6,434     $ 6,094  
Interest bearing deposits at banks
    3       10  
Securities:
               
Taxable
    320       861  
Non-taxable
    392       435  
 
           
Total interest income
    7,149       7,400  
INTEREST EXPENSE
               
Deposits
    1,866       2,670  
Other borrowings
    299       313  
Junior subordinated debentures
    154       223  
 
           
Total interest expense
    2,319       3,206  
NET INTEREST INCOME
    4,830       4,194  
PROVISION FOR LOAN AND LEASE LOSSES
    675       345  
 
           
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES
    4,155       3,849  
NON-INTEREST INCOME:
               
Bank charges
    540       548  
Insurance service and fees
    1,617       1,423  
Net gain (loss) on sales of securities
    7       (2,302 )
Premium on loans sold
    4       4  
Bank-owned life insurance
    151       177  
Other
    493       439  
 
           
Total non-interest income
    2,812       289  
NON-INTEREST EXPENSE:
               
Salaries and employee benefits
    2,837       2,621  
Occupancy
    578       525  
Supplies
    62       73  
Repairs and maintenance
    143       140  
Advertising and public relations
    102       133  
Professional services
    254       273  
Technology and communications
    290       255  
Amortization of intangibles
    166       142  
Other insurance
    84       90  
Other
    526       460  
 
           
 
               
Total non-interest expense
    5,042       4,712  
 
           
 
               
INCOME (LOSS) BEFORE INCOME TAXES
    1,925       (574 )
INCOME TAX PROVISION (BENEFIT)
    540       (435 )
 
           
NET INCOME (LOSS)
  $ 1,385       ($139 )
 
           
 
Net income (loss) per common share-basic
  $ 0.50     $ (0.05 )
 
           
Net income (loss) per common share-diluted
  $ 0.50     $ (0.05 )
 
           
Cash dividends per common share
  $ 0.00     $ 0.00  
 
           
Weighted average number of common shares
    2,748,771       2,743,819  
 
           
Weighted average number of diluted shares
    2,750,563       2,743,819  
 
           
See Notes to Unaudited Consolidated Financial Statements

 


Table of Contents

3
PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(in thousands, except share and per share amounts)
                 
    Six Months Ended  
    June 30,  
    2008     2007  
INTEREST INCOME
               
Loans and leases
  $ 12,608     $ 11,694  
Interest bearing deposits at banks
    7       97  
Securities:
               
Taxable
    641       1,873  
Non-taxable
    791       878  
 
           
Total interest income
    14,047       14,542  
INTEREST EXPENSE
               
Deposits
    3,823       5,373  
Other borrowings
    689       663  
Junior subordinated debentures
    347       441  
 
           
Total interest expense
    4,859       6,477  
NET INTEREST INCOME
    9,188       8,065  
PROVISION FOR LOAN AND LEASE LOSSES
    1,232       660  
 
           
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES
    7,956       7,405  
NON-INTEREST INCOME:
               
Bank charges
    1,072       1,019  
Insurance service and fees
    3,751       3,552  
Net gain (loss) on sales of securities
    7       (2,303 )
Premium on loans sold
    5       5  
Bank-owned life insurance
    208       317  
Pension curtailment
    328        
Other
    972       843  
 
           
Total non-interest income
    6,343       3,433  
NON-INTEREST EXPENSE:
               
Salaries and employee benefits
    5,709       5,289  
Occupancy
    1,204       1,128  
Supplies
    129       151  
Repairs and maintenance
    290       279  
Advertising and public relations
    210       220  
Professional services
    522       525  
Technology and communications
    565       519  
Amortization of intangibles
    328       286  
Other insurance
    165       180  
Other
    1,009       1,067  
 
           
 
               
Total non-interest expense
    10,131       9,644  
 
           
 
               
INCOME BEFORE INCOME TAXES
    4,168       1,194  
INCOME TAX PROVISION
    1,190       46  
 
           
NET INCOME
  $ 2,978     $ 1,148  
 
           
 
               
Net income per common share-basic
  $ 1.08     $ 0.42  
 
           
Net income per common share-diluted
  $ 1.08     $ 0.42  
 
           
Cash dividends per common share
  $ 0.37     $ 0.34  
 
           
Weighted average number of common shares
    2,748,643       2,737,232  
 
           
Weighted average number of diluted shares
    2,749,645       2,737,914  
 
           
See Notes to Unaudited Consolidated Financial Statements

 


Table of Contents

4
PART 1 — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(in thousands, except share and per share amounts)
                                                 
                            Accumulated              
                            Other              
    Common     Capital     Retained     Comprehensive     Treasury        
    Stock     Surplus     Earnings     Income (Loss)     Stock     Total  
Balance, January 1, 2007
  $ 1,373     $ 26,160     $ 14,196     $ (1,917 )   $ (269 )   $ 39,543  
 
                                               
Comprehensive income:
                                               
Net Income
                    1,148                       1,148  
 
                                               
Unrealized gain on available-for-sale securities, net of reclassification of loss of $1,413 (after tax) and tax effect of ($629)
                            985               985  
Amortization of prior service cost and net loss, net tax effect ($17)
                            26               26  
 
                                             
 
                                               
Total comprehensive income
                                            2,159  
 
                                             
 
Cash dividends ($0.34 per common share)
                    (928 )                     (928 )
 
                                               
Stock options expense
            56                               56  
 
Reissued 8,747 shares treasury stock under dividend reinvestment plan
            (21 )                     195       174  
 
                                               
Reissued 2,500 shares of restricted stock
            (53 )                     53        
 
                                               
Issued 7,983 shares treasury stock
    4       161                               165  
 
                                               
Reissued 4,689 shares treasury stock under employee stock purchase plan
            (20 )                     101       81  
 
                                               
Purchased 9,300 shares for treasury
                                    (189 )     (189 )
 
                                   
 
                                               
Balance, June 30, 2007
  $ 1,377     $ 26,283     $ 14,416     $ (906 )   $ (109 )   $ 41,061  
 
                                   
 
                                               
Balance, January 1, 2008
  $ 1,378     $ 26,380     $ 15,612     $ 16     $ (83 )   $ 43,303  
 
                                               
Comprehensive income:
                                               
Net Income
                    2,978                       2,978  
 
Unrealized loss on available-for-sale securities, net of tax effect of $65
                            (101 )             (101 )
 
                                               
Amortization of prior service cost and net loss
                            37               37  
 
                                               
Pension curtailment adjustment net of taxes $7
                            9               9  
 
                                             
Total comprehensive income
                                            2,923  
 
                                             
 
                                               
Cash dividends ($0.37 per common share)
                    (1,017 )                     (1,017 )
 
                                               
Stock options expense
            74                               74  
 
                                               
Reissued 7,733 shares treasury stock under dividend reinvestment plan
            (12 )                     130       118  
 
                                               
Issued 2,969 shares under dividend reinvestment plan
    2       44                               46  
 
                                               
Reissued 6,575 shares treasury stock under employment stock purchase plan
            (27 )                     112       85  
 
                                               
Purchased 13,701 shares for treasury
                                    (234 )     (234 )
 
                                   
 
                                               
Balance, June 30, 2008
  $ 1,380     $ 26,459     $ 17,573     $ (39 )   $ (75 )   $ 45,298  
 
                                   
See Notes to Unaudited Consolidated Financial Statements

 


Table of Contents

5
PART I—FINANCIAL INFORMATION
ITEM I—FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(in thousands)
                 
    Six Months Ended  
    June 30,  
    2008     2007  
OPERATING ACTIVITIES:
               
Interest received
  $ 14,020     $ 13,748  
Fees received
    5,677       5,367  
Interest paid
    (4,963 )     (6,416 )
Cash paid to employees and suppliers
    (8,484 )     (8,525 )
Income taxes paid
    (2,344 )     (1,069 )
Proceeds from sale of loans held for resale
    1,391       1,117  
Originations of loans held for resale
    (1,336 )     (1,385 )
 
           
 
               
Net cash provided by operating activities
    3,961       2,837  
 
               
INVESTING ACTIVITIES:
               
Available for sales securities:
               
Purchases
    (49,005 )     (66,937 )
Proceeds from sales
          45,653  
Proceeds from maturities
    54,149       39,733  
Held to maturity securities:
               
Purchases
    (41 )     (93 )
Proceeds from maturities
    229       1,917  
Additions to properties and equipment
    (536 )     (193 )
Increase in loans, net of repayments
    (43,088 )     (13,676 )
Sale of other real estate
          (6 )
Cash paid on earn-out agreements
    (40 )     (202 )
 
           
 
               
Net cash (used in) provided by investing activities
    (38,332 )     6,196  
 
               
FINANCING ACTIVITIES:
               
Proceeds from short-term borrowings
    7,517        
Proceeds from long-term borrowings
    5,000        
Repayments of short-term borrowings
    (18,585 )     (21,285 )
Repayments of long-term borrowings
    (64 )     (2,381 )
Increase in deposits
    45,631       17,378  
Dividends paid
    (1,017 )     (928 )
Purchase of treasury stock
    (234 )     (189 )
Re-issuance of treasury stock
    203       255  
 
           
 
               
Net cash provided by (used in) financing activities
    38,451       (7,150 )
 
               
Net increase in cash and equivalents
    4,080       1,883  
 
               
CASH AND CASH EQUIVALENTS:
               
Beginning of period
    12,604       12,592  
 
           
 
               
End of period
  $ 16,684     $ 14,475  
 
           

 


Table of Contents

6
PART I—FINANCIAL INFORMATION
ITEM I—FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(in thousands)
                 
    Six Months Ended  
    June 30,  
    2008     2007  
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
               
 
               
Net income
  $ 2,978     $ 1,148  
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    813       856  
Deferred tax benefit
    66       91  
Provision for loan and lease losses
    1,232       660  
Net (gain) loss on sales of assets
    (7 )     2,309  
Premiums on loans sold
    (5 )     (5 )
Stock options expense
    74       56  
Proceeds from sale of loans held for resale
    1,391       1,117  
Originations of loans held for resale
    (1,336 )     (1,385 )
Changes in assets and liabilities affecting cash flow:
               
Other assets
    (2,514 )     (2,968 )
Other liabilities
    1,269       958  
 
           
 
               
NET CASH PROVIDED BY OPERATING ACTIVITIES
  $ 3,961     $ 2,837  
 
           
 
               
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
               
 
               
Issuance of shares for earn out agreement
  $     $ 165  
See Notes to Unaudited Consolidated Financial Statements

 


Table of Contents

7
PART 1 — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
EVANS BANCORP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED JUNE 30, 2008 AND 2007
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 National Bank, effective August 1, 2008 its name was changed to 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, Inc. (“ENFS”), and ENFS’s subsidiary ENB Insurance Agency, Inc. (“ENBI”) and ENBI’s subsidiaries, Frontier Claims Services, Inc. (“FCS”) and ENB Associates Inc. (“ENB”), in the preparation of the accompanying interim unaudited consolidated financial statements conform with U.S. generally accepted accounting principles and with general practice within the banking industry. 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. Such adjustments are of a normal recurring nature.
 
    The results of operations for the three and six month period ended June 30, 2008 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, 2007.
 
2.   SECURITIES
 
    Securities which the Company has the positive ability and intent to hold to maturity are stated at amortized cost. Securities which the Company has identified as available-for-sale are stated at fair value with unrealized gains and losses excluded from earnings and reported net of deferred income taxes, in accumulated other comprehensive income, a component of stockholders’ equity. Available-for-sale securities are shown at fair value which includes an unrealized gain of $0.6 million, $1.2 million and $0.7 million as of June 30, 2008, March 31, 2008, and December 31, 2007, respectively. As of June 30, 2008 the securities portfolio should not contain any other than temporary declines in fair value.
 
3.   FAIR VALUE MEASUREMENTS
 
    As of January 1, 2008, the Company adopted on a prospective basis certain required provisions of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, as amended by Financial Accounting Standards Board (FASB) Financial Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157. Those provisions relate to financial assets and liabilities carried at fair value and fair value disclosures related to financial assets and liabilities. SFAS 157 defines fair value, expands related disclosure requirements 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.

 


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    Investments that are classified as available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in Other Comprehensive Income. The fair value measurement of these instruments are measured using quoted prices for similar instruments in active markets, which is defined as Level 2 inputs. All other financial assets and liabilities, including held to maturity securities, loans and leases, deposits, securities sold under agreement to repurchase, other short-term borrowings, junior subordinated debentures, and long-term borrowings are carried at either amortized cost or historical proceeds. The adoption of SFAS 157 did not have significant impact on our consolidated financial statements. The Company did not elect to adopt SFAS 157 for acquired non-financial assets and assumed non-financial liabilities.
 
4.   ALLOWANCE FOR LOAN AND LEASE LOSSES
 
    The provision for loan and lease losses represents the amount charged against the Bank’s earnings to maintain an allowance for probable loan and lease losses based on management’s evaluation of the loan and lease portfolio at the balance sheet date. Factors considered by the Bank’s management in establishing the allowance include: the collectibility of individual loans and leases, current loan and lease concentrations, charge-off history, delinquent loan and lease percentages, input from regulatory agencies and general economic conditions.
 
    On a quarterly basis, management of the Bank meet to review and determine the adequacy of the allowance for loan and lease losses. In making this determination, the Bank’s management analyzes the ultimate collectibility of the loans and leases in its portfolio by incorporating feedback provided by the Bank’s internal loan and lease staff, an independent internal loan and lease review function and information provided by examinations performed by regulatory agencies.
 
    The analysis of the allowance for loan and lease losses is composed of three components: specific credit allocation, general portfolio allocation and a subjective allocation. The specific credit allocation includes a detailed review of the credit in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,” and allocation is made based on this analysis. The general portfolio allocation consists of an assigned reserve percentage based on the historical loss experience of the loan or lease category.
 
    The subjective portion of the allowance reflects management’s evaluation of various conditions, and involves a higher degree of uncertainty because this component of the allowance is not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with this component include the following: industry and regional conditions; seasoning of the loan and lease portfolio and changes in the composition of and growth in the loan and lease portfolio; the strength and duration of the business cycle; existing general economic and business conditions in the lending areas; credit quality trends in nonaccruing loans and leases; historical loan and lease charge-off experience; and the results of bank regulatory examinations.
 

 


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    The following table sets forth information regarding the allowance for loan and lease losses for the six month periods ended June 30, 2008 and 2007.
Allowance for loan and lease losses
                 
    Six months ended June 30,  
    2008     2007  
    (in thousands)  
Beginning balance, January 1
  $ 4,555     $ 3,739  
Charge-offs:
               
Commercial
          (153 )
Real estate
    (1 )     (5 )
Installment loans
    (3 )     (4 )
Overdrafts
    (26 )     (16 )
Direct financing leases
    (838 )     (400 )
 
           
Total charge-offs
    (868 )     (578 )
 
               
Recoveries:
               
Commercial
    18       9  
Real estate
           
Installment loans
    2       1  
Overdrafts
    13       8  
Direct financing leases
    107       27  
 
           
Total recoveries
    140       45  
 
           
 
               
Net charge-offs
    (728 )     (533 )
 
               
Provision for loan and lease losses
    1,232       660  
 
           
 
               
Ending balance, June 30
  $ 5,059     $ 3,866  
 
           
 
               
Ratio of net charge-offs to average total loans and leases outstanding (annualized)
    0.43 %     0.37 %
 
           
5.   PER SHARE DATA
The common stock per share information is based upon the weighted average number of shares outstanding during each period, retroactively adjusted for stock dividends and stock splits. The Company’s potential dilutive securities included 1,792 and 1,002 dilutive shares for the three and six month periods ended June 30, 2008, respectively. This compares with 0 and 682 for the three and six month periods ended June 30, 2007, respectively.
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 six months periods ended June 30, 2008, there were approximately 106 thousand and 100 thousand shares, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive. For the three and six months periods ended June 30, 2007, there were approximately 74 thousand and 61 thousand shares, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive.
6.   SEGMENT INFORMATION
 
    The Company is comprised of two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three and six month periods ended June 30, 2008 and 2007.

 


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Three Months Ended
June 30, 2008
(in thousands)
                         
            Insurance Agency        
    Banking Activities     Activities     Total  
Net interest income (expense)
  $ 4,898     $ (68 )   $ 4,830  
 
                       
Provision for loan and lease losses
    675             675  
 
                 
 
                       
Net interest income (expense) after provision for loan and lease losses
    4,223       (68 )     4,155  
 
                       
Non-interest income
    1,195             1,195  
 
                       
Insurance service and fees
          1,617       1,617  
 
                       
Non-interest expense
    3,761       1,281       5,042  
 
                 
 
                       
Income before income taxes
    1,657       268       1,925  
 
                       
Income tax provision
    437       103       540  
 
                 
 
                       
Net income
  $ 1,220     $ 165     $ 1,385  
 
                 
Six Months Ended
June 30, 2008
(in thousands)
                         
            Insurance Agency        
    Banking Activities     Activities     Total  
Net interest income (expense)
  $ 9,347     $ (159 )   $ 9,188  
 
                       
Provision for loan and lease losses
    1,232             1,232  
 
                 
 
                       
Net interest income (expense) after provision for loan and lease losses
    8,115       (159 )     7,956  
 
                       
Non-interest income
    2,592             2,592  
 
                       
Insurance service and fees
          3,751       3,751  
 
                       
Non-interest expense
    7,557       2,574       10,131  
 
                 
 
                       
Income before income taxes
    3,150       1,018       4,168  
 
                       
Income tax provision
    796       394       1,190  
 
                 
 
                       
Net income
  $ 2,354     $ 624     $ 2,978  
 
                 

 


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Three Months Ended
June 30, 2007
(in thousands)
                         
            Insurance Agency        
    Banking Activities     Activities     Total  
Net interest income (expense)
  $ 4,297     $ (103 )   $ 4,194  
Provision for loan and lease losses
    345             345  
 
                 
Net interest income (expense) after provision for loan and lease losses
    3,952       (103 )     3,849  
Non-interest loss
    (1,134 )           (1,134 )
Insurance service and fees
          1,423       1,423  
Non-interest expense
    3,577       1,135       4,712  
 
                 
Income before income taxes
    (759 )     185       (574 )
Income tax (benefit) provision
    (509 )     74       (435 )
 
                 
Net (loss) income
    ($250 )   $ 111     $ (139 )
 
                 
Six Months Ended
June 30, 2007
(in thousands)
                         
            Insurance Agency        
    Banking Activities     Activities     Total  
Net interest income (expense)
  $ 8,288     $ (223 )   $ 8,065  
Provision for loan and lease losses
    660             660  
 
                 
Net interest income (expense) after provision for loan and lease losses
    7,628       (223 )     7,405  
Non-interest loss
    (119 )           (119 )
Insurance service and fees
          3,552       3,552  
Non-interest expense
    7,360       2,284       9,644  
 
                 
Income before income taxes
    149       1,045       1,194  
Income tax (benefit) provision
    (372 )     418       46  
 
                 
Net income
  $ 521     $ 627     $ 1,148  
 
                 
7.   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 at June 30, 2008 and 2007 is as follows:


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    2008     2007  
    (in thousands)  
Commitments to extend credit
  $ 71,213     $ 57,662  
 
               
Standby letters of credit
    2,787       2,089  
 
           
 
               
Total
  $ 74,000     $ 59,751  
 
           
Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance of 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 has not incurred any losses on its commitments during the past two years.
Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” 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 are not considered material.
The Company is subject to possible litigation proceedings in the normal course of business. As of June 30, 2008, there were no claims pending against the Company that management considered to be material.
8.   RECLASSIFICATIONS
Certain reclassifications have been made to the 2007 unaudited consolidated financial statements to conform with the presentation used in 2008.
9.   NET PERIODIC BENEFIT COSTS
On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Company employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive the benefits already earned through January 31, 2008 at retirement, but will not be able to accrue any additional benefits. As a result, service cost will no longer be incurred.
The Bank used an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual experience and assumptions being different than those that are projected. The amortized method the Bank used recognized the prior service cost and net gains or losses over the average remaining service period of active employees. The freezing of the defined benefit pension plan was considered a curtailment. This resulted in the elimination of the unrecognized prior service cost and the unrecognized net loss. The elimination of those two components resulted in a $328 thousand gain in the first quarter of 2008.
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.


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    Six months ended June 30,  
    (in thousands)  
                    Supplemental Executive  
    Pension Benefits     Retirement Plan  
    2008     2007     2008     2007  
         
Service cost
  $     $ 91     $ 30     $ 15  
Interest cost
    118       61       87       40  
Expected return on plan assets
    (146 )     (62 )            
Amortization of prior service cost
          (4 )     28       14  
Amortization of the net loss
          7       9       4  
 
                       
Net periodic (benefit) cost
  $ (28 )   $ 93     $ 154     $ 73  
 
                       
10. RECENT ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles. In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). We expect the hierarchical guidance provided by SFAS 162 will not have a significant impact on the Company’s financial statements.
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 and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; and other factors discussed elsewhere in this Report on Form 10-Q, as well as in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”). Many of these factors are beyond the Company’s control and are difficult to predict.
Because of these and other uncertainties, the Company’s actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein.


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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.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The Company’s Unaudited Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the Company’s Unaudited Consolidated Financial Statements and Notes. These estimates, assumptions and judgments are based on information available as of the date of the Unaudited Consolidated Financial Statements. Accordingly, as this information changes, the Unaudited Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques. Refer to Note 3 in Item 1 of this report for further detail on fair value measurement.
The most significant accounting policies followed by the Company are presented in Note 1 to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K. 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 valued in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.
Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses and valuation of goodwill to be the accounting areas that require the most subjective or complex judgments, and as such, could be most subject to revision as new information becomes available.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses represents management’s estimate of probable losses in the Company’s loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the Unaudited Consolidated Balance Sheets. Note 1 to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K describes the methodology used to determine the allowance for loan and lease 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.


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ANALYSIS OF FINANCIAL CONDITION
Loan and Lease Activity
     Total loans and leases grew to $366.0 at June 30, 2008, reflecting a $26.3 million or 7.7% increase from March 31, 2008 and a $41.9 million or 12.9% increase from December 31, 2007. Gross loans and leases are net of $10.1 million, $9.8 million and $9.7 million of unearned income on direct financing leases as of June 30, 2008, March 31, 2008 and December 31, 2007, respectively. Commercial loans and leases totaled $267.2 million at June 30, 2008, reflecting a $24.4 million or 10.1% increase from March 31, 2008 and a $38.8 million or 17.0% increase from December 31, 2007. Growth in commercial real estate loans of $16.8 million for the second fiscal quarter and $28.2 million for the year to date was largely responsible for the increase in commercial loans and leases from March 31, 2008 and December 31, 2007, respectively, to June 30, 2008.
     The Company has no exposure to sub-prime lending, and as a result, the faltering sub-prime credit market has not affected the Company’s loan portfolio. Further, the local real estate market to date has not experienced the significant deterioration in values seen in high-growth parts of the United States as local real estate values have remained steady to slightly up. In contrast, some of the Bank’s larger competitors and the conduit markets are having capital adequacy and liquidity problems due to their exposure to sub-prime loans in their investment portfolio or lending activities in other parts of the United States. These problems have curtailed their lending activities somewhat and consequently created opportunities in the local commercial real estate market for smaller banks not experiencing the same issues such as the Bank. The increased opportunities have resulted in the Bank’s strong loan growth rates.
     Direct finance leases increased $3.5 million or 7.4% from March 31, 2008 and $5.8 million or 12.9% from December 31, 2007. Direct finance leases are sold through a national channel of brokers with whom the Company has had long standing relationships and finance small commercial equipment. Direct leases carry a higher risk than the rest of the loan portfolio, but also provide a higher return. Management employs strict underwriting standards in selecting credits for this portion of the portfolio. The loan composition strategy is to maintain the direct lease portfolio at an optimum percentage of the loan portfolio that weights the risk involved in this type of credit.
     Consumer loans totaled $97.9 million at June 30, 2008, reflecting a $2.0 million or 2.1% increase from March 31, 2008 and a $3.0 million or 3.2% increase from December 31, 2007. Real estate loans increased $0.7 million or 1.2% from March 31, 2008 and $1.3 million or 2.3% from December 31, 2007. While short-term interest rates have sharply decreased in 2008, long-term fixed rates have actually been gradually increasing. This has put some downward pressure on the demand for consumer loans, resulting in lower growth rates in consumer loan balances.
     The Bank continues to sell certain fixed rate residential mortgages originated below a designated interest level to the Federal National Mortgage Association (“FNMA”), while maintaining the servicing rights for those mortgages. During the three month period ended June 30, 2008, the Bank sold mortgages to FNMA totaling $0.9 million, as compared with $0.8 million during the three month period ended June 30, 2007. During the six month period ended June 30, 2008, the Bank sold mortgages to FNMA totaling $1.4 million, as compared to $1.1 million during the six month period ended June 30, 2007. At June 30, 2008, the Bank had a loan servicing portfolio principal balance of $28.1 million upon which it earns servicing fees, as compared with $28.2 million at March 31, 2008 and $28.4 million at December 31, 2007.
Loan and Lease Portfolio Composition
     The following table presents selected information on the composition of the Company’s loan and lease portfolio in dollar amounts and in percentages as of the dates indicated.


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    June 30, 2008     Percentage     December 31, 2007     Percentage  
    (in thousands)             (in thousands)          
Commercial Loans and Leases
                               
Real Estate
  $ 176,498       48.2 %   $ 148,257       45.7 %
Installment
    20,647       5.6 %     18,502       5.7 %
Direct Financing Leases
    50,875       13.9 %     45,078       13.9 %
Lines of Credit
    19,148       5.2 %     16,446       5.1 %
Cash Reserve
    79       0.0 %     71       0.0 %
 
                       
 
                               
Total Commercial Loans and Leases
    267,247       72.9 %     228,354       70.4 %
 
                               
Consumer Loans
                               
Real Estate
    57,828       15.8 %     56,529       17.5 %
Home Equity
    37,449       10.3 %     36,035       11.1 %
Installment
    2,199       0.6 %     1,858       0.6 %
Overdrafts
    275       0.1 %     379       0.1 %
Other
    147       0.1 %     75       0.0 %
 
                       
 
                               
Total Consumer Loans
    97,898       26.9 %     94,876       29.3 %
Net Deferred Costs & Unearned Discounts
    875       0.2 %     881       0.3 %
 
                       
 
                               
Total Loans and Leases
    366,020       100.0 %     324,111       100.0 %
Allowance for Loan and Lease Losses
    (5,059 )             (4,555 )        
 
                           
Loans and Leases, net
  $ 360,961             $ 319,556          
 
                           
     Net loan and lease charge-offs were $368 thousand in the three month period ended June 30, 2008 as compared with $360 thousand in the first quarter of 2008 and $365 thousand in the three month period ended June 30, 2007. Net charge-offs were $728 thousand for the six month period ended June 30, 2008, as compared with $533 thousand for the same period of 2007. Despite the turbulent economic environment, the Bank has experienced a relatively stable charge-off level year-to-date through June 30, 2008. Non-performing loans and leases, defined as accruing loans and leases greater than 90 days past due and non-accrual loans and leases, totaled 0.12% of total loans and leases outstanding at June 30, 2008 as compared with 0.13% at March 31, 2008 and 0.22% at December 31, 2007. The allowance for loan and lease losses totaled $5.1 million or 1.38% of total loans and leases outstanding at June 30, 2008 as compared with $4.8 million or 1.40% of total loans and leases outstanding as of March 31, 2008 and $4.6 million or 1.41% of total loans and leases at December 31, 2007.
     The adequacy of the Company’s allowance for loan and lease losses is reviewed quarterly by the Company’s management with consideration given to loan and lease concentrations, charge-off history, delinquent loan and lease percentages, and general economic conditions. Management believes the allowance for loan and lease losses is adequate for losses from existing loans and leases.


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The following table sets forth information regarding non-performing loans and leases as of the dates specified.
                 
    June 30, 2008     December 31, 2007  
    (in thousands)  
Non-accruing loans and leases:
               
Mortgage loans on real estate
               
Residential 1-4 family
  $     $  
Commercial and multi-family
    97       112  
Construction
           
Second mortgages
           
Home equity lines of credit
    50        
 
           
Total mortgage loans on real estate
    147       112  
 
               
Direct financing leases
    136       215  
 
               
Commercial loans
    125       224  
 
               
Consumer installment loans
               
Personal
           
Credit cards
           
 
           
Other
           
Total consumer installment loans
           
 
               
Total non-accruing loans and leases
  $ 408     $ 551  
     
 
               
Accruing loans and leases 90+ days past due
    22       163  
 
           
Total non-performing loans and leases
    430       714  
 
           
Total non-performing loans and leases as a percentage of total assets
    0.09 %     0.16 %
Total non-performing loans and leases as a percentage of total loans and leases
    0.12 %     0.22 %
     For the three and six month period ended June 30, 2008, gross interest income that would have been reported on non-accruing loans and leases had they been current was $14 thousand and $30 thousand. For the three and six month periods ended June 30, 2007, gross interest income that would have been reported on non-accruing loans and leases had they been current, was $28 thousand and $46 thousand, respectively. There was $12 thousand and $22 thousand of interest income included in net income for the three and six month periods ended June 30, 2008 on non-accruing loans and leases. There was $12 thousand and $18 thousand of interest income included in net income for the three and six month periods ended June 30, 2007 on non-accruing loans and leases.
Investing Activities
     Total securities decreased to $67.1 million at June 30, 2008, reflecting a $6.5 million, or 8.8% decrease from $73.6 million at March 31, 2008, and a $5.3 million, or 7.3% decrease from $72.4 million at December 31, 2007. Securities and interest-bearing deposits at banks made up 16.0% of the Bank’s total average interest earning assets in the second quarter of 2008 compared with 18.0% in the trailing first quarter of 2008 and 30.3% in the second quarter of 2007. The large decline in the securities portfolio compared with the second quarter of 2007 is a result of the Company’s strategy to de-leverage a portion of its balance sheet. The Company sold $45 million in securities in June 2007.


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     The Bank continues to have a large concentration in tax-advantaged municipal bonds, which make up 50.1% of the portfolio at June 30, 2008 compared with 51.5% at March 31, 2008 and 52.3% at December 31, 2007; and U.S. government-sponsored agency bonds of various types, which comprise 19.5% of the portfolio at June 30, 2008 versus 27.3% at March 31, 2008 and 19.6% at December 31, 2007. Agency mortgage-backed securities comprise 25.6% at June 30, 2008 compared with 16.5% at March 31, 2008 and 23.2% as of December 31, 2007. As a member of both the Federal Reserve System and the Federal Home Loan Bank of New York, the Bank is required to hold stock in those entities. These investments made up 4.8% of the portfolio at June 30, 2008 versus 4.7% at March 31, 2008 and 4.9% of the portfolio at December 31, 2007. The credit quality of the securities portfolio is believed to be strong, with 96.9% of the securities portfolio carrying the equivalent of a Moody’s rating of Aaa.
     The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. Management believes the average expected life of the securities portfolio is 2.9 years as of June 30, 2008 compared with 2.4 years as of March 31, 2008 and December 31, 2007. Available-for-sale securities with a total fair value of $58.5 million at June 30, 2008 were pledged as collateral to secure public deposits and for other purposes required or permitted by law.
Funding Activities
     Total deposits at June 30, 2008 were $371.5 million, reflecting a $27.9 million or 8.1% increase from March 31, 2008 and a $45.7 million or 14.0% increase from December 31, 2007. Demand deposits at June 30, 2008 were $76.9 million, reflecting a $3.6 million or 4.9% increase from March 31, 2008 and a $7.6 million or 11.1% increase from December 31, 2007. Demand deposit balances fluctuate day-to-day based on the high volume of transactions normally associated with the demand product. Average demand deposit growth is a better measure of sustained growth. Average demand deposits in the three month period ended June 30, 2008 were 4.2% higher than the first quarter of 2008 and 2.2% higher than the prior year’s second quarter. Much of the overall deposit growth in the second quarter ended June 30, 2008 is attributable to an increase in regular savings deposits of $21.7 million, or 25.2%, to $107.8 million. After a period of flat growth to declining balances, the Company introduced a new money market product in an effort to attract savings deposits. The effort resulted in the increase in savings deposits in the second quarter ended June 30, 2008. Compared with December 31, 2007, savings deposits have increased $14.9 million, or 16.1%. Time deposits were $152.0 million at June 30, 2008, reflecting a $5.0 million or 3.4% increase from March 31, 2008, and a $23.0 million or 17.8% increase from December 31, 2007. Due to the significant growth in the Company’s loan and lease portfolio, the Company has been aggressive in attracting time deposits, particularly those with longer-term maturities. NOW deposits increased in the second quarter ended June 30, 2008 while muni-vest balances decreased in the same quarter as a result of one large municipal customer moving money between two products with similar rates.
     Short-term borrowings from other correspondent banks and the Federal Home Loan Bank of New York decreased from $34.0 million at December 31, 2007 and $27.4 million at March 31, 2008 to $23.1 million at June 30, 2008. In contrast, long-term borrowings remained at $18.3 million at June 30, 2008, virtually flat to the balance at March 31, 2008, and higher than the December 31, 2007 balance of $14.1 million. The Federal Reserve continued to cut its target rate for federal funds in the first half of 2008 in light of a sluggish economy. By the end of the 2008 second quarter, the target rate stood at 2.00%. Compared to historical norms, interest rates were at a lower than usual level in the first and second quarter of 2008, prompting the Company to lock in relatively low rates for a longer period of time, resulting in the increase in long-term borrowings and the decrease in short-term borrowings.


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19

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 and lease balances include both performing and non-performing loans and leases. Investments are included at amortized cost. Yields are presented on a non-tax-equivalent basis.
                                                 
            Three Months Ended                     Three Months Ended        
            June 30, 2008                     June 30, 2007        
    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 and leases, net
  $ 345,200     $ 6,434       7.46 %   $ 294,365     $ 6,094       8.28 %
Taxable securities
    29,130       320       4.39 %     85,975       861       4.01 %
Tax-exempt securities
    35,947       392       4.36 %     39,425       435       4.41 %
Interest bearing deposits at banks
    651       3       1.84 %     2,333       10       1.71 %
 
                                   
 
                                               
Total interest-earning assets
    410,928       7,149       6.96 %     422,098       7,400       7.01 %
 
                                       
 
                                               
Non interest-earning assets:
                                               
 
                                               
Cash and due from banks
    12,143                       10,789                  
Premises and equipment, net
    8,343                       8,653                  
Other assets
    29,734                       29,681                  
 
                                           
 
                                               
Total Assets
    461,148                     $ 471,221                  
 
                                           
LIABILITIES & STOCKHOLDERS’ EQUITY
                                               
Interest-bearing liabilities:
                                               
NOW
  $ 12,722     $ 24       0.75 %   $ 11,015     $ 6       0.22 %
Regular savings
    93,448       285       1.22 %     85,638       256       1.20 %
Muni-Vest savings
    24,457       118       1.93 %     46,989       514       4.38 %
Time deposits
    145,705       1,439       3.95 %     156,521       1,894       4.84 %
Other borrowed funds
    39,901       288       2.89 %     30,495       298       3.91 %
Junior subordinated debentures
    11,330       154       5.44 %     11,330       223       7.87 %
Securities sold U/A to repurchase
    5,363       11       0.82 %     7,453       15       0.81 %
 
                                   
 
                                               
Total interest-bearing liabilities
    332,926     $ 2,319       2.79 %     349,441     $ 3,206       3.67 %
 
                                       
 
                                               
Noninterest-bearing liabilities:
                                               
Demand deposits
    72,940                       71,340                  
Other
    10,493                       9,913                  
 
                                           
Total liabilities
    416,359                     $ 430,694                  
 
                                               
Stockholders’ equity
    44,789                       40,527                  
 
                                           
 
                                               
Total Liabilities and Equity
    461,148                     $ 471,221                  
 
                                           
Net interest earnings
          $ 4,830                     $ 4,194          
 
                                           
Net yield on interest earning assets
                    4.70 %                     3.97 %
 
                                           
Interest rate spread
                    4.17 %                     3.34 %
 
                                           


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20

                                                 
            Six Months Ended                     Six Months Ended        
            June 30, 2008                     June 30, 2007        
    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 and leases, net
  $ 333,680     $ 12,608       7.56 %   $ 290,696     $ 11,694       8.05 %
Taxable securities
    31,023       641       4.13 %     90,159       1,873       4.15 %
Tax-exempt securities
    36,400       791       4.35 %     40,327       878       4.35 %
Interest bearing deposits at banks
    676       7       2.07 %     4,676       97       4.15 %
 
                                   
 
                                               
Total interest-earning assets
    401,779       14,047       6.99 %     425,858       14,542       6.83 %
 
                                       
Non interest-earning assets:
                                               
 
                                               
Cash and due from banks
    12,086                       10,889                  
Premises and equipment, net
    8,332                       8,681                  
Other assets
    29,684                       29,619                  
 
                                           
 
                                               
Total Assets
    451,881                     $ 475,047                  
 
                                           
LIABILITIES & STOCKHOLDERS’ EQUITY
                                               
Interest-bearing liabilities:
                                               
NOW
  $ 11,549     $ 39       0.68 %   $ 11,532     $ 12       0.21 %
Regular savings
    90,089       541       1.20 %     86,933       508       1.17 %
Muni-Vest savings
    24,458       295       2.41 %     47,458       1,032       4.35 %
Time deposits
    140,896       2,948       4.18 %     156,988       3,821       4.87 %
Other borrowed funds
    41,566       667       3.21 %     32,248       634       3.93 %
Junior subordinated debentures
    11,330       347       6.13 %     11,330       441       7.78 %
Securities sold U/A to repurchase
    5,439       22       0.81 %     7,447       29       0.78 %
 
                                   
 
                                               
Total interest-bearing liabilities
    325,327     $ 4,859       2.99 %     353,936     $ 6,477       3.66 %
 
                                       
Noninterest-bearing liabilities:
                                               
Demand deposits
    71,464                       71,132                  
Other
    10,651                       9,685                  
 
                                           
Total liabilities
    407,442                     $ 434,753                  
 
                                               
Stockholders’ equity
    44,439                       40,294                  
 
                                           
 
                                               
Total Liabilities and Equity
    451,881                     $ 475,047                  
 
                                           
Net interest earnings
          $ 9,188                     $ 8,065          
 
                                           
Net yield on interest earning assets
                    4.57 %                     3.79 %
 
                                           
Interest rate spread
                    4.01 %                     3.17 %
 
                                           
Net Income
Net income for the second quarter of 2008 was $1.39 million, or $0.50 per diluted share, compared with a net loss of $0.14 million, or $0.05 per diluted share, in the second quarter of 2007. In last year’s second quarter, the Company sold $45 million of securities at an after-tax loss of $1.41 million, or $0.51 per diluted share. Return on average equity was 12.37% for the second quarter 2008, compared with a negative 1.37% in last year’s second quarter. For the six-month period ended June 30, 2008, net income was $2.98 million, or $1.08 per diluted share, up from $1.15 million, or $0.42 per diluted share, in the same period in 2007. The return on average equity was 13.40% and 5.70% for the six-month periods ended June 30, 2008 and 2007, respectively.


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“Net operating” income (as defined in the following Supplemental Non-GAAP Disclosure) is net income adjusted for what management considers to be “non-operating” items. Net operating income for the second quarter of 2008 was $1.48 million, or $0.54 per diluted share, up $0.12 million, or 8.9%, from net operating income of $1.36 million, or $0.50 per diluted share, in the second quarter of 2007. For the six-month period ended June 30, 2008, net operating income of $3.18 million, or $1.15 per diluted share, was 16.0% higher than net operating income of $2.74 million, or $1.00 per diluted share, in the same period in 2007.
Supplemental Reporting of Non-GAAP Results of Operations
To provide investors with greater visibility of the Company’s operating results, in addition to the results measured in accordance with U.S. generally accepted accounting principles (“GAAP”), the Company provides supplemental reporting on “net operating income”, which excludes items that management believes to be non-operating in nature. Specifically, “net operating income” excludes gains and losses on the sale of securities and the amortization of acquisition-related intangible assets. This non-GAAP information is being disclosed because management believes that providing these non-GAAP financial measures provides investors with information useful in understanding the Company’s financial performance, its performance trends, and financial position. While the Company’s management uses these non-GAAP measures in its analysis of the Company’s performance, this information should not be viewed as a substitute for financial results determined in accordance with GAAP or considered to be more important than financial results determined in accordance with GAAP, nor is it necessarily comparable with non-GAAP measures which may be presented by other companies.
See the reconciliation of net operating income and diluted net operating earnings per share to net income and diluted earnings per share in the following table:
Reconciliation of GAAP Net Income to Net Operating Income
                                                 
    Three months ended             Six months ended        
    June 30     Inc     June 30        
(in thousands, except per share)   2008     2007     (dec)     2008     2007     Inc (dec)  
GAAP Net Income (Loss)
  $ 1,385     $ (139 )           $ 2,978     $ 1,148       159.4 %
 
                                               
(Gain) loss on sale of securities*
    (4 )     1,413               (4 )     1,414          
Amortization of intangibles*
    101       87               201       176          
 
                                       
 
                                               
Net operating income
  $ 1,482     $ 1,361       8.9 %   $ 3,175     $ 2,738       16.0 %
 
                                       
 
                                               
GAAP diluted (loss) earnings per share
  $ 0.50     $ (0.05 )           $ 1.08     $ 0.42       157.1 %
 
                                               
(Gain) loss on sale of securities*
          0.51                     0.52          
Amortization of intangibles*
    0.04       0.04               0.07       0.06          
 
                                       
 
                                               
Diluted net operating earnings per share
  $ 0.54     $ 0.50       8.0 %   $ 1.15     $ 1.00       15.0 %
 
                                       
 
*   After any tax-related effect
Other Operating Results
Net interest income for the three and six month periods ended June 30, 2008 was $4.8 million and $9.2 million, respectively, an increase of $0.6 million and $1.1 million over the same periods in 2007. There are several factors driving the increase. First, there has been strong growth in the Company’s commercial loan portfolio, particularly its commercial real estate portfolio. Second, there has been a benefit to net interest income from the de-leverage of the balance sheet in June 2007 of low-earning investment securities and high-cost borrowings. Third, the Company has benefited from a decline in market interest rates as the Federal Reserve has cut its target federal funds rate by 300 basis points since September 2007 to 2.00% at the end of June 2008.


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The net interest margin for the three month period ended June 30, 2008 was 4.70%, as compared with 4.44% in the first quarter of 2008 and 3.97% for the three months ended June 30, 2007. The return on interest earning assets in the three month period ended June 30, 2008 decreased 7 and 5 basis points from the linked quarter and the prior year second quarter, respectively. The decrease from those periods is due to the decreased yield earned on variable rate loans. The cost of interest-bearing liabilities was 2.79% in the second quarter of 2008, compared to 3.20% in the linked quarter and 3.67% in the second quarter of 2007. The drop in market interest rates resulted in lower rates paid on most funding sources, particularly muni-vest savings, time deposits, and short-term borrowings. Interest free funds contributed 53 basis points to the net interest margin in the three month period ended June 30, 2008, compared to 61 basis points in the first quarter of 2008, and 63 basis points in the second quarter of 2007. The contribution of interest-free funds has decreased due to the large decrease in the cost of interest-bearing liabilities.
The net interest margin for the six month period ended June 30, 2008 was 4.57%, as compared with 3.79% in the same period in 2007.
The provision for loan and lease losses for the three month period ended June 30, 2008 increased to $675 thousand from $557 thousand in the linked quarter and $345 thousand in the same three month period in 2007 as a result of increased loan growth and additional reserves needed for the continued seasoning of the leasing portfolio. The ratio of net charge-offs to average loans and leases decreased from 0.50% in the second quarter of 2007, and from 0.44% in the first quarter of 2008, to 0.42% in the second quarter of 2008. The net charge-off level has remained approximately the same while the loan and lease portfolio has grown, resulting in a lower ratio. As has been the experience since the Company began originating small-ticket leases, the majority of write-offs have been in leases. This is consistent with the nature of these credits in which the Company requires a higher rate of return.
Non-interest income was $2.8 and $6.3 million for the three and six month periods ended June 30, 2008, respectively. This is an increase of $2.5 and $2.9 million, respectively, from the same periods of 2007. Most of the increases ($2.3 million) are attributable to the loss on the sale of $45 million in securities in the second quarter of 2007 when the Company restructured its balance sheet. Excluding securities gains and losses, all other non-interest income rose 8.5% for the three month period ended June 30, 2008 and 10.5% for the six month period ended June 30, 2008, when compared with the same periods of 2007. The largest component of non-interest income, insurance revenue, improved 13.6% to $1.6 million in the three month period ended June 30, 2008 compared to the same period of the prior year. For the six month period ended June 30, 2008, it increased 5.6%, or $0.2 million, to $3.8 million when compared with the six month period in the prior year. The increase in insurance revenue is due in large part to the purchase of an insurance agency in July 2007.
Total non-interest expenses were $5.0 and $10.1 million for the three and six month periods ended June 30, 2008, respectively. This is an increase of $0.3 million, or 7.0%, and $0.5 million, or 5.0%, respectively, from the same periods in 2007. Salary and employee benefit expense for the three month period ended June 30, 2008 increased $0.2 million, or 8.2%, to $2.8 million for the quarter due to merit increases, the addition of new employees in sales and retail operations, as well as through the acquisition of an insurance agency in July 2007, an enhanced incentive compensation system, and increased contributions to the 401(k) savings plan, which were somewhat offset by savings related to the freezing of the defined benefit pension plan. Those same factors contributed to the increase in salary and employee benefit expense for the six month period ended June 30, 2008 of $0.4 million, or 7.9%, to $5.7 million.
Income tax expense totaled $0.5 and $1.2 million for the three and six month periods ended June 30, 2008, respectively. The effective tax rates for the periods were 28.0% and 28.6%, respectively. The effective tax rates for the comparable periods in 2007 were impacted by the aforementioned loss on the sale of securities. Excluding the loss on sale of securities, the effective tax rate on all other income for the three-month and six-month periods ended June 30, 2007 was 26.3% and 26.7%, respectively. The increase in the effective rate is a result of tax-exempt income such as interest earned on municipal bonds and the increase in value of bank-owned life insurance being a smaller portion of total income. The Company records an effective tax rate for the period that will be reflective of the projected annual tax rate based on expected supportable tax positions.


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CAPITAL
The Company has consistently maintained regulatory capital ratios at, or above, federal “well capitalized” standards. Equity as a percentage of assets was 9.3% at June 30, 2008, down from 9.6% at March 31, 2008 and 9.8% at December 31, 2007. The ratio has declined due to assets growing faster than equity. Book value per outstanding common share was $16.44 at June 30, 2008, compared with $16.07 at March 31, 2008 and $15.74 at December 31, 2007. Total stockholders’ equity was $45.3 million at June 30, 2008, compared with $44.0 million at March 31, 2008 and $43.3 million at December 31, 2007. The increase is primarily attributable to total comprehensive income of $2.9 million in the first three months of 2008, offset by $1.0 million in dividends.
LIQUIDITY
The Company 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. As a member of the Federal Home Loan Bank (“FHLB”) the Bank is able to borrow funds at competitive rates. Advances of up to $35.0 million can be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. An amount equal to 25% of the Bank’s total assets could be borrowed through the advance programs under certain qualifying circumstances. The Bank also has the ability to purchase up to $14.0 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 Company’s liquidity needs also can be met by more aggressively pursuing time deposits, or accessing the brokered time deposit market. Additionally, the Company has access to capital markets as a funding source.
The cash flows from the 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 June 30, 2008, approximately 16.9% of the Bank’s securities had contractual maturity dates of one year or less and approximately 49.0% had maturity dates of five years or less. At June 30, 2008, the Company had net short-term liquidity of $23.4 million as compared with $17.0 million at March 31, 2008 and $28.2 million at December 31, 2007. Available assets of $70.7 million, divided by public and purchased funds of $154.2 million, resulted in a long-term liquidity ratio of 46% at June 30, 2008, compared with 48% at March 31, 2008 and 51% at December 31, 2007.
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 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 the 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.


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     The Bank’s Asset Liability Committee, which includes members of senior management, monitors the Bank’s interest rate sensitivity with the aid of a computer 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 other financial instruments used for interest rate risk management purposes.
     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 (decrease) increase
    in projected annual net interest income
    (in thousands)
    June 30, 2008   December 31, 2007
Changes in interest rates
               
 
+200 basis points
    (138 )     (676 )
+100 basis points
    (66 )     (333 )
 
               
-100 basis points
    (13 )     394  
-200 basis points
    (185 )     629  
     Many assumptions were utilized by management to calculate the impact that changes in the 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 event that the 200 basis point rate changes cannot be achieved, the applicable rate changes are limited to lesser amounts such that interest rates cannot be less than zero. These assumptions 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). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures as of June 30, 2008 (the end of the period covered by this Report) have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.


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CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
     No changes in the Company’s internal control over financial reporting were identified in the fiscal quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2008 annual shareholders meeting of the registrant was held on April 24, 2008. At the meeting James E. Biddle, Jr., Kenneth C. Kirst, and Nancy W. Ware were re-elected as directors for a term of three years. The following table reflects the tabulation of votes with respect to each director who was elected at the 2008 annual meeting.
                 
    Number of Votes
Director Nominees:   For:   Withheld:
James E. Biddle, Jr
  1,843,841     130,908  
Kenneth C. Kirst
  1,854,461     119,488  
Nancy W. Ware
  1,850,411     123,537  
The following directors also continued their terms as directors of the Company following the 2008 annual shareholders meeting:
Phillip Brothman
Mary Catherine Militello
Robert G. Miller, Jr.
David J. Nasca
John R. O’Brien
David M. Taylor
James Tilley
Thomas H. Waring, Jr.


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ITEM 6 — EXHIBITS
             
Exhibit No.   Name   Page No.  
 
           
10.1
  Summary of Evans Excels Plan     29  
 
           
31.1
  Certification of Principal Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.     30  
 
           
31.2
  Certification of the Principal Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.     31  
 
           
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  
 
           
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.     33  


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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
       
August 13, 2008
  /s/ David J. Nasca    
 
       
 
        David J. Nasca    
 
        President and CEO    
 
       (Principal Executive Officer)    
 
       
DATE
       
August 13, 2008
  /s/ Gary A. Kajtoch    
 
       
 
        Gary A. Kajtoch    
 
       Treasurer    
 
       (Principal Financial Officer)    


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Exhibit Index
             
Exhibit No.   Name   Page No.  
 
           
10.1
  Summary of Evans Excels Plan     29  
 
           
31.1
  Certification of Principal Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.     30  
 
           
31.2
  Certification of the Principal Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.     31  
 
           
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  
 
           
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.     33