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ENB Financial Corp - Quarter Report: 2012 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended     September 30, 2012

OR

 

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

 

For the transition period from ___________________________ to ___________________________

 

 

ENB Financial Corp

(Exact name of registrant as specified in its charter)

 

Pennsylvania   000-53297   51-0661129
(State or Other Jurisdiction of Incorporation)   (Commission File Number)   (IRS Employer Identification No)
         
         
31 E. Main St., Ephrata, PA   17522-0457    
(Address of principal executive offices)   (Zip Code)    

 

Registrant’s telephone number, including area code (717) 733-4181

 

Former name, former address, and former fiscal year, if changed since last report 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 ý     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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 ý     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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

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

Yes o     No ý

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of November 2, 2012, the registrant had 2,855,235 shares of $0.20 (par) Common Stock outstanding.

 

 
 

ENB FINANCIAL CORP

INDEX TO FORM 10-Q

September 30, 2012

 

Part I – FINANCIAL INFORMATION  
       
  Item 1. Financial Statements  
       
  Consolidated Balance Sheets at September 30, 2012 and 2011 and December 31, 2011 (Unaudited) 3
       
  Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2012 and 2011 (Unaudited) 4
       
  Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and 2011 (Unaudited) 5
       
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011 (Unaudited) 6
       
  Notes to the Unaudited Consolidated Interim Financial Statements   7-28
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   29-60
       
  Item 3. Quantitative and Qualitative Disclosures about Market Risk   61-65
       
  Item 4.  Controls and Procedures   66
       
       
       

Part II – OTHER INFORMATION

67
       
  Item 1. Legal Proceedings 67
       
  Item 1A.  Risk Factors 67
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 67
       
  Item 3. Defaults Upon Senior Securities 67
       
  Item 4. Mine Safety Disclosures 67
       
  Item 5. Other Information 67
       
  Item 6. Exhibits 68
       
       
SIGNATURE PAGE 69
       

EXHIBIT INDEX

70

 

2
 

PART I.     FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

ENB Financial Corp

Consolidated Balance Sheets (Unaudited)

 

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)  September 30,   December 31,   September 30, 
   2012   2011   2011 
   $   $   $ 
ASSETS               
Cash and due from banks   10,198    12,511    10,541 
Interest-bearing deposits in other banks   24,754    19,375    24,479 
                
  Total cash and cash equivalents   34,952    31,886    35,020 
                
Securities available for sale (at fair value)   304,481    284,011    284,644 
                
Loans held for sale   897    1,926    210 
                
Loans (net of unearned income)   401,644    412,638    408,450 
                
  Less: Allowance for loan losses   7,644    8,480    8,253 
                
  Net loans   394,000    404,158    400,197 
                
Premises and equipment   21,112    21,366    20,912 
                
Regulatory stock   4,033    4,148    4,102 
                
Bank owned life insurance   19,015    16,552    16,393 
                
Other assets   6,349    7,099    7,351 
                
      Total assets   784,839    771,146    768,829 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
                
Liabilities:               
 Deposits:               
   Noninterest-bearing   149,839    149,510    139,426 
   Interest-bearing   470,095    456,168    463,995 
                
   Total deposits   619,934    605,678    603,421 
                
 Long-term debt   70,500    73,000    80,500 
 Accounts payable for security purchases not yet settled   2,097    6,964     
 Other liabilities   3,394    3,033    3,170 
                
      Total liabilities   695,925    688,675    687,091 
                
Stockholders' equity:               
 Common stock, par value $0.20;               
Shares:  Authorized 12,000,000               
 Issued 2,869,557 and Outstanding 2,857,475               
 (Issued 2,869,557 and Outstanding 2,858,831 as of 12-31-11)               
 (Issued 2,869,557 and Outstanding 2,859,035 as of 9-30-11)   574    574    574 
 Capital surplus   4,315    4,304    4,317 
 Retained earnings   77,611    73,632    72,450 
 Accumulated other comprehensive income, net of tax   6,711    4,221    4,655 
 Less: Treasury stock shares at cost 12,082 (10,726 shares               
  as of 12-31-11 and 10,522 shares as of 9-30-11)   (297)   (260)   (258)
                
      Total stockholders' equity   88,914    82,471    81,738 
                
      Total liabilities and stockholders' equity   784,839    771,146    768,829 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

3
 

ENB Financial Corp

 Consolidated Statements of Income (Unaudited)

Periods Ended September 30, 2012 and 2011

 

   Three Months   Nine Months 
   2012   2011   2012   2011 
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)  $   $   $   $ 
Interest and dividend income:                    
                     
   Interest and fees on loans   5,011    5,386    15,272    16,271 
   Interest on securities available for sale                    
        Taxable   977    1,603    3,336    4,710 
        Tax-exempt   924    867    2,711    2,565 
   Interest on deposits at other banks   24    11    60    29 
   Dividend income   31    28    86    94 
                     
      Total interest and dividend income   6,967    7,895    21,465    23,669 
                     
Interest expense:                    
   Interest on deposits   1,061    1,270    3,271    4,005 
   Interest on long-term debt   499    785    1,655    2,338 
                     
      Total interest expense   1,560    2,055    4,926    6,343 
                     
       Net interest income   5,407    5,840    16,539    17,326 
                     
   Provision (credit) for loan losses   (250)   450    (850)   1,350 
                     
       Net interest income after provision (credit) for loan losses   5,657    5,390    17,389    15,976 
                     
Other income:                    
   Trust and investment services income   248    253    816    847 
   Service fees   393    435    1,259    1,320 
   Commissions   490    469    1,454    1,376 
   Gains on securities transactions, net   342    269    1,003    1,346 
    Impairment losses on securities:                    
         Impairment losses on investment securities       (92)   (55)   (171)
         Non-credit related (gains) losses on securities not expected                    
           to be sold in other comprehensive income before tax       11    (31)   (129)
   Net impairment losses on investment securities       (81)   (86)   (300)
   Gains on sale of mortgages   52    28    183    108 
   Losses on sale of loans               (263)
   Earnings on bank owned life insurance   164    148    762    441 
   Other income   69    88    265    264 
                     
      Total other income   1,758    1,609    5,656    5,139 
                     
Operating expenses:                    
   Salaries and employee benefits   3,020    2,904    9,326    8,566 
   Occupancy   420    410    1,261    1,217 
   Equipment   221    206    657    604 
   Advertising & marketing   65    74    285    239 
   Computer software & data processing   418    397    1,216    1,174 
   Bank shares tax   202    208    618    625 
   Professional services   262    287    850    974 
   FDIC insurance   90    88    270    433 
   Other expense   373    401    1,282    1,133 
                     
      Total operating expenses   5,071    4,975    15,765    14,965 
                     
       Income before income taxes   2,344    2,024    7,280    6,150 
                     
Provision for federal income taxes   384    293    1,160    870 
                     
Net income   1,960    1,731    6,120    5,280 
                     
Earnings per share of common stock   0.69    0.61    2.14    1.85 
                     
Cash dividends paid per share   0.25    0.24    0.75    0.72 
                     
Weighted average shares outstanding   2,854,723    2,858,809    2,855,555    2,857,626 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

4
 

ENB Financial Corp

Consolidated Statements of Comprehensive Income  (Unaudited)

Periods Ended September 30, 2012 and 2011

 

   Three Months   Nine Months 
   2012   2011   2012   2011 
(DOLLARS IN THOUSANDS)  $   $   $   $ 
                 
Net income   1,960    1,731    6,120    5,280 
                     
Other comprehensive (income) loss, net of tax:                    
Net change in unrealized (gains) losses:                    
                     
Other-than-temporarily impaired securities available for sale:                    
                     
  Gains (losses) arising during the quarter       (92)   (55)   (171)
  Income tax effect       31    18    58 
        (61)   (37)   (113)
                     
  Losses recognized in earnings       81    86    300 
  Income tax effect       (27)   (29)   (103)
        54    57    197 
Unrealized holding gains (losses) on other-than-temporarily impaired                    
 securities available for sale, net of tax       (7)   20    84 
                     
Securities available for sale not other-than-temporarily impaired:                    
                     
  Gains arising during the period   2,568    3,021    4,745    7,602 
  Income tax effect   (873)   (1,027)   (1,613)   (2,585)
    1,695    1,994    3,132    5,017 
                     
  Gains recognized in earnings   (342)   (269)   (1,003)   (1,346)
  Income tax effect   116    91    341    458 
    (226)   (178)   (662)   (888)
Unrealized holding (losses) gains on securities available for sale not                    
 other-than-temporarily impaired, net of tax   1,469    1,816    2,470    4,129 
                     
Other comprehensive income   1,469    1,809    2,490    4,213 
                     
Comprehensive Income   3,429    3,540    8,610    9,493 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

5
 

ENB Financial Corp

Consolidated Statements of Cash Flows (Unaudited)

 

(DOLLARS IN THOUSANDS)  Nine Months Ended September 30, 
   2012   2011 
   $   $ 
Cash flows from operating activities:          
Net income   6,120    5,280 
Adjustments to reconcile net income to net cash          
provided by operating activities:          
Net amortization of securities premiums and discounts and loan fees   2,649    1,353 
Increase in interest receivable   (205)   (35)
Decrease in interest payable   (175)   (158)
Provision (credit) for loan losses   (850)   1,350 
Gains on securities transactions, net   (1,003)   (1,346)
Impairment losses on securities   86    300 
Losses on the sale of student loans       263 
Gains on sale of mortgages   (183)   (108)
Loans originated for sale   (10,212)   (7,277)
Proceeds from sales of loans   11,424    7,946 
Earnings on bank-owned life insurance   (762)   (441)
Gains on sale of other real estate owned   (15)    
Depreciation of premises and equipment and amortization of software   1,001    999 
Deferred income tax   598    (212)
Decrease in prepaid federal deposit insurance   236    395 
Decrease in accounts payable for securities purchased not yet settled   (4,867)    
Other assets and other liabilities, net   (485)   (400)
Net cash provided by operating activities   3,357    7,909 
           
Cash flows from investing activities:          
Securities available for sale:          
  Proceeds from maturities, calls, and repayments   70,460    41,795 
  Proceeds from sales   29,624    58,530 
  Purchases   (118,512)   (119,762)
Purchase of other real estate owned   (112)    
Proceeds from sale of other real estate owned   132      
Purchase of regulatory bank stock   (230)    
Redemptions of regulatory bank stock   345    578 
Purchase of bank-owned life insurance   (2,527)   (61)
Proceeds from bank-owned life insurance   826     
Proceeds from sale of student loans       7,981 
Net decrease (increase) in loans   10,729    (1,682)
Purchases of premises and equipment   (582)   (1,226)
Purchase of computer software   (33)   (107)
Net cash used for investing activities   (9,880)   (13,954)
           
Cash flows from financing activities:          
Net increase in demand, NOW, and savings accounts   13,104    15,606 
Net increase (decrease) in time deposits   1,152    (7,779)
Proceeds from long-term debt   15,000    10,500 
Repayments of long-term debt   (17,500)   (4,500)
Dividends paid   (2,141)   (2,056)
Treasury stock sold   317    334 
Treasury stock purchased   (343)   (266)
Net cash provided by financing activities   9,589    11,839 
Increase in cash and cash equivalents   3,066    5,794 
Cash and cash equivalents at beginning of period   31,886    29,226 
Cash and cash equivalents at end of period   34,952    35,020 
           
Supplemental disclosures of cash flow information:          
Interest paid   5,100    6,501 
Income taxes paid   745    1,065 
           
Supplemental disclosure of non-cash investing and financing activities:          
Securities purchased not yet settled   2,097     
Net transfer of other real estate owned held for sale from loans   278     
Fair value adjustments for securities available for sale   3,773    6,383 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

6
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

1.       Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and to general practices within the banking industry. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all significant adjustments considered necessary for fair presentation have been included. Certain items previously reported have been reclassified to conform to the current period’s reporting format. Such reclassifications did not affect net income or stockholders’ equity.

 

ENB Financial Corp (“the Corporation”) is the bank holding company for its wholly-owned subsidiary Ephrata National Bank (the “Bank”). This Form 10-Q, for the third quarter of 2012, is reporting on the results of operations and financial condition of ENB Financial Corp.

 

Operating results for the three and nine months ended September 30, 2012, are not necessarily indicative of the results that may be expected for the year ended December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

 

2.       Securities Available for Sale

 

The amortized cost and fair value of securities held at September 30, 2012, and December 31, 2011, are as follows:

 

       Gross   Gross     
(DOLLARS IN THOUSANDS)  Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   $   $   $   $ 
September 30, 2012                    
U.S. government agencies   36,741    1,935    (60)   38,616 
U.S. agency mortgage-backed securities   54,425    1,234    (11)   55,648 
U.S. agency collateralized mortgage obligations   47,503    285    (368)   47,420 
Private collateralized mortgage obligations   6,352    62    (479)   5,935 
Corporate bonds   47,606    1,382    (36)   48,952 
Obligations of states and political subdivisions   96,686    6,428    (160)   102,954 
Total debt securities   289,313    11,326    (1,114)   299,525 
Marketable equity securities   5,000        (44)   4,956 
Total securities available for sale   294,313    11,326    (1,158)   304,481 
                     
December 31, 2011                    
U.S. government agencies   44,669    1,959    (14)   46,614 
U.S. agency mortgage-backed securities   54,264    874    (9)   55,129 
U.S. agency collateralized mortgage obligations   55,908    462    (321)   56,049 
Private collateralized mortgage obligations   8,251    25    (1,051)   7,225 
Corporate bonds   25,579    230    (511)   25,298 
Obligations of states and political subdivisions   84,945    4,852    (52)   89,745 
Total debt securities   273,616    8,402    (1,958)   280,060 
Marketable equity securities   4,000        (49)   3,951 
Total securities available for sale   277,616    8,402    (2,007)   284,011 

7
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The amortized cost and fair value of debt securities available for sale at September 30, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.

 

CONTRACTUAL MATURITY OF DEBT SECURITIES        
(DOLLARS IN THOUSANDS)        
         
   Amortized     
   Cost   Fair Value 
   $   $ 
Due in one year or less   36,641    36,979 
Due after one year through five years   104,948    107,512 
Due after five years through ten years   74,391    76,672 
Due after ten years   73,333    78,362 
Total debt securities   289,313    299,525 

 

Securities available for sale with a par value of $83,331,000 and $73,049,000 at September 30, 2012, and December 31, 2011, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $89,138,000 at September 30, 2012, and $77,874,000 at December 31, 2011.

 

Proceeds from active sales of securities available for sale, along with the associated gross realized gains and gross realized losses, are shown below. Realized gains and losses are computed on the basis of specific identification.

 

PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE        
(DOLLARS IN THOUSANDS)            
                 
   Three Months Ended September 30,   Nine Months Ended September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Proceeds from sales   6,720    12,542    29,624    58,530 
Gross realized gains   351    315    1,080    1,567 
Gross realized losses   9    46    77    221 

 

SUMMARY OF GAINS AND LOSSES ON SECURITIES AVAILABLE FOR SALE    
(DOLLARS IN THOUSANDS)                
   Three Months Ended September 30,   Nine Months Ended September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Gross realized gains   351    315    1,080    1,567 
                     
Gross realized losses   9    46    77    221 
Impairment on securities       81    86    300 
Total gross realized losses   9    127    163    521 
                     
Net gains on securities   342    188    917    1,046 

 

The bottom portion of the above table shows the net gains on security transactions, including any impairment taken on securities held by the Corporation. Unlike the sale of a security, impairment is a write-down of the book value of the security which produces a loss and does not provide any proceeds. The net gain or loss from security transactions is also reflected on the Corporation’s Consolidated Statements of Income and Consolidated Statements of Cash Flows.

8
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

Management evaluates all of the Corporation’s securities for other than temporary impairment (OTTI) on a periodic basis. As of September 30, 2012, no impairment was needed on any of the Corporation’s securities; however, three private collateralized mortgage obligations (PCMOs) were being held that had experienced prior impairment. Analysis of these three securities as of September 30, 2012, based on the projected future cash flows, including prepayment speeds, delinquencies, foreclosures, and the severity of losses, did not indicate a need to take additional impairment. While there was no security impairment recorded in the second or third quarters of 2012, in the first quarter of 2012, $86,000 of impairment was recorded on two PCMO securities considered to be other than temporarily impaired. Impairment was taken on four PCMO securities in the third quarter of 2011 that amounted to $81,000 and year-to-date impairment on these securities as of September 30, 2011, was $300,000. One of the four PCMOs that experienced impairment in 2011 was sold in May 2012, leaving only three PCMOs that had experienced impairment. Information pertaining to securities with gross unrealized losses at September 30, 2012, and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

 

TEMPORARY IMPAIRMENTS OF SECURITIES                   
(DOLLARS IN THOUSANDS)              
   Less than 12 months   More than 12 months   Total 
       Gross       Gross       Gross 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
   $   $   $   $   $   $ 
As of September 30, 2012                              
U.S. government agencies   3,975    (60)           3,975    (60)
U.S. agency mortgage-backed securities   5,638    (11)           5,638    (11)
U.S. agency collateralized mortgage obligations   27,612    (270)   5,719    (98)   33,331    (368)
Private collateralized mortgage obligations           4,844    (479)   4,844    (479)
Corporate bonds   1,971    (28)   992    (8)   2,963    (36)
Obligations of states & political subdivisions   9,817    (131)   2,005    (29)   11,822    (160)
                               
Total debt securities   49,013    (500)   13,560    (614)   62,573    (1,114)
                               
Marketable equity securities           956    (44)   956    (44)
                               
Total temporarily impaired securities   49,013    (500)   14,516    (658)   63,529    (1,158)
                               
As of December 31, 2011                              
U.S. government agencies   5,995    (14)           5,995    (14)
U.S. agency mortgage-backed securities   4,998    (9)           4,998    (9)
U.S. agency collateralized mortgage obligations   23,631    (321)           23,631    (321)
Private collateralized mortgage obligations           4,919    (1,051)   4,919    (1,051)
Corporate bonds   12,392    (497)   491    (14)   12,883    (511)
Obligations of states & political subdivisions   2,767    (17)   2,977    (35)   5,744    (52)
                               
Total debt securities   49,783    (858)   8,387    (1,100)   58,170    (1,958)
                               
Marketable equity securities           951    (49)   951    (49)
                               
Total temporarily impaired securities   49,783    (858)   9,338    (1,149)   59,121    (2,007)

 

In the debt security portfolio, there are 47 positions that were considered temporarily impaired at September 30, 2012. Based on analysis conducted as of September 30, 2012, no securities indicated impairment, and therefore, no securities were considered other-than-temporarily impaired.

9
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The Corporation evaluates both equity and fixed maturity positions for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluation. The Corporation adopted a provision of U.S. generally accepted accounting principles which provides for the bifurcation of OTTI into two categories: (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss), which is recognized in earnings, and (b) the amount of total OTTI related to all other factors, which is recognized, net of taxes, as a component of accumulated other comprehensive income. The adoption of this provision was only applicable to four of the Corporation’s PCMOs since these were the only instruments management deemed to be other-than-temporarily impaired and have experienced some impairment.

 

A cumulative total of $1,143,000 of impairment has been recorded on the three impaired PCMO securities currently held, plus the PCMO that was sold in May 2012. Impairment of $340,000 was first recorded in 2009 on two of these securities. Additional impairment was recorded in 2010 for a total of $393,000 on the same two PCMO securities. During 2011, there was an additional $324,000 of impairment recorded on the three PCMO securities, currently identified as other than temporarily impaired, plus the impaired PCMO that was sold in May 2012. In the first quarter of 2012, an additional $86,000 of impairment was recorded on two of the PCMO securities. There was no impairment recorded in the second or third quarters of 2012.

 

The impairment on the PCMOs is a result of a deterioration of expected cash flows on these securities due to higher projected credit losses than the amount of credit protection carried by these securities. Specifically, the foreclosure and severity rates have been running at levels where expected principal losses are in excess of the remaining credit protection on these instruments. The projected principal losses are based on prepayment speeds that are equal to or slower than the actual last twelve-month prepayment speeds the particular securities have experienced. Every quarter, management evaluates third-party reporting that shows projected principal losses based on various prepayment speed and severity rate scenarios. Based on the assumption that all loans over 60 days delinquent will default and at a severity rate equal to or above that previously experienced, and based on historical and expected prepayment speeds, management determined that it was appropriate to take additional impairment on two PCMOs in the first quarter of 2012, with no impairment necessary in the second or third quarters.

 

The following tables reflect the amortized cost, market value, and unrealized loss as of September 30, 2012 and 2011, on the PCMO securities held which had impairment taken in each respective year. The values shown are after the Corporation recorded year-to-date impairment charges of $86,000 through September 30, 2012, and $300,000 through September 30, 2011. The $86,000 and $300,000 are deemed to be credit losses and are the amounts that management expects the principal losses will be by the time these securities mature. The remaining $308,000 and $1,031,000 of unrealized losses are deemed to be market value losses that are considered temporary.

 

SECURITY IMPAIRMENT CHARGES                
(DOLLARS IN THOUSANDS)                
                 
   As of September 30, 2012 
   Amortized  Market  Unrealized  Impairment
   Cost  Value  Loss  Charge
   $  $  $  $
                 
Private collateralized mortgage obligations   3,605    3,297    (308)   (86)

 

   As of September 30, 2011 
   Amortized  Market  Unrealized  Impairment
   Cost  Value  Loss  Charge
   $  $  $  $
                     
Private collateralized mortgage obligations   7,427    6,396    (1,031)   (300)

 

10
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table provides a cumulative roll forward of credit losses recognized in earnings for debt securities held:

 

CREDIT LOSSES RECOGNIZED IN EARNINGS ON DEBT SECURITIES            
(DOLLARS IN THOUSANDS)                
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
                 
Beginning balance   977    951    1,057    732 
                     
Credit losses on debt securities for which other-than-                    
  temporary impairment has not been previously recognized               105 
                     
Additional credit losses on debt securities for which other-                    
  than-temporary impairment was previously recognized       81    86    195 
                     
Sale of debt securities with previously recognized impairment            (166)    
                     
Ending balance   977    1,032    977    1,032 

 

Recent market conditions throughout the financial sector have made the evaluation regarding the possible impairment of PCMOs difficult to fully determine given the volatility of their pricing, based not only on interest rate changes, but on collateral uncertainty as well. The Corporation’s mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO) holdings are backed by the U.S. government, and therefore, experience significantly less volatility and uncertainty than the PCMO securities. The Corporation has not experienced any impairment on U.S. government MBS or CMO securities and does not expect impairment in the future on these instruments. The Corporation’s PCMO holdings make up a minority of the total MBS, CMO, and PCMO securities held. As of September 30, 2012, on an amortized cost basis, PCMOs accounted for 5.9% of the Corporation’s total MBS, CMO, and PCMO holdings, compared to 7.0% as of December 31, 2011. As of September 30, 2012, four PCMOs were held with one of the four rated AAA by either Moody’s or S&P. The remaining three securities were rated below investment grade. Impairment charges, as detailed above, were taken on two of these securities in the first quarter of 2012, with no impairment taken in the second or third quarters of 2012.

 

Management conducts impairment analysis on a quarterly basis and currently plans to continue to hold these securities as cash flow analysis performed under severe stress testing does not indicate a need to take further impairment on the bonds that are considered impaired. The unrealized loss position of all of the Corporation’s PCMOs has improved since December 31, 2011. The PCMO net unrealized losses stood at $1.0 million as of December 31, 2011, and improved to a $417,000 net unrealized loss as of September 30, 2012. One of the four PCMOs is carrying an unrealized gain. Management has concluded that, as of September 30, 2012, the unrealized losses outlined in the above table represent temporary declines. Management currently does not intend to sell these securities as a result of unrealized holding losses carried and impairment taken, and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. While management does not intend to sell these securities related to their impairment, it is standard practice to sell off smaller MBS, CMO, and PCMO instruments once normal principal payments have reduced the size of the security to less than $1 million. This is done to reduce the administrative costs and improve the efficiency of the entire portfolio. One previously impaired PCMO instrument was sold in the second quarter of 2012 with proceeds of $1,051,000 at a minimal loss of $8,000. Management will continue to monitor the remaining PCMO instruments.

 

11
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

3.        Loans and Allowance for Loan Losses

 

The following tables present the Corporation’s loan portfolio by category of loans as of September 30, 2012, and December 31, 2011.

 

LOAN PORTFOLIO         
          
   September 30,   December 31, 
   2012   2011 
   $   $ 
Commercial real estate          
Commercial mortgages   86,941    95,347 
Agriculture mortgages   76,675    73,287 
Construction   17,525    18,957 
Total commercial real estate   181,141    187,591 
           
Consumer real estate (a)          
1-4 family residential mortgages   130,762    133,959 
Home equity loans   13,525    14,687 
Home equity lines of credit   15,907    15,004 
Total consumer real estate   160,194    163,650 
           
Commercial and industrial          
Commercial and industrial   25,612    25,913 
Tax-free loans   17,774    19,072 
Agriculture loans   13,058    12,884 
Total commercial and industrial   56,444    57,869 
           
Consumer   3,798    3,590 
           
Gross loans prior to deferred fees   401,577    412,700 
Less:          
Deferred loan fees (costs), net   (67)   62 
Allowance for loan losses   7,644    8,480 
Total net loans   394,000    404,158 
           

 

(a) Real estate loans serviced for Fannie Mae, which are not included in the Consolidated Balance Sheets, totaled $7,345,000 and $8,904,000 as of September 30, 2012, and December 31, 2011, respectively.    

 

The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of September 30, 2012, and December 31, 2011. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled or at all. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.

 

The Corporation's internally assigned grades for commercial credits are as follows:

 

·Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

 

·Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. 

 

·Substandard – loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.

 

12
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

·Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset.  In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

 

COMMERCIAL CREDIT EXPOSURE
CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE
(DOLLARS IN THOUSANDS)
                             
September 30, 2012  Commercial
Mortgages
   Agriculture
Mortgages
   Construction   Commercial
and
Industrial
   Tax-free
Loans
   Agriculture
Loans
   Total 
   $   $   $   $   $   $   $ 
Grade:                                   
Pass   77,946    73,400    13,054    23,198    17,534    12,161    217,293 
Special Mention   619    419        338        88    1,464 
Substandard   8,376    2,856    4,471    2,076    240    809    18,828 
Doubtful                            
Loss                            
                                    
   Total   86,941    76,675    17,525    25,612    17,774    13,058    237,585 
                                    

 

December 31, 2011  Commercial
Mortgages
   Agriculture
Mortgages
   Construction   Commercial
and
Industrial
   Tax-free
Loans
   Agriculture
Loans
   Total 
   $   $   $   $   $   $   $ 
Grade:                                   
Pass   76,532    67,235    13,869    21,561    19,072    11,943    210,212 
Special Mention   3,872    773    132    1,173        65    6,015 
Substandard   14,943    5,279    4,956    3,179        876    29,233 
Doubtful                            
Loss                            
                                    
   Total   95,347    73,287    18,957    25,913    19,072    12,884    245,460 

13
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and non-accrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of September 30, 2012, and December 31, 2011:

 

CONSUMER CREDIT EXPOSURE
CREDIT RISK PROFILE BY PAYMENT PERFORMANCE
(DOLLARS IN THOUSANDS)
September 30, 2012  1-4 Family
Residential
Mortgages
   Home Equity
Loans
   Home Equity
Lines of
Credit
   Consumer   Total 
Payment performance:  $   $   $   $   $ 
                          
Performing   130,451    13,384    15,907    3,794    163,536 
Non-performing   311    141        4    456 
                          
  Total   130,762    13,525    15,907    3,798    163,992 
                          

 

December 31, 2011  1-4 Family
Residential
Mortgages
   Home Equity
Loans
   Home Equity
Lines of
Credit
   Consumer   Total 
Payment performance:  $   $   $   $   $ 
                     
Performing   133,643    14,541    15,004    3,590    166,778 
Non-performing   316    146            462 
                          
  Total   133,959    14,687    15,004    3,590    167,240 

 

 

14
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of September 30, 2012, and December 31, 2011:

 

AGING OF LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
                             
                           Loans 
           Greater               Receivable > 
   30-59 Days   60-89 Days   than 90   Total Past       Total Loans   90 Days and 
September 30, 2012  Past Due   Past Due   Days   Due   Current   Receivable   Accruing 
   $   $   $   $   $   $   $ 
Commercial real estate                                   
  Commercial mortgages   128    225        353    86,588    86,941     
  Agriculture mortgages                   76,675    76,675     
  Construction                   17,525    17,525     
Consumer real estate                                   
  1-4 family residential mortgages   640    21    172    833    129,929    130,762    172 
  Home equity loans   132            132    13,393    13,525     
  Home equity lines of credit   17            17    15,890    15,907     
Commercial and industrial                                   
  Commercial and industrial   32            32    25,580    25,612     
  Tax-free loans                   17,774    17,774     
  Agriculture loans                   13,058    13,058     
Consumer   5        2    7    3,791    3,798     
      Total   954    246    174    1,374    400,203    401,577    172 

 

                           Loans 
           Greater               Receivable > 
   30-59 Days   60-89 Days   than 90   Total Past       Total Loans   90 Days and 
December 31, 2011  Past Due   Past Due   Days   Due   Current   Receivable   Accruing 
   $   $   $   $   $   $   $ 
Commercial real estate                                   
  Commercial mortgages   390            390    94,957    95,347     
  Agriculture mortgages                   73,287    73,287     
  Construction   132            132    18,825    18,957     
Consumer real estate                                   
  1-4 family residential mortgages   1,684    140    107    1,931    132,028    133,959    107 
  Home equity loans   79    101        180    14,507    14,687     
  Home equity lines of credit       15        15    14,989    15,004     
Commercial and industrial                                   
  Commercial and industrial   49        101    150    25,763    25,913     
  Tax-free loans                   19,072    19,072     
  Agriculture loans                   12,884    12,884     
Consumer   18    5        23    3,567    3,590     
      Total   2,352    261    208    2,821    409,879    412,700    107 

 

15
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following table presents nonaccrual loans by classes of the loan portfolio as of September 30, 2012, and December 31, 2011:

 

NONACCRUAL LOANS BY LOAN CLASS    
(DOLLARS IN THOUSANDS)    
   September 30,   December 31, 
   2012   2011 
   $   $ 
         
Commercial real estate          
 Commercial mortgages   963    1,265 
 Agriculture mortgages        
 Construction        
Consumer real estate          
 1-4 family residential mortgages   184    209 
 Home equity loans   141    146 
 Home equity lines of credit        
Commercial and industrial          
 Commercial and industrial   54    242 
 Tax-free loans        
 Agriculture loans        
Consumer   4     
            Total   1,346    1,862 

 

As of September 30, 2012, and December 31, 2011, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three and nine months ended September 30, 2012, and September 30, 2011, is as follows:

 

IMPAIRED LOANS                
(DOLLARS IN THOUSANDS)                
   Three months ended September 30,   Nine months ended September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Impaired loans:                    
Average recorded balance of impaired loans   3,074    3,645    3,286    4,075 
Interest income recognized on impaired loans   50    29    106    92 

 

Interest income on impaired loans would have increased by approximately $4,000 and $65,000 for the three and nine months ended September 30, 2012, and $35,000 and $114,000 for the three and nine months ended September 30, 2011, had these loans performed in accordance with their original terms.

16
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following tables summarize information in regards to impaired loans by loan portfolio class as of September 30, 2012, and December 31, 2011:

 

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
September 30, 2012  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   $   $   $   $   $ 
                     
With no related allowance recorded:                         
Commercial real estate                         
   Commercial mortgages   304    304        416     
   Agriculture mortgages   1,640    1,640        1,646    83 
   Construction                    
Total commercial real estate   1,944    1,944        2,062    83 
                          
Commercial and industrial                         
   Commercial and industrial   54    95        155    20 
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial   54    95        155    20 
                          
Total with no related allowance   1,998    2,039        2,217    103 
                          
With an allowance recorded:                         
Commercial real estate                         
   Commercial mortgages   983    1,080    162    1,069    3 
   Agriculture mortgages                    
   Construction                    
Total commercial real estate   983    1,080    162    1,069    3 
                          
Commercial and industrial                         
   Commercial and industrial                    
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial                    
                          
Total with a related allowance   983    1,080    162    1,069    3 
                          
Total by loan class:                         
Commercial real estate                         
   Commercial mortgages   1,287    1,384    162    1,485    3 
   Agriculture mortgages   1,640    1,640        1,646    83 
   Construction                    
Total commercial real estate   2,927    3,024    162    3,131    86 
                          
Commercial and industrial                         
   Commercial and industrial   54    95        155    20 
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial   54    95        155    20 
                          
Total   2,981    3,119    162    3,286    106 

 

17
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
December 31, 2011  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   $   $   $   $   $ 
                     
With no related allowance recorded:                         
Commercial real estate                         
   Commercial mortgages   473    473        641     
   Agriculture mortgages   1,658    1,658        1,667    119 
   Construction       67        44     
Total commercial real estate   2,131    2,198        2,352    119 
                          
Commercial and industrial                         
   Commercial and industrial   137    137        226     
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial   137    137        226     
                          
Total with no related allowance   2,268    2,335        2,578    119 
                          
With an allowance recorded:                         
Commercial real estate                         
   Commercial mortgages   1,147    1,244    140    1,245     
   Agriculture mortgages                    
   Construction                    
Total commercial real estate   1,147    1,244    140    1,245     
                          
Commercial and industrial                         
   Commercial and industrial   105    105    61    71     
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial   105    105    61    71     
                          
Total with a related allowance   1,252    1,349    201    1,316     
                          
Total by loan class:                         
Commercial real estate                         
   Commercial mortgages   1,620    1,717    140    1,886     
   Agriculture mortgages   1,658    1,658        1,667    119 
   Construction       67        44     
Total commercial real estate   3,278    3,442    140    3,597    119 
                          
Commercial and industrial                         
   Commercial and industrial   242    242    61    297     
   Tax-free loans                    
   Agriculture loans                    
Total commercial and industrial   242    242    61    297     
                          
Total   3,520    3,684    201    3,894    119 

 

18
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The following tables detail activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2012, and September 30, 2011:

 

ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
                         
   Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
Allowance for credit losses:                              
Beginning balance - December 31, 2011   3,441    1,424    2,825    61    729    8,480 
                               
   Charge-offs           42    5        47 
   Recoveries           20    5        25 
   Provision   (371)   (103)   214    (6)   16    (250)(1)
                               
Balance - March 31, 2012   3,070    1,321    3,017    55    745    8,208 
                               
   Charge-offs           5    2        7 
   Recoveries           23    3        26 
   Provision   41    96    (434)   4    (57)   (350)(1)
                               
Balance - June 30, 2012   3,111    1,417    2,601    60    688    7,877 
                               
   Charge-offs               2        2 
   Recoveries   15        3    1        19 
   Provision   296    (14)   (457)   (5)   (70)   (250)(1)
                               
Ending Balance - September 30, 2012   3,422    1,403    2,147    54    618    7,644 

(1)The Corporation recognized a $250,000 credit provision in the first quarter of 2012, a $350,000 credit provision in the second quarter of 2012, and a $250,000 credit provision in the third quarter of 2012, as a result of lower levels of non-performing and  delinquent loans, minimum charge-offs, and a decline in loan balances.

 

   Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
Allowance for credit losses:                              
Beginning balance - December 31, 2010   2,605    1,254    2,816    75    382    7,132 
                               
   Charge-offs   97    13    30    9        149 
   Recoveries       2    145    3        150 
   Provision   527    39    (165)       49    450 
                               
Balance - March 31, 2011   3,035    1,282    2,766    69    431    7,583 
                               
   Charge-offs       1    285    1        287 
   Recoveries       (2)   55    2        55 
   Provision   167    (7)   396    (11)   (95)   450 
                               
Balance - June 30, 2011   3,202    1,272    2,932    59    336    7,801 
                               
   Charge-offs       (1)       15        14 
   Recoveries       2    15    (1)       16 
   Provision   8    93    (37)   17    369    450 
                               
Ending Balance - September 30, 2011   3,210    1,368    2,910    60    705    8,253 

 

19
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present, by portfolio segment, the recorded investment in loans at September 30, 2012, and December 31, 2011.

 

ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
                         
   Commercial
Real Estate
   Consumer
Real Estate
   Commercial and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
September 30, 2012                              
                               
Allowance for credit losses:                              
Ending balance   3,422    1,403    2,147    54    618    7,644 
Ending balance: individually                              
    evaluated for impairment   162                    162 
Ending balance: collectively                              
    evaluated for impairment   3,260    1,403    2,147    54    618    7,482 
Ending balance: loans acquired                              
    with deteriorated credit quality                        
                               
Loans receivable:                              
Ending balance   181,141    160,194    56,444    3,798         401,577 
Ending balance: individually                              
   evaluated for impairment   2,931        54             2,985 
Ending balance: collectively                              
   evaluated for impairment   178,210    160,194    56,390    3,798         398,592 
Ending balance: loans acquired                              
   with deteriorated credit quality                         

   Commercial
Real Estate
   Consumer
Real Estate
   Commercial and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
December 31, 2011                              
                               
Allowance for credit losses:                              
Ending balance   3,441    1,424    2,825    61    729    8,480 
Ending balance: individually                              
    evaluated for impairment   140        61            201 
Ending balance: collectively                              
    evaluated for impairment   3,301    1,424    2,764    61    729    8,279 
Ending balance: loans acquired                              
    with deteriorated credit quality                        
                               
Loans receivable:                              
Ending balance   187,591    163,650    57,869    3,590         412,700 
Ending balance: individually                              
   evaluated for impairment   3,278        242             3,520 
Ending balance: collectively                              
   evaluated for impairment   184,313    163,650    57,627    3,590         409,180 
Ending balance: loans acquired                              
   with deteriorated credit quality                         

20
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

During the first nine months of 2012, there was no loan modification made that would cause a loan to be considered a troubled debt restructuring (TDR). Three loans that were previously considered TDRs in 2011 due to principal deferments, continue to pay based on contractual terms without delinquency. These loans were no longer considered TDRs in 2012, since they resumed normal principal and interest payments without delinquency and the interest rate was considered a market interest rate. A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial condition of the borrower and improve the likelihood of full collection by the lender. In the case of these three previous TDRs, the concession was in the form of a principal deferment.

 

4.        Fair Value Presentation

 

U.S. generally accepted accounting principles establish a hierarchal disclosure framework associated with the level of observable pricing utilized in measuring assets and liabilities at fair value. The three broad levels defined by the hierarchy are as follows:

 

  Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
     
  Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.
     
  Level III: Assets and liabilities that have little to no observable pricing as of the reported date.  These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

The following tables present the assets reported on the consolidated balance sheets at their fair value as of September 30, 2012, and December 31, 2011, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

Fair Value Measurements:

 

(DOLLARS IN THOUSANDS)                
   September 30, 2012 
                 
   Level I   Level II   Level III   Total 
                 
U.S. government agencies  $   $38,616   $   $38,616 
U.S. agency mortgage-backed securities       55,648        55,648 
U.S. agency collateralized mortgage obligations       47,420        47,420 
Private collateralized mortgage obligations       5,935        5,935 
Corporate bonds       48,952        48,952 
Obligations of states & political subdivisions       102,954        102,954 
Marketable equity securities   4,956            4,956 
                     
Total securities  $4,956   $299,525   $   $304,481 

 

On September 30, 2012, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of September 30, 2012, the CRA fund investments had a $5,000,000 book value with a fair market value of $4,956,000.

21
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

Fair Value Measurements:

 

(DOLLARS IN THOUSANDS)                
   December 31, 2011 
                 
   Level I   Level II   Level III   Total 
                 
U.S. government agencies  $   $46,614   $   $46,614 
U.S. agency mortgage-backed securities       55,129        55,129 
U.S. agency collateralized mortgage obligations       56,049        56,049 
Private collateralized mortgage obligations       7,225        7,225 
Corporate bonds       25,298        25,298 
Obligations of states & political subdivisions       89,745        89,745 
Marketable equity securities   3,951            3,951 
                     
Total securities  $3,951   $280,060   $   $284,011 

 

On December 31, 2011, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. As of December 31, 2011, the Corporation’s CRA fund investments had a book value of $4,000,000 and a fair market value of $3,951,000 utilizing level I pricing.

 

Financial instruments are considered level III when their values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. There were no level III securities as of September 30, 2012 or December 31, 2011.

 

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheets at their fair value as of September 30, 2012, and December 31, 2011, by level within the fair value hierarchy:

 

ASSETS MEASURED ON A NONRECURRING BASIS

(Dollars in Thousands)

 

   September 30, 2012 
   Level I   Level II   Level III   Total 
Assets:                    
  Impaired Loans  $   $   $2,823   $2,823 
  OREO           264    264 
Total  $   $   $3,087   $3,087 

 

   December 31, 2011 
   Level I   Level II   Level III   Total 
Assets:                    
  Impaired Loans  $   $   $3,319   $3,319 
  OREO                
Total  $   $   $3,319   $3,319 

 

   September 30, 2011 
   Level I   Level II   Level III   Total 
Assets:                    
  Impaired Loans  $   $   $3,409   $3,409 
  OREO           400    400 
Total  $   $   $3,809   $3,809 

 

22
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The Corporation had a total of $2,985,000 of impaired loans as of September 30, 2012, with $162,000 of specifically allocated allowance against these loans. The Corporation had a total of $3,520,000 of impaired loans as of December 31, 2011, with $201,000 of specifically allocated allowance against these loans. This compares to a total of $3,584,000 of impaired loans as of September 30, 2011, with $175,000 of specifically allocated allowance against these loans. Impaired loans are valued based on a discounted present value of expected future cash flows.

 

Other real estate owned (OREO) is measured at fair value, less estimated costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management. The assets are carried at the lower of carrying amount or fair value, less estimated costs to sell. The Corporation’s OREO balance consists of one residential property that was classified as OREO in the third quarter of 2012. Management has estimated the current value of the OREO property at $264,000 utilizing level III pricing. Income and expenses from operations and changes in valuation allowance are included in the net expenses from OREO.

 

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Corporation has utilized level III inputs to determine fair value:

 

QUANTITATIVE INFORMATION ABOUT LEVEL III FAIR VALUE MEASUREMENTS
(DOLLARS IN THOUSANDS)                
   Fair Value  Valuation   Unobservable   Range 
September 30, 2012:  Estimate  Techniques   Input   (Weighted Avg) 
                 
Impaired loans   2,823    Appraisal of    Appraisal    0% to -20% (-20%) 
         collateral (1)    adjustments (2)      
              Liquidation    0% to -10% (-10%) 
              expenses (2)      
                     
OREO   264    Appraisal of    Liquidation    -2% to -10% (-6%) 
         collateral (1),(3)    expenses (2)      
                     

 

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally

include various level III inputs which are not identifiable.  

 

(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated

liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments

are presented as a percent of the appraisal.  

 

(3) Includes qualitative adjustments by management and estimated liquidation expenses.  

5.        Interim Disclosures about Fair Value of Financial Instruments

 

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

 

Cash and Cash Equivalents

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Securities Available for Sale

Management utilizes quoted market pricing for the fair value of the Corporation's securities that are available for sale, if available. If a quoted market rate is not available, fair value is estimated using quoted market prices for similar securities.

 

Regulatory Stock

Regulatory stock is valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the carrying amount is a reasonable estimate of fair value.

 

Loans Held for Sale

Loans held for sale are individual loans for which the Corporation has a firm sales commitment; therefore, the carrying value is a reasonable estimate of the fair value.

23
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

Loans

The fair value of fixed and variable rate loans is estimated by discounting back the scheduled future cash flows of the particular loan product, using the market interest rates of comparable loan products in the Corporation’s greater market area, with the same general structure, comparable credit ratings, and for the same remaining maturities.

 

Accrued Interest Receivable

The carrying amount of accrued interest receivable is a reasonable estimate of fair value.

 

Bank Owned Life Insurance

Fair value is equal to the cash surrender value of the life insurance policies.

 

Mortgage Servicing Assets

The fair value of mortgage servicing assets is based on the present value of future cash flows for pools of mortgages, stratified by rate and maturity date.

 

Deposits

The fair value of non-interest bearing demand deposit accounts and interest bearing demand, savings, and money market deposit accounts is based on the amount payable on demand at the reporting date. The fair value of fixed-maturity time deposits is estimated by discounting back the expected cash flows of the time deposit using market interest rates from the Corporation’s greater market area currently offered for similar time deposits with similar remaining maturities.

 

Long-term Borrowings

The fair value of a long-term borrowing is estimated by comparing the rate currently offered for the same type of borrowing instrument with a matching remaining term.

 

Accrued Interest Payable

The carrying amount of accrued interest payable is a reasonable estimate of fair value.

 

Firm Commitments to Extend Credit, Lines of Credit, and Open Letters of Credit

These financial instruments are generally not subject to sale and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment, using fees currently charged to enter into similar agreements with similar credit risk, is not considered material for disclosure purposes. The contractual amounts of unfunded commitments are presented in Note 6.

24
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

Fair Value of Financial Instruments

 

The carrying amounts and estimated fair values of the Corporation's financial instruments at September 30, 2012, are summarized as follows:

 

FAIR VALUE OF FINANCIAL INSTRUMENTS
(DOLLARS IN THOUSANDS)
                     
   September 30, 2012 
           Quoted Prices in         
           Active Markets   Significant Other   Significant 
           for Identical   Observable   Unobservable 
   Carrying       Assets   Inputs   Inputs 
   Amount   Fair Value   (Level 1)   (Level II)   (Level III) 
   $   $   $   $   $ 
Financial Assets:                         
Cash and cash equivalents   34,952    34,952    34,952         
Securities available for sale   304,481    304,481    4,956    299,525     
Regulatory stock   4,033    4,033    4,033           
Loans held for sale   897    897        897     
Loans, net of allowance   394,000    404,707            404,707 
Accrued interest receivable   3,362    3,362    3,362         
Bank owned life insurance   19,015    19,015    19,015         
Mortgage servicing assets   19    19            19 
                          
Financial Liabilities:                         
Demand deposits   149,839    149,839    149,839         
Interest-bearing demand deposits   7,385    7,385    7,385         
NOW accounts   61,107    61,107    61,107         
Savings accounts   109,618    109,618    109,618         
Money market deposit accounts   53,159    53,159    53,159         
Time deposits   238,826    244,036            244,036 
    Total deposits   619,934    625,144    381,108        244,036 
                          
Long-term borrowings   70,500    74,375            74,375 
                          
Accrued interest payable   830    830    830         

 

25
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The carrying amounts and estimated fair values of the Corporation’s financial instruments at December 31, 2011, and September 30, 2011, are summarized as follows:

FAIR VALUE OF FINANCIAL INSTRUMENTS
(DOLLARS IN THOUSANDS)
                 
   December 31,   September 30, 
   2011   2011 
   Carrying       Carrying     
   Amount   Fair Value   Amount   Fair Value 
   $   $   $   $ 
Financial Assets:                    
Cash and cash equivalents   31,886    31,886    35,020    35,020 
Securities available for sale   284,011    284,011    284,644    284,644 
Regulatory stock   4,148    4,148    4,102    4,102 
Loans held for sale   1,926    1,926    210    210 
Loans, net of allowance   404,158    412,796    400,197    417,286 
Accrued interest receivable   3,157    3,157    3,079    3,079 
Bank owned life insurance   16,552    16,552    16,393    16,393 
Mortgage servicing assets   26    26    27    27 
                     
Financial Liabilities:                    
Demand deposits   149,510    149,510    139,426    139,426 
NOW accounts   61,246    61,246    62,608    62,608 
Savings accounts   100,377    100,377    98,673    98,673 
Money market deposit accounts   56,872    56,872    58,385    58,385 
Time deposits   237,673    242,536    244,329    247,926 
    Total deposits   605,678    610,541    603,421    607,018 
                     
Long-term borrowings   73,000    77,180    80,500    84,983 
                     
Accrued interest payable   1,005    1,005    1,110    1,110 

 

6.       Commitments and Contingent Liabilities

 

In order to meet the financing needs of its customers in the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of September 30, 2012, firm loan commitments were $9.3 million, unused lines of credit were $102.2 million, and open letters of credit were $8.0 million. The total of these commitments was $119.5 million, which represents the Corporation’s exposure to credit loss in the event of nonperformance by its customers with respect to these financial instruments. The actual credit losses that may arise from these commitments are expected to compare favorably with the Corporation’s loan loss experience on its loan portfolio taken as a whole. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for balance sheet financial instruments.

 

7.       Recently Issued Accounting Standards

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Corporation has provided the necessary disclosure in Note 5.

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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Corporation has provided the necessary disclosure in the Consolidated Statements of Comprehensive Income.

  

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment. The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this Update apply to all entities, both public and nonpublic, that have goodwill reported in their financial statements and are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

  

In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary's operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2013, and interim and annual periods thereafter. Early adoption is permitted. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

  

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

 

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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Corporation has provided the necessary disclosure in the Consolidated Statements of Comprehensive Income.

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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

 

The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2011 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.

 

Forward-Looking Statements

 

The U.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regards to the inclusion of forward-looking statements in this document and documents incorporated by reference. Forward-looking statements pertain to possible or assumed future results that are made using current information. These forward-looking statements are generally identified when terms such as: “believe,” “estimate,” “anticipate,” “expect,” “project,” “forecast,” and other similar wordings are used. The readers of this report should take into consideration that these forward-looking statements represent management’s expectations as to future forecasts of financial performance, or the likelihood that certain events will or will not occur. Due to the very nature of estimates or predications, these forward-looking statements should not be construed to be indicative of actual future results. Additionally, management may change estimates of future performance, or the likelihood of future events, as additional information is obtained. This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative of actual results.

 

Readers should note that many factors affect this forward-looking information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into this document. These factors include, but are not limited to, the following:

 

·Economic conditions
·Monetary and interest rate policies of the Federal Reserve Board
·Volatility of the securities markets
·Effects of deteriorating economic conditions, specifically the effect on loan customers to repay loans
·Political changes and their impact on new laws and regulations
·Competitive forces
·Changes in deposit flows, loan demand, or real estate and investment securities values
·Changes in accounting principles, policies, or guidelines
·Ineffective business strategy due to current or future market and competitive conditions
·Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk
·Operation, legal, and reputation risk
·The risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful
·The impact of new laws and regulations, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations issued thereunder

 

Readers should be aware if any of the above factors change significantly, the statements regarding future performance could also change materially. The safe harbor provision provides that the Corporation is not required to publicly update or revise forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should review any changes in risk factors in documents filed by the Corporation periodically with the Securities and Exchange Commission, including Item 1A of Part II of this Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports on Form 8-K.

 

Results of Operations

 

Overview

 

The Corporation recorded net income of $1,960,000 and $6,120,000 for the three and nine-month periods ended September 30, 2012, a 13.2% and 15.9% increase, over the $1,731,000 and $5,280,000 earned during the same periods in 2011. Earnings per share, basic and diluted, were $0.69 and $2.14 for the three and nine months ended September 30, 2012, compared to $0.61 and $1.85 for the same periods in 2011.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

The Corporation’s net interest income for the three and nine months ended September 30, 2012, decreased from the same periods in 2011. Net interest income was $5,407,000 for the third quarter of 2012, compared to $5,840,000 for the same quarter of 2011, a 7.4% decrease. Year-to-date net interest income was $16,539,000 as of September 30, 2012, a 4.5% decrease, from the $17,326,000 earned in the first nine months of 2011. The Corporation’s net interest margin was 3.31% for the third quarter of 2012, compared to 3.59% for the third quarter of 2011. The Corporation’s year-to-date net interest margin was 3.39% through September 30, 2012, as compared to 3.59% for the same period in 2011.

 

The Corporation recorded a credit provision for loan losses of $250,000 for the third quarter of 2012, and $850,000 for the year-to-date period compared to an expense of $450,000 and $1,350,000 for the respective periods in 2011. Improvements in asset quality, as evidenced by lower levels of non-performing and delinquent loans, minimal charge-offs, and a decline in outstanding loan balances, allowed the Corporation to reverse a portion of the allowance for loan losses into earnings in 2012 while still maintaining strong coverage ratios. Previously, in 2010 and 2011, the provision expense was at an increased level to provide for high levels of classified loans. When classified loans first began to decline in late 2011, the provision for loan losses was initially reduced. With further declines in classified assets, along with low levels of non-performing and delinquent loans, and an overall decrease in outstanding loan balances, the first, second, and third quarter 2012 allowance for loan losses calculation supported a decrease in this balance. With the reductions in 2012, the allowance for loan losses as a percentage of total loans was 1.90% as of September 30, 2012, compared to 2.02% as of September 30, 2011. More detail is provided in the Provision for Loan Losses section that follows and the Allowance for Loan Losses section under Financial Condition.

 

Other income, excluding the gain or loss on the sale of securities and impairment losses on securities, decreased 0.4%, or $5,000, for the third quarter of 2012, compared to 2011. For the first nine months of 2012, other income, excluding the gain or loss on the sale of securities and impairment losses on securities, increased 15.8%, or $646,000, compared to the same period in 2011. Meanwhile, operational costs for the three months ended September 30, 2012, compared to the same period in 2011, increased at a pace of 1.9%, or $96,000. For the first nine months of 2012, total operational costs increased by 5.3%, or $800,000, over the same period in 2011.

 

The financial services industry uses two primary performance measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders. The ROA and ROE increased for the three-month and nine-month periods ended September 30, 2012, compared to the same periods in the prior year due to the increase in the Corporation’s income.

 

Key Ratios  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
                 
Return on Average Assets   1.00%    0.90%    1.06%    0.94% 
Return on Average Equity   8.93%    8.69%    9.60%    9.23% 

 

The results of the Corporation’s operations are best explained by addressing, in further detail, the five major sections of the income statement, which are as follows:

 

·Net interest income
·Provision for loan losses
·Non-interest income
·Non-interest expenses
·Provision for income taxes

 

The following discussion analyzes each of these five components.

 

Net Interest Income

 

Net interest income (NII) represents the largest portion of the Corporation’s operating income. Net interest income typically generates approximately 75% of the Corporation’s gross revenue stream. The overall performance of the Corporation is highly dependent on the changes in net interest income since it comprises such a significant portion of operating income.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

The following table shows a summary analysis of net interest income on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE net interest income shown in both tables below will exceed the NII reported on the consolidated statements of income. The amount of FTE adjustment totaled $549,000 and $1,619,000 for the three and nine months ended September 30, 2012, respectively, compared to $528,000 and $1,570,000 for the same periods in 2011.

 

The amount of the tax adjustment varies depending on the amount of income earned on tax-free assets. The Corporation had been in an alternative minimum tax (AMT) position for years 2006 through 2009. As a result, tax–free loans and securities did not offer the full tax advantage they did when the Corporation was not subject to AMT. During 2008 and early 2009, management was actively reducing the tax-free municipal bond portfolio in an effort to reduce the Corporation’s AMT position, which acted to reduce the tax-equivalent adjustments. However, because of legislation that followed the credit crisis in the fall of 2008, financial institutions were permitted to treat 2009 and 2010 newly issued tax-free municipal bonds as AMT-exempt for the life of the bond. Additionally, financial institutions were still able to purchase AMT-exempt for life municipal bonds in 2011 and 2012, if they were first issued during 2009 and 2010. As a result, management resumed normal purchasing of municipal bonds, but only purchased AMT-exempt municipal bonds. This action began to increase the size of the tax-free municipal bond portfolio, which resulted in a higher tax-equivalent adjustment in 2011 and 2012. The tax-equivalent adjustment is expected to remain stable throughout the remainder of 2012.

 

NET INTEREST INCOME                
(DOLLARS IN THOUSANDS)                
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Total interest income   6,967    7,895    21,465    23,669 
Total interest expense   1,560    2,055    4,926    6,343 
                     
Net interest income   5,407    5,840    16,539    17,326 
Tax equivalent adjustment   549    528    1,619    1,570 
                     
Net interest income (fully taxable equivalent)   5,956    6,368    18,158    18,896 

 

NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect net interest income:

 

·The rates charged on interest earning assets and paid on interest bearing liabilities
·The average balance of interest earning assets and interest bearing liabilities

 

The Federal funds rate, the Prime rate, and the shape of the U.S. Treasury curve all affect net interest income.

 

On December 16, 2008, the Federal Reserve Bank last cut the Federal funds rate from 1.00% to a target rate of 0.00% to 0.25%. The Federal funds rate has effectively remained at 0.25% ever since and is the rate at the time of this filing, nearly four years later. The Federal funds rate is the overnight rate financial institutions charge other financial institutions to borrow or invest overnight funds. The historically low Federal funds rate, along with historically low U.S. Treasury and other market rates, has allowed the Corporation to reduce interest rates paid on deposit products and has reduced the cost of all types of borrowings, allowing management to reduce the cost of funds and reduce the Corporation’s interest expense. The Prime rate declined in tandem with the Federal funds rate over the same period mentioned above, reducing the loan rates for Prime-based loans. Market interest rates have remained very low from a historical perspective since the last Fed action in late 2008; however, mid-term and longer-term yields such as the 5-year and 10-year U.S. Treasuries have varied with a relatively wide range. For example, the 10-year U.S. Treasury yield stood at 2.47% on December 16, 2008, the date of the last Fed action, but traded with yields as high as 4.01% in April 2010 and was back down to 1.65% as of September 30, 2012. Despite the wide range, market rates have been at historically low levels for a long period and the predominant trend from the end of 2008 to present has been declining U.S. Treasury yields. At the time of this report, U.S. Treasury yields were at historically low levels, never before experienced, even during the Great Depression. The prolonged low rate period has resulted in lower fixed rates on loans and securities, which management purchases with excess liquidity. The historically low interest rates have generally had offsetting positive and negative impacts to the Corporation’s NII, but more recently, the decline in asset yields has exceeded the reductions to the funding costs, resulting in a lower margin. This trend was not evident until the end of 2011.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

The decrease in the Prime rate, and a prolonged period with a Prime rate of 3.25%, has reduced the yield on the Corporation’s Prime-based loans, having a direct negative impact on the interest income for the Corporation. The Corporation’s fixed-rate loans do not reprice as rates change; however, with the historic decline in interest rates, more customers have moved into Prime-based loans or have refinanced into lower fixed-rate loans. Management instituted floors on consumer Prime-based loans at the end of 2008 and phased in floors on business and commercial Prime-based loans in 2009 and 2010 and revised pricing standards to help minimize the reduction of loan yield during this historically low-rate period.

 

Even though the Federal funds rate remains at a historic low of 0.25%, the Treasury yield curve has retained some slope to allow banks the ability to invest or lend at longer terms with slightly higher yields. Mid-term and longer-term Treasury yields have been decreasing since the end of 2011. As of September 30, 2012, the yield curve only offered about 142 basis points of slope between the 2-year and 10-year Treasury, down from approximately 165 basis points as of December 31, 2011. Since deposits and borrowings generally price off short-term rates, the extremely low cost of short-term funds permitted management to continue to reduce the overall cost of funds during the third quarter of 2012. Management continued to reprice time deposits and borrowings to lower levels. Meanwhile, management continued to invest in securities and originate loans at longer terms, where the U.S. Treasury curve and market rates are slightly higher, but down from levels experienced in 2011.

 

Management anticipates that interest rates will remain near these historically low levels for the remainder of 2012 and well into 2013 because of the current economic conditions. Continued economic concerns include unemployment rates, weaker retail sales, low gross national product projections, the European Union debt crisis, and the U.S. government’s “fiscal cliff”. The lack of any material improvement in our rapidly growing national debt would only put more pressure on mid-term and long-term interest rates to increase, while the weak economy and relatively high levels of unemployment and low levels of inflation have kept the Federal Reserve from increasing overnight interest rates. These concerns will likely weigh on the market and result in the U.S. Treasury curve retaining a positive slope for the remainder of 2012, and into 2013. Depending on how the U.S. deficit issue is addressed, the yield curve could gain additional slope in 2013 if mid-term and long-term rates were to increase. The current slope, while not large by historical standards, still allows management to continue to price the vast majority of liabilities off lower short-term rates, while pricing loans and investing in longer securities, which are based off the five-year and ten-year U.S. Treasury rates that are moderately higher.

 

The Corporation’s margin was 3.31% for the third quarter of 2012, a 28 basis-point decrease from the 3.59% for the third quarter of 2011. For the year-to-date period, the Corporation’s margin was 3.39%, a 20 basis-point decline from the 3.59% for the nine months ended September 30, 2011. Although it has become challenging to prevent margin declines, the Corporation has done well in consistently reducing its cost of funds in order to maintain a sufficient margin. Management believes this will get progressively more difficult if interest rates remain at these levels well out into 2013 as cost of funds savings will slow and the decline in asset yields will continue.

 

For the third quarter of 2012, the Corporation’s NII on an FTE basis decreased by $412,000, or 6.5%, compared to the same period in 2011. For the nine months ended September 30, 2012, the Corporation’s NII on an FTE basis decreased by $738,000, or 3.9%, compared to the nine months ended September 30, 2011. As shown on the tables that follow, interest income, on an FTE basis for the quarter ending September 30, 2012, decreased by $907,000, or 10.8%, and interest expense decreased by $495,000, or 24.1%, compared to the same period in 2011. For the first nine months of 2012, interest income and interest expense on an FTE basis decreased by $2,155,000, or 8.5%, and $1,417,000, or 22.3%, respectively, compared to the first nine months of 2011.

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

The following tables show a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation’s consolidated balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. A deficiency of the net interest spread is that it does not give credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, management emphasizes the net yield on interest earning assets, also referred to as the net interest margin (NIM). The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. NIM is generally the benchmark used by analysts to measure how efficiently a bank generates net interest income. For example, a financial institution with a NIM of 3.50% would be able to use fewer interest-earning assets and still achieve the same level of net interest income as a financial institution with a NIM of 3.25%.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

 

COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME

(DOLLARS IN THOUSANDS)

 

   For the Three Months Ended September 30, 
   2012   2011 
           (c)           (c) 
   Average       Annualized   Average       Annualized 
   Balance   Interest   Yield/Rate   Balance   Interest   Yield/Rate 
   $   $   %   $   $   % 
ASSETS                              
Interest earning assets:                              
Federal funds sold and interest                              
on deposits at other banks   22,208    24    0.42    18,319    11    0.23 
                               
Securities available for sale:                              
Taxable   198,287    1,005    2.03    197,070    1,628    3.30 
Tax-exempt   92,348    1,380    5.98    80,104    1,292    6.45 
Total securities (d)   290,635    2,385    3.29    277,174    2,920    4.21 
                               
Loans (a)   402,523    5,104    5.06    410,937    5,490    5.33 
                               
Regulatory stock   4,077    3    0.34    4,145    2    0.23 
                               
Total interest earning assets   719,443    7,516    4.18    710,575    8,423    4.73 
                               
Non-interest earning assets (d)   58,033              52,188           
                               
Total assets   777,476              762,763           
                               
LIABILITIES &                              
STOCKHOLDERS' EQUITY                              
Interest bearing liabilities:                              
Demand deposits   121,162    68    0.22    122,066    98    0.32 
Savings deposits   110,416    30    0.11    99,097    26    0.10 
Time deposits   237,583    963    1.61    240,550    1,146    1.89 
Borrowed funds   70,972    499    2.80    81,967    785    3.80 
Total interest bearing liabilities   540,133    1,560    1.15    543,680    2,055    1.50 
                               
Non-interest bearing liabilities:                              
                               
Demand deposits   146,335              136,466           
Other   3,722              3,550           
                               
Total liabilities   690,190              683,696           
                               
Stockholders' equity   87,286              79,067           
                               
Total liabilities & stockholders' equity   777,476              762,763           
                               
Net interest income (FTE)        5,956              6,368      
                               
Net interest spread (b)             3.03              3.23 
Effect of non-interest                              
    bearing funds             0.28              0.36 
Net yield on interest earning assets (c)             3.31              3.59 

 

(a) Includes balances of nonaccrual loans and the recognition of any related interest income.  The quarter-to-date average balances include net deferred loan fees and costs of $42,000 as of September 30, 2012, and ($90,000) as of September 30, 2011.  Such fees and costs recognized through income and included in the interest amounts totaled ($4,000) in 2012, and $4,000 in 2011.

(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. 

(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.

(d) Securities recorded at amortized cost.  Unrealized holding gains and losses are included in non-interest earning assets. 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME

(DOLLARS IN THOUSANDS)

 

   For the Nine Months Ended September 30, 
   2012   2011 
           (c)           (c) 
   Average       Annualized   Average       Annualized 
   Balance   Interest   Yield/Rate   Balance   Interest   Yield/Rate 
   $   $   %   $   $   % 
ASSETS                
Interest earning assets:                
Federal funds sold and interest                              
on deposits at other banks   20,100    60    0.40    17,884    29    0.22 
                               
Securities available for sale:                              
Taxable   194,317    3,412    2.34    184,493    4,797    3.47 
Tax-exempt   88,067    4,049    6.13    79,441    3,818    6.41 
Total securities (d)   282,384    7,461    3.52    263,934    8,615    4.35 
                               
Loans (a)   407,461    15,552    5.09    415,662    16,588    5.33 
                               
Regulatory stock   4,216    11    0.34    4,345    7    0.23 
                               
Total interest earning assets   714,161    23,084    4.31    701,825    25,239    4.80 
                               
Non-interest earning assets (d)   57,022              50,660           
                               
Total assets   771,183              752,485           
                               
LIABILITIES &                              
STOCKHOLDERS' EQUITY                              
Interest bearing liabilities:                              
Demand deposits   119,363    216    0.24    118,654    292    0.34 
Savings deposits   107,729    86    0.11    97,925    76    0.10 
Time deposits   236,868    2,969    1.67    241,049    3,637    2.02 
Borrowed funds   74,619    1,655    2.96    80,906    2,338    3.86 
Total interest bearing liabilities   538,579    4,926    1.22    538,534    6,343    1.58 
                               
Non-interest bearing liabilities:                              
                               
Demand deposits   143,964              133,795           
Other   3,483              3,673           
                               
Total liabilities   686,026              676,002           
                               
Stockholders' equity   85,157              76,483           
                               
Total liabilities & stockholders' equity   771,183              752,485           
                               
Net interest income (FTE)        18,158              18,896      
                               
Net interest spread (b)             3.09              3.22 
Effect of non-interest                              
    bearing funds             0.30              0.37 
Net yield on interest earning assets (c)             3.39              3.59 

 

(a) Includes balances of nonaccrual loans and the recognition of any related interest income.  The year-to-date average balances include net deferred loan fees and costs of ($4,000) as of September 30, 2012, and ($116,000) as of September 30, 2011.  Such fees and costs recognized through income and included in the interest amounts totaled ($1,000) in 2012, and $7,000 in 2011.

(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. 

(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.

(d) Securities recorded at amortized cost.  Unrealized holding gains and losses are included in non-interest earning assets.

35
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Earnings and yields on loans have been negatively impacted by the very low Prime rate of 3.25% and the increased volume in Prime-based loans. Previously in 2011, management was able to price the majority of new Prime-based loans with a Prime floor of 4.00%, which acted to limit the loss in yield as customers converted to variable rate Prime- based pricing. However, as the competitive forces continued to intensify and treasury rates further declined, management had to revert to pricing most commercial customers at the Prime rate later in 2011. The Prime rate is materially below typical fixed-rate business and commercial loans, which generally range between 4.00% and 6.50%, depending on term and credit risk. Management was able to price customers with higher levels of credit risk at Prime plus pricing but these rates were still generally below the fixed rate loan-pricing levels. While Prime-based loans will aid the Corporation when interest rates rise, any increase in Prime-based loans will generally cause the Corporation’s average loan yield to decrease. There are times when sufficient growth in the loan portfolio can make up for decreases in yield and provide a higher overall interest income on loans. However, with the Prime rate at extremely low levels, even with Prime-plus loans being originated, the net impact is generally a reduction of loan yield. This occurs as more variable rate loan growth is occurring than fixed rate loan growth. Additionally, many consumers and businesses are taking the opportunity presented by the historically low Prime rate to borrow additional amounts on existing lines of credit not fully utilized. Nearly all of the Prime or Prime-plus rates on the Corporation’s business and commercial lines of credit are below the business and commercial fixed rates. Growth in this type of loan does not provide the amount of income generated on fixed rate loans.

 

Management instituted floors on certain types of consumer home equity lines of credit at the end of 2008, and instituted limited floors on business or commercial Prime-based loans in 2009. Effective January 1, 2010, all new commercial and business Prime-based lines of credit were floored at 4.00%. This policy did not change until the second quarter of 2011, when lower Prime-based pricing for commercial and business borrowers became available. Additionally, in January 2010, a Prime-plus tiered rating system was implemented on business or commercial borrowers that factor in downgrades in credit rating. As downgrades occurred, the interest rate would be increased based on a set of conditions. These actions were designed to preserve loan yield and more effectively assign higher Prime-based loan rates to weaker credits to be adequately compensated for the higher degree of credit risk. In the second quarter of 2011, due to lower loan growth, increased competition, and lower cost of funds, management did grant new Prime-based loans at Prime to customers with the highest credit ratings, and at 3.50% and 3.75% to strong-rated credits, with average and lower credits receiving higher interest rates. Later in 2011, due to further competitive pressures and additional reductions in the cost of funds, management granted loans at Prime to customers with credit grades of average, above average, and minimum with higher interest rates assigned to acceptable and lower credit grades. As a result, most variable rates being originated in 2011 were between 3.25% and 4.00%, while in 2012 most variable rate loans were being granted at Prime. Management believes Prime-based loan growth is critical to strengthen the Corporation’s asset liability position in preparation for higher interest rates. As such, management will remain competitive with Prime-based loans, as these loans will significantly outperform fixed rate loans given a rise in interest rates. Management also believes there is a very large opportunity cost in not booking Prime-based loans due to competitive reasons and therefore having to reinvest cash flows into securities that are at much lower yields and model as much longer instruments from an interest rate risk standpoint.

 

Earnings and yields on the Corporation’s securities have also been negatively impacted by the historically low interest rates. The Corporation’s securities portfolio consists of nearly all fixed income debt instruments. The U.S. Treasury rates have remained at historically low levels since the Federal funds rate was reduced to 0.25% in December 2008. As the low-rate period continues to extend, larger amounts of securities are maturing forcing the proceeds to be reinvested into lower-yielding instruments. The Corporation’s taxable securities experienced a 127 basis-point reduction in yield for the three months ended September 30, 2012, and a 113 basis-point reduction for the nine months ended September 30, 2012, compared to the same periods in 2011, due to reinvesting into lower-yielding instruments. Tax-exempt security yields decreased by 47 basis points for the three months ended September 30, 2012, and by 28 basis points for the nine months ended September 30, 2012, compared to the same periods in 2011.

 

The average balance of the Corporation’s interest bearing liabilities declined during 2011 only as a result of a significant decline in time deposits. The other areas of NOW, MMDA, and savings grew but not sufficiently enough to compensate for the decline in time deposits. The average balance of interest bearing liabilities remained steady through the first nine months of 2012, however with lower interest rates, total interest expense declined significantly. Interest expense on deposits declined by $209,000 for the three months ended September 30, 2012, and $734,000 for the nine months ended September 30, 2012, compared to the same periods in 2011. Demand and savings deposits reprice in entirety whenever the offering rates are changed. This allows management to reduce interest costs rapidly; however, it becomes difficult to continue to gain cost savings once offering rates decline to these historically low levels. Due to the size of rate decreases relative to the initial interest rate, the percentage decreases in the actual interest rates are very high. The annualized rate on interest bearing demand accounts decreased by 31.3%, and 29.4%, for the three and nine-month periods ended September 30, 2012, compared to the prior year’s periods. Importantly, while the percentage of rate decreases is large, the scope of further reductions in dollar amount of interest expense is very limited since rates cannot feasibly be reduced much lower. For the first nine months of 2012, the average balances of interest bearing demand deposits increased by $0.7 million, or 0.6%, over the same period in 2011, while the average balance of savings accounts increased by $9.8 million, or 10.0%, over the same period in 2011. This increase in balances of lower cost accounts has helped to reduce the Corporation’s overall interest expense in 2012 compared to 2011.

36
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. During 2011 and through the third quarter of 2012, time deposit balances decreased. The decrease can be attributed to the lowest rates paid historically on time deposits, which has caused the differential between time deposit rates and interest rates on non-maturing deposits to be minimal. As a result, customers have elected to keep more of their funds in non-maturity deposits and fewer in time deposits. Because time deposits are the most expensive deposit product for the Corporation and the largest dollar expense from a funding standpoint, the reduction in time deposits, along with the increases in interest-bearing checking, savings, and non-interest bearing checking, has allowed the Corporation to achieve a lower cost and more balanced deposit funding position. The Corporation was able to reduce interest expense on time deposits by $183,000 for the third quarter of 2012, and $668,000 for the year-to-date period compared to the same periods in 2011. Average balances decreased by $3.0 million for the three months ended September 30, 2012, and $4.2 million for the nine months ended September 30, 2012, compared to the same periods in 2011. The annualized rate paid on time deposits decreased by 28 basis points when comparing the three-month periods in both years and 35 basis points when comparing the nine-month periods in both years.

 

The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. In 2012, the Corporation took advantage of some competitively priced short-term advances in addition to the normal portfolio of long-term borrowings. No short-term advances were utilized in 2011. The short-term borrowings at September 30, 2012, only accounted for $1.4 million of the year-to-date average borrowings balance. Management has used long-term borrowings as part of an asset liability strategy to lengthen liabilities rather than as a source of liquidity. The Corporation decreased average total borrowings by $11.0 million in the third quarter of 2012 compared to the same quarter in 2011, and interest expense was $286,000 lower for the same time period as a result. The year-to-date period shows a decrease in average borrowings of $6.3 million with a corresponding decrease in interest expense of $683,000 compared to the year-to-date period in 2011.

 

The NIM was 3.31% for the third quarter of 2012, and 3.39% for the nine months ended September 30, 2012, compared to 3.59% for both the three-month and nine-month periods in 2011. For the three-month period ended September 30, 2012, the net interest spread decreased twenty basis points to 3.03%, from 3.23% for the same period in 2011. For the nine-month period ended September 30, 2012, the net interest spread decreased thirteen basis points to 3.09%, from 3.22% for the same period in 2011. The effect of non-interest bearing funds dropped eight basis points for the three-month period and seven basis points for the nine-month period compared to the prior year. The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go lower, the benefit of non-interest bearing deposits is reduced because there is less difference between no-cost funds and interest bearing liabilities. For example, if a savings account with $10,000 earns 1%, the benefit for $10,000 non-interest bearing deposits is equivalent to $100; but if the rate is reduced to 0.20%, then the benefit is only $20. This assumes dollar-for-dollar replacement, which is not realistic, but demonstrates the way the lower cost of funds affects the benefit to non-interest bearing deposits.

 

The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in net interest income, the Corporation’s largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of rising rates, please see Quantitative and Qualitative Disclosures about Market Risk.

 

Provision for Loan Losses

 

The allowance for loan losses provides for losses inherent in the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The amount of the provision reflects the adjustment management determines necessary to ensure the allowance for loan losses is adequate to cover any losses inherent in the loan portfolio. The Corporation had a credit provision of $250,000 for the quarter ended September 30, 2012, and a credit provision of $850,000 for the nine months ended September 30, 2012, compared to a provision expense of $450,000 and $1,350,000, respectively, for the same periods in 2011. The analysis of the loan loss allowance takes into consideration, among other things, the following factors:

37
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

·levels and trends in delinquencies, nonaccruals, and charge-offs,
·trends within the loan portfolio,
·changes in lending policies and procedures,
·experience of lending personnel and management oversight,
·national and local economic trends,
·concentrations of credit,
·external factors such as legal and regulatory requirements,
·changes in the quality of loan review and board oversight,
·changes in the value of underlying collateral.

 

The provision for 2012 was lower than the provision for 2011 due to the following factors:

 

·Lower levels of delinquent and non-performing loans
·Decreased charge-offs
·Increased allowance as a percentage of total loans
·Declines in total loans

 

Coupled with the prolonged period of economic decline, specifically the weaker housing market and ongoing credit concerns, the Corporation had experienced a general increase in loan delinquencies since the beginning of 2009 through 2010. However, in 2011 and through the third quarter of 2012, delinquencies declined from a January 31, 2011 high of 1.45% of total loans to 0.68% of total loans as of September 30, 2012. The reduction in loan delinquencies was affected by the 2011 payoff of approximately $1.5 million related to a commercial borrower who had several loans on nonaccrual status. The Corporation’s classified loans, which include those loans rated substandard, doubtful and loss, are down significantly from the high in December 2011. Classified loans were $33.3 million as of September 30, 2011, $33.4 million as of December 31, 2011, and $23.8 million as of September 30, 2012, net of specific allocations of $175,000, $201,000, and $162,000, respectively. Total delinquencies, as a percentage of total loans, stood at 0.92% as of September 30, 2011, 1.11% as of December 31, 2011, and 0.68% as of September 30, 2012.

 

Management has been closely tracking delinquencies and classified loans as a percentage of the loan portfolio. The vast majority of the Corporation’s loan customers have remained very steadfast in making their loan payments and avoiding delinquency, even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly, the character of the Corporation’s customers and lending practices. Classified loans are determined strictly by the loan-to-value and debt-to-income ratios. The prolonged economic downturn, including devaluation of residential and commercial real estate, has stressed these ratios to the point that many long-term strong borrowers now fall below industry guidelines for loan-to-value ratios. Higher levels of classified loans have not resulted in higher delinquencies or higher loan losses; however, management is committed to reversing the trend of higher classified loans. This includes seeking additional collateral, limiting the Corporation’s credit exposure, and working out of classified loans that are not in the Corporation’s best interests to continue to hold. During the second quarter of 2012, a classified loan relationship paid off resulting in a decline of approximately $4.2 million of substandard loans. The delinquency and classified loan information is utilized in the quarterly allowance for loan loss (ALLL) calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies and/or classified loans during the quarter would be cause for management to increase or decrease the provision expense. Generally, management will evaluate and adjust, if necessary, the provision expense each quarter upon completion of the quarterly ALLL calculation.

 

Improvements in asset quality, as evidenced by lower levels of non-performing and delinquent loans, minimal charge-offs, along with declines in total loans outstanding, allowed the Corporation to reverse a portion of the allowance for loan losses into earnings in 2012 while still maintaining strong coverage ratios. Previously, in 2010 and 2011, the provision expense was at an increased level to provide for high levels of classified loans. When classified loans first began to decline in late 2011, the provision for loan losses was initially reduced. With further declines in classified assets, along with low levels of non-performing and delinquent loans, the first, second, and third quarter of 2012 allowance for loan losses calculation supported decreases in this balance. Adding to these favorable trends, the charge-offs for the nine months ended September 30, 2012, were $56,000 compared to $450,000 of charge-offs for the same period in 2011. The culmination of all of these factors supported reducing the allowance for loan losses.

 

In addition to the above, provision expense is impacted by three major components that are all included in the quarterly calculation of the ALLL. First, specific allocations are made for any loans where management has determined an exposure that needs to be provided for. These specific allocations are reviewed each quarter to determine if adjustments need to be made. It is common for specific allocations to be reduced as additional principal payments are made, so while some specific allocations are being added, others are being reduced. Second, management provides for estimated losses on pools of similar loans based on historical loss experience. Finally, management utilizes qualitative factors every quarter to adjust historical loss experience to take into consideration the current trends in loan volume, delinquencies, charge-offs, changes in lending practices, and the quality of the Corporation’s underwriting, credit analysis, lending staff, and Board oversight. National and local economic trends and conditions are helpful to determine the amount of loan loss allowance the Corporation should be carrying on the various types of loans. Management evaluates and adjusts, if necessary, the qualitative factors on a quarterly basis.

 

38
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Several higher qualitative adjustments were made in the third quarter of 2012, with the majority related to changes in the agriculture loan portfolio. In the third quarter of 2012 the agricultural portfolio was broken out into dairy and non-dairy. This resulted in modifications to five of the qualitative factors under dairy and non-dairy as the factors were re-analyzed based on these more specific categories. The net impact of all of these changes was a slightly higher composite total for all of the qualitative factors. The new dairy-only sector had higher qualitative factors than the non-dairy agricultural sector due to higher known and perceived risks to the dairy industry. Other than the agricultural qualitative factor changes, the only other qualitative adjustments made were in regard to business loans and business mortgages where a slight increase in the factor occurred to consider minor changes in lending procedures. The other sectors that did not experience any change in qualitative factors were residential real estate, home equity loans, personal loans, and credit lines.

 

The net of all qualitative factor changes over the past several years has resulted in higher required allowance for loan losses, assuming all other factors remained constant. The periodic adjustment of qualitative factors allows the Corporation’s historical loss experience to be continually brought current to more accurately reflect estimated credit losses, based on the current environment. Despite the general trend of higher qualitative factors, there are other significant considerations in the allowance calculations that supported a reduction in the allowance. The impact of lower levels of delinquencies, non-performing and classified loans, as well as a declining outstanding loan portfolio has more than offset the trend of higher qualitative factors in terms of arriving at lower levels of allowance.

 

Management monitors the allowance as a percentage of total loans and has increased this percentage over time. Because of the credit provision recorded for the first nine months of 2012, this percentage has decreased slightly since December 31, 2011, but still remains very high compared to historical percentages. As of September 30, 2012, the allowance as a percentage of total loans was 1.90%, down from 2.06% at December 31, 2011, and 2.02% at September 30, 2011. More detail is provided under Allowance for Loan Losses in the Financial Condition section that follows.

 

Management continues to evaluate the allowance for loan losses in relation to the size of the loan portfolio and changes to the segments within the loan portfolio and their associated credit risk. Management believes the allowance for loan losses is adequate to provide for future loan losses based on the current portfolio and the current economic environment. For further discussion of the calculation, see the Allowance for Loan Losses section under Financial Condition.

 

Other Income

 

Other income for the third quarter of 2012 was $1,758,000, an increase of $149,000, or 9.3%, compared to the $1,609,000 earned during the third quarter of 2011. For the year-to-date period ended September 30, 2012, other income totaled $5,656,000, an increase of $517,000, or 10.1%, compared to the same period in 2011. The following tables detail the categories that comprise other income.

39
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

OTHER INCOME                
(DOLLARS IN THOUSANDS)                
   Three Months Ended September 30,   Increase (Decrease) 
   2012   2011         
   $   $   $   % 
                 
Trust and investment services   248    253    (5)   (2.0)
Service charges on deposit accounts   254    329    (75)   (22.8)
Other service charges and fees   139    106    33    31.1 
Commissions   490    469    21    4.5 
Gains on securities transactions   342    269    73    27.1 
Impairment losses on securities       (81)   81    (100.0)
Gains on sale of mortgages   52    28    24    85.7 
Earnings on bank owned life insurance   164    148    16    10.8 
Other miscellaneous income   69    88    (19)   (21.6)
                     
Total other income   1,758    1,609    149    9.3 

 

  

OTHER INCOME                
(DOLLARS IN THOUSANDS)                
   Nine Months Ended September 30,   Increase (Decrease) 
   2012   2011         
   $   $   $   % 
                 
Trust and investment services   816    847    (31)   (3.7)
Service charges on deposit accounts   860    972    (112)   (11.5)
Other service charges and fees   399    348    51    14.7 
Commissions   1,454    1,376    78    5.7 
Gains on securities transactions   1,003    1,346    (343)   (25.5)
Impairment losses on securities   (86)   (300)   214    (71.3)
Gains on sale of mortgages   183    108    75    69.4 
Losses on sale of loans       (263)   263    (100.0)
Earnings on bank owned life insurance   762    441    321    72.8 
Other miscellaneous income   265    264    1    0.4 
                     
Total other income   5,656    5,139    517    10.1 

 

Trust and investment services revenue consists of income from traditional trust services and income from alternative investment services provided through a third party. For the three months ended September 30, 2012, traditional trust services income decreased $20,000, or 10.5%, from the same period in 2011, while income from alternative investment services increased by $15,000, or 23.0%. For the nine months ended September 30, 2012, traditional trust service income decreased by $20,000, or 3.3%, from the same period in 2011, while income from alternative investment services decreased by $11,000, or 4.5%. It has been more difficult to grow the trust and investment services area in the past several years due to a very weak stock market that coincided with the sub-prime and credit crisis that began in 2008.

 

Service charges on deposit accounts decreased by $75,000, or 22.8%, and $112,000, or 11.5%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Overdraft service charges are the largest component of this category and comprised between 84% and 86% of the total deposit service charges for the three and nine months ended September 30, 2012. Total overdraft fees decreased by $69,000, or 24.4%, and $101,000, or 12.0%, for the three and nine-month periods ended September 30, 2012, compared to the same periods in 2011. Management continues to experience changes in customer behavior related to past regulatory changes on overdrafts, with customers being more proactive in preventing overdrafts from occurring. Most of the other service charge areas remained stable from the third quarter of 2011 to the third quarter of 2012.

 

Other fees increased by $33,000, or 31.1%, and $51,000, or 14.7%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. This is primarily due to an increase in loan-related fees. When customers choose to amend the original terms of their mortgage agreement, to change the length of the term, or to change the rate, they are assessed fees based on the remaining loan balance. These amendments allow customers to obtain favorable terms without completely rewriting the loan. These loan amendments do not involve delinquent loans, or loans with collateral quality deterioration, which are restructured loans. These fees increased by $32,000 for the three months ended September 30, 2012, and $44,000 for the nine months ended September 30, 2012. Various other fee income categories increased or decreased slightly accounting for the remainder of the change.

40
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Commission income increased $21,000, or 4.5%, and $78,000, or 5.7%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The largest component of commission income is from Debit MasterCard® commissions. The amount of customer usage of cards at point of sale transactions determines the level of commission income received. The debit card income increased $10,000, or 2.5%, and $78,000, or 6.5%, for the three months and nine months ended September 30, 2012, compared to the same periods in 2011. Customers have become more comfortable with the use of debit cards, as they are now widely accepted by merchants, thereby increasing the number of transactions processed. Another significant component of commission income is from MasterCard and Visa® commissions, which provided income of $37,000 for the three months ended September 30, 2012, and $125,000 for the nine months ended September 30, 2012. This represents decreases of $13,000, or 25.4%, and $18,000, or 12.7%, compared to the same periods in 2011. MasterCard and Visa commissions are the amount the Corporation earns on transactions processed through the MasterCard and Visa systems for business customers. This revenue had declined due to lower levels of business activity. Another component of commission income is income received from Banker’s Settlement Services for title insurance commissions. This income increased by $23,000 for the three months ended September 30, 2012, and $18,000 for the nine months ended September 30, 2012, compared to the same periods in 2011.

 

For the three months ended September 30, 2012, $342,000 of gains on securities transactions were recorded compared to $269,000 for the same period in 2011. For the nine months ended September 30, 2012, $1,003,000 of gains on securities transactions were recorded compared to $1,346,000 for the same period in 2011. Gains or losses on securities transactions fluctuate based on opportunities to reposition the securities portfolio to improve long-term earnings, or as part of management’s asset liability goals to improve liquidity or reduce interest rate risk or fair value risk. The gains or losses on this type of activity fluctuate based on current market prices and the volume of security sales. Due to favorable market conditions, with U.S. Treasury rates lower and bond prices higher, management had opportunities to sell securities at favorable gains in the first three quarters of 2012 and 2011.

 

There were no impairment losses on securities for the three months ended September 30, 2012, and impairment losses totaled $86,000 for the nine months ended September 30, 2012, compared to $81,000 and $300,000 for the same periods in 2011. Impairment losses occur when securities are written down to a lower value based on anticipated credit losses. The other than temporary impairment losses recorded in 2012 were related to two private collateralized mortgage obligations. The impairment losses recorded in 2011 were related to four private collateralized mortgage obligations. Further information on securities and other than temporary impairment is provided in the Securities Available for Sale section, under Financial Condition, in this filing.

 

Gains on the sale of mortgages were $52,000 and $183,000 for the three and nine-month periods ended September 30, 2012, compared to $28,000 and $108,000 for the same periods in 2011. Secondary mortgage financing activity drives the gains on the sale of mortgages, and this activity increased towards the end of 2011 and has continued in 2012 as refinancing activity was high due to the extremely low interest rate environment.

 

For the three and nine months ended September 30, 2012, earnings on BOLI were $164,000 and $762,000, compared to $148,000 and $441,000 for the same periods in 2011. Increases and decreases in BOLI income depend on insurance cost components on the Corporation’s BOLI policies, the actual annual return of the policies, and any benefits paid upon death that exceed the policy’s cash surrender value. Increases in cash surrender value are a function of the return of the policy net of all expenses. Management made an additional BOLI purchase in the first quarter of 2012 that contributed to the increase in BOLI income from the third quarter of 2011 to the third quarter of 2012. In addition, the death of a former director resulted in further BOLI income of $256,000 in 2012.

 

The miscellaneous income category decreased $19,000, or 21.6%, and increased $1,000, or 0.4%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. In the third quarter of 2011, the provision for off balance sheet credit losses was reduced by $37,000, which was recorded as miscellaneous income. In the third quarter of 2012, this provision was reduced by $18,000, representing a $19,000 decrease from the same quarter in 2011.

41
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Operating Expenses

 

The following tables provide details of the Corporation’s operating expenses for the three and nine-month periods ended September 30, 2012, compared to the same periods in 2011.

 

OPERATING EXPENSES            
(DOLLARS IN THOUSANDS)                
   Three Months Ended September 30,   Increase (Decrease) 
   2012   2011         
   $   $   $   % 
                 
Salaries and employee benefits   3,020    2,904    116    4.0 
Occupancy expenses   420    410    10    2.4 
Equipment expenses   221    206    15    7.3 
Advertising & marketing expenses   65    74    (9)   (12.2)
Computer software & data processing expenses   418    397    21    5.3 
Bank shares tax   202    208    (6)   (2.9)
Professional services   262    287    (25)   (8.7)
FDIC Insurance   90    88    2    2.3 
Other operating expenses   373    401    (28)   (7.0)
Total Operating Expenses   5,071    4,975    96    1.9 

 

  

OPERATING EXPENSES            
(DOLLARS IN THOUSANDS)                
   Nine Months Ended September 30,   Increase (Decrease) 
   2012   2011         
   $   $   $   % 
                 
Salaries and employee benefits   9,326    8,566    760    8.9 
Occupancy expenses   1,261    1,217    44    3.6 
Equipment expenses   657    604    53    8.8 
Advertising & marketing expenses   285    239    46    19.2 
Computer software & data processing expenses   1,216    1,174    42    3.6 
Bank shares tax   618    625    (7)   (1.1)
Professional services   850    974    (124)   (12.7)
FDIC Insurance   270    433    (163)   (37.6)
Other operating expenses   1,282    1,133    149    13.2 
Total Operating Expenses   15,765    14,965    800    5.3 

 

Salaries and employee benefits are the largest category of operating expenses. In general, they comprise between 55% and 60% of the Corporation’s total operating expenses. For the three and nine months ended September 30, 2012, salaries and benefits increased $116,000, or 4.0%, and $760,000, or 8.9%, over the same periods in 2011. Salaries increased by $76,000, or 3.5%, and $549,000, or 8.7%, and employee benefits increased by $40,000, or 5.5%, and $211,000, or 9.5%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. In addition to the normal wage and cost of living increases, the salary and benefits costs increased due to the addition of multiple new professional staff members, primarily in the loan function.

 

Occupancy expenses consist of the following:

  

·Depreciation of bank buildings
·Real estate taxes and property insurance
·Utilities
·Building repair and maintenance

 

42
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Occupancy expenses increased $10,000, or 2.4%, and $44,000, or 3.6%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The majority of this increase was due to a $13,000 and a $19,000 increase in building repair and maintenance expenses for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Various other occupancy categories had minimal increases and decreases accounting for the remainder of the quarterly and year-to-date variances.

 

Equipment expenses increased $15,000, or 7.3%, and $53,000, or 8.8%, for the three and nine months ended September 30, 2012, compared to the same periods in the prior year. This expense category includes equipment depreciation, repair and maintenance, and various other equipment-related expenses. Depreciation expense increased by $7,000, or 5.4%, and $21,000, or 5.6%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Equipment assets have shorter asset depreciation lives, generally five to seven years. In addition, expenses related to equipment repair and maintenance increased by $14,000 and $35,000 for the three and nine-month periods ended September 30, 2012, when compared to the same periods in 2011. Partially offsetting these increases, equipment service contract expenses decreased by $9,000 and $6,000 for the three and nine-month periods ended September 30, 2012, compared to the same periods in the prior year. Other equipment expenses changed minimally.

 

Advertising and marketing expenses decreased by $9,000, or 12.2%, and increased by $46,000, or 19.2%, for the three and nine months ended September 30, 2012, compared to the same periods in the prior year. The expenses of this category support the overall business strategies of the Corporation; therefore, the timing of these expenses is dependent upon those strategies and fluctuations are normal.

 

The computer software and data processing expenses are comprised of STAR® network processing fees, software amortization, software purchases, and software maintenance agreements. This expense category increased $21,000, or 5.3%, and $42,000, or 3.6%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Software-related expenses increased $9,000, or 4.2%, and decreased $10,000, or 1.6%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011, as a result of an increase in software maintenance agreement expense for the quarter and year-to-date periods and a decrease in software amortization costs for the year-to-date period . STAR network fees were up $12,000, or 6.3%, and $52,000, or 10.0%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The STAR network fees are the fees paid to process all ATM and debit card transactions.

 

Bank shares tax expense decreased $6,000, or 2.9%, and $7,000, or 1.1%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The shares tax is a calculation based on the Bank’s capital net of shares tax-exempt assets. The shares tax will generally increase as the Bank’s capital levels grow unless the Bank purchases more shares tax-exempt assets. Management continually weighs the benefits of holding more bank shares tax-exempt assets versus the costs in terms of the lower yield that these securities produce compared to other securities.

 

Professional services expense decreased $25,000, or 8.7%, and $124,000, or 12.7%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. These services include accounting and auditing fees, legal fees, loan review fees, and fees for other third-party services. Accounting and auditing fees decreased by $29,000 and $20,000 for the three and nine months ended September 30, 2012, compared to the same periods in 2011, due to an adjustment made in 2011 for fees that were over-accrued in 2010. The fee accruals in 2010 were elevated due to an expected increase in internal and external audit fees related to compliance with the Sarbanes-Oxley Act. However, due to the deferral of the external audit attestation piece of the Sarbanes-Oxley Act, the Corporation was not required to pay these additional audit fees. In addition, student loan servicing expense decreased $35,000 and $191,000 for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Management decided to stop originating student loans in the first quarter of 2010 and sold the remaining portfolio of student loans in the second quarter of 2011. Other outside services expense increased $35,000 and $66,000 for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Several other professional services expenses increased or decreased slightly making up the remainder of the variance.

 

The expenses associated with FDIC insurance increased by $2,000, or 2.3%, and decreased by $163,000, or 37.6%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The FDIC expenses for 2012 were reduced primarily because of a change in assessment base. Prior to 2011, assessments were calculated based on the total deposits of a financial institution. Beginning in the second quarter of 2011, the assessment base was changed from deposits to total assets less tangible equity. This change resulted in significant savings for the Corporation beginning in the second quarter of 2011. FDIC premiums were prepaid at the end of 2009 for the 2010 to 2012 period. The Corporation had a total of $1,014,000 outstanding in the prepaid FDIC insurance assessment asset account as of September 30, 2012. In addition to FDIC insurance costs, the Corporation is subject to assessments to pay the interest on Financing Corporation Bonds, which is also recorded as FDIC insurance expense. Congress created the Financing Corporation to issue bonds to finance the resolution of failed thrift institutions. The total Financing Corporation assessments paid by the Corporation in the first three quarters of 2012 were approximately $34,000 and were approximately 23% lower than the assessments paid in the first three quarters of 2011.

43
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Other operating expenses are comprised of the remainder of the Corporation’s operating expenses. Some of the larger items included in this category are:

 

·Postage
·Director fees and expense
·Travel expense
·General supplies
·Charitable contributions
·Delinquent loan expenses
·Deposit account charge-offs and recoveries

 

Other operating expenses decreased by $28,000, or 7.0%, and increased by $149,000, or 13.2%, for the three and nine months ended September 30, 2012, compared to the same periods in 2011. The year-to-date increase can be attributed to an increase in the allowance for off-balance sheet credit losses of $77,000, additional charitable contributions expenses of $33,000, and additional fraud related charge-off expenses of $115,000 for the nine months ended September 30, 2012. Operating supplies expenses decreased by $21,000 and postage expenses decreased by $19,000, partially offsetting these increases. Several other expense categories had minimal increases and decreases making up the remaining variance.

 

Income Taxes

 

The majority of the Corporation’s income is taxed at a corporate rate of 34% for Federal income tax purposes. The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, the Corporation has no taxable corporate net income activities. The Corporation’s wholly owned subsidiary, Ephrata National Bank, is not subject to state corporate income tax, but does pay Pennsylvania Bank Shares Tax. The Bank Shares Tax expense appears on the Corporation’s Consolidated Statements of Income, under operating expenses.

 

Certain items of income are not subject to Federal income tax, such as tax-exempt interest income on loans and securities, and BOLI income; therefore, the effective income tax rate for the Corporation is lower than the stated tax rate. The effective tax rate is calculated by dividing the Corporation’s provision for income tax by the pre-tax income for the applicable period.

 

For the three and nine months ended September 30, 2012, the Corporation recorded tax expense of $384,000 and $1,160,000, compared to tax expense of $293,000 and $870,000 for the three and nine months ended September 30, 2011. The effective tax rate for the Corporation was 15.9% for the nine months ended September 30, 2012, compared to 14.1% for the same period in 2011. The effective tax rate was higher because the Corporation’s level of pre-tax income was 18.4% higher for the nine months ended September 30, 2012, compared to the same period in 2011.

44
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Financial Condition

 

Securities Available for Sale

 

The Corporation classifies all of its securities as available for sale and reports the portfolio at fair market value. As of September 30, 2012, the Corporation had $304.5 million of securities available for sale, which accounted for 38.8% of assets, compared to 36.8% as of December 31, 2011, and 37.0% as of September 30, 2011. Based on ending balances, the securities portfolio increased 7.0% from September 30, 2011, and 7.2% from December 31, 2011.

 

The Corporation typically invests excess liquidity into securities, primarily fixed-income bonds. The securities portfolio provides interest and dividend income to supplement the interest income on loans. Additionally, the securities portfolio assists in the management of both liquidity risk and interest rate risk. In order to provide maximum flexibility for management of liquidity and interest rate risk, the securities portfolio is classified as available for sale and reported at fair value. Management adjusts the value of all the Corporation’s securities on a monthly basis to fair market value as determined in accordance with U.S. generally accepted accounting principles. Management has the ability and intent to hold all debt securities until maturity, and does not generally record impairment on bonds that are currently valued below book value. In addition to the fixed-income bonds, the Corporation also has two small equity holdings with a book value of $5 million in the form of two CRA-qualified mutual funds. These equity funds make up less than 2% of the Corporation’s securities available for sale. The one CRA fund is a Small Business Association (SBA) variable rate fund with a stable dollar price, while the other CRA fund is an equity fund subject to fair value adjustment.

 

All securities, bonds, and equity holdings are evaluated for impairment on a quarterly basis. Should any impairment occur, management would write down the security to a fair market value in accordance with U.S. generally accepted accounting principles, with the amount of the write down recorded as a loss on securities.

 

Each quarter, management sets portfolio allocation guidelines and adjusts the security portfolio strategy generally based on the following factors:

 

·Relative performance of the various instruments
·Duration and average length of the portfolio
·Volatility of the portfolio
·Direction of interest rates
·Slope of the yield curve
·ALCO positions as to liquidity, credit risk, interest rate risk, and net portfolio value
·Economic factors impacting debt securities

 

The investment policy of the Corporation imposes guidelines to ensure diversification within the portfolio. The diversity specifications provide opportunities to shorten or lengthen duration, maximize yield, and mitigate credit risk. The composition of the securities portfolio based on fair market value is shown in the following table.

 

SECURITIES PORTFOLIO                        
(DOLLARS IN THOUSANDS)                        
   Period Ending 
   September 30, 2012   December 31, 2011   September 30, 2011 
   $   %   $   %   $   % 
                         
U.S. government agencies   38,616    12.7    46,614    16.4    51,537    18.1 
U.S. agency mortgage-backed securities   55,648    18.3    55,129    19.4    51,585    18.1 
U.S. agency collateralized mortgage obligations   47,420    15.6    56,049    19.8    60,568    21.3 
Private collateralized mortgage obligations   5,935    1.9    7,225    2.5    10,245    3.6 
Corporate debt securities   48,952    16.1    25,298    8.9    22,297    7.8 
Obligations of states and political subdivisions   102,954    33.8    89,745    31.6    84,458    29.7 
Equity securities   4,956    1.6    3,951    1.4    3,954    1.4 
                               
Total securities   304,481    100.0    284,011    100.0    284,644    100.0 

 

45
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The largest movements within the securities portfolio were shaped by market factors, such as:

 

·interest spread versus U.S. Treasury rates on the various securities
·pricing of the instruments, including supply and demand for the product
·structure of the instruments, including duration and average life
·portfolio weightings versus policy guidelines
·prepayment speeds on mortgage-backed securities and collateralized mortgage obligations
·risk-based capital reasons
·federal income tax considerations with regard to obligations of states and political subdivisions.

 

Since September of 2011, the most significant shift occurring in the Corporation’s securities portfolio was an increase in corporate bonds. Corporate bonds increased $26.7 million, or 119.5%, from September 30, 2011 to September 30, 2012. The Corporation invested in additional corporate bonds in order to add diversity to the portfolio and provide strong yields for shorter maturities. In addition to strong performance for a relatively short maturity, a number of government-backed foreign financial corporate bonds now carry a favorable 20% risk weighting rather than the normal 100% risk weighting. The 100% risk weighting of corporate bonds has been a major reason why U.S. financial institutions were limited on their corporate bond purchases as they strove to increase their risk-based capital levels. The Corporation already maintains a high total risk-based capital level and the new opportunity of investing in corporate bonds with a 20% risk weighting makes them a more attractive investment. As of September 30, 2012, nearly 45% of the Corporation’s corporate bonds carried a favorable 20% risk weighting. Corporate bonds had historically been a relatively small percentage of the securities portfolio, accounting for only 7.8% of the portfolio as of September 30, 2011. As a result of the added investments, corporate bonds now account for 16.1% of the portfolio as of September 30, 2012.

 

The next highest growth in the portfolio occurred with municipal bonds, which grew $18.5 million, or 21.9%, since September 30, 2011. The Corporation has historically maintained large municipal bond holdings that have generally averaged between 30% and 34% of the portfolio. Because of the substantial growth that has occurred in the portfolio, a large dollar increase is necessary just to maintain municipal bonds in this preferred range. The other areas of the securities portfolio, with the exception of mortgage-backed securities (MBS) and equity securities, declined in dollar amount or as a percentage of the portfolio. The areas that declined were U.S. government agencies, collateralized mortgage obligations (CMOs), and private collateralized mortgage obligations (PCMOs). Equity securities are a very small percentage of the portfolio and increased by $1.0 million, or 25.3%, from September 30, 2011 to September 30, 2012. The MBS sector grew out of a strategy to reinvest CMO maturities and cash flow back into MBS rather than into shorter structure CMOs to limit excessive cash flows and reduce reinvestment risk. The more significant components of the securities portfolio along with a more detailed explanation of their changes are discussed below.

 

The decrease in the Corporation’s U.S. government agencies sector occurred primarily due to calls and maturities, but also as payments were received in the form of normally scheduled principal payments on the portion of agencies that are structured notes. As agencies were called or matured, only a portion of these proceeds were reinvested back into the agency sector because of the extremely low yields available on these bonds. Management continues to invest in agencies when advantageous to maintain a minimum sector weighting, maintain adequate risk weightings of the portfolio, to ensure sufficient U.S. government securities for pledging purposes, and importantly to ladder out a schedule of agency and corporate maturities over the next 5 years to avoid any concentration of maturities. Next to U.S. Treasuries, U.S. agencies are viewed as the safest instruments and are considered by management as foundational to the portfolio. Management prefers to maintain U.S. agencies at a minimum of 15% of the portfolio. As of September 30, 2012, U.S. agencies represented 12.7% of the fair market value of the portfolio. Management has a goal of returning to the 15% level by the end of 2012.

 

The increase in the Corporation’s U.S. agency MBS sector since September 30, 2011, occurred due to the strategy of reinvesting CMO dollars into MBS as mentioned above. Investments in a substantial amount of MBS assist management in maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity and interest rate risk positions. Unlike the typical U.S. agency paper, corporate bonds, and obligations of states and political subdivisions, which only pay principal at final maturity, the U.S. agency MBS, CMO, and PCMO securities pay monthly principal and interest and are subject to prepayment of principal. The combined effect of all of these instruments paying monthly principal and interest provides the Corporation with a significant and reasonably stable cash flow. Cash flows coming off of MBS, CMOs, and PCMOs do slow down and speed up as interest rates increase or decrease, which has an impact on the portfolio’s length and yield. As interest rates decline, prepayment of principal on securities increases, the duration of the security shortens, and the yield declines as more amortization is required on premium bonds. If interest rates were to increase, the opposite of this would occur. In this prolonged period of historically low interest rates, the shorter structure of the CMO securities has not benefited the Corporation as increased cash flows have to be reinvested at historically low rates. Therefore, management has been purchasing structures that limit the amount of cash flow that can be returned over the next year or two. Despite the fluctuations that occur in terms of monthly cash flow as a result of changing prepayment speeds, the monthly cash flow generated by U.S. agency MBS, CMO, and PCMO securities as a group is significant, and helps to soften or smooth out the Corporation’s total monthly cash flow from all securities.

46
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Obligations of states and political subdivisions, or municipal bonds, are tax-free securities that generally provide the highest yield in the securities portfolio. From 2006 through 2009, the Corporation was in an alternative minimum tax (AMT) position when income levels fell and tax-exempt income remained high. The AMT requires the payment of a minimum level of tax should an entity have excessive amounts of tax preference items relative to a Corporation’s income. The Corporation’s primary tax preference item is the large amount of tax-free income generated by tax-free loans and tax-exempt securities. As a result of the Corporation’s AMT position in 2008, management had determined that the size of the municipal bond holdings in relation to the rest of the securities portfolio should be decreased. However, because of legislation that followed the credit crisis in the fall of 2008, beginning in 2009, financial institutions were permitted to purchase 2009 and 2010 issued tax-free municipal bonds, which are AMT-exempt for the life of the bond. In addition, management could continue to purchase AMT exempt municipals in 2011 and 2012 as long as they were originally issued in 2009 and 2010. In 2010, 2011, and through the first nine months of 2012, management increased the amount of tax-free municipal bonds due to very favorable tax-free yields that far surpassed the yields available on similar length taxable instruments and the favorable AMT-exempt for life tax treatment that exists. Management views this as a unique opportunity to both take advantage of the more favorable tax-equivalent yields on municipal bonds without causing the Corporation to be subject to AMT, typically caused by carrying too many tax-free investments. Municipal bonds as a percentage of the total investment portfolio have increased slightly from 29.7% at September 30, 2011, compared to 31.6% as of December 31, 2011, and 33.8% at September 30, 2012. Management is comfortable with municipal bonds at approximately 34% of the portfolio and does not anticipate growth beyond this level.

 

The harsh economic and credit environment, that began in 2008 and continues to this day, has caused the downgrading of many securities. This phenomenon has affected all segments of the Corporation’s portfolio not backed by the U.S. government, specifically PCMOs, corporate bonds, and municipal bonds. By policy, management is to identify and recommend whether to hold or sell securities with credit ratings that have fallen below minimum policy credit ratings required at the time of purchase, or below investment grade. Management monitors the security ratings on a monthly basis and reviews quarterly with the Board of Directors. Management, with Board approval, determines whether it is in the Corporation’s best interest to continue to hold any security that has fallen below policy guidelines or below investment grade based on the expectation of recovery of market value or improved performance. At this time management has elected, and the Board has approved holding securities that have fallen below initial policy guidelines or investment grade.

 

As of September 30, 2012, the Corporation held four PCMO securities with an amortized cost of $6.4 million, a reduction of $1.9 million from the balance as of December 31, 2011. One of the four PCMO securities, with an amortized cost of $1.0 million, carried an AAA credit rating by at least one of the major credit rating services. The three remaining PCMOs, with an amortized cost of $5.4 million, had credit ratings below investment grade, which is BBB- for S&P and Baa3 for Moody’s. Management currently has no plans to sell these securities as management believes the current market values are not true indications of the value of the bonds based on cash flow analysis performed under severe stress testing. Management’s September 30, 2012 cash flow analysis did not indicate a need to take additional impairment on any of the PCMO securities; however, impairment charges of $86,000 were recognized on two of these bonds in the first quarter of 2012. The $86,000 of year-to-date impairment in 2012 is down from $300,000 of impairment recorded in the first nine months of 2011. Should any future analysis reflect the need for additional impairment, management would expect it to be diminished as projected loss numbers were increased in the first quarter of 2012 and have now been provided for. Additionally, all of these securities continue to pay down in terms of monthly principal payments.

 

For all of the PCMO bonds with impairment recorded, the cash flow analysis, conducted at slower prepayment speeds than the securities had been paying, revealed that there was an expectation that these particular bonds would suffer some loss of principal at the time of analysis, resulting in the impairment charge. Based on management’s methodology, current data does not support additional impairment on these PCMO securities, but it is possible further impairment would be necessary if both default and severity of loss rates rose to levels that have not yet been experienced, and if prepayment speeds slowed to speeds not previously experienced. Management will continue to update cash flow analysis quarterly that incorporates the most current default rates and prepayment speeds. Prepayment speeds on all of the Corporation’s PCMOs have been relatively fast, which is assisting in the cash flow analysis. Faster prepayment speeds make it more likely that the Corporation’s principal will be returned before additional credit losses are incurred.

47
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

As of September 30, 2012, the Corporation held corporate bonds with a total amortized cost of $47.6 million and fair market value of $49.0 million. Management increased its holdings in corporate securities to 16.1% of the portfolio, compared to 8.9% at December 31, 2011. Like any security, corporate bonds have both positive and negative qualities and management must evaluate these securities on a risk versus reward basis. Corporate bonds add diversity to the portfolio and provide strong yields for short maturities; however, by their very nature, corporate bonds carry a high level of credit risk should the entity experience financial difficulties. Management stands to possibly lose the entire principal amount if the entity that issued the corporate paper fails. As a result of the higher level of credit risk taken by purchasing a corporate bond, management has in place minimal credit ratings that must be met in order for management to purchase a corporate bond.

 

As of September 30, 2012, three of the forty-four corporate securities held by the Corporation showed an unrealized holding loss. These securities with unrealized holding losses were valued at 98.8% of book value. The Corporation’s investment policy requires that corporate bonds have a minimum credit rating of A3 by Moody’s or A- by S&P or Fitch at the time of purchase, or an average or composite rating of A-. As of September 30, 2012, all of the corporate bonds had at least one A3 or A- rating by one of the major credit rating services. As of September 30, 2012, there were nine corporate bonds with $8 million of par value that were carrying split ratings with one rating within policy limit and another rating below the initial policy purchase requirement but above investment grade. These securities are monitored on an ongoing basis to ensure these credits do not deteriorate further and remain at investment grade. Currently, there are no indications that any of these bonds would discontinue contractual payments.

 

Since 2008, the municipal bond ratings have been adversely affected by downgrades on nearly all of the insurance companies backing municipal bond issues. Previous to the sharp decline in the health of the insurance companies in 2008, nearly 95% of the Corporation’s municipal bonds carried AAA credit ratings with the added insurance protection. Now, with the health of most of the insurers greatly diminished, the final rating of most municipal bonds has fallen to AA or A. As of September 30, 2012, approximately 3.9% of the Corporation’s municipal bonds carried an AAA rating. The Corporation’s investment policy requires that municipal bonds not carrying insurance have a minimum credit rating of A3 by Moody’s or A- by S&P or Fitch at the time of purchase. As of September 30, 2012, two municipal bonds with an amortized cost of $1.1 million carried credit ratings under these levels. In the current environment, the major rating services have tightened their credit underwriting procedures and are more apt to downgrade municipalities. Additionally, the very weak economy has reduced revenue streams for many municipalities and has called into question the basic premise that municipalities have unlimited power to tax, i.e. the ability to raise taxes to compensate for revenue shortfalls. Presently, despite the lower credit ratings on the two municipal securities, management has the intent and the ability to hold these securities to maturity and believes that full recovery of principal is probable.

 

The entire securities portfolio is reviewed monthly for credit risk and evaluated quarterly for possible impairment. In terms of credit risk and impairment, management views the Corporation’s one CRA fund with a $1 million book value differently because it is an equity investment with no maturity date. Bond investments could have larger unrealized losses but significantly less probability of impairment due to having a fixed maturity date. As of September 30, 2012, this CRA fund was showing unrealized losses of $44,000, or a 4.4% price decline. The prices on this fund tend to lag behind decreases in U.S. Treasury rates. Management believes that the price declines are primarily rate driven, and temporary as opposed to permanent. The other $4 million CRA SBA fund is a variable rate fund with a stable dollar price that does not carry fair value risk. Corporate bonds and private collateralized mortgage obligations have the most potential credit risk out of the Corporation’s debt instruments. Due to the rapidly changing credit environment and weak economic conditions, management is closely monitoring all corporate bonds and all private label securities. As of September 30, 2012, two private collateralized mortgage obligations were considered to be other-than-temporarily impaired. These two securities were written down by $86,000 during the first quarter of 2012, which was the only impairment taken during the year.

 

Loans

 

Net loans outstanding decreased by 1.5%, to $394.0 million at September 30, 2012, from $400.2 million at September 30, 2011. Net loans decreased by $10.2 million, or 2.5%, since December 31, 2011. The following table shows the composition of the loan portfolio as of September 30, 2012, December 31, 2011, and September 30, 2011.

48
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

 

  

LOANS BY MAJOR CATEGORY
(DOLLARS IN THOUSANDS)
   September 30,   December 31,   September 30, 
   2012   2011   2011 
   $   %   $   %   $   % 
                         
Commercial real estate                              
Commercial mortgages   86,941    21.6    95,347    23.1    94,991    23.3 
Agriculture mortgages   76,675    19.1    73,287    17.7    69,436    17.0 
Construction   17,525    4.4    18,957    4.6    14,874    3.6 
Total commercial real estate   181,141    45.1    187,591    45.4    179,301    43.9 
                               
Consumer real estate (a)                              
1-4 family residential mortgages   130,762    32.5    133,959    32.5    137,731    33.7 
Home equity loans   13,525    3.4    14,687    3.6    15,652    3.8 
Home equity lines of credit   15,907    4.0    15,004    3.6    14,258    3.5 
Total consumer real estate   160,194    39.9    163,650    39.7    167,641    41.0 
                               
Commercial and industrial                              
Commercial and industrial   25,612    6.4    25,913    6.3    26,107    6.4 
Tax-free loans   17,774    4.4    19,072    4.6    20,161    4.9 
Agriculture loans   13,058    3.3    12,884    3.1    11,295    2.8 
Total commercial and industrial   56,444    14.1    57,869    14.0    57,563    14.1 
                               
Consumer   3,798    0.9    3,590    0.9    4,023    1.0 
                               
Total loans   401,577    100.0    412,700    100.0    408,528    100.0 
Less:                              
Deferred loan fees (costs), net   (67)        62         78      
Allowance for loan losses   7,644         8,480         8,253      
Total net loans   394,000         404,158         400,197      

 

(a) Residential real estate loans do not include mortgage loans sold to Fannie Mae and serviced by ENB. These loans totaled $7,345,000 as of September 30, 2012, $8,904,000 as of December 31, 2011, and $9,225,000 as of September 30, 2011.  

 

The composition of the loan portfolio has undergone relatively minor changes in recent years. The total of all categories of real estate loans comprises 85% of total loans. At $181.1 million, commercial real estate is the largest category of the loan portfolio, consisting of 45.1% of total loans. This category includes commercial mortgages, agriculture mortgages, and construction loans. Commercial real estate loans increased from $179.3 million as of September 30, 2011, to $181.1 million as of September 30, 2012, a $1.8 million, or 1.0% increase.

 

The growth in commercial real estate loans has occurred in those secured by farmland and construction loans. Agricultural mortgages increased from $69.4 million, or 38.7% of commercial real estate loans as of September 30, 2011, to $76.7 million, or 42.3% of commercial real estate loans as of September 30, 2012. Similarly, commercial construction loans increased from $14.9 million, or 8.3% of commercial real estate loans as of September 30, 2011, to $17.5 million, or 9.7% of commercial real estate loans as of September 30, 2012. Unlike other commercial areas, agricultural and construction related projects have started to move forward in 2012. As construction projects are completed, some of the loans are converted from construction loans to permanent commercial mortgages.

 

The commercial mortgage segment of the commercial real estate category of loans has declined from September 30, 2011, to September 30, 2012. This area represented $95.0 million, or 53.0%, of commercial real estate loans as of September 30, 2011, and $86.9 million, or 48.0%, of commercial real estate loans as of September 30, 2012. Growth in this area over the past twelve months has slowed significantly since most businesses are unwilling to expand during uncertain economic conditions. Management believes the commercial real estate growth rate will remain low going forward and attributes this to a lag effect in terms of the economic conditions impacting Lancaster County. Locally, commercial loan growth continued during 2008 and 2009 while the national economic slowdown was occurring. That growth continued into the first part of 2010, but slowed as the year progressed and tapered off in 2011 and through the third quarter of 2012. The long-term economic weakness is now having an effect on many commercial projects causing them to be placed on hold. Management also would expect that any rebound in the growth of commercial real estate would lag a recovery by the economy.

49
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Residential real estate loans make up just under 40% of the total loan portfolio with balances of $160.2 million. These loans include 1-4 family residential mortgages, home equity term loans, and home equity lines of credit. Personal residential mortgages account for 81.6% of total residential real estate loans and 32.5% of total loans. Traditional 10 to 20-year personal mortgages originated from and held by the Corporation have consistently been the largest single product of the Corporation’s loan portfolio, varying between 20% and 24% of the loan portfolio over the past five years. The Corporation has experienced some slowdown in the residential mortgage area in the latter part of 2012 as the secondary mortgage market rates became extremely competitive and more customers were opting for this alternative. Payoffs and paydowns of existing mortgages held by the Corporation were exceeding new mortgages issued resulting in a decline in portfolio mortgages through the third quarter of 2012. The Corporation has taken action to lower internal mortgage rates to be more competitive and expects there will be an increase in volume throughout the remainder of 2012 and into 2013. The Corporation’s personal residential mortgages declined modestly to $130.8 million at September 30, 2012, a decrease of $7.0 million, or 5.1%, from balances as of September 30, 2011. The weaker economic conditions, including continued weakness in home prices and home building, have had some impact on demand for the 10 to 20-year mortgages held by the Corporation. The Corporation generally only holds 10, 15, and 20-year mortgages, and will sell any mortgage originated over 20 years. While terms of 10, 15, 20, and 30 years are offered to the customer, the most popular term is the 30-year, which are all sold on the secondary market. Therefore, to grow the Corporation’s residential real estate loans, a sufficient number of 10, 15, and 20-year residential mortgages must be originated to compensate for normal principal pay downs and still grow the portfolio.

 

Second mortgages and home equity loans, fixed or variable, make up the remainder of the Corporation’s residential real estate loans. Requests for fixed-rate home equity loans have slowed in the current environment, while home equity lines of credit, which float on the Prime rate, have increased. From September 30, 2011, to September 30, 2012, fixed rate home equity loans have decreased from $15.7 million to $13.5 million, a $2.2 million, or 16.3% decrease. Meanwhile, home equity lines of credit increased from $14.3 million to $15.9 million, a $1.6 million, or 11.2% increase. The net of these two trends is a $0.6 million reduction in total home equity loan balances. Consumers are borrowing less in total due to economic conditions and a general desire to pay off household debt, while at the same time seeking the lowest interest rate to borrow money against their home value. The trends of lower levels of home equity borrowing and more variable rate versus fixed rate financing is likely to continue until economic conditions improve and home valuations improve. Management does not anticipate any marked improvement in the economy through the remainder of 2012 and into 2013. While management does not anticipate any rate increase from the Federal Reserve in the near future, it is highly expected that when the Federal Reserve eventually acts to increase the overnight rate, and the Prime rate increases, the reaction will be that floating rate loans will become less attractive to borrowers who will act to protect themselves against further rate increases by converting to a fixed rate loan. Management anticipates slow growth in the residential real estate area throughout the remainder of 2012.

 

Commercial loans not secured by real estate are significantly smaller than the Corporation’s commercial loans secured by real estate portfolio. These loans are generally extended based on the health of the commercial borrower. They include both fixed rate loans and Prime-based variable rate loans. The variable rate loans are generally in the form of a business line of credit. The Corporation’s position as to these loans can be further strengthened by obtaining the personal guarantees of the owners. This is a preferred approach on commercial accounts as it allows the Corporation to pursue assets of the owner in addition to assets of the commercial entity. Management can also obtain additional collateral by securitizing the inventory of the business. This portfolio of loans in total showed a decline of $1.1 million, or 1.9%, from September 30, 2011, to September 30, 2012. As of September 30, 2012, this category of commercial loans was made up of $25.6 million of commercial and industrial loans, $17.8 million of tax-free loans, and $13.1 million of agriculture loans. In the case of the Corporation, all of the $17.8 million of tax-free loans are to local municipalities. These loans declined by $2.4 million, or 11.9%, from September 30, 2011, to September 30, 2012, due to several loan payoffs. Agriculture loans increased by $1.8 million, or 15.6%, from September 30, 2011, to September 30, 2012, while other non-real estate secured commercial and industrial purpose loans were down from $26.1 million as of September 30, 2011, to $25.6 million as of September 30, 2012, primarily due to weak economic conditions and a lack of new commercial projects.

50
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The consumer loan portfolio continued to decline from $4.0 million as of September 30, 2011, to $3.8 million as of September 30, 2012. Consumer loans made up 1.0% of total loans on September 30, 2011, and 0.9% of total loans on September 30, 2012. The long-term trend over the past decade has seen homeowners turning to the equity in their homes to finance cars and education rather than traditional consumer loans for those expenditures. More recently, management has seen the need for additional unsecured credit increase; however, this increased need for credit has only resulted in low levels of consumer loans for the Corporation. Slightly higher demand for unsecured credit is being offset by principal payments on existing loans. In the current weak economy, customers delay purchasing new and used cars which has the impact of reducing the consumer loan portfolio, as lower amounts of new loans are going on the books. Management anticipates that the Corporation’s level of consumer loans will likely be relatively unchanged in the near future, as the need for additional unsecured credit in the current weaker economic conditions is generally offset by those borrowers wishing to reduce debt levels and move away from the higher cost of unsecured financing relative to other forms of real estate secured financing.

 

 

Non-Performing Assets

 

Non-performing assets include:

 

·Nonaccrual loans
·Loans past due 90 days or more and still accruing
·Troubled debt restructurings
·Other real estate owned

 

NON-PERFORMING ASSETS            
(DOLLARS IN THOUSANDS)            
   September 30,   December 31,   September 30, 
   2012   2011   2011 
   $   $   $ 
             
Nonaccrual loans   1,346    1,862    1,916 
Loans past due 90 days or more and still accruing   172    107    462 
Troubled debt restructurings            
Total non-performing loans   1,518    1,969    2,378 
                
Other real estate owned   264        400 
                
Total non-performing assets   1,782    1,969    2,778 
                
Non-performing assets to net loans   0.45%    0.49%    0.69% 

The total balance of non-performing assets declined by $1.0 million, or 35.9%, from September 30, 2011, to September 30, 2012. The non-performing assets declined slightly, by $187,000, or 9.5%, from December 31, 2011, to September 30, 2012. There were no loans classified as a TDR as of September 30, 2011, December 31, 2011, or September 30, 2012. Management is monitoring delinquency trends and the level of non-performing loans closely in light of the slightly improved but continued weak economic conditions. At this time, management believes that the potential for material losses related to non-performing loans has declined with the level of non-performing assets down significantly and the Corporation’s total exposure reduced. Additionally, the direction of the risk is viewed as declining from the higher levels experienced in 2010 and early 2011.

 

As of September 30, 2012, other real estate owned (OREO) is shown at the lower of cost or fair market value, net of anticipated selling costs, of $264,000. The balance consists of one residential property that was placed in OREO in the third quarter of 2012. As of September 30, 2011, there was one OREO property, consisting of a manufacturing property with a fair market value of $400,000. The manufacturing property had environmental conditions that had to be remediated in order for the property to be approved for future commercial purposes. These remediation efforts were completed in late 2011, after which management determined that the property was suitable for bank purposes in the future. As such, the property was removed from OREO and classified as land as of December 31, 2011.

51
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Allowance for Loan Losses

 

The allowance for loan losses is established to cover any losses inherent in the loan portfolio. Management reviews the adequacy of the allowance each quarter based upon a detailed analysis and calculation of the allowance for loan losses. This calculation is based upon a systematic methodology for determining the allowance for loan losses in accordance with generally accepted accounting principles. The calculation includes estimates and is based upon losses inherent in the loan portfolio. The allowance calculation includes specific provisions for under-performing loans and general allocations to cover anticipated losses on all loan types based on historical losses. Based on the quarterly loan loss calculation, management will adjust the allowance for loan losses through the provision as necessary. Changes to the allowance for loan losses during the year are primarily affected by four main factors:

 

·Growth or decline of the loan portfolio
·Charge off of loans considered not recoverable
·Recovery of loans previously charged off
·Provision for loan losses

 

Strong credit and collateral policies have been instrumental in producing a favorable history of loan losses. The Allowance for Loan Losses table below shows the activity in the allowance for loan losses for the nine-month periods ended September 30, 2012, and September 30, 2011. At the bottom of the table, two benchmark percentages are shown. The first is net charge-offs as a percentage of average loans outstanding for the year. The second is the total allowance for loan losses as a percentage of total loans.

 

ALLOWANCE FOR LOAN LOSSES        
(DOLLARS IN THOUSANDS)        
   Nine Months Ended 
   September 30, 
   2012   2011 
   $   $ 
           
Balance at January 1,   8,480    7,132 
Loans charged off:          
Real estate       97 
Commercial and industrial   47    315 
Consumer   9    38 
Total charged off   56    450 
           
Recoveries of loans previously charged off:          
Real estate   15     
Commercial and industrial   46    215 
Consumer   9    6 
Total recovered   70    221 
Net loans (recovered) charged off   (14)   229 
           
Provision (credited) charged to operating expense   (850)   1,350 
           
Balance at June 30,   7,644    8,253 
           
Net charge-offs as a % of average total loans outstanding   0.00%    0.06% 
           
Allowance at end of period as a % of total loans   1.90%    2.02% 

 

52
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Charge-offs for the nine months ended September 30, 2012, were $56,000, compared to $450,000 for the same period in 2011. Management typically charges off unsecured debt over 90 days delinquent with little likelihood of recovery. The real estate and consumer charge-offs were lower in the first nine months of 2012 compared to 2011, due to a single real estate loan that was charged off for $97,000 in the first quarter of 2011. Commercial and industrial loan charge-offs were lower in the first nine months of 2012 due to three commercial and industrial loans that were charged off in 2011 with no similar activity in 2012. These charge-offs included two agriculture purpose loans to different borrowers totaling $188,000, and a commercial line of credit totaling $97,000.

 

The allowance as a percentage of total loans represents the portion of the total loan portfolio for which an allowance has been provided. The composition of the Corporation’s loan portfolio has undergone only minor changes since September 30, 2011, however the decline in the balance of loans is having a significant impact on the allowance. All other factors held constant, a decline in the loan portfolio would require less of an allowance to cover losses inherent in the portfolio. Management regularly reviews the overall risk profile of the loan portfolio and the impact that current economic trends have on the Corporation’s loans. The financial industry typically evaluates the quality of loans on a scale with “unclassified” representing healthy loans, “special mention” being the first indication of credit concern, and several successive classified ratings indicating further credit declines of “substandard,” “doubtful,” and, ultimately, “loss.”

 

During 2011, continued downgrades by management in the business loan and business mortgage portfolios resulted in more classified loans. Real estate loans represent a more substantial portion of the outstanding loan portfolio and more of these types of loans indicated either further devaluation of collateral and/or deteriorating financial health that could result in future losses to the Corporation. Conversely, the commercial and industrial loans not secured by real estate represent a smaller portion of the outstanding loan portfolio and these loans have shown improved financial health resulting in less of a need for reserve allocations. Total classified loans, net of specific allowances, reached a peak on December 31, 2011, at $33.4 million, or 39.0% of risked-based capital, and have since declined to $23.8 million, or 26.8% of risked-based capital as of September 30, 2012. The decline is primarily due to one commercial borrower who paid off $4.2 million of loans rated substandard, plus principal payments on many of the remaining classified loans. The Corporation’s total classified loans were $33.3 million as of September 30, 2011, $33.4 million as of December 31, 2011, and $23.8 million as of September 30, 2012, net of specifically allocated allowance against these loans of $175,000, $201,000, and $162,000, respectively. The classified loans require larger provision amounts due to a higher potential risk of loss, so as the classified loan balance declines, the associated specific allowance applied to them declines, resulting in a lower required allowance. The allowance as a percentage of total loans was 2.02% as of September 30, 2011, 2.06% as of December 31, 2011, and 1.90% as of September 30, 2012. Management anticipates that the allowance percentage will remain fairly constant throughout the remainder of 2012.

 

The net charge-offs as a percentage of average total loans outstanding indicates the percentage of the Corporation’s total loan portfolio that has been charged off during the period, after reducing charge-offs by recoveries. The Corporation has historically experienced very low net charge-off percentages due to strong credit practices. Management continually monitors delinquencies, classified loans, and charge-off activity closely, and is not anticipating significant increases throughout the remainder of 2012. Management practices are in place to reduce the number and severity of losses. In regard to severely delinquent loans, management attempts to improve the Corporation’s collateral or credit position and, in the case of a loan workout, intervene to minimize additional charge-offs.

 

 

Premises and Equipment

 

Premises and equipment, net of accumulated depreciation, increased by $200,000, or 1.0%, to $21,112,000 as of September 30, 2012, from $20,912,000, as of September 30, 2011. The renovations at the Corporation’s Main Office location were completed and placed into service during the third quarter of 2011. As of September 30, 2012, $304,000 was classified as construction in process.

 

 

Regulatory Stock

 

The Corporation owns multiple forms of regulatory stock that is required in order to be a member of the Federal Reserve Bank (FRB) and members of banks such as the Federal Home Loan Bank (FHLB) and Atlantic Central Bankers Bank (ACBB). The Corporation’s $4,033,000 of regulatory stock holdings as of September 30, 2012, consisted of $3,845,000 of FHLB of Pittsburgh stock, $151,000 of FRB stock, and $37,000 of ACBB stock. All of these stocks are valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the investment is carried at book value and there is no fair market value adjustment.

53
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

 

The Corporation’s investment in FHLB stock is required for membership in the organization. The amount of stock required is dependent upon the relative size of outstanding borrowings from FHLB. Excess stock is typically repurchased from the Corporation at par if the borrowings decline to a predetermined level. The Corporation earned a return or dividend on the FHLB stock since becoming a member until the end of 2008, when the FHLB announced that it had suspended the payment of dividends and the repurchase of excess capital stock to preserve its capital level. That decision was based on FHLB’s analysis and consideration of certain negative market trends and the impact those trends had on their financial condition. As a result, for years 2009, 2010, and 2011, no dividends were received on the Corporation’s FHLB stock.

 

In the fourth quarter of 2010, as a first indication of improved financial position and capital levels, the FHLB of Pittsburgh announced the resumption of excess capital stock repurchases, that have continued on a quarterly basis to date. The resumption of excess capital stock repurchases was primarily the reason why the Corporation’s capital stock position declined from $4,492,000 as of December 31, 2010, to $3,845,000 as of September 30, 2012. As of September 30, 2012, the Corporation held no excess capital stock. Management believes future capital stock repurchases will continue.

 

On February 22, 2012, the FHLB of Pittsburgh announced payment of their first dividend to shareholders since suspension of the dividend in December 2008. The dividend payment was equivalent to 0.10 percent annualized and is a significant step towards the restoration of ongoing dividend payments. Also, on April 30, 2012, and July 31, 2012, the FHLB paid two more dividend payments of 0.10 percent annualized. Prior to the filing of this third quarter 2012 Form 10-Q, on October 30, 2012, FHLB announced their fourth consecutive quarterly dividend and an increase to 0.43 percent annualized. They also announced an increase in the planned excess capital stock repurchase. This news is further evidence of improved financial results at the FHLB of Pittsburgh. While the FHLB has not committed to regular quarterly dividend payments, they have stated they will continue to monitor the overall financial performance of the bank in order to determine the status of future dividends. This sustained pattern of purchasing back excess capital stock, based on the improved financial performance of the FHLB, and the resumption of a quarterly dividend, and further increase in that dividend, has resulted in management’s conclusion that its investment in FHLB stock is not other-than-temporarily impaired. The Corporation will continue to monitor the financial condition of the FHLB quarterly to assess its ability to continue to periodically repurchase excess capital stock and pay a quarterly dividend.

 

Management believes that the FHLB will continue to be a primary source of wholesale liquidity for both short-term and long-term funding. Management’s strategy in terms of future use of FHLB borrowings is addressed under the Borrowings section of this Management’s Discussion and Analysis.

 

 

Deposits

 

The Corporation’s total ending deposits increased $16.5 million, or 2.7%, and $14.3 million, or 2.4%, from September 30, 2011, and December 31, 2011, respectively. Customer deposits are the Corporation’s primary source of funding for loans and securities. During 2011 and continuing into 2012, the economic concerns and poor performance of other types of investments led customers back to banks for safe places to invest money, despite historically low interest rates. The mix of the Corporation’s deposit categories has changed marginally since September 30, 2011, with a $10.4 million increase in non-interest demand deposit accounts, a $7.4 million increase in the Corporation’s new interest bearing demand deposit account, which was introduced in March of 2012, and a $10.9 million increase in savings account balances. Offsetting these increases, money market accounts declined by $5.2 million and time deposits decreased by $7.0 million.

 

The increase in savings account balances is the result of historically low interest rates, which have resulted in little difference between savings rates and other core deposit rates and even short-term time deposit rates. Customers view savings as the safest, most convenient place to maintain funds for maximum flexibility. Management believes savings accounts will continue to hold higher balances until short-term interest rates increase.

 

The Corporation’s new interest-bearing demand deposit product is a direct result of the repeal of Regulation Q, which prohibited financial institutions from paying interest on demand deposits. Regulation Q, which existed since 1933, was repealed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Under that legislation, beginning on July 21, 2011, financial institutions have been allowed, but not required, to offer interest-bearing demand deposits. When the product was first offered by the Corporation in March 2012, a number of the cash management money market deposit accounts were transferred over to the new interest-bearing demand deposit product. This accounts for the $3.7 million reduction in money market deposit accounts from December 31, 2011 to September 30, 2012.

 

54
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The Deposits by Major Classification table, shown below, provides the balances of each category for September 30, 2012, December 31, 2011, and September 30, 2011.

 

DEPOSITS BY MAJOR CLASSIFICATION            
(DOLLARS IN THOUSANDS)            
             
   September 30,   December 31,   September 30, 
   2012   2011   2011 
   $   $   $ 
             
Non-interest bearing demand   149,839    149,510    139,426 
Interest bearing demand   7,385         
NOW accounts   61,107    61,246    62,608 
Money market deposit accounts   53,159    56,872    58,385 
Savings accounts   109,618    100,377    98,673 
Time deposits   231,304    231,629    238,288 
Brokered time deposits   7,522    6,044    6,041 
Total deposits   619,934    605,678    603,421 

 

The growth and mix of deposits is often driven by several factors including:

 

·Convenience and service provided
·Current rates paid on deposits relative to competitor rates
·Level of and perceived direction of interest rates
·Financial condition and perceived safety of the institution
·Possible risks associated with other investment opportunities
·Level of fees on deposit products

 

The Corporation has been a stable presence in the local area and offers convenient locations, low service fees, and competitive interest rates because of a strong commitment to the customers and the communities that it serves. Management has always priced products and services in a manner that makes them affordable for all customers. This in turn creates a high degree of customer loyalty and a stable deposit base. Additionally, as financial institutions have come under increased scrutiny from both regulators and customers, the Corporation has maintained an outstanding reputation. The Corporation’s deposit base increased as a result of customers seeking a longstanding, reliable institution as a partner to meet their financial needs.

 

Time deposits are typically a more rate-sensitive product, making them a source of funding that is prone to balance variations depending on the interest rate environment and how the Corporation’s time deposit rates compare with the local market rates. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution. As of September 30, 2012, time deposit balances, excluding brokered deposits, had decreased $7.0 million, or 2.9%, and $0.3 million, or 0.1%, from September 30, 2011, and December 31, 2011, respectively. The Corporation has recently seen a shift in deposit trends as customers have moved money from time deposits into core checking and savings accounts. With minimal differences between shorter term CD rates and interest bearing non-maturity deposits, customers are more inclined to accumulate their funds in a liquid account that can be accessed at any time. This has resulted in slower growth in time deposit balances and more significant growth in the core deposit areas.

 

Time deposits are a safe investment with FDIC coverage insuring no loss of principal up to certain levels. Prior to October 3, 2008, FDIC coverage was $100,000 on non-IRA time deposits and $250,000 on IRA time deposits. Effective October 3, 2008, the FDIC insurance increased to $250,000 for all deposit accounts with the signing of the Emergency Economic Stabilization Act of 2008, which was made permanent under the Dodd-Frank Wall Street Reform and Consumer Protection Act. As the equity markets continued to decline in 2008 and 2009, customers began placing more and more time deposits in financial institutions; however, they did not want to exceed the FDIC insurance limits. The increase in FDIC coverage generally enabled time deposit customers to increase their deposit balances held with the Corporation. Previously, a significant segment of the Corporation’s larger CD customers would limit their deposit by account title to $100,000. Now customers can deposit up to $250,000 with full FDIC coverage, under each form of eligible account ownership. Management anticipates that the recent declines in time deposits will likely continue until interest rates increase and cause more of a separation between longer-term rates and overnight rates.

55
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

 

Borrowings

 

Total borrowings were $70.5 million, $73.0 million, and $80.5 million as of September 30, 2012, December 31, 2011, and September 30, 2011, respectively. The Corporation was purchasing no short-term funds as of September 30, 2012, December 31, 2011, or September 30, 2011. Short-term funds are used for immediate liquidity needs and are not typically part of an ongoing liquidity or interest rate risk strategy; therefore, they fluctuate more rapidly. The short-term funds are purchased through correspondent and member bank relationships as overnight borrowings.

 

Total long-term borrowings, borrowings initiated for terms longer than one year, were $70.5 million, $73.0 million, and $80.5 million as of September 30, 2012, December 31, 2011, and September 30, 2011. The Corporation uses two main sources for long-term borrowings: FHLB advances and repurchase agreements obtained through brokers. The repurchase agreement portion of the long-term debt was $25.0 million at September 30, 2011, and declined to $15.0 million by September 30, 2012. FHLB advances were $55.5 million at September 30, 2011, and remained at $55.5 million as of September 30, 2012. Both FHLB advances and repurchase agreements are used as a secondary source of funding and to mitigate interest rate risk. These long-term funding instruments are typically a more manageable funding source in regard to amount, timing, and rate for interest rate risk and liquidity purposes compared to deposits. Over the course of the past twelve months, the Corporation has minimally changed the ladder of long-term FHLB borrowings, by replacing maturing advances with new long-term advances at significant rate savings. In the current interest rate environment, management has preferred to seek new long-term borrowings from FHLB rather than through repurchase agreements. For this reason, it is likely the FHLB portion of long-term debt will increase with the repurchase agreements reducing as they mature. Management will continue to analyze and compare the costs and benefits of borrowing versus obtaining funding from deposits.

 

In order to limit the Corporation’s exposure and reliance to a single funding source, the Corporation’s Asset Liability Policy sets a goal of maintaining the amount of borrowings from the FHLB to 15% of asset size. As of September 30, 2012, the Corporation was within this policy guideline at 7.1% of asset size with $55.5 million of total FHLB borrowings. The Corporation also has a policy that limits total borrowings from all sources to 150% of the Corporation’s capital. As of September 30, 2012, the Corporation was within this policy guideline at 79.3% of capital with $70.5 million total borrowings from all sources. The Corporation has maintained FHLB borrowings and total borrowings within these policy guidelines throughout all of 2011 and through the third quarter of 2012.

 

The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently $192.0 million. The Corporation’s two internal policy limits mentioned above are far more restrictive than the FHLB MBC, which is calculated and set quarterly by FHLB.

 

 

Stockholders’ Equity

 

Federal regulatory authorities require banks to meet minimum capital levels. The Corporation maintains capital ratios well above those minimum levels and higher than the Corporation’s national peer group average. The risk-weighted capital ratios are calculated by dividing capital by total risk-weighted assets. Regulatory guidelines determine the risk-weighted assets by assigning assets to one of four risk-weighted categories. The calculation of tier I capital to risk-weighted average assets does not include an add-back to capital for the amount of the allowance for loan losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio.

56
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The following tables reflect the capital ratios for the Corporation and Bank compared to the regulatory capital requirements.

 

REGULATORY CAPITAL RATIOS:            
       Regulatory Requirements 
      Adequately  Well 
As of September 30, 2012  Capital Ratios   Capitalized   Capitalized 
Total Capital to Risk-Weighted Assets               
Consolidated   18.6%    8.0%    10.0% 
Bank   18.5%    8.0%    10.0% 
Tier I Capital to Risk-Weighted Assets               
Consolidated   17.4%    4.0%    6.0% 
Bank   17.2%    4.0%    6.0% 
Tier I Capital to Average Assets               
Consolidated   10.6%    4.0%    5.0% 
Bank   10.5%    4.0%    5.0% 
As of December 31, 2011               
Total Capital to Risk-Weighted Assets               
Consolidated   17.9%    8.0%    10.0% 
Bank   17.7%    8.0%    10.0% 
Tier I Capital to Risk-Weighted Assets               
Consolidated   16.6%    4.0%    6.0% 
Bank   16.4%    4.0%    6.0% 
Tier I Capital to Average Assets               
Consolidated   10.2%    4.0%    5.0% 
Bank   10.1%    4.0%    5.0% 
As of September 30, 2011               
Total Capital to Risk-Weighted Assets               
Consolidated   18.0%    8.0%    10.0% 
Bank   17.8%    8.0%    10.0% 
Tier I Capital to Risk-Weighted Assets               
Consolidated   16.8%    4.0%    6.0% 
Bank   16.5%    4.0%    6.0% 
Tier I Capital to Average Assets               
Consolidated   10.1%    4.0%    5.0% 
Bank   10.0%    4.0%    5.0% 

 

The Corporation’s dividends per share for the nine months ended September 30, 2012, were $0.75 per share, compared to $0.72 per share for the same period of 2011. Dividends are paid from current earnings and available retained earnings. Management’s current capital plan calls for management to maintain tier I capital to average assets between 10.0% and 12.0%. The Corporation’s current tier I capital ratio is 10.6%. Management also desires a dividend payout ratio to be approximately 35%. This ratio will vary according to income, but over the long term, management’s goal is to average a payout ratio within this range. For the first nine months of 2012 the payout ratio was 35.0%. Due to improved financial performance and increased capital levels, the Corporation increased the dividend amount to $0.25 per share in the first quarter of 2012.

 

The amount of unrealized gain or loss on the securities portfolio is reflected, net of tax, as an adjustment to capital, as required by U.S. generally accepted accounting principles. This is recorded as accumulated other comprehensive income or loss in the capital section of the consolidated balance sheet. An unrealized gain increases capital, while an unrealized loss reduces capital. This requirement takes the position that, if the Corporation liquidated the securities portfolio at the end of each period, the current unrealized gain or loss on the securities portfolio would directly impact the Corporation’s capital. As of September 30, 2012, the Corporation showed unrealized gains, net of tax, of $6,711,000, compared to unrealized gains of $4,221,000 as of December 31, 2011, and unrealized gains of $4,655,000 as of September 30, 2011. These unrealized gains or losses, net of tax are excluded from capital when calculating the tier I capital to average assets numbers above. The amount of unrealized net gain or loss on the securities portfolio, shown net of tax, as an adjustment to capital, does not include any actual impairment taken on securities, which are shown as a reduction to income on the Corporation’s Consolidated Statements of Income. The changes in unrealized gains and losses are due to normal changes in market valuations of the Corporation’s securities as a result of interest rate movements.

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Management’s Discussion and Analysis

Proposed Regulatory Capital Changes

 

In June 2012, the Federal Reserve Bank, the FDIC, and the OCC issued proposed rules that would revise bank regulatory capital requirements and the risk-weighted asset rules. These rules represent the most extensive changes to bank capital requirements in the recent past. The rules will extend large parts of a regulatory capital administration to all U.S. banks and their holding companies, other than the smallest bank holding companies (generally, those with under $500 million in consolidated assets). Prior to the filing of this report, but subsequent to September 30, 2012, a joint statement was issued by the regulators postponing the original January 1, 2013 implementation date for these rules. A summary of the proposed rules is as follows:

 

Summary of proposed rules for capital

 

·Revise the definition of regulatory capital components and related calculations, which would include conservative guidelines for determining whether an instrument could qualify as regulatory capital;
·Add common equity tier 1 capital as a new regulatory capital component;
·Increase the minimum tier 1 capital ratio requirement;
·Create a capital conservation buffer that would limit payment of capital distributions and certain discretionary bonus payments to executive officers if the institution does not hold enough common equity tier 1 capital;
·Provide for a transition period for several aspects of the rule; and
·Incorporate the new and revised regulatory capital requirements into the Prompt Corrective Action rules.

 

Summary of proposed rules for risk-weighted assets

 

The proposal would expand the number of risk-weighted categories and increase the required capital for certain categories of assets, including higher-risk residential mortgages and higher-risk construction real estate loans. In addition, the rule would:

 

·revise risk weights for residential mortgages based on LTV ratios and certain loan characteristics, assigning risk weights between 35% and 200%;
·increase capital requirements for past due loans from 100% to 150% and set the risk weight for high volatility commercial real estate loans at 150%; and
·revise the risk-weighted percentage for unused commitments with an original maturity of one year or less from 0% to 20% unless the commitment is unconditionally cancelable by the bank.

 

The risk-weighted asset rule will apply to all U.S. banks and savings banks and almost all of their holding companies, although smaller, “non-complex” banking organizations will not need to comply with some of the rule’s requirements. The rule would be effective on January 1, 2015. The Corporation is in the process of assessing the impact of these proposed changes on the regulatory ratios of the Corporation and the Bank on the capital, operations, liquidity, and earnings of the Corporation and Bank.

 

 

Off-Balance Sheet Arrangements

 

In the normal course of business, the Corporation typically has off-balance sheet arrangements related to loan funding commitments. These arrangements may impact the Corporation’s financial condition and liquidity if they were to be exercised within a short period of time. As discussed in the following liquidity section, the Corporation has in place sufficient liquidity alternatives to meet these obligations. The following table presents information on the commitments by the Corporation as of September 30, 2012.

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Management’s Discussion and Analysis

OFF-BALANCE SHEET ARRANGEMENTS    
(DOLLARS IN THOUSANDS)    
  September 30, 
   2012 
   $ 
Commitments to extend credit:     
Revolving home equity   20,384 
Construction loans   16,120 
Real estate loans   8,376 
Business loans   61,645 
Consumer loans   1,689 
Other   3,323 
Standby letters of credit   7,972 
Total   119,509 

 

 

Jumpstart Our Business Startups Act

 

On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act is aimed at facilitating capital raising by smaller companies and banks and bank holding companies by implementing the following changes:

 

·raising the threshold requiring registration under the Securities Exchange Act of 1934 (the "Exchange Act") for banks and bank holding companies from 500 to 2,000 holders of record;
·raising the threshold for triggering deregistration under the Exchange Act for banks and bank holding companies from 300 to 1,200 holders of record;
·raising the limit for Regulation A offerings from $5 million to $50 million per year and exempting some Regulation A offerings from state blue sky laws;
·permitting advertising and general solicitation in Rule 506 and Rule 144A offerings;
·allowing private companies to use "crowdfunding" to raise up to $1 million in any 12-month period, subject to certain conditions; and
·creating a new category of issuer, called an "Emerging Growth Company," for companies with less than $1 billion in annual gross revenue, which will benefit from certain changes that reduce the cost and burden of carrying out an equity IPO and complying with public company reporting obligations for up to five years.

 

While the JOBS Act is not expected to have any immediate application to the Corporation, management will continue to monitor the implementation rules for potential effects which might benefit the Corporation.

  

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law. Dodd-Frank is intended to effect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally creates a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank is expected to have a significant impact on the Corporation’s business operations as its provisions take effect. It is difficult to predict at this time what specific impact Dodd-Frank and the yet-to-be-written implementing rules and regulations will have on community banks. However, it is expected that, at a minimum, they will increase the Corporation’s operating and compliance costs and could increase interest expense. Among the provisions that are likely to affect the Corporation are the following:

 

Holding Company Capital Requirements

Dodd-Frank requires the Federal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010, by a bank holding company with less than $15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, are consistent with safety and soundness.

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Management’s Discussion and Analysis

Deposit Insurance

Dodd-Frank permanently increases the maximum deposit insurance amount for banks, savings institutions, and credit unions to $250,000 per depositor, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. Previous to 2011, unlimited deposit insurance on non-interest bearing transaction accounts was covered through the Transaction Account Guarantee (TAG) program. The TAG program expired December 31, 2010, and Dodd-Frank has incorporated this unlimited deposit insurance coverage for another two years. Dodd-Frank also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. Dodd-Frank requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective one year from the date of enactment, Dodd-Frank eliminated the federal statutory prohibition against the payment of interest on business checking accounts, formerly known as Reg Q.

 

Corporate Governance

Dodd-Frank requires publicly traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The SEC has finalized the rules implementing these requirements which took effect on January 21, 2011. The Corporation is exempt from these requirements until January 21, 2013, due to its status as a smaller reporting company. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded. Dodd-Frank also gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

 

Limits on Interchange Fees

Dodd-Frank amends the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

 

Consumer Financial Protection Bureau

Dodd-Frank creates a new, independent federal agency called the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

As a financial institution, the Corporation is subject to three primary risks:

 

·Credit risk
·Liquidity risk
·Interest rate risk

 

The Board of Directors has established an Asset Liability Management Committee (ALCO) to measure, monitor, and manage these primary market risks. The Asset Liability Policy has instituted guidelines for all of these primary risks, as well as other financial performance measurements with target ranges. The Asset Liability goals and guidelines are consistent with the Strategic Plan goals.

 

Credit Risk

For discussion on credit risk refer to the sections in Item 2. Management’s Discussion and Analysis, on securities, non-performing assets, and allowance for loan losses.

 

Liquidity Risk

Liquidity refers to having an adequate supply of cash available to meet business needs. Financial institutions must ensure that there is adequate liquidity to meet a variety of funding needs, at a minimal cost. Minimal cost is an important component of liquidity. If a financial institution is required to take significant action to obtain funding, and is forced to utilize an expensive source, it has not properly planned for its liquidity needs. Funding new loans and covering deposit withdrawals are the primary liquidity needs of the Corporation. The Corporation uses a variety of funding sources to meet liquidity needs, such as:

 

·Deposits
·Loan repayments
·Maturities and sales of securities
·Borrowings from correspondent and member banks
·Repurchase agreements
·Brokered deposits
·Current earnings

 

As noted in the discussion on deposits, customers have historically provided the Corporation with a reliable and steadily increasing source of funds liquidity. The Corporation also has in place relationships with other banking institutions for the purpose of buying and selling Federal funds. The lines of credit with these institutions provide immediate sources of additional liquidity. The Corporation currently has unsecured lines of credit totaling $42 million. This does not include amounts available from member banks such as the Federal Reserve Discount Window or the FHLB of Pittsburgh.

 

Management uses a cumulative maturity gap analysis to measure the amount of assets maturing within various periods versus liabilities maturing in those same periods. Management monitors six-month, one-year, three-year, and five-year cumulative gaps to assist in determining liquidity risk. The Corporation was within internal gap guidelines for all ratios as of September 30, 2012. During the second quarter of 2010, management implemented prepayment speed assumptions for its securities portfolio to more accurately model principal paydowns received on securities. Additionally, as of September 30, 2011, management purchased software that allows prepayment speed assumptions from the bond accounting software provider to be directly imported into the ALM model on a security-by-security basis. It is management’s opinion that these securities are now modeled as accurately as possible utilizing current software, and the cash flows received on each bond are reflected appropriately. After the initial prepayment speed changes were made, as of June 30, 2010, the Corporation was within the internal gap guidelines for the one-year and three-year gap ratios, with the one-year gap at 66% and the three-year gap at 87%. As of December 31, 2010, these ratios were further improved and all were within the internal guidelines with the one-year gap at 84% and the three-year gap at 101%. As of December 31, 2011, these ratios were further improved and all were within the internal guidelines with the one-year gap at 93% and the three-year gap at 103%. The gap ratios as of September 30, 2012, had increased with a one-year gap of 103% and a three-year gap of 110%. The primary reason for the increase in gap ratios can be attributed to higher cash levels, faster principal payments on securities, purchasing securities with shorter durations, and a lengthening of the Corporation’s liabilities. Management has been maintaining higher levels of cash and cash equivalents since 2011 to assist in offsetting the Corporation’s relatively long securities portfolio. The strategy of maintaining higher cash levels to improve gap ratios and act as an immediate hedge against liquidity risk and interest rate risk is expected to continue until the securities portfolio is materially shorter in duration.

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Generally, through 2011 and into 2012, management had a bias towards rates remaining unchanged for a longer period of time and preferred to maintain gap ratios on the low end of gap guidelines, as it is advantageous to have a smaller amount of assets subject to repricing while interest rates are at historically low levels. Management took the position that rates could remain low for an extended period of time, which has occurred. Management also believes that the Corporation’s large securities portfolio, with the vast majority of these securities carrying unrealized gains, is a readily accessible source of liquidity in the event any repositioning of assets is needed. Management believes at this point that current economic conditions need to improve significantly before short term interest rates could be increased. The most recent economic data indicate slight improvement in unemployment and housing data. Gross national domestic product still remains at levels around 2% or less, which is lower than desired. The October 24th 2012 Federal Open Market Committee (FOMC) Policy Statement states that, “Growth in employment has been slow, and the unemployment rate remains elevated. Household spending has advanced a bit more quickly, but growth in business fixed investment has slowed. The housing sector has shown further signs of improvement, albeit from a depressed level.” The Committee goes on further to state, “A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” The Committee concludes that, “Exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.” Therefore, based on the present economic conditions, and FOMC’s forward guidance, the likelihood of sharp increases in market interest rates in the near future is remote. However, it is only prudent to be planning for possible higher mid-term and long-term market interest rates in 2013 and higher short term rates in 2014 and beyond.

 

Ideally, management would prefer to maintain lower six-month and one-year gap ratios to limit reinvestment risk at historically low levels while maintaining a higher three-year gap ratio to be positioned to reinvest assets after interest rates have increased significantly over a period of time. For example, even if the FOMC were to act a year earlier than planned in 2014, it would be at least until late 2015 that interest rates would near the highs of the next rate cycle. Therefore, it is important for the Corporation to keep the one-year gap ratio on the low side of management’s preferred range, while maintaining the three-year gap ratio on the high end of the preferred range. To this regard, the Corporation is already higher on the one-year gap ratio than would be preferred, while the three-year gap ratio is already on the higher side of the preferred range to ensure adequate performance out three years, given higher interest rates. The risk to positioning for higher interest rates too early is subjecting the Corporation to more repricing risk and lower net interest margin. That is already occurring to a moderate degree. Management will make future asset liability decisions that are consistent with reducing the one-year gap ratio while maintaining the three-year gap ratio at a higher level to protect against future interest rate increases.

 

Management expects that the gap ratios will remain within the established guidelines throughout the remainder of 2012.

 

In addition to the cumulative maturity gap analysis discussed above, management utilizes a number of liquidity measurements that management believes has advantages over and gives better clarity to the Corporation’s present and projected liquidity that the static gap analysis offers.

 

The Corporation analyzes the following additional liquidity measurements in an effort to monitor and mitigate liquidity risk:

 

·Core Deposit Ratio – Core deposits as a percentage of assets
·Funding Concentration Analysis – Alternative funding sources outside of core deposits as a percentage of assets
·Short-term Funds Availability – Readily available short-term funds as a percentage of assets
·Securities Portfolio Liquidity – Cash flows maturing in one year or less as a percentage of assets and securities portfolio
·Borrowing Limits – Internal borrowing limits in terms of both FHLB and total borrowings
·Three, Six, and Twelve-month Projected Sources and Uses of Funds – Projection of future liquidity positions

 

These measurements are designed to prevent undue reliance on outside sources of funding and to ensure a steady stream of liquidity is available should events occur that would cause a sudden decrease in deposits or large increase in loans or both, which would in turn draw significantly from the Corporation’s available liquidity sources. As of September 30, 2012, the Corporation was within guidelines for all of the above measurements except the securities portfolio liquidity as a percentage of assets. The policy calls for the Corporation to maintain securities portfolio cash flows maturing in one year or less between 5% and 10% of total assets. As of September 30, 2012, these cash flows represented 4.6% of total assets, just under the lower guideline. However, when factoring in available overnight cash, the Corporation’s securities portfolio liquidity represented 7.8% of total assets. It is important for the Corporation to prepare for a rates-up environment and having more liquidity is advantageous as funds can be reinvested in higher yielding assets faster when sufficient liquidity exists. Management has been carrying an average of $15 million or more of readily available cash on hand and approximately $30 to $35 million of cash and cash equivalents on a daily basis throughout most of 2012, and expects this will continue in the near future. All liquidity measurements are tracked and reported quarterly by management to both observe trends and ensure the measurements stay within desired ranges. Management is confident that a sufficient amount of internal and external liquidity exists to provide for significant unanticipated liquidity needs.

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Interest Rate Risk

Interest rate risk is measured using two analytical tools:

 

·Changes in net interest income
·Changes in net portfolio value

 

Financial modeling is used to forecast net interest income and earnings, as well as net portfolio value, also referred to as fair value. The modeling is generally conducted under seven different interest rate scenarios. The scenarios consist of a projection of net interest income if rates remain flat, increase 100, 200, 300, or 400 basis points, or decrease 50 or 100 basis points. The results obtained through the use of forecasting models are based on a variety of factors. Both the net interest income and fair value forecasts make use of the maturity and repricing schedules to determine the changes to the balance sheet over the course of time. Additionally, there are many assumptions that factor into the results. These assumptions include, but are not limited to, the following:

 

·Projected interest rates
·Timing of interest rate changes
·Changes to the yield curve
·Prepayment speeds on the loans and mortgage-backed securities
·Anticipated calls on financial instruments with call options
·Deposit and loan balance fluctuations
·Economic conditions
·Consumer reaction to interest rate changes

 

For the interest rate sensitivity analysis and net portfolio value analysis discussed below, results are based on a static balance sheet reflecting no projected growth from balances as of September 30, 2012. While it is unlikely that the balance sheet will not grow at all, management considers a static analysis of this sort to be the most conservative and most accurate means to evaluate fair value and future interest rate risk. Management does run expected growth scenarios through the asset liability model to most accurately predict future financial performance. This is done separately and apart from the static balance sheet approach discussed above to test fair value and future interest rate risk. The static balance sheet approach is used to reduce the number of variables in calculating the model’s accuracy in predicting future net interest income. It is appropriate to pull out various balance sheet growth scenarios which could be utilized to compensate for a declining margin. By testing the model using a base model assuming no growth, this variable is eliminated and management can focus on predicted net interest income based on the current existing balance sheet.

 

As a result of the many assumptions, this information should not be relied upon to predict future results. Additionally, both of the analyses discussed below do not consider any action that management could take to minimize or offset the negative effect of changes in interest rates. These tools are used to assist management in identifying possible areas of risk in order to address them before a greater risk is posed. Personnel perform an in-depth annual validation and a quarterly review of the settings and assumptions used in the model to ensure reliability of the forecast results. Back testing of the model to actual results is performed quarterly to ensure the validity of the assumptions in the model. Both the validation and back testing indicate that the model assumptions are reliable.

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Changes in Net Interest Income

 

The change in net interest income measures the amount of net interest income fluctuation that would be experienced over one year, assuming interest rates change immediately and remain the same for one year. This is considered to be a short-term view of interest rate risk. The analysis of changes in net interest income due to changes in interest rates is commonly referred to as interest rate sensitivity. The Corporation has historically been liability sensitive; meaning that as interest rates go up, the Corporation would likely achieve lower levels of net interest income due to sharper increases in the cost of funds than increases in asset yield. Conversely, if rates go down, there would be sharper reductions in the cost of funds than decreases to asset yield, causing an increase to net interest income. However, more recently the Corporation is becoming more balanced or neutral to the impact of interest rate changes on net interest income. The Corporation’s one-year gap ratio of 103% as of September 30, 2012 indicates a balanced amount of cumulative assets maturing versus liabilities maturing. However, because the interest rate sensitivity analysis, based on the repricing of assets and liabilities, shows a slight negative exposure to increased rates in two of the modeled interest rate scenarios, the Corporation’s asset liability position would still be categorized as liability sensitive.

 

The third quarter 2012 analysis projects the net interest income expected in the seven modified rate scenarios on a one-year time horizon. As of September 30, 2012, the Corporation was within guidelines for the maximum amount of net interest income declines, given five of the seven rate scenarios. Importantly, the unchanged and all four rates up scenarios were within guidelines, with only the two rates down scenarios slightly outside of guidelines. Any reduction in rates is highly unlikely due to the current Federal funds level and the relationship between Prime rate and the Federal funds rate. Prime rate is the driver rate on the Corporation’s asset liability model. Since the Prime rate has consistently remained at 300 basis points over the Federal funds rate for well over a decade and the Federal funds rate is at 0.25%, it is unlikely we would see even a 0.25% reduction in rates as this would drive the target Federal funds rate to zero. The only possible change to allow the Prime rate to drop by more than 0.25% would require a change in the historical 300 basis point relationship between Prime and the Federal funds rate. The Corporation’s projected net interest income fluctuations given the different rate scenarios have changed slightly since December 31, 2011, with all scenarios reasonable and plausible.

 

The rates-down 50 and 100 basis point scenarios showed a decline in net interest income that is just outside of the Corporation’s established guidelines of 2.5% and 5.0%, respectively. However, given the unlikelihood of any rate decreases at this time, management was not concerned about these measurements. As of September 30, 2012, the Federal funds stated target rate remained between 0.00% and 0.25%, but effectively the rate has been 0.25% since December 2008. It is very unlikely the Federal Reserve would lower any key rates, including Federal funds or the Discount rate further.

 

Management’s primary concern in this current rate environment is with higher interest rate scenarios; therefore, they are reviewed with more scrutiny. For the rates-up 100 and 200 basis-point scenarios, net interest income decreased when compared to the rates unchanged scenario, by 4.1% in the rates up 100 basis-point scenario, and 2.7% in the rates up 200 basis-point scenario. The decreases are primarily due to the fact that the Corporation would not experience an increase in interest income on its portfolio of fixed rate loans and securities, but would see an increase in its cost of funds as deposit costs increase even if they are held to a percentage of the rate increase. Nearly all the Corporation’s securities are fixed rate instruments, while approximately 72% of the loan portfolio is at fixed rates. Only about one-sixth of the Corporation’s primary assets would reprice to a higher rate given an increase in the Prime rate. Also contributing to higher decreases in net interest income in the rates up 100 basis-point scenario, is a minority segment of Prime-based commercial lines of credit floored at 4.00% or higher. Given a 100 basis point increase in interest rates, the loans already floored at 4.00% would only see a 0.25% increase in interest rate rather than the full 1.00%. This is unique to the up 100 basis point scenario and helps explain why there is less of a reduction in net interest income given rates up 200 basis points. Additionally, for all scenarios, projections are diminished slightly since the interest rate sensitivity analysis is now based on a balance sheet projection showing no asset growth, meaning there are fewer interest earning assets that will have the ability to reprice as rates increase. The analysis is based on assuming no loan growth from current balances, as well as no securities or deposit growth. With such an assumption, it is harder to achieve net interest income growth and it would be expected that this income would decline or grow at a very slow rate.

 

For the rates up 300 and 400 basis-point scenarios, the net interest income increases, by 2.5% in the rates up 300 basis-point scenario, and by 9.3% in the rates up 400 basis-point scenario, compared to the rates unchanged scenario. The positive impact of significantly higher rates is primarily due to the favorable impact of all of the Corporation’s variable rate loans repricing by the full amount of the Federal rate change, assisted by the Corporation’s relatively high interest earning cash balances and that component of the loans and securities portfolios that reprice in less than one year. This more than offsets the normal liability sensitivity of the Corporation, where a larger amount of liabilities reprice than assets, but they are only repricing by a fraction of the rate change. The more aggressive rates up scenarios also benefit from known historical experience of deposit rate increases lagging and slowing in the pace of the increase as interest rates continue to rise. For example, in the initial 100 and 200 rate increases, savings accounts may reprice 25 basis points higher for every 100 basis point of interest rate increase, while in the 300 and 400 rates up scenarios that scale may drop to 20 and 15 basis points, respectively. This in essence allows management the ability to neutralize the impact of higher rates by controlling the large amount of liabilities that are repricing. Management does not expect the Corporation’s exposure to interest rate changes to increase or change significantly over the next twelve months.

 

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Changes in Net Portfolio Value

 

The change in net portfolio value is considered a tool to measure long-term interest rate risk. The analysis measures the exposure of the balance sheet to valuation changes due to changes in interest rates. The calculation of net portfolio value discounts future cash flows to the present value based on current market rates. The change in net portfolio value estimates the gain or loss that would occur on market sensitive instruments given an interest rate increase or decrease in the same seven scenarios mentioned under “Changes in Net Interest Income” above. As of September 30, 2012, the Corporation was within guidelines for all scenarios with the rates up exposures showing slightly more volatility compared to the December 31, 2011 measurements. Generally, the rates up scenarios showed between 2% and 4% more exposure than the December 31, 2011 measurements. The slight increase in fair value exposure can be attributed to a larger securities portfolio which had a larger impact on the overall length of the Corporation’s assets. This indicates that, as rates rise, the Corporation loses net portfolio value, with the value of assets declining at a faster rate than the decrease in the value of deposits. As a result, beginning in the third quarter of 2012, management acted to reduce the securities portfolio duration by purchasing shorter instruments. The securities portfolio duration has been declining throughout 2012 and management expects further declines in the future. Management has also reviewed the duration and price volatility of all of the Corporation’s securities to identify and target those taxable securities with the most exposure to higher interest rates for possible sale when it is advantageous to do so, based on market conditions. It is anticipated that these actions, along with carrying larger cash levels, will allow the Corporation to show slight reductions in the rates up exposure to net portfolio value in the final quarter of 2012 and into 2013.

 

The weakness with the net portfolio value analysis is that it assumes liquidation of the Corporation rather than as a going concern. For that reason, it is considered a secondary measurement of interest rate risk to “Changes in Net Interest Income” discussed above.

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Item 4. Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures.

 

Management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Treasurer (Principal Financial Officer), of the effectiveness of the design and the operation of the Corporation’s disclosure controls and procedures (as such term as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2012, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer along with the Treasurer (Principal Financial Officer) concluded that the Corporation’s disclosure controls and procedures as of September 30, 2012, are effective to ensure that information required to be disclosed in the reports that the company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

 

(b) Changes in Internal Controls.

 

There have been no changes in the Corporation’s internal controls over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

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PART II – OTHER INFORMATION

September 30, 2012

 

Item 1. Legal Proceedings

 

Management is not aware of any litigation that would have a material adverse effect on the financial position of the Corporation. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation. In addition, no material proceedings are pending, are known to be threatened, or contemplated against the Corporation by governmental authorities.

 

Item 1A. Risk Factors

 

The Corporation continually monitors the risks related to the Corporation’s business, other events, the Corporation’s Common Stock, and the Corporation’s industry. Management has not identified any new risk factors since the December 31, 2011 Form 10-K filing.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds – Nothing to Report

 

Item 3. Defaults Upon Senior Securities – Nothing to Report

 

Item 4. Mine Safety Disclosures – Not Applicable

 

Item 5. Other Information – Nothing to Report
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Item 6. Exhibits:

 

Exhibits - The following exhibits are filed as part of this filing on Form 10-Q or incorporated by reference hereto:

 

         Page
3 (i) Articles of Incorporation of the Registrant, as amended *
     
3 (ii) By-Laws of the Registrant, as amended **
     
10.1 Form of Deferred Income Agreement. ***
     
10.2 2011 Employee Stock Purchase Plan ****
     
10.3  2010 Non-Employee Directors’ Stock Plan *****
     
11 Statement re: computation of per share earnings  (Included on page 4 herein) 4
     
31.1 Section 302 Chief Executive Officer Certification 71
     
31.2 Section 302 Principal Financial Officer Certification 72
     
32.1 Section 1350 Chief Executive Officer Certification 73
     
32.2 Section 1350 Principal Financial Officer Certification 74

 

*Incorporated herein by reference to Exhibit 4.1 of the Corporation’s Registration Statement on Form S-8 filed with the SEC on June 28, 2012.

 

**Incorporated herein by reference to Exhibit 3.2 of the Corporation’s Form 8-K filed with the SEC on January 15, 2010.

 

***Incorporated herein by reference to Exhibit 10.1 of the Corporation’s Quarterly Report on Form 10-Q, filed with the SEC on August 13, 2008.

 

****Incorporated herein by reference to Exhibit 10.2 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 29, 2012.

 

*****Incorporated herein by reference to Exhibit 10 of the Corporation’s Registration Statement on Form S-8 filed with the SEC on June 4, 2010.

 

 

 

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SIGNATURES

 

 

Pursuant to the requirements of Section 13 or 15 (d) 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.

 

 

 

    ENB Financial Corp
           (Registrant)
     
     
Dated: November 14, 2012 By: /s/  Aaron L. Groff, Jr.
    Aaron L. Groff, Jr.
    Chairman of the Board,
    President & CEO
     
     
Dated: November 14, 2012 By: /s/  Scott E. Lied
    Scott E. Lied, CPA
    Treasurer
    Principal Financial Officer

 

 

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EXHIBIT INDEX

 

 

 

 

Exhibit No.

 

 

Description

Page number

on Manually
Signed

Original

3(i) Articles of Incorporation of the Registrant, as amended. (Incorporated herein by reference to Exhibit 4.1 of the Corporation’s Registration Statement on Form S-8 filed with the SEC on June 28, 2012.)  
3 (ii) By-Laws of the Registrant, as amended. (Incorporated herein by reference to Exhibit 3.2 of the Corporation’s Form 8-K filed with the SEC on January 15, 2010.)  
10.1 Form of Deferred Income Agreement.  (Incorporated herein by reference to Exhibit 10.1 of the Corporation’s Quarterly Report on Form 10-Q filed with the SEC on August 13, 2008.)  
10.2 2011 Employee Stock Purchase Plan (Incorporated herein by reference to Exhibit 10.2 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 29, 2012.)  
10.3 2010 Non-Employee Directors’ Stock Plan.  (Incorporated herein by reference to Exhibit 10 of the Corporation’s Form S-8 filed with the SEC on June 4, 2010.)  
11 Statement re: Computation of Earnings Per Share as found on page 4 of Form 10-Q, which is included herein. Page 4

31.1

 

Section 302 Chief Executive Officer Certification (Required by Rule 13a-14(a)). Page 71

31.2

 

Section 302 Principal Financial Officer Certification (Required by Rule 13a-14(a)). Page 72

32.1

 

Section 1350 Chief Executive Officer Certification (Required by Rule 13a-14(b)). Page 73

32.2

 

Section 1350 Principal Financial Officer Certification (Required by Rule 13a-14(b)). Page 74

 

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