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Section 1: 10-Q (10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended September 30, 2018

OR

 

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

 

For the transition period from _______________________ to _______________________

 

 

ENB Financial Corp

(Exact name of registrant as specified in its charter)

 

Pennsylvania 000-53297 51-0661129
(State or Other Jurisdiction of Incorporation) (Commission File Number) (IRS Employer Identification No)

 

 

31 E. Main St., Ephrata, PA       17522-0457        
(Address of principal executive offices) (Zip Code)  

 

 

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

 

Former name, former address, and former fiscal year, if changed since last report           Not Applicable          

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x          No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

Yes x          No o

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

  Large accelerated filer o Accelerated filer o
  Non-accelerated filer o Smaller reporting company x
      Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   o

 

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

Yes o          No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of November 1, 2018, the registrant had 2,857,874 shares of $0.20 (par) Common Stock outstanding.

 

 

ENB FINANCIAL CORP

INDEX TO FORM 10-Q

September 30, 2018

 

 

Part I – FINANCIAL INFORMATION  
       
  Item 1. Financial Statements  
       
  Consolidated Balance Sheets at September 30, 2018 and 2017, and December 31, 2017 (Unaudited) 3
       
  Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited) 4
       
  Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited) 5
       
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017 (Unaudited) 6
       
  Notes to the Unaudited Consolidated Interim Financial Statements 7-31
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32-67
       
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 68-73
       
  Item 4.   Controls and Procedures 74
       
       
       
Part II – OTHER INFORMATION 75
       
  Item 1. Legal Proceedings 75
       
  Item 1A. Risk Factors 75
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 75
       
  Item 3. Defaults Upon Senior Securities 75
       
  Item 4. Mine Safety Disclosures 75
       
  Item 5. Other Information 75
       
  Item 6. Exhibits 76
       
       
SIGNATURE PAGE 77

 

Index 

Part I - Financial Information

Item 1. Financial Statements

 

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

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

             

 

   September 30,   December 31,   September 30, 
   2018   2017   2017 
   $   $   $ 
ASSETS               
Cash and due from banks   17,097    21,867    18,426 
Interest-bearing deposits in other banks   11,091    31,206    25,814 
                
   Total cash and cash equivalents   28,188    53,073    44,240 
                
Securities available for sale (at fair value)   295,335    314,078    315,078 
Equity securities (at fair value)   5,789    5,583    5,617 
                
Loans held for sale   2,804    2,892    3,809 
                
Loans (net of unearned income)   667,769    597,553    584,077 
                
   Less: Allowance for loan losses   8,428    8,240    8,028 
                
   Net loans   659,341    589,313    576,049 
                
Premises and equipment   25,730    25,687    24,402 
Regulatory stock   6,392    5,794    6,139 
Bank owned life insurance   27,901    27,814    25,161 
Other assets   10,715    9,388    9,583 
                
       Total assets   1,062,195    1,033,622    1,010,078 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
                
Liabilities:               
  Deposits:               
    Noninterest-bearing   346,827    314,917    301,978 
    Interest-bearing   544,099    551,560    536,847 
                
    Total deposits   890,926    866,477    838,825 
                
  Short-term borrowings   1,074         
  Long-term debt   68,361    65,850    68,350 
  Other liabilities   2,632    1,536    2,036 
                
       Total liabilities   962,993    933,863    909,211 
                
Stockholders' equity:               
  Common stock, par value $0.20;               
Shares:  Authorized 12,000,000               
             Issued 2,869,557 and Outstanding  2,861,274 as of 9/30/18               
             Issued 2,869,557 and Outstanding 2,849,823 as of 12/31/17               
             Issued 2,869,557 and Outstanding  2,848,679 as of 9/30/17   574    574    574 
  Capital surplus   4,436    4,415    4,413 
  Retained earnings   102,670    98,629    98,815 
  Accumulated other comprehensive loss net of tax   (8,200)   (3,195)   (2,232)
  Less: Treasury stock cost on 8,283 shares as of 9/30/18               
  19,734 shares as of 12/31/17 and 20,878 shares as of 9/30/17   (278)   (664)   (703)
                
       Total stockholders' equity   99,202    99,759    100,867 
                
       Total liabilities and stockholders' equity   1,062,195    1,033,622    1,010,078 

 

See Notes to the Unaudited Consolidated Interim Financial Statements  

Index 

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

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

                   

   Three Months ended September 30,   Nine Months ended September 30, 
   2018   2017   2018   2017 
   $   $   $   $ 
Interest and dividend income:                    
Interest and fees on loans   7,157    6,180    20,259    17,996 
Interest on securities available for sale                    
Taxable   1,207    997    3,494    2,818 
Tax-exempt   701    1,051    2,196    3,281 
Interest on deposits at other banks   141    111    388    257 
Dividend income   142    105    432    287 
                     
Total interest and dividend income   9,348    8,444    26,769    24,639 
                     
Interest expense:                    
Interest on deposits   512    489    1,503    1,438 
Interest on borrowings   360    265    985    749 
                     
Total interest expense   872    754    2,488    2,187 
                     
Net interest income   8,476    7,690    24,281    22,452 
                     
Provision for loan losses   190    240    470    450 
                     
Net interest income after provision for loan losses   8,286    7,450    23,811    22,002 
                     
Other income:                    
Trust and investment services income   449    427    1,477    1,335 
Service fees   853    648    2,351    1,894 
Commissions   658    583    1,899    1,714 
Gains (losses) on the sale of debt securities, net   4    170    (24)   417 
Gains on equity securities, net   3        50     
Gains on sale of mortgages   515    510    1,102    1,302 
Earnings on bank-owned life insurance   186    170    1,477    514 
Other income   119    114    463    370 
                     
Total other income   2,787    2,622    8,795    7,546 
                     
Operating expenses:                    
Salaries and employee benefits   5,197    4,840    15,378    14,370 
Occupancy   624    624    1,889    1,828 
Equipment   296    299    875    878 
Advertising & marketing   147    143    583    539 
Computer software & data processing   590    575    1,708    1,654 
Shares tax   226    215    669    644 
Professional services   438    377    1,376    1,260 
Other expense   553    574    1,644    1,707 
                     
Total operating expenses   8,071    7,647    24,122    22,880 
                     
Income before income taxes   3,002    2,425    8,484    6,668 
                     
Provision for federal income taxes   425    391    960    935 
                     
Net income   2,577    2,034    7,524    5,733 
                     
Earnings per share of common stock   0.90    0.71    2.64    2.01 
                     
Cash dividends paid per share   0.29    0.28    0.86    0.84 
                     
Weighted average shares outstanding   2,858,002    2,848,504    2,854,010    2,849,849 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

Index 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(DOLLARS IN THOUSANDS)

 

   Three Months ended September 30,   Nine Months ended September 30, 
   2018   2017   2018   2017 
   $   $   $   $ 
                 
Net income   2,577    2,034    7,524    5,733 
                     
Other comprehensive income (loss), net of tax:                    
Securities available for sale not other-than-temporarily impaired:                    
                     
   Unrealized gains (losses) arising during the period   (1,796)   (406)   (5,562)   4,437 
   Income tax effect   377    138    1,172    (1,509)
    (1,419)   (268)   (4,390)   2,928 
                     
                     
Gain/(loss) on sale of debt securities recognized in earnings   (4)   (170)   24   (417)
   Income tax effect   1   58    (5)   142 
    (3)   (112)   19   (275)
                     
                     
Other comprehensive income (loss), net of tax   (1,422)   (380)   (4,371)   2,653 
                     
Comprehensive Income   1,155    1,654    3,153    8,386 

 

See Notes to the Unaudited Consolidated Interim Financial Statements  

Index 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

(DOLLARS IN THOUSANDS)  Nine Months Ended September 30, 
   2018   2017 
   $   $ 
Cash flows from operating activities:          
Net income   7,524    5,733 
Adjustments to reconcile net income to net cash          
provided by operating activities:          
Net amortization of securities premiums and discounts and loan fees   3,024    2,936 
Decrease (increase) in interest receivable   (36)   359 
Increase in interest payable   33    7 
Provision for loan losses   470    450 
(Gain) loss on sale of debt securities, net   24    (417)
Gain on equity securities, net   (50)    
Gain on sale of mortgages   (1,102)   (1,302)
Loans originated for sale   (32,227)   (34,064)
Proceeds from sales of loans   33,417    34,109 
Earnings on bank-owned life insurance   (1,477)   (514)
Depreciation of premises and equipment and amortization of software   1,217    1,229 
Deferred income tax   (10)   (159)
Other assets and other liabilities, net   2,241    (71)
Net cash provided by operating activities   13,048    8,296 
           
Cash flows from investing activities:          
Securities available for sale:          
   Proceeds from maturities, calls, and repayments   13,048    14,855 
   Proceeds from sales   45,734    60,404 
   Purchases   (50,279)   (86,007)
Proceeds from the sale of equity securities   222     
Purchase of regulatory bank stock   (1,860)   (2,537)
Redemptions of regulatory bank stock   1,262    1,770 
Purchase of bank-owned life insurance   26     
Net increase in loans   (70,880)   (12,829)
Purchases of premises and equipment, net   (1,135)   (2,882)
Purchase of computer software   (58)   (102)
Net cash used for investing activities   (63,920)   (27,328)
           
Cash flows from financing activities:          
Net increase in demand, NOW, and savings accounts   35,324    30,680 
Net decrease in time deposits   (10,875)   (9,346)
Net increase (decrease) in short-term borrowings   1,074    (8,329)
Proceeds from long-term debt   14,161    17,093 
Repayments of long-term debt   (11,650)   (10,000)
Dividends paid   (2,454)   (2,393)
Proceeds from sale of treasury stock   407    403 
Treasury stock purchased       (468)
Net cash provided by financing activities   25,987    17,640 
Decrease in cash and cash equivalents   (24,885)   (1,392)
Cash and cash equivalents at beginning of period   53,073    45,632 
Cash and cash equivalents at end of period   28,188    44,240 
           
Supplemental disclosures of cash flow information:          
    Interest paid   2,457    2,180 
    Income taxes paid   375    1,175 
           
Supplemental disclosure of non-cash investing and financing activities:          
Fair value adjustments for securities available for sale   5,479    (4,020)

 

See Notes to the Unaudited Consolidated Interim Financial Statements  

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

1.       Summary of Significant Accounting Policies

 

Basis of Presentation

 

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

 

ENB Financial Corp (“the Corporation”) is the bank holding company for its wholly-owned subsidiary Ephrata National Bank (the “Bank”). This Form 10-Q, for the third quarter of 2018, is reporting on the results of operations and financial condition of ENB Financial Corp.

 

Operating results for the nine months ended September 30, 2018, are not necessarily indicative of the results that may be expected for the year ended December 31, 2018. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

Revenue from Contracts with Customers

 

The Company records revenue from contracts with customers in accordance with Accounting Standards Topic 606, Revenue from Contracts with Customers (Topic 606). Under Topic 606, the Corporation must identify contracts with customers, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when the Corporation satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

 

The Corporation’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Corporation has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

Financial Instruments

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (g) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

ASU 2016-01 was effective for the Corporation on January 1, 2018, and resulted in separate classification of equity securities previously included in available for sale securities on the consolidated balance sheets with changes in the fair value of the equity securities captured in the consolidated statements of income. See Note 3 – Securities for disclosures related to equity securities. Adoption of the standard also resulted in the use of an exit price rather than an entrance price to determine the fair value of loans not measured at fair value on a non-recurring basis in the consolidated balance sheets. See Note 5 – Fair Value Presentation for further information regarding the valuation of these loans.

 

Nonrefundable Fees and Other Costs

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The Corporation elected to early adopt the Update effective January 1, 2018. Upon adoption, the Corporation made a one-time cumulative effect adjustment from accumulated other comprehensive income to retained earnings of $1.7 million. The net effect was a decrease to retained earnings.

 

Reporting Comprehensive Income

 

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220), to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. Upon adoption in February 2018, the Corporation made a one-time cumulative effect adjustment from accumulated other comprehensive income to retained earnings of $634,000. The net effect was an increase to retained earnings.

 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

2.       Securities Available for Sale

 

The amortized cost, gross unrealized gains and losses, and fair value of securities held at September 30, 2018, and December 31, 2017, are as follows:

  

      Gross  Gross   
(DOLLARS IN THOUSANDS)  Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
   $  $  $  $
September 30, 2018                    
U.S. government agencies   35,083        (1,593)   33,490 
U.S. agency mortgage-backed securities   48,542        (2,292)   46,250 
U.S. agency collateralized mortgage obligations   56,545    20    (2,021)   54,544 
Asset-backed securities   7,772    1    (26)   7,747 
Corporate bonds   59,748        (1,503)   58,245 
Obligations of states and political subdivisions   98,025    7    (2,973)   95,059 
Total debt securities available for sale   305,715    28    (10,408)   295,335 
                     
December 31, 2017                    
U.S. government agencies   35,101        (749)   34,352 
U.S. agency mortgage-backed securities   52,981    8    (916)   52,073 
U.S. agency collateralized mortgage obligations   55,493    46    (898)   54,641 
Corporate bonds   61,334    24    (589)   60,769 
Obligations of states and political subdivisions   114,047    243    (2,047)   112,243 
Total debt securities   318,956    321    (5,199)   314,078 
Equity securities   5,547    36        5,583 
Total securities available for sale   324,503    357    (5,199)   319,661 

 

The amortized cost and fair value of debt securities available for sale at September 30, 2018, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.

 

CONTRACTUAL MATURITY OF DEBT SECURITIES      
(DOLLARS IN THOUSANDS)      
   Amortized   
   Cost  Fair Value
   $  $
Due in one year or less   13,818    13,310 
Due after one year through five years   140,922    136,039 
Due after five years through ten years   38,896    37,280 
Due after ten years   112,079    108,706 
Total debt securities   305,715    295,335 

 

 

Securities available for sale with a par value of $63,950,000 and $64,580,000 at September 30, 2018, and December 31, 2017, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $63,360,000 at September 30, 2018, and $66,157,000 at December 31, 2017.

 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

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

 

 

PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE   
(DOLLARS IN THOUSANDS)            
             
   Three Months Ended September 30,  Nine Months Ended September 30,
   2018  2017  2018  2017
   $  $  $  $
Proceeds from sales   13,092    20,319    45,734    60,404 
Gross realized gains   20    243    130    631 
Gross realized losses   16    73    154    214 

 

 

Management evaluates all of the Corporation’s securities for other than temporary impairment (OTTI) on a periodic basis. No securities in the portfolio had other-than-temporary impairment recorded in the first nine months of 2018 or 2017.

 

Information pertaining to securities with gross unrealized losses at September 30, 2018, and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

 

TEMPORARY IMPAIRMENTS OF SECURITIES                  
(DOLLARS IN THOUSANDS)                  
   Less than 12 months  More than 12 months  Total   
      Gross     Gross     Gross
   Fair  Unrealized  Fair  Unrealized  Fair  Unrealized
   Value  Losses  Value  Losses  Value  Losses
   $  $  $  $  $  $
As of September 30, 2018                  
U.S. government agencies   5,809    (191)   27,681    (1,402)   33,490    (1,593)
U.S. agency mortgage-backed securities   6,667    (141)   39,583    (2,151)   46,250    (2,292)
U.S. agency collateralized mortgage obligations   15,815    (267)   37,153    (1,754)   52,968    (2,021)
Asset-backed securities   4,828    (26)           4,828    (26)
Corporate bonds   28,509    (521)   27,721    (982)   56,230    (1,503)
Obligations of states & political subdivisions   35,787    (803)   57,246    (2,170)   93,033    (2,973)
                               
Total temporarily impaired securities   97,415    (1,949)   189,384    (8,459)   286,799    (10,408)
                               
                               
As of December 31, 2017                              
U.S. government agencies   9,941    (59)   24,411    (690)   34,352    (749)
U.S. agency mortgage-backed securities   10,326    (78)   37,123    (838)   47,449    (916)
U.S. agency collateralized mortgage obligations   29,551    (280)   20,980    (618)   50,531    (898)
Corporate bonds   38,543    (282)   15,019    (307)   53,562    (589)
Obligations of states & political subdivisions   15,188    (142)   68,278    (1,905)   83,466    (2,047)
                               
Total temporarily impaired securities   103,549    (841)   165,811    (4,358)   269,360    (5,199)

 

 

In the debt security portfolio there were 201 positions that were carrying unrealized losses as of September 30, 2018. There were no instruments considered to be other-than-temporarily impaired at September 30, 2018.

 

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ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The Corporation evaluates fixed maturity positions for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluation. U.S. generally accepted accounting principles provide for the bifurcation of OTTI into two categories: (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss), which is recognized in earnings, and (b) the amount of total OTTI related to all other factors, which is recognized, net of taxes, as a component of accumulated other comprehensive income.

 

 

3.       Equity Securities

 

The following table summarizes the amortized cost, gross unrealized gains and losses, and fair value of equity securities held at September 30, 2018.

 

      Gross  Gross   
(DOLLARS IN THOUSANDS)  Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
   $  $  $  $
September 30, 2018                    
CRA-qualified mutual funds   5,374            5,374 
Bank stocks   396    25    (6)   415 
Total equity securities   5,770    25    (6)   5,789 

 

 

As of January 1, 2018, the Corporation adopted ASU 2016-01, resulting in the reclassification of equity securities from available-for-sale.

 

The following table presents the net gains and losses on the Corporation’s equity investments recognized in earnings during the quarter and year-to-date periods ended September 30, 2018, and the portion of unrealized gains and losses for the periods that relates to equity investments held as of September 30, 2018.

 

 

NET GAINS AND LOSSES ON EQUITY INVESTMENTS RECOGNIZED IN EARNINGS
(DOLLARS IN THOUSANDS)   
   Three Months Ended  Nine Months Ended
   September 30, 2018  September 30, 2018
   $  $
       
Net gains (losses)  recognized in equity securities during the period   3   50 
           
Less:  Net gains realized on the sale of equity securities during the period   10    40 
           
Unrealized gains (losses) recognized in equity securities held at reporting date   (7)   10 

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ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

4.        Loans and Allowance for Loan Losses

 

The following table presents the Corporation’s loan portfolio by category of loans as of September 30, 2018, and December 31, 2017:

 

LOAN PORTFOLIO      
(DOLLARS IN THOUSANDS)      
   September 30,  December 31,
   2018  2017
   $  $
Commercial real estate          
Commercial mortgages   100,871    90,072 
Agriculture mortgages   157,057    152,050 
Construction   19,245    18,670 
Total commercial real estate   277,173    260,792 
           
Consumer real estate (a)          
1-4 family residential mortgages   207,992    176,971 
Home equity loans   10,328    11,181 
Home equity lines of credit   64,151    61,104 
Total consumer real estate   282,471    249,256 
           
Commercial and industrial          
Commercial and industrial   54,836    41,426 
Tax-free loans   23,008    20,722 
Agriculture loans   19,274    18,794 
Total commercial and industrial   97,118    80,942 
           
Consumer   9,471    5,320 
           
Gross loans prior to deferred fees   666,233    596,310 
Less:          
Deferred loan costs, net   1,536    1,243 
Allowance for loan losses   (8,428)   (8,240)
Total net loans   659,341    589,313 

 

(a) Real estate loans serviced for others, which are not included in the Consolidated Balance Sheets, totaled $117,655,000 and $98,262,000 as of September 30, 2018, and December 31, 2017, respectively.

 

 

The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of September 30, 2018 and December 31, 2017. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.

 

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

 

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

 

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

 

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

 

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ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

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

 

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

 

 

COMMERCIAL CREDIT EXPOSURE      
CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE   
(DOLLARS IN THOUSANDS)     
                      
September 30, 2018  Commercial
Mortgages
  Agriculture
Mortgages
  Construction  Commercial
and
Industrial
  Tax-free
Loans
  Agriculture
Loans
  Total
   $  $  $  $  $  $  $
Grade:                                   
Pass   98,282    145,991    17,715    52,774    22,806    18,219    355,787 
Special Mention   315    3,251    1,530    570    202    508    6,376 
Substandard   2,274    7,815        1,492        547    12,128 
Doubtful                            
Loss                            
                                    
    Total   100,871    157,057    19,245    54,836    23,008    19,274    374,291 
                                    

 

December 31, 2017  Commercial
Mortgages
  Agriculture
Mortgages
  Construction  Commercial
and
Industrial
  Tax-free
Loans
  Agriculture
Loans
  Total
   $  $  $  $  $  $  $
Grade:                                   
Pass   86,259    143,037    17,670    37,947    20,514    17,798    323,225 
Special Mention   160    3,873        1,015    208    270    5,526 
Substandard   3,653    5,140    1,000    2,464        726    12,983 
Doubtful                            
Loss                            
                                    
    Total   90,072    152,050    18,670    41,426    20,722    18,794    341,734 

 

 

13 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and nonaccrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of September 30, 2018 and December 31, 2017:

 

CONSUMER CREDIT EXPOSURE
CREDIT RISK PROFILE BY PAYMENT PERFORMANCE
(DOLLARS IN THOUSANDS)
September 30, 2018  1-4 Family
Residential
Mortgages
  Home Equity
Loans
  Home Equity
Lines of
Credit
  Consumer  Total
Payment performance:  $  $  $  $  $
                
Performing   207,430    10,192    64,122    9,470    291,214 
Non-performing   562    136    29    1    728 
                          
   Total   207,992    10,328    64,151    9,471    291,942 
                          

 

December 31, 2017  1-4 Family
Residential
Mortgages
  Home Equity
Loans
  Home Equity
Lines of
Credit
  Consumer  Total
Payment performance:  $  $  $  $  $
                
Performing   176,576    11,181    61,074    5,305    254,136 
Non-performing   395        30    15    440 
                          
   Total   176,971    11,181    61,104    5,320    254,576 

 

14 

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ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of September 30, 2018 and December 31, 2017:

 

AGING OF LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
                      
                     Loans
         Greater           Receivable >
   30-59 Days  60-89 Days  than 90  Total Past     Total Loans  90 Days and
September 30, 2018  Past Due  Past Due  Days  Due  Current  Receivable  Accruing
   $  $  $  $  $  $  $
Commercial real estate                                   
   Commercial mortgages           17    17    100,854    100,871    17 
   Agriculture mortgages   432            432    156,625    157,057     
   Construction                   19,245    19,245     
Consumer real estate                                   
   1-4 family residential mortgages   243    518    55    816    207,176    207,992    55 
   Home equity loans   61            61    10,267    10,328     
   Home equity lines of credit           29    29    64,122    64,151    29 
Commercial and industrial                                   
   Commercial and industrial                   54,836    54,836     
   Tax-free loans                   23,008    23,008     
   Agriculture loans       128        128    19,146    19,274     
Consumer   7    2    1    10    9,461    9,471    1 
       Total   743    648    102    1,493    664,740    666,233    102 

 

 

                     Loans
         Greater           Receivable >
   30-59 Days  60-89 Days  than 90  Total Past     Total Loans  90 Days and
December 31, 2017  Past Due  Past Due  Days  Due  Current  Receivable  Accruing
   $  $  $  $  $  $  $
Commercial real estate                                   
   Commercial mortgages           372    372    89,700    90,072     
   Agriculture mortgages                   152,050    152,050     
   Construction                   18,670    18,670     
Consumer real estate                                   
   1-4 family residential mortgages   533    248    395    1,176    175,795    176,971    395 
   Home equity loans   40            40    11,141    11,181     
   Home equity lines of credit           30    30    61,074    61,104    30 
Commercial and industrial                                   
   Commercial and industrial   65    109        174    41,252    41,426     
   Tax-free loans                   20,722    20,722     
   Agriculture loans                   18,794    18,794     
Consumer   8    3    15    26    5,294    5,320    15 
       Total   646    360    812    1,818    594,492    596,310    440 

 

15 

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ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table presents nonaccrual loans by classes of the loan portfolio as of September 30, 2018 and December 31, 2017:

 

NONACCRUAL LOANS BY LOAN CLASS
(DOLLARS IN THOUSANDS)
   September 30,  December 31,
   2018  2017
   $  $
       
Commercial real estate          
  Commercial mortgages   375    393 
  Agriculture mortgages        
  Construction        
Consumer real estate          
  1-4 family residential mortgages   507     
  Home equity loans   136     
  Home equity lines of credit        
Commercial and industrial          
  Commercial and industrial        
  Tax-free loans        
  Agriculture loans        
Consumer        
             Total   1,018    393 

 

 

As of September 30, 2018 and December 31, 2017, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three and nine months ended September 30, 2018 and September 30, 2017, is as follows:

 

IMPAIRED LOANS
(DOLLARS IN THOUSANDS)
   Three months ended September 30,  Nine months ended September 30,
   2018  2017  2018  2017
   $  $  $  $
             
Average recorded balance of impaired loans   1,388    2,152    2,153    2,394 
Interest income recognized on impaired loans   11    17    42    49 

 

 

There were no loan modifications made during the nine months ended September 30, 2018 causing a loan to be considered a troubled debt restructuring (TDR). However, there was a loan modification made during the nine months ended September 30, 2017, that constituted a TDR. A TDR is a loan where management has granted a concession to a borrower that is experiencing financial difficulty. A concession is generally defined as more favorable payment or credit terms granted to a borrower in an effort to improve the likelihood of the lender collecting principal in its entirety. Concessions usually are in the form of interest only for a period of time, or a lower interest rate offered in an effort to enable the borrower to continue to make normally scheduled payments. The loan classified as a TDR during the three months ended March 31, 2017, was an agricultural loan. The concession initially granted to the borrower during the first quarter of 2017 was an interest-only period initially running for three months to March 31, 2017. However, on March 31, 2017, that deferral period was extended for an additional three months, causing management to classify the loan as a TDR. The concession period ended June 30, 2017. Subsequent to June 30, 2017, the borrower resumed normal principal and interest payments as of July 2017. This loan subsequently paid off in the third quarter of 2018.

 

16 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following tables summarize information regarding impaired loans by loan portfolio class as of September 30, 2018, December 31, 2017, and September 30, 2017:

 

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
September 30, 2018  Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
   $  $  $  $  $
                
With no related allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   429    958        506     
    Agriculture mortgages   884    884        1,017    35 
    Construction                    
Total commercial real estate   1,313    1,842        1,523    35 
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial                    
                          
Total with no related allowance   1,313    1,842        1,523    35 
                          
With an allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   589    629    116    464     
    Agriculture mortgages                    
    Construction                    
Total commercial real estate   589    629    116    464     
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans               166    6 
Total commercial and industrial               166    6 
                          
Total with a related allowance   589    629    116    630    6 
                          
Total by loan class:                         
Commercial real estate                         
    Commercial mortgages   1,018    1,587    116    970     
    Agriculture mortgages   884    884        1,017    35 
    Construction                    
Total commercial real estate   1,902    2,471    116    1,987    35 
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans               166    6 
Total commercial and industrial               166    6 
                          
Total   1,902    2,471    116    2,153    41 

 

17 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 
IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
December 31, 2017  Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
   $  $  $  $  $
                
With no related allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   393    690        585    4 
    Agriculture mortgages   1,174    1,174        1,210    54 
    Construction                    
Total commercial real estate   1,567    1,864        1,795    58 
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans   245    245        163    7 
Total commercial and industrial   245    245        163    7 
                          
Total with no related allowance   1,812    2,109        1,958    65 
                          
With an allowance recorded:                         
Commercial real estate                         
    Commercial mortgages                    
    Agriculture mortgages                    
    Construction                    
Total commercial real estate                    
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial                    
                          
Total with a related allowance                    
                          
Total by loan class:                         
Commercial real estate                         
    Commercial mortgages   393    690        585    4 
    Agriculture mortgages   1,174    1,174        1,210    54 
    Construction                    
Total commercial real estate   1,567    1,864        1,795    58 
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans   245    245        163    7 
Total commercial and industrial   245    245        163    7 
                          
Total   1,812    2,109        1,958    65 

18 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
September 30, 2017  Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
   $  $  $  $  $
                
With no related allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   195    292        281    4 
    Agriculture mortgages   1,193    1,193        1,220    40 
    Construction                    
Total commercial real estate   1,388    1,485        1,501    44 
                          
Commercial and industrial                         
    Commercial and industrial   75    75        75     
    Tax-free loans                    
    Agriculture loans   263    263        400    5 
Total commercial and industrial   338    338        475    5 
                          
Total with no related allowance   1,726    1,823        1,976    49 
                          
With an allowance recorded:                         
Commercial real estate                         
    Commercial mortgages   418    418    98    418     
    Agriculture mortgages                    
    Construction                    
Total commercial real estate   418    418    98    418     
                          
Commercial and industrial                         
    Commercial and industrial                    
    Tax-free loans                    
    Agriculture loans                    
Total commercial and industrial                    
                          
Total with a related allowance   418    418    98    418     
                          
Total by loan class:                         
Commercial real estate                         
    Commercial mortgages   613    710    98    699    4 
    Agriculture mortgages   1,193    1,193        1,220    40 
    Construction                    
Total commercial real estate   1,806    1,903    98    1,919    44 
                          
Commercial and industrial                         
    Commercial and industrial   75    75        75     
    Tax-free loans                    
    Agriculture loans   263    263        400    5 
Total commercial and industrial   338    338        475    5 
                          
Total   2,144    2,241    98    2,394    49 

 

19 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2018:

 

ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
                   
   Commercial
Real Estate
  Consumer
Real Estate
  Commercial
and Industrial
  Consumer  Unallocated  Total
   $  $  $  $  $  $
Allowance for credit losses:                              
Beginning balance - December 31, 2017   3,863    2,052    1,829    98    398    8,240 
                               
    Charge-offs   (224)       (110)   (18)       (352)
    Recoveries           4    1        5 
    Provision   408    137    (422)   (9)   76    190 
                               
Balance - March 31, 2018   4,047    2,189    1,301    72    474    8,083 
                               
    Charge-offs               (8)       (8)
    Recoveries           2    4        6 
    Provision   (43)   (7)   (21)   63    98    90 
                               
Ending Balance - June 30, 2018   4,004    2,182    1,282    131    572    8,171 
                               
    Charge-offs       (20)               (20)
    Recoveries   30        55    2        87 
    Provision   90    192    90    (16)   (166)   190 
                               
Ending Balance - September 30, 2018   4,124    2,354    1,427    117    406    8,428 

 

During the nine months ended September 30, 2018, management charged off $380,000 in loans while recovering $98,000 and added $470,000 to the provision. The level of charge-offs along with the growth in the loan portfolio was primarily responsible for the $470,000 of additional provision.

During the nine months ended September 30, 2018, provision expenses were recorded for the commercial real estate, consumer real estate, and consumer segments with a credit provision recorded for the commercial and industrial segment. The increase in the allowance for commercial real estate loans was primarily a result of higher levels of charge-offs in the first nine months of 2018 as well as the addition of $116,000 of specific reserves allocated to this loan segment. The increase in the amount of the allowance for loan losses allocated to the consumer real estate and consumer segment was primarily a result of growth in these portfolios during the nine months ended September 30, 2018. The decrease in commercial and industrial loans from December 31, 2017 to September 30, 2018, was caused by a qualitative factor change across the portfolio and also by the declining level of substandard commercial and industrial loans. The qualitative factors were adjusted across the loan portfolio to better reflect the forward risk in each portfolio. Commercial and consumer real estate carried heavier risk factors, while commercial and industrial was adjusted down. While commercial and industrial did have charge-offs in the first quarter of 2018 they were relative to the size of the allowance and sufficiently covered with prior provisions. There was no commercial and industrial charge-offs in the second or third quarters of 2018, and the amount of commercial and industrial loans rated substandard declined from $2.5 million on December 31, 2017, to $1.5 million on September 30, 2018. While the balances of commercial and industrial loans increased moderately from December 31, 2017 to September 30, 2018, the required allowance and related provision for these loans is influenced more heavily by the amount of classified loans.

Delinquency rates among the Corporation's loan pools remain low and made up 0.34% of total loans as of September 30, 2018, compared to 0.31% of total loans as of December 31, 2017. Charge-offs for the nine months ended September 30, 2018, were $380,000, however $352,000 of the charge-offs came in the first quarter of 2018, with third quarter 2018 charge-offs being very low at $20,000. Classified loans continued to decline in the first nine months of 2018, from $16.6 million on December 31, 2017, to $15.9 million as of September 30, 2018. Classified loans were significantly higher at $21.0 million as of September 30, 2017. The agricultural lending sector has generally been under stress over the past several years due to lower milk and egg prices. These are the two indicators that have the most immediate impact to the majority of the Corporation's agricultural borrowers. In 2018, egg prices improved with better pricing on average than 2017. After a first quarter spike, egg prices have stabilized over the past two quarters, while closing in on the three-year average. However, milk prices remain at a three-year low, with 2018 prices lower on average than in 2017. Milk prices have slightly improved as of the end of the third quarter of 2018, but margins are very thin and overcapacity remains an issue with some consolidation occurring in the local dairy industry. The health of the Corporation's commercial real estate and commercial and industrial borrowers is generally stable with no material trends related to certain types of industries. Commercial borrowers that have exposure to agriculture are subject to more financial stress in the current environment.

Outside of the above measurements and indicators, management continues to utilize nine qualitative factors to continually refine the potential credit risks across the Corporation's various loan types. The majority of the qualitative factors had little change during 2018. Minor adjustments to the qualitative factors covering trends in the nature of the loan portfolio and levels and trends of delinquencies and charge-offs were made throughout the year as these levels increased or decreased. The qualitative factor covering experience, ability and depth of lending management was reduced as loan teams remained consistent with more experience in all aspects of lending. The qualitative factor for external factors such as competition and legal and regulatory changes was increased for agricultural dairy loans to be consistent with the higher qualitative factor for economic conditions, which already was in place as of December 31, 2017. The same qualitative factor for external influence was reduced for residential real estate and consumer lending where loan underwriting personnel have grown accustomed to the most recently enacted regulatory requirements.

 

20 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2017:

 

ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
                   
   Commercial
Real Estate
  Consumer
Real Estate
  Commercial
and Industrial
  Consumer  Unallocated  Total
   $  $  $  $  $  $
Allowance for credit losses:                              
Beginning balance - December 31, 2016   3,795    1,652    1,552    82    481    7,562 
                               
    Charge-offs           (7)   (4)       (11)
    Recoveries       20    9    2        31 
    Provision   (275)   163    95    3    104    90 
                               
Balance - March 31, 2017   3,520    1,835    1,649    83    585    7,672 
                               
    Charge-offs               (3)       (3)
    Recoveries           10    3        13 
    Provision   208    83    (42)   36    (165)   120 
                               
Balance - June 30, 2017   3,728    1,918    1,617    119    420    7,802 
                               
    Charge-offs           (7)   (9)       (16)
    Recoveries           2            2 
    Provision   31    (16)   201    (18)   42    240 
                               
Balance - September 30, 2017   3,759    1,902    1,813    92    462    8,028 

 

 

During the nine months ended September 30, 2017, provision expenses were recorded for the consumer real estate, commercial and industrial, and consumer loan segments, with a credit provision recorded in the commercial real estate loan category. The decrease in the amount of allowance for loan losses allocated to commercial real estate was primarily due to a material decrease in commercial real estate loans over the first nine months of 2017. As of December 31, 2016, 50.2% of the Corporation’s allowance for loan losses was allocated to commercial real estate loans, which consisted of 48.2% of all loans. As of September 30, 2017, 46.8 % of the allowance was allocated to commercial real estate loans which consisted of 44.5% of total loans.

 

21 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following tables present the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of September 30, 2018 and December 31, 2017:

 

ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
                   
As of September 30, 2018:  Commercial
Real Estate
  Consumer
Real Estate
  Commercial
and Industrial
  Consumer  Unallocated  Total
   $  $  $  $  $  $
Allowance for credit losses:                              
Ending balance: individually evaluated                              
  for impairment   116                    116 
Ending balance: collectively evaluated                              
  for impairment   4,008    2,354    1,427    117    406    8,312 
                               
Loans receivable:                              
Ending balance   277,173    282,471    97,118    9,471         666,233 
Ending balance: individually evaluated                              
  for impairment   1,902                     1,902 
Ending balance: collectively evaluated                              
  for impairment   275,271    282,471    97,118    9,471         664,331 
                               

 

As of December 31, 2017:  Commercial
Real Estate
  Consumer
Real Estate
  Commercial
and Industrial
  Consumer  Unallocated  Total
   $  $  $  $  $  $
Allowance for credit losses:                              
Ending balance: individually evaluated                              
  for impairment                        
Ending balance: collectively evaluated                              
  for impairment   3,863    2,052    1,829    98    398    8,240 
                               
Loans receivable:                              
Ending balance   260,792    249,256    80,942    5,320         596,310 
Ending balance: individually evaluated                              
  for impairment   1,567        245             1,812 
Ending balance: collectively evaluated                              
  for impairment   259,225    249,256    80,697    5,320         594,498 

 

22 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

5. Fair Value Presentation

 

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

 

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

 

Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

 

Level III: Assets and liabilities that have little to no observable pricing as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

The following tables provide the fair market value for assets required to be measured and reported at fair value on a recurring basis on the Consolidated Balance Sheets as of September 30, 2018, and December 31, 2017, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

 

ASSETS MEASURED ON A RECURRING BASIS
(DOLLARS IN THOUSANDS)
   September 30, 2018
   Level I  Level II  Level III  Total
   $  $  $  $
             
U.S. government agencies       33,490        33,490 
U.S. agency mortgage-backed securities       46,250        46,250 
U.S. agency collateralized mortgage obligations       54,544        54,544 
Asset-backed securities       7,747        7,747 
Corporate bonds       58,245        58,245 
Obligations of states & political subdivisions       95,059        95,059 
Equity securities   5,789            5,789 
                     
Total securities   5,789    295,335        301,124 

 

 

On September 30, 2018, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of September 30, 2018, the CRA fund investments had a $5,374,000 book and fair market value and the bank stock portfolio had a book value of $396,000, and fair market value of $415,000.

 

Financial instruments are considered level III when their values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.

23 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

ASSETS MEASURED ON A RECURRING BASIS            
(DOLLARS IN THOUSANDS)            
   December 31, 2017
   Level I  Level II  Level III  Total
   $  $  $  $
             
U.S. government agencies       34,352        34,352 
U.S. agency mortgage-backed securities       52,073        52,073 
U.S. agency collateralized mortgage obligations       54,641        54,641 
Corporate bonds       60,769        60,769 
Obligations of states & political subdivisions       112,243        112,243 
Equity securities   5,583            5,583 
                     
Total securities   5,583    314,078        319,661 

 

 

On December 31, 2017, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of December 31, 2017, the CRA fund investments had a $5,280,000 book and market value and the bank stocks had a book value of $267,000 and a market value of $303,000.

 

The following tables provide the fair value for each class of assets required to be measured and reported at fair value on a nonrecurring basis on the Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017, by level within the fair value hierarchy:

 

ASSETS MEASURED ON A NONRECURRING BASIS

(Dollars in Thousands)

   September 30, 2018 
   Level I
$
   Level II
$
   Level III
$
   Total
$
 
Assets:                    
   Impaired Loans           1,786    1,786 
Total           1,786    1,786 

 

 

   December 31, 2017 
   Level I
$
   Level II
$
   Level III
$
   Total
$
 
Assets:                    
   Impaired Loans           1,812    1,812 
Total           1,812    1,812 

 

The Corporation had a total of $1,902,000 of impaired loans as of September 30, 2018, with $116,000 of specific allocation against these loans and $1,812,000 of impaired loans as of December 31, 2017, with no specific allocation against these loans. The value of impaired loans is generally determined through independent appraisals of the underlying collateral.

 

24 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

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

 

QUANTITATIVE INFORMATION ABOUT LEVEL III FAIR VALUE MEASUREMENTS  
(DOLLARS IN THOUSANDS)  
  September 30, 2018  
  Fair Value Valuation Unobservable Range  
  Estimate Techniques Input (Weighted Avg)  
           
Impaired loans            1,786 Appraisal of Appraisal -20% (-20%)  
    collateral (1) adjustments (2)    
      Liquidation -10% (-10%)  
      expenses (2)    
           

 

  December 31, 2017  
   Fair Value  Valuation Unobservable  Range  
  Estimate Techniques Input (Weighted Avg)  
           
Impaired loans             1,812 Appraisal of Appraisal -20% (-20%)  
    collateral (1) adjustments (2)    
      Liquidation  -10% (-10%)  
      expenses (2)    

 

 

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable.

 

(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.        

 

25 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following table provides the carrying amount for each class of assets and liabilities and the fair value for certain financial instruments that are not required to be measured or reported at fair value on the Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017:

 

FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE

(DOLLARS IN THOUSANDS)

 

   September 30, 2018
         Quoted Prices in      
         Active Markets  Significant Other  Significant
         for Identical  Observable  Unobservable
   Carrying     Assets  Inputs  Inputs
   Amount  Fair Value  (Level 1)  (Level II)  (Level III)
   $  $  $  $  $
Financial Assets:                         
Cash and cash equivalents   28,188    28,188    28,188         
Regulatory stock   6,392    6,392    6,392         
Loans held for sale   2,804    2,804    2,804         
Loans, net of allowance   659,341    653,495            653,495 
Mortgage servicing assets   837    946            946 
Accrued interest receivable   3,719    3,719    3,719         
Bank owned life insurance   27,901    27,901    27,901         
                          
Financial Liabilities:                         
Demand deposits   346,827    346,827    346,827         
Interest-bearing demand deposits   19,379    19,379    19,379         
NOW accounts   86,031    86,031    86,031         
Money market deposit accounts   103,080    103,080    103,080         
Savings accounts   197,075    197,075    197,075         
Time deposits   138,534    138,313            138,313 
     Total deposits   890,926    890,705    752,392        138,313 
                          
Short-term borrowings   1,074    1,074    1,074         
Long-term debt   68,361    68,361            68,361 
Accrued interest payable   417    417    417         

 

26 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE

(DOLLARS IN THOUSANDS)

 

   December 31, 2017
         Quoted Prices in      
         Active Markets  Significant Other  Significant
         for Identical  Observable  Unobservable
   Carrying     Assets  Inputs  Inputs
   Amount  Fair Value  (Level 1)  (Level II)  (Level III)
   $  $  $  $  $
Financial Assets:                         
Cash and cash equivalents   53,073    53,073    53,073         
Regulatory stock   5,794    5,794    5,794         
Loans held for sale   2,892    2,892    2,892         
Loans, net of allowance   589,313    590,415            590,415 
Mortgage servicing assets   661    751            751 
Accrued interest receivable   3,684    3,684    3,684         
Bank owned life insurance   27,814    27,814    27,814         
                          
Financial Liabilities:                         
Demand deposits   314,917    314,917    314,917         
Interest-bearing demand deposits   20,230    20,230    20,230         
NOW accounts   86,758    86,758    86,758         
Money market deposit accounts   105,994    105,994    105,994         
Savings accounts   189,169    189,169    189,169         
Time deposits   149,409    150,165            150,165 
     Total deposits   866,477    867,233    717,068        150,165 
                          
Long-term debt   65,850    65,850            65,850 
Accrued interest payable   385    385    385         

 

 

7.       Commitments and Contingent Liabilities

 

In order to meet the financing needs of its customers in the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of September 30, 2018, firm loan commitments were $55.7 million, unused lines of credit were $234.5 million, and open letters of credit were $10.8 million. The total of these commitments was $301.0 million, which represents the Corporation’s exposure to credit loss in the event of nonperformance by its customers with respect to these financial instruments. The actual credit losses that may arise from these commitments are expected to compare favorably with the Corporation’s loan loss experience on its loan portfolio taken as a whole. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for balance sheet financial instruments.

 

27 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

8. Accumulated Other Comprehensive Loss

 

The activity in accumulated other comprehensive loss for the nine months ended September 30, 2018 and 2017 is as follows:

 

ACCUMULATED OTHER COMPREHENSIVE LOSS (1) (2)
(DOLLARS IN THOUSANDS)
   Unrealized
   Gains (Losses)
   on Securities
   Available-for-Sale
   $
Balance at December 31, 2017   (3,195)
  Other comprehensive loss before reclassifications   (2,685)
  Amount reclassified from accumulated other comprehensive loss   (27)
  Reclassification of certain income tax effects from accumulated other comprehensive income (loss)   (634)
Period change   (3,346)
      
Balance at March 31, 2018   (6,541)
  Other comprehensive loss before reclassifications   (286)
  Amount reclassified from accumulated other comprehensive loss   49 
Period change   (237)
      
Balance at June 30, 2018   (6,778)
  Other comprehensive loss before reclassifications   (1,419)
  Amount reclassified from accumulated other comprehensive loss   (3)
Period change   (1,422)
      
Balance at September 30, 2018   (8,200)
      
      
      
      
Balance at December 31, 2016   (4,885)
  Other comprehensive income before reclassifications   418 
  Amount reclassified from accumulated other comprehensive loss   (92)
Period change   326 
      
Balance at March 31, 2017   (4,559)
  Other comprehensive income before reclassifications   2,778 
  Amount reclassified from accumulated other comprehensive loss   (71)
Period change   2,707 
      
Balance at June 30, 2017   (1,852)
  Other comprehensive income before reclassifications   (268)
  Amount reclassified from accumulated other comprehensive loss   (112)
Period change   (380)
      
Balance at September 30, 2017   (2,232)

 

(1) All amounts are net of tax.  Related income tax expense or benefit is calculated using a Federal income tax rate of 21% for 2018 periods and 34% for 2017 periods.

(2) Amounts in parentheses indicate debits.  

28 

Index 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) COMPONENTS (1)
(DOLLARS IN THOUSANDS)
  Amount Reclassified from    
    Accumulated Other Comprehensive    
  Income (Loss)    
  For the Three Months    
  Ended September 30,    
  2018 2017   Affected Line Item in the
  $ $   Consolidated Statements of Income
Securities available-for-sale:        
  Net securities gains (losses), 170    Gains (losses) on the sale of
           reclassified into earnings              debt securities, net
     Related income tax expense (1) (58)   Provision for federal income taxes
  Net effect on accumulated other comprehensive        
     income for the period 112     

 

(1) Amounts in parentheses indicate debits.

 

 

  Amount Reclassified from    
  Accumulated Other Comprehensive    
  Income (Loss)    
  For the Nine Months    
  Ended September 30,    
  2018 2017   Affected Line Item in the
  $ $   Consolidated Statements of Income
Securities available-for-sale:        
  Net securities gains (losses), (24) 417    Gains (losses) on the sale of
           reclassified into earnings              debt securities, net
     Related income tax expense (142)   Provision for federal income taxes
  Net effect on accumulated other comprehensive        
     income for the period (19) 275     

 

(1) Amounts in parentheses indicate debits.        

 

 

9. Recently Issued Accounting Standards

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet.  A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Corporation is currently assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial statements. Based on the Corporation’s preliminary analysis of its current portfolio, the impact to the Corporation’s balance sheet is estimated to result in less than a 1 percent increase in assets and liabilities. The Corporation also anticipates additional disclosures to be provided at adoption.

In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842), which provides an optional transition practical expedient to not evaluate under Topic 842 existing or expired land easements that were not previously accounted for as leases under the current lease guidance in Topic 840. An entity that elects this practical expedient should evaluate new or modified land easements under Topic 842 beginning at the date the entity adopts Topic 842; otherwise, an entity should evaluate all existing or expired land easements in connection with the adoption of the new lease requirements in Topic 842 to assess whether they meet the definition of a lease. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in ASU 2016-02. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

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Notes to the Unaudited Consolidated Interim Financial Statements

 

In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10), to clarify certain aspects of the guidance issued in ASU 2016-01. (1) An entity measuring an equity security using the measurement alternative may change its measurement approach to a fair value method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issuer. Once an entity makes this election, the entity should measure all future purchases of identical or similar investments of the same issuer using a fair value method in accordance with Topic 820. (2) Adjustments made under the measurement alternative are intended to reflect the fair value of the security as of the date that the observable transaction for a similar security took place. (3) Remeasuring the entire value of forward contracts and purchased options is required when observable transactions occur on the underlying equity securities. (4) When the fair value option is elected for a financial liability, the guidance in paragraph 825-10- 45-5 should be applied, regardless of whether the fair value option was elected under either Subtopic 815-15, Derivatives and Hedging—Embedded Derivatives, or 825-10, Financial Instruments—Overall. (5) Financial liabilities for which the fair value option is elected, the amount of change in fair value that relates to the instrument specific credit risk should first be measured in the currency of denomination when presented separately from the total change in fair value of the financial liability. Then, both components of the change in the fair value of the liability should be remeasured into the functional currency of the reporting entity using end-of-period spot rates. (6) The prospective transition approach for equity securities without a readily determinable fair value in the amendments in Update 2016-01 is meant only for instances in which the measurement alternative is applied. An insurance entity subject to the guidance in Topic 944, Financial Services— Insurance, should apply a prospective transition method when applying the amendments related to equity securities without readily determinable fair values. An insurance entity should apply the selected prospective transition method consistently to the entity’s entire population of equity securities for which the measurement alternative is elected. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Public business entities with fiscal years beginning between December 15, 2017, and June 15, 2018, are not required to adopt these amendments until the interim period beginning after June 15, 2018, and public business entities with fiscal years beginning between June 15, 2018, and December 15, 2018, are not required to adopt these amendments before adopting the amendments in Update 2016-01. For all other entities, the effective date is the same as the effective date in Update 2016-01. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted Update 2016-01. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

ASU 2018-04, Investments – Debt Securities (Topic 320) and Regulated Operations (Topic 980) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273, ASU 2018-04 supersedes various SEC paragraphs and adds an SEC paragraph pursuant to the issuance of Staff Accounting Bulletin No. 117. This Update is not expected to have a significant impact on the Corporation’s financial statements.

ASU 2018-05, Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 118, ASU 2018-05 amends the Accounting Standards Codification to incorporate various SEC paragraphs pursuant to the issuance of SAB 118. SAB 118 addresses the application of generally accepted accounting principles in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act.

In July 2018, the FASB issued ASU 2018-09, Codification Improvements, represents changes to clarify, correct errors in, or make minor improvements to the Codification. The amendments make the Codification easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. The transition and effective date guidance is based on the facts and circumstances of each amendment. Some of the amendments do not require transition guidance and will be effective upon issuance of this ASU. However, many of the amendments in this ASU do have transition guidance with effective dates for annual periods beginning after December 15, 2018, for public business entities. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

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Notes to the Unaudited Consolidated Interim Financial Statements

 

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, represents changes to clarify, correct errors in, or make minor improvements to the Codification. The amendments in this ASU affect the amendments in ASU 2016-02, which are not yet effective, but for which early adoption upon issuance is permitted. For entities that early adopted Topic 842, the amendments are effective upon issuance of this ASU, and the transition requirements are the same as those in Topic 842. For entities that have not adopted Topic 842, the effective date and transition requirements will be the same as the effective date and transition requirements in Topic 842. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements. This Update provides another transition method which allows entities to initially apply ASC 842 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Entities that elect this approach should report comparative periods in accordance with ASC 840, Leases. In addition, this Update provides a practical expedient under which lessors may elect, by class of underlying assets, to not separate nonlease components from the associated lease component, similar to the expedient provided for lessees. However, the lessor practical expedient is limited to circumstances in which the nonlease component or components otherwise would be accounted for under the new revenue guidance and both (a) the timing and pattern of transfer are the same for the nonlease component(s) and associated lease component and (b) the lease component, if accounted for separately, would be classified as an operating lease. If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity should account for the combined component in accordance with ASC 606, Revenue from Contracts with Customers. Otherwise, the entity should account for the combined component as an operating lease in accordance with ASC 842. If a lessor elects the practical expedient, certain disclosures are required. This Update is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

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Management’s Discussion and Analysis

 

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

 

The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2017 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.

 

Forward-Looking Statements

 

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

 

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

 

·National and local economic conditions
·Effects of slow economic conditions or prolonged economic weakness, specifically the effect on loan customers to repay loans
·Health of the housing market
·Real estate valuations and its impact on the loan portfolio
·Interest rate and monetary policies of the Federal Reserve Board
·Volatility of the securities markets including the valuation of securities
·Future actions or inactions of the United States government, including a failure to increase the government debt limit or a prolonged shutdown of the federal government
·Political changes and their impact on new laws and regulations
·Competitive forces
·Impact of mergers and acquisition activity in the local market and the effects thereof
·Potential impact from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses
·Changes in customer behavior impacting deposit levels and loan demand
·Changes in accounting principles, policies, or guidelines as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standards setters
·Ineffective business strategy due to current or future market and competitive conditions
·Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk
·Operation, legal, and reputation risk
·Results of the regulatory examination and supervision process
·The impact of new laws and regulations, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations issued thereunder
·Possible impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules
·Disruptions due to flooding, severe weather, or other natural disasters
·The risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful

 

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Management’s Discussion and Analysis

 

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

 

Results of Operations

 

Overview

The Corporation recorded net income of $2,577,000 and $7,524,000 for the three and nine-month periods ended September 30, 2018, a 26.7% and 31.2% increase respectively, from the $2,034,000 and $5,733,000 earned during the same periods in 2017. The earnings per share, basic and diluted, were $0.90 and $2.64 for the three and nine months ended September 30, 2018, compared to $0.71 and $2.01 for the same periods in 2017. The increase in the Corporation’s 2018 earnings was caused primarily by insurance proceeds from a bank owned life insurance (BOLI) policy. The Corporation purchased and is the beneficiary of all BOLI life insurance policies taken out on select officers. Due to the death of a participant during the first quarter of 2018, the Corporation recorded additional BOLI income of $913,000. This net death benefit caused an increase in the Corporation’s 2018 earnings. The Corporation also experienced growth in net interest income (NII) for the nine-month period ended September 30, 2018, largely driven by the Federal Reserve rate increases which have positively impacted the yield on earning assets.

 

The Corporation’s NII increased by $786,000, or 10.2%, and $1,829,000, or 8.1%, for the three and nine months ended September 30, 2018, compared to the same periods in 2017. The increase in NII primarily resulted from an increase in interest and fees on loans of $977,000, or 15.8%, and $2,263,000, or 12.6%, for the three and nine-month periods ended September 30, 2018. The increase in NII was partially offset by an increase in interest expense. The Corporation’s interest expense on deposits and borrowings increased by $118,000, or 15.6%, and $301,000, or 13.8%, for the three and nine-month periods ended September 30, 2018, compared to 2017.

 

The Corporation recorded $50,000 less provision expense in the third quarter of 2018 compared to the same quarter of 2017, with $190,000 of provision compared to $240,000 of provision for the third quarter of 2017. However, for the nine-month period ended September 30, 2018, the Corporation recorded $20,000 additional provision expense, with $470,000 of provision expense compared to $450,000 in the same period of 2017. The gains from securities were $7,000 for the three months ended September 30, 2018, compared to gains of $26,000 for the nine months ended September 30, 2018, compared to gains of $170,000 and $417,000 for the same periods in 2017. Market interest rates were lower in 2017, making it more conducive to achieving gains from the sale of securities. The gain on the sale of mortgages increased by $5,000, or 1.0%, and decreased $200,000, or 15.4%, for the three and nine-month periods ended September 30, 2018, compared to the prior year’s periods. Margins made on sold mortgages were lower in the first nine months of 2018 compared to 2017 primarily causing the decrease in gain income. Total operating expenses increased $424,000, or 5.5%, and $1,242,000, or 5.4%, for the three and nine months ended September 30, 2018, compared to the same periods in 2017.

 

The financial services industry uses two primary performance measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders. The ROA and ROE increased for the three and nine months ended September 30, 2018, compared to the same periods in the prior year due primarily to higher earnings.

 

Key Ratios  Three Months Ended  Nine Months Ended
   September 30,  September 30,
   2018  2017  2018  2017
             
Return on Average Assets   0.97%    0.80%    0.97%    0.77% 
Return on Average Equity   10.33%    8.06%    10.28%    7.86% 

 

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:

 

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Management’s Discussion and Analysis

 

·Net interest income
·Provision for loan losses
·Other income
·Operating expenses
·Provision for 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 the first nine months of 2018, NII generated 73.4% of the Corporation’s gross revenue stream, which consists of net interest income and non-interest income, compared to 74.8% in the first nine months of 2017. The overall performance of the Corporation is highly dependent on the changes in net interest income since it comprises such a significant portion of operating income.

 

The following table shows a summary analysis of net interest income on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE net interest income shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis. The amount of FTE adjustment totaled $217,000 and $670,000 for the three and nine months ended September 30, 2018, compared to $582,000 and $1,793,000 for the same periods in 2017.

 

NET INTEREST INCOME                
(DOLLARS IN THOUSANDS)                
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2018   2017   2018   2017 
   $   $   $   $ 
Total interest income   9,348    8,444    26,769    24,639 
Total interest expense   872    754    2,488    2,187 
                     
Net interest income   8,476    7,690    24,281    22,452 
Tax equivalent adjustment   217    582    670    1,793 
                     
Net interest income (fully taxable equivalent)   8,693    8,272    24,951    24,245 

 

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

 

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

 

The Federal funds rate, the Prime rate, the shape of the U.S. Treasury curve, and other wholesale funding curves, all affect NII. The Federal Reserve controls the Federal funds rate, which is one of a number of tools available to the Federal Reserve to conduct monetary policy. The Federal funds rate, and guidance on when the rate might be changed, is often the focal point of discussion regarding the direction of interest rates. Until December 16, 2015, the Federal funds rate had not changed since December 16, 2008, a period of seven years. On December 16, 2015, the Federal funds rate was increased 25 basis points to 0.50%, from 0.25%. On December 14, 2016, one year later, the Federal funds rate was increased 25 basis points to 0.75%. During 2017, the Federal funds rate was increased three times so that the rate was 1.50% as of December 31, 2017. In March, June, and September of 2018, the Federal Reserve again increased the Federal funds rate by 25 basis points so that the rate was 2.25% as of September 30, 2018. Prior to December of 2015, the period of seven years with extremely low and unchanged overnight rates was the lowest and longest in U.S. history. The impact has been a lower net interest margin to the Corporation and generally across the financial services industry. The Federal Reserve rate increases resulted in higher short-term U.S. Treasury rates, but the long-term rates initially decreased, resulting in a flattening of the yield curve. Long-term rates like the 10-year U.S. Treasury were 220 basis points under the 5.25% Prime rate as of September 30, 2018. It appears that the general conditions of a flatter yield curve with low long-term U.S. Treasury rates, significantly below the Prime rate, will continue for the remainder of 2018. Management anticipates the next 0.25% Federal Reserve rate increase could occur in the fourth quarter of 2018. It remains to be seen whether mid and long-term U.S. Treasury rates will also increase to the same degree that the Federal Reserve will move the overnight Federal funds rate. If they do not, the yield curve would further flatten making it more difficult for the Corporation to increase asset yield.

 

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Management’s Discussion and Analysis

 

The Prime rate is generally used by commercial banks to extend variable rate loans to business and commercial customers. For many years, the Prime rate has been set at 300 basis points, or 3.00% higher, than the Federal funds rate and typically moves when the Federal funds rate changes. As such, the Prime rate increased from 3.25% prior to December 2015, to 5.25% as of September 30, 2018, following the eight Federal Reserve rate moves that began in December 2015. The Corporation’s Prime-based loans, including home equity lines of credit and some variable rate commercial loans reprice a day after the Federal Reserve rate movement.

 

As a result of the Federal Reserve rate increases, the Corporation’s NII on a tax equivalent basis began to increase in 2017. However, the margin decreased in the first quarter of 2018 primarily as a result of lower tax-equivalent yields on the Corporation’s municipal securities, which were negatively impacted by the lower corporate tax rate. Subsequent to the tax rate change, the Corporation’s net interest margin began increasing again. The net interest margin for the third quarter increased to 3.52%, with a year to date margin of 3.42%. The Corporation’s NII on a tax-equivalent basis increased for the three months ended September 30, 2018, by $421,000, or 5.1%, and for the nine months ended September 30, 2018, by $705,000, or 2.9%, over the same periods in 2017. Management’s asset liability sensitivity measurements continue to show a benefit to both margin and NII given further Federal Reserve rate increases. Actual results over the past two years have confirmed the asset sensitivity of the Corporation’s balance sheet. Management expects that any additional Federal Reserve rate increases in 2018 would further improve both margin and NII, although to a slightly lesser degree because the cost on deposits and borrowings will likely begin to increase more rapidly.

 

The extended extremely low Federal funds rate had enabled management to reduce the average cost of funds over a period of years. However, in the first nine months of 2018, this trend reversed with slight increases in both deposit and borrowings interest expense as the cost to replace maturing borrowings increased and rates paid on deposits increased slightly. It was only after the third 25-basis point Fed rate increase in March of 2017 that the Corporation raised some deposit rates minimally, which resulted in slightly higher interest expense in the first nine months of 2018 compared to the prior year. While the low Prime rate reduced the average yield on the Corporation’s loans for many years, the rate increases in 2017, and through September of 2018, did act to boost interest income. With a higher Prime rate and elevated Treasury rates, higher asset yields are expected throughout the remainder of 2018. The increasing number of Federal Reserve rate moves assists the Corporation in growing NII and net interest margin (NIM) because of the variable rate portion of the loan portfolio which resets every time the Prime rate changes. The magnitude of increase in NII and net interest margin may slow down during the remainder of 2018 as some deposit rates were increased marginally in October.

 

Security yields will generally fluctuate more rapidly than loan yields based on changes to the U.S. Treasury rates and yield curve. With higher Treasury rates in the first nine months of 2018 compared to the same period in 2017, security reinvestment has been occurring at slightly higher yields and amortization has slowed resulting in higher yields. However, yields on the Corporation’s municipal bonds have decreased significantly due to the change in the corporate tax rate, making tax-free yields less attractive than they were in prior years. Management has added variable rate securities and has reduced the municipal bond holdings in an effort to improve the rates-up performance of the securities portfolio.

 

The Corporation’s loan portfolio yield has begun to increase as the variable rate portion of the loan portfolio is repricing higher with each Federal Reserve rate movement. The vast majority of the Corporation’s commercial Prime-based loans are priced at the Prime rate, currently at 5.25%. The pricing for the most typical five-year fixed rate commercial loans is currently very similar to the Prime rate. Previous to 2018, any increases in variable rate loans acted to bring down overall loan yield. Now with the Prime rate being very similar or higher than fixed commercial rates, it is immediately beneficial to the Corporation’s asset yield to increase variable rate loans. Since the Prime rate generally moves in tandem with the overnight Federal Funds Rate, the key benefit of adding variable rate loans in the present interest rate environment is the immediate repricing to a higher rate should the Federal Reserve continue with rate increases. There are also elements of the Corporation’s Prime-based commercial loans priced above the Prime rate based on the level of credit risk of the borrower. Management does price a portion of consumer variable rate loans above the Prime rate, which also helps to improve loan yield. Both commercial and consumer Prime-based pricing continues to be influenced by local competition.

 

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Management’s Discussion and Analysis

 

Mid-term and long-term interest rates on average were higher in 2018 compared to 2017. The average rate of the 10-year U.S. Treasury was 2.87% in the first nine months of 2018 compared to 2.32% in the first nine months of 2017, and it stood at 3.05% on September 30, 2018, compared to 2.33% on September 30, 2017. The slope of the yield curve has been compressed throughout 2017 and through the first nine months of 2018, with a difference of 80 basis points between the Fed funds rate of 2.25% and the 10-year U.S. Treasury as of September 30, 2018, compared to 108 basis points as of September 30, 2017. The slope of the yield curve has fluctuated many times in the past two years with the 10-year U.S. Treasury yield as high as 3.11% in the first nine months of 2018 and 2.62% in the first nine months of 2017, and as low as 2.44% in 2018, and 2.05% in 2017.

 

While the Corporation’s overall cost of funds remained low and did not increase throughout 2017, there were slight increases in the first nine months of 2018 due to higher interest expense on both deposits and borrowings, with the vast majority of the increase coming from the borrowing side. Deposit interest rates are still very low and have not been increased significantly since 2017, although savings on longer-term time deposits that are maturing are no longer being achieved. Deposit interest rate increases are first seen in the pricing of new and repricing of reissued certificates of deposit. The Corporation increased interest rates marginally on the Corporation’s interest bearing core accounts after September 30, 2018, along with selective time deposit increases. Further rate increases are likely given the expectations for further Federal Reserve rate increases. Typically, financial institutions will make small systematic moves on core interest bearing accounts while making larger rate increases in the pricing of new or reissued time deposits. Borrowing costs, and the wholesale borrowing curves that they are based on, generally follow the direction and slope of the U.S. Treasury curve. However, these curves can be quicker to rise and slower to fall as the providers of these funds seek to protect themselves from rate movements. The Corporation refinanced the majority of borrowings at higher rates in 2017 and 2018 as lower-priced borrowings matured with no ability to refinance at lower rates, so the yield on borrowings increased during 2017 and continued to do so moving into 2018.

 

Management currently anticipates that the overnight interest rate and Prime rate will remain at the current levels until December of 2018 with the possibility of an additional 0.25% Federal Reserve rate increase at the end of 2018. It is likely that mid and long-term U.S. Treasury rates will increase slowly throughout the remainder of the year, being driven higher due to expected additional Federal Reserve rate movements. This would allow management to achieve higher earnings on new higher yielding securities and allow for the ability to price new loans at higher market rates. However, it is also possible that even after a Federal Reserve rate increase, the yield curve could flatten, making it more difficult for management to lend out or reinvest at higher interest rates out further on the yield curve. Additionally, any further Federal Reserve rate increases would have a greater effect on the repricing of the Corporation’s liabilities as the cost of money increases and more marketplace competition returns. Management anticipates that more deposit rate increases will need to be made to remain competitive in the market while maturing borrowings would also reprice to higher rates.

 

The following table provides an analysis of year-to-date 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.

 

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Management’s Discussion and Analysis

 

RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME

(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)

 

 

   Nine Months Ended Sept 30,  Nine Months Ended Sept 30,
   2018 vs. 2017  2017 vs. 2016
   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   (92)   223    131    27    136    163 
                               
Securities available for sale:                              
Taxable   307    394    701    44    2,059    2,103 
Tax-exempt   (662)   (1,495)   (2,157)   766    (49)   717 
Total securities   (355)   (1,101)   (1,456)   810    2,010    2,820 
                               
Loans   1,451    760    2,211    938    340    1,278 
Regulatory stock   24    97    121    31    (3)   28 
                               
Total interest income   1,028    (21)   1,007    1,806    2,483    4,289 
                               
INTEREST EXPENSE                              
                               
Deposits:                              
Demand deposits   16    91    107    19    32    51 
Savings deposits   4        4    10    (1)   9 
Time deposits   (92)   46    (46)   (93)   (97)   (190)
Total deposits   (72)   137    65    (64)   (66)   (130)
                               
Borrowings:                              
Total borrowings   30    206    236    (25)   23    (2)