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ENB Financial Corp - Quarter Report: 2013 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, 2013

OR

 

¨ 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 ¨

 

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 ¨

 

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 ¨
   
Non-accelerated filer  ¨   (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 ¨           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 1, 2013, the registrant had 2,852,097 shares of $0.20 (par) Common Stock outstanding.

 

 
 

ENB FINANCIAL CORP

INDEX TO FORM 10-Q

September 30, 2013

 

Part I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
Consolidated Balance Sheets at September 30, 2013 and 2012 and December 31, 2012 (Unaudited) 3
     
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2013 and 2012 (Unaudited) 4
     
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012 (Unaudited) 5
     
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012 (Unaudited)   6
     
Notes to the Unaudited Consolidated Interim Financial Statements   7-30
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   31-61
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 62-66
     
Item 4. Controls and Procedures 67
     
     
     
Part II – OTHER INFORMATION 68
     
Item 1. Legal Proceedings 68
     
Item 1A. Risk Factors 68
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 68
     
Item 3. Defaults Upon Senior Securities 68
     
Item 4. Mine Safety Disclosures 68
     
Item 5. Other Information 68
     
Item 6. Exhibits 69
     
     
SIGNATURE PAGE 70
     
EXHIBIT INDEX   71

 

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ENB FINANCIAL CORP

 

PART I.     FINANCIAL INFORMATION

Item 1.  Financial Statements

 

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

 

   September 30,   December 31,   September 30, 
   2013   2012   2012 
   $   $   $ 
ASSETS               
Cash and due from banks   12,579    14,035    10,198 
Interest-bearing deposits in other banks   17,753    21,625    24,754 
                
   Total cash and cash equivalents   30,332    35,660    34,952 
                
Securities available for sale (at fair value)   280,705    305,634    304,481 
                
Loans held for sale   308    768    897 
                
Loans (net of unearned income)   435,916    414,359    401,644 
                
   Less: Allowance for loan losses   7,283    7,516    7,644 
                
   Net loans   428,633    406,843    394,000 
                
Premises and equipment   22,305    20,862    21,112 
                
Regulatory stock   3,415    4,148    4,033 
                
Bank owned life insurance   19,719    19,216    19,015 
                
Other assets   9,131    6,055    6,349 
                
       Total assets   794,548    799,186    784,839 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
                
Liabilities:               
  Deposits:               
    Noninterest-bearing   165,874    156,327    149,839 
    Interest-bearing   476,877    476,834    470,095 
                
    Total deposits   642,751    633,161    619,934 
                
  Long-term debt   65,000    73,000    70,500 
  Accounts payable for security purchases not yet settled           2,097 
  Other liabilities   2,606    3,510    3,394 
                
       Total liabilities   710,357    709,671    695,925 
                
Stockholders' equity:               
  Common stock, par value $0.20;               
Shares:  Authorized 12,000,000               
           Issued 2,869,557 and Outstanding 2,852,097               
          (Issued 2,869,557 and Outstanding 2,851,952 as of 12-31-12)               
          (Issued 2,869,557 and Outstanding 2,857,475 as of 9-30-12)   574    574    574 
  Capital surplus   4,344    4,320    4,315 
  Retained earnings   81,767    78,421    77,611 
  Accumulated other comprehensive income (loss), net of tax   (2,009)   6,663    6,711 
  Less: Treasury stock cost on 17,460 shares (17,605 shares               
   as of 12-31-12 and 12,082 shares as of 9-30-12)   (485)   (463)   (297)
                
       Total stockholders' equity   84,191    89,515    88,914 
                
       Total liabilities and stockholders' equity   794,548    799,186    784,839 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

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ENB FINANCIAL CORP

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

 

   Three Months ended September 30,   Nine Months ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Interest and dividend income:                    
Interest and fees on loans   4,766    5,011    14,224    15,272 
Interest on securities available for sale                    
Taxable   1,016    977    2,795    3,336 
Tax-exempt   913    924    2,840    2,711 
Interest on deposits at other banks   18    24    56    60 
Dividend income   32    31    92    86 
                     
Total interest and dividend income   6,745    6,967    20,007    21,465 
                     
Interest expense:                    
Interest on deposits   853    1,061    2,651    3,271 
Interest on long-term debt   469    499    1,449    1,655 
                   
Total interest expense   1,322    1,560    4,100    4,926 
                     
Net interest income   5,423    5,407    15,907    16,539 
                     
Credit for loan losses       (250)   (150)   (850)
                     
Net interest income after credit for loan losses   5,423    5,657    16,057    17,389 
                     
Other income:                    
Trust and investment services income   273    248    883    816 
Service fees   461    393    1,300    1,259 
Commissions   491    490    1,467    1,454 
Gains on securities transactions, net   537    342    2,216    1,003 
Impairment losses on securities:                    
Impairment gains (losses) on investment securities   139        178    (55)
Non-credit related gains on securities not expected to                    
be sold in other comprehensive income before taxes   (183)       (335)   (31)
Net impairment losses on investment securities   (44)       (157)   (86)
Gains on sale of mortgages   20    52    208    183 
Earnings on bank owned life insurance   162    164    480    762 
Other income   39    69    274    265 
                   
Total other income   1,939    1,758    6,671    5,656 
                     
Operating expenses:                    
Salaries and employee benefits   3,193    3,020    9,545    9,326 
Occupancy   462    420    1,303    1,261 
Equipment   248    221    716    657 
Advertising & marketing   68    65    307    285 
Computer software & data processing   386    418    1,193    1,216 
Shares tax   215    202    644    618 
Professional services   297    262    925    850 
Other expense   478    463    1,566    1,552 
                     
Total operating expenses   5,347    5,071    16,199    15,765 
                     
Income before income taxes   2,015    2,344    6,529    7,280 
                     
Provision for federal income taxes   274    384    958    1,160 
                     
Net income   1,741    1,960    5,571    6,120 
                     
Earnings per share of common stock   0.61    0.69    1.95    2.14 
                     
Cash dividends paid per share   0.26    0.25    0.78    0.75 
                     
Weighted average shares outstanding   2,851,695    2,854,723    2,851,863    2,855,555 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

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ENB FINANCIAL CORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

 

   Three Months ended September 30,   Nine Months ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
                 
Net income   1,741    1,960    5,571    6,120 
                     
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 period   139        178    (55)
   Income tax effect   (47)       (60)   18 
    92        118    (37)
                     
   Losses recognized in earnings   44        157    86 
   Income tax effect   (15)       (54)   (29)
    29        103    57 
Unrealized holding gains on other-than-temporarily impaired                    
  securities available for sale, net of tax   121        221    20 
                     
Securities available for sale not other-than-temporarily impaired:                    
                     
   Gains (losses) arising during the period   (1,049)   2,568    (11,257)   4,745 
   Income tax effect   357    (873)   3,827    (1,613)
    (692)   1,695    (7,430)   3,132 
                     
   Gains recognized in earnings   (537)   (342)   (2,216)   (1,003)
   Income tax effect   182    116    753    341 
    (355)   (226)   (1,463)   (662)
Unrealized holding gains (losses) on securities available for sale                    
  not other-than-temporarily impaired, net of tax   (1,047)   1,469    (8,893)   2,470 
                     
Other comprehensive income (loss), net of tax   (926)   1,469    (8,672)   2,490 
                     
Comprehensive Income (Loss)   815    3,429    (3,101)   8,610 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

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Index

ENB FINANCIAL CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(DOLLARS IN THOUSANDS)

 

   Nine Months Ended September 30, 
   2013   2012 
   $   $ 
Cash flows from operating activities:          
Net income   5,571    6,120 
Adjustments to reconcile net income to net cash          
provided by operating activities:          
Net amortization of securities premiums and discounts and loan fees   3,086    2,649 
Net decrease (increase) in interest receivable   152    (205)
Decrease in interest payable   (101)   (175)
Credit for loan losses   (150)   (850)
Gains on securities transactions, net   (2,216)   (1,003)
Impairment losses on securities   157    86 
Gains on sale of mortgages   (208)   (183)
Loans originated for sale   (10,276)   (10,212)
Proceeds from sales of loans   10,944    11,424 
Earnings on bank-owned life insurance   (480)   (762)
Depreciation of premises and equipment and amortization of software   990    1,001 
Deferred income tax   (171)   598 
Decrease in prepaid federal deposit insurance   936    236 
Decrease in accounts payable for securities purchased not yet settled       (4,867)
Other assets and other liabilities, net   (386)   (500)
Net cash provided by operating activities   7,848    3,357 
           
Cash flows from investing activities:          
Securities available for sale:          
   Proceeds from maturities, calls, and repayments   41,994    70,460 
   Proceeds from sales   76,427    29,624 
   Purchases   (107,602)   (118,512)
Purchase of other real estate owned       (112)
Proceeds from sale of other real estate owned       132 
Purchase of regulatory bank stock   (230)   (230)
Redemptions of regulatory bank stock   963    345 
Purchase of bank-owned life insurance   (23)   (2,527)
Proceeds from bank-owned life insurance       826 
Net (increase) decrease in loans   (21,695)   10,729 
Purchases of premises and equipment   (2,333)   (582)
Purchase of computer software   (44)   (33)
Net cash used for investing activities   (12,543)   (9,880)
           
Cash flows from financing activities:          
Net increase in demand, NOW, and savings accounts   17,951    13,104 
Net (decrease) increase in time deposits   (8,361)   1,152 
Proceeds from long-term debt   5,000    15,000 
Repayments of long-term debt   (13,000)   (17,500)
Dividends paid   (2,225)   (2,141)
Treasury stock sold   359    317 
Treasury stock purchased   (357)   (343)
Net cash (used for) provided by financing activities   (633)   9,589 
Increase (decrease) in cash and cash equivalents   (5,328)   3,066 
Cash and cash equivalents at beginning of period   35,660    31,886 
Cash and cash equivalents at end of period   30,332    34,952 
           
Supplemental disclosures of cash flow information:          
    Interest paid   4,201    5,100 
    Income taxes paid   950    745 
           
Supplemental disclosure of non-cash investing and financing activities:          
Net transfer of other real estate owned from loans       278 
Securities purchased not yet settled       2,097 
Fair value adjustments for securities available for sale   (13,138)   3,773 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

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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 2013, 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, 2013, are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. 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, 2012.

 

 

2.  Securities Available for Sale

 

The amortized cost and fair value of securities held at September 30, 2013, and December 31, 2012, are as follows:

 

       Gross   Gross     
(DOLLARS IN THOUSANDS)  Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   $   $   $   $ 
Septermber 30, 2013                    
U.S. government agencies   38,285    395    (1,760)   36,920 
U.S. agency mortgage-backed securities   48,149    418    (430)   48,137 
U.S. agency collateralized mortgage obligations   38,012    249    (703)   37,558 
Private collateralized mortgage obligations   4,285    48    (166)   4,167 
Corporate bonds   52,293    841    (509)   52,625 
Obligations of states and political subdivisions   98,502    1,661    (3,110)   97,053 
Total debt securities   279,526    3,612    (6,678)   276,460 
Marketable equity securities   4,222    23        4,245 
Total securities available for sale   283,748    3,635    (6,678)   280,705 
                     
December 31, 2012                    
U.S. government agencies   42,374    1,971    (61)   44,284 
U.S. agency mortgage-backed securities   49,173    931    (101)   50,003 
U.S. agency collateralized mortgage obligations   40,612    206    (218)   40,600 
Private collateralized mortgage obligations   6,123    59    (432)   5,750 
Corporate bonds   48,179    1,517    (47)   49,649 
Obligations of states and political subdivisions   104,133    6,531    (261)   110,403 
Total debt securities   290,594    11,215    (1,120)   300,689 
Marketable equity securities   4,945            4,945 
Total securities available for sale   295,539    11,215    (1,120)   305,634 

 

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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, 2013, 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   24,115    24,212 
Due after one year through five years   97,861    97,912 
Due after five years through ten years   96,468    93,049 
Due after ten years   61,082    61,287 
Total debt securities   279,526    276,460 

 

Securities available for sale with a par value of $91,939,000 and $79,089,000 at September 30, 2013, and December 31, 2012, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $93,020,000 at September 30, 2013, and $84,585,000 at December 31, 2012.

 

Proceeds from active sales of debt 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 DEBT SECURITIES AVAILABLE FOR SALE

(DOLLARS IN THOUSANDS)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Proceeds from sales   41,252    6,720    76,427    29,624 
Gross realized gains   1,149    351    2,852    1,080 
Gross realized losses   612    9    636    77 

 

SUMMARY OF GAINS AND LOSSES ON DEBT SECURITIES AVAILABLE FOR SALE

(DOLLARS IN THOUSANDS)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Gross realized gains   1,149    351    2,852    1,080 
                     
Gross realized losses   612    9    636    77 
Impairment on securities   44        157    86 
Total gross realized losses   656    9    793    163 
                     
Net gains on securities   493    342    2,059    917 

 

The bottom portion of the above table shows the net gains on security transactions, including any impairment taken on securities held by the Corporation. 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.

 

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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, 2013, two private collateralized mortgage obligations (PCMOs) were considered to be other-than-temporarily impaired, of which the cash flow analysis on these securities indicated a need to take additional impairment of $44,000 as of September 30, 2013. One of these two bonds had impairment of $3,000 recorded during the second quarter of 2013. Another PCMO for which no impairment was recorded in the third quarter had impairment of $20,000 taken during the first quarter of 2013. During the third quarter, one PCMO which had impairment of $89,000 taken in 2013, was sold. As of September 30, 2013, cumulative impairment of $157,000 was taken on three PCMO bonds, including the one PCMO that was sold. As of September 30, 2012, no impairment was needed on any of the Corporation’s securities; however, two PCMOs had experienced prior impairment for a total of $86,000 for the nine months ended September 30, 2012. Information pertaining to securities with gross unrealized losses at September 30, 2013, and December 31, 2012, 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, 2013                              
U.S. government agencies   27,114    (1,535)   1,795    (225)   28,909    (1,760)
U.S. agency mortgage-backed securities   20,298    (403)   3,570    (27)   23,868    (430)
U.S. agency collateralized mortgage obligations   19,566    (694)   809    (9)   20,375    (703)
Private collateralized mortgage obligations   1,444    (44)   1,800    (122)   3,244    (166)
Corporate bonds   20,248    (497)   2,009    (12)   22,257    (509)
Obligations of states & political subdivisions   48,170    (2,899)   3,723    (211)   51,893    (3,110)
                               
Total debt securities   136,840    (6,072)   13,706    (606)   150,546    (6,678)
                               
Marketable equity securities                        
                               
Total temporarily impaired securities   136,840    (6,072)   13,706    (606)   150,546    (6,678)
                               
As of December 31, 2012                              
U.S. government agencies   11,947    (61)           11,947    (61)
U.S. agency mortgage-backed securities   11,876    (101)           11,876    (101)
U.S. agency collateralized mortgage obligations   22,235    (167)   3,230    (51)   25,465    (218)
Private collateralized mortgage obligations           4,714    (432)   4,714    (432)
Corporate bonds   2,985    (41)   994    (6)   3,979    (47)
Obligations of states & political subdivisions   16,616    (225)   1,997    (36)   18,613    (261)
                               
Total debt securities   65,659    (595)   10,935    (525)   76,594    (1,120)
                               
Marketable equity securities                        
                               
Total temporarily impaired securities   65,659    (595)   10,935    (525)   76,594    (1,120)

 

In the debt security portfolio, there are 138 positions that were considered temporarily impaired at September 30, 2013. Two PCMOs, which have had impairment recorded at some point in time, are the only instruments considered other-than-temporarily impaired at September 30, 2013.

 

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. U.S. generally accepted accounting principles provide 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. This accounting treatment was only applicable to three of the Corporation’s PCMOs, since these were the only instruments management deemed to be other-than-temporarily impaired and have experienced some impairment.

 

9
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

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 third quarter of 2013.

 

The following tables reflect the amortized cost, market value, and unrealized loss as of September 30, 2013 and 2012, on the PCMO securities held which had impairment taken in each respective year. In 2013, there were three PCMOs that had impairment taken whereas in 2012 there were only two. The values shown are after the Corporation recorded year-to-date impairment charges of $157,000 through September 30, 2013, and $86,000 through September 30, 2012. The $157,000 and $86,000 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 $166,000 and $308,000 of unrealized losses, as of September 30, 2013, and September 30, 2012, respectively, are deemed to be market value losses that are considered temporary.

 

SECURITY IMPAIRMENT CHARGES

(DOLLARS IN THOUSANDS)

 

   As of September 30, 2013
   Book  Market  Unrealized  Impairment
   Value  Value  Loss  Charge
   $  $  $  $
                     
Impaired private collateralized mortgage obligations   3,411    3,245    (166)   (157)

 

   As of September 30, 2012
   Book  Market  Unrealized  Impairment
   Value  Value  Loss  Charge
   $  $  $  $
                     
Impaired private collateralized mortgage obligations   3,605    3,297    (308)   (86)

 

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 September 30,   Nine Months Ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
                 
Beginning balance   1,090    977    977    1,057 
                     
Credit losses on debt securities for which other-than-                    
  temporary impairment has not been previously recognized                
                     
Additional credit losses on debt securities for which other-                    
   than-temporary impairment was previously recognized   44        157    86 
                     
Sale of debt securities with previously recognized impairment   (89)       (89)   (166)
                     
Ending balance   1,045    977    1,045    977 

 

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. This is not the case for the Corporation’s mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO) holdings which are backed by the U.S. government. They 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 small minority of the total MBS, CMO, and PCMO securities held. As of September 30, 2013, on an amortized cost basis, PCMOs accounted for 4.7% of the Corporation’s total MBS, CMO, and PCMO holdings, compared to 6.4% as of December 31, 2012. During the third quarter of 2013, one PCMO security was sold which had an amortized cost of $1 million. This sale left the Corporation with three PCMOs held, with one of the three investment grade, rated A+ by S&P. The remaining two securities were rated below investment grade. Impairment charges, as detailed above, were taken on the securities rated below investment grade in both 2013 and 2012.

 

The unrealized loss position of all of the Corporation’s PCMOs has improved since December 31, 2012. The PCMO net unrealized losses stood at $373,000 as of December 31, 2012, and improved to a $118,000 net unrealized loss as of September 30, 2013. One of the three PCMOs is carrying an unrealized gain based on current book values. Management has concluded that, as of September 30, 2013, the unrealized losses outlined in the Security Impairment Charges table above 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.

 

11
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

3. Loans and Allowance for Loan Losses

 

The following table presents the Corporation’s loan portfolio by category of loans as of September 30, 2013, and December 31, 2012.

 

LOAN PORTFOLIO

(DOLLARS IN THOUSANDS)  

 

   September 30,   December 31, 
   2013   2012 
   $   $ 
Commercial real estate          
Commercial mortgages   97,661    91,943 
Agriculture mortgages   110,673    85,501 
Construction   8,503    16,435 
Total commercial real estate   216,837    193,879 
           
Consumer real estate (a)          
1-4 family residential mortgages   124,520    126,686 
Home equity loans   10,940    13,122 
Home equity lines of credit   19,837    15,956 
Total consumer real estate   155,297    155,764 
           
Commercial and industrial          
Commercial and industrial   27,720    27,503 
Tax-free loans   18,343    17,991 
Agriculture loans   13,548    15,204 
Total commercial and industrial   59,611    60,698 
           
Consumer   3,863    3,872 
           
Gross loans prior to deferred fees   435,608    414,213 
Less:          
Deferred loan costs, net   (308)   (146)
Allowance for loan losses   7,283    7,516 
Total net loans   428,633    406,843 

 

(a) Real estate loans serviced for Fannie Mae, which are not included in the Consolidated Balance Sheets, totaled $4,334,000 and $6,014,000 as of September 30, 2013, and December 31, 2012, respectively.

The attached Financial Condition section of Management’s Discussion and Analysis explains the changes occurring to the loan portfolio; however it is appropriate to immediately cover the most significant changes that are shown above. The Corporation experienced rapid agricultural real estate loan growth in the third quarter of 2013 that was much the product of loans in the pipeline that were being worked on in the second quarter of 2013. In many of the cases the economic conditions of the farmers had improved sufficiently to move ahead with new projects. Additionally, since December 31, 2012, $9.6 million of construction loans converted to permanent financing with $7.7 million of these converting to commercial mortgages and $1.9 million converting to agricultural mortgages. The only other significant move within the loan portfolio was the furthering of the trend of less fixed rate home equity loans and more home equity lines of credit.

 

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, 2013, and December 31, 2012. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.

12
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

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.

 

·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.

 

·Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

 

COMMERCIAL CREDIT EXPOSURE

CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE

(DOLLARS IN THOUSANDS)

 

September 30, 2013  Commercial
Mortgages
   Agriculture
Mortgages
   Construction   Commercial
and
Industrial
   Tax-free
Loans
   Agriculture
Loans
   Total 
   $   $   $   $   $   $   $ 
Grade:                                   
Pass   85,801    108,389    6,056    26,258    18,109    12,890    257,503 
Special Mention   5,148            211        310    5,669 
Substandard   6,712    2,284    2,447    1,251    234    348    13,276 
Doubtful                            
Loss                            
                                    
    Total   97,661    110,673    8,503    27,720    18,343    13,548    276,448 
                                    

 

December 31, 2012  Commercial
Mortgages
   Agriculture
Mortgages
   Construction   Commercial
and
Industrial
   Tax-free
Loans
   Agriculture
Loans
   Total 
   $   $   $   $   $   $   $ 
Grade:                                   
Pass   83,376    82,103    13,145    25,182    17,752    14,379    235,937 
Special Mention   798    622        355        81    1,856 
Substandard   7,769    2,776    3,290    1,966    239    744    16,784 
Doubtful                            
Loss                            
                                    
    Total   91,943    85,501    16,435    27,503    17,991    15,204    254,577 

 

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 nonaccrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of September 30, 2013 and December 31, 2012:

13
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

CONSUMER CREDIT EXPOSURE

CREDIT RISK PROFILE BY PAYMENT PERFORMANCE

(DOLLARS IN THOUSANDS)  

 

September 30, 2013  1-4 Family
Residential
Mortgages
   Home Equity
Loans
   Home Equity
Lines of
Credit
   Consumer   Total 
Payment performance:  $   $   $   $   $ 
                     
Performing   124,279    10,940    19,837    3,851    158,907 
Non-performing   241            12    253 
                          
   Total   124,520    10,940    19,837    3,863    159,160 

 

December 31, 2012  1-4 Family
Residential
Mortgages
   Home Equity
Loans
   Home Equity
Lines of
Credit
   Consumer   Total 
Payment performance:  $   $   $   $   $ 
                     
Performing   126,187    12,983    15,956    3,872    158,998 
Non-performing   499    139            638 
                          
   Total   126,686    13,122    15,956    3,872    159,636 

 

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, 2013 and December 31, 2012:

 

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, 2013  Past Due   Past Due   Days   Due   Current   Receivable   Accruing 
   $   $   $   $   $   $   $ 
Commercial real estate                                   
   Commercial mortgages   120    209        329    97,332    97,661     
   Agriculture mortgages       72        72    110,601    110,673     
   Construction                   8,503    8,503     
Consumer real estate                                   
   1-4 family residential mortgages   1,078    217    241    1,536    122,984    124,520    241 
   Home equity loans   109            109    10,831    10,940     
   Home equity lines of credit                   19,837    19,837     
Commercial and industrial                                   
   Commercial and industrial   79        102    181    27,539    27,720     
   Tax-free loans                   18,343    18,343     
   Agriculture loans                   13,548    13,548     
Consumer   8        12    20    3,842    3,863    12 
       Total   1,394    498    355    2,247    433,360    435,608    253 

 

 

 

                           Loans 
           Greater               Receivable > 
   30-59 Days   60-89 Days   than 90   Total Past       Total Loans   90 Days and 
December 31, 2012  Past Due   Past Due   Days   Due   Current   Receivable   Accruing 
   $   $   $   $   $   $   $ 
Commercial real estate                                   
   Commercial mortgages       347        347    91,596    91,943     
   Agriculture mortgages   79            79    85,422    85,501     
   Construction                   16,435    16,435     
Consumer real estate                                   
   1-4 family residential mortgages   780    187    308    1,275    125,411    126,686    308 
   Home equity loans   98    36        134    12,988    13,122     
   Home equity lines of credit   14            14    15,942    15,956     
Commercial and industrial                                   
   Commercial and industrial   179        8    187    27,316    27,503    6 
   Tax-free loans                   17,991    17,991     
   Agriculture loans   74            74    15,130    15,204     
Consumer   8    5        13    3,859    3,872     
       Total   1,232    575    316    2,123    412,090    414,213    314 

 

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, 2013 and December 31, 2012:

 

NONACCRUAL LOANS BY LOAN CLASS

(DOLLARS IN THOUSANDS)  

 

   September 30,   December 31, 
   2013   2012 
   $   $ 
         
Commercial real estate          
  Commercial mortgages   773    915 
  Agriculture mortgages        
  Construction        
Consumer real estate          
  1-4 family residential mortgages   150    191 
  Home equity loans   129    139 
  Home equity lines of credit        
Commercial and industrial          
  Commercial and industrial   133    53 
  Tax-free loans        
  Agriculture loans        
Consumer        
             Total   1,185    1,298 

 

As of September 30, 2013 and December 31, 2012, 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, 2013 and September 30, 2012, is as follows:

 

IMPAIRED LOANS

(DOLLARS IN THOUSANDS)  

 

   Three months ended September 30,   Nine months ended September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
                 
Average recorded balance of impaired loans   2,853    3,074    2,862    3,286 
Interest income recognized on impaired loans   28    50    85    106 

 

Interest income on impaired loans would have increased by approximately $22,000 for the three months ended September 30, 2013, and $64,000 for the nine months ended September 30, 2013, compared to $4,000 and $65,000 for the three and nine months ended September 30, 2012, respectively, had these loans performed in accordance with their original terms.

 

During the nine months ended September 30, 2013 and 2012, there were no loan modifications made that would cause a loan to be considered a troubled debt restructuring (TDR). 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. A concession is generally defined as more favorable payment or credit terms granted to a borrower in an effort to improve the likelihood of the lender collecting principal in its entirety. Concessions usually are in the form of interest only for a period of time, or a lower interest rate offered in an effort to enable the borrower to continue to make normally scheduled payments.

 

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, 2013, and December 31, 2012:

 

IMPAIRED LOAN ANALYSIS

(DOLLARS IN THOUSANDS)  

 

September 30, 2013  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   $   $   $   $   $ 
                          
With no related allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   1,224    1,321        1,159    1 
    Agriculture mortgages   1,603    1,603        1,613    84 
    Construction                    
Total commercial real estate   2,827    2,924        2,772    85 
                          
Commercial and industrial                         
    Commercial and industrial   31    31        45     
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial   31    31        45     
                          
Total with no related allowance   2,858    2,955        2,817    85 
                          
With an allowance recorded:                         
Commercial real estate                         
    Commercial mortgages                    
    Agriculture mortgages                    
    Construction                    
Total commercial real estate                    
                          
Commercial and industrial                         
    Commercial and industrial   102    102    8    45     
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial   102    102    8    45     
                          
Total with a related allowance   102    102    8    45     
                          
Total by loan class:                         
Commercial real estate                         
    Commercial mortgages   1,224    1,321        1,159    1 
    Agriculture mortgages   1,603    1,603        1,613    84 
    Construction                    
Total commercial real estate   2,827    2,924        2,772    85 
                          
Commercial and industrial                         
    Commercial and industrial   133    133    8    90     
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial   133    133    8    90     
                          
Total   2,960    3,057    8    2,862    85 

17
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

IMPAIRED LOAN ANALYSIS

(DOLLARS IN THOUSANDS)  

 

December 31, 2012  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   $   $   $   $   $ 
                     
With no related allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   310    310        401     
    Agriculture mortgages   1,629    1,629        1,643    112 
    Construction                    
Total commercial real estate   1,939    1,939        2,044    112 
                          
Commercial and industrial                         
    Commercial and industrial   53    93        129    20 
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial   53    93        129    20 
                          
Total with no related allowance   1,992    2,032        2,173    132 
                          
With an allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   935    1,032    110    1,030    3 
    Agriculture mortgages                    
    Construction                    
Total commercial real estate   935    1,032    110    1,030    3 
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial                    
                          
Total with a related allowance   935    1,032    110    1,030    3 
                          
Total by loan class:                         
Commercial real estate                         
    Commercial mortgages   1,245    1,342    110    1,431    3 
    Agriculture mortgages   1,629    1,629        1,643    112 
    Construction                    
Total commercial real estate   2,874    2,971    110    3,074    115 
                          
Commercial and industrial                         
    Commercial and industrial   53    93        129    20 
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial   53    93        129    20 
                          
Total   2,927    3,064    110    3,203    135 

18
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table details activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2013:

 

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, 2012   3,575    1,510    1,640    61    730    7,516 
                               
    Charge-offs       (78)   (41)   (6)       (125)
    Recoveries           16            16 
    Provision   (355)   48    281    7    (31)   (50)(1)
                               
Balance - March 31, 2013   3,220    1,480    1,896    62    699    7,357 
                               
    Charge-offs                        
    Recoveries           16            16 
    Provision   8    (22)   (107)   19    2    (100)(1)
                               
Ending Balance - June 30, 2013   3,228    1,458    1,805    81    701    7,273 
                               
    Charge-offs               (10)       (10)
    Recoveries           19    1        20 
    Provision   494    (26)   (213)   7    (262)     (1)
                               
Ending Balance - September 30, 2013   3,722    1,432    1,611    79    439    7,283 

 

(1) The Corporation recognized a $50,000 credit provision in the first quarter of 2013, and a $100,000 credit provision in the second quarter of 2013, with no provision recorded in the third quarter of 2013, for a total year-to-date credit provision of $150,000, as a result of lower levels of non-performing and delinquent loans and minimum charge-offs.

 

During the first quarter of 2013, a large commercial real estate (CRE) loan was upgraded and was no longer considered substandard, reducing the required provision for this loan type. Conversely, a commercial and industrial (C&I) loan moved from pass to substandard increasing the related required provision. In the second quarter of 2013, paydowns and payoffs of C&I loans reduced the required provision. This continued in the third quarter of 2013 including the upgrading of a C&I loan. The sharp third quarter increase in both commercial real estate and agricultural real estate loans, which are included in the same column, was primarily responsible for the sharp increase in the provision for these loans.

 

19
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following table details activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2012: 

 

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)
                               
Ending 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.

 

20
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of September 30, 2013 and December 31, 2012: 

 

ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE

(DOLLARS IN THOUSANDS)

 

As of Septermber 30, 2013:  Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
Allowance for credit losses:                              
Ending balance: individually evaluated                              
  for impairment           8            8 
Ending balance: collectively evaluated                              
  for impairment   3,722    1,432    1,603    79    439    7,275 
                               
Loans receivable:                              
Ending balance   216,837    155,297    59,611    3,863         435,608 
Ending balance: individually evaluated                              
  for impairment   2,827        133             2,960 
Ending balance: collectively evaluated                              
  for impairment   214,010    155,297    59,478    3,863         432,648 
                               

 

As of December 31, 2012:  Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
Allowance for credit losses:                              
Ending balance: individually evaluated                              
  for impairment   110                    110 
Ending balance: collectively evaluated                              
  for impairment   3,465    1,510    1,640    61    730    7,406 
                               
Loans receivable:                              
Ending balance   193,879    155,764    60,698    3,872         414,213 
Ending balance: individually evaluated                              
  for impairment   2,874        53             2,927 
Ending balance: collectively evaluated                              
  for impairment   191,005    155,764    60,645    3,872         411,286 

 

21
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

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, 2013, and December 31, 2012, 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:

ASSETS MEASURED ON A RECURRING BASIS

(DOLLARS IN THOUSANDS)  

 

   September 30, 2013 
   Level I   Level II   Level III   Total 
   $   $   $   $ 
                 
U.S. government agencies       36,920        36,920 
U.S. agency mortgage-backed securities       48,137        48,137 
U.S. agency collateralized mortgage obligations       37,558        37,558 
Private collateralized mortgage obligations       4,167        4,167 
Corporate bonds       52,625        52,625 
Obligations of states & political subdivisions       97,053        97,053 
Marketable equity securities   4,245            4,245 
                     
Total securities   4,245    276,460        280,705 

 

On September 30, 2013, 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 and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of September 30, 2013, the CRA fund investments had a $4,000,000 book and fair market value and the bank stocks had a book value of $222,000, and fair market value of $245,000.

22
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

Fair Value Measurements:

ASSETS MEASURED ON A RECURRING BASIS

(DOLLARS IN THOUSANDS)  

 

   December 31, 2012 
   Level I   Level II   Level III   Total 
   $   $   $   $ 
                 
U.S. government agencies       44,284        44,284 
U.S. agency mortgage-backed securities       50,003        50,003 
U.S. agency collateralized mortgage obligations       40,600        40,600 
Private collateralized mortgage obligations       5,750        5,750 
Corporate bonds       49,649        49,649 
Obligations of states & political subdivisions       110,403        110,403 
Marketable equity securities   4,945            4,945 
                     
Total securities   4,945    300,689        305,634 

 

On December 31, 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. As of December 31, 2012, the Corporation’s CRA fund investments had a book and fair market value of $4,945,000 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, 2013 or December 31, 2012.

 

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheets at their fair value as of September 30, 2013 and December 31, 2012, by level within the fair value hierarchy:

 

ASSETS MEASURED ON A NONRECURRING BASIS

(Dollars in Thousands)

   September 30, 2013 
   Level I
$
   Level II
$
   Level III
$
   Total
$
 
Assets:                    
   Impaired Loans           2,952    2,952 
   OREO           264    264 
Total           3,216    3,216 

 

 

   December 31, 2012 
   Level I
$
   Level II
$
   Level III
$
   Total
$
 
Assets:                    
   Impaired Loans           2,817    2,817 
   OREO           264    264 
Total           3,081    3,081 

 

The Corporation had a total of $2,960,000 of impaired loans as of September 30, 2013, with $8,000 of specifically allocated allowance against these loans. The Corporation had a total of $2,927,000 of impaired loans as of December 31, 2012, with $110,000 of specifically allocated allowance against these loans. Impaired loans are valued based on a discounted present value of expected future cash flows.

23
Index

ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

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 consisted of one residential property that was classified as OREO as of September 30, 2013, and December 31, 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         
   Estimate  Techniques   Unobservable   Range 
September 30, 2013:  $  $   Input   (Weighted Avg) 
                     
Impaired loans   2,952    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)      
                     
                     
                     
December 31, 2012:                    
                     
Impaired loans   2,817    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.

 

24
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

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.

 

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.

 

Bank Owned Life Insurance

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

 

Accrued Interest Receivable

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

 

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 Debt

The fair value of long-term debt is estimated by comparing the rate currently offered for the same type of debt 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.

 

25
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, 2013 and December 31, 2012, are summarized as follows:

FAIR VALUE OF FINANCIAL INSTRUMENTS

(DOLLARS IN THOUSANDS)

 

   September 30, 2013 
           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   30,332    30,332    30,332         
Securities available for sale   280,705    280,705    4,245    276,460     
Loans held for sale   308    308    308         
Loans, net of allowance   428,633    437,034            437,034 
Regulatory stock   3,415    3,415    3,415         
Bank owned life insurance   19,719    19,719    19,719         
Accrued interest receivable   3,332    3,332    3,332         
                          
Financial Liabilities:                         
Demand deposits   165,874    165,874    165,874         
Interest-bearing demand deposits   15,294    15,294    15,294         
NOW accounts   64,710    64,710    64,710         
Savings accounts   119,702    119,702    119,702         
Money market deposit accounts   59,132    59,132    59,132         
Time deposits   218,039    221,812            221,812 
     Total deposits   642,751    646,524    424,712        221,812 
                          
Long-term debt   65,000    67,201            67,201 
Accrued interest payable   692    692    692         

26
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

FAIR VALUE OF FINANCIAL INSTRUMENTS

(DOLLARS IN THOUSANDS)

 

   December 31, 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   35,660    35,660    35,660         
Securities available for sale   305,634    305,634    4,945    300,689     
Loans held for sale   768    768    768         
Loans, net of allowance   406,843    412,719            412,719 
Regulatory stock   4,148    4,148    4,148         
Bank owned life insurance   19,216    19,216    19,216         
Accrued interest receivable   3,484    3,484    3,484         
                          
Financial Liabilities:                         
Demand deposits   156,327    156,327    156,327         
Interest-bearing demand deposits   8,650    8,650    8,650         
NOW accounts   69,521    69,521    69,521         
Savings accounts   114,067    114,067    114,067         
Money market deposit accounts   58,195    58,195    58,195         
Time deposits   226,401    227,862            227,862 
     Total deposits   633,161    634,622    406,760        227,862 
                          
Long-term debt   73,000    76,504            76,504 
Accrued interest payable   793    793    793         

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, 2013, firm loan commitments were $12.1 million, unused lines of credit were $119.0 million, and open letters of credit were $7.8 million. The total of these commitments was $138.9 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.

 

27
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

7. Accumulated Other Comprehensive Income

 

The activity in accumulated other comprehensive income for the three and nine months ended September 30, 2013 and 2012 is as follows:

 

ACCUMULATED OTHER COMPREHENSIVE INCOME (1) (2)

(DOLLARS IN THOUSANDS)

   

   Unrealized 
   Gains (Losses) 
   on Securities 
   Available-for-Sale 
   $ 
Balance at December 31, 2012   6,663 
      
    Other comprehensive income (loss)  before reclassifications   (712)
   Amount reclassified from accumulated other comprehensive income (loss)   (606)
Period change   (1,318)
      
Balance at March 31, 2013   5,345 
    Other comprehensive income (loss) before reclassifications   (6,000)
   Amount reclassified from accumulated other comprehensive income (loss)   (428)
Period change   (6,428)
      
Balance at June 30, 2013   (1,083)
    Other comprehensive income (loss) before reclassifications   (600)
   Amount reclassified from accumulated other comprehensive income (loss)   (326)
Period change   (926)
      
Balance at September 30, 2013   (2,009)
      
      
Balance at December 31, 2011   4,221 
      
    Other comprehensive income before reclassifications   260 
   Amount reclassified into accumulated other comprehensive income (loss)   (227)
Period change   33 
      
Balance at March 31, 2012   4,254 
    Other comprehensive income before reclassifications   1,140 
   Amount reclassified into accumulated other comprehensive income (loss)   (152)
Period change   988 
      
Balance at June 30, 2012   5,242 
    Other comprehensive income before reclassifications   1,695 
   Amount reclassified into accumulated other comprehensive income (loss)   (226)
Period change   1,469 
      
Balance at September 30, 2012   6,711 

 

(1) All amounts are net of tax.  Related income tax expense or benefit is calculated using a Federal income tax rate of 34%.
(2) Amounts in parentheses indicate debits.

 

28
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME COMPONENTS (1)

(DOLLARS IN THOUSANDS)  

 

   Amount Reclassified from    
   Accumulated Other Comprehensive    
   Income (Loss)    
   For the Three Months Ended    
   September 30,   Affected Line Item
   2013   2012   in the Statements of
   $   $   Income
Securities available-for-sale:             
  Net securities gains reclassified into earnings   537    342   Gains on securities transactions, net
     Related income tax expense   (182)   (116)  Provision for federal income taxes
  Net effect on accumulated other comprehensive             
     income for the period   355    226    
              
  Net impairment losses reclassified into earnings   (44)      Impairment losses on securities
     Related income tax expense   15       Provision for federal income taxes
  Net effect on accumulated other comprehensive             
     income for the period   (29)       
  Total reclassifications for the period   326    226    

 

(1) Amounts in parentheses indicate debits.

 

DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME COMPONENTS (1)

(DOLLARS IN THOUSANDS)

 

   Amount Reclassified from    
   Accumulated Other Comprehensive    
   Income (Loss)    
   For the Nine Months Ended    
   September 30,   Affected Line Item
   2013   2012   in the Statements of
   $   $   Income
Securities available-for-sale:             
  Net securities gains reclassified into earnings   2,216    1,003   Gains on securities transactions, net
     Related income tax expense   (753)   (341)  Provision for federal income taxes
  Net effect on accumulated other comprehensive             
     income for the period   1,463    662    
              
  Net impairment losses reclassified into earnings   (157)   (86)  Impairment losses on securities
     Related income tax expense   54    29   Provision for federal income taxes
  Net effect on accumulated other comprehensive             
     income for the period   (103)   (57)   
  Total reclassifications for the period   1,360    605    

 

(1) Amounts in parentheses indicate debits.

29
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ENB FINANCIAL CORP
Notes to the Unaudited Consolidated Interim Financial Statements

8. Recently Issued Accounting Standards

 

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The standard requires that companies present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. The new requirements will take effect for public companies in fiscal years, and interim periods within those years, beginning after December 15, 2012. The Corporation adopted this standard on January 1, 2013. The effect of adopting this standard increased our disclosure surrounding reclassification items out of accumulated other comprehensive income.

 

In February 2013, the FASB issued ASU 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date. The ASU requires the measurement of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement with its co-obligors as well as any additional amount that the entity expects to pay on behalf of its co-obligors. The new standard is effective retrospectively for fiscal years and interim periods within those years, beginning after December 15, 2013, and early adoption is permitted. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

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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 2012 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:

 

·National and local economic conditions
·Real estate market and its impact on the loan portfolio
·Monetary and interest rate policies of the Federal Reserve Board
·Volatility of the securities markets including the valuation of securities
·Future actions or inactions of the United States government, including a failure to increase the government debt limit or a prolonged shutdown of the federal government
·Effects of deteriorating economic conditions and the prolonged economic weakness, specifically the effect on loan customers to repay loans
·Political changes and their impact on new laws and regulations
·Competitive forces
·Changes in customer behavior impacting deposit levels and loan demand
·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
·Possible impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules.

 

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.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

Results of Operations

 

Overview

The Corporation recorded net income of $1,741,000 and $5,571,000 for the three and nine-month periods ended September 30, 2013, an 11.2% and 9.0% decrease, from the $1,960,000 and $6,120,000 earned during the same periods in 2012. Earnings per share, basic and diluted, were $0.61 and $1.95 for the three and nine months ended September 30, 2013, compared to $0.69 and $2.14 for the same periods in 2012.

 

The Corporation’s net interest income increased for the three months ended September 30, 2013, and decreased for the nine months ended September 30, 2013, compared to the same periods in 2012. Net interest income was $5,423,000 for the third quarter of 2013, compared to $5,407,000 for the same quarter of 2012, a 0.3% increase. Year-to-date net interest income was $15,907,000 as of September 30, 2013, a 3.8% decrease, from the $16,539,000 earned in the first nine months of 2012. The Corporation’s net interest margin was 3.18% for the third quarter of 2013, compared to 3.31% for the third quarter of 2012. The Corporation’s year-to-date net interest margin was 3.16% through September 30, 2013, compared to 3.39% for the same period in 2012.

 

The Corporation did not record a provision for loan losses in the third quarter of 2013, and recorded a credit provision for loan losses of $150,000 for the year-to-date period compared to credit provisions of $250,000 and $850,000 for the three and nine months ended September 30, 2012, respectively. Improvements in asset quality, as evidenced by lower levels of non-performing and delinquent loans, and minimal charge-offs allowed the Corporation to reverse a portion of the allowance for loan losses into earnings in 2012 and 2013, while still maintaining strong coverage ratios. In years prior to 2012, the provision expense was at an increased level to provide for higher levels of classified loans that existed during those periods. When classified loans first began to decline in the fourth quarter of 2011, the provision for loan losses was initially reduced. In 2012, 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 quarterly allowance for loan loss calculation supported taking a credit provision. With the credit provisions in 2012 and the first nine months of 2013, the allowance for loan losses as a percentage of total loans declined to 1.67% as of September 30, 2013, compared to 1.90% as of September 30, 2012. 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, increased 2.1%, or $30,000, for the third quarter of 2013, compared to 2012. For the first nine months of 2013, other income, excluding the gain or loss on the sale of securities and impairment losses on securities, decreased 2.7%, or $127,000, compared to the same period in 2012. Meanwhile, operational costs for the three months ended September 30, 2013, compared to the same period in 2012, increased at a pace of 5.4%, or $276,000. For the first nine months of 2013, total operational costs increased by 2.8%, or $434,000, over the same period in 2012.

 

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 decreased for the three and nine-month periods ended September 30, 2013, compared to the same periods in the prior year due to the decrease in the Corporation’s income.

 

Key Ratios  Three Months Ended  Nine Months Ended
   September 30,  September 30,
   2013  2012  2013  2012
             
Return on Average Assets   0.86%   1.00%   0.93%   1.06%
Return on Average Equity   8.37%   8.93%   8.55%   9.60%

 

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
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ENB FINANCIAL CORP
Management’s Discussion and Analysis

·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. In the first nine months of 2013, NII generated 70.5% of the Corporation’s gross revenue stream, which consists of net interest income and non-interest income, compared to 74.5% in the first nine months of 2012. 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.

 

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, which is not shown on an FTE basis. The amount of FTE adjustment totaled $548,000 and $1,684,000 for the three and nine months ended September 30, 2013, compared to $549,000 and $1,619,000 for the same periods in 2012.

 

NET INTEREST INCOME

(DOLLARS IN THOUSANDS)  

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Total interest income   6,745    6,967    20,007    21,465 
Total interest expense   1,322    1,560    4,100    4,926 
                     
Net interest income   5,423    5,407    15,907    16,539 
Tax equivalent adjustment   548    549    1,684    1,619 
                     
Net interest income (fully taxable equivalent)   5,971    5,956    17,591    18,158 

 

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, in addition to all of the economic, competitive, and regulatory factors previously listed.

 

The Federal funds rate, which is the overnight rate that financial institutions charge other financial institutions to buy or sell overnight funds, has been at 0.25% since December 15, 2008, and is expected to remain there into 2014. The Prime rate typically moves in tandem with the Federal funds rate and similarly has not moved from its historical low of 3.25% since December of 2008. In addition to the current interest rate cycle being the lowest in U.S. history, it has also remained at the bottom far longer than any other rate cycle. It will be five full years if overnight rates remain at 0.25% until December of 2013.

 

The fact that the Federal funds rate and the Prime rate have remained at these very low levels for nearly five years has generally had offsetting positive and negative impacts to the Corporation’s NII, however the long-term trend has been lower NII and margin. The decrease in the Federal funds rate has reduced the cost of funds on overnight borrowings and allowed lower interest rates paid on deposits, reducing the Corporation’s interest expense, while the decrease in the Prime rate has reduced the yield on the Corporation’s Prime-based loans. The Corporation’s fixed rate loans do not reprice as rates change; however, with the steep decline in interest rates and a prolonged period with lower market rates, more customers have refinanced into lower fixed rate loans or moved into Prime-based loans. Management has instituted floors on certain loan instruments and revised pricing standards to help slow the reduction of loan yield during this historically low-rate period. Most of those floors have gradually been removed as the historically low interest rate environment continued and competitive pressures grew in terms of retaining and attracting new loans. As a result, loan yields have fallen. However, with significant loan growth during the third quarter of 2013, volume has helped to offset the declining yields and asset reallocation from securities to loans has increased overall asset yields. Additionally, yields on the Corporation’s securities had declined during the first half of 2013, but with the increase in long-term Treasury rates at the end of the second quarter, new investments made in the third quarter were at higher yields helping to increase the yield on the securities portfolio. These factors helped to increase NII and the margin for the third quarter of 2013 compared to the second quarter of 2013.

 

33
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ENB FINANCIAL CORP
Management’s Discussion and Analysis

Short-term interest rates have remained very low over the past four years as a result of the economic recession and slow recovery. The very low overnight rates and the recently higher longer-term rates have helped to provide an increased positive slope on the treasury curve despite low long-term rates from a historical standpoint. The positive slope has increased more recently with overnight rates close to 0.25% and the 10-year U.S. Treasury close to 2.70%. The positive slope of the yield curve has fluctuated many times in the past two years with the overnight rates remaining the same, with the 10-year U.S. Treasury varying between as high as 2.39% in 2012 and 2.98% in 2013, and as low as 1.43% in 2012, and 1.66% in 2013. As of September 30, 2013, the 10-year U.S. Treasury rate was 2.64%, which provided for 239 basis points of slope off the overnight rate of 0.25%. It was only at the end of June that the longer-term Treasury rates spiked as a result of comments made by the Federal Reserve Board. Prior to this time, the 10-year Treasury was close to 2.00%.

 

The recent strengthening in the slope of the yield curve has provided management with opportunities to invest excess liquidity in securities with more attractive yields than were available previously and should continue to do so in the foreseeable future. However, the increase in rates also caused significant valuation declines in the Corporation’s securities. The impact of these declines was immediate and far-reaching. Beyond directly affecting capital, the lower valuations have already significantly impacted management’s asset liability strategies in terms of taking gains and repositioning the portfolio to prepare for higher interest rates. The impact on the Corporation’s capital is discussed later in the Stockholders’ Equity section under Financial Condition.

 

On the liability side of the balance sheet, the Corporation’s deposits and borrowings generally price off overnight funds and the shorter U.S. Treasury rates. The very low short-term rates permitted management to continue to reduce the overall cost of funds during 2012 and into 2013. Typically, deposits and borrowings are priced off the one-year to five-year U.S. Treasury rates. These rates have also remained very low allowing management to continue to reprice time deposits and borrowings to lower levels.

 

Although long-term Treasury rates increased significantly at the end of the second quarter, management currently anticipates that the overnight interest rate and Prime rate will remain at these historically low levels through the remainder of 2013 and well into 2014 because of the current economic conditions. It is also likely that the 10-year U.S. Treasury will continue to trade in a higher range than early 2013, but will still be low based on historical standards. This will result in a positive slope in excess of the slope in early 2013. This will allow management to continue to price the vast majority of liabilities off very low short-term rates, while pricing loans and investing in longer securities, which are based off the 5-year and 10-year U.S. Treasury rates that are above short-term rates. With more slope in the 5 and 10-year area of the yield curve, investment opportunities have improved and trends are more favorable now to improving net interest margin. As long as short-term rates remain compressed and long-term rates remain more attractive than earlier in the year, liabilities can continue to be priced off the short end of the curve and investments and loans can be priced off the longer end of the curve.

 

The prolonged time 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.

 

The Corporation’s margin was 3.18% for the third quarter of 2013, a 13 basis-point decrease from the 3.31% for the third quarter of 2012. However, on a sequential basis, margin increased five basis points from the second quarter to the third quarter of 2013. For the year-to-date period, the Corporation’s margin was 3.16%, a 23 basis-point decline from the 3.39% for the nine months ended September 30, 2012. 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. As cost of funds savings become harder to achieve, the only way to stabilize and increase net interest margin is through increases in asset yield, which has now begun to happen given the increase in mid and long-term Treasury rates.

 

34
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

For the third quarter of 2013, the Corporation’s NII on an FTE basis increased by $15,000, or 0.3%, compared to the same period in 2012. For the nine months ended September 30, 2013, the Corporation’s NII on an FTE basis decreased by $567,000, or 3.1%, compared to the nine months ended September 30, 2012. As shown on the tables that follow, interest income, on an FTE basis for the quarter ending September 30, 2013, decreased by $223,000, or 3.0%, and interest expense decreased by $238,000, or 15.3%, compared to the same period in 2012. For the first nine months of 2013, interest income and interest expense on an FTE basis decreased by $1,393,000, or 6.0%, and $826,000, or 16.8%, respectively, compared to the first nine months of 2012.

 

The following table shows a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation’s consolidated balance sheets, 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%.

 

35
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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,
   2013  2012
         (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   19,674    18    0.36    22,208    24    0.42 
                               
Securities available for sale:                              
Taxable   193,895    1,036    2.14    198,287    1,005    2.03 
Tax-exempt   105,290    1,365    5.18    92,348    1,380    5.98 
Total securities (d)   299,185    2,401    3.21    290,635    2,385    3.29 
                               
Loans (a)   428,886    4,862    4.53    402,523    5,104    5.06 
                               
Regulatory stock   3,791    12    1.24    4,077    3    0.34 
                               
Total interest earning assets   751,536    7,293    3.88    719,443    7,516    4.18 
                               
Non-interest earning assets (d)   50,411              58,033           
                               
Total assets   801,947              777,476           
                               
LIABILITIES &                              
STOCKHOLDERS' EQUITY                              
Interest bearing liabilities:                              
Demand deposits   138,529    63    0.18    121,162    68    0.22 
Savings deposits   120,227    17    0.06    110,416    30    0.11 
Time deposits   220,948    773    1.39    237,583    963    1.61 
Borrowed funds   68,318    469    2.72    70,972    499    2.80 
Total interest bearing liabilities   548,022    1,322    0.96    540,133    1,560    1.15 
                               
Non-interest bearing liabilities:                              
                               
Demand deposits   168,239              146,335           
Other   3,206              3,722           
                               
Total liabilities   719,467              690,190           
                               
Stockholders' equity   82,480              87,286           
                               
Total liabilities & stockholders' equity   801,947              777,476           
                               
Net interest income (FTE)        5,971              5,956      
                               
Net interest spread (b)             2.92              3.03 
Effect of non-interest                              
     bearing funds             0.26              0.28 
Net yield on interest earning assets (c)             3.18              3.31 

 

(a) Includes balances of nonaccrual loans and the recognition of any related interest income.  The quarter-to-date average balances include net deferred loan costs of $282,000 as of September 30, 2013, and net deferred loan fees of $42,000 as of September 30, 2012.  Such fees and costs recognized through income and included in the interest amounts totaled ($21,000) in 2013, and $4,000 in 2012.

(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,
   2013  2012
         (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   21,224    55    0.35    20,100    60    0.40 
                               
Securities available for sale:                              
Taxable   192,591    2,864    1.98    194,317    3,412    2.34 
Tax-exempt   105,293    4,242    5.37    88,067    4,049    6.13 
Total securities (d)   297,884    7,106    3.18    282,384    7,461    3.52 
                               
Loans (a)   420,370    14,507    4.60    407,461    15,552    5.09 
                               
Regulatory stock   3,958    23    0.77    4,216    11    0.34 
                               
Total interest earning assets   743,436    21,691    3.89    714,161    23,084    4.31 
                               
Non-interest earning assets (d)   55,926              57,022           
                               
Total assets   799,362              771,183           
                               
LIABILITIES &                              
STOCKHOLDERS' EQUITY                              
Interest bearing liabilities:                              
Demand deposits   136,396    191    0.19    119,363    216    0.24 
Savings deposits   117,989    50    0.06    107,729    86    0.11 
Time deposits   223,429    2,410    1.44    236,868    2,969    1.67 
Borrowed funds   69,249    1,449    2.80    74,619    1,655    2.96 
Total interest bearing liabilities   547,063    4,100    1.00    538,579    4,926    1.22 
                               
Non-interest bearing liabilities:                              
                               
Demand deposits   161,704              143,964           
Other   3,477              3,483           
                               
Total liabilities   712,244              686,026           
                               
Stockholders' equity   87,118              85,157           
                               
Total liabilities & stockholders' equity   799,362              771,183           
                               
Net interest income (FTE)        17,591              18,158      
                               
Net interest spread (b)             2.89              3.09 
Effect of non-interest                              
     bearing funds             0.27              0.30 
Net yield on interest earning assets (c)             3.16              3.39 

 

(a) Includes balances of nonaccrual loans and the recognition of any related interest income.  The year-to-date average balances include net deferred loan costs of $228,000 as of September 30, 2013, and net deferred loan fees of $4,000 as of September 30, 2012.  Such fees and costs recognized through income and included in the interest amounts totaled ($55,000) in 2013, and ($1,000) in 2012.

(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.

37
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 by late 2011 and into 2012. The Prime rate is materially below typical fixed-rate business and commercial loans, which generally range between 3.50% and 6.00%, 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. The Corporation also benefits when growth in variable rate loans enables management to sell off lower yielding securities. Due to significant loan growth during the third quarter of 2013, the decrease in interest income from the loan portfolio declined at a much slower rate than in previous quarters.

 

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. At the end of the second quarter, the increase in mid and long-term Treasury rates began to allow for reinvestment into the securities portfolio at slightly higher rates. However, due to the previously low rates, the Corporation’s taxable securities experienced an 11 basis-point increase in yield for the three months ended September 30, 2013, and a 36 basis-point reduction in yield for the nine months ended September 30, 2013, compared to the same periods in 2012. Tax-exempt security yields decreased by 80 basis points for the three months ended September 30, 2013, and 76 basis points for the nine months ended September 30, 2013, compared to the same periods in 2012. With recent investments into securities at higher yields, these declines in yield should decrease in the remainder of 2013 and into 2014.

 

The average balance of the Corporation’s interest bearing liabilities increased during 2013 as a result of an increase in deposits that was partially offset by a decrease in borrowed funds. The average balance of time deposits declined in the first nine months of 2013 compared to 2012, but the other areas of NOW, MMDA, and savings grew sufficiently enough to compensate for the decline in time deposits. Interest expense on deposits declined by $208,000 for the three months ended September 30, 2013, and $620,000 for the nine months ended September 30, 2013, compared to the same periods in 2012. 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 18.2% for the three-month period ended September 30, 2013, and 20.8% for the nine-month period ended September 30, 2013, 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 be reduced much lower. For the first nine months of 2013, the average balances of interest bearing demand deposits increased by $17.0 million, or 14.3%, over the same period in 2012, while the average balance of savings accounts increased by $10.3 million, or 9.5%, over the same period in 2012. This increase in balances of lower cost accounts has helped to reduce the Corporation’s overall interest expense in 2013 compared to 2012.

 

Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. During 2012 and through the third quarter of 2013, 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 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 $190,000, or 19.7%, for the third quarter of 2013, compared to the same period in 2012, and $559,000, or 18.8%, for the nine months ended September 30, 2013, compared to the same period in 2012. Average balances decreased by $16.6 million, or 7.0%, and $13.4 million, or 5.7%, for the three and nine months ended September 30, 2013, compared to the same periods in 2012. The annualized rate paid on time deposits decreased by 22 basis points for the three-month period and 23 basis points for the nine-month period when comparing both years.

 

38
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. In the first nine months of 2013, the Corporation used some excess cash to pay off long-term debt. No short-term advances were utilized in 2013, but average short-term advances of $1,414,000 were utilized in the first nine months of 2012. Average overnight fed funds borrowings of $295,000 and $141,000 are included in the total borrowings for the nine months ended September 30, 2013, and September 30, 2012, respectively. 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 $2.7 million, or 3.7%, in the third quarter of 2013 compared to the same quarter in 2012, and $5.4 million, or 7.2%, for the nine months ended September 30, 2013, compared to the same period in 2012. Interest expense was $30,000, or 6.0% lower for the three-month period and $206,000, or 12.4% lower for the nine-month period when comparing 2013 to 2012.

 

The NIM was 3.18% for the third quarter of 2013, and 3.16% for the nine months ended September 30, 2013, compared to 3.31% and 3.39% for the same periods in 2012. For the quarter ended September 30, 2013, the net interest spread decreased eleven basis points to 2.92%, from 3.03% for the same period in 2012. For the nine-month period ended September 30, 2013, the net interest spread decreased twenty basis points to 2.89%, from 3.09% for the same period in 2012. The effect of non-interest bearing funds dropped two basis points for the three-month period and three 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 no provision expense for the three months ended September 30, 2013, and had a credit provision of $150,000 for the nine months ended September 30, 2013, and credit provisions of $250,000 and $850,000 for the three and nine months ended September 30, 2012, respectively. The analysis of the loan loss allowance takes into consideration, among other things, the following factors:

 

·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.

 

Credit provisions were recorded in 2013 and 2012 due to the following factors:

 

·Low levels of delinquent and non-performing loans
·Lower levels of classified loans
·Low charge-offs

 

39
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Prior to 2012, the annual provision expense was at increased levels to account for difficult economic conditions that had an impact on the financial health of the Corporation’s borrowers and a direct impact on asset quality. Throughout 2012 and into 2013, because of the factors listed above, the allowance for loan loss calculation indicated a need to reduce the provision because of significant improvements in the loan portfolio related to delinquent, non-performing, and classified loans. Management closely tracks delinquent loans as a percentage of the loan portfolio. As of September 30, 2013, total delinquencies represented 0.76% of total loans, compared to 0.68% as of September 30, 2012. These ratios are extremely low compared to local and national peer groups. 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 primarily determined by loan-to-value and debt-to-income ratios. The prolonged economic downturn, including devaluation of residential and commercial real estate, has stressed these ratios, although valuations have recently shown improvements and levels of classified loans have continued to decline and are significantly lower than levels in 2011 and 2012. 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 based upon completion of the quarterly ALLL calculation. The provision reached a neutral level in the third quarter of 2013 where no charge or credit was necessary. Future provision amounts will depend on the amount of loan growth achieved versus levels of delinquent, non-performing, and classified loans.

 

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.

 

In 2013, factors related to dairy farming have improved reflecting the improved outlook for the industry. Additionally, the factor related to the experience, ability, and depth of lending personnel and management was lowered reflecting low turnover and added depth in personnel. Additionally, as a reflection of improved real estate values both locally and nationally, the factor related to the value of underlying collateral was reduced. However, due to the significant loan growth that occurred in the third quarter of 2013, several qualitative factors were adjusted higher to reflect the higher volume in the loan portfolio.

 

The net of all qualitative factor changes in 2013 has resulted in a slightly higher required allowance for loan losses primarily due to the significant loan growth in the third quarter of 2013, assuming all other factors remained constant. Because the allowance for loan loss balance was already large enough to account for the higher requirement, no additional provision was made in the third quarter of 2013. 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.

 

Management monitors the allowance as a percentage of total loans. Because of the credit provision recorded in 2012 and in the first nine months of 2013, the percentage of the allowance to total loans has decreased slightly since December 31, 2012, but still remains very high compared to historical percentages. As of September 30, 2013, the allowance as a percentage of total loans was 1.67%, down from 1.81% at December 31, 2012, and 1.90% at September 30, 2012. 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.

 

40
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Other Income

 

Other income for the third quarter of 2013 was $1,939,000, an increase of $181,000, or 10.3%, compared to the $1,758,000 earned during the third quarter of 2012. For the year-to-date period ended September 30, 2013, other income totaled $6,671,000, an increase of $1,015,000, or 17.9%, compared to the same period in 2012. The following tables detail the categories that comprise other income.

 

OTHER INCOME

(DOLLARS IN THOUSANDS)  

 

   Three Months Ended September 30,   Increase (Decrease) 
   2013   2012         
   $   $   $   % 
                 
Trust and investment services   273    248    25    10.1 
Service charges on deposit accounts   308    254    54    21.3 
Other service charges and fees   153    139    14    10.1 
Commissions   491    490    1    0.2 
Gains on securities transactions, net   537    342    195    57.0 
Impairment losses on securities   (44)       (44)    
Gains on sale of mortgages   20    52    (32)   (61.5)
Earnings on bank owned life insurance   162    164    (2)   (1.2)
Other miscellaneous income   39    69    (30)   (43.5)
                     
Total other income   1,939    1,758    181    10.3 

 

OTHER INCOME

(DOLLARS IN THOUSANDS)  

 

   Nine Months Ended September 30,   Increase (Decrease) 
   2013   2012         
   $   $   $   % 
                 
Trust and investment services   883    816    67    8.2 
Service charges on deposit accounts   827    860    (33)   (3.8)
Other service charges and fees   473    399    74    18.5 
Commissions   1,467    1,454    13    0.9 
Gains on securities transactions, net   2,216    1,003    1,213    120.9 
Impairment losses on securities   (157)   (86)   (71)   82.6 
Gains on sale of mortgages   208    183    25    13.7 
Earnings on bank owned life insurance   480    762    (282)   (37.0)
Other miscellaneous income   274    265    9    3.4 
                     
Total other income   6,671    5,656    1,015    17.9 

 

Service charges on deposit accounts increased by $54,000, or 21.3%, for the three months ended September 30, 2013, and decreased by $33,000, or 3.8%, for the nine months ended September 30, 2013, compared to the same periods in 2012. Overdraft service charges are the largest component of this category and comprised approximately 84% of the total deposit service charges for the three and nine months ended September 30, 2013. Total overdraft fees increased by $47,000, or 21.8%, and decreased by $45,000, or 6.0%, for the three and nine-month periods ended September 30, 2013, compared to the same periods in 2012. Transaction posting order was changed in mid-2012, which has resulted in lower year-to-date overdraft fees. However, due to increased customer activity in the third quarter of 2013, the quarter-to-date fees reflect an increase over the third quarter of 2012. Most of the other service charge areas showed minimal increases or decreases from the prior year.

 

Other service charges and fees increased by $14,000, or 10.1%, and $74,000, or 18.5%, for the three and nine months ended September 30, 2013, compared to the same periods in 2012. 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. Loan modification fees increased by $2,000 for the three months ended September 30, 2013, and $76,000 for the nine months ended September 30, 2013, compared to the same periods in the prior year. Letter of credit fees increased by $6,000 for the three months ended September 30, 2013, and decreased by $14,000 for the nine months ended September 30, 2013. Loan administration fees, which consist primarily of mortgage document preparation fees, increased by $8,000 for the three months ended September 30, 2013, and $14,000 for the nine months ended September 30, 2013. Various other fee income categories increased or decreased slightly.

41
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

For the three months ended September 30, 2013, $537,000 of gains on securities transactions excluding impairment were recorded compared to $342,000 for the same period in 2012. For the nine months ended September 30, 2013, $2,216,000 of gains on securities transactions were recorded compared to $1,003,000 for the nine months ended September 30, 2012. Gains or losses on securities transactions fluctuate based on market opportunities to take gains and 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 securities 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 in the first half of 2013, management had more opportunities to sell securities at favorable gains. During the third quarter of 2013, with an increase in market rates that caused a devaluation in the securities portfolio, management sold securities to reposition the portfolio as well as take advantage of selective gains that were still available in some segments.

 

Impairment losses on securities were $44,000 for the three months ended September 30, 2013, with no corresponding impairment losses recorded in the third quarter of 2012. Impairment losses on securities were $157,000 for the nine months ended September 30, 2013, compared to $86,000 for the same period in 2012. Impairment losses occur when securities are written down to a lower value based on anticipated credit losses. Impairment losses of $20,000 were recorded on one private collateralized mortgage obligation (PCMO) in the first quarter of 2013; impairment losses of $93,000 were recorded on two PCMOs in the second quarter of 2013; and impairment losses of $44,000 were recorded on two PCMOs in the third quarter of 2013, resulting in the year-to-date impairment of $157,000 on three PCMOs, one of which was sold in the third quarter of 2013 at a $12,000 gain over impaired levels. 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 $20,000 for the three-month period ended September 30, 2013, compared to $52,000 for the same period in 2012, a $32,000, or 61.5% decrease. For the nine months ended September 30, 2013, gains on the sale of mortgages increased by $25,000, or 13.7%, compared to the same period in 2012. Secondary mortgage financing activity drives the gains on the sale of mortgages, and this activity increased in the first half of 2013 as refinancing activity was high due to the extremely low interest rate environment. When market rates increased at the end of the second quarter of 2013, mortgage activity slowed down significantly resulting in the quarterly decrease in gains.

 

For the nine months ended September 30, 2013, earnings on BOLI decreased by $282,000, or 37.0%, compared to the same period in 2012, caused by a BOLI claim in 2012 resulting in an additional $276,000 of income. 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.

 

Operating Expenses

 

Operating expenses for the third quarter of 2013 were $5,347,000, an increase of $276,000, or 5.4%, compared to the $5,071,000 for the third quarter of 2012. For the year-to-date period ended September 30, 2013, operating expenses totaled $16,199,000, an increase of $434,000, or 2.8%, compared to the same period in 2012. The following tables provide details of the Corporation’s operating expenses for the three and nine-month periods ended September 30, 2013, compared to the same periods in 2012.

42
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

OPERATING EXPENSES

(DOLLARS IN THOUSANDS)  

 

   Three Months Ended September 30,   Increase (Decrease) 
   2013   2012         
   $   $   $   % 
                 
Salaries and employee benefits   3,193    3,020    173    5.7 
Occupancy expenses   462    420    42    10.0 
Equipment expenses   248    221    27    12.2 
Advertising & marketing expenses   68    65    3    4.6 
Computer software & data processing expenses   386    418    (32)   (7.7)
Bank shares tax   215    202    13    6.4 
Professional services   297    262    35    13.4 
Other operating expenses   478    463    15    3.2 
Total Operating Expenses   5,347    5,071    276    5.4 

 

OPERATING EXPENSES

(DOLLARS IN THOUSANDS)

 

   Nine Months Ended September 30,   Increase (Decrease) 
   2013   2012         
   $   $   $   % 
                 
Salaries and employee benefits   9,545    9,326    219    2.3 
Occupancy expenses   1,303    1,261    42    3.3 
Equipment expenses   716    657    59    9.0 
Advertising & marketing expenses   307    285    22    7.7 
Computer software & data processing expenses   1,193    1,216    (23)   (1.9)
Bank shares tax   644    618    26    4.2 
Professional services   925    850    75    8.8 
Other operating expenses   1,566    1,552    14    0.9 
Total Operating Expenses   16,199    15,765    434    2.8 

 

Salaries and employee benefits are the largest category of operating expenses. In general, they comprise close to 60% of the Corporation’s total operating expenses. For the three months ended September 30, 2013, salaries and benefits increased $173,000, or 5.7%, from the same period in 2012. For the nine months ended September 30, 2013, salaries and benefits increased $219,000, or 2.3%, compared to the nine months ended September 30, 2012. Salaries increased by $148,000, or 6.6%, and employee benefits increased by $25,000, or 3.2%, for the three months ended September 30, 2013, compared to the same period in 2012. For the nine months ended September 30, 2013, salary expense increased by $149,000, or 2.2%, while employee benefits increased by $70,000, or 2.9%, compared to the nine months ended September 30, 2012. Salary and benefit expenses are growing primarily as a result of new staff costs for the Leola and Myerstown branch offices.

 

Occupancy expenses consist of the following:

 

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

 

43
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Occupancy expenses and equipment-related expenses increased minimally for both the three and nine-month periods ended September 30, 2013, compared to the same periods in the prior year. Increases in both of these areas can be attributed to expenses related to new branch locations.

 

Professional services expense increased $35,000, or 13.4%, and $75,000, or 8.8%, for the three and nine months ended September 30, 2013, compared to the same periods in 2012. These services include accounting and auditing fees, legal fees, loan review fees, and fees for other third-party services. Accounting and auditing fees increased by $27,000, or 58.1%, and $36,000, or 19.5%, for the three and nine months ended September 30, 2013, compared to the same periods in 2012. The increase was due to adjusting the accrual in 2013 to bring the year-to-date expense up to a reasonable level based on actual expected expenses for the accounting and audit area, as well as a decrease reflected in the 2012 accrual to account for over accrued fees in 2012. Payroll processing charges decreased by $22,000, or 52.5%, for the nine months ended September 30, 2013, compared to the same period in 2012, due to a change in payroll providers. Fees for administration of the pension and 401(K) plans increased $5,000 for the third quarter of 2013, and $21,000 for the nine months ended September 30, 2013, compared to the same periods in 2012. Other outside services expense increased $6,000, or 5.0%, and $42,000, or 12.3%, for the three and nine months ended September 30, 2013, compared to the same periods in 2012, primarily due to a commercial lending sales initiative implemented in 2013. Several other professional services expenses increased or decreased slightly making up the remainder of the variance.

 

Income Taxes

 

The majority of the Corporation’s income is taxed at a corporate rate of 34% for Federal income tax purposes. For the three and nine months ended September 30, 2013, the Corporation recorded Federal income tax expense of $274,000 and $958,000, compared to tax expense of $384,000 and $1,160,000 for the three and nine months ended September 30, 2012. The effective tax rate for the Corporation was 13.6% for the three months ended September 30, 2013, compared to 16.4% for the same period in 2012. For the nine months ended September 30, 2013, the effective tax rate for the Corporation was 14.7%, compared to 15.9% for the year-to-date period in 2012.

 

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 Federal income taxes on the Consolidated Statements of Income by the income before income taxes for the applicable period.

 

The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, the Corporation’s Holding Company has very limited taxable corporate net income activities. The Corporation’s wholly owned subsidiary, Ephrata National Bank, is subject to Pennsylvania Bank Shares Tax. Like Federal Corporate income tax, the Pennsylvania Bank Shares Tax is a significant expense for the Corporation. The Bank Shares Tax expense appears on the Corporation’s Consolidated Statements of Income, under operating expenses.

 

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, 2013, the Corporation had $280.7 million of securities available for sale, which accounted for 35.3% of assets, compared to 38.2% as of December 31, 2012, and 38.8% as of September 30, 2012. Based on ending balances, the securities portfolio decreased 7.8% from September 30, 2012, and 8.2% from December 31, 2012.

 

The most significant event occurring by the end of the third quarter of 2013 was the sharp declines in the market valuation of the Corporation’s securities. These declines were a result of marked increases in mid-term and long-term interest rates that occurred on the heels of the Federal Reserve comments made on June 19, 2013. The Chairman of the Federal Reserve commented on the winding down of its $85 billion of bond purchases per month by later in 2013 and all together by mid-2014. This caused unsettling in the bond market with mid-term and longer term rates increasing rapidly. At the time of the remarks, the 10-year U.S. Treasury stood at a 2.20% yield. Within one week, the 10-year yield had risen to 2.60%. Since longer term interest rates were impacted the most, the Corporation’s longest securities, obligations of states and political subdivisions, saw the most declines. The table below summarizes the Corporation’s cost, unrealized gain or loss position, and fair value for each sector of the securities available for sale portfolio for the periods ending September 30, 2013, December 31, 2012, and September 30, 2012.

 

AMORTIZED COST AND FAIR VALUE OF SECURITIES HELD      Net     
(DOLLARS IN THOUSANDS)  Amortized   Unrealized   Fair 
   Cost   Gains (Losses)   Value 
September 30, 2013  $   $   $ 
             
U.S. government agencies   38,285    (1,365)   36,920 
U.S. agency mortgage-backed securities   48,149    (12)   48,137 
U.S. agency collateralized mortgage obligations   38,012    (454)   37,558 
Private collateralized mortgage obligations   4,285    (118)   4,167 
Corporate bonds   52,293    332    52,625 
Obligations of states and political subdivisions   98,502    (1,449)   97,053 
Total debt securities   279,526    (3,066)   276,460 
Marketable equity securities   4,222    23    4,245 
Total securities available for sale   283,748    (3,043)   280,705 
                
December 31, 2012               
U.S. government agencies   42,374    1,910    44,284 
U.S. agency mortgage-backed securities   49,173    830    50,003 
U.S. agency collateralized mortgage obligations   40,612    (12)   40,600 
Private collateralized mortgage obligations   6,123    (373)   5,750 
Corporate bonds   48,179    1,470    49,649 
Obligations of states and political subdivisions   104,133    6,270    110,403 
Total debt securities   290,594    10,095    300,689 
Marketable equity securities   4,945        4,945 
Total securities available for sale   295,539    10,095    305,634 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

       Net     
   Amortized   Unrealized   Fair 
   Cost   Gains (Losses)   Value 
   $   $   $ 
September 30, 2012               
U.S. government agencies   36,741    1,875    38,616 
U.S. agency mortgage-backed securities   54,425    1,223    55,648 
U.S. agency collateralized mortgage obligations   47,503    (83)   47,420 
Private collateralized mortgage obligations   6,352    (417)   5,935 
Corporate bonds   47,606    1,346    48,952 
Obligations of states and political subdivisions   96,686    6,268    102,954 
Total debt securities   289,313    10,212    299,525 
Marketable equity securities   5,000    (44)   4,956 
Total securities available for sale   294,313    10,168    304,481 

 

Longer term interest rates have remained at higher levels throughout the third quarter but it is unknown whether these rates will increase even more, or decline after the recent run up in rates. While interest rate changes and the perceived forward direction of interest rates generally have a close relationship to the valuation of the Corporation’s fixed income security portfolio, there are also a number of other market factors that impact bond prices. Reduced demand for longer duration securities is having the largest impact to market pricing currently more than the absolute movement of interest rates. This can be demonstrated by looking back earlier in 2013 when the 10-year U.S. Treasury rate was at a similar level and unrealized gains on longer securities were much higher. Even in the past quarter, valuations were significantly reduced by the end of June, got slightly worse in July, worsened to a greater degree in August, and then improved by the end of September. It is evident that the market overreacted to the run up in rates initially and has settled back down more recently. Valuations will continue to be influenced by the timing of the reduction of longer term bond purchases by the Federal Reserve. Another important factor is the market’s projection of the timing of an increase in the overnight Federal funds rate. Even variations on the timing of this future event will impact the U.S. Treasury curve and the valuation of the Corporation’s securities.

 

Management has already taken steps to reduce the Corporation’s exposure to additional increases in interest rates and declines in the market valuation of the securities portfolio. These actions have included the sales of longer duration securities, primarily municipal bonds. Those actions are part of a broader asset liability plan to continually work to mitigate future interest rate risk and fair value risk to the Corporation. Part of that strategy is to retain higher levels of cash and cash equivalents to increase liquidity and provide an immediate hedge against higher interest rates and fair value risk. However, despite taking actions to mitigate the Corporation’s future risk, these risks are inherent to the banking model. Unrealized gains and losses on securities will vary significantly according to market forces. Management’s focus will continue to be on the long-term performance of these securities. While management has and will continue to take gains from the portfolio when opportunities exist, the broader securities strategy remains to buy and hold securities.

 

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’s equity holdings consist of a small CRA-qualified mutual fund with a book value of $4.0 million. The Corporation also has a small portfolio of bank stocks with a book value of $222,000. These equity holdings make up less than 1.5% of the Corporation’s securities available for sale. The CRA fund is a Small Business Association (SBA) variable rate fund with a stable dollar price.

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Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

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:

 

·ALCO positions as to liquidity, credit risk, interest rate risk, and net portfolio value
·Growth of the loan portfolio
·Slope of the U.S. Treasury curve
·Relative performance of the various instruments
·Duration and average length of the portfolio
·Volatility of the portfolio
·Direction of interest rates
·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, 2013  December 31, 2012  September 30, 2012
   $  %  $  %  $  %
                   
U.S. government agencies   36,920    13.2    44,284    14.5    38,616    12.7 
U.S. agency mortgage-backed securities   48,137    17.1    50,003    16.4    55,648    18.3 
U.S. agency collateralized mortgage obligations   37,558    13.4    40,600    13.3    47,420    15.6 
Private collateralized mortgage obligations   4,167    1.5    5,750    1.9    5,935    1.9 
Corporate debt securities   52,625    18.7    49,649    16.2    48,952    16.1 
Obligations of states and political subdivisions   97,053    34.6    110,403    36.1    102,954    33.8 
Equity securities   4,245    1.5    4,945    1.6    4,956    1.6 
                               
Total securities   280,705    100.0    305,634    100.0    304,481    100.0 

 

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

 

·slope of the U.S. Treasury curve and projected forward rates
·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 considerations
·federal income tax considerations with regard to obligations of states and political subdivisions.

 

Since September of 2012, the most significant changes occurring in the Corporation’s securities portfolio was a decrease in mortgage backed securities (MBS) and collateralized mortgage obligations (CMOs), and a decrease in obligations of states and political subdivisions. Due to the low interest rate environment and government purchases of MBS and CMO securities, pay downs received on these bonds have increased and reinvestments have been made into other segments of the portfolio in order to achieve higher yield and better instrument structure such as stronger prepayment and call protection. The obligations of states and political subdivisions have also been decreasing as a result of recent ALCO strategy to sell longer bonds in order to reposition the portfolio for a rates-up environment. The more significant components of the securities portfolio along with a more detailed explanation of their changes are discussed below.

 

47
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The Corporation’s U.S. government agency sector decreased minimally since September 30, 2012, related to recent sales of several agency bonds to generate gains off of the portfolio. Generally, management’s goal is to maintain agency securities at approximately 15% of the investment portfolio. As of September 30, 2013, U.S. agencies represented 13.2% of the fair market value of the portfolio. 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.

 

The decrease in the Corporation’s U.S. agency MBS and CMO sectors since September 30, 2012, occurred due to fast prepayment speeds and a lack of good options to reinvest back into the MBS or CMO segments. Payments from the MBS and CMO portfolios have been primarily invested into the municipal and corporate segments in order to achieve more attractive yields and better structure. Management still desires to maintain a substantial amount of MBS and CMOs in order to assist 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 contractual monthly principal and interest, but are also subject to additional 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. When interest rates increase, the opposite of this occurs. 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. With the recent increase in interest rates, prepayments have already slowed down on this portfolio of securities and it is anticipated pay downs will be less in the remainder of 2013 than previously in the year, therefore yields will be higher and duration longer.

 

As of September 30, 2013, the Corporation held corporate bonds with a total amortized cost of $52.3 million and fair market value of $52.6 million. Management increased its holdings in corporate securities to 18.7% of the portfolio, compared to 16.1% at September 30, 2012. 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 procedures to closely analyze the financial health of the company as well as policy guidelines. The guidelines include both maximum investment by issuer and minimal credit ratings that must be met in order for management to purchase a corporate bond.

 

Obligations of states and political subdivisions, or municipal bonds, are tax-free securities that generally provide the highest yield in the securities portfolio. In the prolonged period of historically low interest rates, the municipal bond sector has far outperformed all other sectors of the portfolio. Municipal tax-equivalent yields generally start well above other taxable bonds and these instruments had experienced significant fair market value gains when interest rates remained low. With the interest rate increases at the end of the second quarter of 2013, the valuations of these instruments have declined rapidly. As a result, management has already begun reducing the size of the municipal bond holdings both prior to and subsequent to September 30, 2013. Municipal bonds as a percentage of the total investment portfolio have increased from 33.8% at September 30, 2012, to 34.6% at September 30, 2013. However, municipal bonds made up a significant 36.1% of the investment portfolio as of December 31, 2012. This sector has declined by $13.4 million, or 12.1%, since December 31, 2012, as a result of sales of a number of bonds in order to generate gains and reposition the portfolio for a rates-up environment.

 

The harsh economic and credit environment, that began in 2008 and continues, 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.

 

48
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

As of September 30, 2013, the Corporation held three PCMO securities with an amortized cost of $4.3 million, a reduction of $1.8 million from the balance as of December 31, 2012. One PCMO security was sold during the third quarter of 2013 for $1 million at a small gain. One of the three remaining PCMO securities, with an amortized cost of $874,000, carried an A+ credit rating by at least one of the major credit rating services. The two remaining PCMOs, with an amortized cost of $3.4 million, had credit ratings below investment grade, which is BBB- for S&P and Baa3 for Moody’s. Management’s September 30, 2013 cash flow analysis did indicate a need to take additional impairment on these two PCMO securities in the amount of $44,000. In the first and second quarters of 2013, $113,000 of impairment was taken on these two securities and the third PCMO which was subsequently sold, resulting in total year-to-date impairment of $157,000. All of these securities continue to pay down in terms of monthly principal payments.

 

As of September 30, 2013, seventeen of the forty-five corporate securities held by the Corporation showed an unrealized holding loss. These securities with unrealized holding losses were valued at 97.8% 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, 2013, all but two of the corporate bonds had at least one A3 or A- rating by one of the major credit rating services. The other two corporate bonds had ratings that were investment grade, but below the A3/A- ratings that the other corporate bonds carried. As of September 30, 2013, there were five corporate bonds with $4.5 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.

 

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, 2013, one municipal bond with an amortized cost of $543,000 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 one municipal security, management has the intent and the ability to hold this security 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. 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.

 

49
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

Loans

 

Net loans outstanding increased by 8.8%, to $428.6 million at September 30, 2013, from $394.0 million at September 30, 2012. Net loans increased by 5.4%, from $406.8 million at December 31, 2012. The following table shows the composition of the loan portfolio as of September 30, 2013, December 31, 2012, and September 30, 2012.

 

LOANS BY MAJOR CATEGORY

(DOLLARS IN THOUSANDS)  

 

   September 30,  December 31,  September 30,
   2013  2012  2012
   $  %  $  %  $  %
                   
Commercial real estate                              
Commercial mortgages   97,661    22.4    91,943    22.2    86,941    21.6 
Agriculture mortgages   110,673    25.4    85,501    20.6    76,675    19.1 
Construction   8,503    2.0    16,435    4.0    17,525    4.4 
Total commercial real estate   216,837    49.8    193,879    46.8    181,141    45.1 
                               
Consumer real estate (a)                              
1-4 family residential mortgages   124,520    28.6    126,686    30.6    130,762    32.5 
Home equity loans   10,940    2.5    13,122    3.2    13,525    3.4 
Home equity lines of credit   19,837    4.5    15,956    3.9    15,907    4.0 
Total consumer real estate   155,297    35.6    155,764    37.7    160,194    39.9 
                               
Commercial and industrial                              
Commercial and industrial   27,720    6.4    27,503    6.6    25,612    6.4 
Tax-free loans   18,343    4.2    17,991    4.3    17,774    4.4 
Agriculture loans   13,548    3.1    15,204    3.7    13,058    3.3 
Total commercial and industrial   59,611    13.7    60,698    14.6    56,444    14.1 
                               
Consumer   3,863    0.9    3,872    0.9    3,798    0.9 
                               
Total loans   435,608    100.0    414,213    100.0    401,577    100.0 
Less:                              
Deferred loan fees (costs), net   (308)        (146)        (67)     
Allowance for loan losses   7,283         7,516         7,644      
Total net loans   428,633         406,843         394,000      

 

(a) Residential real estate loans do not include mortgage loans sold to Fannie Mae and serviced by ENB.  
  These loans totaled $4,334,000 as of September 30, 2013, $6,014,000 as of December 31, 2012, and $7,345,000 as of September 30, 2012.

 

During the third quarter of 2013, loan growth increased significantly over prior quarters. This growth allowed the Corporation to reposition the balance sheet and achieve better net interest income than the previous quarter. Due to the rapid loan growth, the Corporation also sold a significant number of investment securities in order to reinvest those funds into the higher yielding loan portfolio. The majority of loan growth occurred in the agriculture segment of the loan portfolio as this area has been an increased focus for the Corporation.

 

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 $216.8 million, commercial real estate is the largest category of the loan portfolio, consisting of 49.8% of total loans. This category includes commercial mortgages, agriculture mortgages, and construction loans. Commercial real estate loans increased from $181.1 million as of September 30, 2012, to $216.8 million as of September 30, 2013, a $35.7 million, or 19.7% increase.

 

The growth in commercial real estate loans has occurred primarily in those secured by farmland. Agricultural mortgages increased from $76.7 million, or 42.4% of commercial real estate loans as of September 30, 2012, to $110.7 million, or 51.1% of commercial real estate loans as of September 30, 2013. On the other hand, commercial construction loans decreased from $17.5 million, or 9.7% of commercial real estate loans as of September 30, 2012, to $8.5 million, or 3.9% of commercial real estate loans as of September 30, 2013. As construction projects are completed, most of the loans are converted from construction loans to permanent commercial mortgages.

 

50
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The commercial mortgage segment of the commercial real estate category of loans has increased from September 30, 2012 to September 30, 2013. This area represented $86.9 million, or 48.0%, of commercial real estate loans as of September 30, 2012, and $97.7 million, or 45.1%, of commercial real estate loans as of September 30, 2013. Growth in this area over the past several years had slowed significantly since most businesses were unwilling to expand during uncertain economic conditions. Since September 30, 2012, this growth picked up with businesses more willing to move forward on projects that were previously placed on hold because of the uncertain economic conditions. Management expects that growth in this area will continue if the economy continues to show signs of recovery and improvement.

 

Residential real estate loans make up 35.6% of the total loan portfolio with balances of $155.3 million. These loans include 1-4 family residential mortgages, home equity term loans, and home equity lines of credit. Personal residential mortgages account for 80.2% of total residential real estate loans and 28.6% 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 and the nine months ended September 30, 2013, 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 2013. In addition, mortgage rates increased during the third quarter as a result of general market rate increases causing a slowdown in new financing and re-financings. The Corporation has taken action to make internal mortgage rates more competitive but expects mortgage balances may decline slightly throughout the remainder of 2013 as fewer customers are seeking financing with rates up slightly from previous quarters. The Corporation’s personal residential mortgages declined to $124.5 million at September 30, 2013, a decrease of $6.3 million, or 4.8%, from balances as of September 30, 2012. 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. As mortgages that are held on the Corporation’s balance sheet refinance, many of these customers are taking advantage of the lower rates offered on the secondary market resulting in the conversion of the Corporation’s residential mortgages into mortgages sold on the secondary market.

 

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, 2012 to September 30, 2013, fixed rate home equity loans have decreased from $13.5 million to $10.9 million, a $2.6 million, or 19.3% decrease. Meanwhile, home equity lines of credit increased from $15.9 million to $19.8 million, a $3.9 million, or 24.5% increase. The net of these two trends is a $1.3 million increase in total home equity loan balances. The Corporation offered a home equity loan special during 2013 that initiated growth in the variable rate line of credit area. Consumers are seeking the lowest interest rate to borrow money against their home value which has resulted in more variable rate versus fixed rate financing. This trend is likely to continue until economic conditions and home valuations improve. Management does not anticipate any marked improvement in the economy through the remainder of 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 2013.

 

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 an increase of $3.2 million, or 5.6%, from September 30, 2012 to September 30, 2013. As of September 30, 2013, this category of commercial loans was made up of $27.7 million of commercial and industrial loans, $18.3 million of tax-free loans, and $13.5 million of agriculture loans. In the case of the Corporation, all of the $18.3 million of tax-free loans are to local municipalities. These loans increased by $0.6 million, or 3.2%, from September 30, 2012 to September 30, 2013. Agriculture loans increased by $0.5 million, or 3.8%, from September 30, 2012 to September 30, 2013, while other non-real estate secured commercial and industrial purpose loans were up from $25.6 million as of September 30, 2012 to $27.7 million as of September 30, 2013.

 

51
Index

ENB FINANCIAL CORP
Management’s Discussion and Analysis

The consumer loan portfolio remained fairly constant at $3.8 million at September 30, 2012, and $3.9 million at September 30, 2013. Consumer loans made up 0.9% of total loans on September 30, 2012, and September 30, 2013. 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 new 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 and other consumer goods 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,
   2013  2012  2012
   $  $  $
          
Nonaccrual loans   1,185    1,298    1,346 
Loans past due 90 days or more and still accruing   253    314    172 
Troubled debt restructurings            
Total non-performing loans   1,438    1,612    1,518 
                
Other real estate owned   264    264    264 
                
Total non-performing assets   1,702    1,876    1,782 
                
Non-performing assets to net loans   0.40%   0.46%   0.45%

 

The total balance of non-performing assets declined by $80,000, or 4.5%, from September 30, 2012 to September 30, 2013, and by $174,000, or 9.3%, from December 31, 2012 to September 30, 2013. There were no loans classified as a TDR as of September 30, 2013, December 31, 2012, 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 and classified loans trending lower. Additionally, the direction of the risk is viewed as declining from the higher levels experienced in prior years.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

As of September 30, 2013 and 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.

 

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 five main factors:

 

·Growth or decline of the loan portfolio
·Levels of non-performing and delinquent loans
·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, 2013, and September 30, 2012. 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.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

ALLOWANCE FOR LOAN LOSSES

(DOLLARS IN THOUSANDS)  

 

   Nine Months Ended 
   September 30, 
   2013   2012 
   $   $ 
         
Balance at January 1,   7,516    8,480 
Loans charged off:          
Real estate   78     
Commercial and industrial   41    47 
Consumer   16    9 
Total charged off   135    56 
           
Recoveries of loans previously charged off:          
Real estate       15 
Commercial and industrial   52    46 
Consumer       9 
Total recovered   52    70 
Net loans charged off   83    (14)
           
Provision credited to operating expense   (150)   (850)
           
Balance at September 30,   7,283    7,644 
           
Net charge-offs as a % of average total loans outstanding   0.02%   0.00%
           
Allowance at end of period as a % of total loans   1.67%   1.90%

 

Charge-offs for the nine months ended September 30, 2013, were $135,000, compared to $56,000 for the same period in 2012. Management typically charges off unsecured debt over 90 days delinquent with little likelihood of recovery. The real estate charge-offs were higher in 2013 compared to 2012 due to a single consumer real estate loan that was charged off for $78,000 in the first quarter of 2013. Commercial and industrial loan charge-offs for 2013 include one loan to a construction company that was charged off for $34,000.

 

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 some changes since September 30, 2012, consisting mostly of significant loan growth. However, offsetting the additional risk represented by larger loan balances, the quality of the loan portfolio has improved since 2012. 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.”

 

The Corporation’s total classified loans were $16.5 million as of September 30, 2013, $21.9 million as of December 31, 2012, and $24.0 million as of September 30, 2012, net of specifically allocated allowance against these loans of $8,000, $110,000, and $162,000, respectively. The classified loans require larger provision amounts due to a higher potential risk of loss, so as the classified loan balances decline, the associated specific allowance applied to them declines, resulting in a lower required allowance. The allowance as a percentage of total loans was 1.67% as of September 30, 2013, 1.81% as of December 31, 2012, and 1.90% as of September 30, 2012. Management anticipates that the allowance percentage will remain fairly constant in the fourth quarter of 2013.

 

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 continues to experience 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 2013. 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.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

Premises and Equipment

 

Premises and equipment, net of accumulated depreciation, increased by $1,193,000, or 5.7%, to $22,305,000 as of September 30, 2013, from $21,112,000, as of September 30, 2012. As of September 30, 2013, $1,630,000 was classified as construction in process primarily related to the construction of a new retail branch location.

 

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 $3,415,000 of regulatory stock holdings as of September 30, 2013, consisted of $3,227,000 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.

 

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. Excess stock repurchases reduced the Corporation’s FHLB stock position from $3,845,000 on September 30, 2012, to $3,227,000 as of September 30, 2013, with no excess capital stock position at that time. Any future excess capital stock repurchase would not impact the Corporation unless the amount of FHLB borrowings would decline and then cause an excess capital stock position. Stock repurchases by the FHLB occur every quarter.

 

In the first quarter of 2012, the FHLB announced the first resumed payment of a dividend to its shareholders after a period of three years without a dividend. Quarterly since then, the FHLB has paid a dividend, initially equal to 0.10% annualized for three quarters and increased to 0.32% annualized in the last quarter of 2012, 0.29% annualized for the first quarter of 2013, and 1.00% annualized for the second and third quarters of 2013.

 

Management will continue to monitor the financial condition of the FHLB quarterly to assess its ability to continue to regularly repurchase excess capital stock and pay a dividend. Management has concluded that the Corporation’s investment in FHLB stock is not other-than-temporarily impaired, based on the improved financial results of FHLB and its demonstrated resumption of a quarterly dividend and regular repurchases of excess stock.

 

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 $9.6 million, or 1.5%, and $22.8 million, or 3.7%, from December 31, 2012, and September 30, 2012, respectively. Customer deposits are the Corporation’s primary source of funding for loans and securities. During 2012 and through the first nine months of 2013, the economic concerns and volatility of the equity market 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, 2012, with a $16.0 million increase in non-interest bearing demand deposit accounts, a $7.9 million increase in interest bearing demand accounts, a $3.6 million increase in NOW accounts, a $6.0 million increase in money market balances, and a $10.1 million increase in savings account balances. Partially offsetting these increases, time deposits decreased by $17.4 million, and brokered time deposits decreased by $3.4 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.

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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, 2013, December 31, 2012, and September 30, 2012.

 

DEPOSITS BY MAJOR CLASSIFICATION

(DOLLARS IN THOUSANDS)

 

   September 30,   December 31,   September 30, 
   2013   2012   2012 
   $   $   $ 
             
Non-interest bearing demand   165,874    156,327    149,839 
Interest bearing demand   15,294    8,650    7,385 
NOW accounts   64,710    69,521    61,107 
Money market deposit accounts   59,132    58,195    53,159 
Savings accounts   119,702    114,067    109,618 
Time deposits   213,884    222,254    231,304 
Brokered time deposits   4,155    4,147    7,522 
Total deposits   642,751    633,161    619,934 

 

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 as well as competitive service fees and 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, 2013, time deposit balances, excluding brokered deposits, had decreased $17.4 million, or 7.5%, and $8.4 million, or 3.8%, from September 30, 2012, and December 31, 2012, 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 declining 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 $250,000 per account, based on certain account structures. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 the $250,000 FDIC insurance coverage on all deposit accounts was made permanent. This has caused an increase in the amount of time deposits over $100,000 held by the Corporation. While total time deposits continue to decline in the present environment, the percentage of time deposits over $100,000 has increased and is expected to remain at these higher percentages due to the FDIC coverage. 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.

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

Borrowings

 

Total borrowings were $65.0 million, $73.0 million, and $70.5 million as of September 30, 2013, December 31, 2012, and September 30, 2012, respectively. The Corporation was purchasing no short-term funds as of September 30, 2013, December 31, 2012, or September 30, 2012. 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. When short term funds are used, they are purchased through correspondent and member bank relationships as overnight borrowings.

 

Total long-term borrowings, borrowings initiated for terms longer than one year, were $65.0 million, $73.0 million, and $70.5 million as of September 30, 2013, December 31, 2012, and September 30, 2012. 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 $15.0 million at September 30, 2012, December 31, 2012, and September 30, 2013. FHLB advances were $55.5 million at September 30, 2012, $58.0 million at December 31, 2012, and declined to $50.0 million as of September 30, 2013. 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 few years, 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. In 2013, management implemented a plan to reduce FHLB borrowings by selectively paying off the advances that mature in the year in order to utilize excess cash balances to reduce long-term debt. 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, 2013, the Corporation was significantly under this policy guideline at 6.3% of asset size with $50.0 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, 2013, the Corporation was significantly under this policy guideline at 77.2% of capital with $65.0 million total borrowings from all sources. The Corporation has maintained FHLB borrowings and total borrowings within these policy guidelines throughout all of 2012 and through the first nine months of 2013.

 

The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently $225.9 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.

 

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

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

REGULATORY CAPITAL RATIOS:    

 

       Regulatory Requirements 
       Adequately   Well 
As of September 30, 2013  Capital Ratios   Capitalized   Capitalized 
Total Capital to Risk-Weighted Assets               
Consolidated   17.7%    8.0%    10.0% 
Bank   17.6%    8.0%    10.0% 
                
Tier I Capital to Risk-Weighted Assets               
Consolidated   16.5%    4.0%    6.0% 
Bank   16.4%    4.0%    6.0% 
                
Tier I Capital to Average Assets               
Consolidated   10.8%    4.0%    5.0% 
Bank   10.7%    4.0%    5.0% 
                
As of December 31, 2012               
Total Capital to Risk-Weighted Assets               
Consolidated   18.2%    8.0%    10.0% 
Bank   18.1%    8.0%    10.0% 
                
Tier I Capital to Risk-Weighted Assets               
Consolidated   16.9%    4.0%    6.0% 
Bank   16.8%    4.0%    6.0% 
                
Tier I Capital to Average Assets               
Consolidated   10.5%    4.0%    5.0% 
Bank   10.4%    4.0%    5.0% 
                
                
As of September 30, 2012               
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% 

 

The Corporation’s dividends per share for the nine months ended September 30, 2013, were $0.78 per share, compared to $0.75 per share for the same period of 2012. 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 10.8%. Management also desires a dividend payout ratio in the range of 35% to 40%. 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 2013, the payout ratio was 40.0%. Due to improved financial performance and increased capital levels, the Corporation increased the dividend amount to $0.26 per share in the first quarter of 2013.

 

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, 2013, the Corporation showed unrealized losses, net of tax, of $2,009,000, compared to unrealized gains of $6,663,000 as of December 31, 2012, and $6,711,000 as of September 30, 2012. 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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ENB FINANCIAL CORP
Management’s Discussion and Analysis

Regulatory Capital Changes

 

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations begins January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) must begin compliance on January 1, 2014. The final rules call for the following capital requirements:

 

·A minimum ratio of common tier 1 capital to risk-weighted assets of 4.5%.
·A minimum ratio of tier 1 capital to risk-weighted assets of 6%.
·A minimum ratio of total capital to risk-weighted assets of 8%
·A minimum leverage ratio of 4%.

 

In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.

 

Under the initially proposed rules, accumulated other comprehensive income (AOCI) would have been included in a banking organization’s common equity tier 1 capital. The final rules allow community banks to make a one-time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. The opt-out election must be made in the first call report or FR Y-9 series report that is filed after the financial institution becomes subject to the final rule.

 

The final rules permanently grandfather non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the tier 1 capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and banking organizations that were mutual holding companies as of May 19, 2010. The Corporation does not have trust preferred securities or cumulative perpetual preferred stock with no plans to add these to the capital structure.

 

The proposed rules would have modified the risk-weight framework applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposures into two categories in order to determine the applicable risk weight. In response to commenter concerns about the burden of calculating the risk weights and the potential negative effect on credit availability, the final rules do not adopt the proposed risk weights but retain the current risk weights for mortgage exposures under the general risk-based capital rules.

 

Consistent with the Dodd-Frank Act, the new rules replace the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-up approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250 percent risk weight.

 

Under the new rules, mortgage servicing assets (MSAs) and certain deferred tax assets (DTAs) are subject to stricter limitations than those applicable under the current general risk-based capital rule. The new rules also increase the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

 

The Corporation is in the process of assessing the impact of these changes on the regulatory ratios of the Corporation and the Bank on the capital, operations, liquidity and earnings of the Corporation and Bank.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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, 2013.

 

OFF-BALANCE SHEET ARRANGEMENTS

(DOLLARS IN THOUSANDS)

   

   September 30, 
   2013 
   $ 
Commitments to extend credit:     
Revolving home equity   27,721 
Construction loans   16,997 
Real estate loans   15,070 
Business loans   66,146 
Consumer loans   1,827 
Other   3,375 
Standby letters of credit   7,755 
      
Total   138,891 

 

Jumpstart Our Business Startups Act

 

In April 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:

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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.

 

Deposit Insurance

Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to $250,000 per depositor. Additionally, on February 7, 2011, the Board of Directors of the FDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which was effective in April 2011, saved the Corporation a significant amount of FDIC insurance premiums.

 

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 was 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 amended 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 created 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 has 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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Management’s Discussion and Analysis

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 $32 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. A gap ratio of 100% represents an equal amount of assets and liabilities maturing in the same stated period. 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, 2013. The gap ratios as of September 30, 2013, had decreased slightly since December 31, 2012, with a one-year gap of 94% and a three-year gap of 102%. The primary reason for the decrease in gap ratios can be attributed to slower principal payments on securities, purchasing securities with longer durations, and a shortening of the Corporation’s liabilities. Management has been maintaining higher levels of cash and cash equivalents 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.

 

Given the likelihood that short term interest rates will not increase in the remainder of 2013, and well into 2014, management’s current position is to maintain maturity gap percentages within guidelines but not necessarily increase them in 2013. The risk in maintaining high gap percentages is that, should interest rates not rise, maturing assets will reprice at lower rates. This is referred to as repricing risk. Carrying high gap ratios in the current environment brings on an increased level of repricing risk, which negatively impacts the Corporation’s interest income and margin. The risk of liabilities repricing at higher interest rates is very low in the present environment as over half of the Corporation’s deposits are core deposits with no repricing expected to occur in the near future. The remainder of the Corporation’s maturing liabilities made up of time deposits and borrowings are currently repricing to lower interest rates. Therefore, higher levels of liabilities repricing would currently benefit the Corporation. Given the limited desirable rates available to the deposit customer, management also does not perceive significant risk that deposits maturing in the shorter time frames will leave the Corporation. It is likely that, should market interest rates rise in the remainder of 2013 and in 2014, customer behavior patterns will change and deposits will be more rate sensitive with a greater portion potentially leaving the Corporation. The performance of the equity markets also has a bearing on how much of the current deposits will remain at the Corporation. For the past several years, deposit customers have been reluctant to redeploy funds presently at banks into the equity market. They have been negatively impacted by multiple declines in the equity markets. It remains to be seen whether further equity market improvements will materially change customer behavior.

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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 begin increasing short-term interest rates in mid-2014, it would likely be at least until late 2015 or early 2016 before 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 of 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 2013.

 

It is important to stress that the gap ratios are a static measurement of the Corporation’s asset liability position. It is only one of many asset liability analysis tools management utilizes to measure, monitor, and manage both liquidity and interest rate risk. The deficiencies with the gap analysis are that it makes no provision for changes to the balance sheet out into the future and would not factor in changes that management would very likely make to mitigate future interest rate risk.

 

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
·Readily Available Unencumbered Securities and Cash – Unencumbered securities as a percentage of the securities portfolio and as a percentage of total assets
·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, 2013, 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, 2013, these cash flows represented 4.2% of total assets, slightly under the lower guideline. However, when factoring in available overnight cash, the Corporation’s securities portfolio liquidity represented 6.4% 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 an average of $35 million of cash and cash equivalents on a daily basis throughout the first nine months of 2013, 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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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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. Rates-down scenarios are unlikely at this point so management is more focused on the rates-up scenarios. 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
·Slope of the U.S. Treasury curve
·Spreads available on securities over the U.S. Treasury curve
·Prepayment speeds on loans held and mortgage-backed securities
·Anticipated calls on securities with call options
·Deposit and loan balance fluctuations
·Competitive pressures affecting loan and deposit rates
·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, 2013. 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. 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. Management does run additional scenarios with expected growth rates 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.

 

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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ENB FINANCIAL CORP
Management’s Discussion and Analysis

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’s gap ratios indicate a nearly equal amount of assets maturing versus liabilities maturing. As a result, as interest rates go up, the Corporation can immediately achieve higher interest earnings on interest-earning assets while having the ability to limit the amount of increase in interest-bearing liabilities based on the timing of deposit rate changes. This results in an increase in net interest income in the up-rate scenarios, but a decline in net interest income in the down-rate scenarios.

 

The third quarter 2013 analysis projects net interest income expected in the seven rate scenarios over a one-year time horizon. As of September 30, 2013, the Corporation was well within guidelines for the maximum amount of net interest income change in all rate scenarios. All up-rate scenarios show a positive impact to net interest income. In the unique current rate environment, the amount of the Corporation’s assets repricing higher will be fairly large due to the amount of variable rate loans that will reprice immediately when Prime increases. On the liability side, if interest rates do increase, it is typical for management to react slowly in increasing deposit rates. The changes in net interest income in the up-rate scenarios are comparable to the changes reflected at June 30, 2013, but are down since December 31, 2012, representing management’s view that deposit rates will need to be moved up competitively because of the very low starting point and the amount of time rates have been at these historic lows. This is based on management’s analysis of the reaction of the Corporation’s deposits in previous rates-up cycles, adjusted for increased competitive pressures. This change in assumptions resulted in a more conservative estimate of the increase in net interest income over the course of one year. It is unlikely that rates will go down, but in the event that they would go lower, the Corporation would have exposure to all maturing fixed-rate loans and securities, which would reprice lower while most of the Corporation’s interest-bearing deposits could not be repriced any lower. This would result in a decline in net interest income in any down-rate scenario. However, even in the highly unlikely down-rate scenarios, the Corporation’s exposure to declining net interest income is still within policy guidelines.

 

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 basis point scenario, net interest income increased minimally by 0.9% compared to the rates unchanged scenario. This minimal increase reflects the fact that some loans are priced at floor rates of 4.00% currently and would not be able to immediately reprice by the full amount of the rate movement. However, in the remaining rates-up scenarios, the net interest income increases more substantially reflecting the full repriceabilty of the Corporation’s interest-earning assets. For the rates-up 200, 300, and 400 basis point scenarios, net interest income increased by 5.0%, 10.4%, and 16.1%, respectively, compared to the rates unchanged scenario. Management’s maximum permitted net interest income declines by policy are -5%, -10%, -15%, and -20% for the rates up 100, 200, 300, and 400 scenarios, respectively.

 

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 increase in interest expense caused by repricing deposits and borrowings, where 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. 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 during the remainder of 2013.

 

The assumptions and analysis of interest rate risk are based on historical experience during varied economic cycles. Management believes these assumptions to be appropriate; however, actual results could vary significantly. Management uses this analysis to identify trends in interest rate sensitivity and determine if action is necessary to mitigate asset liability risk.

 

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 above. As of September 30, 2013, the Corporation was within guidelines for all scenarios with the rates-up exposures showing less volatility than the December 31, 2012 measurements, but slightly more volatility than the June 30, 2013 measurements. The decrease in fair value exposure since December 31, 2012, can be attributed to a change in the valuation of interest-bearing core deposit accounts. The value of non-interest bearing deposit accounts has always been highly favorable in a rising rate environment as these balances are more valuable as interest rates rise. In the first quarter of 2013, the asset liability model settings were changed for the Corporation’s interest-bearing core deposit accounts to reflect their true value more accurately as rates rise based on assumptions regarding the proportionality of their rates changing in relation to the change in the Prime rate.

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

The results as of September 30, 2013, indicate that the Corporation’s net portfolio value would experience a slight valuation decline of 1.6% in the rates-up 100 basis point scenario, a loss of 6.4% in the rates-up 200 basis point scenario, and losses of 13.3% and 22.0% in the rates-up 300 and 400 basis point scenarios, respectively. Management’s maximum permitted declines in net portfolio value by policy are -10% for rates-up 100 basis points, graduating up to -40% for rates-up 400 basis points. A valuation loss indicates that the value of the Corporation’s assets is declining at a faster pace than the decrease in the value of the Corporation’s liabilities. The more significant valuation losses represented in the higher rates-up scenarios are indicative of the Corporation’s longer-term assets like residential mortgages and municipal securities showing significant declines in value as interest rates increase further. It is not anticipated that these exposures to valuation changes will change materially during the remainder of 2013. Additionally, based on three past decay rate studies on the Corporation’s core deposits, management does not expect a material decline in core deposit accounts, including the non-interest bearing accounts, when short term interest rates do increase. The Corporation’s core deposits have been stable through a number of rate cycles.

 

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. However, the net portfolio value analysis is a more important tool to measure the impact of interest rate changes to capital. In the current regulatory climate, the focus is on ensuring adequate asset liability modeling is being done to project the impact of very large interest rate increases. The asset liability modeling currently in place measures the impact of such a rate change on the valuation of the Corporation’s loans, securities, deposits, and borrowings, and the resulting impact to capital. Management continues to analyze additional scenario testing to model “worst case” scenarios to adequately plan for the possible impact of such events.

 

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ENB FINANCIAL CORP
Management’s Discussion and Analysis

  

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, 2013, 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, 2013, 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 have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

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ENB FINANCIAL CORP

PART II – OTHER INFORMATION

September 30, 2013

 

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, 2012 Form 10-K filing.

 

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

 

Purchases

 

The following table details the Corporation’s purchase of its own common stock during the three months ended September 30, 2013.

 

Issuer Purchase of Equity Securites
                 
           Total Number of   Maximum Number 
   Total Number   Average   Shares Purchased   of Shares that May 
   of Shares   Price Paid   as Part of Publicly   Yet be Purchased 
Period  Purchased   Per Share   Announced Plans *   Under the Plan * 
                 
July 2013               36,660 
August 2013               36,660 
September 2013   3,500   $29.25    3,500    33,160 
                     
Total   3,500                

  

 

*On August 13, 2008, the Board of Directors of ENB Financial Corp announced the approval of a plan to purchase, in open market and privately negotiated transactions, up to 140,000 shares of outstanding common stock. Shares repurchased are being held as treasury shares to be utilized in connection with the Corporation’s three stock purchase plans previously mentioned. The first purchase of common stock under this plan occurred on August 27, 2008. By September 30, 2013, a total of 106,840 shares were repurchased at a total cost of $2,745,000, for an average cost per share of $25.69. Management may choose to repurchase additional shares during the remainder of 2013.

 

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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ENB FINANCIAL CORP

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   4
    (Included on page 4 herein)  
       
  31.1 Section 302 Chief Executive Officer Certification 72
       
  31.2 Section 302 Principal Financial Officer Certification 73
       
  32.1 Section 1350 Chief Executive Officer Certification 74
       
  32.2 Section 1350 Principal Financial Officer Certification 75

 

*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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ENB FINANCIAL CORP

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 13, 2013 By: /s/  Aaron L. Groff, Jr.
    Aaron L. Groff, Jr.
    Chairman of the Board,
    Chief Executive Officer and President
     
     
Dated:  November 13, 2013 By: /s/  Scott E. Lied
    Scott E. Lied, CPA
    Treasurer
    Principal Financial Officer

 

 

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ENB FINANCIAL CORP

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 72
31.2 Section 302 Principal Financial Officer Certification (Required by Rule 13a-14(a)). Page 73
32.1 Section 1350 Chief Executive Officer Certification (Required by Rule 13a-14(b)). Page 74
32.2 Section 1350 Principal Financial Officer Certification (Required by Rule 13a-14(b)). Page 75

 

 

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