Item 1. Business
General
ENB Financial Corp (“the Corporation”) is a bank holding company that was formed on July 1, 2008. The Corporation’s wholly owned subsidiary, Ephrata National Bank (“the Bank”), is a full service commercial bank organized under the laws of the United States. Presently, no other subsidiaries exist under the bank holding company. The Corporation and the Bank are both headquartered in Ephrata, Lancaster County, Pennsylvania. The Bank was incorporated in 1881 pursuant to the United States National Bank Act under a charter granted by the Office of the Comptroller of the Currency (OCC). The Federal Deposit Insurance Corporation (FDIC) insures deposit accounts to the maximum extent provided by law. The Corporation’s retail, operational, and administrative offices are all located in northern Lancaster County, Pennsylvania, the Corporation’s primary market area.
The basic business of the Corporation is to provide a broad range of financial services to individuals and small-to-medium-sized businesses in Northern Lancaster County and surrounding market areas. The Corporation utilizes
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funds gathered through deposits from the general public to originate loans. The Corporation offers time, demand, and savings deposits and secured and unsecured commercial, real estate, and consumer loans. Ancillary services that provide added convenience for our customers include direct deposit and direct payments of funds through Electronic Funds Transfer, ATMs linked to the Star® network, telephone and internet banking, MasterCard® debit cards, Visa® or MasterCard credit cards, and safe deposit box facilities. The Corporation also offers a full complement of trust and investment advisory services through ENB’s Money Management Group.
As of December 31, 2010, the Corporation employed 217 persons, consisting of 171 full-time and 46 part-time employees. The number of full-time employees decreased by one and the number of part-time employees increased by one from the previous year-end. A collective bargaining agent does not represent the employees.
Operating Segments
The Corporation’s business is providing financial products and services. These products and services are provided through the Corporation’s wholly owned subsidiary, the Bank. The Bank is presently the only subsidiary of the Corporation, and the Bank only has one reportable operating segment, community banking, as described in Note A of the Notes to the Consolidated Financial Statements included in this Report. The segment reporting information in Note A is incorporated by reference into this Part I, Item 1.
Business Operations
Products and Services with Reputation Risk
The Corporation offers a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies becomes dissatisfied with or objects to any product or service offered by the Corporation, negative publicity with respect to any such product or service, whether legally justified or not, could have a negative impact on the Corporation’s reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on the Corporation’s reputation.
Market Area and Competition
The Corporation’s primary market area is northern Lancaster County, Pennsylvania; however, the Corporation’s market area also extends into contiguous Berks, Lebanon, and Chester Counties. The area served by the Corporation is a mix of rural communities and small to mid-sized towns. The Corporation’s service area is located just south of the Pennsylvania turnpike between the greater metropolitan areas of Philadelphia and Harrisburg and the smaller cities of Reading and Lancaster. Lancaster County ranks high nationally as a favored place to reside due to its scenic farmland, low cost of living, diversity of the local economy, and proximity to large cities. As a result, the area is experiencing strong population growth and development.
In the course of attracting and retaining deposits, and originating loans, the Corporation faces considerable competition. The Corporation competes with other commercial banks, savings and loan institutions, and credit unions for traditional banking products, such as deposits and loans. Additionally, the Corporation competes with consumer finance companies for loans, mutual funds, and other investment alternatives for deposits. The Corporation competes for deposits based on the ability to provide a range of products, low fees, quality service, competitive rates, and convenient locations and hours. The competition for loan origination generally relates to interest rates offered, products available, quality of service, and loan origination fees charged. Several competitors within the Corporation’s primary market have substantially higher legal lending limits that enable them to service larger loans.
The Corporation continues to assess the competition and market area to determine the best way to meet the financial needs of the communities it serves. Management strategically addresses these competitive issues by determining the new products and services to be offered as well as investing in the expertise of staffing for expansion of the Corporation’s services.
Concentrations and Seasonality
The Corporation does not have any portion of its businesses dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its businesses. No substantial portion of loans or
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investments is concentrated within a single industry or group of related industries, although a significant amount of loans are secured by real estate located in northern Lancaster County, Pennsylvania. The business activities of the Corporation are not seasonal in nature. Financial instruments with concentrations of credit risk are described in Note Q of the Notes to Consolidated Financial Statements included in this Report. The concentration of credit risk information in Note P is incorporated by reference into this Part I, Item 1.
Supervision and Regulation
General Overview
Bank holding companies operate in a highly regulated environment and are routinely examined by federal and state regulatory authorities. The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulations on the Corporation and the Bank.
To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. The Corporation cannot determine the likelihood or timing of any such proposals or legislation, or the impact they may have on the Corporation and the Bank. A change in law, regulations, or regulatory policy may have a material effect on the Corporation and the Bank’s business.
The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. Bank operations are subject to regulations of the OCC, the Board of Governors of the Federal Reserve System, and the FDIC.
Supervision and Regulation of the Corporation
The Holding Company Act of 1956.
The Corporation is subject to the provisions of the Holding Company Act of 1956, as amended, and to supervision by the Federal Reserve Board. The following restrictions apply:
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General Supervision by the Federal Reserve Board. As a bank holding company, the Corporation’s activities are limited to the business of banking and activities closely related or incidental to banking. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has adopted a risk-focused supervision program for small shell bank holding companies that is tied to the examination results of the subsidiary bank. The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board may require that the Corporation stand ready to provide adequate capital funds to the Bank during periods of financial stress or adversity.
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Restrictions on Acquiring Control of Other Banks and Companies. A bank holding company may not:
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acquire direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank, or
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merge or consolidate with another bank holding company, without prior approval of the Federal Reserve Board.
In addition, a bank holding company may not:
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engage in a non-banking business, or
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acquire ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business,
unless the Federal Reserve Board determines the business to be so closely related to banking as to be a
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proper incident to banking. In making this determination, the Federal Reserve Board considers whether these activities offer benefits to the public that outweigh any possible adverse effects.
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Anti-Tie-In Provisions. A bank holding company and its subsidiaries may not engage in tie-in arrangements in connection with any extension of credit or provision of any property or services. These anti-tie-in provisions state generally that a bank may not:
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extend credit,
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lease or sell property, or
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furnish any service to a customer
on the condition that the customer provides additional credit or service to a bank or its affiliates, or on the condition that the customer not obtain other credit or service from a competitor of the bank.
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Restrictions on Extensions of Credit by Banks to their Holding Companies. Subsidiary banks of a holding company are also subject to restrictions imposed by the Federal Reserve Act on:
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any extensions of credit to the bank holding company or any of its subsidiaries,
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investments in the stock or other securities of the Corporation, and
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taking these stock or securities as collateral for loans to any borrower.
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Risk-Based Capital Guidelines. Bank holding companies must comply with the Federal Reserve Board’s risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets, including some off-balance sheet activities, such as standby letters of credit, is 8%. At least half of the total capital is required to be Tier I Capital, consisting principally of common shareholders’ equity, less certain intangible assets. The remainder, Tier II Capital, may consist of:
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some types of preferred stock,
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a limited amount of subordinated debt,
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some hybrid capital instruments,
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other debt securities, and
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a limited amount of the general loan loss allowance.
The risk-based capital guidelines are required to take adequate account of interest rate risk, concentrations of credit risk, and risks of nontraditional activities.
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Capital Leverage Ratio Requirements. The Federal Reserve Board requires a bank holding company to maintain a leverage ratio of a minimum level of Tier I capital, as determined under the risk-based capital guidelines, equal to 3% of average total consolidated assets for those bank holding companies that have the highest regulatory examination rating and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 1% to 2% above the stated minimum. The Bank is subject to similar capital requirements pursuant to the Federal Deposit Insurance Act.
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Restrictions on Control Changes. The Change in Bank Control Act of 1978 requires persons seeking control of a bank or bank holding company to obtain approval from the appropriate federal banking agency before completing the transaction. The law contains a presumption that the power to vote 10% or more of voting stock confers control of a bank or bank holding company. The Federal Reserve Board is responsible for reviewing changes in control of bank holding companies. In doing so, the Federal Reserve Board reviews the financial position, experience and integrity of the acquiring person, and the effect the change of control will have on the financial condition of the Corporation, relevant markets, and federal deposit insurance funds.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act (SOX), also known as the “Public Company Accounting Reform and Investor Protection Act,” was established in 2002 and introduced major changes to the regulation of financial practice. SOX was established as a reaction to the outbreak of corporate and accounting scandals, including Enron and Worldcom. SOX represents a comprehensive revision of laws affecting corporate governance, accounting obligations, and
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corporate reporting. SOX is applicable to all companies with equity or debt securities that are either registered, or file reports under the Securities Exchange Act of 1934. In particular, SOX establishes: (i) requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Principal Executive Officer and Principal Financial Officer of the reporting company; (iii) standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) increased civil and criminal penalties for violations of the securities laws. Many of the provisions were effective immediately while other provisions become effective over a period of time and are subject to rulemaking by the SEC.
Congress determined that the primary responsibility for enacting, implementing, and enforcing the new rules brought about by SOX would be that of the U.S. Securities and Exchange Commission (SEC). While some provisions of SOX became effective upon enactment on July 30, 2002, the other provisions became effective as the SEC adopted various rules. The SOX requirements have been deferred a number of times for the Corporation, previously as a non-accelerated filer, and more recently, as a smaller reporting company.
To ensure greater investor confidence in corporate disclosures from public companies, SOX restricts the services that public accounting firms can provide to publicly traded companies. The Corporation does not engage the same professional accounting firm for external and internal auditing.
Section 404 of SOX requires publicly held companies to document and test their internal controls that impact financial reporting and report on the findings, known as Section 404a. External auditors also must test and report on the effectiveness of a company’s internal controls to ensure accurate financial reporting, which is known as Section 404b. Companies must report any deficiencies or material weaknesses in their internal controls, as well as their remediation efforts.
Accelerated and large accelerated filers have had to comply with Sections 404a and 404b of SOX in their annual reports since 2004, with their auditors required to report on the effectiveness of internal controls. An accelerated filer is defined as having between $75 million and $700 million of publicly traded market capitalization; large accelerated filers are companies with over $700 million of publicly traded market capitalization as of the end of their second quarter. Non-accelerated filers with publicly traded market capitalization under $75 million were not required to comply with Section 404b. The Corporation has always met the definition of a non-accelerated filer as the public equity float has always been under $75 million, and therefore is only subject to Section 404a. The Corporation filed as a non-accelerated filer through 2007 and as a smaller reporting company beginning in 2008, when the SEC expanded the definition of a smaller reporting company.
During 2005, as the SEC and Public Company Accounting Oversight Board (PCAOB) jointly reviewed the 2004 annual reporting and evaluated the impact of SOX on these accelerated filers, it was apparent that the experience was difficult and costly, requiring more resources, people, and time than expected. The SEC was particularly concerned about the cost and other difficulties that smaller companies would face in preparing to implement Section 404. As a result, the requirement for non-accelerated filers, and subsequently smaller reporting companies, to comply with Section 404b was delayed.
During 2007, the SEC issued rulings on several parts of Section 404. The 2007 SEC ruling refined the definitions of material weakness and significant deficiencies under Section 404a that management would be required to disclose if determined that such weaknesses or deficiencies existed in the internal controls over financial reporting. The rule also refined parts of Section 404b regarding the independent registered public accounting firm requirement of attesting to the effectiveness of the Corporation’s internal control structure over financial reporting. It allowed the independent registered public accounting company to place more reliance on the testing of internal controls over financial reporting done by management or the Corporation’s internal auditors. Section 404b was expected to be required for financial years ending on or after December 15, 2008.
In February 2008, the SEC proposed a rule that extended the date for independent auditor attestation to first be included for years ended on or after December 15, 2009. Also in 2008, the SEC expanded the definitions of smaller public companies beyond non-accelerated filers to include a new definition of smaller reporting company. The smaller reporting company definition was more favorable to smaller businesses that qualified under certain conditions. On July 1, 2008, the Corporation came into existence as ENB Financial Corp, which succeeded Ephrata National Bank. With the new entity and new SEC registration statement, the Corporation changed the filing status from non-accelerated filer to smaller reporting company. An issuer has the ability to determine its filing status on an annual basis.
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Those public companies with public floats under $75 million that did not qualify under the smaller reporting company were considered non-accelerated filers. Both were not subject to Section 404b. The non-accelerated filers also included publicly traded companies that previously did have a public float over $75 million but were now less than $50 million due to market conditions. The Corporation continues to meet the definition of a smaller public company as it has a public equity float of approximately $33.5 million as of June 30, 2010.
On October 2, 2009, the SEC announced, concurrent with the release of its most recent cost-benefit study that the Commission was granting a final deferral of the effective date of Section 404b for small companies, extending the deadline to annual reports for fiscal years ending after June 15, 2010. Then on July 21, 2010, when the Dodd-Frank Act was signed into law, Section 404b was permanently deferred for all small companies.
Permitted Activities for Bank Holding Companies
The Federal Reserve Board permits bank holding companies to engage in activities so closely related to banking or managing or controlling banks as to be a proper incident of banking. In 1997, the Federal Reserve Board significantly expanded its list of permissible non-banking activities to improve the competitiveness of bank holding companies. The following list includes activities that a holding company may engage in, subject to change by the Federal Reserve Board:
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Making, acquiring, or servicing loans and other extensions of credit for its own account or for the account of others.
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Any activity used in connection with making, acquiring, brokering, or servicing loans or other extensions of credit, as determined by the Federal Reserve Board. The Federal Reserve Board has determined that the following activities are permissible:
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real estate and personal property appraising;
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arranging commercial real estate equity financing;
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check-guaranty services;
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collection agency services;
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credit bureau services;
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asset management, servicing, and collection activities;
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acquiring debt in default, if a holding company divests shares or assets securing debt in default that are not permissible investments for bank holding companies within prescribed time periods, and meets various other conditions; and
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real estate settlement services.
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Leasing personal and real property or acting as agent, broker, or advisor in leasing property, provided that:
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the lease is a non-operating lease;
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the initial term of the lease is at least 90 days;
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if real property is being leased, the transaction will compensate the lessor for at least the lessor’s full investment in the property and costs, with various other conditions.
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Operating non-bank depository institutions, including an industrial bank or savings association.
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Performing functions or activities that may be performed by a trust company, including activities of a fiduciary, agency, or custodial nature, in the manner authorized by federal or state law, so long as the holding company is not a bank.
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Acting as investment or financial advisor to any person, including:
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serving as investment advisor to an investment company registered under the Investment Company Act of 1940;
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furnishing general economic information and advice, general economic statistical forecasting services, and industry studies;
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providing advice in connection with mergers, acquisitions, divestitures, investments, joint
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ventures, capital structuring, financing transactions, and conducting financial feasibility studies;
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providing general information, statistical forecasting, and advice concerning any transaction in foreign exchange, swaps, and similar transactions, commodities, options, futures, and similar instruments;
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providing educational courses and instructional materials to consumers on individual financial management matters; and
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providing tax planning and tax preparation services to any person.
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Agency transactional services for customer investments, including:
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Securities brokerage -- Providing securities brokerage services, whether alone or in combination with investment advisory services, and incidental activities, including related securities credit activities compliant with Federal Reserve Board Regulation T and custodial services, if the securities brokerage services are restricted to buying and selling securities solely as agent for the account of customers and do not include securities underwriting or dealing.
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Riskless-principal transactions -- Buying and selling all types of securities in the secondary market on the order of customers as “riskless principal.”
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Private-placement services -- Acting as agent for the private placement of securities in accordance with the requirements of the Securities Act of 1933 and the rules of the SEC.
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Futures commission merchant -- Acting as a futures commission merchant for unaffiliated persons in the execution and clearance of any futures contract and option on a futures contract traded on an exchange in the United States or abroad, if the activity is conducted through a separately incorporated subsidiary of the holding company and the company satisfies various other conditions.
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Investment transactions as principal:
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Underwriting and dealing in government obligations and money market instruments, including bankers’ acceptances and certificates of deposit, under the same limitations applicable if the activity were performed by a holding company’s subsidiary member banks.
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Engaging as principal in:
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foreign exchanges; and
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forward contracts, options, futures, options on futures, swaps, and similar contracts, with various conditions.
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Buying and selling bullion, and related activities.
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Management consulting and counseling activities:
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Subject to various limitations, management consulting on any matter to unaffiliated depository institutions, or on any financial, economic, accounting, or audit matter to any other company; and
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Providing consulting services to employee benefit, compensation, and insurance plans, including designing plans, assisting in the implementation of plans, providing administrative services to plans, and developing employee communication programs for plans.
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Providing career counseling services to:
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a financial organization and individuals currently employed by, or recently displaced from, a financial organization;
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individuals who are seeking employment at a financial organization; and
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individuals who are currently employed in or who seek positions in the finance, accounting, and audit departments of any company.
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Support services:
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providing limited courier services; and
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printing and selling checks and related items requiring magnetic ink character recognition.
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Insurance agency and underwriting:
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Subject to various limitations, acting as principal, agent, or broker for credit, life, accident, health, and unemployment insurance that is directly related to an extension of credit by a holding company or any of its subsidiaries.
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Engaging in any insurance agency activity in a place where the Corporation or a subsidiary of the Corporation has a lending office and that has a population not exceeding 5,000 or has inadequate insurance agency facilities, as determined by the Federal Reserve Board.
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Supervising, on behalf of insurance underwriters, the activities of retail insurance agents who sell fidelity insurance and property and casualty insurance on the real and personal property used in the Corporation’s operations or its subsidiaries, and group insurance that protects the employees of the Corporation or its subsidiaries.
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Engaging in any insurance agency activities if the Corporation has total consolidated assets of $50 million or less, with the sale of life insurance and annuities being limited to sales in small towns or as credit insurance.
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Making equity and debt investments in corporations or projects designed primarily to promote community welfare, and providing advisory services to these programs.
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Subject to various limitations, providing others with financially oriented data processing or bookkeeping services.
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Issuing and selling money orders, travelers' checks, and United States savings bonds.
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Providing consumer financial counseling that involves counseling, educational courses, and distribution of instructional materials to individuals on consumer-oriented financial management matters, including debt consolidation, mortgage applications, bankruptcy, budget management, real estate tax shelters, tax planning, retirement and estate planning, insurance, and general investment management, so long as this activity does not include the sale of specific products or investments.
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Providing tax planning and preparation advice.
Permitted Activities for Financial Holding Companies
The Gramm-Leach-Bliley Financial Services Modernization Act became law in November 1999 and amends the Holding Company Act of 1956 to create a new category of holding company - the financial holding company. To be designated as a financial holding company, a bank holding company must file an application with the Federal Reserve Board (FRB). The corporation must be and remain well capitalized and well managed, as determined by FRB regulations and maintain at least a satisfactory examination rating under the Community Reinvestment Act. Once a bank holding company becomes a financial holding company, the holding company or its affiliates may engage in any activities that are financial in nature or incidental to financial activities. Furthermore, the Federal Reserve may approve a proposed activity if it is complementary to financial activities and does not threaten the safety and soundness of banking. The Act provides an initial list of activities that constitute activities that are financial in nature, including:
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lending and deposit activities,
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insurance activities, including underwriting, agency, and brokerage,
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providing financial investment advisory services,
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underwriting in, and acting as a broker or dealer in, securities,
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merchant banking, and
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insurance company portfolio investment.
The Corporation is currently not a financial holding company.
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Supervision and Regulation of the Bank
Safety and Soundness
The primary regulator for the Bank is the OCC. The OCC has the authority under the Financial Institutions Supervisory Act and the Federal Deposit Insurance Act to prevent a national bank from engaging in any unsafe or unsound practice in conducting business or from otherwise conducting activities in violation of the law.
Federal and state banking laws and regulations govern, but are not limited to, the following:
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Scope of a bank’s business
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Investments a bank may make
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Reserves that must be maintained against certain deposits
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Loans a bank makes and collateral it takes
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Merger and consolidation activities
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Establishment of branches
The Corporation is a member of the Federal Reserve System. Therefore, the policies and regulations of the Federal Reserve Board have a significant impact on many elements of the Corporation’s operations, including:
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Loan and deposit growth
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Rate of interest earned and paid
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Levels of liquidity
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Levels of required capital
Management cannot predict the effect of changes to such policies and regulations upon the Corporation’s business model and the corresponding impact they may have on future earnings.
FDIC Insurance Assessments
The FDIC imposes a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on the Bank’s capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semi-annual basis, each depository institution to one of three capital groups, the best of these being “Well Capitalized.” For purposes of calculating the insurance assessment, the Bank was considered “Well Capitalized” as of December 31, 2010. This designation has benefited the Bank in the past and continues to benefit it in terms of a lower quarterly FDIC rate. The Bank was utilizing a one-time credit against calculated quarterly FDIC assessments. This credit was fully utilized in the second quarter of 2008, upon which the Bank began to pay FDIC insurance again. The FDIC adjusts the insurance rates when necessary. The FDIC insurance rate increased by 140% in 2009. This increase was designed to replenish the FDIC fund due to 2008 bank failures and to provide for additional FDIC insurance coverage on deposit accounts. The insurance coverage increases include an FDIC insurance increase from $100,000 to $250,000, and unlimited insurance coverage on non-interest bearing deposits and interest bearing deposit balances with rates less than or equal to 0.50%. The total FDIC assessments paid by the Bank in 2010 were $617,000.
In addition to FDIC insurance costs, the Bank is subject to assessments to pay the interest on Financing Corporation Bonds. Congress created the Financing Corporation to issue bonds to finance the resolution of failed thrift institutions. These assessment rates are set quarterly. The total Financing Corporation assessments paid by the Bank in 2010 were $72,000.
FDIC Insurance Premium Increase
On February 27, 2009, the FDIC announced that it was increasing federal deposit insurance premiums, beginning in the second quarter of 2009, for well-managed, well-capitalized banks to a range between 12 and 16 cents per $100 of insured deposits on an annual basis. The FDIC also voted to impose a special assessment of 5 basis points on all FDIC-insured banks to be collected on September 30, 2009. This special assessment totaled $326,000. As a result, the Bank’s total regular insurance premiums for 2009, which were paid from earnings, increased by approximately $792,000, or 344.3%.
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In the third quarter of 2009, the FDIC announced that they would be requesting that banks prepay three years worth of assessments at the end of 2009 to help replenish the severely depleted Deposit Insurance Fund (DIF). The Bank paid $2.3 million in prepaid FDIC insurance on December 30, 2009. The entire amount was recorded as a prepaid expense (asset). Each quarter, the Bank records an expense (charge to earnings) for its regular quarterly assessment for the quarter with an offsetting credit to the prepaid assessment. Once the asset is exhausted, the Bank will record an accrued expense payable each quarter for the assessment payment, which would be paid in arrears to the FDIC at the end of the following quarter. If the prepaid assessment is not exhausted by December 30, 2014, any remaining amount will be returned to the Bank. As of December 31, 2010, the prepaid FDIC insurance amounted to $1.7 million.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act made the temporary $250,000 FDIC insurance coverage the permanent standard maximum deposit insurance amount. Additionally, on February 7, 2011, the Board of Directors of the FDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which will be effective in April 2011, should save the Corporation a significant amount of FDIC insurance premiums going forward.
Community Reinvestment Act
Under the Community Reinvestment Act (CRA), as amended, the OCC is required to assess all financial institutions that it regulates to determine whether these institutions are meeting the credit needs of the community that they serve. The Act focuses specifically on low and moderate income neighborhoods. The OCC takes an institution’s CRA record into account in its evaluation of any application made by any of such institutions for, among other things:
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Approval of a new branch or other deposit facility
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Closing of a branch or other deposit facility
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An office relocation or a merger
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Any acquisition of bank shares
The CRA, as amended, also requires that the OCC make publicly available the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation includes a descriptive rating of either outstanding, satisfactory, needs to improve, or substantial noncompliance, along with a statement describing the basis for the rating. These ratings are publicly disclosed. The Bank received an outstanding rating on the most recent CRA Performance Evaluation completed on April 13, 2009.
Capital Adequacy
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), institutions are classified in one of five defined categories as illustrated below:
The Bank’s and Corporation’s capital ratios exceed the regulatory requirements to be considered well capitalized for Total Risk-Based Capital, Tier 1 Risk-Based Capital, and Tier 1 Leverage Capital. The capital ratio table and consolidated financial statement Note M - Regulatory Matters and Restrictions, are incorporated by reference herein, from Item 8, and made a part hereof. Note M discloses capital ratios for both the Bank and the Corporation, shown as Consolidated.
During 2009, capital adequacy became a primary focus of regulators in light of the challenging financial conditions of the past two years which have caused a larger number of bank failures, higher loan losses, and lower earnings
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levels of financial institutions. In 2008, there were 25 bank failures; in 2009, the number climbed to 140; and in 2010, it climbed even higher to 157. As of February 18, 2011, 22 banks had failed in 2011. As a result, regulators are discussing, and have acted to require banks with weaker capital levels to maintain levels higher than the regulatory minimums. The most commonly discussed proposed capital levels for well-capitalized institutions have been: 8% rather than 5% for Tier 1 Leverage, 10% rather than 6% for Tier 1 Risk-Based, and 12% rather than 10% for Total Risk-Based Capital. These discussed levels, and the associated higher levels for the related lower rated categories, have not been approved as of the time of this filing. However, management is aware of regulatory practices that are requiring that these levels of capital be attained. Management expects higher regulatory capital levels to be enacted in 2011 but is not able to predict what those levels will be.
Prompt Corrective Action
In the event that an institution’s capital deteriorates to the Undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including:
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Implementation of a capital restoration plan and a guarantee of the plan by a parent institution
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Placement of a hold on increases in assets, number of branches, or lines of business
If capital reaches the significantly or critically undercapitalized level, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management, and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, FDICIA provides authority for regulatory intervention where they deem the institution to be engaging in unsafe or unsound practices, or if the institution receives a less than satisfactory examination report rating for asset quality, management, earnings, liquidity, or sensitivity to market risk.
Regulation O
Regulation O, also known as Loans to Insiders, governs the permissible lending relationships between a bank and its executive officers, directors, and principal shareholders and their related interests. The primary restriction of Regulation O is that loan terms and conditions, including interest rates and collateral coverage, can be no more favorable to the insider than loans made in comparable transactions to non-covered parties. Additionally, the loan may not involve more than normal risk. The regulation requires quarterly reporting to regulators of the total amount of credit extended to insiders.
Under Regulation O, a bank is not required to obtain approval from the bank’s Board of Directors prior to making a loan to an executive officer, as long as a first lien on the executive officer’s residence secures the loan. Further amendments allow bank insiders to take advantage of preferential loan terms that are available to substantially all employees. Regulation O does permit an insider to participate in a plan that provides more favorable credit terms than the bank provides to non-employee customers provided that the plan:
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Is widely available to employees
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Does not give preference to any insider over other employees
The Bank has a policy in place that offers general employees more favorable loan terms than those offered to non-employee customers. The Bank’s policy on loans to insiders allows insiders to participate in the same favorable rate and terms offered to all other employees; however, any loan to an insider must receive the approval of the Bank’s Board of Directors.
Legislation and Regulatory Changes
From time to time, legislation is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions are frequently made in Congress, and before various regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the Corporation’s operations. See Item 1A.
Item 1A. Risk Factors
An investment in the Corporation’s common stock is subject to risks inherent to the banking industry and the equity markets. The material risks and uncertainties that management believes affect the Corporation are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing the Corporation. Additional risks and uncertainties that management is not aware of or is not focused on, or currently deems immaterial, may also impair the Corporation’s business operations. This report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, the Corporation’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Corporation’s common stock could decline significantly, and you could lose all or part of your investment.
Risks Related To The Corporation’s Business:
The Corporation Is Subject To Interest Rate Risk
The Corporation’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest earning assets, such as loans and securities, and interest expense paid on interest bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including general economic conditions and policies of various governmental and regulatory agencies, particularly, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and securities, but also the amount of interest it pays on deposits and borrowings. Changes in interest rates could also affect:
·
The Corporation’s ability to originate loans and obtain deposits
·
The fair value of the Corporation’s financial assets and liabilities
·
The average duration of the Corporation’s assets and liabilities
·
The future liquidity of the Corporation
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Corporation’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Corporation’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation Is Subject To Lending Risk
There are inherent risks associated with the Corporation’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Corporation operates, as well as those across the Commonwealth of Pennsylvania and the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Corporation is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Corporation to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Corporation.
As of December 31, 2010, 41.3% of the Corporation’s loan portfolio consisted of commercial, industrial, and construction loans secured by real estate. Another 15.2% of the Corporation’s loan portfolio consisted of commercial loans not secured by real estate. These types of loans are generally viewed as having more risk of default than consumer real estate loans or other consumer loans. These types of loans are also typically larger than consumer real estate loans and other consumer loans. Because the Corporation’s loan portfolio contains a significant number of commercial and industrial, construction, and commercial real estate loans with relatively large
ENB FINANCIAL CORP
balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on the Corporation’s financial condition and results of operations.
If We Conclude That The Decline In Value Of Any Of Our Investment Securities Is Other Than Temporary, We Are Required To Write Down The Value Of That Security Through A Charge To Earnings.
We review our investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. Changes in the expected cash flows of these securities and/or prolonged price declines have resulted and may result in our concluding in future periods that there is additional impairment of these securities that is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset is impaired, the impairment disclosed may not accurately reflect the actual impairment in the future.
The Corporation’s Allowance For Possible Loan Losses May Be Insufficient
The Corporation maintains an allowance for possible loan losses, which is a reserve established through a provision for loan losses, charged to expense. The allowance represents management’s best estimate of expected losses inherent in the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Determining the appropriate level of the allowance for possible loan losses understandably involves a high degree of subjectivity and requires the Corporation to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of the Corporation’s control, may require an increase in the allowance for possible loan losses. In addition, bank regulatory agencies periodically review the Corporation’s allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for possible loan losses, the Corporation will need additional provisions to increase the allowance for possible loan losses. Any increases in the allowance for possible loan losses will result in a decrease in net income, and may have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation Is Subject To Environmental Liability Risk Associated With Lending Activities
A significant portion of the Corporation’s loan portfolio is secured by real property. During the ordinary course of business, the Corporation may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Corporation may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Corporation to incur substantial expenses and may materially reduce the affected property’s value or limit the Corporation’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws, may increase the Corporation’s exposure to environmental liability. Although the Corporation has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation’s Profitability Depends Significantly On Economic Conditions In The Commonwealth Of Pennsylvania And Our Market Area
The Corporation’s success depends primarily on the general economic conditions of the Commonwealth of Pennsylvania, and more specifically, the local markets in which the Corporation operates. Unlike larger national or other regional banks that are more geographically diversified, the Corporation provides banking and financial
ENB FINANCIAL CORP
services to customers primarily located in Lancaster County, as well as Berks, Chester, and Lebanon Counties. The local economic conditions in these areas have a significant impact on the demand for the Corporation’s products and services as well as the ability of the Corporation’s customers to repay loans, the value of the collateral securing loans, and the stability of the Corporation’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation Operates In A Highly Competitive Industry And Market Area
The Corporation faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets in which the Corporation operates. Additionally, various out-of-state banks have begun to enter or have announced plans to enter the market areas in which the Corporation currently operates. The Corporation also faces competition from many other types of financial institutions, including, without limitation, online banks, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes, and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Corporation’s competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Corporation can offer.
The Corporation’s ability to compete successfully depends on a number of factors, including, among other things:
·
The ability to develop, maintain, and build upon long-term customer relationships based on quality service, high ethical standards, and safe, sound management practices.
·
The ability to expand the Corporation’s market position.
·
The scope, relevance, and pricing of products and services offered to meet customer needs and demands.
·
The rate at which the Corporation introduces new products and services relative to its competitors.
·
Customer satisfaction with the Corporation’s level of service.
·
Industry and general economic trends.
Failure to perform in any of these areas could significantly weaken the Corporation’s competitive position, which could adversely affect the Corporation’s growth and profitability and have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation Is Subject To Extensive Government Regulation And Supervision
The Corporation is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system as a whole, not shareholders. These regulations affect the Corporation’s lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect the Corporation in substantial and unpredictable ways. Such changes could subject the Corporation to additional costs, limit the types of financial services and products the Corporation may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on the Corporation’s business, financial condition, and results of operations. While the Corporation has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
ENB FINANCIAL CORP
The Corporation’s Controls And Procedures May Fail Or Be Circumvented
Management regularly reviews and updates the Corporation’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Corporation’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Corporation’s business, results of operations, and financial condition.
New Lines Of Business Or New Products And Services May Subject The Corporation To Additional Risks
From time to time, the Corporation may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Corporation may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Corporation’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Corporation’s business, results of operations, and financial condition.
The Corporation’s Ability To Pay Dividends Depends On Earnings And Is Subject To Regulatory Limits
The Corporation’s ability to pay dividends is also subject to its profitability, financial condition, capital expenditures, and other cash flow requirements. Dividend payments are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. There is no assurance that the Corporation will have sufficient earnings to be able to pay dividends or generate adequate cash flow to pay dividends in the future. The Corporation’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.
Future Acquisitions May Disrupt The Corporation’s Business And Dilute Stockholder Value
The Corporation may use its common stock to acquire other companies or make investments in Corporations and other complementary businesses. The Corporation may issue additional shares of common stock to pay for future acquisitions, which would dilute the ownership interest of current shareholders of the Corporation. Future business acquisitions could be material to the Corporation, and the degree of success achieved in acquiring and integrating these businesses into the Corporation could have a material effect on the value of the Corporation’s common stock. In addition, any acquisition could require the Corporation to use substantial cash or other liquid assets or to incur debt. In those events, the Corporation could become more susceptible to economic downturns and competitive pressures.
The Corporation May Not Be Able To Attract And Retain Skilled People
The Corporation’s success highly depends on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Corporation can be intense and the Corporation may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Corporation’s key personnel could have a material adverse impact on the Corporation’s business because of their skills, knowledge of the Corporation’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. The Corporation does not currently have employment agreements or non-competition agreements with any of its senior officers.
The Corporation’s Information Systems May Experience An Interruption Or Breach In Security
The Corporation relies heavily on communications and information systems to conduct its business. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in the Corporation’s customer relationship management, general ledger, deposit, loan, and other systems. While the Corporation has
ENB FINANCIAL CORP
policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of its information systems, there can be no assurance that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of the Corporation’s information systems could damage the Corporation’s reputation, result in a loss of customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation Continually Encounters Technological Change
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Corporation’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Corporation’s operations. Many of the Corporation’s competitors have substantially greater resources to invest in technological improvements. The Corporation may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Corporation’s business, financial condition, and results of operations.
The Corporation Is Subject To Claims And Litigation Pertaining To Fiduciary Responsibility
From time to time, customers make claims and take legal action pertaining to the Corporation’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to the Corporation’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Corporation, they may result in significant financial liability and/or adversely affect the market perception of the Corporation and its products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Corporation’s business, financial condition, and results of operations.
Financial Services Companies Depend On The Accuracy And Completeness Of Information About Customers And Counterparties
In deciding whether to extend credit or enter into other transactions, the Corporation may rely on information furnished by, or on behalf of, customers and counterparties, including financial statements, credit reports, and other financial information. The Corporation may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could have a material adverse impact on the Corporation’s business and, in turn, the Corporation’s financial condition and results of operations.
Consumers May Decide Not To Use Banks To Complete Their Financial Transactions
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on the Corporation’s financial condition and results of operations.
Other Events:
Natural Disasters, Acts Of War Or Terrorism, and Other External Events Could Significantly Impact The Corporation’s Business
ENB FINANCIAL CORP
Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on the Corporation’s ability to conduct business. Such events could affect the stability of the Corporation’s deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause the Corporation to incur additional expenses. Severe weather or natural disasters, acts of war or terrorism, or other adverse external events, may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on the Corporation’s business, financial condition, and results of operations.
Risks Associated With The Corporation’s Common Stock:
The Corporation’s Stock Price Can Be Volatile
Stock price volatility may make it more difficult for shareholders to resell their shares of common stock when they desire and at prices they find attractive. The Corporation’s stock price can fluctuate significantly in response to a variety of factors including, among other things:
·
Actual or anticipated variations in quarterly results of operations.
·
Recommendations by securities analysts.
·
Operating and stock price performance of other companies that investors deem comparable to the Corporation.
·
News reports relating to trends, concerns, and other issues in the financial services industry.
·
Perceptions in the marketplace regarding the Corporation and/or its competitors.
·
New technology used, or services offered, by competitors.
·
Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by, or involving, the Corporation or its competitors.
·
Changes in government regulations.
·
Geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause the Corporation’s stock price to decrease regardless of operating results.
The Trading Volume In The Corporation’s Common Stock Is Less Than That Of Other Larger Financial Services Companies
The Corporation’s common stock is listed for trading on the Over the Counter Bulletin Board (OTCBB) exchange. The trading volume in its common stock is a fraction of that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Corporation’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Corporation has no control. Given the lower trading volume of the Corporation’s common stock, significant sales of the Corporation’s common stock, or the expectation of these sales, could cause the Corporation’s stock price to fall.
An Investment In The Corporation’s Common Stock Is Not An Insured Deposit
The Corporation’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. Investment in the Corporation’s common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, an investor in the Corporation’s common stock may lose some or all of their investment.
The Corporation’s Articles Of Association and Bylaws, As Well As Certain Banking Laws May Have An Anti-Takeover Effect
Provisions of the Corporation’s articles of incorporation and bylaws, federal banking laws, including regulatory approval requirements, and the Corporation’s stock purchase rights plan, could make it more difficult for a third party to acquire the Corporation, even if doing so would be perceived to be beneficial to the Corporation’s
ENB FINANCIAL CORP
shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination that could adversely affect the market price of the Corporation’s common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
ENB Financial Corp’s headquarters and main office of Ephrata National Bank are located at 31 East Main Street, Ephrata, Pennsylvania.
Listed below are the office locations of properties owned by the Corporation. No mortgages, liens, or encumbrances exist on any of the Corporation’s owned properties. The Corporation does not currently lease any locations.
ENB FINANCIAL CORP
Property Location
Owned
Corporate Headquarters/Main Office
Owned
31 East Main Street
Ephrata, Pennsylvania
ENB's Money Management Group
Owned
47 East Main Street
Ephrata, Pennsylvania
Technology Center
Owned
31 East Franklin Street
Ephrata, Pennsylvania
Main Street Drive-In
Owned
42 East Main Street
Ephrata, Pennsylvania
Cloister Office
Owned
809 Martin Avenue
Ephrata, Pennsylvania
Hinkletown Office
Owned
935 North Railroad Avenue
New Holland, Pennsylvania
Denver Office
Owned
1 Main Street
Denver, Pennsylvania
Akron Office
Owned
351 South 7th Street
Akron, Pennsylvania
Lititz Office
Owned
3190 Lititz Pike
Lititz, Pennsylvania
Blue Ball Office
Owned
110 Marble Avenue
East Earl, Pennsylvania
Manheim Office
Owned
1 North Penryn Road
Manheim, Pennsylvania
In addition to the above properties, the Corporation owns two other properties located in the Corporation’s Ephrata Main Street campus. These properties were acquired in 2002, when a group of properties adjacent and surrounding the Corporation’s Main Office was purchased. These two properties are being held for future use or possible sale. The other properties purchased in 2002 have been remodeled as office or operational space and are reflected in the offices shown above.
Item 3.
Item 3. Legal Proceedings
The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business; however, in the opinion of management, there are no proceedings pending to which the Corporation is a party to, or which would be material in relation to the Corporation’s undivided profits or financial
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condition. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation. In addition, no material proceedings are pending, known to be threatened, or contemplated against the Corporation by governmental authorities.
Item 4.
Item 4. (Removed and Reserved)
Part II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities
The Corporation has only one class of stock authorized, issued, and outstanding, which consists of common stock with a par value of $0.20 per share. As of December 31, 2010, there were 12,000,000 shares of common stock authorized with 2,869,557 shares issued, and 2,856,039 shares outstanding to approximately 1,645 shareholders. The Corporation’s common stock is traded on a limited basis on the OTCBB under the symbol “ENBP.” Prices presented in the table below reflect high and low prices of actual transactions known to management. Prices and dividends per share are adjusted for stock splits. Market quotations reflect inter-dealer prices, without retail mark up, mark down, or commission and may not reflect actual transactions.
Source - SNL Financial LC
Dividends
Since 1973, the Corporation has paid quarterly cash dividends on approximately March 15, June 15, September 15, and December 15 of each year. Prior to 1973, dividends were paid semi-annually. The Corporation currently expects to continue the practice of paying quarterly cash dividends to its shareholders for the foreseeable future. However, future dividends are dependent upon future earnings. Certain laws restrict the amount of dividends that may be paid to shareholders in any given year. In addition, under Pennsylvania corporate law, the Corporation may not pay a dividend if, after issuing the dividend (1) the Corporation would be unable to pay its debts as they become due, or (2) the Corporation’s total assets would be less than its total liabilities plus the amount needed to satisfy any preferential rights of shareholders. In addition, as declared by the Board of Directors, Ephrata National Bank’s dividend restrictions apply indirectly to ENB Financial Corp because cash available for dividend distributions will initially come from dividends Ephrata National Bank pays to ENB Financial Corp. See Note M to the consolidated financial statements in this Form 10-K filing, for information that discusses and quantifies this regulatory restriction.
ENB Financial Corp offers its shareholders the convenience of a Dividend Reinvestment Plan and the direct deposit of cash dividends. The Dividend Reinvestment Plan gives shareholders registered with the Corporation the opportunity to have their quarterly dividends invested automatically in additional shares of the Corporation’s common stock. Shareholders who prefer a cash dividend may have their quarterly dividends deposited directly into a checking or savings account at their financial institution. For additional information on either program, contact the Corporation’s stock registrar and dividend paying agent, Registrar and Transfer Company, 10 Commerce Drive, Cranford, NJ 07016.
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Purchases
The following table details the Corporation’s purchase of its own common stock during the fourth quarter of 2010.
Issuer Purchase of Equity Securites
*On August 13, 2008, the Board of Directors of ENB Financial Corp announced the approval of a plan to purchase, in open market and privately negotiated transactions, up to 140,000 shares of outstanding common stock. Shares repurchased are being held as treasury shares to be utilized in connection with the Corporation’s Dividend Reinvestment Plan and Employee Stock Purchase Plan. The first purchase of common stock under this plan occurred on August 27, 2008. By December 31, 2010, a total of 55,000 shares were repurchased at a total cost of $1,385,000, for an average cost per share of $25.18. Management may choose to repurchase additional shares in 2011.
Recent Sales of Unregistered Securities and Equity Compensation Plan
The Corporation does not have an equity compensation plan and has not sold any unregistered securities.
Shareholder Performance Graph
Set forth below is a line graph comparing the yearly change in the cumulative total shareholder return on ENB Financial Corp’s common stock against the cumulative total return of the Russell 2000 Index, the Mid-Atlantic Custom Peer Group Index, and the SNL Small Cap Bank Index for the period of six fiscal years commencing December 31, 2005, and ending December 31, 2010. The graph shows that the cumulative investment return to shareholders, based on the assumption that a $100 investment was made on December 31, 2005, in each of the following: the Corporation’s common stock, the Russell 2000 Index, the Mid-Atlantic Custom Peer Group Index, and the SNL Small Cap Bank Index and that all dividends were reinvested in those securities over the past six years, the cumulative total return on such investment would be $73.95, $124.46, $79.07, and $59.56 respectively. The shareholder return shown on the graph below is not necessarily indicative of future performance.
ENB FINANCIAL CORP
*Mid-Atlantic Custom Peer Group consists of 157 commercial banks located in the Mid-Atlantic states of Pennsylvania, New York, New Jersey, Maryland, and Delaware. The largest bank in this peer group had assets of $993 million with the smallest having assets of $48 million.
ENB FINANCIAL CORP
Item 6
Item 6 - Selected Financial Data
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected financial data set forth below should be read in conjunction with the Corporation's financial statements and their accompanying notes presented elsewhere herein.
ENB FINANCIAL CORP
Management’s Discussion and Analysis
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this annual report. The financial condition and results of operations presented are not indicative of future performance.
Results of Operations
Overview
The Corporation recorded net income of $6,345,000 for the year ended December 31, 2010, a 47.6% increase over the $4,300,000 earned during the same period in 2009. The 2009 net income was 7.1% higher than the 2008 net income of $4,014,000. Earnings per share, basic and diluted, were $2.23 for 2010, compared to $1.52 in 2009, and $1.40 in 2008.
Earnings were positively affected by an increase in net interest income and a decrease in the provision for loan losses.
·
Net interest income showed a 5.8% improvement over 2009 levels, primarily as a result of the continued low-rate environment that allowed the Corporation to achieve significant savings on funding costs.
·
The Corporation recorded a provision for loan loss expense of $1,800,000 for the year ended December 31, 2010, a $1,120,000 decrease from the $2,920,000 recorded for the same period in 2009. The lower provision was primarily a result of an increase in the provision expense in 2009 to compensate for credit quality deterioration in the Corporation’s loan portfolio. The allowance as a percentage of loans increased from 1.38% as of December 31, 2009, to 1.72% as of December 31, 2010.
Despite significant economic weakness and an extremely low interest rate environment, the Corporation’s net interest income increased at a rate of 5.8%, or $1,222,000, for the year ended December 31, 2010, compared to 4.3%, or an $858,000 increase from 2008 to 2009. Other income, excluding the gain or loss on securities, decreased 4.4%, or $277,000 in 2010, compared to 2009. Total operational costs were nearly unchanged from 2009 to 2010, decreasing by $12,000, as the Corporation continued to leverage efficiencies gained from the business process improvement engagement that occurred in 2008 and 2009.
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 Corporation’s 2010 ROA was 0.85%, compared to 0.60% in 2009; likewise ROE increased from 6.28% in 2009 to 8.62% in 2010. Both increases were primarily due to the sharp increase in the Corporation’s earnings. The 41.7% increase in ROA was slightly lower than the 47.6% increase in earnings due to a 4.7% growth in the Corporation’s average assets. The ROE increased 37.3%, as the 47.6% increase in earnings was partially offset by a 7.4% increase in average equity. This resulted in more return from the equity utilized.
The results of the Corporation’s operations are best explained by addressing in further detail the five major sections of the income statement, which are as follows:
·
Net interest income
·
Provision for loan losses
·
Other income
·
Operating expenses
·
Income taxes
ENB FINANCIAL CORP
Management's Discussion and Analysis
The following discussion analyzes each of these five components.
Net Interest Income
Net interest income (NII) represents the largest portion of the Corporation’s operating income. In 2010, NII generated 76.1% of the Corporation’s gross revenue stream, compared to 76.5% in 2009, and 80.4% in 2008. Since NII comprises a significant portion of the operating income, the direction and rate of increase or decrease will often indicate the overall performance of the Corporation.
The following table shows a summary analysis of NII on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets, are presented on an FTE basis. The FTE NII shown in both tables below will exceed the NII reported on the statements of income. The amount of FTE adjustment totaled $1,999,000 for 2010, $1,746,000 for 2009, and $1,649,000 for 2008.
The amount of the tax adjustment varies depending on the amount of income earned on tax-free assets. The Corporation has historically carried a larger component of tax-free loans and securities relative to its size. When income levels were diminished in 2006 through 2009, this caused the Corporation to be in an alternative minimum tax (AMT) position, as tax-free income grew to a much larger percentage of total income. When the Corporation was in an AMT position, tax-free loans and securities did not offer the full tax advantage they do when the Corporation is not subject to AMT. As a result of the AMT position, management began reducing the tax-free municipal bond portfolio in 2008 and early 2009 in an effort to reduce the Corporation’s AMT position, which acted to reduce the tax-equivalent adjustments. However, because of legislation that followed the credit crisis in the fall of 2008, beginning in 2009, financial institutions were permitted to purchase 2009 and 2010 newly issued tax-free municipal bonds, which are AMT-exempt for the life of the bond. As a result, management resumed the purchase of AMT-exempt municipal bonds in mid 2009 increasing the size of the tax-free municipal bond portfolio, and again increasing the tax equivalent adjustment. This is why the tax equivalent adjustment increased from 2008 to 2009, and again from 2009 to 2010. The Corporation was not in an AMT position for 2010 due to higher levels of taxable income and is not expected to be in an AMT position in 2011, therefore it is likely the Corporation’s tax-equivalent adjustment will continue to grow slowly in 2011.
Net Interest Income
(DOLLARS IN THOUSANDS)
NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect NII:
·
The rates charged on interest earning assets and paid on interest bearing liabilities
·
The average balance of interest earning assets and interest bearing liabilities
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 funds rate, which is the overnight rate that financial institutions charge other financial institutions to buy or sell overnight funds, has declined from 5.25% in August 2007, to 0.25% by December 15, 2008, and has remained at this historically low level to the writing of this filing.
ENB FINANCIAL CORP
Management's Discussion and Analysis
The Prime rate typically moves in tandem with the Federal funds rate and similarly has not moved from its historically low 3.25% since December 31, 2008. The fact that the Federal funds rate and the Prime rate have remained at these very low levels for over two years has generally had offsetting positive and negative impacts to the Corporation’s NII. The decrease in the Federal funds rate has reduced the cost of funds on overnight borrowings and allowed lower interest rates paid on deposits, reducing the Corporation’s interest expense, while the decrease in the Prime rate has reduced the yield on the Corporation’s prime-based loans. The Corporation’s fixed rate loans do not reprice as rates change; however, with the steep decline in interest rates and a prolonged period with lower market rates, more customers have refinanced into lower fixed rate loans or moved into Prime-based loans. Management has instituted floors on certain loan instruments and revised pricing standards to help slow the reduction of loan yield during this historically low-rate period.
During 2008, short-term interest rates decreased dramatically, and by the end of 2008, the U.S. Treasury curve resumed a more normal, positively sloped yield curve with overnight rates just under 0.25% and the 10-year U.S. Treasury close to 2.15%. The nearly 200 basis points of positive slope between overnight rates and the 10-year U.S. Treasury was material, but not favorable enough for financial institutions to take on more interest rate risk by making fixed-rate loans or purchasing fixed-rate securities. The positive slope of the yield curve has fluctuated many times in the past two years with the overnight rates remaining the same with the 10-year U.S. Treasury varying between as high as 4.00% for both 2009 and 2010, and as low as 2.20% in 2009, and 2.40% in 2010. The 10-year U.S. Treasury finished 2010 at 3.30%, which provided for more than 300 basis points of slope off the overnight rate of 0.25%. Generally, there was a little more positive slope in the yield curve during 2009 than in 2010. The average 10-year U.S. Treasury close was approximately 3.21% in 2010 versus 3.38% in 2009; however, the slope was greater than what existed at the end of 2008. The 300 basis points of slope that existed for much of 2010 was enough for management to be able to extend on the yield curve to pick up greater asset yield. Since deposits and borrowings generally price off short-term rates, the significant rate drops on the short end of the rate curve permitted management to continue to reduce the overall cost of funds during 2010. Over this period, management continued to reprice time deposits and borrowings to lower levels. Rates on interest bearing core deposit accounts were also steadily reduced during 2010. Meanwhile, management continued to invest in securities and originate loans at longer terms, where the U.S. Treasury curve and market interest rates remained higher.
Management currently anticipates that the overnight interest rate and Prime rate will remain at these historically low levels throughout 2011 because of the current economic and credit situation. This will likely result in the U.S. Treasury curve retaining a significant positive slope for 2011, based on the economic data currently available. This will allow management to continue to price the vast majority of liabilities off lower short-term rates, while pricing loans and investing in longer securities, which are based off the 5-year and 10-year U.S. Treasury rates that are significantly above short-term rates.
ENB FINANCIAL CORP
Management's Discussion and Analysis
The following table provides an analysis of year-to-year changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
In 2010, the Corporation’s NII on an FTE basis increased by $1,475,000 compared to 2009, a 6.5% increase. Total interest income on an FTE basis for 2010 decreased $796,000, or 2.2%, from 2009, while interest expense decreased $2,271,000, or 17.7%, from 2009 to 2010. The FTE interest income from the securities portfolio decreased by $672,000, or 5.5%, while loan interest income declined $136,000, or 0.6%. During most of 2010, loan demand was moderately low and the Corporation used available liquidity generated by deposits and additional borrowings to invest in securities. Although the growth in the securities portfolio added $765,000 to net interest income, the lower yields on securities caused a $1,437,000 reduction, resulting in a net decrease of $672,000. Loan demand was modest in the first half of the year, contributing to growth in loan balances, which added $513,000 to net interest income. However, decreases in loan yield more than offset the additional income from loan growth, reducing net interest income by $649,000, resulting in a net decrease of $136,000.
Interest bearing liabilities grew steadily throughout 2010. Despite the increase in balances, total interest expense declined with the significantly lower interest rates. Lower interest rates on all deposit groups caused $2,103,000 of savings, while higher balances increased interest expense by $350,000, resulting in net savings of $1,753,000. Out of all the Corporation’s deposit types, demand deposits reprice the most rapidly, as nearly all accounts are immediately affected by rate changes. The Corporation reduced demand deposit interest expense by $243,000 due to lower rates. Time deposit balances increased adding $264,000 to expense, but time deposits repricing to lower interest rates reduced interest expense by $1,786,000, causing a net reduction of $1,522,000 in time deposit interest expense.
ENB FINANCIAL CORP
Management's Discussion and Analysis
Historically, the Corporation has seen increases in time deposits when the equity markets decline, as investors attempt to protect principal. This occurred in both 2009 and 2010. Even with the historically low rate environment, the Corporation was successful in increasing nearly all deposit types by providing competitive rates. As 2010 progressed and interest rates remained low, the Corporation was able to continue to reprice time deposits maturing at lower interest rates thereby reducing the cost of funds significantly. Management was also able to reduce interest rates throughout the year on the other interest bearing core deposit balances. These rate reductions more than compensated for the increase in deposit balances for all deposit types.
The Corporation was able to rely more on the liquidity generated by deposits during the year and slightly less on borrowed funds. The Federal funds purchased declined, decreasing interest expense $10,000 related to decreased balances, while reducing expense $6,000 due to lower rates, for a net decrease to expense of $16,000. Long-term borrowing balances decreased interest expense $388,000, and lower rates reduced expense $114,000, for a net decrease of $502,000.
The following table shows a more detailed analysis of net interest income on an FTE basis shown with all the major elements of the Corporation’s balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency of not giving credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, Management emphasizes the net yield on interest earning assets, also referred to as the net interest margin (NIM). The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. The NIM is generally the benchmark used by analysts to measure how efficiently a bank generates NII. For example, a financial institution with a NIM of 3.50% would be able to use fewer assets and still achieve the same level of NII as a financial institution with a NIM of 3.25%.
ENB FINANCIAL CORP
Management's Discussion and Analysis
COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
(a) Includes balances of non-accrual loans and the recognition of any related interest income. Average balances also include net deferred loan fees of ($227,000) in 2010, ($306,000) in 2009, and ($308,000) in 2008. Such fees recognized through income and included in the interest amounts totaled $55,000 in 2010, $59,000 in 2009, and $48,000 in 2008.
(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities.
(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.
(d) Securities recorded at amortized cost. Unrealized holding gains and losses are included in non-interest earning assets.
ENB FINANCIAL CORP
Management's Discussion and Analysis
The Corporation’s interest expense decreased at a faster pace than interest income, resulting in a higher NIM of 3.50% for 2010, compared to 3.43% for 2009. The yield earned on assets dropped 34 basis points while the rate paid on liabilities dropped 50 basis points. Management anticipates further NIM improvement in 2011 as the rate curve remains in a relatively steep positive slope, allowing further cost savings to occur on liabilities, while loans have essentially reached the bottom of the pricing cycle. Prime rate decreases that have a negative impact to loan yield should be over now that the target Federal funds rate is between 0.00% and 0.25%. While the amount of the Corporation’s Prime-based loans continues to increase, management is also flooring more Prime-based loans above 3.25% in an effort to slow the loss of loan yield. Management is also taking action to increase Prime-based loan rates when the customer’s credit standing has diminished. Management’s efforts to price Prime-based loans higher were mainly offset by more Prime-based loan demand. Customers are seeking more Prime-based loans because even with Prime floors instituted at 4.00%, these variable rate loans are viewed as more desirable than commercial fixed rate loans that range from just under 5.00% to over 7.00%, depending on the term and credit quality of the borrower. Some business and commercial borrowers are paying down these fixed rate loans, and refinancing with a Prime-based variable rate loan. The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in net interest income, the Corporation’s largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of rising rates, please refer to Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a financial institution, the Corporation is subject to four primary market risks:
·
Credit risk
·
Liquidity risk
·
Interest rate risk
·
Fair value risk
The Board of Directors has established an Asset Liability Management Committee (ALCO) to measure, monitor, and manage these four primary market risks. The Asset Liability Policy has instituted guidelines for all of these primary risks, as well as other financial performance measurements with target ranges. The Asset Liability goals and guidelines are consistent with the Strategic Plan goals.
For discussion on credit risk, refer to the sections on non-performing assets, allowance for loan losses, Note C, and Note P to the Consolidated Financial Statements.
Liquidity
Liquidity refers to having an adequate supply of cash available to meet business needs. Financial institutions must ensure that there is adequate liquidity to meet a variety of funding needs, at a minimal cost. Minimal cost is an important component of liquidity. If a financial institution is required to take significant action to obtain funding, and is forced to utilize an expensive source, it has not properly planned for its liquidity needs. Funding new loans and covering deposit withdrawals are the primary liquidity needs of the Corporation. The Corporation uses a variety of funding sources to meet liquidity needs, such as:
·
Deposits
·
Loan repayments
·
Maturities and sales of securities
·
Borrowings from correspondent and member banks
·
Repurchase agreements
·
Brokered deposits
·
Current earnings
One of the measurements used in liquidity planning is the Maturity Gap Analysis. The Maturity Gap Analysis below measures the amount of assets maturing within various time frames versus liabilities maturing in those same periods. These time frames are referred to as gaps and are reported on a cumulative basis. For instance, the one-year gap shows all assets maturing one year or less from a specific date versus the total liabilities maturing in the same time period. The gap is then expressed as a percentage of assets over liabilities. Mismatches between assets and liabilities maturing are identified and assist management in determining potential liquidity issues.
The maturity gap analysis does not include non-interest earning assets and non-interest bearing liabilities, with the exception of non-interest bearing demand deposit accounts. The non-interest bearing demand deposits are considered additional deposit liabilities with a 0.00% interest rate, which acts to lower the overall interest rate paid on total deposits. For purposes of this analysis, items like cash, premises and equipment, bank owned life insurance, and other assets are considered non-interest earning assets and are not included in assets maturing. On the liability side, the only liability not included is other liabilities, which represent open obligations of the Corporation.
It is unlikely that maturing assets would equal maturing liabilities because, on the balance sheet, assets do not equal liabilities. However, after non-earning assets and liabilities are pulled out, the remaining assets and liabilities maturing are relatively close resulting in a cumulative maturity gap percentage near 100%. For purposes of this analysis, $682.2 million of assets mature in all time frames while $671.2 million of liabilities mature in all time frames, resulting in a 101.6% cumulative maturity gap. So, while a cumulative maturity gap of 100% would indicate that the same amount of assets and liabilities are maturing within the specified period, this is rather unlikely to occur within any time frame, or on a cumulative basis. The Corporation has historically been liability sensitive in the shorter time frames because loans usually have longer maturities than deposits, resulting in ratios under 100%. In the 1-year to 3-year time frame, assets maturing exceed liabilities maturing. Liability maturities exceed deposit maturities in the 3-year to 5-year time frame. In the time frame of 5 years and greater, deposit maturities exceed loan maturities.
ENB FINANCIAL CORP
Management's Discussion and Analysis
The table below shows the six-month, one-year, three-year, and five-year cumulative gaps as of December 31, 2010, along with the cumulative maturity gap guidelines monitored by management. For the purposes of this analysis, core deposits without a specific maturity date are spread across all time periods based on historical behavior.
MATURITY GAP ANALYSIS
(DOLLARS IN THOUSANDS)
As of December 31, 2010, all maturity gaps are well within Corporate Policy guidelines and were showing significant improvement over the prior year’s level. As of December 31, 2009, the Corporation was under guidelines for the three middle time frames. At that time, management preferred to have lower amounts of assets available for repricing as rates were historically low with little likelihood of increasing. However, as 2010 progressed and the likelihood of higher market rates increased, management desired to increase gap ratios and bring the cumulative maturity gap ratios back within guidelines. Improvement occurred due to the combined result of both management’s actions and customer reaction to the present environment. Management worked to purposefully extend liabilities in 2010 by offering attractive rates on long-term CDs to encourage customers to invest for more than one year. Unlike in 2009, customers were more willing to invest in five-year CDs during 2010 because of the unlikelihood of rates increasing in the near term as well as the disparity in interest rates from one-year to five-year investments. Secondly, in the fall of 2010, U.S. Treasury rates fell to record levels which increased prepayment speeds on the Corporation’s MBS, CMO, and PCMO securities. This increased cash flows and shortened the Corporation’s assets. Additionally, several long-term advances were initiated to take advantage of the low interest rates and lock in funding for four or five years. These three factors were primarily responsible for the improved gap ratios as of December 31, 2010. While the Corporation is still liability sensitive in three out of five time frames, the gap ratios indicate that this liability sensitivity is low and well within corporate policy guidelines.
Given the likelihood that short term interest rates may increase by late 2011 or early 2012, management’s current position is to maintain the cumulative maturity gap percentages within guidelines for each successive quarter in 2011. The risk in this situation is that, should interest rates not rise, maturing assets will reprice at lower rates. However, the risk of liabilities repricing at higher interest rates is low. Given the alternative investment options available, management also does not perceive significant risk that deposits maturing in the shorter time frames will leave the Corporation. It is likely that, should market interest rates rise in late 2011 and throughout 2012, customer behavior patterns will change and deposits will be more rate sensitive with a greater portion potentially leaving the Corporation. These maturity gaps are closely monitored along with additional liquidity measurements discussed below. Management will work to maintain these ratios within policy guidelines throughout 2011 in order to position for the increased likelihood of rising interest rates.
In addition to the cumulative maturity gap analysis discussed above, management utilizes a number of other important liquidity measurements that management believes have advantages over, and give better clarity to, the Corporation’s present and projected liquidity.
ENB FINANCIAL CORP
Management's Discussion and Analysis
The following is a listing of the Corporation’s other liquidity measurements, along with a short definition, that are evaluated in an effort to monitor and mitigate liquidity risk:
·
Core Deposit Ratio - Core deposits as a percentage of assets
·
Funding Concentration Analysis - Alternative funding sources outside of core deposits as a percentage of assets
·
Short-term Funds Availability - Readily available short-term funds as a percentage of assets
·
Securities Portfolio Liquidity - Cash flows maturing in one year or less as a percentage of assets and securities
·
Borrowing Limits - Internal borrowing limits in terms of both FHLB and total borrowings.
·
Three, Six, and Twelve-month Projected Sources and Uses of Funds - Net projected liquidity surplus/shortage shown for each period.
These measurements are designed to prevent undue reliance on outside sources of funding and ensure a steady stream of liquidity is available should events occur that would cause a sudden decrease in deposits or large increase in loans or both, which would in turn draw significantly from the Corporation’s available liquidity sources.
As of December 31, 2010, the Corporation was within guidelines for all of the above measurements. These measurements are tracked and reported quarterly by management to both observe trends and ensure the measurements stay within desired ranges. Management is confident that a sufficient amount of internal and external liquidity exists to provide for significant unanticipated liquidity needs.
Interest Rate Risk and Fair Value Risk
Identifying the interest rate risk of the Corporation’s interest earning assets and interest bearing liabilities is essential to managing net interest margin and net interest income. In addition to the impact on earnings, management is also concerned about how much the value of the Corporation’s assets might rise or fall given an increasing or decreasing interest rate environment. Net portfolio value (NPV) analysis measures the change in the Corporation’s capital fair value, given interest rate fluctuations, while interest rate sensitivity analysis (IRSA) measures the impact of a change in interest rates on the net interest income and net interest margin. Therefore, the two primary approaches to measuring the impact of interest rate changes on the Corporation’s earnings and fair value are referred to as:
·
Changes in net portfolio value
·
Changes in net interest income
The Corporation’s asset liability model is able to perform dynamic forecasting based on a wide range of assumptions provided. The model is flexible and can be used for many types of financial projections. The Corporation uses financial modeling to forecast balance sheet growth and earnings. The results obtained through the use of forecasting models are based on a variety of factors. Both earnings and balance sheet forecasts make use of maturity and repricing schedules to determine the changes to the Corporation’s balance sheet over the course of time. Additionally, there are many assumptions that factor into the results. These assumptions include, but are not limited to:
·
Projected interest rates
·
Timing of interest rate changes
·
Slope of the U.S. Treasury curve
·
Spreads available on securities over the U.S. Treasury curve
·
Prepayment speeds on loans held and mortgage-backed securities
·
Anticipated calls on securities with call options
·
Deposit and loan balance fluctuations
·
Competitive pressures affecting loan and deposit rates
·
Economic conditions
·
Consumer reaction to interest rate changes
As a result of the many assumptions, this information should not be relied upon to predict future results. Additionally, both of the analyses shown below do not consider any action that management could take to minimize or offset the negative effect of changes in interest rates. These tools are used to assist management in identifying possible areas of risk in order to address them before a greater risk is posed.
ENB FINANCIAL CORP
Management's Discussion and Analysis
Change in Net Portfolio Value
The change in net portfolio value gives a long-term view of the exposure to changes in interest rates. The NPV is calculated by discounting the future cash flows to the present value based on current market rates. The NPV is the mathematical equivalent of the present value of assets minus the present value of liabilities.
The table below indicates the changes in the Corporation’s NPV as of December 31, 2010. As part of the Asset Liability Policy, the Board of Directors has established risk measurement guidelines to protect the Corporation against decreases in the net portfolio value and net interest income in the event of interest rate changes described above. All scenarios for both 2010 and 2009 show the Corporation within ALCO guidelines.
CHANGES IN NET PORTFOLIO VALUE
This table shows the effect of an immediate interest rate shock on the net portfolio value of the Corporation's assets and liabilities.
Base rate is the Prime rate.
The results as of December 31, 2010, indicate that the Corporation’s NPV would improve in the down-rate scenarios and experience a valuation loss in all up-rate scenarios. The percentage change for all scenarios is within policy guidelines, however the projected valuation loss in the rates up 200, 300, and 400 scenarios is significantly higher than at the end of 2009. In 2010, management changed the seven rate scenarios because of the greatly diminished likelihood that interest rates would decline further. While the Prime rate of 3.25% could potentially decline, since the Federal Reserve’s target Federal funds rate is already down to 0.00% to 0.25%, and because the Prime rate and the Federal funds rate generally move in tandem, it is not likely that the Prime rate will decline further. Therefore, management removed the rates down 300 and 200 and went with only two rates down scenarios of down 50 and 100 basis points. These two rates down scenarios could happen but are unlikely. Management then added a rates up 400 basis points scenario to model a more aggressive rates up move.
There is portfolio value volatility as rates rise indicating that the Corporation loses NPV, which is the result of the value of assets declining at a faster rate than the decrease in the value of deposits. Stated in another manner, an increase in interest rates would devalue the Corporation’s assets and this decrease would not be entirely overshadowed by the value of the Corporation’s liabilities declining. The material reductions in the rates up 200, 300, and 400 basis point scenarios are caused by longer term securities and mortgages on the asset side of the balance sheet. During 2010, the Corporation’s municipal bond segment of the securities portfolio grew significantly due to tax strategies, low loan growth, and high tax equivalent yields available. The book value of municipal bonds grew $17.7 million, or 28.3%, from December 31, 2009, to December 31, 2010. These securities represent the Corporation’s longest and highest yielding securities and they also carry the largest amount of fair value risk if long term rates increase. Similarly, as commercial loan growth slowed and the loan portfolio declined in the latter half of 2010, the amount of 1 to 4 family residential mortgages continued to increase and grew by $5.9 million, or 4.6%. These assets are predominately 15 and 20-year mortgages which represents the Corporation’s longest loan assets. Management anticipates that the rates up NPV reductions will decline slightly going forward as reductions in longer term assets have already occurred in early 2011.
ENB FINANCIAL CORP
Management's Discussion and Analysis
Changes in Net Interest Income
The changes in net interest income reflect how much the Corporation’s net interest income would be expected to increase or decrease given a change in market interest rates. The changes in net interest income shown are measured over a one-year time horizon and assume an immediate rate change on the rate sensitive assets and liabilities. This is considered the more important measure of interest rate sensitivity due to the immediate effect that rate changes may have on the overall performance of the Corporation. The following table takes into consideration when financial instruments would most likely reprice and the duration of the pricing change. It is important to emphasize that the information shown in the table is an estimate based on hypothetical changes in market interest rates.
CHANGES IN NET INTEREST INCOME
This table shows the effect of an immediate interest rate shock over a one-year period on the Corporation's net interest income.
Base rate is the Prime rate
The above analysis shows a slightly negative impact to the Corporation’s net interest income when rates decline 100 basis points, but a positive impact in all other rate scenarios. In the unique current rate environment, the amount of the Corporation’s assets repricing higher will be fairly large due to the amount of variable rate loans that will reprice immediately when Prime increases. On the liability side, if rates increase, it is typical for management to react slowly in increasing deposit rates. Even when deposit rates are increased, they are typically increased at a fraction of the increase in the Prime rate. In the current environment, if interest rates rise, it is expected that deposit rates will move upward, but more slowly than in past rates-up cycles. It is unlikely that rates will go down, but in the event that they would go lower, the Corporation would have exposure to all maturing fixed rate loans and securities which would reprice lower while most of the Corporation’s interest-bearing deposits could not be repriced any lower. The analysis above focuses on immediate rate movements, referred to as rate shocks, and measured over the course of one year. The Corporation’s model also has the ability to measure changes to net interest income given interest rate changes that occur more slowly over time. This type of modeling is referred to as “interest rate ramps,” where a set change in rates occurs over a period of time. If rates were to move upward slowly over the course of the next year, the results are very close to the results using a rate shock.
The above analysis also shows that the Corporation’s net interest income would decrease if rates decline by 100 basis points. This results from several types of deposit products’ current offering rates being at or near the floor for pricing. For instance, savings accounts had an interest rate of 0.10% as of December 31, 2010. Management is only able to reduce the rate to zero; therefore, any reduction in the savings rate only benefits earnings in the case of a 10-basis point rate decline. Since most loan rates would be able to reprice lower under the declining rate scenarios and the deposit rate decreases are limited, the Corporation would have less earnings under a declining rate scenario. It is likely that management would control the reduction in loan rates to limit the reduction in net interest income in a downward rate environment.
The assumptions and analysis of interest rate risk are based on historical experience during varied economic cycles. Management believes these assumptions to be appropriate; however, actual results could vary significantly. Management uses this analysis to identify trends in interest rate sensitivity and determine if action is necessary to mitigate asset liability risk.
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ENB FINANCIAL CORP
Item 8.
Item 8. Financial Statements and Supplementary Data
The following audited consolidated financial statements are set forth in this Annual Report of Form 10-K on the following pages:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
ENB Financial Corp
We have audited the accompanying consolidated balance sheets of ENB Financial Corp (the “Corporation”) and subsidiary as of December 31, 2010 and 2009, and the related statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2010. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ENB Financial Corp and subsidiary as of
December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
/s/ S.R. Snodgrass, A.C.
Wexford, PA
March 23, 2011
S.R. Snodgrass, A.C. * 2100 Corporate Drive, Suite 400 * Wexford, Pennsylvania 15090-8399 * Phone: (724) 934-0344 * Facsimile: (724) 934-0345
ENB FINANCIAL CORP
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See notes to consolidated financial statements
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See notes to consolidated financial statements
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See notes to consolidated financial statements
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
See notes to consolidated financial statements
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations:
ENB Financial Corp, through its wholly owned subsidiary, Ephrata National Bank, provides financial services to Northern Lancaster County and surrounding communities. ENB Financial Corp, a bank holding company, was formed on July 1, 2008, to become the parent company of Ephrata National Bank, which existed as a stand-alone national bank since its formation in 1881. The Corporation’s wholly owned subsidiary, Ephrata National Bank, offers a full array of banking services including loan and deposit products for both personal and commercial customers, as well as trust and investment services, through nine office locations.
Basis of Presentation:
The consolidated financial statements of ENB Financial Corp and its subsidiary, Ephrata National Bank, (collectively “the Corporation”) conform to U.S. generally accepted accounting principles (GAAP). The preparation of these statements requires that management make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates of the Corporation, including the allowance for loan losses, the fair market value of securities available for sale, the valuation of foreclosed real estate, other than temporary investment impairments, and deferred tax assets or liabilities, are evaluated regularly by management. Actual results could differ from the reported estimates given different conditions or assumptions.
The accounting and reporting policies followed by the Corporation conform with U.S. GAAP and to general practices within the banking industry. All intercompany transactions have been eliminated in consolidation. The following is a summary of the more significant policies.
Cash and Cash Equivalents:
For purposes of reporting cash flows, cash and cash equivalents are identified as cash and due from banks, and includes cash on hand, collection items, amounts due from banks, and interest bearing deposits in other banks with maturities of less than 90 days.
Securities Available for Sale:
The Corporation classifies its entire portfolio of debt and equity securities as available for sale securities, which the Corporation reports at fair value. Any unrealized valuation gains or losses in the portfolio are reported as a separate component of stockholders' equity, net of deferred income taxes. The constant yield method is used for the amortization of premiums and the accretion of discounts for all of the Corporation’s securities with the exception of collateralized mortgage obligations (CMOs) and index amortizing notes (IANs). The constant yield method maintains a stable yield on the instrument through its maturity. For CMOs and IANs, a two-step/proration method is used for amortization and accretion. The first step is a proration based on the current pay down. This component ensures that the book price stays level with par. The second step amortizes or accretes the remaining premium or discount to the calculated final amortization or accretion date based on the current three-month constant prepayment rates. Net gains or losses realized on sales or calls of securities are reported as gains or losses on security transactions during the year of sale, using the specific identification method.
Other Than Temporary Impairment (“OTTI”):
Management monitors all of the Corporation’s securities for OTTI on a monthly basis and determines whether any impairment should be recorded. A number of factors are considered in determining whether a security is impaired, including, but not limited to, the following:
·
period of time the security has had unrealized losses,
·
percentage of unrealized losses,
·
type of security,
·
the intent to sell the security or whether it is more likely than not that the Corporation would be required to sell the security before its anticipated recovery in market value
·
amount of projected credit losses based on current cash flow analysis, default, and severity rates, and
·
market dynamics impacting the market and liquidity of the security.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Management will more closely evaluate those securities that have unrealized losses of 10% or more and have had unrealized losses for more than twelve months. If management determines that the declines in value of the security are not temporary, or if management does not have the ability to hold the security until maturity, which is the case with equity securities, then management will record impairment on the security. For equity securities, typically the amount of impairment is the difference between the security’s book value and current fair market value determined by obtaining independent market pricing. For debt securities evaluated for impairment, management will determine what portion of the unrealized valuation loss is attributed to projected or known loss of principal, and what portion is attributed to market pricing not reflective of the true value of the security, based on current cash flow analysis. Management will generally record impairment equivalent to the projected or known loss of principal, known as the credit loss. The other portion of the fair market value loss is attributed to market factors and it is management’s opinion that these fair value losses are temporary and not permanent. All impairment is recorded as a loss on securities and is included in the Corporation’s Consolidated Statements of Income.
Loans:
The Corporation reports loans receivable at the outstanding principal balances, reduced by any charge-offs and net of any deferred loan origination fees or costs. Net loan origination fees and costs are deferred and recognized as an adjustment of yield over the contractual life of the loan.
In general, fixed-rate residential mortgage loans originated by the Corporation and held for sale, are carried in the aggregate at the lower of cost or market. Such mortgage loans are sold to Fannie Mae and serviced by the Corporation. The Corporation also originates loans for immediate sale to Wells Fargo but does not service these mortgages.
Interest accrues daily on outstanding loan balances. Generally, the accrual of interest discontinues when the ability to collect the loan becomes doubtful or when a loan becomes more than 90 days past due as to principal and interest. Management may elect to continue the accrual of interest based on the expectation of future payments and/or the sufficiency of the underlying collateral.
Allowance for Loan Losses:
The allowance for loan losses is maintained at a level considered by management to be adequate to provide for known and inherent risks in the loan portfolio at the Consolidated Balance Sheets date. The monthly provision for loan losses is an expense which increases the allowance, while charge-offs, net of recoveries, decrease the allowance. The Corporation performs ongoing credit reviews of the loan portfolio and considers current economic conditions, historical loan loss experience, and other factors in determining the adequacy of the reserve balance. Loans determined to be uncollectible are charged to the allowance during the period in which such determination is made.
In calculating the allowance, management will begin by compiling the balance of loans by credit quality for each loan segment in order that allocations can be made in aggregate based on historic losses and qualitative factors. Prior to calculating these aggregate allocations, management will individually evaluate commercial and commercial real estate loans for impairment. A loan is impaired when it is probable that a creditor will be unable to collect all principal and interest due according to the contractual terms of the loan agreement. All other loan types such as residential mortgages, home equity loans, and all other consumer loans, are not individually evaluated for impairment and are therefore allocated for in aggregate. These loans are considered to be large groups of smaller-balance homogenous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.
For loans deemed to be impaired, management will provide a specific allocation. This loan balance is then subtracted from the total loan balances being allocated for in the aggregate. The remaining balances, along with the full loan balances for the other loan types are then multiplied by an adjusted loss ratio, which is the sum of both the historical loss ratio and a qualitative factor adjustment. Generally both the historical loss ratio and the qualitative factor adjustment will increase as the credit rating of the loan deteriorates. The credit ratings begin with unclassified loans being the lowest, special mention loans being higher, and the classified graded loans, which include substandard, doubtful, and loss, being the highest. The loan balance multiplied by the adjusted loss ratio produces the allowance
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
required for each credit rating of each loan type. The allowances are totaled and added to any specific allocations on impaired loans to arrive at the total allowance for loan losses for the Corporation.
Management tracks and assigns a historical loss percentage for each loan rating category within each loan type. A rolling three-year historical loss ratio, calculated on a quarterly basis, with a 60%, 30%, and 10% weighting for the past three years is used. In this manner the historical loss percentage is heavily weighted to the current loss environment, but has sufficient weighting assigned to prior periods to avoid unnecessary volatile fluctuations based on just one period’s data.
Management currently utilizes nine qualitative factors that are adjusted based on changes in the lending environment and economic conditions. The qualitative factors include the following:
·
levels of and trends in delinquencies, non-accruals, and charge-offs,
·
trends within the loan portfolio,
·
changes in lending policies and procedures,
·
experience of lending personnel and management oversight,
·
national and local economic trends,
·
concentrations of credit,
·
external factors such as legal and regulatory requirements,
·
changes in the quality of loan review and Board oversight,
·
changes in the value of underlying collateral.
The number of qualitative factors can change. Factors can be added for new risks or taken away if the risk no longer applies. Each loan type will have its own risk profile and management will evaluate and adjust each qualitative factor for each loan type quarterly, if necessary. For example, if one area of the loan portfolio is experiencing sharp increases in growth, it is likely the qualitative factor for trends in the loan portfolio would be increased for that loan type. As levels of delinquencies and non-accrual loans decline for commercial real estate and commercial loans it is likely that factor would be reduced.
In terms of the Corporation’s loan portfolio, the commercial and industrial loans and commercial real estate loans are deemed to have more risk than the consumer real estate loans and other consumer loans in the portfolio. The commercial loans not secured by real estate are highly dependent on financial condition and are more dependent on economic conditions. The commercial loans secured by real estate are also dependent on economic conditions but generally have stronger forms of collateral. More recently, commercial real estate has been negatively impacted by devaluation so these commercial loans carry a higher qualitative factor for changes in the value of collateral. The commercial loans and commercial real estate loans have historically been responsible for the majority of the Corporation’s delinquencies, non-accrual loans, and charge-offs so both of these categories carry higher qualitative factors than consumer real estate loans and other consumer loans. The Corporation has historically experienced very low levels of consumer real estate and consumer loan charge-offs so these qualitative factors are set lower than the commercial real estate and commercial and industrial loans. More recently, the consumer real estate segment of the loan portfolio is growing faster than all other segments and, therefore, the qualitative factors for trends and collateral were increased in this area due to more volume and increased exposure to housing valuations.
Impaired and Non-Accrual Loans:
The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap. Generally, a non-accrual loan will always be considered impaired due to payment delinquency or uncertain collection, but there are cases where an impaired loan is not considered non-accrual. For example, management may consider a loan impaired due to insufficient collateral, but not place the loan on non-accrual because the loan is current and has a history of timely payments. The primary factors considered by management in determining impairment include payment status and collateral value but could also include debt service coverage, financial health of the business, and other external factors that could impact the ability of the borrower to fully repay the loan. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan using the original interest rate and its recorded value or, as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan. When foreclosure is probable, impairment is measured based on the fair value of the collateral.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Management will place a business or commercial loan on non-accrual status when it is determined that the loan is impaired, or when the loan is 90 days past due with a history of prolonged periods of delinquency. These customers will generally be placed on non-accrual status at the end of each quarter. Consumer loans over 90 days delinquent are generally charged off or, in the case of larger residential real estate loans, they would be placed on non-accrual as the Corporation seeks to bring the customer current or pursue foreclosure options. When the borrower is on non-accrual, the Corporation will reverse any accrued interest on the books and will discontinue recognizing any interest income until the borrower is placed back on accrual status or fully pays off the loan balance plus any accrued interest. Any payments received by the customer while the loan is on non-accrual are fully applied against principal. The Corporation maintains records of the full amount of interest that is owed by the borrower. A non-accrual loan will generally only be placed back on accrual status when the borrower has demonstrated six consecutive months of non delinquency.
Allowance for Off Balance Sheet Extensions of Credit:
The Corporation maintains an allowance for off balance sheet extensions of credit which would include any unadvanced amount on lines of credit and any letters of credit provided to borrowers. The allowance is carried as a liability and is included in other liabilities on the Corporation’s Consolidated Balance Sheets. The liability was $263,000 as of December 31, 2010, and $215,000 as of December 31, 2009. Management follows the same methodology as the allowance for loan losses when calculating the allowance for off balance sheet extensions of credit, with the exception of multiplying the unadvanced total by a high/low balance variance to arrive at the expected unadvanced portion that could be drawn upon at any time, or the amount at risk. The unadvanced amounts for each loan segment are broken down by credit classification. A historical loss ratio and qualitative factor are calculated for each credit classification by loan type. The historical loss ratio and qualitative factor are combined to produce an adjusted loss ratio which is multiplied by the amount at risk for each credit classification within each loan segment to arrive at an allocation. The allocations are summed to arrive at the total allowance for off balance sheet extensions of credit.
Other Real Estate Owned (OREO):
OREO represents properties acquired through customer loan defaults. These properties are recorded at the fair value less projected disposal costs at acquisition date. Fair value is determined by current appraisals. Costs associated with holding OREO are charged to operational expense. OREO is a component of other assets on the Corporation’s Consolidated Balance Sheets.
Mortgage Servicing Rights (MSRs):
The Corporation has agreements for the express purpose of selling residential mortgage loans in the secondary market, referred to as mortgage servicing rights. The Corporation maintains all servicing rights for the loans sold through Fannie Mae. Originated MSRs are recorded by allocating total costs incurred between the loans and servicing rights based on their relative fair values. MSRs are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio. Impairment is evaluated based on the fair value of the right, portfolio interest rates, and prepayment characteristics. MSRs are a component of other assets on the Consolidated Balance Sheets.
Premises and Equipment:
Premises and equipment are stated at cost, less accumulated depreciation. Book depreciation is computed using straight-line methods over the estimated useful lives of generally fifteen to thirty-nine years for buildings and improvements and five to ten years for furniture and equipment. Maintenance and repairs of property and equipment are charged to operational expense as incurred, while major improvements are capitalized. Net gains or losses upon disposition are included in other income or operational expense, as applicable.
Transfer of Assets:
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Bank-Owned Life Insurance (BOLI):
BOLI is carried by the Corporation at the cash surrender value of the underlying policies. Income earned on the policies is based on any increase in cash surrender value less the cost of the insurance, which varies according to age
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
and health of the insured. The life insurance policies owned by the Corporation had a cash surrender value of $15,891,000 and $15,248,000 as of December 31, 2010, and 2009, respectively.
Long-Lived Assets:
Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. When required, impairment losses on assets to be held and used are recognized based on the difference between the carrying value and the fair market value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair market value, less cost to sell or dispose.
Advertising Costs:
The Corporation expenses advertising costs as incurred. Advertising costs for the years ended December 31, 2010, 2009, and 2008, were $445,000, $387,000, and $411,000, respectively.
Income Taxes:
An asset and liability approach is followed for financial accounting and reporting for income taxes. Accordingly, a net deferred tax asset or liability is recorded in the consolidated financial statements for the tax effects of temporary differences, which are items of income and expense reported in different periods for income tax and financial reporting purposes. Deferred tax expense is determined by the change in the assets or liabilities related to deferred income taxes. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Earnings per Share:
The Corporation currently maintains a simple capital structure with no stock option plans that would have a dilutive effect on earnings per share. Earnings per share are calculated by dividing net income by the weighted-average number of shares outstanding for the periods.
Comprehensive Income:
The Corporation is required to present comprehensive income in a full set of general-purpose consolidated financial statements for all periods presented. Other comprehensive income consists of unrealized holding gains and losses on the available for sale securities portfolio. The Corporation has elected to report the effects of other comprehensive income as part of the Consolidated Statements of Changes in Stockholders’ Equity.
Segment Disclosure:
U.S. generally accepted accounting principles establish standards for the manner in which public business enterprises report information about segments in the annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures regarding financial products and services, geographic areas, and major customers. The Corporation has only one operating segment consisting of its banking and fiduciary operations.
Pension Plans:
The Corporation has a noncontributory defined contribution pension plan covering substantially all employees. The Corporation contributes 7.5% of qualifying employees’ covered compensation, plus 5.7% of covered compensation in excess of the Social Security wage base, which is charged to operating expense and funded on a current basis.
Trust Assets and Income:
Assets held by ENB’s Money Management Group in a fiduciary or agency capacity for customers are not included in the Corporation’s Consolidated Balance Sheets since these items are not assets of the Corporation. In accordance with banking industry practice, trust income is recognized on a cash basis, and such income does not differ significantly from amounts that would be recognized on an accrual basis. Trust income is reported in the Corporation’s Consolidated Statements of Income under other income.
Reclassification of Comparative Amounts:
Certain comparative amounts for the prior year have been reclassified to conform to current-year classifications. Such reclassifications had no effect on net income or stockholders’ equity.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Recently Issued Accounting Standards:
In December 2009, the FASB issued ASU 2009-16, Accounting for Transfer of Financial Assets. ASU 2009-16 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASU 2009-16 is effective for annual periods beginning after November 15, 2009, and for interim periods within those fiscal years. The adoption of this guidance did not have a material impact on the Corporation’s financial position or results of operations.
In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash - a consensus of the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend. ASU 2010-01 is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. The adoption of this guidance did not have a material impact on the Corporation’s financial position or results of operations.
In January 2010, the FASB issued ASU 2010-05, Compensation - Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that, for certain shareholders, escrowed share arrangements represent compensation. ASU 2010-05 is effective January 15, 2010. The adoption of this guidance did not have a material impact on the Corporation’s financial position or results of operations.
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level III fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this guidance is not expected to have a significant impact on the Corporation’s financial statements.
In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of this guidance did not have a material impact on the Corporation’s financial position or results of operations.
In March 2010, the FASB issued ASU 2010-11, Derivatives and Hedging. ASU 2010-11 provides clarification and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in ASC 815-15-15-8. ASU 2010-11 is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. The adoption of this guidance has not had a significant impact on the Corporation’s financial statements.
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset - a consensus of the FASB Emerging Issues Task Force. ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets. Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said. The amendment is effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15, 2010, or later. Adoption of this guidance has not had a significant impact on the Corporation’s financial statements.
In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
ending after initial adoption. The adoption of this guidance has not had a significant impact to the Corporation’s financial statements. See Note C for the new disclosures required effective as of December 31, 2010.
In August 2010, the FASB issued ASU 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This ASU amends various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules, and Codification of Financial Reporting Policies and is not expected to have a significant impact on the Corporation’s financial statements.
In August 2010, the FASB issued ASU 2010-22, Technical Corrections to SEC Paragraphs - An announcement made by the staff of the U.S. Securities and Exchange Commission. This ASU amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics and is not expected to have a significant impact on the Corporation’s financial statements.
In September 2010, the FASB issued ASU 2010-25, Plan Accounting - Defined Contribution Pension Plans. The amendments in this ASU require that participant loans be classified as notes receivable from participants, which are segregated from plan investments and measured at their unpaid principal balance plus any accrued but unpaid interest. The amendments in this update are effective for fiscal years ending after December 15, 2010. The adoption of this guidance has not had a significant impact on the Corporation’s financial statements.
In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU addresses the diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The amendments are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2011, and are not expected to have a significant impact on the Corporation’s financial statements.
In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. This ASU is not expected to have a significant impact on the Corporation’s financial statements.
In January 2011, the FASB issued ASU 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20, enabling public-entity creditors to provide those disclosures after the FASB clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. In the proposed Update for determining what constitutes a troubled debt restructuring, the FASB proposed that the clarifications would be effective for interim and annual periods ending after June 15, 2011. For the new disclosures about troubled debt restructurings in Update 2010-20, those clarifications would be applied retrospectively to the beginning of the fiscal year in which the proposal is adopted. The adoption of this guidance is not expected to have a significant impact on the Corporation’s financial statements.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE B - SECURITIES AVAILABLE FOR SALE
(DOLLARS IN THOUSANDS)
The amortized cost and fair value of securities held at December 31, 2010, and 2009, are as follows:
The amortized cost and fair value of debt securities available for sale at December 31, 2008, by contractual maturity are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.
CONTACTUAL MATURITY OF DEBT SECURITIES
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Proceeds from 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)
The gross realized losses above include $393,000 of impairment in 2010, $369,000 in 2009, and $760,000 in 2008.
Securities available for sale with a par value of $66,801,000 and $64,568,000 at December 31, 2010 and 2009, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $70,718,000 at December 31, 2010, and $67,383,000 at December 31, 2009.
Management evaluates all of the Corporation’s securities for other than temporary impairment (OTTI) on a periodic basis. As of December 31, 2010, four private collateralized mortgage obligation (PCMO) securities were considered to be other than temporarily impaired. Of these four securities only two had impairment taken during 2010 in the amount of $393,000. Cumulative impairment on the four PCMO securities deemed impaired as of December 31, 2010, was $732,000. During 2010, one PCMO security was sold that had $30,000 of cumulative impairment.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
As of December 31, 2010, all other securities carrying unrealized losses were determined not to be other than temporarily impaired. Information pertaining to securities with gross unrealized losses at December 31, 2010, and December 31, 2009, 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)
Nearly all of the Corporation’s unrealized losses as of December 31, 2010, originated from debt rather than equity securities. Debt securities were responsible for 97% of the unrealized losses as of December 31, 2010, compared to 98% as of December 31, 2009. In the debt security portfolio, there are 117 positions carrying unrealized losses as of December 31, 2010, compared to 52 positions as of December 31, 2009. Out of the 117 unrealized loss positions on December 31, 2010, 92 were on municipal bonds of which the average loss was $15,000. Of those 117 positions, 113 were considered temporarily impaired and four PCMOs were considered other than temporarily impaired at December 31, 2010, whereas on December 31, 2009, 49 of 52 positions were considered temporarily impaired.
Impairment charges of $393,000 were recognized during 2010 on two of the four PCMOs considered impaired as of December 31, 2010, in order to write the securities down to a level of anticipated principal recovery. The other two PCMOs considered impaired due to a minimum amount of projected principal loss, had no impairment recorded during 2010 because the projected loss of principal was within the remaining amount of discount on the bond. Impairment would be recorded once the projected losses exceed the remaining discount. The amount of impairment recorded during 2010 on two of the PCMO bonds was determined by evaluating cash flow analysis along with projected default and severity rates on a security-by-security basis. Each of the two PCMO securities had a level of credit protection that initially protected the bonds from principal losses. Impairment is taken only after the analysis
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
shows credit protection against past and present losses being exhausted. Management tracks historical prepayment speeds and projects future speeds. Faster prepayment speeds are beneficial in accelerating the return of principal to the Corporation and minimizing the risk of more defaults which would cause credit losses. Management has determined that it is likely all of the PCMOs will continue to pay an average of 8 constant prepayment rate (CPR) or higher, with one security being modeled at 15 CPR due to consistent speeds at 15 CPR or above. An 8 CPR means that eight percent of the principal would be expected to prepay in one year’s time. The average CPR on the entire portfolio of PCMOs for 2010 was just under 10 CPR, which is a slower speed than the 11.5 CPR experienced in 2009. These speeds may slow in the future should interest rates increase. Based on the historical, current, and expected prepayment speeds, management determined that it was appropriate to take impairment on two of the PCMOs during 2010, with expectations of principal loss based on forward projections of default and severity rates, with one security paying at an average of 8 CPR and the other paying at an average of 15 CPR.
The Corporation evaluates both equity and fixed maturity positions for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluation. The table below details the other-than-temporary impairment charges recorded as of December 31, 2010:
SECURITY IMPAIRMENT CHARGES
(DOLLARS IN THOUSANDS)
The above table reflects the book value, market value, and unrealized losses carried on the four impaired PCMO securities after the Corporation recorded $393,000 of impairment as of December 31, 2010. The $393,000 is deemed to be a credit loss and is the amount that management expects the principal loss will be by the time these four securities mature. The remaining $1,220,000 of unrealized losses is deemed to be a market value loss that is temporary.
Recent market conditions throughout the financial industry have made the evaluation regarding the possible impairment of MBS and CMO securities difficult to fully determine given the volatility of their pricing, based not only on rate changes, but collateral uncertainty as well. The vast majority of the MBS and CMOs owned by the Corporation are backed by the U.S. government. Approximately 11% of the Corporation’s MBS and CMOs are PCMOs, not backed by the U.S. government. As of December 31, 2010, six PCMOs were held with two of the six rated AAA by either Moodys or S&P. The remaining four PCMOs were rated below investment grade, which are the same securities considered impaired as of December 31, 2010. Impairment charges, as detailed above, were taken on two of these securities during 2010. Management conducts impairment analysis on a quarterly basis and currently has no plans to sell these securities. Cash flow analysis performed under severe stress testing does not indicate a need to take impairment on the remaining four bonds, however default rates on these PCMOs, the severity rates of the defaults, and future prepayment speeds could alter management’s projections of future losses and the need to take additional impairment. Management has concluded that, as of December 31, 2010, the declines outlined in the above table represent temporary declines. The Corporation does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES
The following tables present the Corporation’s loan portfolio by category of loans for 2010 and 2009 and the summary of the allowance for loan losses for years 2010, 2009, and 2008.
LOAN PORTFOLIO
(DOLLARS IN THOUSANDS)
(a)
Real estate loans serviced for Fannie Mae, which are not included in the Consolidated Balance Sheets, totaled $10,101,000 and $11,754,000 as of December 31, 2010, and 2009, respectively.
ALLOWANCE FOR LOAN LOSSES SUMMARY
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The Corporation grades commercial credits differently than consumer credits. The following table represents all of the Corporation’s commercial credit exposures by internally assigned grades as of December 31, 2010. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled or at all. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.
The Corporation's internally assigned grades for commercial credits are as follows:
·
Pass - loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
·
Special Mention - loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
·
Substandard - loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
·
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)
For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. The following table presents the balances of consumer loans by classes of the loan portfolio based on payment performance as of December 31, 2010:
CONSUMER CREDIT EXPOSURE
CREDIT RISK PROFILE BY PAYMENT PERFORMANCE
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The following table presents an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of December 31, 2010:
AGING OF LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
As of December 31, 2010, 2009, and 2008, all of the Corporation’s loans on non-accrual status were also considered impaired. Interest income on loans would have increased by approximately $293,000, $111,000, and $1,000 during 2010, 2009, and 2008, respectively, if these loans had performed in accordance with their original terms.
The following table presents nonaccrual loans by classes of the loan portfolio as of December 31:
NONACCRUAL LOANS BY LOAN CLASS
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Information with respect to impaired loans as of and for the years ended December 31 is as follows:
IMPAIRED LOANS
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The following table summarizes information in regards to impaired loans by loan portfolio class as of December 31, 2010:
IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The following table details activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2010:
ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
NOTE D - PREMISES AND EQUIPMENT
(DOLLARS IN THOUSANDS)
The major classes of the Corporation's premises and equipment and accumulated depreciation are as follows:
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Depreciation expense, which is included in operating expenses, amounted to $1,077,000 for 2010, $1,038,000 for 2009, and $1,103,000 for 2008. The construction in process category represents expenditures for ongoing projects. When construction is completed, these amounts will be reclassified into buildings and improvements, and/or furniture and equipment. Depreciation only begins when the project or asset is placed into service. As of December 31, 2010, the construction in process consists primarily of costs associated with renovations being made to existing facilities to be completed in 2011.
NOTE E - FEDERAL HOME LOAN BANK STOCK
The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB), which is one of 12 regional Federal Home Loan Banks. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the FHLB System. It makes loans to members in accordance with policies and procedures established by the board of directors of the FHLB. As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts, or similar obligations at the beginning of each year, or 5% of its outstanding advances from the FHLB. At December 31, 2010, the Bank held $4,492,000 in stock of the FHLB compared to $4,728,000 as of December 31, 2009. In December 2008, the FHLB announced that it had suspended the payment of dividends and the regular repurchase of excess capital stock to preserve its capital level. That decision was based on FHLB’s analysis and consideration of certain negative market trends and the impact those trends had on their financial condition.
In the fourth quarter of 2010, the FHLB announced that it would be repurchasing a limited amount of excess capital stock from member institutions. On October 29, 2010, the Corporation received $236,000 from the FHLB to lower the balance of excess capital stock the Corporation owns. This brought the total FHLB capital stock holdings to $4,492,000 as of December 31, 2010. Additionally, subsequent to year-end, but prior to the filing of this report, the FHLB again announced that it would be repurchasing excess capital stock from member institutions who held more stock than was required. On February 23, 2011, the Corporation received $225,000 from the FHLB to further lower the balance of excess capital stock the Corporation owns. While the FHLB has not committed to regular repurchases of excess stock, the Corporation does view these recent actions as a sign that more stock will be repurchased in the future. Management further believes that the FHLB will continue to be a primary source of wholesale liquidity for both short-term and long-term funding and has concluded that its investment in FHLB stock is not other-than-temporarily impaired. The Corporation will continue to monitor the financial condition of the FHLB quarterly to assess its ability to continue to periodically repurchase excess capital stock and resume payment of a dividend.
The Corporation evaluated its holding of FHLB stock for impairment and deemed the stock to not be impaired due to the expected recoverability of the par value, which equals the value reflected within the Corporation’s financial statements. The decision was based on several items ranging from the estimated true economic losses embedded within the FHLB’s mortgage portfolio to the FHLB’s liquidity position and credit rating. The Corporation utilizes the impairment framework outlined in GAAP to evaluate FHLB stock for impairment.
The following factors were evaluated to determine the ultimate recoverability of the par value of the Corporation’s FHLB stock holding; (i) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted; (ii) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB; (iii) the impact of legislative and regulatory changes on the institutions and, accordingly, on the customer base of the FHLB; (iv) the liquidity position of the FHLB; and (v) whether a decline is temporary or whether it affects the ultimate recoverability of the FHLB stock based on (a) the materiality of the carrying amount to the member institution and (b) whether an assessment of the institution’s operational needs for the foreseeable future allows management to dispose of the stock. Based on its analysis of these factors, the Corporation determined that its holding of FHLB stock was not impaired on December 31, 2010.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE F - DEPOSITS
(DOLLARS IN THOUSANDS)
Deposits by major classification are summarized as follows:
At December 31, 2010, the scheduled maturities of time deposits are as follows:
NOTE G - SHORT-TERM BORROWINGS
(DOLLARS IN THOUSANDS)
Short-term borrowings consist of Federal funds purchased that mature one business day from the transaction date, overnight borrowings from the Federal Reserve Discount Window, and FHLB advances with a term of less than one year.
A summary of short-term borrowings is as follows for the years ended December 31, 2010, and 2009:
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
As of December 31, 2010, the Corporation had approved unsecured Federal funds lines of $35 million. An additional $2 million of secured credit is available upon the pledging of collateral. The Corporation also has the ability to borrow through the FRB Discount Window. The amount of borrowing available through the Discount Window was $10.4 million as of December 31, 2010. For further information on borrowings from the FHLB see Note H.
NOTE H - OTHER BORROWED FUNDS
(DOLLARS IN THOUSANDS)
Maturities of other borrowings at December 31, 2010, and 2009, are summarized as follows:
As a member of the FHLB Pittsburgh, the Corporation has access to significant credit facilities. Borrowings from FHLB are secured with a blanket security agreement and required investment of FHLB member bank stock. As part of the security agreement, the Corporation maintains unencumbered qualifying assets (principally 1-4 family residential mortgage loans) in an amount at least as much as the advances from the FHLB. Additionally, the Corporation’s FHLB stock of $4,492,000 at December 31, 2010, and $4,728,000 at December 31, 2009, is also pledged to secure these advances.
The Corporation had an FHLB maximum borrowing capacity of $221.1 million as of December 31, 2010, with remaining borrowing capacity of approximately $171.6 million. The borrowing arrangement with FHLB is subject to annual renewal. The maximum borrowing capacity is recalculated quarterly.
The terms of FHLB convertible borrowings allow the FHLB to convert the interest rate to an adjustable rate based on the three-month London Interbank Offering Rate (LIBOR). The rates on these instruments can change quarterly, once certain conditions or rate lockout periods are met. At the conversion date, the Corporation has the option of paying the borrowing off, or continuing to borrow under the new terms of the convertible borrowing.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
As of December 31, 2010, the Corporation had five repurchase agreements, securities sold under an agreement to repurchase, for $25 million, compared to $30 million at December 31, 2009 and 2008. All of these repurchase agreements are accounted for as collateralized financing. The Corporation pledged securities with a fair market value of $31.6 million as of December 31, 2010, as collateral for these borrowings. All repurchase instruments have call features with different variable-to-fixed and fixed-to-variable rate provisions. A summary of repurchase agreements for the years ended December 31, 2010, 2009, and 2008 is as follows:
REPURCHASE AGREEMENTS
(DOLLARS IN THOUSANDS)
The Corporation uses repurchase agreements as a secondary source of funding after customer deposits as a way to mitigate interest rate risk and extend liability length. Management views repurchase agreements as a diversification of funding outside of the FHLB. No new repurchase agreements have been entered into since 2008.
NOTE I - CAPITAL TRANSACTIONS
On July 1, 2008, ENB Financial Corp, a bank holding company, was formed. At that time, all shares of Ephrata National Bank stock were converted to ENB Financial Corp shares on a one-for-one basis. The 130,443 treasury shares owned by the Bank as of June 30, 2008, were retired and the Corporation began existence with 2,869,557 outstanding shares of common stock.
On August 14, 2008, the Board authorized a stock buyback plan for the purchase of up to 140,000 shares. Through December 31, 2010, 55,000 shares were purchased at a weighted-average cost per share of $25.18.
Currently, three stock plans are in place, a nondiscriminatory employee stock purchase plan, which allows employees to purchase shares at a 10% discount from the stock’s fair market value at the end of each quarter, a dividend reinvestment plan, and a director’s stock purchase plan. All plans issue shares from treasury shares acquired. During 2010, 19,139 shares were reissued from treasury shares in connection with the plans. As of December 31, 2010, the Corporation held 13,518 treasury shares, at a weighted-average cost of $24.70 per share, with a cost basis of $334,000.
NOTE J - RETIREMENT PLANS
The Corporation has a defined contribution pension plan (the plan) covering all employees aged 21 or older who work 1,000 or greater hours in a calendar year and have completed at least one full year of employment. During years 2008 and 2009, the Corporation contributed 7.5% of the covered compensation of all plan participants, plus 5.7% of covered compensation in excess of the Social Security wage base, which was $106,800 for 2009, and $102,000 for 2008. Beginning in January 2010, the Corporation reduced the employer contribution into the pension plan from 7.5% to 5.0% and began a 50% match on 401(K) contributions up to 5.0%, limiting the match to a total of 2.5%.
For purposes of the defined contribution pension plan, covered compensation was limited to $245,000 in 2010 and 2009, and $230,000 in 2008. Total expenses of the plan were $387,000, $531,000, and $527,000, for 2010, 2009, and 2008, respectively. The Corporation’s pension plan is fully funded as all obligations are funded monthly.
The Corporation also provides an optional 401(K) plan, in which employees may elect to defer pre-tax salary dollars, subject to the maximum annual Internal Revenue Service contribution amounts. The contribution maximum for 2010 was $16,500 for persons under age 50, and $22,000 for persons over age 50. In years prior to 2010, no employer
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
contributions were made into the 401(K) plan. Beginning in January 2010, related to the decrease in the pension contribution amount discussed above, the Corporation began to match employee contributions into the 401(K) plan at a rate of 50% on the first 5.0% of employee contributions. In this manner, employees that contributed at least 5% of their pre-tax pay into the 401(K) plan would receive the equivalent of 7.5% of employee contributions, 5.0% in the pension plan and 2.5% in the 401(K) plan. In 2010, the Corporation had a total expense of $152,000 in the form of matching 401(K) contributions to employees.
NOTE K - DEFERRED COMPENSATION
Prior to 1999, directors of the Corporation had the ability to defer their directors’ fees into a directors’ deferred compensation plan. Directors electing to defer their compensation signed a contract that allowed the Corporation to take out a life insurance policy on the director designed to fund the future deferred compensation obligation, which is paid out over a ten-year period at retirement age. A contract and life insurance policy was taken out for each period of pay deferred. The amount of deferred compensation to be paid to each director was actuarially determined based on the amount of life insurance the annual directors’ fees were able to purchase. This amount varies for each director depending on age, general health, and the number of years until the director is entitled to begin receiving payments. The Corporation is the owner and beneficiary of all life insurance policies on the directors.
At the time the directors’ pay was deferred, the Corporation used the amount of the annual directors’ fees to pay the premiums on the life insurance policies. The Corporation could continue to pay premiums after the deferment period, or could allow the policies to fund annual premiums through loans against the policy’s cash surrender value. The Corporation has continued to pay the premiums on the life insurance policies and no loans exist on the policies.
The life insurance policies had an aggregate face amount of $3,911,000 for December 31, 2010, and 2009. The death benefits totaled $6,678,000 and $6,370,000 as of December 31, 2010, and 2009, respectively. The cash surrender value of the above policies totaled $4,044,000 and $3,848,000 as of December 31, 2010, and 2009, respectively. The net present value of the vested portion of deferred payments totaled $1,327,000 at December 31, 2010, and $1,583,000 at December 31, 2009. The interest rate used to discount these obligations was 5.50% for 2010, 2009, and 2008. These net present value amounts are included in other liabilities on the Corporation’s Consolidated Balance Sheets. Total charges to expense for deferred compensation amounted to $35,000 for 2010, $94,000 for 2009, and $145,000 for 2008, and are included in other operating expenses in the Consolidated Statements of Income.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE L - INCOME TAXES
Federal income tax expense as reported differs from the amount computed by applying the statutory Federal income tax rate to income before taxes. A reconciliation of the differences by amount and percent is as follows:
FEDERAL INCOME TAX SUMMARY
(DOLLARS IN THOUSANDS)
The ability to realize the benefit of deferred tax assets is dependent upon a number of factors, including the generation of future taxable income, the ability to carry back taxes paid in previous years, the ability to offset capital losses with capital gains, the reversal of deferred tax liabilities, and certain tax planning strategies. A valuation allowance of $262,000 was established during the year ending December 31, 2006, to offset in its entirety the tax benefits associated with certain impaired securities that management believes may not be realizable. Due to sales in 2007 and 2008 of previously impaired securities at a book gain, this valuation allowance was reduced to $125,000 as of December 31, 2008. The Corporation sold equity securities at a net loss of $60,000 during 2009, which increased the valuation allowance by $20,000 to $145,000 as of December 31, 2009. No adjustment to the valuation allowance was deemed necessary as of December 31, 2010.
The Corporation had a deferred tax asset of $1,090,000 and $1,093,000 for credits related to Alternative Minimum Taxes (AMT) as of December 31, 2010, and 2009, respectively, and a deferred tax asset of $107,000 as of December 31, 2010, and 2009, respectively, for credits related to low income housing. In addition, as of the end of 2010, the Corporation had a deferred tax asset of $154,000 related to a charitable contribution carryover compared to $151,000 at the end of 2009. The AMT credits have an unlimited carry-forward period, while the low income housing credits can be carried forward 20 years, and the charitable contributions 5 years. No valuation has been established for these deferred tax assets in view of the Corporation’s ability to carry forward taxes paid and credits earned in previous years, to future years, coupled with the anticipated future taxable income as evidenced by the Corporation’s earnings potential.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Significant components of income tax expense are as follows:
U.S. generally accepted accounting principles prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Corporation recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Consolidated Statements of Income. With few exceptions, the Corporation is no longer subject to U.S. federal, state, or local income tax examinations by tax authorities for years before 2007.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE M - REGULATORY MATTERS AND RESTRICTIONS
The Corporation and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The quantitative measures established by regulation to ensure capital adequacy, require the Corporation and the Bank to maintain minimum amounts and ratios (set forth below) of Tier 1 capital to average assets and Tier 1 and total capital to risk-weighted assets.
As of December 31, 2010, and 2009, the Corporation and Bank were categorized as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category. The following chart details the Corporation’s and the Bank’s capital levels as of December 31, 2010, and December 31, 2009, compared to regulatory levels.
In addition to the capital guidelines, certain laws restrict the amount of dividends paid to stockholders in any given year. The approval of the OCC shall be required if the total of all dividends declared by the Corporation in any year shall exceed the total of its net profits for that year combined with retained net profits of the preceding two years. Under this restriction, the Corporation could declare dividends in 2011, without the approval of the OCC, of approximately $4.2 million, plus an additional amount equal to the Corporation’s net profits for 2011, up to the date of any such dividend declaration.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE N - TRANSACTIONS WITH DIRECTORS AND OFFICERS
The following table presents activity in the amounts due from directors, executive officers, immediate family, and affiliated companies. These transactions are made on the same terms and conditions, including interest rates and collateral requirements as those prevailing at the time for comparable transactions with others. An analysis of the activity with respect to such aggregate loans to related parties is shown below.
LOANS TO INSIDERS
(DOLLARS IN THOUSANDS)
Deposits from the insiders represented in the table above totaled $4,711,000 as of December 31, 2010, and $6,904,000 as of December 31, 2009.
NOTE O - COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These are commonly referred to as off-balance sheet commitments and include firm commitments to extend credit, unused lines of credit, and open letters of credit. On December 31, 2010, firm loan commitments totaled approximately $16 million; unused lines of credit totaled approximately $84 million; and open letters of credit totaled approximately $7 million. The sum of these commitments, $107 million, represents total exposure to credit loss in the event of nonperformance by customers with respect to these financial instruments; however the vast majority of these commitments are typically not drawn upon. The same credit policies for on-balance sheet instruments apply for making commitments and conditional obligations and the actual credit losses that could arise from the exercise of these commitments is expected to compare favorably with the loan loss experience on the loan portfolio taken as a whole. Commitments to extend credit on December 31, 2009, totaled $116 million, representing firm loan commitments of $16 million, unused lines of credit of $91 million, and open letters of credit totaling $9 million.
Firm commitments to extend credit and unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on an individual basis. The amount of collateral obtained, if deemed necessary by the extension of credit, is based on management’s credit evaluation of the customer. These commitments are supported by various types of collateral, where it is determined that collateral is required.
Open letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Most guarantees expire within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. While various assets of the customer act as collateral for these letters of credit, real estate is the primary collateral held for these potential obligations.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE P - FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK
The Corporation determines concentrations of credit risk by reviewing loans by borrower, geographical area, and loan purpose. The amount of credit extended to a single borrower or group of borrowers is capped by the legal lending limit, which is defined as 15% of risk-based capital, less the allowance for loan losses. The Corporation’s lending policy further restricts the amount to 75% of the legal lending limit. As of December 31, 2010, the Corporation’s legal lending limit was $11,771,000, and the Corporation’s policy limit was $8,829,000. This compared to a legal lending limit of $11,249,000, and policy limit of $8,436,000 as of December 31, 2009. As of December 31, 2010, no lending relationships exceeded the Corporation’s internal policy limit. As of December 31, 2009, one lending relationship to a local municipality totaled $8,611,000, or 11.4%, of risk-based capital, which exceeded the Corporation’s internal lending policy limit by $175,000, but not the legal lending limit.
Geographically, the primary lending area for the Corporation encompasses Lancaster, Lebanon, and Berks counties of Pennsylvania, with the majority of the loans made in Lancaster County. The ability of debtors to honor their loan agreements is impacted by the health of the local economy. The Corporation’s immediate market area benefits from a diverse economy, which has resulted in a diverse loan portfolio. As a community bank, the largest amount of loans outstanding consists of personal mortgages, residential rental loans, and personal loans secured by real estate. Beyond personal lending, the Corporation’s business and commercial lending includes loans for agricultural, construction, specialized manufacturing, service industries, many types of small businesses, and loans to non-profit entities and governmental units.
Management evaluates concentrations of credit based on loan purpose on a quarterly basis. The Corporation’s greatest concentration of loans by purpose is residential real estate, which comprises $167.6 million, or 40.3%, of the $415.4 million gross loans outstanding. Residential real estate consists of first mortgages and home equity loans. A concentration in commercial real estate of 41.3%, or $171.6 million, also exists; however, within that category there is not a concentration by specific industry type. Agricultural mortgages consist of 14.6% of gross loans as of December 31, 2010, compared to 12.4% as of December 31, 2009; however these agricultural mortgages are spread over several types of agricultural purpose loans. More specifically within these larger purpose categories, management monitors on a quarterly basis the largest concentrations of non-consumer credit based on the North American Industrial Classification System (NAICS). As of December 31, 2010, the largest specific industry type categories were dairy cattle and milk production loans of $34.4 million, or 8.3% of gross loans, non-residential real estate investment loans with a balance of $34.1 million, or 8.2% of gross loans, and residential investment real estate of $29.9 million, or 7.2% of gross loans. Out of the $63.2 million of loans designated as commercial & industrial for the Uniform Bank Performance Reports, the largest concentration within that area is $23.0 million of loans to political subdivisions, which accounts for 5.5% of gross loans outstanding. For the Corporation, these loans consisted of tax-free loans to local municipalities.
To evaluate risk for the securities portfolio, the Corporation reviews both geographical concentration and credit ratings. As of December 31, 2010, based on fair market value, the Corporation held $19.2 million of obligations of states and political subdivisions issued by municipalities located within the state of Pennsylvania, which is 24.2% of the municipal portfolio, and 7.5% of the total debt securities. Internal policy requires municipal bonds purchased to be rated at least A3 by Moodys and/or A- by Standard & Poor’s (S&P) at the time of purchase. Presently, $8.4 million, or 10.6%, of the municipal bonds are below the A3/A- credit ratings the Corporation requires at the time of purchase.
The Corporation held $11.7 million of corporate bonds based on amortized cost as of December 31, 2010. This represented 4.5% of the securities portfolio. Management has a target of maintaining corporate bonds at approximately 5% of the securities portfolio. Within the corporate bond segment of the portfolio management has preferred to invest in the banking and finance industry where management is more comfortable analyzing and evaluating the credit risk of these firms. As a result, based on amortized cost, $9.2 million, or 78.6%, of the corporate bonds held are invested in national or global bank holding companies. Management presently has no corporate bonds issued by any of the major brokerage firms. The remaining $2.5 million of corporate bonds consist of $2 million in conglomerates and $0.5 million in computer manufacturing. By internal policy, at time of purchase, all corporate bonds must carry a credit rating of at least A3 by Moodys or A- by S&P, and at all times corporate bonds are to be investment grade, which is defined as Baa3 for Moodys and BBB- for S&P, or above. As of December 31, 2010, all of the Corporation’s corporate bonds carried at least a credit rating of A3 by Moodys and A- by S&P.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
As of December 31, 2010, the Corporation held $12.9 million of book value in private collateralized mortgage obligations (PCMO). The PCMOs are not backed by the U.S. government. A total of six PCMO instruments were held as of December 31, 2010. Two of these securities, with a book value of $4.3 million, carried an AAA credit rating by at least one of the major credit rating services. The four remaining PCMOs, with a book value of $8.6 million, had credit ratings below investment grade, which is BBB- for S&P and Baa3 for Moodys.
NOTE Q - FAIR VALUE MEASUREMENTS
The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:
Level I:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date. 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:
Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires the use of observable market data when available.
The following table presents the assets reported on the Consolidated Balance Sheets at their fair value as of December 31, 2010, by level within the fair value hierarchy. 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 REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
On December 31, 2010, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of December 31, 2010, the CRA fund investments had a $4,000,000 book value with a fair market value of $3,899,000.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
ASSETS REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
On December 31, 2009, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of December 31, 2009, the CRA fund investments had a $3,000,000 book value with a fair market value of $2,906,000.
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.
The following table represents securities with fair value measurements using significant unobservable (Level III) inputs:
FAIR VALUE MEASUREMENTS OF SECURITIES UTILIZING LEVEL III PRICING:
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The following table presents the assets measured on a nonrecurring basis on the consolidated statements of financial condition at their fair value as of December 31, 2010, and December 31, 2009, by level within the fair value hierarchy.
ASSETS MEASURED ON A NONRECURRING BASIS
(DOLLARS IN THOUSANDS)
The Corporation had a total of $5,556,000 of impaired loans as of December 31, 2010, with $231,000 of specifically allocated allowance against these loans. Management believes the fair value of the loans to be the current loan amount less the specific allowance, or $5,325,000. As of December 31, 2009, the Corporation had a total of $7,615,000 of impaired loans with $811,000 of specifically allocated allowance against these loans. Management believes the fair value of the loans to be the current loan amount less the specific allowance, or $6,804,000.
Other real estate owned (OREO) is measured at fair value less cost to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value, less cost to sell. Management has estimated the current value of the OREO property at $400,000 utilizing level III pricing. Previous in 2009 there was a signed agreement of sale on this property that directly supported the sales price and was therefore shown as level I pricing. That agreement of sale expired at the end of 2010. As a result, the OREO valuation was written down by $120,000 as of December 31, 2010, to reflect management’s best estimate of the current fair value of the property less anticipated selling costs. Income and expenses from operations and changes in valuation allowance are included in the net expenses from OREO.
NOTE R - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Cash and Cash Equivalents
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities Available for Sale
Management utilizes quoted market pricing for the fair value of the Corporation's securities that are available for sale, if available. If a quoted market rate is not available, fair value is estimated using quoted market prices for similar securities.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
Regulatory Stock
Regulatory stock is valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore the carrying amount is a reasonable estimate of fair value.
Loans Held for Sale
Loans held for sale are individual loans for which the Corporation has a firm sales commitment; therefore, the carrying value is a reasonable estimate of the fair value.
Loans
The fair value of fixed and variable rate loans is estimated by discounting back the scheduled future cash flows of the particular loan product, using the market interest rates of comparable loan products in the Corporation’s greater market area, with the same general structure, comparable credit ratings, and for the same remaining maturities.
Accrued Interest Receivable
The carrying amount of accrued interest receivable is a reasonable estimate of fair value.
Bank-Owned Life Insurance
Fair value is equal to the cash surrender value of the life insurance policies.
Mortgage Servicing Assets
The fair value of mortgage servicing assets is based on the present value of future cash flows for pools of mortgages, stratified by rate and maturity date.
Deposits
The fair value of non-interest bearing demand deposit accounts and interest bearing demand deposit and savings accounts is based on the amount payable on demand at the reporting date. The fair value of fixed-maturity time deposits is estimated by discounting back the expected cash flows of the time deposit using market interest rates from the Corporation’s greater market area, which are currently being offered for similar time deposits with similar remaining maturities.
Borrowings
The fair value of a term borrowing is estimated by comparing the rate currently offered for the same type of borrowing instrument with a matching remaining term.
Accrued Interest Payable
The carrying amount of accrued interest payable is a reasonable estimate of fair value.
Firm Commitments to Extend Credit, Lines of Credit, and Open Letters of Credit
These financial instruments are generally not subject to sale and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment, using fees currently charged to enter into similar agreements with similar credit risk, is not considered material for disclosure purposes. The contractual amounts of unfunded commitments are presented in Note O.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
The carrying amounts and estimated fair values of the Corporation's financial instruments at December 31, 2010, and 2009, are as follows:
FAIR VALUE OF FINANCIAL INSTRUMENTS
(DOLLARS IN THOUSANDS)
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE S - CONDENSED PARENT ONLY DATA
(1) ENB Financial Corp was formed on July 1, 2008.
ENB FINANCIAL CORP
Notes to Consolidated Financial Statements
NOTE T - SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The unaudited quarterly results of operations for the years ended 2010 and 2009 are as follows:
ENB FINANCIAL CORP
Item 9.
Item 9. Changes in and Disagreements with Accountant on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Treasurer (Principal Financial Officer), of the effectiveness of the design and the operation of the Corporation’s disclosure controls and procedures (as such term as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2010, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer along with the Treasurer (Principal Financial Officer) concluded that the Corporation’s disclosure controls and procedures as of December 31, 2010, are effective in timely alerting them to material information relating to the Corporation required to be in the Corporation’s periodic filings under the Exchange Act.
(b) Changes in Internal Controls.
There have been no changes in the Corporation’s internal controls over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
(c) Report on Management’s Assessment of Internal Control over Financial Reporting
The Corporation is responsible for the preparation, integrity, and fair presentation of the financial statements included in this annual report. The financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on management's best estimates and judgments.
Management of the Corporation is responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Corporation’s system of internal control over financial reporting as of December 31, 2010, in relation to criteria for effective internal control over financial reporting as described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concludes that, as of December 31, 2010, its system of internal control over financial reporting is effective and meets the criteria of the "Internal Control - Integrated Framework.”
This annual report does not include an attestation report of the Corporation’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Corporation’s registered public accounting firm pursuant to a
ENB FINANCIAL CORP
provision of the Dodd-Frank Act which eliminates such requirement for smaller reporting companies, as defined in SEC regulations.
/s/ Aaron L. Groff, Jr.
/s/ Scott E. Lied
Aaron L. Groff, Jr.
Scott E. Lied
President, Chief Executive Officer
Treasurer
& Chairman of the Board
(Principal Financial Officer)
Ephrata, PA
March 23, 2011
Item 9B.
Item 9B. Other Information
None
ENB FINANCIAL CORP
Part III
Item 10.
Item 10. Directors, Executive Officers, and Corporate Governance
The information required by this Item, relating to directors, executive officers, and control persons is set forth under the captions, “Election of Directors,” “Director Qualifications,” “Meetings and Committees of the Board of Directors - Audit Committee,” “Executive Officers,” “Audit Committee Report,” and “Section 16(a) Beneficial Ownership Reporting Compliance,” of the Corporation’s definitive Proxy Statement to be used in connection with the Annual Meeting of Shareholders, to be held on May 3, 2011, which is incorporated herein by reference.
The Corporation has adopted a Code of Ethics that applies to directors, officers, and employees of the Corporation and the Bank. The Code of Ethics is attached as Exhibit 14 to this Form 10-K.
There were no material changes to the procedures by which security holders may recommend nominees to the Corporation’s Board of Directors during the fourth quarter of 2010.
Item 11.
Item 11. Executive Compensation
The information required by this Item, relating to executive compensation, is set forth under the captions, “Summary Compensation Table,” “Compensation Discussion and Analysis,” Compensation Committee Report,” and “Compensation Committee Interlocks and Insider Participation,” of the Corporation’s definitive Proxy Statement to be used in connection with the Annual Meeting of Shareholders, to be held on May 3, 2011, which is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item, related to beneficial ownership of the Corporation’s common stock, is set forth under the caption, “Share Ownership” of the Corporation’s definitive Proxy Statement to be used in connection with the Annual Meeting of Shareholders to be held on May 3, 2011, which is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item related to transactions with management and others, certain business relationships, and indebtedness of management, is set forth under the caption, “Transactions with Related Persons,” and “Governance of the Company” of the Corporation’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 3, 2011, which is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item related to fees and the audit committees’ pre-approved policies are set forth under the caption, “Audit Committee Report” of the Corporation’s definitive Proxy Statement to be used in connection with the Annual Meeting of Shareholders to be held on May 3, 2011, which is incorporated herein by reference.
ENB FINANCIAL CORP
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)
1.
Financial Statements.
The following financial statements are included by reference in Part II, Item 8 hereof.
Report of Independent Registered Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2.
The financial statement schedules required by this Item are omitted because the information is either inapplicable, not required, or is shown in the respective consolidated financial statements or the notes thereto.
3.
The Exhibits filed herewith or incorporated by reference as a part of this Annual Report, are set forth in (b), below.
(b)
EXHIBITS
3 (i)
Articles of Association of the Registrant, as amended. (Incorporated herein by reference to Exhibit 3.1 of the Corporation’s Form 8-K12g3 filed with the SEC on July 1, 2008.)
3 (ii)
Bylaws of the Registrant, as amended. (Incorporated herein by reference to Exhibit 3.2 of the Corporation’s Form 8-K filed with the SEC on January 15, 2010.)
10.1
Form of Deferred Income Agreement. (Incorporated herein by reference to Exhibit 10.1 of the Corporation’s Form 10-Q, filed with the SEC on August 13, 2008.)
10.2
2001 Employee Stock Purchase Plan (Incorporated herein by reference to Exhibit 99.1 of the Corporation’s Registration Statement on Form S-8 filed with the SEC on July 9, 2008.)
10.3
2010 Non-Employee Directors’ Stock Plan (Incorporated herein by reference to Exhibit 10 of the Corporation’s Form S-8 filed with the SEC on June 4, 2010.)
Statement re: Computation of Earnings per Share as found on pages 32 and 75 of this 2010 Form 10-K filing, which is included herein.
Statement re: Computation of Ratios as found on page 32 of this 2010 Form 10-K filing, which is included herein.
Code of Ethics Policy of Registrant as amended March 11, 2009. (Incorporated herein by reference to Exhibit 14 of the Corporation’s Form 10-K filed with the SEC on March 12, 2009)
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
31.1
Section 302 Chief Executive Officer Certification (Required by Rule 13a-14(a)/15a-14(a)).
31.2
Section 302 Principal Financial Officer Certification (Required by Rule 13a-14(a)/15a-14(a)).
32.1
Section 1350 Chief Executive Officer Certification (Required by Rule 13a-14(b)).
32.2
Section 1350 Principal Financial Officer Certification (Required by Rule 13a-14(b)).
(c)
NOT APPLICABLE.
ENB FINANCIAL CORP
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ENB FINANCIAL CORP
By:
/s/ Aaron L. Groff, Jr.
Aaron L. Groff, Jr., Chairman of the Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Aaron L. Groff, Jr
Chairman of the Board, President,
March 23, 2011
(Aaron L. Groff, Jr.)
Chief Executive Officer and Director
/s/ Scott E. Lied
Treasurer
March 23, 2011
(Scott E. Lied)
(Principal Financial Officer)
/s/ Paul W. Wenger
Secretary
March 23, 2011
(Paul W. Wenger)
/s/ Donald Z. Musser
Director
March 23, 2011
(Donald Z. Musser)
/s/ Willis R. Lefever
Director
March 23, 2011
(Willis R. Lefever)
/s/ Susan Young Nicholas
Director
March 23, 2011
(Susan Young Nicholas)
/s/ Bonnie R. Sharp
Director
March 23, 2011
(Bonnie R. Sharp)
/s/ J. Harold Summers
Director
March 23, 2011
(J. Harold Summers)
/s/ Mark C. Wagner
Director
March 23, 2011
(Mark C. Wagner)
/s/ Paul M. Zimmerman, Jr.
Director
March 23, 2011
(Paul M. Zimmerman, Jr.)
/s/ Thomas H. Zinn
Director
March 23, 2011
(Thomas H. Zinn)
ENB FINANCIAL CORP
EXHIBIT INDEX