ENB Financial Corp - Annual Report: 2021 (Form 10-K)

☒	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended	December 31, 2021
OR
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ______________
Commission File Number 000-53297
ENB Financial Corp
(Exact name of registrant as specified in its charter)

Pennsylvania		51-0661129
State or other jurisdiction of incorporation or organization		(IRS Employer Identification No.)
31 E. Main St. Ephrata, PA		17522
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code (717) 733-4181
Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None	N/A	N/A

	Large Accelerated filer ☐	Accelerated filer ☐
	Non-accelerated filer ☒	Smaller reporting company ☒
	Emerging growth company ☐

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Part I
	Item 1.	Business	5
	Item 1A.	Risk Factors	15
	Item 1B.	Unresolved Staff Comments	26
	Item 2.	Properties	26
	Item 3.	Legal Proceedings	26
	Item 4.	Mine Safety Disclosures	26
Part II
	Item 5.	Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities	26
	Item 6.	[Reserved]	27
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	49
	Item 8.	Financial Statements and Supplementary Data	54
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	104
	Item 9A.	Controls and Procedures	104
	Item 9B.	Other Information	105
	Item 9C.	Disclosure Regarding Foreign Jurisdictions that Prevent Inspections	105
Part III
	Item 10.	Directors, Executive Officers, and Corporate Governance	106
	Item 11.	Executive Compensation	106
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	106
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	106
	Item 14.	Principal Accountant Fees and Services	106
Part IV
	Item 15.	Exhibits and Financial Statement Schedules	107
	Item 16.	Form 10-K Summary	108
	Signatures		108

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Table of Contents

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Table of Contents

 

ENB FINANCIAL CORP

Item 1. Business

 

General

 

ENB Financial Corp (“the Corporation”) is a bank holding company that was formed on July 1, 2008. The Corporation’s wholly owned subsidiary, Ephrata National Bank (“the Bank”), also referred to as ENB, is a full service commercial bank organized under the laws of the United States. Presently, no other subsidiaries exist under the bank holding company. The Corporation and the Bank are both headquartered in Ephrata, Lancaster County, Pennsylvania. The Bank was incorporated on April 11, 1881, pursuant to The National Bank Act under a charter granted by the Office of the Comptroller of the Currency (OCC). The Federal Deposit Insurance Corporation (FDIC) insures deposit accounts to the maximum extent provided by law. The Corporation’s retail, operational, and administrative offices are predominantly located in Lancaster County, southeastern Lebanon County, and southern Berks County, Pennsylvania. Ten full service offices are located in Lancaster County with one full service office in Lebanon County and one full service office in Berks County, Pennsylvania.

 

The basic business of the Corporation is to provide a broad range of financial services to individuals and small-to-medium-sized businesses in Lancaster County as well as Berks and Lebanon Counties. The Corporation utilizes funds gathered through deposits from the general public to originate loans. The Corporation offers a range of demand accounts, in addition to savings and time deposits. The Corporation also offers secured and unsecured commercial, real estate, and consumer loans. Ancillary services that provide added convenience to customers include direct deposit and direct payments of funds through Electronic Funds Transfer, ATMs linked to the Star® network, telephone banking, MasterCard® debit cards, Visa® or MasterCard credit cards, and safe deposit box facilities. In addition, the Corporation offers internet banking including bill pay and wire transfer capabilities, remote deposit capture, and an ENB Bank on the Go! app for iPhones or Android phones. The Corporation also offers a full complement of trust and investment advisory services through ENB’s Money Management Group.

 

As of December 31, 2021, the Corporation employed 272 persons, consisting of 251 full-time and 21 part-time employees.  The number of full-time employees decreased by one employee, and the number of part-time employees decreased by three from the previous year-end.  The decrease in the number of full-time and part-time employees is attributable to retirements that were expected.  The Bank expects to evaluate opportunities to align headcount with operational efficiencies in 2022, while investing in roles to improve the Bank’s growth initiatives.  A collective bargaining agent does not represent the employees.

 

Operating Segments

 

The Corporation’s business is providing financial products and services. These products and services are provided through the Corporation’s wholly owned subsidiary, the Bank. The Bank is presently the only subsidiary of the Corporation, and the Bank only has one reportable operating segment, community banking, as described in Note A of the Notes to the Consolidated Financial Statements included in this Report. The segment reporting information in Note A is incorporated by reference into this Part I, Item 1.

 

Business Operations

 

Products and Services with Reputation Risk

The Corporation offers a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies becomes dissatisfied with or objects to any product or service offered by the Corporation, negative publicity with respect to any such product or service, whether legally justified or not, could have a negative impact on the Corporation’s reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on the Corporation’s reputation.

 

Market Area and Competition

The Corporation’s primary market area is Lancaster County, Pennsylvania, where ten full service offices are located. However, the Corporation’s market area also extends into contiguous Lebanon and Berks Counties. The Corporation opened a full service office in southeastern Lebanon County (Myerstown) in 2013 and a full service office in southern Berks County (Morgantown) in 2016 to extend physical presence to those counties. The Corporation’s greater service area is considered to be Lancaster, Lebanon, and southern and western Berks Counties of Pennsylvania. The area served by the Corporation is a mix of rural communities and small to mid-sized towns.

 

The Corporation’s headquarters and main campus are located in Ephrata, Pennsylvania. The Corporation’s main office and drive-up are located in downtown Ephrata, while the Cloister office is also located within Ephrata Borough. The Corporation ranks a commanding first in deposit market share in the Ephrata area with 41.1% of deposits as of June 30, 2021, based on data compiled annually by the Federal Deposit Insurance Corporation (FDIC). The Corporation’s deposit market share in the Ephrata area was 37.8% as of June 30, 2020. The Corporation’s very high market share in the Ephrata area equates to a saturation of the local market that has led to the expansion of the Corporation’s branch network.

 

In the course of attracting and retaining deposits and originating loans, the Corporation faces considerable competition. The Corporation competes with other commercial banks, savings and loan institutions, and credit unions for traditional banking products, such as deposits and loans. The Corporation competes with consumer finance companies for loans, mutual funds, and other investment alternatives for deposits. The Corporation competes for deposits based on the ability to provide a range of products, low fees, quality service, competitive rates, and convenient locations and hours. The competition for loan origination generally relates to interest rates offered, products available, quality of service, and loan origination fees charged. Several competitors within the Corporation’s primary market have substantially higher legal lending limits that enable them to service larger loans and larger commercial customers.

 

The Corporation continues to assess the competition and market area to determine the best way to meet the financial needs of the communities it serves. Management also continues to pursue new market opportunities based on the strategic plan to efficiently grow the Corporation, improve earnings performance, and bring the Corporation’s products and services to customers currently not being reached. Management strategically addresses growth opportunities versus competitive issues by determining the new products and services to be offered, expansion of existing footprint with new locations, as well as investing in the expertise of staffing for expansion of these services.

 

Concentrations and Seasonality

The Corporation does not have any portion of its businesses dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its businesses. No substantial portion of loans or investments is concentrated within a single industry or group of related industries, although a significant amount of loans are secured by real estate located in northern Lancaster County, Pennsylvania. The business activities of the Corporation are generally not seasonal in nature. However, the sizable agricultural portfolio has minority elements that are predominately seasonal in nature due to typical farming operations. Financial instruments with concentrations of credit risk are described in Note P of the Notes to Consolidated Financial Statements included in this Report. The concentration of credit risk information in Note P is incorporated by reference into this Part I, Item 1.

 

Supervision and Regulation

 

Bank holding companies operate in a highly regulated environment and are routinely examined by federal and state regulatory authorities. The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulations on the Corporation and the Bank.

 

To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. The Corporation cannot determine the likelihood or timing of any such proposals or legislation, or the impact they may have on the Corporation and the Bank. A change in law, regulations, or regulatory policy may have a material effect on the Corporation and the Bank’s business.

 

The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. Bank operations are subject to regulations of the OCC, the Consumer Financial Protection Bureau (CFPB), the Board of Governors of the Federal Reserve System, and the FDIC.

 

Bank Holding Company Supervision and Regulation

 

The Bank Holding Company Act of 1956

The Corporation is subject to the provisions of the Bank Holding Company Act of 1956, as amended, and to supervision by the Federal Reserve Board. The following restrictions apply:

 

General Supervision by the Federal Reserve Board

As a bank holding company, the Corporation’s activities are limited to the business of banking and activities closely related or incidental to banking. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has adopted a risk-focused supervision program for small shell bank holding companies that is tied to the examination results of the subsidiary bank. The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board may require that the Corporation stand ready to provide adequate capital funds to the Bank during periods of financial stress or adversity.

 

Restrictions on Acquiring Control of Other Banks and Companies

A bank holding company may not:

 

·

acquire direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank, or

·

merge or consolidate with another bank holding company, without prior approval of the Federal Reserve Board.

 

In addition, a bank holding company may not:

 

·

engage in a non-banking business, or

·

acquire ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business,

 

unless the Federal Reserve Board determines the business to be so closely related to banking as to be a proper incident to banking. In making this determination, the Federal Reserve Board considers whether these activities offer benefits to the public that outweigh any possible adverse effects.

 

Anti-Tie-In Provisions

A bank holding company and its subsidiaries may not engage in tie-in arrangements in connection with any extension of credit or provision of any property or services. These anti-tie-in provisions state generally that a bank may not:

 

·

extend credit,

·

lease or sell property, or

·

furnish any service to a customer,

 

on the condition that the customer provides additional credit or service to a bank or its affiliates, or on the condition that the customer not obtain other credit or service from a competitor of the bank.

 

Restrictions on Extensions of Credit by Banks to their Holding Companies

Subsidiary banks of a holding company are also subject to restrictions imposed by the Federal Reserve Act on:

 

·

any extensions of credit to the bank holding company or any of its subsidiaries,

·

investments in the stock or other securities of the Corporation, and

·

taking these stock or securities as collateral for loans to any borrower.

 

Risk-Based Capital Guidelines

Bank holding companies must comply with the Federal Reserve Board’s current risk-based capital guidelines, which are amended provisions of the Bank Holding Company Act of 1956. The required minimum ratio of total capital to risk-weighted assets, including some off-balance sheet activities, such as standby letters of credit, is 8%. At least half of the total capital is required to be Tier I Capital, consisting principally of common shareholders’ equity, less

certain intangible assets. The remainder, Tier II Capital, may consist of:

 

·

some types of preferred stock,

·

a limited amount of subordinated debt,

·

some hybrid capital instruments,

·

other debt securities, and

·

a limited amount of the general loan loss allowance.

 

The risk-based capital guidelines are required to take adequate account of interest rate risk, concentrations of credit risk, and risks of nontraditional activities.

 

Capital Leverage Ratio Requirements

The Federal Reserve Board requires a bank holding company to maintain a leverage ratio of a minimum level of Tier I capital, as determined under the risk-based capital guidelines, equal to 3% of average total consolidated assets for those bank holding companies that have the highest regulatory examination rating and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 1% to 2% above the stated minimum. The Bank is subject to similar capital requirements pursuant to the Federal Deposit Insurance Act.

 

In 2019, the federal banking agencies issued a final rule to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, including the community bank leverage ratio (“CBLR”) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than $10 billion, and limited amounts of off-balance-sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9%. Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework. The CBLR framework was available for banks to use in their March 31, 2020, Call Report. The Corporation did not opt into the CBLR framework.

 

Restrictions on Control Changes

The Change in Bank Control Act of 1978 requires persons seeking control of a bank or bank holding company to obtain approval from the appropriate federal banking agency before completing the transaction. The law contains a presumption that the power to vote 10% or more of voting stock confers control of a bank or bank holding company. The Federal Reserve Board is responsible for reviewing changes in control of bank holding companies. In doing so, the Federal Reserve Board reviews the financial position, experience and integrity of the acquiring person, and the effect the change of control will have on the financial condition of the Corporation, relevant markets, and federal deposit insurance funds.

 

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act (SOX), also known as the “Public Company Accounting Reform and Investor Protection Act,” was established in 2002 and introduced major changes to the regulation of financial practice. SOX was established as a reaction to the outbreak of corporate and accounting scandals, including Enron and WorldCom. SOX represents a comprehensive revision of laws affecting corporate governance, accounting obligations, and corporate reporting. SOX is applicable to all companies with equity or debt securities that are either registered, or file reports under the Securities Exchange Act of 1934 such as the Corporation. SOX includes significant additional disclosure requirements and expanded corporate governance rules and the SEC has adopted extensive additional disclosures, corporate governance provisions, and other related rules pursuant to it. The Corporation has expended and will continue to expend, considerable time and money in complying with SOX.

 

Bank Supervision and Regulation

 

Safety and Soundness

The primary regulator for the Bank is the OCC. The OCC has the authority under the Financial Institutions Supervisory Act and the Federal Deposit Insurance Act to prevent a national bank from engaging in any unsafe or unsound practice in conducting business or from otherwise conducting activities in violation of the law.

 

Federal and state banking laws and regulations govern, but are not limited to, the following:

 

·

Scope of a bank’s business

·

Investments a bank may make

·

Reserves that must be maintained against certain deposits

·

Loans a bank makes and collateral it takes

·

Merger and consolidation activities

·

Establishment of branches

 

The Corporation is a member of the Federal Reserve System. Therefore, the policies and regulations of the Federal Reserve Board have a significant impact on many elements of the Corporation’s operations, including:

 

·

Loan and deposit growth

·

Rate of interest earned and paid

·

Types of securities

·

Breadth of financial services provided

·

Levels of liquidity

·

Levels of required capital

 

Management cannot predict the effect of changes to such policies and regulations upon the Corporation’s business model and the corresponding impact they may have on future earnings.

 

FDIC Insurance Assessments

The FDIC imposes a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on the Bank’s capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semi-annual basis, each depository institution to one of three capital groups, the best of these being “Well Capitalized.” For purposes of calculating the insurance assessment, the Bank was considered “Well Capitalized” as of December 31, 2021, and December 31, 2020. This designation has benefited the Bank in the past and continues to benefit it in terms of a lower quarterly FDIC rate. The FDIC adjusts the insurance rates when necessary. The total FDIC assessments paid by the Bank in 2021 were $408,000, compared to $232,000 in 2020.

 

Community Reinvestment Act

Under the Community Reinvestment Act (CRA), as amended, the OCC is required to assess all financial institutions that it regulates to determine whether these institutions are meeting the credit needs of the community that they serve. The Act focuses specifically on low and moderate income neighborhoods. The OCC takes an institution’s CRA record into account in its evaluation of any application made by any of such institutions for, among other things:

 

·

Approval of a new branch or other deposit facility

·

Closing of a branch or other deposit facility

·

An office relocation or a merger

·

Any acquisition of bank shares

 

The CRA, as amended, also requires that the OCC make publicly available the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation includes a descriptive rating of either outstanding, satisfactory, needs to improve, or substantial noncompliance, along with a statement describing the basis for the rating. These ratings are publicly disclosed. The Bank received a satisfactory rating on the most recent CRA Performance Evaluation completed on July 12, 2021.

 

The Federal Deposit Insurance Corporation Improvement Act of 1991

 

Capital Adequacy

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), institutions are classified in one of five defined categories as illustrated below:

 

 

		Tier I Capital	Common Equity Tier I
Capital Category	Total Capital Ratio	Ratio	Capital Ratio	Leverage Ratio
Well Capitalized	> 10.0	> 8.0	> 6.5	> 5.0
Adequately Capitalized	>   8.0	> 6.0	> 4.5	> 4.0*
Undercapitalized	<   8.0	< 6.0	< 4.5	< 4.0*
Significantly Undercapitalized	<   6.0	< 4.0	< 3.5	< 3.0
Critically Undercapitalized				< 2.0

 

*3.0 for those banks having the highest available regulatory rating.

 

The Bank’s and Corporation’s capital ratios exceed the regulatory requirements to be considered well capitalized for Total Risk-Based Capital, Tier I Risk-Based Capital, Common Equity Tier I Capital, and Tier I Leverage Capital. The capital ratio table and Consolidated Financial Statement Note M – Regulatory Matters and Restrictions, are incorporated by reference herein, from Item 8, and made a part hereof. Note M discloses capital ratios for both the Bank and the Corporation, shown as Consolidated.

 

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 began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance on January 1, 2014. The final rules call for the following capital requirements:

 

·

A minimum ratio of common equity tier I capital to risk-weighted assets of 4.5%

·

A minimum ratio of tier I 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 established a common equity tier I 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 began 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 I capital. The final rules allowed 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 was made by the Corporation with the filing of the first quarter Call Report as of March 31, 2015.

 

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 I 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. The Corporation does not securitize assets and has no plans to do so.

 

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.

 

Management has evaluated the impact of the above rules on levels of the Corporation’s capital. The final rulings were highly favorable in terms of the items that would have a more significant impact to the Corporation and community banks in general. Specifically, the AOCI final ruling, which would have had the greatest impact, now provides the Corporation with an opt-out provision. The final ruling on the risk weightings of mortgages was favorable and did not have a material negative impact. The rulings as to trust preferred securities, preferred stock, and securitization of assets are not applicable to the Corporation, and presently the revised treatment of MSAs is not material to capital. The remaining changes to risk weightings on several items mentioned above such as past-due loans and certain commercial real estate loans do not have a material impact to capital presently, but could change as these levels change.

 

Real Estate Lending Standards

Pursuant to the FDICIA, federal banking agencies adopted real estate lending guidelines which would set loan-to-value (“LTV”) ratios for different types of real estate loans. The LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. If the institution does not hold a first lien position, the total loan amount would be combined with the amount of all junior liens when calculating the ratio. In addition to establishing the LTV ratios, the guidelines require all real estate loans to be based upon proper loan documentation and a recent appraisal or certificate of inspection of the property.

 

Prompt Corrective Action

In the event that an institution’s capital deteriorates to the Undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including:

 

·

Implementation of a capital restoration plan and a guarantee of the plan by a parent institution

·

Placement of a hold on increases in assets, number of branches, or lines of business

 

If capital reaches the significantly or critically undercapitalized level, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management, and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, FDICIA provides authority for regulatory intervention where they deem the institution to be engaging in unsafe or unsound practices, or if the institution receives a less than satisfactory examination report rating for asset quality, management, earnings, liquidity, or sensitivity to market risk.

 

Other FDICIA Provisions

Each depository institution must submit audited financial statements to its primary regulator and the FDIC, whose reports are made publicly available. In addition, the audit committee of each depository institution must consist of outside directors and the audit committee at “large institutions” (as defined by FDIC regulation) must include members with banking or financial management expertise. The audit committee at “large institutions” must also have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution’s primary regulator of any change in the institution’s independent auditor, and annual management letters must be provided to the FDIC and the depository institution’s primary regulator. The regulations define a “large institution” as one with over $500 million in assets, which does include the Bank. Also, under the rule, an institution's independent public accountant must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance with laws and regulations concerning safety and soundness.

Under the FDICIA, each federal banking agency must prescribe certain safety and soundness standards for depository institutions and their holding companies. Three types of standards must be prescribed:

 

·

asset quality and earnings

·

operational and managerial, and

·

compensation

 

Such standards would include a ratio of classified assets to capital, minimum earnings, and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of such institutions and holding companies. Operational and managerial standards must relate to:

 

·

internal controls, information systems and internal audit systems

·

loan documentation

·

credit underwriting

·

interest rate exposure

·

asset growth, and

·

compensation, fees and benefits

 

The FDICIA also sets forth Truth in Savings disclosure and advertising requirements applicable to all depository institutions.

 

USA PATRIOT Act of 2001/Bank Secrecy Act

In October 2001, the USA Patriot Act of 2001 (Patriot Act) was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

 

Under the Bank Secrecy Act (BSA), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which a bank is aware in any one day that aggregate in excess of $10,000 and to report suspicious transactions under specified criteria. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA, or for filing a false or fraudulent report.

 

Loans to Insiders/Regulation O

Regulation O, also known as Loans to Insiders, governs the permissible lending relationships between a bank and its executive officers, directors, and principal shareholders and their related interests. The primary restriction of Regulation O is that loan terms and conditions, including interest rates and collateral coverage, can be no more favorable to the insider than loans made in comparable transactions to non-covered parties. Additionally, the loan may not involve more than normal risk. The regulation requires quarterly reporting to regulators of the total amount of credit extended to insiders.

 

Under Regulation O, a bank is not required to obtain approval from the bank’s Board of Directors prior to making a loan to an executive officer or Board of Director member as long as a first lien on the executive officer’s residence secures the loan. The Corporation’s policy requires prior Board of Director approval of any Executive Officer or Director loan that when aggregated with other outstanding extensions of credit to the Insider and their related interests exceeds $500,000. Loans to any Executive Officer or Director with aggregate exposure of under $500,000 must be reported at the next scheduled Board of Director meeting. Further amendments allow bank insiders to take advantage of preferential loan terms that are available to substantially all employees. Regulation O does permit an insider to participate in a plan that provides more favorable credit terms than the bank provides to non-employee customers provided that the plan:

 

·

Is widely available to employees

·

Does not give preference to any insider over other employees

The Bank has a policy in place that offers general employees more favorable loan terms than those offered to non-employee customers. The Bank’s policy on loans to insiders allows insiders to participate in the same favorable rate and terms offered to all other employees; however, any loan to an insider that does not fall within permissible regulatory exceptions must receive the prior approval of the Bank’s Board of Directors.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

Dodd-Frank Act, was the culmination of the legislative efforts in response to the financial crisis of 2007 - 2008. The act reshaped Wall Street and the American banking industry by bringing the most significant changes to financial regulation in the United States since the regulatory reform that followed the Great Depression. The Act’s numerous provisions were to be implemented over a period of several years and were intended to decrease various risks in the U.S. financial system. Dodd-Frank created a new Financial Stability Oversight Council to identify systemic risks in the financial system and gave federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank was expected to and did have an impact on the Corporation’s business operations as its provisions began to take effect. To date the provisions that did go into effect, or began to phase in, did at a minimum increase the Corporation’s operating and compliance costs.

 

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 I 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.

 

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. 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 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.

 

Consumer Financial Protection Bureau (CFPB)

Dodd-Frank created a new, independent federal agency called the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorized 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 allows 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.

Ability-to-Repay and Qualified Mortgage Rule

Pursuant to the Dodd-Frank Act, the CFPB amended Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment

for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Loans which meet these criteria will be considered qualified mortgages, and as a result generally protect lenders from fines or litigation in the event of foreclosure. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. Prime loans) are given a safe harbor of compliance. The final rule, as issued, is not expected to have a material impact on the Corporation’s lending activities and on the Corporation’s Consolidated Financial Statements.

 

Interchange Fees

Under the Durbin Amendment to the Dodd-Frank Act, the Federal Reserve adopted rules establishing standards for assessing whether the interchange fees that may be charged with respect to certain electronic debit transactions are “reasonable and proportional” to the costs incurred by issuers for processing such transactions.

 

Interchange fees or “swipe” fees, are charges that merchants pay to the Corporation and other card-issuing banks for processing electronic payment transactions. The Federal Reserve Board has ruled that for financial institutions with assets of $10 billion or more the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. The Federal Reserve Board also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product. While the Corporation’s asset size is presently under $10 billion, there is concern that these requirements impacting financial institutions over $10 billion in assets will eventually be pushed down to either financial institutions over $1 billion or to all financial institutions. This would negatively impact the Corporation’s non-interest income.

 

TILA/RESPA Integrated Disclosure (TRID) Rules

The TRID rules were mandated by Dodd-Frank to address the problem of the sometimes duplicative and overlapping disclosures required by the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA) involving consumer purpose, closed end loans secured by real property. The CFPB was tasked with developing the new disclosures, defining the regulatory compliance parameters, and implementation. The timing elements built around these new disclosures were established to provide the consumer with ample time to consider the credit transaction and its associated costs. The final rules were implemented by amending the Truth in Lending Act; however implementation proved to be difficult as this marked the first time in thirty years that these standard disclosures were changed. Much reliance was placed on third party providers to the financial institutions to make all the necessary changes to the disclosures. After one delay, the rules became effective October 3, 2015. The Corporation partnered with its loan document software providers to ensure timely, compliant implementation.

 

Department of Defense Military Lending Rule

In 2015, the U.S. Department of Defense issued a final rule which restricts pricing and terms of certain credit extended to active duty military personnel and their families.  This rule, which was implemented effective October 3, 2016, caps the interest rate on certain credit extensions to an annual percentage rate of 36% and restricts other fees.  The rule requires financial institutions to verify whether customers are military personnel subject to the rule.  The impact of this final rule, and any subsequent amendments thereto, on the Corporation’s lending activities and the Corporation’s statements of income or condition has had little or no impact; however, management will continue to monitor the implementation of the rule for any potential side effects on the Corporation’s business.  

 

Cybersecurity

 

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement instructed financial institutions to design multiple layers of security controls to establish lines of defense and to ensure that their risk management practices cover the risk of compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving malware. Financial institutions are expected to develop appropriate processes to enable recovery of data and business operations and address the rebuilding of network capabilities and restoring data if the institution or

its critical service providers are victim to a cyber-attack. The Corporation could be subject to fines or penalties if it fails to observe this regulatory guidance. See Item 1A. Risk Factors for further discussion of risks related to cybersecurity.

 

Ongoing Legislation

 

As a consequence of the extensive regulation of the financial services industry and specifically commercial banking activities in the United States, the Corporation’s business is particularly susceptible to changes in federal and state legislation and regulations. Over the course of time, various federal and state proposals for legislation could result in additional regulatory and legal requirements for the Corporation. Management cannot predict if any such legislation will be adopted, or if adopted, how it would affect the business of the Corporation. Past history has demonstrated that new legislation or changes to existing legislation usually results in a heavier compliance burden and generally increases the cost of doing business.

 

Management believes that the effect of any current legislative proposals on the liquidity, capital resources and the results of operations of the Corporation and the Bank will be minimal. It is possible that there will be regulatory proposals which, if implemented, could have a material effect upon our liquidity, capital resources and results of operations. In addition, the general cost of compliance with numerous federal and state laws does have, and in the future may have, a negative impact on our results of operations. As with other banks, the status of the financial services industry can affect the Bank. Consolidations of institutions are expected to continue as the financial services industry seeks greater efficiencies and market share. Bank management believes that such consolidations may enhance the Bank’s competitive position as a community bank. See Item 1A. Risk Factors for more information.

 

Statistical Data

 

The statistical disclosures required by this item are incorporated by reference herein from the Consolidated Statements of Income on page 59 as found in this Form 10-K filing.

 

Available Information

 

The Corporation maintains a website on the Internet at www.enbfc.com. The Corporation makes available free of charge, on or through its website, its proxy statements, annual reports on From 10-K, quarterly reports on From 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). This reference to the Corporation’s Internet address shall not, under any circumstances, be deemed to incorporate the information available at such Internet address into this Form 10-K or other SEC filings. The information available at the Corporation’s Internet address is not part of this Form 10-K or any other report filed by the Corporation with the SEC. The Corporation’s SEC filings can also be obtained on the SEC’s website on the Internet at http://www.sec.gov.

 

Item 1A. Risk Factors

 

An investment in the Corporation’s common stock is subject to risks inherent to the banking industry and the equity markets. The material risks and uncertainties that management believes affect the Corporation are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing the Corporation. Additional risks and uncertainties that management is not aware of or is not focused on, or currently deems immaterial, may also impair the Corporation’s business operations. This report is qualified in its entirety by these risk factors.

 

If any of the following risks actually occur, the Corporation’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Corporation’s common stock could decline significantly, and you could lose all or part of your investment.

 

Risks Related To The Corporation’s Business

 

The Corporation Is Subject To Interest Rate Risk

The Corporation’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest earning assets, such as loans and securities, and interest expense paid on interest bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including general economic conditions and policies of various governmental and regulatory agencies, particularly, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and securities, but also the amount of interest it pays on deposits and borrowings. Changes in interest rates could also affect:

 

·

The Corporation’s ability to originate loans and obtain deposits

·

The fair value of the Corporation’s financial assets and liabilities

·

The average duration of the Corporation’s assets and liabilities

·

The future liquidity of the Corporation

 

If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other securities, the Corporation’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other securities fall more quickly than the interest rates paid on deposits and other borrowings.

 

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Corporation’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation Is Subject To Lending Risk

There are inherent risks associated with the Corporation’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Corporation operates, as well as those across the Commonwealth of Pennsylvania and the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Corporation is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Corporation to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Corporation.

 

As of December 31, 2021, 43.6% of the Corporation’s loan portfolio consisted of commercial, industrial, and construction loans secured by real estate. Another 11.9% of the Corporation’s loan portfolio consisted of commercial loans not secured by real estate. These types of loans are generally viewed as having more risk of default than consumer real estate loans or other consumer loans. These types of loans are also typically larger than consumer real estate loans and other consumer loans. Because the Corporation’s loan portfolio contains a significant number of commercial and industrial, construction, and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

An Accounting Standard Will Result In A Significant Change In How We Recognize Credit Losses And May Have A Material Impact On Our Financial Condition Or Results Of Operations.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as

well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

 

The Corporation’s Allowance For Possible Loan Losses May Be Insufficient

The Corporation maintains an allowance for possible loan losses, which is a reserve established through a provision for loan losses, charged to expense. The allowance represents management’s best estimate of expected losses inherent in the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Determining the appropriate level of the allowance for possible loan losses understandably involves a high degree of subjectivity and requires the Corporation to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of the Corporation’s control, may require an increase in the allowance for possible loan losses. In addition, bank regulatory agencies periodically review the Corporation’s allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for possible loan losses, the Corporation will need additional provisions to increase the allowance for possible loan losses. Any increases in the allowance for possible loan losses will result in a decrease in net income, and may have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Basel III Capital Requirements May Require Us To Maintain Higher Levels Of Capital, Which Could Reduce Our Profitability

Basel III targets higher levels of base capital, certain capital buffers, and a migration toward common equity as the key source of regulatory capital. Although the new capital requirements are phased in over the next decade, Basel III signals a growing effort by domestic and international bank regulatory agencies to require financial institutions, including depository institutions, to maintain higher levels of capital. As Basel III is implemented, regulatory viewpoints could change and require additional capital to support our business risk profile. If the Corporation and the Bank are required to maintain higher levels of capital, the Corporation and the Bank may have fewer opportunities to invest capital into interest-earning assets, which could limit the profitable business operations available to the Corporation and the Bank and adversely impact our financial condition and results of operations.

 

Future Credit Downgrades Of The United States Government Due To Issues Relating To Debt And The Deficit May Adversely Affect The Corporation

As a result of past difficulties of the federal government to reach agreement over federal debt and issues connected with the debt ceiling, certain rating agencies placed the United States Government’s long-term sovereign debt rating on their equivalent of negative watch and announced the possibility of a rating downgrade.  The rating agencies, due to constraints related to the rating of the United States, also placed government-sponsored enterprises in which the Corporation invests and receives lines of credit on negative watch and a downgrade of the United States credit rating would trigger a similar downgrade in the credit rating of these government-sponsored enterprises.  Furthermore, the credit rating of other entities, such as state and local governments, may also be downgraded should the United States credit rating be downgraded. Credit downgrades often cause a lower valuation of the Corporation’s securities.

 

The Corporation Is Subject To Environmental Liability Risk Associated With Lending Activities

A significant portion of the Corporation’s loan portfolio is secured by real property. During the ordinary course of business, the Corporation may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Corporation may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Corporation to incur substantial expenses and may materially reduce the

affected property’s value or limit the Corporation’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws, may increase the Corporation’s exposure to environmental liability. Although the Corporation has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

If The Corporation Concludes That The Decline In Value Of Any Of Its Investment Securities Is Other Than Temporary, The Corporation is Required To Write Down The Value Of That Security Through A Charge To Earnings

The Corporation reviews the investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of the investment securities has declined below its carrying value, the Corporation is required to assess whether the decline is other than temporary. If it concludes that the decline is other than temporary, it is required to write down the value of that security through a charge to earnings. Changes in the expected cash flows of these securities and/or prolonged price declines have resulted and may result in concluding in future periods that there is additional impairment of these securities that is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset is impaired, the impairment disclosed may not accurately reflect the actual impairment in the future.

 

The Corporation’s Profitability Depends Significantly On Economic Conditions In The Commonwealth Of Pennsylvania And Its Market Area

The Corporation’s success depends primarily on the general economic conditions of the Commonwealth of Pennsylvania, and more specifically, the local markets in which the Corporation operates. Unlike larger national or other regional banks that are more geographically diversified, the Corporation provides banking and financial services to customers primarily located in Lancaster County, as well as Berks, Chester, and Lebanon Counties. The local economic conditions in these areas have a significant impact on the demand for the Corporation’s products and services as well as the ability of the Corporation’s customers to repay loans, the value of the collateral securing loans, and the stability of the Corporation’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Earnings Of Financial Services Companies Are Significantly Affected By General Business And Economic Conditions

The Corporation’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which the Corporation operates, all of which are beyond the Corporation’s control. Deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for the Corporation’s products and services, among other things, any of which could have a material adverse impact on the Corporation’s financial condition and results of operations.

 

The Corporation Operates In A Highly Competitive Industry And Market Area

The Corporation faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets in which the Corporation operates. Additionally, various out-of-state banks have begun to enter or have announced plans to enter the market areas in which the Corporation currently operates. The Corporation also faces competition from many other types of financial institutions, including, without limitation, online banks, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes, and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-

banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Corporation’s competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Corporation can offer.

 

The Corporation’s ability to compete successfully depends on a number of factors, including, among other things:

 

·

The ability to develop, maintain, and build upon long-term customer relationships based on quality service, high ethical standards, and safe, sound management practices

·

The ability to expand the Corporation’s market position

·

The scope, relevance, and pricing of products and services offered to meet customer needs and demands

·

The rate at which the Corporation introduces new products and services relative to its competitors

·

Customer satisfaction with the Corporation’s level of service

·

Industry and general economic trends

 

Failure to perform in any of these areas could significantly weaken the Corporation’s competitive position, which could adversely affect the Corporation’s growth and profitability and have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation Is Subject To Extensive Government Regulation And Supervision

The Corporation is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system as a whole, not shareholders. These regulations affect the Corporation’s lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect the Corporation in substantial and unpredictable ways. Such changes could subject the Corporation to additional costs, limit the types of financial services and products the Corporation may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on the Corporation’s business, financial condition, and results of operations. While the Corporation has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

 

Future Governmental Regulation And Legislation Could Limit The Corporation’s Future Growth

The Corporation is a registered bank holding company, and its subsidiary bank is a depository institution whose deposits are insured by the FDIC. As a result, the Corporation is subject to various regulations and examinations by various regulatory authorities. In general, statutes establish the corporate governance and eligible business activities for the Corporation, certain acquisition and merger restrictions, limitations on inter-company transactions such as loans and dividends, capital adequacy requirements, requirements for anti-money laundering programs and other compliance matters, among other regulations. The Corporation is extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole. Compliance with these statutes and regulations is important to the Corporation’s ability to engage in new activities and consummate additional acquisitions.

In addition, the Corporation is subject to changes in federal and state tax laws as well as changes in banking and credit regulations, accounting principles and governmental economic and monetary policies. The Corporation cannot predict whether any of these changes may adversely and materially affect it. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on the Corporation’s activities that could have a material adverse effect on its business and profitability. While these statutes are generally designed to minimize potential loss to depositors and the FDIC insurance funds, they do not eliminate risk, and compliance with such statutes increases the Corporation’s expense, requires management’s attention and can be a disadvantage from a competitive standpoint with respect to non-regulated competitors.

 

The Regulatory Environment For The Financial Services Industry Is Being Significantly Impacted By Financial Regulatory Reform Initiatives In The United States And Elsewhere, Including Dodd-Frank And Regulations Promulgated To Implement It

Dodd-Frank, which was signed into law on July 21, 2010, comprehensively reforms the regulation of financial institutions, products and services. Dodd-Frank requires various federal regulatory agencies to implement numerous rules and regulations. Because the federal agencies are granted broad discretion in drafting these rules and regulations, many of the details and the impact of Dodd-Frank may not be known for many months or years.

 

While much of how the Dodd-Frank and other financial industry reforms will change our current business operations depends on the specific regulatory reforms and interpretations, many of which have yet to be released or finalized, it is clear that the reforms, both under Dodd-Frank and otherwise, will have a significant effect on our entire industry. Although Dodd-Frank and other reforms will affect a number of the areas in which we do business, it is not clear at this time the full extent of the adjustments that will be required and the extent to which we will be able to adjust our businesses in response to the requirements. Although it is difficult to predict the magnitude and extent of these effects at this stage, we believe compliance with Dodd-Frank and implementing its regulations and initiatives will negatively impact revenue and increase the cost of doing business, both in terms of transition expenses and on an ongoing basis, and it may also limit our ability to pursue certain business opportunities.

 

The Corporation’s Banking Subsidiary May Be Required To Pay Higher FDIC Insurance Premiums Or Special Assessments Which May Adversely Affect Its Earnings

Future bank failures may prompt the FDIC to increase its premiums above the current levels or to issue special assessments. The Corporation generally is unable to control the amount of premiums or special assessments that its subsidiary is required to pay for FDIC insurance. Any future changes in the calculation or assessment of FDIC insurance premiums may have a material adverse effect on the Corporation’s results of operations, financial condition, and the ability to continue to pay dividends on common stock at the current rate or at all.

 

The Corporation’s Controls And Procedures May Fail Or Be Circumvented

Management regularly reviews and updates the Corporation’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Corporation’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Corporation’s business, results of operations, and financial condition.

 

New Lines Of Business Or New Products And Services May Subject The Corporation To Additional Risks

From time to time, the Corporation may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Corporation may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Corporation’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Corporation’s business, results of operations, and financial condition.

 

The Corporation’s Ability To Pay Dividends Depends On Earnings And Is Subject To Regulatory Limits

The Corporation’s ability to pay dividends is also subject to its profitability, financial condition, capital expenditures, and other cash flow requirements. Dividend payments are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. There is no assurance that the Corporation will have sufficient earnings to be able to pay dividends or generate adequate cash flow to pay dividends in the future. The Corporation’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.

 

Future Acquisitions May Disrupt The Corporation’s Business And Dilute Stockholder Value

The Corporation may use its common stock to acquire other companies or make investments in corporations and other complementary businesses. The Corporation may issue additional shares of common stock to pay for future acquisitions, which would dilute the ownership interest of current shareholders of the Corporation. Future business acquisitions could be material to the Corporation, and the degree of success achieved in acquiring and integrating these businesses into the Corporation could have a material effect on the value of the Corporation’s common stock.

In addition, any acquisition could require the Corporation to use substantial cash or other liquid assets or to incur debt. In those events, the Corporation could become more susceptible to economic downturns and competitive pressures.

 

The Corporation May Need To Or Be Required To Raise Additional Capital In The Future, And Capital May Not Be Available When Needed And On Terms Favorable To Current Shareholders

Federal banking regulators require the Corporation and its subsidiary bank to maintain adequate levels of capital to support their operations. These capital levels are determined and dictated by law, regulation, and banking regulatory agencies.  In addition, capital levels are also determined by the Corporation’s management and board of directors based on capital levels that they believe are necessary to support the Corporation’s business operations.  

 

If the Corporation raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of current investors and could dilute the per share book value and earnings per share of its common stock. Furthermore, a capital raise through issuance of additional shares may have an adverse impact on the Corporation’s stock price. New investors also may have rights, preferences and privileges senior to the Corporation’s current shareholders, which may adversely impact its current shareholders.

 

The Corporation’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside of its control, and on its financial performance. Accordingly, the Corporation cannot be certain of its ability to raise additional capital on acceptable terms and acceptable time frames or to raise additional capital at all. If the Corporation cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect the Corporation’s financial condition and results of operations.

 

The Corporation May Not Be Able To Attract And Retain Skilled People

The Corporation’s success highly depends on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Corporation can be intense and the Corporation may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Corporation’s key personnel could have a material adverse impact on the Corporation’s business because of their skills, knowledge of the Corporation’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. The Corporation does not currently have employment agreements or non-competition agreements with any of its senior officers.

 

The Corporation’s Information Systems May Experience An Interruption Or Breach In Security

The Corporation relies heavily on communications and information systems to conduct its business. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in the Corporation’s customer relationship management, general ledger, deposit, loan, and other systems. While the Corporation has policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of its information systems, there can be no assurance that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. Further, while the Corporation maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. The occurrence of any failures, interruptions, or security breaches of the Corporation’s information systems could damage the Corporation’s reputation, adversely affecting customer or consumer confidence, result in a loss of customer business, subject the Corporation to additional regulatory scrutiny and possible regulatory penalties, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation Continually Encounters Technological Change

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Corporation’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Corporation’s operations. Many of the Corporation’s competitors have substantially greater resources to invest in technological improvements. The Corporation may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Corporation’s business, financial condition, and results of operations.

The Corporation’s Operations Of Its Business, Including Its Interaction With Customers, Are Increasingly Done Via Electronic Means, And This Has Increased Its Risks Related To Cyber Security

The Corporation is exposed to the risk of cyber-attacks in the normal course of business. In general, cyber incidents can result from deliberate attacks or unintentional events. The Corporation has observed an increased level of attention in the industry focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. To combat against these attacks, policies and procedures are in place to prevent or limit the effect on the possible security breach of its information systems. While the Corporation maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. While the Corporation has not incurred any material losses related to cyber-attacks, nor is it aware of any specific or threatened cyber-incidents as of the date of this report, it may incur substantial costs and suffer other negative consequences if it falls victim to successful cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; deploying additional personnel and protection technologies, training employees, and engaging third party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; disruption or failures of physical infrastructure, operating systems or networks that support our business and customers resulting in the loss of customers and business opportunities; additional regulatory scrutiny and possible regulatory penalties; litigation; and reputational damage adversely affecting customer or investor confidence.

 

The Increasing Use Of Social Media Platforms Presents New Risks And Challenges And Our Inability Or Failure To Recognize, Respond To And Effectively Manage The Accelerated Impact Of Social Media Could Materially Adversely Impact Our Business

There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Social media practices in the banking industry are evolving, which creates uncertainty and risk of noncompliance with regulations applicable to our business. Consumers value readily available information concerning businesses and their goods and services and often act on such information without further investigation and without regard to its accuracy. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to our interests and/or may be inaccurate. The dissemination of information online could harm our business, prospects, financial condition, and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording us an opportunity for redress or correction.

 

Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about our business, exposure of personally identifiable information, fraud, out-of-date information, and improper use by employees and customers. The inappropriate use of social media by our customers or employees could result in negative consequences including remediation costs including training for employees, additional regulatory scrutiny and possible regulatory penalties, litigation or negative publicity that could damage our reputation adversely affecting customer or investor confidence.

 

The Corporation Is Subject To Claims And Litigation Pertaining To Fiduciary Responsibility

From time to time, customers make claims and take legal action pertaining to the Corporation’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to the Corporation’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Corporation, they may result in significant financial liability and/or adversely affect the market perception of the Corporation and its products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Corporation’s business, financial condition, and results of operations.

 

 

Financial Services Companies Depend On The Accuracy And Completeness Of Information About Customers And Counterparties

In deciding whether to extend credit or enter into other transactions, the Corporation may rely on information furnished by, or on behalf of, customers and counterparties, including financial statements, credit reports, and other

financial information. The Corporation may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could have a material adverse impact on the Corporation’s business and, in turn, the Corporation’s financial condition and results of operations.

 

Consumers May Decide Not To Use Banks To Complete Their Financial Transactions

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

A Change In Control Of The United States Government And Issues Relating To Debt And The Deficit May Adversely Affect The Corporation

The outcome of future elections could result in changes in control of the federal government and bring significant changes (or uncertainty) in governmental policies, regulatory environments, spending sentiment and many other factors and conditions, some of which could adversely impact the Corporation’s business, financial condition and results of operations.

 

Risks Related to COVID-19

 

The COVID-19 Pandemic Has Adversely Impacted Our Business And Financial Results, And The Ultimate Impact Will Depend On Future Developments, Which Are Highly Uncertain And Cannot Be Predicted, Including The Scope And Duration Of The Pandemic And Actions Taken By Governmental Authorities In Response To The Pandemic.

The COVID-19 pandemic has negatively impacted the global, national and local economies, disrupted global and national supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities and may result in the same or similar restrictions in the future. As a result, the demand for our products and services have been and may continue to be significantly impacted, which could adversely affect our revenue and results of operations. Furthermore, the pandemic could continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed or are required to operate at diminished capacities or are required to close again, the impact on the global, national and local economies worsen, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize further impairments on the securities we hold as well as reductions in other comprehensive income. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

 

We continue to closely monitor the COVID-19 pandemic and related risks as they evolve. The magnitude, duration and likelihood of the current outbreak of COVID-19, further outbreaks of COVID-19, future actions taken by governmental authorities and/or other third parties in response to the COVID-19 pandemic, and its future direct and indirect effects on the global, national and local economy and our business and results of operation are highly uncertain. The COVID-19 pandemic may cause prolonged global or national recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on our business, results of operations and financial condition.

 

Due to the Corporation’s participation in the U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP"), the Corporation is subject to additional risks of litigation from its clients or other parties regarding the processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders. The Corporation participated as a lender in the PPP. Because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there was some ambiguity in the laws, rules and guidance regarding the operation of the PPP along with the continually evolving nature of SBA the rules, interpretations and guidelines concerning this program, which exposes us to risks relating to noncompliance with the PPP. Since the launch of the PPP, several large banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. As such, we may be exposed to the risk of litigation, from both clients and non-clients that approached the Corporation regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

 

The Corporation also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, underwritten, certified by the borrower, funded, or serviced by the Corporation, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, certified by the borrower, funded, or serviced by the Corporation, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

 

Other Events

 

Natural Disasters, Acts Of War Or Terrorism, Pandemics, and Other External Events Could Significantly Impact The Corporation’s Business

Severe weather, natural disasters, acts of war or terrorism, pandemics, and other adverse external events could have a significant impact on the Corporation’s ability to conduct business. Such events could affect the stability of the Corporation’s deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause the Corporation to incur additional expenses. Severe weather or natural disasters, acts of war or terrorism, pandemics, or other adverse external events, may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on the Corporation’s business, financial condition, and results of operations.

 

Risks Associated With The Corporation’s Common Stock

 

The Corporation’s Stock Price Can Be Volatile

Stock price volatility may make it more difficult for shareholders to resell their shares of common stock when they desire and at prices they find attractive. The Corporation’s stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

	•	Actual or anticipated variations in quarterly results of operations
	•	Recommendations by securities analysts
	•	Operating and stock price performance of other companies that investors deem comparable to the Corporation
	•	News reports relating to trends, concerns, and other issues in the financial services industry
	•	Perceptions in the marketplace regarding the Corporation and/or its competitors
	•	New technology used, or services offered, by competitors
	•	Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by, or involving, the Corporation or its competitors
	•	Changes in government regulations
	•	Geopolitical conditions such as acts or threats of terrorism or military conflicts

General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause the Corporation’s stock price to decrease regardless of operating results.

 

The Trading Volume In The Corporation’s Common Stock Is Less Than That Of Other Larger Financial Services Companies

The Corporation’s common stock is listed for trading on the OTCQX Best Market (OTCQX) under the symbol ENBP. The trading volume in its common stock is a fraction of that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Corporation’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Corporation has no control. Given the lower trading volume of the Corporation’s common stock, significant sales of the Corporation’s common stock, or the expectation of these sales, could cause the Corporation’s stock price to fall.

 

An Investment In The Corporation’s Common Stock Is Not An Insured Deposit

The Corporation’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. Investment in the Corporation’s common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, an investor in the Corporation’s common stock may lose some or all of their investment.

 

The Corporation’s Articles Of Incorporation And Bylaws, As Well As Certain Banking Laws, May Have An Anti-Takeover Effect

Provisions of the Corporation’s articles of incorporation and bylaws, federal banking laws, including regulatory approval requirements, and the Corporation’s stock purchase rights plan, could make it more difficult for a third party to acquire the Corporation, even if doing so would be perceived to be beneficial to the Corporation’s shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination that could adversely affect the market price of the Corporation’s common stock.

 

 

Item 1B. Unresolved Staff Comments

 

None

 

Item 2. Properties

 

As of December 31, 2021, ENB Financial Corp and Ephrata National Bank owned and leased buildings in the normal course of business. The headquarters of ENB Financial Corp and main office of Ephrata National Bank is at 31 East Main Street, Ephrata, Pennsylvania. As of December 31, 2021, the Bank owned 16 properties and leased four properties.

 

For more information concerning the amounts recorded for premises and equipment and commitments under current leasing agreements, see Notes D and Q of the Notes to Consolidated Financial Statements included in Item 8. “Financial Statements and Supplementary Data” of this report on Form 10-K.

 

Item 3. Legal Proceedings

 

The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business; however, in the opinion of management, there are no material proceedings pending to which the Corporation is a party to, or which would be material in relation to the Corporation’s undivided profits or financial condition. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation. In addition, no material proceedings are pending, known to be threatened, or contemplated against the Corporation by governmental authorities.

 

 

Item 4. Mine Safety Disclosures – Not Applicable

 

 

Part II

 

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities

 

The Corporation has only one class of stock authorized, issued, and outstanding, which consists of common stock with a par value of $0.10 per share. As of December 31, 2021, there were 24,000,000 shares of common stock authorized with 5,739,114 shares issued, and 5,583,956 shares outstanding to 1,376 shareholders. The Corporation’s common stock is traded on a limited basis on the OTCQX Best Market under the symbol “ENBP.” Prices presented in the table below reflect high and low prices of actual transactions known to management. Prices and dividends per share are adjusted for stock splits. Market quotations reflect inter-dealer prices, without retail mark up, mark down, or commission and may not reflect actual transactions.

  

		2021												2020
		High				Low				Dividend				High				Low				Dividend
First quarter		$	22.00			$	18.60			$	0.16			$	23.25			$	17.73			$	0.16
Second quarter			22.00				20.70				0.17				21.50				18.25				0.16
Third quarter			23.75				21.13				0.17				19.50				17.55				0.16
Fourth quarter			22.23				21.15				0.17				19.25				17.60				0.16

 

Dividends

Since 1973, the Corporation, and before it the Bank, has paid quarterly cash dividends on or around March 15, June 15, September 15, and December 15 of each year. The Corporation currently expects to continue the practice of paying regular quarterly cash dividends to its shareholders for the foreseeable future. However, future dividends are dependent upon future earnings. The dividend payments reflected above amount to a dividend payout ratio between 25.0% and 29.1% for 2021 and 2020, respectively. The dividend payout ratio is only one element of management’s plan for managing capital. Certain laws restrict the amount of dividends that may be paid to shareholders in any given year. In addition, under Pennsylvania corporate law, the Corporation may not pay a dividend if, after issuing the dividend (1) the Corporation would be unable to pay its debts as they become due, or (2) the Corporation’s total

assets would be less than its total liabilities plus the amount needed to satisfy any preferential rights of shareholders. In addition, as declared by the Board of Directors, Ephrata National Bank’s dividend restrictions apply indirectly to ENB Financial Corp because cash available for dividend distributions will initially come from dividends Ephrata National Bank pays to ENB Financial Corp. See Note M to the consolidated financial statements in this Form 10-K filing, for information that discusses and quantifies this regulatory restriction.

 

ENB Financial Corp offers its shareholders the convenience of a Dividend Reinvestment Plan (DRP) and the direct deposit of cash dividends. The DRP gives shareholders registered with the Corporation the opportunity to have their quarterly dividends invested automatically in additional shares of the Corporation’s common stock. Shareholders who prefer a cash dividend may have their quarterly dividends deposited directly into a checking or savings account at their financial institution. For additional information on either program, contact the Corporation’s stock registrar and dividend paying agent, Computershare Shareholder Services, P.O. Box 505000, Louisville, KY 40233-5000.

 

Purchases

The following table details the Corporation’s purchase of its own common stock during the three months ended December 31, 2021.

 

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 *
October 2021			—				—				—				172,100
November 2021			2,500			$	22.14				2,500				169,600
December 2021			2,500			$	21.75				2,500				167,100
Total			5,000

 

* On October 21, 2020, the Board of Directors of the Corporation approved a plan to repurchase, in the open market and privately renegotiated transactions, up to 200,000 shares of its outstanding common stock. This plan replaces the 2019 plan. The first purchase of common stock under this plan occurred on October 28, 2020. By December 31, 2021, a total of 32,900 shares were repurchased at a total cost of $669,362, for an average cost per share of $20.35.

 

Recent Sales of Unregistered Securities and Equity Compensation Plan

 

The Corporation does not have an equity compensation plan and has not sold any unregistered securities.

 

 

Item 6. [Reserved]

 

Item 7. 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 annual report. The financial condition and results of operations presented are not indicative of future performance.

 

Strategic Overview

 

ENB Financial Corp and its wholly owned subsidiary, Ephrata National Bank, are committed to remaining an independent community bank serving its market area and the greater communities surrounding Lancaster County, Pennsylvania. The Corporation’s roots date back to the April 11, 1881 charter granted to Ephrata National Bank by the Office of the Comptroller of the Currency. The Bank’s growth has been entirely organic over 140 years of existence. The Board and Management are committed to the principals and values that have served the company well over its history and the desire is to produce strong financial results that will ensure trust from the Bank’s customers and favorable returns to the shareholders.

 

Results of Operations

 

Overview

 

The year ended December 31, 2021 was positively impacted by a number of items resulting in strong financial results. The COVID-19 pandemic and governmental and business responses thereto continues to impact customer behavior and balance sheet growth, but as of the date of this report there has not been significant negative impacts on earnings or credit. Customers have adapted to changes in behavior and the Corporation continues to seek ways to manage the structure of the balance sheet to achieve positive financial results now and in future time periods.

 

The Corporation recorded net income of $14,916,000 for the year ended December 31, 2021, a $2,617,000, or 21.3% increase over the year ended December 31, 2020. The earnings per share, basic and diluted, were $2.68 in 2021, compared to $2.20 in 2020, a 21.8% increase. The increase in the Corporation’s 2021 earnings was caused primarily by growth in other income and net interest income, coupled with a decline in the provision for loan losses.

 

Non-interest income excluding security and mortgage gains increased by $2,524,000, or 28.8%, for the year ended December 31, 2021, due to many positive trends such as higher trust income, higher commissions on debit card interchange fees, and lower mortgage servicing asset amortization. Mortgage gains were elevated for the second year in a row at $5,526,000, compared to $5,850,000 in 2020. Additionally, gains on debt and equity securities were $321,000, or 43.8% higher in 2021 compared to the prior year.

 

The Corporation’s net interest income (NII) increased by $2,323,000, or 6.1%, in 2021, compared to 2020. The increase in NII primarily resulted from an increase in interest on securities available for sale of $2,097,000, or 31.0%, for the year ended December 31, 2021, compared to 2020. In addition, interest expense on deposits and borrowings decreased by $826,000, or 21.5%, in 2021 compared to the prior year. The low interest rate environment has caused a rapid decline in asset yield, but also a decline in the cost of funds, which has resulted in these much lower levels of interest expense.

 

The Corporation recorded a $475,000 provision for loan losses in 2021, compared to $2,950,000 in 2020. The higher provision in 2020 was primarily caused by increasing the qualitative factors across industry lines to various degrees as a result of potential forward credit concerns related to COVID-19 and a higher specific allocation related to one commercial borrower that paid off in 2021.

 

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.

 

Key Performance Ratios
		Year ended December 31,
		2021				2020
Return on Average Assets			0.95%				0.96%
Return on Average Equity			11.16%				10.16%

 

 

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

·

Other income

·

Operating expenses

·

Income taxes

 

The following discussion analyzes each of these five components.

 

Net Interest Income

 

NII represents the largest portion of the Corporation’s operating income. In 2021, NII generated 69.4% of the Corporation’s revenue stream, which consists of NII and non-interest income, compared to 71.3% in 2020. This decrease is a result of much higher levels of non-interest income in 2021 compared to 2020. The overall performance of the Corporation is highly dependent on the changes in NII since it comprises such a significant portion of operating income.

 

The following table shows a summary analysis of NII 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 NII shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis.

 

Net Interest Income

(DOLLARS IN THOUSANDS)

 

		Year ended December 31,
		2021				2020
		$				$
Total interest income			43,591				42,094
Total interest expense			3,020				3,846
Net interest income			40,571				38,248
Tax equivalent adjustment			1,141				814
Net interest income
(fully taxable equivalent)			41,712				39,062

 

 

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

 

·

The rates charged on interest earning assets and paid on interest bearing liabilities

·

The average balance of interest earning assets and interest bearing liabilities

 

NII is impacted by yields earned on assets and rates paid on liabilities. With the decrease in the short-term Federal Reserve rates in 2020, asset yields have declined significantly and the U.S. Treasury curve has been relatively flat.

During 2021, longer-term U.S. Treasury rates did increase adding some slope to the yield curve, but asset yields are still constrained, which adds strain to NII and net interest margin (NIM).

 

As a result of a larger balance sheet in 2021, even with much lower asset yields, the Corporation’s NII on a tax equivalent basis increased while the Corporation’s margin decreased to 2.81% for year ended December 31, 2021, compared to 3.24% in 2020. Loan yields were lower in 2021 due to the 150 basis point Fed rate decline during the first quarter of 2020 as well as competitive pressure throughout 2020 and 2021. The Corporation’s NII in 2021 increased over 2020, by $2,650,000, or 6.8%.

 

Security yields will generally fluctuate more rapidly than loan yields based on changes to the U.S. Treasury rates and yield curve. With lower Treasury rates in 2020, security reinvestment had generally been occurring at lower yields. With slightly higher Treasury rates in 2021, security yields have increased slightly, but still remain compressed compared to years prior to 2020.

 

The Corporation’s overall cost of funds, including non-interest bearing funds, remained stable through 2021 between 19 and 13 basis points. Core deposit interest rates were reduced throughout 2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core deposit products. The average balance of borrowings was slightly higher in 2021 compared to 2020, resulting in higher interest expense of $25,000. Additionally, the $20 million sub debt issuance beginning on December 30, 2020, carried a higher rate of interest than FHLB long-term advances. As a result, the total cost of borrowings increased $145,000 when comparing 2021 to 2020, resulting in a total increase in borrowings interest expense of $170,000.

 

The following table provides an analysis of year-to-year changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.

 

RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME

(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)

 

		2021 vs. 2020												2020 vs. 2019
		Increase (Decrease)												Increase (Decrease)
		Due To Change In												Due To Change In
										Net												Net
		Average				Interest				Increase				Average				Interest				Increase
		Balances				Rates				(Decrease)				Balances				Rates				(Decrease)
		$				$				$				$				$				$
INTEREST INCOME
Interest on deposits at other banks			65				(114	)			(49	)			179				(410	)			(231	)
Securities available for sale:
Taxable			1,844				(987	)			857				542				(1,479	)			(937	)
Tax-exempt			2,139				(548	)			1,591				559				(191	)			368
Total securities			3,983				(1,535	)			2,448				1,101				(1,670	)			(569	)
Loans			2,180				(2,597	)			(417	)			3,929				(2,610	)			1,319
Regulatory stock			(64	)			(94	)			(158	)			2				(99	)			(97	)
Total interest income			6,164				(4,340	)			1,824				5,211				(4,789	)			422
INTEREST EXPENSE
Deposits:
Demand deposits			99				(441	)			(342	)			137				(1,298	)			(1,161	)
Savings deposits			16				(14	)			2				17				(60	)			(43	)
Time deposits			(109	)			(547	)			(656	)			(118	)			(91	)			(209	)
Total deposits			6				(1,002	)			(996	)			36				(1,449	)			(1,413	)
Borrowings:
Total borrowings			25				145				170				(137	)			277				140
Total interest expense			31				(857	)			(826	)			(101	)			(1,172	)			(1,273	)
NET INTEREST INCOME			6,133				(3,483	)			2,650				5,312				(3,617	)			1,695

 

In 2021, the Corporation’s NII on an FTE basis increased by $2,650,000, a 6.8% increase over 2020. Total interest income increased $1,824,000, or 4.3%, while interest expense decreased $826,000, or 21.5%, from 2020 to 2021. The FTE interest income from the securities portfolio increased by $2,448,000, or 32.5%, while loan interest income decreased $417,000, or 1.2%. During 2021, additional loan volume added $2,180,000 to net interest income, and lower yields primarily due to the Prime rate decreases in the first quarter of 2020, caused a $2,597,000 decrease, resulting in a net decrease of $417,000. Higher balances in the securities portfolio caused an increase of $3,983,000 in net interest income, while lower yields on securities caused a $1,535,000 decrease, resulting in a net increase of $2,448,000.

 

The average balance of interest bearing liabilities increased by 18.0% during 2021, driven by the growth in deposit balances. Deposit rates decreased significantly throughout 2020 and 2021 more than offsetting the slightly higher interest expense caused by much higher balances of deposits. Lower interest rates contributed to $1,002,000 of interest expense reduction while higher balances only caused $6,000 of increased expense, resulting in a total decline in interest expense of $996,000.

 

Out of all the Corporation’s deposit types, interest-bearing demand deposits reprice the most rapidly, as these rates can be adjusted lower after a Federal Reserve rate decrease. Demand deposit interest expense decreased a total of $342,000 in 2021, with $441,000 due to lower rates, offsetting the higher balances that caused an increase of $99,000. Higher balances in savings accounts caused an increase of $16,000, while lower rates caused a decrease of $14,000, resulting in the net increase in interest expense of $2,000 on savings deposits. Time deposit balances declined throughout 2021, resulting in lower interest expense of $109,000, while lower rates caused a decline of $547,000, resulting in a net decrease of $656,000.

 

The average balance of total borrowings increased by $643,000, or 0.9%, from December 31, 2020, to December 31, 2021. The increase in total borrowings increased interest expense by $25,000. Higher rates on borrowings, driven by the subordinated debt issued at the end of 2020, resulted in higher interest expense of $145,000. The aggregate of these amounts was an increase in interest expense of $170,000 related to total borrowings.

 

The following table shows a more detailed analysis of net interest income on an FTE basis shown with all the major elements of the Corporation’s balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency of not giving 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. The NIM is generally the benchmark used by analysts to measure how efficiently a bank generates NII.

COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME

(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)

 

		December 31,
		2021												2020
		Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate
		$				$				%				$				$				%
ASSETS
Interest earning assets:
Federal funds sold and
deposits at other banks			59,199				91				0.15				35,261				140				0.40
Securities available for sale:
Taxable			363,883				5,001				1.37				238,995				4,144				1.73
Tax-exempt			185,972				4,973				2.67				108,154				3,382				3.13
Total securities (d)			549,855				9,974				1.81				347,149				7,526				2.17
Loans (a)			868,460				34,388				3.96				815,563				34,805				4.27
Regulatory stock			5,870				279				4.75				7,010				437				6.23
Total interest earning assets			1,483,384				44,732				3.02				1,204,983				42,908				3.56
Non-interest earning assets (d)			82,827												74,391
Total assets			1,566,211												1,279,374
LIABILITIES &
STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits			344,783				170				0.05				279,280				512				0.18
Savings accounts			315,161				63				0.02				242,572				61				0.03
Time deposits			117,320				910				0.78				126,742				1,566				1.24
Borrowed funds			70,473				1,877				2.66				69,830				1,707				2.44
Total interest bearing liabilities			847,737				3,020				0.36				718,424				3,846				0.54
Non-interest bearing liabilities:
Demand deposits			579,996												435,495
Other			4,867												4,409
Total liabilities			1,432,600												1,158,328
Stockholders' equity			133,611												121,046
Total liabilities & stockholders' equity			1,566,211												1,279,374
Net interest income (FTE)							41,712												39,062
Net interest spread (b)											2.66												3.02
Effect of non-interest bearing funds											0.15												0.22
Net yield on interest earning assets (c)											2.81												3.24

 

(a)

Includes balances of non-accrual loans and the recognition of any related interest income.  Average balances also include net deferred loan costs of $1,755,000 in 2021, $1,277,000 in 2020, and $1,753,000 in 2019. Such fees recognized through income and included in the interest amounts totaled $1,201,000 in 2021, $993,000 in 2020, and ($523,000) in 2019.

(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.

The Corporation’s average balance on securities increased by $202.7 million, or 58.4%, in 2021 compared to 2020 and the tax equivalent yield on investments declined by 36 basis points. Interest income on securities increased due to the volume growth which offset the declining yield due to lower market rates. Security reinvestment in 2021 has been occurring at slightly higher rates due to the increase in U.S. Treasury rates, but reinvestment throughout the majority of 2020 was at much lower yields. The sharp growth in the investment portfolio during a period of very low rates also contributed to the decline in average security yield. This large amount of new investment was caused by the significant influx of deposits, which caused excess liquidity.

 

Average balances on loans increased by $52.9 million, or 6.5%, for the year ended December 31, 2021, compared to the prior year. Loan yields declined by 31 basis points for the year and loan interest income decreased $417,000, or 1.2% as a result of these lower yields.

 

The average balance of interest-bearing deposit accounts increased by $128.7 million, or 19.8%, in 2021 compared to 2020. While the average balance of time deposits did decrease for the year-to-date time periods, the average balance of demand and savings accounts increased significantly and more than offset the decline in time deposits. The interest rate paid on deposits decreased as well. This resulted in a decrease in interest expense on deposits of $996,000, or 46.6%, for the year ended December 31, 2021, compared to 2020.

 

The Corporation’s average balance on borrowed funds increased marginally in 2021. The Corporation’s borrowed funds consist of FHLB advances as well as subordinated debt issued in December of 2020 which was used to support capital growth for the Corporation. The subordinated debt issuance caused average borrowings to increase year-over-year, but the Corporation also paid off $10.6 million in FHLB advances during the year. The rate paid on borrowed funds increased by 22 basis points for 2021, compared to 2020 as a result of the issuance of subordinated debt which carries a 4.00% rate, significantly higher than the rate on FHLB advances.

 

For the year ended December 31, 2021, the net interest spread decreased by 36 basis points to 2.66%, compared to 3.02% for 2020. The effect of non-interest bearing funds decreased to 15 basis points from 22 basis points when comparing both years. 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 decreases because there is less difference between non-interest bearing funds and interest bearing liabilities. The Corporation’s NIM for 2021 was 2.81%, compared to 3.24% for 2020.

 

Provision for Loan Losses

 

The allowance for credit losses (ACL) 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 ACL is adequate to cover any losses inherent in the loan portfolio. The Corporation gives special attention to the level of underperforming loans when calculating the necessary provision for loan losses. The analysis of the credit loss allowance takes into consideration, among other things, the following factors:

 

·

levels and trends in delinquencies, non-accruals, and charge-offs,

·

levels of classified loans,

·

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, and

·

changes in the value of underlying collateral.

 

The Corporation recorded a provision of $475,000 in 2021, compared to $2,950,000 in 2020. The provision expense was elevated in 2020 due to the onset of COVID-19 and the deteriorating economic conditions that were expected to impact credit risk moving forward. The Corporation also provided $1.1 million in a specific allocation to one commercial borrower in 2020. This loan paid off during 2021 resulting in a reversal of that specific allocation and an overall reduction in provision expense. As of December 31, 2021, the allowance as a percentage of total loans was 1.40%, compared to 1.50% at December 31, 2020.

Management continues to evaluate the allowance for credit losses in relation to the growth or decline of the loan portfolio and its associated credit risk, and believes the provision and the allowance for credit losses are adequate to provide for future losses. For further discussion of the calculation, see the “Allowance for Credit Losses” section.

 

Other Income

 

Other income for 2021 was $17,881,000, an increase of $2,521,000, or 16.4%, compared to the $15,360,000 earned in 2020. The following table details the categories that comprise other income.

 

OTHER INCOME

(DOLLARS IN THOUSANDS)

 

		2021 vs. 2020
		2021				2020				Increase (Decrease)
		$				$				$				%
Trust and investment services			2,362				1,974				388				19.7
Service charges on deposit accounts			1,069				1,047				22				2.1
Other fees			1,443				1,615				(172	)			(10.7	)
Commissions			3,702				2,963				739				24.9
Net gains on debt and equity securities			1,054				733				321				43.8
Gains on sale of mortgages			5,526				5,850				(324	)			(5.5	)
Earnings on bank-owned life insurance			880				829				51				6.2
Other miscellaneous income			1,845				349				1,496				428.7
Total other income			17,881				15,360				2,521				16.4

 

Trust and investment services income increased by 19.7% from 2020 to 2021 primarily as a result of higher income on the non-deposit investment services side which increased by $281,000, or 38.6%. Service charges on deposit accounts has remained stable from the prior year and other fees have decreased by 10.7% as a result of lower fees on a third party sweep product in 2021. Commissions increased by $739,000, or 24.9% for the year ended December 31, 2021, compared to 2020, driven by higher debit card interchange commissions. Gains on debt and equity securities were higher in 2021 driven by solid gains on debt securities sold and gains recognized on the sale of equity securities and gains from the market value increases on equity securities. Mortgage gains were very strong in both years but were higher in 2020 due to slightly higher refinancing volume and better margins on loans sold. Earnings on bank-owned life insurance increased marginally year-over-year and other miscellaneous income was significantly higher due to improvements in net mortgage servicing income and investment adjustments that positively impacted this category of income.

Operating Expenses

 

The following table provides details of the Corporation’s operating expenses for the last two years along with the percentage increase or decrease compared to the previous year.

 

OPERATING EXPENSES

(DOLLARS IN THOUSANDS)

 

		2021 vs. 2020
		2021				2020				Increase (Decrease)
		$				$				$				%
Salaries and employee benefits			24,465				22,062				2,403				10.9
Occupancy expenses			2,621				2,407				214				8.9
Equipment expenses			1,053				1,196				(143	)			(12.0	)
Advertising & marketing expenses			992				894				98				11.0
Computer software & data processing expenses			4,420				3,148				1,272				40.4
Shares tax			1,282				1,060				222				20.9
Professional services			2,099				2,317				(218	)			(9.4	)
Other operating expenses			3,509				2,990				519				17.4
Total operating expenses			40,441				36,074				4,367				12.1

 

Salaries and employee benefits are the largest category of operating expenses. For the year 2021, salaries and benefits increased $2,403,000, or 10.9%, compared to 2020. This was primarily due to merit and cost of living increases, additions to staff, and higher costs to replace employees who retired or left the organization due to nationwide staffing challenges. Occupancy and equipment expenses in total did not change significantly from the prior year. Advertising and marketing expenses increased by 11.0% which is typical as the Corporation grows and promotes new market areas and new products and services. Computer software and data processing expenses are growing at a rapid pace, 40.4% year-over year, as a result of higher technology costs and new bank-wide initiatives that rely heavily on software platforms. Shares tax expense is based on the Corporation’s levels of shareholders’ equity and has grown substantially in the past two years commensurate with the growth in shareholders’ equity. Professional services expenses declined by 9.4% in 2021 compared to the prior year driven lower by a decline in outside services. Other operating expenses increased by 17.4% year-over-year primarily as a result of higher loan-related costs as well as higher FDIC insurance costs.

 

Income Taxes

 

Nearly all of the Corporation’s income is taxed at a corporate rate of 21% for Federal income tax purposes. The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, very limited taxable activity is conducted at the corporate level. The Corporation’s wholly owned subsidiary, Ephrata National Bank, is not subject to state income tax, but does pay Pennsylvania Bank Shares Tax. The Bank Shares Tax expense appears on the Corporation’s Consolidated Statements of Income under operating expenses.

 

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

 

For the year ended December 31, 2021, the Corporation recorded a tax provision of $2,620,000, compared to $2,285,000 for 2020. This increase in tax expense can be attributed to higher pretax earnings. The effective tax rate for the Corporation was 14.9% for 2021 and 15.7% for 2020. The Corporation’s effective tax rate is lower than the 21% corporate rate as a result of tax-free assets that the Corporation holds on its balance sheet. The majority of the Corporation’s tax-free assets are in the form of obligations of states and political subdivisions, referred to as municipal bonds. The Corporation also has a relatively small component of tax-free municipal loans.

Financial Condition

 

 

Balance Sheet Overview and Liquidity

 

We maintain liquid assets at adequate levels in order to meet the needs of our balance sheet. Our primary source of liquidity is core deposits and our available-for-sale investment portfolio both of which provide more than enough liquidity to fund loans to customers and any other funding needs.

A portion of our liquidity consists of cash and cash equivalents and borrowings. At December 31, 2021, cash and equivalents amounted to $158.4 million, an increase of $63.5 million, or 66.9%, from balances at December 31, 2020. Our primary sources of cash are principal repayments on loans, proceeds from the sales, calls, and maturities of investment securities, principal repayments of mortgage-backed securities, and increases in deposit accounts. As of December 31, 2021, we had borrowings outstanding from the FHLB of $44.2 million and subordinated debt of $19.7 million.

At December 31, 2021, we had $491.4 million in loan commitments outstanding, which included $99.0 million in firm loan commitments, $379.6 million in unused lines of credit, and open letters of credit of $12.8 million. Certificates of deposit due within one year totaled $63.6 million, or 55.8% of certificates of deposit. We believe, based on past experience that a significant portion of our certificates of deposit will remain with us upon maturity and we have ample liquidity outside of these funds. We have the ability to attract and retain deposits by adjusting the interest rates offered.

As reported in the Consolidated Statements of Cash Flows, our cash flows are classified for financial reporting purposes as operating, investing or financing cash flows. Net cash provided by operating activities was $13.3 million and $16.4 million for the years ended December 31, 2021 and 2020, respectively. Net cash used for investing activities was $195.2 million and $232.5 million in fiscal years 2021 and 2020, respectively, reflecting our loan and investment security activities in the respective periods. Cash provided by financing activities amounted to $245.5 million and $269.9 million for years ended December 31, 2021 and 2020, respectively primarily representing increases in our core deposits through the year.

 

Investment Securities

 

The Corporation classifies all of its debt securities as available for sale and reports the portfolio at fair market value. As of December 31, 2021, the Corporation had $567.1 million of debt and equity securities, compared to $483.5 million at December 31, 2020, an increase of $83.6 million, or 17.3%.

 

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

·

credit risk of each instrument and risk-based capital considerations

·

Federal income tax considerations with regard to obligations of tax-free states and political subdivisions.

 

The Corporation purchased $14.8 million of U.S. Treasuries during 2021 and held no Treasuries in 2020. U.S. Treasuries represent a safe credit at a market appropriate yield which added some diversity to the portfolio. The Corporation’s U.S. government agency sector decreased by $25.3 million, or 46.6%, since December 31, 2020. Management had purchased $35.5 million of short-term discount notes at the end of 2020 to offset the Corporation’s shares tax expense. These bonds were sold in the first quarter of 2021 and are responsible for the decline in this category. Management has increased the allocations of both asset-backed securities (ABS) and obligations of states and political subdivisions (municipals) since December 31, 2020, in order to better structure the portfolio to achieve higher yields while also protecting in preparation for a rates-up environment.

 

The Corporation’s asset-backed securities (ABS) and municipal sectors have increased significantly since December 31, 2020, with ABS increasing $40.7 million, or 67.4%, and municipals increasing $53.7 million, or 27.7%. ABS securities are floating rate student loan pools which are instruments that will perform well in a rates-up environment and offset the interest rate risk of the longer fixed-rate municipal bonds. These securities provide a variable rate return materially above the overnight Federal funds rate in a safe investment with a risk rating very similar to that of U.S. Agency bonds. The asset-backed securities generally provide monthly principal and interest payments to complement the Corporation’s ongoing cash flows. With liquidity and cash levels remaining high, management views the ABS sector as a safe, higher yielding option than cash, with the qualities of cash in a rates-up environment.

 

Obligations of states and political subdivisions, or municipal bonds, consist of both tax-free and taxable securities that generally provide the highest yield in the securities portfolio. They also carry the longest duration on average of any instrument in the securities portfolio. These instruments also experience significant fair market value gains and losses when interest rates decrease and increase. Municipal bonds represented 44.3% of the debt securities portfolio as of December 31, 2021, compared to 40.7% as of December 31, 2020.

 

The Corporation’s U.S. agency MBS and CMO sectors decreased in total by $23.0 million, or 21.7%, from December 31, 2020 to December 31, 2021. Management desires to maintain a portfolio of MBS and CMOs in order to assist in adding to and maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity to the balance sheet. U.S. agency MBS and CMO securities pay contractual monthly principal and interest, but are also subject to additional prepayment of principal.

 

As of December 31, 2021, the fair value of the Corporation’s corporate bonds increased by $20.8 million, or 33.7%, from balances at December 31, 2020. 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.

 

The following table shows the weighted-average life and yield on the Corporation’s debt securities by maturity intervals as of December 31, 2021, based on amortized cost. All of the Corporation’s securities are classified as available for sale and are reported at fair value; however, for purposes of this schedule they are shown at amortized cost. Securities are assigned to categories based on stated contractual maturity except for MBS and CMOs, which are based on anticipated payment periods.

 

SECURITIES PORTFOLIO MATURITY ANALYSIS

(DOLLARS IN THOUSANDS)

 

		Within								1 - 5								5 - 10								Over 10
		1 Year								Years								Years								Years								Total
						%								%								%								%								%
		$				Yield				$				Yield				$				Yield				$				Yield				$				Yield
U.S. Treasuries			—				—				—				—				14,821				1.40				—				—				14,821				1.40
U.S. government agencies			—				—				15,713				0.78				13,900				0.80				—				—				29,613				0.79
U.S. agency mortgage-backed securities			15,044				0.57				23,706				0.87				11,625				1.30				1,589				1.38				51,964				0.90
U.S. agency collateralized mortgage obligations			5,742				1.37				9,035				2.07				15,878				1.29				262				1.94				30,917				1.54
Corporate bonds			3,605				1.24				39,590				1.74				39,422				2.08				—				—				82,617				1.88
Obligations of states and political subdivisions			—				—				4,090				3.38				22,232				2.89				216,485				2.43				242,807				2.49
Asset-backed securities			3,957				0.78				17,660				0.77				30,269				0.78				49,112				0.85				100,998				0.82
Total securities available for sale			28,348				0.85				109,794				1.35				148,147				1.60				267,448				2.13				553,737				1.77

 

Loans

 

Net loans outstanding increased $97.0 million, or 12.0%, from $811.0 million at December 31, 2020, to $908.0 million at December 31, 2021. Most major loan categories showed an increase in balances over the prior year but the majority of loan growth came from the commercial and consumer real estate categories with a decline in the commercial and industrial category as PPP loan balances declined by $36.6 million during 2021.

Commercial real estate loans increased to $400.8 million at December 31, 2021, from $342.1 million at December 31, 2020, a 17.2% increase. Commercial mortgages increased by $34.7 million, or 24.3%, agriculture mortgages increased by $27.7 million, or 15.7%, and commercial construction loans decreased by $3.8 million, or 16.2% from December 31, 2020, to December 31, 2021.

 

The consumer real estate category represents the largest group of loans for the Corporation. The consumer residential real estate category of total loans increased from $345.6 million on December 31, 2020, to $403.9 million on December 31, 2021, a 16.9% increase. This category includes closed-end fixed rate or adjustable rate residential real estate loans secured by 1-4 family residential properties, including first and junior liens, and floating rate home equity loans. The first lien 1-4 family mortgages increased by $53.5 million, or 20.3%, from December 31, 2020, to December 31, 2021. The vast majority of the first lien 1-4 family closed end loans consist of single family personal first lien residential mortgages and home equity loans, with the remainder consisting of 1-4 family residential non-owner-occupied mortgages. During 2021, mortgage production increased 18.1% over the prior year.  The increase in overall production was due to a large increase in portfolio production, which was up 73% over last year, while secondary market production decreased by 23%.  The percentage of mortgage originations that went into the Corporation’s held for investment mortgage portfolio increased to 63% compared to 55% in 2020. The interest rate environment throughout the year remained relatively stable and created a nice balance within our mix; 36% of volume in 2021 was purchase, 31% was residential construction lending, and 33% was refinance activity.  The volume of mortgage production in 2021 led to a 20.7% increase in growth of the held for investment residential loan portfolio and a 22.8% increase in the servicing on behalf of others portfolio, with mortgage servicing rights growing to over $1.7 million.

 

As of December 31, 2021, the remainder of the residential real estate loans consisted of $11.2 million of fixed rate junior lien home equity loans, and $75.7 million of variable rate home equity lines of credit (HELOCs). This compares to $10.7 million of fixed rate junior lien home equity loans, and $71.3 million of HELOCs as of December 31, 2020. Therefore, combined, these two types of home equity loans increased from $82.0 million to $86.9 million, an increase of 6.0%.

 

The other area of commercial lending is non-real estate secured commercial lending, referred to as commercial and industrial lending. Commercial and industrial loans not secured by real estate loans decreased from $129.2 million at December 31, 2020, to $109.3 million at December 31, 2021, a 15.4% decrease, primarily attributable to the forgiveness of PPP loans throughout 2021. Outside of PPP loans, the commercial and industrial category generally includes unsecured lines of credit, truck, equipment, and receivable and inventory loans, in addition to tax-free loans to municipalities. PPP loan balances declined by $36.6 million during 2021, and ended the year with a balance of only $11.3 million. Management expects that virtually all of the remaining balance will be forgiven during 2022.

 

Consumer loans not secured by real estate represent a very small portion of the Corporation’s loan portfolio, at $5.1 million as of December 31, 2021 and December 31, 2020. These loans consist of personal loans, automobile loans, and other consumer-related loans.

 

The following tables show the maturities for the loan portfolio as of December 31, 2021, by time frame for the major categories, and also the loans, which are floating or fixed, maturing after one year.

LOAN MATURITIES

(DOLLARS IN THOUSANDS)

						Due After				Due After
						One Year				Five Years
		Due in One				Through				Through				Due After
		Year or Less				Five Years				15 Years				15 Years				Total
		$				$				$				$				$
Commercial real estate
Commercial mortgages			3,904				22,540				73,512				77,440				177,396
Agriculture mortgages			9,999				4,464				51,902				137,360				203,725
Construction			342				2,479				4,931				11,887				19,639
Total commercial real estate			14,245				29,483				130,345				226,687				400,760
Consumer real estate
1-4 family residential mortgages			9,658				10,554				68,371				228,454				317,037
Home equity loans			5,409				901				3,700				1,171				11,181
Home equity lines of credit			76				2,005				8,269				65,348				75,698
Total consumer real estate			15,143				13,460				80,340				294,973				403,916
Commercial and industrial
Commercial and industrial			21,601				40,520				2,950				544				65,615
Tax-free loans			—				256				12,033				10,720				23,009
Agriculture loans			13,313				5,151				2,253				—				20,717
Total commercial and industrial			34,914				45,927				17,236				11,264				109,341
Consumer			1,995				3,057				80				—				5,132
Total amount due			66,297				91,927				228,001				532,924				919,149

 

FIXED AND FLOATING RATE LOANS DUE AFTER ONE YEAR

(DOLLARS IN THOUSANDS)

						Floating or
		Fixed Rates				Adjustable Rates				Total
		$				$				$
Commercial real estate
Commercial mortgages			46,832				126,660				173,492
Agriculture mortgages			7,948				185,778				193,726
Construction			3,956				15,341				19,297
Total commercial real estate			58,736				327,779				386,515
Consumer real estate
1-4 family residential mortgages			143,967				163,412				307,379
Home equity loans			3,202				2,570				5,772
Home equity lines of credit			7,711				67,911				75,622
Total consumer real estate			154,880				233,893				388,773
Commercial and industrial
Commercial and industrial			38,657				5,357				44,014
Tax-free loans			6,936				16,073				23,009
Agriculture loans			6,505				899				7,404
Total commercial and industrial			52,098				22,329				74,427
Consumer			3,137				—				3,137
Total amount due			268,851				584,001				852,852

 

The majority of the Corporation’s fixed-rate loans have a maturity date longer than five years. The primary reason for the longevity of the portfolio is the high percentage of real estate loans, which typically have maturities of 15 or 20 years. Out of all the loans due after one year, $268.9 million, or 31.5%, are fixed-rate loans as of December 31, 2021. These loans will not reprice to a higher or lower interest rate unless they mature or are refinanced by the borrower. The remaining $584.0 million, or 68.5% of loans due after one year, are made up of loans that are true floating loans and loans that will reprice at a predetermined time in the amortization of the loan. True floating rate loans that would immediately reprice according to changes in the Prime rate are favorable in reducing the Corporation’s total exposure to interest rate risk and fair value risk should interest rates increase. It is likely the borrowing habits of commercial borrowers will change if the Fed raises rates in the near term. More commercial customers will desire to lock into an initial fixed interest rate period to avoid future rate increases. However, if the customer perceives rates will remain low for an extended period of time, there is a greater likelihood that borrowers will opt for variable rate loans in order to get the best available pricing.

 

For more details regarding how the length of the loan portfolio and its repricing affects interest rate risk, please see Item 7A Quantitative and Qualitative Disclosures about Market Risk.

 

Non-Performing Assets

 

Non-performing assets include:

 

·

Non-accrual loans

·

Loans past due 90 days or more and still accruing

·

Troubled debt restructurings

·

Other real estate owned

 

 

NON-PERFORMING ASSETS

(DOLLARS IN THOUSANDS)  

		December 31,
		2021				2020
		$				$
Non-accrual loans			2,556				725
Loans past due 90 days or more and still accruing			325				1,373
Troubled debt restructurings, non-performing			—				—
Total non-performing loans			2,881				2,098
Other real estate owned			—				—
Total non-performing assets			2,881				2,098
Non-accrual loans to total loans			0.28%				0.09%
Non-performing loans to total loans			0.31%				0.25%
Allowance for credit losses to total loans			1.40%				1.50%
Allowance for credit losses to non-accrual loans			505.91%				1700.28%
Allowance for credit losses to non-performing loans			448.84%				587.56%

 

Non-performing assets increased by $783,000, or 37.3%, from December 31, 2020, to December 31, 2021, primarily as a result of increases in non-accrual loans and partially offset by a decline in loans past due 90 days or more and still accruing. Several customer relationships were added to non-accrual during 2021 resulting in an increase of $1,831,000 in the total balance of non-accrual loans. As of December 31, 2021, there were fifteen loans to seven unrelated borrowers totaling $2,556,000 on non-accrual compared to three loans to three unrelated borrowers totaling $725,000 as of December 31, 2020. The largest non-accrual relationship at December 31, 2021, was a commercial loan to a single borrower with a balance of $466,000.

 

Loans past due 90 days or more and still accruing declined by $1,048,000 during 2021 partially offsetting the increases in non-accrual loans. There were no loans considered non-performing troubled debt restructurings (TDR) as of December 31, 2021 or 2020. 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 position of the borrower and improve the likelihood of full collection by the lender.

Management continues to monitor delinquency trends and the level of non-performing loans as a leading indicator of future credit risk. At this time, management believes that the potential for material losses related to non-performing loans remains low but is likely to trend higher. It is far more likely the level of non-performing assets would increase than decline to lower levels. The level of the Corporation’s non-performing loans remains very low relative to the size of the portfolio and relative to peers.

 

As of December 31, 2021 and 2020, the Corporation had no properties classified as other real estate owned (OREO). Expenses related to OREO are included in other operating expenses and gains or losses on the sale of OREO are included in other income on the Consolidated Statements of Income.

 

 

Allowance for Credit Losses

 

The allowance for credit 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 credit losses. This calculation is based upon a systematic methodology for determining the allowance for credit losses in accordance with U.S. generally accepted accounting principles. The calculation includes estimates and is based upon losses inherent in the loan portfolio. The calculation, and detailed analysis supporting it, emphasizes the level of delinquent, non-performing and classified loans. The allowance calculation includes specific provisions for non-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 credit losses through the provision as necessary. Changes to the allowance for credit losses during the year are primarily affected by three events:

 

·

Charge off of loans considered not recoverable

·

Recovery of loans previously charged off

·

Provision or credit for loan losses

 

The Corporation’s strong credit and collateral policies have been instrumental in producing a favorable history. In recent years, the Corporation has recorded more normal levels of provision expenses in order to account for the growth in the loan portfolio as well as make adjustments for increasing levels of delinquencies and classified loans.

 

The Net Charge-Off table below shows the net charge-offs as a percentage of average loans outstanding for each segment of the Corporation’s loan portfolio as of December 31, 2021 and 2020.

 

Net Charge-Offs

(DOLLARS IN THOUSANDS)

		2021				2020
		$				$
Loans charged-off:
Commercial real estate			—				45
Consumer real estate			20				—
Commercial and industrial			—				23
Consumer			35				20
Total loans charged-off			55				88
Recoveries of loans previously charged-off
Commercial real estate			109				11
Consumer real estate			2				—
Commercial and industrial			56				4
Consumer			17				3
Total recoveries			184				18
Net charge-offs (recoveries)
Commercial real estate			(109	)			34
Consumer real estate			18				—
Commercial and industrial			(56	)			19
Consumer			18				17
Total net charge-offs (recoveries)			(129	)			70
Average loans outstanding
Commercial real estate			357,727				323,881
Consumer real estate			328,969				301,008
Commercial and industrial			176,212				184,951
Consumer			5,552				5,722
Total average loans outstanding			868,460				815,562
Net charge-offs (recoveries) as a % of average loans outstanding
Commercial real estate			(0.03%)				0.01%
Consumer real estate			0.01%				0.00%
Commercial and industrial			(0.03%)				0.01%
Consumer			0.32%				0.30%
Total net charge-offs (recoveries) as a % of average loans outstanding			(0.01%)				0.01%

 

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. The Corporation has historically experienced very low net charge-off percentages due to conservative credit practices. During 2021, recoveries exceeded charge-offs by $129,000, representing a net recovery position of (0.01%) of average loans outstanding as reflected above. Net charge-offs for 2020 were very low at $70,000, resulting in a net charge-off as a percentage of average loans of 0.01% for the year.

 

The following table provides the allocation of the Corporation’s allowance for credit losses by major loan classifications. The percentage of loans indicates the percentage of the loan portfolio represented by the indicated loan type.

 

ALLOCATION OF RESERVE

(DOLLARS IN THOUSANDS)

		December 31,
		2021								2020
						% of								% of
		$				Loans				$				Loans
Real estate			10,097				87.5				9,778				83.7
Commercial and industrial			2,112				11.9				1,972				15.7
Consumer			87				0.6				52				0.6
Unallocated			635				—				525				—
Total allowance for loan losses			12,931				100.0				12,327				100.0

 

Real estate loans represent 87.5% of total loans with 78.1% of the allowance covering these loans. Real estate secured loans have historically experienced lower losses than non-real estate secured loans, accounting for the difference. Commercial and industrial loans not secured by real estate have historically experienced higher loan losses as a percentage of balances and therefore require a larger relative percentage of the reserve. The reserve allocated to these loans has increased and decreased in recent years, but has not changed significantly as a percentage of total loans. For 2021, the dollar amount of allocation for commercial and industrial loans increased by $140,000, or 7.1%, with this allocation accounting for 16.3% of the total allowance as of December 31, 2021. As of December 31, 2021, commercial and industrial loans make up 11.9% of all loans. The amount of allowance allocated to consumer loans has always been very small as generally consumer loans more than 90 days delinquent are charged off. The amount of allowance allocated to consumer loans and personal loans is based on historical losses and qualitative factors.

 

The $635,000 unallocated portion of the allowance as of December 31, 2021, increased slightly from the balance at the end of 2020, and the unallocated portion as a percentage of the total allowance increased from 4.3% at December 31, 2020, to 4.9% at December 31, 2021.

 

Premises and Equipment

 

Premises and equipment, net of accumulated depreciation, decreased by $284,000, or 1.1%, from December 31, 2020, to December 31, 2021. During 2021, capital investments were made by the Corporation in various small projects and normal ongoing capital needs. However, the new investments were more than offset by depreciation of the existing premises and equipment. The Corporation had $369,000 in construction in process at the end of 2021 compared to $385,000 at the end of 2020. These balances consisted of amounts for small projects or equipment not yet placed in service as of each year-end. For further information on fixed assets refer to Note D to the Consolidated Financial Statements.

 

Regulatory Stock

 

The Corporation owns multiple forms of regulatory stock that is required to be a member of the Federal Reserve Bank (FRB) and members of banks such as the Federal Home Loan Bank (FHLB) of Pittsburgh and Atlantic Community Bankers Bank (ACBB). The Corporation’s $5,380,000 of regulatory stock holdings as of December 31, 2021, consisted of $4,742,000 of FHLB of Pittsburgh stock, $601,000 of FRB stock, and $37,000 of Atlantic Community Bancshares, Inc. stock, the Bank Holding Company of ACBB. 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.

 

Bank-Owned Life Insurance (BOLI)

 

The Corporation owned life insurance with a total recorded cash surrender value (CSV) of $35,414,000 on December 31, 2021, compared to $29,646,000 on December 31, 2020. The Corporation holds two distinct BOLI programs. The first, with a CSV of $5,270,000, was the result of insurance policies taken out on directors of the Corporation electing to participate in a directors’ deferred compensation plan. The program was designed to use the insurance policies to fund future annuity payments as part of a directors’ deferred compensation plan that permitted deferral of Board pay from

1979 through 1999. The second BOLI plan was originated in 2006 when life insurance was first taken out on a select group of the Corporation’s officers. The additional income generated from this BOLI plan is to assist in offsetting the rising cost of benefits currently being provided to all employees. The Corporation made a $5 million investment in this BOLI plan during 2021, so the CSV was $30,144,000 as of December 31, 2021.

 

Deposits

 

The Corporation’s total ending deposits at December 31, 2021, increased by $259.4 million, or 20.7%, from December 31, 2020. Customer deposits are the Corporation’s primary source of funding for loans and securities. In the past few years, the economic concerns and volatility of the equity markets continued to lead customers to banks for safe places to invest money, despite historically low interest rates. The mix of the Corporation’s deposit categories has changed moderately since December 31, 2020, with the changes being a $151.4 million, or 28.3% increase in non-interest bearing demand deposit accounts, a $15.9 million, or 33.8% increase in interest bearing demand balances, a $2.0 million, or 1.4% increase in NOW balances, a $28.2 million, or 20.1% increase in money market account balances, a $66.9 million, or 24.4% increase in savings account balances, and a $5.2 million, or 4.3% decrease in time deposit balances.

 

The growth across most categories of core deposit accounts is a direct result of the PPP funding, government stimulus payments, and the change in customer’s spending habits during the uncertain economic conditions brought on by COVID-19. Customers view demand deposit, money market and savings accounts as the safest, most convenient place to maintain funds for maximum flexibility.

 

The Deposits by Major Classification table, shown below, provides the balances of each category for December 31, 2021 and December 31, 2020.

 

DEPOSITS BY MAJOR CLASSIFICATION

(DOLLARS IN THOUSANDS)

 

Average balances and average rates paid on deposits by major category are summarized as follows:

 

		December 31,
		2021								2020
		$				%				$				%
Non-interest bearing demand			579,996				—				435,495				—
Interest-bearing demand			55,819				0.10				39,116				0.20
NOW accounts			130,328				0.03				107,104				0.11
Money market deposit accounts			158,635				0.05				133,059				0.24
Savings accounts			315,161				0.02				242,572				0.03
Time deposits			117,320				0.78				126,742				1.24
Total deposits			1,357,259								1,084,088

 

The average balance of the Corporation’s core deposits, including non-interest bearing demand deposits, interest-bearing demand deposits, NOW accounts, MMDA accounts, and savings accounts, grew $282.6 million, or 29.5%, since December 31, 2020. Time deposits are typically a more rate-sensitive product making them a less reliable source of funding. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution. In 2021, time deposits declined in both dollars and as a percentage of the Corporation’s deposits with the average balance decreasing by $9.4 million, or 7.4%, compared to 2020 average balances. A reduction in time deposits has worked in concert with management’s asset liability plan for a better mix of core deposits relative to time deposits. Management was willing to see a decline in time deposit balances as the most expensive source of funding for the Corporation.

 

As of December 31, 2021, time deposits over $250,000 made up 7.3% of the total time deposits. This compares to 6.8% on December 31, 2020. The total dollar amount of time deposits over $250,000 increased $234,000, or 2.9%, from December 31, 2020 to December 31, 2021. Since time deposits over $250,000 are made up of relatively few customers with large dollar accounts, management monitors these accounts closely due to the potential for these deposits to rapidly increase or decrease. The following table provides the total amount of time deposits of $250,000 or more for the past two years by maturity distribution.

MATURITY OF TIME DEPOSITS OF $250,000 OR MORE

(DOLLARS IN THOUSANDS)

 

		December 31,
		2021				2020
		$				$
Three months or less			1,592				721
Over three months through six months			575				1,539
Over six months through twelve months			1,655				1,896
Over twelve months			4,499				3,931
Total			8,321				8,087

  

As of December 31, 2021 and 2020, the total uninsured deposits of the Corporation were $313,122,000 and $217,770,000, respectively. Total uninsured deposits is calculated based on regulatory reporting requirements and reflects the portion of any deposit of a customer at an insured depository institution that exceeds the applicable FDIC insurance coverage for that depositor at that institution and amounts in any other uninsured investment or deposit accounts that are classified as deposits and not subject to any federal or state deposit insurance regime.

 

 

Borrowings

 

Total borrowings were $63.9 million as of December 31, 2021, and $74.4 million as of December 31, 2020. The Corporation had no short-term borrowings at either year-end. Long-term borrowings with the Federal Home Loan Bank (FHLB) decreased to $44.2 million as of December 31, 2021, from $54.8 million as of December 31, 2020. The Corporation primarily uses FHLB advances as the source for long-term borrowings. These borrowings are used as a secondary source of funding and to mitigate interest rate risk. The decrease in long-term FHLB borrowing balances during the year related to management taking advantage of declining rates by prepaying FHLB advances in order to save on interest expense in future years. As of December 31, 2021, all the borrowings of FHLB were fixed-rate loans. The Corporation continues to be well under the FHLB maximum borrowing capacity which is $505.1 million as of December 31, 2021.

 

In addition to the long-term advances funded through the FHLB, on December 30, 2020, the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $20.0 million of subordinated debt notes with a maturity date of December 30, 2030. These notes are non-callable for 5 years and carry a fixed interest rate of 4% per year for 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As of December 31, 2021, $16.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% that will be amortized to the call date on a pro-rata basis.

 

Stockholders’ Equity

 

Federal regulatory authorities require banks to meet minimum capital levels. The Corporation, as well as the Bank, as the solely owned subsidiary of the Corporation, maintains capital ratios well above those minimum levels. 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 specific 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 credit losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio.

 

The consolidated asset limit on small bank holding companies is $3 billion and a company with assets under that limit is not subject to the consolidated capital rules but may disclose capital amounts and ratios. The Corporation has elected to disclose those amounts and ratios.

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

 

REGULATORY CAPITAL RATIOS:
					Regulatory Requirements
					Adequately		Well
As of December 31, 2021			Capital Ratios		Capitalized		Capitalized
Total Capital to Risk-Weighted Assets
	Consolidated		15.6%		N/A		N/A
	Bank		14.9%		8.0%		10.0%
Tier 1 Capital to Risk-Weighted Assets
	Consolidated		12.5%		N/A		N/A
	Bank		13.6%		6.0%		8.0%
Common Equity Tier 1 Capital to Risk-Weighted Assets
	Consolidated		12.5%		N/A		N/A
	Bank		13.6%		4.5%		6.5%
Tier 1 Capital to Average Assets
	Consolidated		8.2%		N/A		N/A
	Bank		9.1%		4.0%		5.0%
As of December 31, 2020
Total Capital to Risk-Weighted Assets
	Consolidated		16.1%		N/A		N/A
	Bank		15.3%		8.0%		10.0%
Tier I Capital to Risk-Weighted Assets
	Consolidated		12.8%		N/A		N/A
	Bank		14.0%		6.0%		8.0%
Common Equity Tier I Capital to Risk-Weighted Assets
	Consolidated		12.8%		N/A		N/A
	Bank		14.0%		4.5%		6.5%
Tier I Capital to Average Assets
	Consolidated		9.0%		N/A		N/A
	Bank		9.8%		4.0%		5.0%

 

As of December 31, 2021 the Bank’s Tier 1 Leverage Ratio stood at 9.1% while the Corporation’s Tier 1 Leverage Ratio was 8.2%. Tier 1 Capital levels at the Corporation level were not impacted by the subordinated debt issue since subordinated debt only qualifies as Tier 2 Capital at the corporate level. As such, in terms of the Corporation’s regulatory capital ratios, only the Total Capital to Risk-Weighted Assets ratio was enhanced as a result of the $20 million subordinated debt issue. Most of the marked improvement in capital ratios occurred at the Bank level.

 

Contractual Cash Obligations

 

The Corporation has a number of contractual obligations that arise from the normal course of business. The following table summarizes the contractual cash obligations of the Corporation as of December 31, 2021, and shows the future periods in which settlement of the obligations is expected. The contractual obligation numbers below do not include accrued interest. Refer to Note O to the Consolidated Financial Statements referenced in the table for additional details regarding these obligations.

CONTRACTUAL OBLIGATIONS

(DOLLARS IN THOUSANDS)

		Less than				1-3				4-5				More than
		1 year				years				years				5 years				Total
		$				$				$				$				$
Time deposits (Note F)			63,603				35,178				15,155				—				113,936
Borrowings (Notes G and H)			—				31,223				32,663				—				63,886
Operating Leases			189				349				91				—				629
Total contractual obligations			63,792				66,750				47,909				—				178,451

 

 

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 liquidity section to follow, 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 December 31, 2021. For further details regarding off-balance sheet arrangements, refer to Note O to the Consolidated Financial Statements.

 

OFF-BALANCE SHEET ARRANGEMENTS

(DOLLARS IN THOUSANDS)

		December 31,
		2021
		$
Commitments to extend credit:
Revolving home equity loans			154,144
Construction loans			33,811
Real estate loans			119,140
Business loans			163,612
Consumer loans			1,478
Other			5,152
Standby letters of credit			12,756
Total			490,093

 

 

Critical Accounting Policies

 

The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.

 

Allowance for Credit Losses

 

A material estimate that is particularly susceptible to significant change is the determination of the allowance for credit losses. Management believes that the allowance for credit losses is adequate and reasonable. The Corporation’s methodology for determining the allowance for credit losses is described in an earlier section of Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing credit losses, it is likely that well-informed individuals could make materially different assumptions and, therefore, calculate a materially different allowance amount. Management uses available information to recognize losses on loans; however, changes in economic conditions may necessitate revisions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for credit losses. Such agencies may require the Corporation

to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

Fair Values of Assets and Liabilities

 

ASC Topic 820 defines fair value as the price that would be received to sell the financial asset or paid to transfer the financial liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. See Note R to the Consolidated Financial Statements for a complete discussion and summary of the Corporation’s use of fair valuation of assets and liabilities and the related measurement techniques.

 

Other than Temporary Impairment of Securities

 

Securities are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospect of a near-term recovery of value is not necessarily favorable or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

 

Deferred Tax Assets

 

The Corporation uses an estimate of future earnings to support the position that the benefit of deferred tax assets will be realized. If future income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the asset may not be realized and the Corporation’s net income will be reduced. Deferred tax assets are described further in Note L to the Consolidated Financial Statements.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

As a financial institution, the Corporation is subject to four primary market risks: Credit risk, liquidity risk, interest rate risk, and fair value risk. The Board of Directors has established an Asset Liability Management Committee (ALCO) to measure, monitor, and manage these four 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 Corporation’s Strategic Plan goals.

 

For discussion on credit risk, refer to the sections on non-performing assets, allowance for credit losses, Note C, and Note P to the Consolidated Financial Statements.

 

Liquidity

 

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. 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, paydowns, maturities, and sales of investment securities, borrowings, and current earnings.

 

One of the measurements used in liquidity planning is the Maturity Gap Analysis. The Maturity Gap Analysis below measures the amount of assets maturing within various time frames versus liabilities maturing in those same periods. These time frames are referred to as gaps and are reported on a cumulative basis. For instance, the one-year gap shows all assets maturing one year or less from a specific date versus the total liabilities maturing in the same time period. The gap is then expressed as a percentage of assets over liabilities. Mismatches between assets and liabilities maturing are identified and assist management in determining potential liquidity issues.

 

The maturity gap analysis does not include non-interest earning assets and non-interest bearing liabilities, with the exception of non-interest bearing demand deposit accounts. The non-interest bearing demand deposits are considered additional deposit liabilities with a 0.00% interest rate, which acts to lower the overall interest rate paid on total deposits.

 

Gap ratios have been increasing for the Corporation throughout 2020 and 2021. The Corporation’s assets are shortening, with very high levels of cash and cash equivalents more than offsetting any additional length taken on in the securities and loan portfolio. Meanwhile the Corporation’s core deposit liabilities continue to model as long liabilities, while the complement of shorter term time deposits continue to decline.

 

The size and length of the Corporation’s core deposit liabilities provide the most extension in terms of lengthening the liabilities on the balance sheet. The length of the core deposits is significantly longer than the Corporation’s longest term deposits and wholesale borrowings. As of December 31, 2021, the Corporation had elevated cash levels due to excess liquidity generated from large increases in the deposit portfolio. These items caused a spike in the short-term gap ratios resulting in the six-month ratio of 362.6% and the one-year ratio of 287.3%. In a rising rate environment, having more assets maturing than liabilities is beneficial because those assets can be reinvested at higher yields.

 

The table below shows the six-month, one-year, three-year, and five-year cumulative gaps as of December 31, 2021, for the Bank, along with the cumulative maturity gap guidelines monitored by management. For the purposes of this analysis, core deposits without a specific maturity date are spread across all time periods based on historical behavior.

MATURITY GAP ANALYSIS

(DOLLARS IN THOUSANDS)  

						More than				More than				More than
		Less than				6 months				1 year				3 years				More than
Maturity Gap		6 months				to 1 year				to 3 years				to 5 years				5 years
		$				$				$				$				$
Assets maturing			300,562				131,596				372,862				235,154				491,865
Liabilities maturing			82,893				67,549				221,023				161,734				1,000,784
Maturity gap			217,669				64,047				151,839				73,420				(508,919	)
Cumulative maturity gap			217,669				281,716				433,555				506,975				(1,944	)
Maturity gap %			362.6%				194.8%				168.7%				145.4%				49.1%
Cumulative maturity gap %			362.6%				287.3%				216.7%				195.1%				99.9%
Cumulative maturity gap % guideline			45% to 155%				60% to 140%				75% to 125%				85% to 115%

 

 

As of December 31, 2021, all cumulative maturity gap ratios were higher than the upper policy guideline. The six-month cumulative gap ratio was 362.6% as of December 31, 2021, higher than the upper guideline of 155%. The one-year, three-year, and five-year ratios were also higher than guidelines at 287.3%, 216.7%, and 195.1%, respectively, compared to guidelines of 140%, 125%, and 115%. In a likely rising rate environment in 2022, higher gap ratios are actually beneficial so these target guidelines exceptions are viewed as acceptable. With potentially rising rates continuing throughout 2022, the risk of liabilities repricing to higher rates is greater and Management anticipates having the ability to control deposit and borrowings costs and potentially achieving limited savings on the liability side. Management will continue to monitor all gap ratios to ensure proper positioning for future interest rate cycles.

 

It is likely that, should market interest rates rise in 2022, customer behavior patterns would change and deposits would become more rate sensitive with a greater portion potentially leaving the Corporation. These maturity gaps are closely monitored along with additional liquidity measurements discussed below. Management believes the probability of future Federal Reserve rate increases is good, driven by concerns of inflation. Therefore, management no longer sees a need to maintain longer gap ratios above target ranges. It is expected that the gap ratios will decline in 2022.

 

In addition to the cumulative maturity gap analysis discussed above, management utilizes a number of other important liquidity measurements that management believes have advantages over, and give better clarity to, the Corporation’s present and projected liquidity. The following is a listing of the Corporation’s other liquidity measurements, along with a short definition, that are evaluated periodically 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 – Net projected liquidity surplus/shortage shown for each period

 

As of December 31, 2021, the Corporation was within guidelines for all of the above measurements except for the securities portfolio liquidity measurements. These measurements were on the low side when not factoring in cash on hand, but were on the high side when factoring in cash. While liquidity from the securities portfolio had decreased with the stagnant rate environment and the higher balance sheet, the very high levels of cash held by the Corporation more than offset these lower levels of security liquidity.

Throughout 2021, with the very low interest rate environment, and economic concerns impacting consumer behavior, the Corporation saw extremely high rates of deposit growth which provided unusually high levels of liquidity on the balance sheet. The growth in the loan portfolio was at a slower rate than deposit growth, so Management invested in the securities portfolio when it made sense from an asset yield perspective and held higher levels of cash throughout most of the year. The increase in deposits was attributed to a surge of stimulus funds arriving in the hands of consumers who were not deploying the funds. Most consumers were saving the funds as a reserve based on expected further economic uncertainly. As a result, cash balances reached $158.4 million by December 31, 2021.

 

The Corporation’s 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.

 

Interest Rate Risk and Fair Value Risk

 

Identifying the interest rate risk of the Corporation’s interest earning assets and interest bearing liabilities is essential to managing net interest margin and net interest income. In addition to the impact on earnings, management is also concerned about how much the value of the Corporation’s assets might fall or rise given an increasing or decreasing interest rate environment. Interest rate sensitivity analysis (IRSA) measures the impact of a change in interest rates on the net interest income and net interest margin of the Corporation, while net portfolio value (NPV) analysis measures the change in the Corporation’s capital fair value, given interest rate fluctuations. Therefore, the two primary approaches to measuring the impact of interest rate changes on the Corporation’s earnings and fair value are referred to as:

 

·

Changes in net interest income

·

Changes in net portfolio value

 

The Corporation’s asset liability model is able to perform dynamic forecasting based on a wide range of assumptions provided. The model is flexible and can be used for many types of financial projections. The Corporation uses financial modeling to forecast balance sheet growth and earnings. The results obtained through the use of forecasting models are based on a variety of factors. Both earnings and balance sheet forecasts make use of maturity and repricing schedules to determine the changes to the Corporation’s 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:

 

·

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 shown below, results are based on a static balance sheet reflecting no projected growth from balances as of December 31, 2021, and December 31, 2020. While it is unlikely that the balance sheet will not grow at all, management considers a static analysis of this sort to be the most conservative and most accurate means to evaluate fair value and future interest rate risk. Management does run expected growth scenarios through the asset liability model to most accurately predict future financial performance. This is done separately and apart from the static balance sheet approach discussed above to test fair value and future interest rate risk. The static balance sheet approach is used to reduce the number of variables in calculating the model’s accuracy in predicting future net interest income. It is appropriate to pull out various balance sheet growth scenarios, which could be utilized to compensate for a declining margin. By testing the model using a base model assuming no growth, this variable is eliminated and management can focus on predicted net interest income based on the current existing balance sheet.

As a result of the many assumptions, this information should not be relied upon to predict future results. Additionally, both of the analyses shown 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.

 

Changes in Net Interest Income

 

The changes in net interest income reflect how much the Corporation’s net interest income would be expected to increase or decrease given a change in market interest rates. The changes in net interest income shown are measured over a one-year time horizon and assume an immediate rate change on the rate sensitive assets and liabilities. This is considered the more important measure of interest rate sensitivity due to the immediate effect that rate changes may have on the overall performance of the Corporation. The following table takes into consideration when financial instruments would most likely reprice and the duration of the pricing change. It is important to emphasize that the information shown in the table is an estimate based on hypothetical changes in market interest rates.

 

CHANGES IN NET INTEREST INCOME

 

		2021				2020				Policy
		Percentage				Percentage				Guidelines
		Change				Change				%
300 basis point rise			1.6				4.7				(15.00	)
200 basis point rise			0.3				3.4				(10.00	)
100 basis point rise			0.5				2.1				(5.00	)
Base rate scenario			—				—				—
25 basis point decline			(0.7	)			0.2				(1.25	)
50 basis point decline			(1.8	)			(1.0	)			(2.50	)
75 basis point decline			(3.1	)			(1.9	)			(3.75	)

 

This table shows the effect of an immediate interest rate shock over a one-year period on the Corporation's net interest income. Base rate is the Prime rate.  

 

The above analysis shows a negative impact to the Corporation’s net interest income in all the down-rate scenarios. All up-rate scenarios show a positive impact. In the current rate environment, the amount of the Corporation’s assets repricing higher will be fairly large due to the amount of cash and variable rate loans and securities that will reprice immediately when Prime increases. These instruments will generally reprice up the full amount of the Federal Reserve’s rate increase. This is not the case on the liability side where it is typical for management to react slowly in increasing deposit rates. Even when deposit rates are increased, they are typically increased at a fraction of the increase in the Federal Funds rate. The analysis above focuses on immediate rate movements, referred to as rate shocks, and measured over the course of one year.

 

In all rates-up scenarios, modeled net interest income increases marginally and all rates-up scenarios show slightly less benefit compared to the results as of December 31, 2020. When rates do go up, most assets with the ability to reprice off a key benchmark rate will generally reprice by the full amount of the Federal Reserve’s rate movement while liabilities will lag and reprice by a much smaller amount, i.e. only a proportion of the asset rate increases. But that proportion is expected to be slightly higher than in past rate cycles. Financial institutions are benefiting from a larger level of deposit balances as a result of the historically long and very low interest rate cycle and the change in customer behavior throughout 2020 and 2021. The analysis above assumes no growth of the Corporation’s balance sheet and no change in the mix of earning assets. This is a very conservative analysis but importantly still shows that the Corporation should benefit when rates rise by achieving a larger increase in income associated with repricing assets than increased expense paid on repricing liabilities.

 

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.

 

Change in Net Portfolio Value

 

The change in NPV gives a long-term view of the exposure to changes in interest rates. The NPV is calculated by discounting the future cash flows to the present value based on current market rates. The NPV is the mathematical equivalent of the present value of assets minus the present value of liabilities.

 

The table below indicates the changes in the Corporation’s NPV as of December 31, 2021 and December 31, 2020. As part of the Asset Liability Policy, the Board of Directors has established risk measurement guidelines to protect the Corporation against decreases in the net portfolio value and net interest income in the event of the interest rate changes described below.

 

As of December 31, 2021, the Corporation was within guidelines for all up-rate scenarios but was outside of guidelines for the down-rate scenarios. The positive impact of higher rates on both loans and securities was up from December 31, 2020. On the liability side of the Corporation’s balance sheet, the value of non-interest bearing deposit accounts only becomes more and more valuable as interest rates rise, which is reflected in NPV as a decrease in liabilities. These deposits have always been highly favorable in a rising rate environment as these balances are more valuable to the Corporation, representing a decrease in liabilities as interest rates rise. The non-interest bearing demand deposit accounts and low-interest bearing checking, NOW, and money market accounts also provide more benefit to the Corporation when interest rates rise and the difference between the overnight funding costs compared to the average interest bearing core deposit rates are greater. As interest rates increase, the discount rate used to value the Corporation’s interest bearing accounts increases, causing a lower net present value. This improves the modeling of the Corporation’s fair value risk as the liability amounts decrease, causing the net present value or fair value of the Corporation’s balance sheet to increase. This was especially apparent throughout 2020 and 2021 as the Corporation’s deposits grew at a very fast pace. The much higher complement of long modeling deposits caused the changes in net portfolio value to be more exaggerated in both the up and down-rate scnenarios as of December 31, 2021 and 2020.

 

CHANGES IN NET PORTFOLIO VALUE

 

		2021				2020				Policy
		Percentage				Percentage				Guidelines
		Change				Change				%
300 basis point rise			28.5				31.2				(15.00	)
200 basis point rise			21.7				26.8				(10.00	)
100 basis point rise			14.7				17.7				(5.00	)
Base rate scenario			—				—				—
25 basis point decline			(6.3	)			(6.9	)			(3.75	)
50 basis point decline			(14.1	)			(17.2	)			(7.50	)
75 basis point decline			(22.5	)			(26.5	)			(11.25	)

 

This table shows the effect of an immediate interest rate shock on the net portfolio value of the Corporation's

assets and liabilities.  Base rate is the Prime rate.

 

The results as of December 31, 2021, indicate that the Corporation’s net portfolio value would experience valuation

gains in all up-rate scenarios with a gain of 14.7% in the rates-up 100 basis point scenario, and gains of 21.7% and 28.5%, in the rates-up 200 and 300 basis point scenarios, respectively. A valuation gain indicates that the value of the Corporation’s assets is declining at a slower pace than the decrease in the value of the Corporation’s liabilities. Even though the Corporation has some longer-term assets such as residential mortgages and municipal securities which show declines in value as interest rates increase further, the large balances of core deposits more than offsets this fair value exposure of the longer-term assets.

 

The changes in net portfolio value do show exposure in the down-rate scenarios that is outside of policy guidelines. A valuation loss would indicate 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. While the down-rate scenarios that are modeled are currently unlikely, the analysis does show a valuation loss in all down-rate scenarios. Even outside of the interest rate environment, the Corporation’s exposure to valuation changes could change going forward if the mix of the Corporation’s deposits change, which would impact the average life of those deposits.