ENB FINANCIAL CORP Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis represents management's view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2020 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance. Forward-Looking Statements TheU.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regards to the inclusion of forward-looking statements in this document and documents incorporated by reference. Forward-looking statements pertain to possible or assumed future results that are made using current information. These forward-looking statements are generally identified when terms such as: "believe," "estimate," "anticipate," "expect," "project," "forecast," and other similar wordings are used. The readers of this report should take into consideration that these forward-looking statements represent management's expectations as to future forecasts of financial performance, or the likelihood that certain events will or will not occur. Due to the very nature of estimates or predications, these forward-looking statements should not be construed to be indicative of actual future results. Additionally, management may change estimates of future performance, or the likelihood of future events, as additional information is obtained. This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative of actual results. Readers should note that many factors affect this forward-looking information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into this document. These factors include, but are not limited to, the following:
· National and local economic conditions
· Effects of economic conditions particularly with regard to the negative impact
of severe, wide-ranging and continuing disruptions caused by the spread of
coronavirus (COVID-19) and government and business responses thereto,
specifically the effect on loan customers to repay loans
· Health of the housing market
· Real estate valuations and its impact on the loan portfolio
· Interest rate and monetary policies of the
· Volatility of the securities markets including the valuation of securities
· Future actions or inactions of
failure to increase the government debt limit, a prolonged shutdown of the
federal government, increase in taxes or regulations, or increasing debt
balances
· Political changes and their impact on new laws and regulations
· Competitive forces
· Impact of mergers and acquisition activity in the local market and the effects
thereof
· Potential impact from continually evolving cybersecurity and other
technological risks and attacks, including additional costs, reputational
damage, regulatory penalties, and financial losses
· Changes in customer behavior impacting deposit levels and loan demand
· Changes in accounting principles, policies, or guidelines as may be adopted by
the regulatory agencies, as well as the Public Company Accounting Oversight
Board, the
setters
· Ineffective business strategy due to current or future market and competitive
conditions
· Management's ability to manage credit risk, liquidity risk, interest rate risk,
and fair value risk
· Operation, legal, and reputation risk
· Results of the regulatory examination and supervision process
· The impact of new laws and regulations
· Possible changes to the capital and liquidity requirements and other regulatory
pronouncements, regulations and rules
· Large scale global disruptions such as pandemics, terrorism, trade wars, and
armed conflict.
· Local disruptions due to flooding, severe weather, or other natural disasters
· The risk that our analyses of these risks and forces could be incorrect and/or
that the strategies developed to address them could be unsuccessful
· Business and competitive disruptions caused by new market and industry entrants
33
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
Readers should be aware if any of the above factors change significantly, the
statements regarding future performance could also change materially. The safe
harbor provision provides that the Corporation is not required to publicly
update or revise forward-looking statements to reflect events or circumstances
that arise after the date of this report. Readers should review any changes in
risk factors in documents filed by the Corporation periodically with the
Securities and Exchange Commission , including Item 1A of Part II of this
Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports
on Form 8-K.
Results of Operations
Overview
The first quarter of 2021 was positively impacted by a number of items resulting
in very strong financial results. The COVID-19 pandemic continues to impact
customer behavior and balance sheet growth, but there has not been significant
negative impacts on earnings or credit. Customers have adapted to changes in
behavior and the Corporation continues to seek ways to manage the structure of
the balance sheet to ensure positive financial results now and in future time
periods.
The Corporation recorded net income of $4,504,000 for the three-month period
ended March 31, 2021 , a $2,339,000 , or 108.0% increase, from the $2,165,000
earned during the same period in 2020. The earnings per share, basic and
diluted, were $0.81 for the three months ended March 31, 2021 , compared to $0.38
for the same period in 2020, a 113.2% increase. The increase in the
Corporation's 2021 earnings was caused primarily by growth in gains on mortgages
sold, other income, and net interest income.
The gains from the sale of mortgages were $1,930,000 for the three months ended
March 31, 2021 , compared to gains of $541,000 for the first quarter of 2020, an
increase of $1,389,000 , or 256.7%. The volume of mortgages sold was higher
during the first three months of 2021 compared to the same period in the prior
year. This volume has been driven by low market rates, which has caused an
increase in refinancing activity over the course of the past year. Additionally,
margins received on sold mortgages have been at higher levels supporting this
higher level of gains. Gains on securities in total increased by $283,000 , or
544.2%, for the three months ended March 31, 2021 , compared to the same period
in the prior year primarly driven by gains on equity securities sold as well as
unrealized gains on equity securities recorded in income due to the increased
market values of bank stocks as of March 31, 2021 . Outside of mortgage and
security gains, other non-interest income increased by $879,000 , or 40.4% for
the first quarter of 2021, due to many positive trends such as higher trust
income, higher commissions on debit card interchange fees, and lower mortgage
servicing asset amortization.
The Corporation's NII increased by $463,000 , or 5.0%, for the three months ended
March 31, 2021 , compared to the same period in 2020. The increase in NII
primarily resulted from an increase in interest on securities available for sale
of $244,000 , or 13.7%, for the three-month period ended March 31, 2021 , as well
as a decrease in interest expense on deposits and borrowings of $420,000 , or
33.0%. The low interest rate environment has caused a rapid decline in asset
yield, but also a decline in the cost of funds, which has resulted in these much
lower levels of interest expense.
The financial services industry uses two primary performance measurements to
gauge performance: return on average assets (ROA) and return on average equity
(ROE). ROA measures how efficiently a bank generates income based on the amount
of assets or size of a company. ROE measures the efficiency of a company in
generating income based on the amount of equity or capital utilized. The latter
measurement typically receives more attention from shareholders. The ROA and ROE
increased for the quarter-to-date period ended March 31, 2021 , compared to the
same period in the prior year, due to much higher earnings in the first quarter
of 2021 compared to 2020.
34
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
Key Ratios Three Months Ended
March 31,
2021 2020
Return on Average Assets 1.24% 0.74%
Return on Average Equity 14.03% 7.42%
The results of the Corporation's operations are best explained by addressing, in
further detail, the five major sections of the income statement, which areas follows: · Net interest income
· Provision for loan losses
· Other income · Operating expenses
· Provision for income taxes
The following discussion analyzes each of these five components.
Net Interest Income NII represents the largest portion of the Corporation's operating income. In the first three months of 2021, NII generated 64.5% of the Corporation's revenue stream, which consists of net interest income and non-interest income, compared to 76.9% in the first three months of 2020. This significant decrease is a result of much higher levels of non-interest income primarily driven by mortgage gains in the first quarter of 2021 which made up 12.9% of the Corporation's revenue stream, compared to only 4.5% in the first quarter of 2020. However, the overall performance of the Corporation is highly dependent on the changes in net interest income since it comprises such a significant portion of operating income. The following table shows a summary analysis of net interest income on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE net interest income shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis. The amount of FTE adjustment totaled$268,000 for the three months endedMarch 31, 2021 , compared to$166,000 for the same period in 2020. NET INTEREST INCOME (DOLLARS IN THOUSANDS) Three Months Ended March 31, 2021 2020 $ $ Total interest income 10,530 10,487 Total interest expense 851 1,271 Net interest income 9,679 9,216 Tax equivalent adjustment 268 166
Net interest income (fully taxable equivalent) 9,947 9,382
NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect net interest income:
· The rates earned on interest earning assets and paid on interest bearing
liabilities
· The average balance of interest earning assets and interest bearing liabilities
35
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
The Federal funds rate, the Prime rate, the shape of the U.S. Treasury curve,
and other wholesale funding curves, all affect NII. The Federal Reserve controls
the Federal funds rate, which is one of a number of tools available to the
Federal Reserve to conduct monetary policy. The Federal funds rate, and guidance
on when the rate might be changed, is often the focal point of discussion
regarding the direction of interest rates. During 2020, the Federal funds rate
was decreased by 150 basis points in March taking the rate to 0.25% by March 31,
2020 . With the declines in the Federal funds rate, the U.S. Treasury yield curve
became flatter. Long-term rates like the ten-year U.S. Treasury were 232 basis
points under the 3.25% Prime rate as of December 31, 2020 . Long-term Treasury
rates remained low throughout 2020, and with the decreases in the Federal
Reserve short-term rates, the yield curve remained essentially flat throughout
the year. Management had not anticipated the Fed rate decreases in the first
quarter of 2020. During the first quarter of 2021, longer-term U.S. Treasury
rates did increase adding some slope to the yield curve. The ten-year Treasury
rate was 1.74% as of March 31, 2021 , which was 151 basis points under the Prime
rate. This Treasury rate movement makes it a little easier to get asset yield on
the longer end of the curve, but yields are still compressed compared to years
prior to 2020, making increasing asset yield much more difficult, which adds
strain to NII and NIM.
The Prime rate is generally used by commercial banks to extend variable rate
loans to business and commercial customers. For many years, the Prime rate has
been set at 300 basis points, or 3.00% higher, than the Federal funds rate and
typically moves when the Federal funds rate changes. As such, the Prime rate
decreased to 3.25% in March of 2020 after the 150 basis point Fed rate decline.
The Corporation's Prime-based loans generally reprice a day after the Federal
Reserve rate movement.
As a result of a larger balance sheet in the first quarter of 2021, even with
much lower asset yields, the Corporation's NII on a tax equivalent basis
increased while the Corporation's margin decreased to 2.86% for the quarter,
compared to 3.41% in the first quarter of 2020. Loan yields were lower in the
first quarter of 2021 due to the 150 basis point Fed rate decline during the
first quarter of 2020. The Corporation's NII for the three months ended March
31, 2021 increased over the same period in 2020, by $565,000 , or 6.0%.
Management's asset liability sensitivity measurements continue to show a benefit
to both margin and NII given Federal Reserve rate increases. Actual results over
the past two years have confirmed the asset sensitivity of the Corporation's
balance sheet. However, in a down-rate environment, the margin and NII would
suffer unless balance sheet growth is enough to offset lower asset yields.
Security yields will generally fluctuate more rapidly than loan yields based on
changes to the U.S. Treasury rates and yield curve. With lower Treasury rates in
2020, security reinvestment had generally been occurring at lower yield levels.
With slightly higher Treasury rates in the first quarter of 2021, security
yields have increased slightly, but still remain compressed compared to years
prior to 2020.
The Corporation's loan portfolio yield has decreased from the prior years' period as the variable rate portion of the loan portfolio repriced lower with eachFederal Reserve rate movement and some fixed rate borrowers requested loan modifications to reset their rates lower in the current record low market rate environment. The vast majority of the Corporation's commercial Prime-based loans were priced at the Prime rate, which was 4.75% to start 2020, and then 4.25% as ofMarch 4, 2020 , and 3.25% as ofMarch 16, 2020 throughMarch 31, 2021 . The pricing for the most typical five-year fixed rate commercial loans is currently in line with the Prime rate. With the significant 2020Federal Reserve rate reductions, adding variable rate loans to the portfolio means they will be priced at very low rates to start but can reprice lower if theFederal Reserve lowers rates any further and would reprice higher if theFederal Reserve would increase rates. There are elements of the Corporation's Prime-based commercial loans priced above the Prime rate based on the level of credit risk of the borrower. Management does price a portion of consumer variable rate loans above the Prime rate, which also helps to improve loan yield. Both commercial and consumer Prime-based pricing continues to be influenced by local competition. Mid-term and long-term interest rates on average were higher in the first quarter of 2021 compared to the first quarter of 2020. The average rate of the 10-yearU.S. Treasury was 1.34% in the first quarter of 2021 compared to 1.37% in the first quarter of 2020, and it stood at 1.74% onMarch 31, 2021 , compared to 0.70% onMarch 31, 2020 . The slope of the yield curve has been compressed throughout 2020 and 2021 with a little more slope in the first quarter of 2021. As ofDecember 31, 2020 , the 10-yearU.S. Treasury rate was only 68 basis points higher than the Fed funds rate and as ofMarch 31, 2021 , it was 149 basis points higher than the Fed funds rate. The slope of the yield curve has fluctuated many times in the past two years with the 10-yearU.S. Treasury yield as high as 1.88% in the first quarter of 2020 and 1.74% in the first quarter of 2021, and as low as 0.54% in the first quarter of 2020, and 0.93% in the first quarter of 2021. 36 IndexENB FINANCIAL CORP Management's Discussion and Analysis The Corporation's overall cost of funds, including non-interest bearing funds, remained stable through the first quarter of 2021 between 19 and 21 basis points. Management expects the cost of funds will decline slightly and then stabilize throughout 2021 as limited deposits reprice to lower rates. Core deposit interest rates were reduced nine times throughout 2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core deposit products. Management does not anticipate significant deposit rate movements in 2021 as deposits are now priced at very low rates. Typically, financial institutions will make small systematic moves on core interest bearing accounts while making larger rate movements in the pricing of new or reissued time deposits. The Corporation's costs on borrowings included$50,000 of prepayment penalties recorded on FHLB long-term advances paid off early during the first quarter of 2021, accelerating the interest expense, but achieving savings in future time periods. While the average balance of borrowings was lower in the first quarter of 2021 than the first quarter of 2020, the interest expense was higher, as the new$20 million sub debt issue beginning onDecember 30, 2020 , carried a higher rate of interest than FHLB long-term advances that were paid off. As a result, the total cost of borrowings increased from the first quarter of 2020 to the first quarter of 2021 by$75,000 . The following table provides an analysis of year-to-date changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
Three Months Ended March 31, Three Months Ended March 31,
2021 vs. 2020 2020 vs. 2019
Increase (Decrease) Increase (Decrease)
Due To Change In Due To Change In
Net Net
Average Interest Increase Average Interest Increase
Balances Rates (Decrease) Balances Rates (Decrease)
$ $ $ $ $ $
INTEREST INCOME
Interest on deposits at other banks 48 (86 ) (38 ) 25 (12 ) 13
Securities available for sale:
Taxable 399 (552 ) (153 ) 116 (179 ) (63 )
Tax-exempt 606 (117 ) 489 (66 ) (35 ) (101 )
Total securities 1,005 (669 ) 336 50 (214 ) (164 )
Loans 837 (912 ) (75 ) 622 (202 ) 420
Regulatory stock (24 ) (54 ) (78 ) 19 1 20
Total interest income 1,866 (1,721 ) 145 716 (427 ) 289
INTEREST EXPENSE
Deposits:
Demand deposits 55 (322 ) (267 ) 28 (152 ) (124 )
Savings deposits 6 (15 ) (9 ) 2 (4 ) (2 )
Time deposits (47 ) (172 ) (219 ) (5 ) 116 111
Total deposits 14 (509 ) (495 ) 25 (40 ) (15 )
Borrowings:
Total borrowings (41 ) 116 75 57 50 107
Total interest expense (27 ) (393 ) (420 ) 82 10 92
NET INTEREST INCOME 1,893 (1,328 ) 565 634 (437 ) 197
During the first three months of 2021, the Corporation's NII on an FTE basis
increased by $565,000 , or 6.0%, over the same period in 2020. Total interest
income on an FTE basis for the three months ended March 31, 2021 , increased
$145,000 , or 1.4%, from 2020, while interest expense decreased $420,000 , or
33.0%, for the three months ended March 31, 2021 , compared to the same period in
2020. The FTE interest income from the securities portfolio increased by
$336,000 , or 17.2%, while loan interest income decreased $75,000 , or 0.9%.
During the first three months of 2021, additional loan volume caused by loan
growth added $837,000 to net interest income, but the lower yields caused a
$912,000 decrease, resulting in a total decrease of $75,000 . Higher balances in
the securities portfolio caused an increase of $1,005,000 in NII, while lower
yields on securities caused a $669,000 decrease, resulting in a net increase of
$336,000 .
37
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
The average balance of interest bearing liabilities increased by 15.4% during
the three months ended March 31, 2021 , compared to the prior year driven by
growth in deposit balances. The lower cost on deposit accounts resulted in a
decrease in interest expense. Lower rates on all deposit types caused a $509,000
decrease in interest expense while higher balances of demand and savings
deposits caused an increase in expense of $14,000 resulting in a total decrease
of $495,000 .
Out of all the Corporation's deposit types, interest-bearing demand deposits
reprice the most rapidly, as nearly all accounts are immediately affected by
rate changes. Time deposit balances decreased resulting in a $47,000 reduction
to expense, and time deposits repricing to lower interest rates decreased
interest expense by $172,000 , causing a net total decrease of $219,000 in time
deposit interest expense. Even with the low rate environment, the Corporation
was successful in increasing balances of other deposit types.
The average balance of outstanding borrowings decreased by 9.4% from the prior
year, due to early payoff of FHLB advances that occurred during 2020 and the
first quarter of 2021. This resulted in a decrease in interest expense of
$41,000 . Although interest rates were lower in the first three months of 2021
compared to the prior year, the Corporation incurred interest prepayment
penalites of $50,000 to pay off a long-term FHLB advance. The Corporation also
issued subordinated debt at the end of 2020, which was at a higher interest rate
than the FHLB advances. These two events increased interest expense by $116,000 .
The combination of lower overall levels of borrowings at a materially higher
weighted average interest rate caused an increase in interest expense of $75,000
on total borrowings. The sub debt issue was pursued because of the benefit of
being treated as Tier 1 capital at the bank level and Tier II capital at the
bank holding company level.
The following table shows a more detailed analysis of net interest income on an
FTE basis with all the major elements of the Corporation's 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 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.
38
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
For the Three Months Ended March 31,
2021 2020
(c) (c)
Average Annualized Average Annualized
Balance Interest Yield/Rate Balance Interest Yield/Rate
$ $ % $ $ %
ASSETS
Interest earning assets:
Federal funds sold and
interest
on deposits at other banks 57,975 22 0.15 18,860 60 1.29
Securities available for
sale:
Taxable 318,921 1,104 1.38 229,149 1,256 2.19
Tax-exempt 172,768 1,189 2.75 86,695 701 3.23
Total securities (d) 491,689 2,293 1.87 315,844 1,957 2.48
Loans (a) 838,954 8,416 4.03 759,998 8,491 4.48
Regulatory stock 6,033 67 4.45 7,468 145 7.77
Total interest earning
assets 1,394,651 10,798 3.11 1,102,170 10,653 3.87
Non-interest earning assets
(d) 79,897 72,386
Total assets 1,474,548 1,174,556
LIABILITIES &
STOCKHOLDERS' EQUITY
Interest bearing
liabilities:
Demand deposits 324,277 38 0.05 265,771 305 0.46
Savings deposits 286,793 14 0.02 215,889 23 0.04
Time deposits 119,309 262 0.89 133,706 481 1.45
Borrowed funds 74,411 537 2.93 82,118 462 2.26
Total interest bearing
liabilities 804,790 851 0.43 697,484 1,271 0.73
Non-interest bearing
liabilities:
Demand deposits 534,503 355,778
Other 5,028 3,896
Total liabilities 1,344,321 1,057,158
Stockholders' equity 130,227 117,398
Total liabilities &
stockholders' equity 1,474,548 1,174,556
Net interest income (FTE) 9,947 9,382
Net interest spread (b) 2.68 3.14
Effect of non-interest
bearing deposits 0.18 0.27
Net yield on interest
earning assets (c) 2.86 3.41
(a) Includes balances of nonaccrual loans and the recognition of any related
interest income. The quarter-to-date average balances include net deferred loan
costs of $1,199,000 as of March,31 2021, and $1,982,000 as of March 31,
2020. Such fees and costs recognized through income and included in the interest
amounts totaled $338,000 in 2021, and ($35,000 ) in 2020.
(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.
39
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
The Corporation's interest income increased primarily due to increased interest
income on securities, but the increase in income was the result of growth in the
securities portfolio, not an increase in asset yield, resulting in a lower NIM
of 2.86% for the first quarter of 2021, compared to 3.41% for the first quarter
of 2020. The yield earned on assets decreased by 76 basis points during the
three months ended March 31, 2021 , while the rate paid on liabilities decreased
by 30 basis points when comparing both years. This resulted in a 46 basis point
decrease in interest spread, and the effect of non-interest bearing deposits
decreased by nine basis points during the three months ended March 31, 2021 ,
compared to the prior year, resulting in the decrease in NIM of 55 basis points.
Management anticipates a levelling out of NIM during the remainder of 2021 as
Treasury rates have increased a little assisting with achieving higher yields in
the securities portfolio and loan yields will benefit some by the remainder of
the PPP fees that are accretive to loan interest income as PPP loans pay off or
are forgiven. Loan yields decreased in the first three months of 2021 compared
to the prior year primarily as a result of the 150 basis points of Prime decline
in the first quarter of 2020 that did not fully impact the loan yields until the
second quarter of 2020. Growth in the loan portfolio will help to offset a
declining asset yield moving through 2021. The Corporation's loan yield
decreased 45 basis points in the first three months of 2021 compared to the
first three months of 2020. Loan interest income decreased $75,000 , or 0.9%, for
this time period as a result of the decline in yields.
Loan pricing was challenging in the first quarter of 2021 as a result of the
very low rate environment and competition resulting in fixed-rate loans being
priced at very low levels and variable-rate loans priced at the Prime rate or
below. The Prime rate decreased by 1.50% in March of 2020 to 3.25%, which is now
comparable to the typical rate of a five-year fixed-rate loan. The commercial or
business fixed rates do increase with longer fixed terms or lower credit
quality. In terms of the variable rate pricing, nearly all variable rate loans
offered are Prime-based. Management is able to price loan customers with higher
levels of credit risk at Prime plus pricing, such as Prime plus 0.75%, which
amounted to 4.00% at March 31, 2021 , still a relatively low rate. However, only
a small minority of the loans in the commercial and agricultural portfolios are
at these higher rates due to the strong credit quality of the Corporation's
borrowers and market competition. Competition in the immediate market area has
been pricing select shorter-term fixed-rate commercial and agricultural lending
rates below 3.25% for the strongest loan credits.
Tax equivalent yields on the Corporation's securities decreased by 61 basis
points for the three months ended March 31, 2021 , compared to 2020. The
Corporation's securities portfolio consists of approximately 75% fixed income
debt instruments and 25% variable rate product as of March 31, 2021 . The
Corporation's taxable securities experienced an 81 basis-point decrease in yield
for the three months ended March 31, 2021 , compared to 2020. Security
reinvestment in 2021 has been occurring at slightly higher rates due to the
increase in U.S. Treasury rates, but reinvestment throughout the majority of
2020 was at much lower yields. The sharp growth in the investment portfolio
during a period of very low rates also contributed to the decline in average
security yield. This large amount of new investment was caused by the
significant influx of deposits, which caused excess liquidity. The sharpest
growth in the securities portfolio occurred in the fourth quarter of 2020 and
the first quarter of 2021. In addition to these negative influences, the
Corporation's U.S. agency mortgage-backed securities and collateralized mortgage
obligations experience faster principal prepayments as market rates decrease,
causing the amortization of premium to increase, effectively decreasing the
yield.
The yield on tax-exempt securities decreased by 48 basis points in the first
quarter of 2021 compared to 2020. For the Corporation, these bonds consist
entirely of tax-free municipal bonds. While the tax-exempt yields on municipal
bonds declined with the tax rate change at the end of 2017, yields became more
attractive again during 2020 and 2021. Management began investing in more of
these bonds in 2020 as yields stood out and provided better returns than other
sectors of the portfolio.
The interest rate paid on deposits decreased for the three months ended March
31, 2021 , from the same period in 2020. Management follows a disciplined pricing
strategy on core deposit products that are not rate sensitive, meaning that the
balances do not fluctuate significantly when interest rates change. Rates on
interest-bearing checking accounts and money market accounts were decreased in
2020, resulting in a decrease in the cost of funds on these accounts of 41 basis
points. Savings account rates were also decreased during 2020 resulting in a two
basis point reduction in the cost of funds associated with these accounts.
Additionally, the cost of funds on time deposits decreased by 56 basis points
during the first quarter of 2021 compared to the same period in the prior year.
Typically, the Corporation sees increases in core deposit products during
periods when consumers are not confident in the stock market or economic
conditions deteriorate. During these periods, there is a "flight to safety" to
federally insured deposits. This trend occurred again in early 2020 as the
federal, state and local governmental bodies began rapidly instituting social
distancing measures in an effort to control the spread of the coronavirus. These
measures had an immediate signicant negative impact to the economy, which also
resulted in the Federal Reserve quickly dropping interest rates back to historic
lows. This in turn resulted in market interest rates declining again to historic
lows, with the Corporation reducing offering rates on deposit products. As the
rate difference between time deposits and core deposits narrowed, many customers
chose to transfer funds from maturing time deposits into checking and savings
accounts.
40
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
The Corporation's average deposits increased$293.7 million , or 30.2%, with all types of interest-bearing deposits increasing$115.0 million , or 18.7%, while non-interest bearing demand deposits increased$178.7 million , or 50.2%. In the current rate environment, with short-term rates low and with small rate differences for longer-term deposits, the consumer generally elected to stay short and maintain funds in accessible deposit instruments. In addition to the consumer staying liquid with their available funds, there has been a general trend of funds flowing from time deposit accounts into non-interest checking, NOW, and savings accounts. The average balance of time deposits declined during the first three months of 2021 compared to 2020, but the other areas of NOW, MMDA, and savings grew sufficiently enough to compensate for the decline in time deposits, causing total interest bearing funds to increase significantly. Time deposit balances had been growing throughout 2018 and 2019 due to the odd-month CD promotions available at those times, but with the recent sharp decline in rates, time deposits declined throughout 2020 and management expects these time deposit balances to decrease throughout the remainder of 2021 as a result of customers electing to allow maturing time deposit balances to roll off and hold them in a liquid account until there is some sign of rate increases. Interest expense on deposits decreased by$495,000 , or 61.2%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. Demand and savings deposits reprice in their entirety whenever the offering rates are changed, so with each successive rate drop in 2020, these deposits repriced lower. Interest rates on interest checking and money market accounts were decreased nine times in 2020. For the three months endedMarch 31, 2021 , the average balances of interest bearing demand deposits increased by$58.5 million , or 22.0%, over the same period in 2020, while the average balance of savings accounts increased by$70.9 million , or 32.8%. Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. During the three months endedMarch 31, 2021 , time deposit balances decreased compared to balances atMarch 31, 2020 . The decrease can be attributed to the low rates paid on time deposits, which has caused the differential between time deposit rates and rates on non-maturity deposits to be minimal. As a result, customers have elected to keep more of their funds in non-maturity deposits and less funds in time deposits. Because time deposits are the most expensive deposit product for the Corporation and the largest dollar expense from a funding standpoint, the reduction in time deposits, along with the increases in interest-bearing checking, savings, and non-interest bearing checking, has allowed the Corporation to achieve a more balanced deposit funding position and maintain a lower cost of funds. The Corporation's interest expense on time deposits decreased by$220,000 , or 45.6%, for the first three months of 2021, compared to the same period in 2020. Management anticipates the interest expense on time deposits and annualized rate paid will decline throughout the remainder of 2021 as these higher-priced time deposits mature and reprice at lower levels or convert to non-maturity deposits. The Corporation's average rate on borrowed funds increased by 67 basis points from the first quarter of 2020 to the first quarter of 2021, as an FHLB borrowing was paid off early during the first quarter of 2021 accelerating$50,000 of interest expense. In addition, the Corporation's subordinated debt issued onDecember 30, 2020 , is included in this total borrowed funds amount and is at a rate of 4.00% for 5 years, so the increase in rate paid on borrowed funds is a direct result of this as well. The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. Average short-term advances of only$77,000 were utilized in the three months endedMarch 31, 2021 , while average short-term advances of$1,806,000 were utilized in the three months endedMarch 31, 2020 . Management has used FHLB long-term borrowings as part of an asset liability strategy to lengthen liabilities rather than as a source of liquidity. Average total long-term FHLB borrowings decreased by$25,589,000 , or 31.9%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. The average balance of subordinated debt increased by$19,610,000 , as subordinated debt was issued at the end of 2020 as a vehicle to support capital growth for the Corporation. This growth in debt balances contributed to an increase in interest expense for the three months endedMarch 31, 2021 , compared to the same period in the prior year. Interest expense on borrowed funds increased$76,000 , or 16.5%, for the three-month period when comparing 2021 to 2020, driven higher by$50,000 of FHLB interest prepayment penalties on the early payoff of an advance as well as$200,000 of interest expense accrued on subordinated debt. Despite these increases, interest expense in total was held to a low level due to the prepayment of many FHLB advances in 2020 which accelerated the interest expense to the prior year and will result in savings in 2021 and future years. For the three months endedMarch 31, 2021 , the net interest spread decreased by 46 basis points to 2.68%, compared to 3.14% for the three months endedMarch 31, 2020 . The effect of non-interest bearing funds decreased to 18 basis points from 27 basis points for the three months endedMarch 31, 2021 . The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go higher, the benefit of non-interest bearing deposits increases because there is more difference between non-interest bearing funds and interest bearing liabilities. For example, if an interest checking account with$10,000 earns 1%, the benefit for$10,000 of non-interest bearing deposits is equivalent to$100 ; but if the interest-checking rate is increased to 1.50%, then the benefit of the non-interest bearing funds is$150 . This assumes dollar-for-dollar replacement, which is not realistic, but demonstrates the way the higher cost of funds affects the benefit to non-interest bearing deposits. 41 IndexENB FINANCIAL CORP Management's Discussion and Analysis
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, refer to Item 7A: Quantitative and Qualitative Disclosures about Market Risk. Provision for Loan Losses The allowance for credit losses (ACL) provides for losses inherent in the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The amount of the provision reflects the adjustment management determines necessary to ensure the ACL is adequate to cover any losses inherent in the loan portfolio. The Corporation recorded a provision expense of$375,000 for the three months endedMarch 31, 2021 , compared to$350,000 for the three months endedMarch 31, 2020 . The analysis of the ACL takes into consideration, among other things, the following factors:
· levels and trends in delinquencies, nonaccruals, charge-offs and recoveries,
· trends within the loan portfolio,
· changes in lending policies and procedures,
· experience of lending personnel and management oversight,
· national and local economic trends,
· concentrations of credit,
· external factors such as legal and regulatory requirements,
· changes in the quality of loan review and board oversight, and
· changes in the value of underlying collateral.
As ofMarch 31, 2021 , total delinquencies represented 0.31% of total loans, compared to 0.67% as ofMarch 31, 2020 . These ratios are very low compared to local and national peer groups. The vast majority of the Corporation's loan customers have remained steadfast in making their loan payments and avoiding delinquency, even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly, the character of the Corporation's customers and lending practices. Classified loans are primarily determined by loan-to-value and debt-to-income ratios. The level of classified loans has decreased fromMarch 31, 2020 , toMarch 31, 2021 , from 20.7% of regulatory capital to 14.7% of regulatory capital. The delinquency and classified loan information is utilized in the quarterly ACL calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies and/or classified loans during the quarter would be cause for management to increase or decrease the provision expense. The level of actual charge-offs relative to the amount of recoveries can also have a significant impact on the provision. Management had minimal charge-offs and recoveries in the first three months of 2021. Generally, management will evaluate and adjust, if necessary, the provision expense each quarter based upon completion of the quarterly ACL calculation. Future provision amounts will generally depend on the amount of loan growth achieved versus levels of delinquent, non-performing, and classified loans, as well as charge-offs and recoveries. In addition to the above, provision expense is impacted by three major components that are all included in the quarterly calculation of the ACL. First, specific allocations are made for any loans where management has determined an exposure that needs to be provided for. These specific allocations are reviewed each quarter to determine if adjustments need to be made. It is common for specific allocations to be reduced as additional principal payments are made, so while some specific allocations are being added, others are being reduced. Second, management provides for estimated losses on pools of similar loans based on historical loss experience. Finally, management utilizes qualitative factors every quarter to adjust historical loss experience to take into consideration the current trends in loan volume, delinquencies, charge-offs, changes in lending practices, and the quality of the Corporation's underwriting, credit analysis, lending staff, and Board oversight. National and local economic trends and conditions are also helpful to determine the amount of loan loss allowance the Corporation should be carrying on the various types of loans. Management evaluates and adjusts, if necessary, the qualitative factors on a quarterly
basis.
42
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ENB FINANCIAL CORP
Management's Discussion and Analysis
In the first three months of 2021, qualitative factors were adjusted by
management based on current internal information regarding trends in the nature
and volume of the loan portfolio and delinquency. An increase in qualitative
factors was made across one loan pool related to trends in the nature and volume
of the loan portfolio. This factor was increased by 5 basis points since
December 31, 2020 . Other factors remained unchanged in the first three months of
2021.
Management also monitors the allowance as a percentage of total loans. The percentage of the allowance to total loans has increased sinceMarch 31, 2020 , and remains higher than the Bank's national peer group from theUniform Bank Performance Reports. As ofMarch 31, 2021 , the allowance as a percentage of total loans was 1.51%, up from 1.28% atMarch 31, 2020 , and 1.50% atDecember 31, 2020 . Management continues to evaluate the ACL in relation to the size of the loan portfolio and changes to the segments within the loan portfolio and their associated credit risk. Management believes the ACL is adequate to provide for future loan losses based on the current portfolio and the current economic environment. More detail is provided under Allowance for Credit Losses in the Financial Condition section that follows. Other Income Other income for the first quarter of 2021 was$5,318,000 , an increase of$2,551,000 , or 92.2%, compared to the$2,767,000 earned during the first quarter of 2020. The following table details the categories that comprise other income. As illustrated in the tables below the primary contributor to the increase was the gains on the sales of mortgages. OTHER INCOME (DOLLARS IN THOUSANDS) Three Months Ended March 31, Increase (Decrease) 2021 2020 $ $ $ % Trust and investment services 670 622 48 7.7 Service charges on deposit accounts 248 315 (67 ) (21.3 ) Other service charges and fees 366 364 2 0.5 Commissions 864 686 178 25.9 Gains on securities transactions, net 87 282 (195 ) (69.1 ) Gains (losses) on equity securities, net 248 (230 ) 478 >100% Gains on sale of mortgages 1,930 541 1,389 256.7 Earnings on bank owned life insurance 216 206 10 4.9 Other miscellaneous income (loss) 689 (19 ) 708 >100% Total other income 5,318 2,767 2,551 92.2 Trust and investment services income increased$48,000 , or 7.7%, for the three months endedMarch 31, 2021 , compared to the same period last year. This revenue consists of income from traditional trust services and income from alternative investment services provided through a third party. In the first quarter of 2021, traditional trust income increased by$61,000 , or 16.1%, while income from alternative investments decreased by$13,000 , or 5.2%, compared to the first quarter of 2020. The decline in income from the investment services area can be attributed to less new business, which was impacted by COVID-19 and the branch lobby closures during 2020. Management would expect activity to increase again going into the remainder of 2021. The trust and investment services area continues to be an area of strategic focus for the Corporation. Management believes there continues to be great need for retirement, estate, small business succession planning, and personal investment services in the Corporation's service area. Management also sees these services as being a necessary part of a comprehensive line of financial solutions across the organization. 43 Index ENB FINANCIAL CORP Management's Discussion and Analysis
Service charges on deposit accounts decreased by$67,000 , or 21.3%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. The decrease is primarily due to a decrease in overdraft fees that were lower by$72,000 , or 27.3%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. This decline can be primarily attributed to the current economic environment, which has necessitated changes in customer behaviors. Various other fee income categories increased or decreased to lesser degrees making up the remainder of the variance compared to the prior year. Commissions increased by$178,000 , or 25.9%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. This increase was primarily caused by an increase in debit card interchange income of$164,000 , or 28.4%. The interchange income is a direct result of the volume of debit card transactions processed and this income is increasing as customers utilize electronic payments more. For the three months endedMarch 31, 2021 ,$87,000 of gains on securities transactions were recorded, compared to gains of$282,000 for the same period in 2020. Gains or losses on securities transactions fluctuate based on market opportunities to take gains and reposition the securities portfolio to improve long-term earnings, or as part of management's asset liability goals to improve liquidity or reduce interest rate risk or fair value risk. The gains or losses recorded by the Corporation depend heavily on market pricing and the volume of security sales. Generally, the lowerU.S. Treasury yields go, the more management will be motivated to pursue taking gains from the sale of securities. However, these market opportunities are evaluated subject to the Corporation's other asset liability measurements and goals. The yield curve in the first three months of 2021 provided fewer opportunities to take gains out of the portfolio than during the first three months of 2020. Gains on equity securities amounted to$248,000 during the first three months of 2021, comared to a loss of$230,000 in the prior year. This represents an increase in income of$478,000 for the first quarter of 2021 compared to the first quarter of 2020. Gains or losses on equity securities are impacted by actual sales of securities as well as changes in the market value of these securities since market value gains and losses are recorded through income. In the first three months of 2021,$95,000 of gains were recorded on the sale of bank stocks and$153,000 was recorded as an unrealized gain due to the increase in market value of the bank stock portfolio. During the first three months of 2020, unrealized losses of$230,000 were recorded due to the decline in bank stock prices as the COVID-19 pandemic began and negatively impacted the market. Gains on the sale of mortgages were$1,930,000 for the three-month period endedMarch 31, 2021 , compared to$541,000 for the same period in 2020, a$1,389,000 , or 256.7% increase. Mortgage activity was significantly higher in the first three months of 2021 compared to the prior year as a result of historically low interest rates and a surge in mortgage refinancing activity. Even with market rates increasing slightly in the first quarter of 2021, refinance activity continued at record levels. Management currently anticipates that gains throughout the remainder of 2021 may decrease slightly compared to the prior year, due to the increase in market rates that will likely result in a slowdown of mortgage activity, as well as lower margins received on mortgages sold. For the three months endedMarch 31, 2021 , earnings on bank-owned life insurance (BOLI) increased by$10,000 , or 4.9%, compared to the same period in 2020. The amount of BOLI income is generally dependent upon the actual return of the policies, the insurance cost components, and any benefits paid upon death that exceed the policy's cash surrender value. Increases in cash surrender value are a function of the return of the policy net of all expenses. The miscellaneous income category increased by$708,000 , for the three months endedMarch 31, 2021 , compared to the same period in 2020. The quarterly increase can be primarily attributed to net mortgage servicing income, which increased by$263,000 in 2021 compared to 2020 due to much lower levels of mortgage servicing asset amortization in 2021. The slightly higher interest rate environment resulted in this lower level of amortization. Other miscellaneous income categories increased as well making up the remainder of the variance
in this category. Operating Expenses Operating expenses for the first quarter of 2021 were$9,187,000 , an increase of$77,000 , or 0.8%, compared to the$9,110,000 for the first quarter of 2020. The following table provides details of the Corporation's operating expenses for the three-month period endedMarch 31, 2021 , compared to the same period in 2020. 44 Index ENB FINANCIAL CORP Management's Discussion and Analysis OPERATING EXPENSES (DOLLARS IN THOUSANDS) Three Months Ended March 31, 2021 2020 Increase (Decrease) $ $ $ %
Salaries and employee benefits 5,699
5,696 3 0.1 Occupancy expenses 683 591 92 15.6 Equipment expenses 267 290 (23 ) (7.9 )
Advertising & marketing expenses 190 274 (84 ) (30.7 ) Computer software & data processing expenses 1,098
706 392 55.5 Bank shares tax 280 239 41 17.2 Professional services 439 623 (184 ) (29.5 ) Other operating expenses 531 691 (160 ) (23.2 )
Total Operating Expenses 9,187 9,110 77 0.8 Salaries and employee benefits are the largest category of operating expenses. In general, they comprise approximately 62% of the Corporation's total operating expenses. For the three months endedMarch 31, 2021 , salaries and benefit costs remained nearly the same as 2020. This has resulted in better operational efficiency as the Corporation's total assets have grown dramatically since the prior year, but salaries and benefit costs have remained static resulting in overall improvements in efficiency.
Occupancy expenses consist of the following:
· Depreciation of bank buildings
· Real estate taxes and property insurance
· Building lease expense · Utilities
· Building repair and maintenance
Occupancy expenses increased by$92,000 , or 15.6% for the three months endedMarch 31, 2021 , compared to the same period in the prior year. Snow removal costs alone increased by$43,000 , or 300.6%, and utilities costs increased by$20,000 , or 10.9%, for the first quarter of 2021, compared to the same period in the prior year. In addition, building repair and maintenance costs increased$16,000 , or 44.9% for the same time period. Other occupancy costs increased or decreased by smaller amounts making up the remainder of the variance in this category. Equipment expenses decreased by$23,000 , or 7.9%, for the three months endedMarch 31, 2021 , compared to the same period in the prior year. The decrease in this category is primarily related to depreciation on existing furniture and equipment which decreased by$28,000 , or 15.0%. This decline can be attributed to depreciation streams ending on furniture and equipment purchased in prior years with new purchases of furniture and equipment only partially offsetting this decline.
Advertising and marketing expenses decreased by$84,000 , or 30.7%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. These expenses can be further broken down into two categories, marketing expenses and public relations. The marketing expenses decreased by$60,000 , or 34.9%, for the quarter-to-date period endedMarch 31, 2021 , compared to the same period in the prior year. Public relations expenses decreased by$24,000 , or 23.9%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. Marketing expenses support the overall business strategies of the Corporation; therefore, the timing of these expenses is highly dependent upon the execution of those strategies. Computer software and data processing expenses increased by$392,000 , or 55.5%, for the first quarter of 2021 compared to 2020. Software-related expenses were up by$336,000 , or 81.3%, as a result of purchasess of new software platforms to support the strategic initiatives of the Corporation as well as higher amortization on software purchased in the prior year. Software expenses are likely to continue to increase in 2021, but the actual increase will be dependent on how quickly new software platforms are identified, analyzed, approved and placed into service. Data processing fees were up$56,000 , or 19.1%, for the three months endedMarch 31, 2021 , compared to the same period in 2020. 45 IndexENB FINANCIAL CORP Management's Discussion and Analysis Bank shares tax expense was$280,000 for the first quarter of 2021, an increase of$41,000 , or 17.2%, from the first quarter of 2020. Two main factors determine the amount of bank shares tax: the ending value of shareholders' equity and the ending value of tax-exemptU.S. obligations. The shares tax calculation uses a period-end balance of shareholders' equity and a tax rate of 0.95%. The increase in 2021 can be primarily attributed to the Corporation's growing value of shareholders' equity. Professional services expense decreased by$184,000 , or 29.5%, for the three-month periods endedMarch 31, 2021 , compared to the same period in 2020. These services include accounting and auditing fees, legal fees, and fees for other third-party services. These fees were elevated in the first quarter of 2020 due to implementation expenses related to a consumer loan platform. Several other professional services expenses increased or decreased slightly making up the remainder of the variance. Other operating expenses decreased by$160,000 , or 23.2%, for the three-month period endedMarch 31, 2021 , compared to the same period in 2020. Contributing to this decrease, fraud-related charges-offs decreased by$88,000 , operating supplies decreased by$44,000 , or 43.8%, loan-related expenses decreased by$35,000 , or 35.8%, and travel costs decreased by$34,000 , or 74.1%. Partially offsetting these decreases,FDIC insurance costs increased by$86,000 for the three months endedMarch 31, 2021 , compared to the first quarter of the prior year. Several other operating expense categories increased or decreased by smaller amounts making up the remainder of this variance. Income Taxes
For the three months endedMarch 31, 2021 , the Corporation recorded Federal income tax expense of$931,000 , compared to$358,000 for the three months endedMarch 31, 2020 . The effective tax rate for the Corporation was 17.1% for the three months endedMarch 31, 2021 , and 14.2% for the three months endedMarch 31, 2020 . Certain items of income are not subject to Federal income tax, such as tax-exempt interest income on loans and securities, and BOLI income; therefore, the effective income tax rate for the Corporation is lower than the stated tax rate. The effective tax rate is calculated by dividing the Corporation's provision for Federal income taxes on the Consolidated Statements of Income by the income before income taxes for the applicable period. The Corporation's effective tax rate has historically been maintained at low levels primarily due to a relatively high level of tax-free municipal bonds held in the securities portfolio. The fluctuation of the effective tax rate will occur as a result of total tax-free revenue as a percentage of total revenue. The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, the Corporation's Holding Company has very limited taxable corporate net income activities. The Corporation's wholly owned subsidiary,Ephrata National Bank , is subject to PennsylvaniaBank Shares Tax . Like Federal Corporate income tax, the PennsylvaniaBank Shares Tax is a significant expense for the Corporation, amounting to$280,000 in the first three months of 2021 compared to$239,000 in 2020. The Bank Shares Tax expense appears on the Corporation's Consolidated Statements of Income, under operating expenses.
46
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
Financial Condition
Investment Securities
The Corporation classifies all of its debt securities as available for sale and
reports the portfolio at fair value. As of March 31, 2021 , the Corporation had
$538.8 million of securities available for sale, which accounted for 35.2% of
assets, compared to 33.1% as of December 31, 2020 , and 27.8% as of March 31,
2020 . Based on ending balances, the securities portfolio increased 64.7% from
March 31, 2020 , and 11.4% from December 31, 2020 .
The debt securities portfolio was showing a net unrealized gain of $3,703,000 as
of March 31, 2021 , compared to an unrealized gain of $10,072,000 as of December
31, 2020 , and an unrealized gain of $1,396,000 as of March 31, 2020 . The
valuation of the Corporation's securities portfolio, predominately debt
securities, is impacted by both the U.S. Treasury rates and the perceived
forward direction of interest rates. The 10-year U.S. Treasury yield was 0.70%
as of March 31, 2020 , 0.93% as of December 31, 2020 , and 1.74% as of March 31,
2021 . The lower Treasury rates have caused an increase in market valuation,
which has resulted in the unrealized gains recorded at March 31, 2021 , December
31, 2020 , and March 31, 2020 . Gains were lower as of March 31, 2021 , compared to
the end of 2020 due to the increase in Treasury rates experienced in the first
quarter of 2021. Additionally, with the Federal Reserve's sudden overnight rate
decreases in March of 2020, the variable rate portion of the Corporation's
security portfolio lost market value due to the market's recognition that these
instruments would yield materially less going forward which resulted in the
lower levels of unrealized gains at March 31, 2020 .
The table below summarizes the Corporation's amortized cost, unrealized gain or
loss position, and fair value for each sector of the securities portfolio for
the periods ended March 31, 2021 , December 31, 2020 , and March 31, 2020 .
AMORTIZED COST AND FAIR VALUE OF SECURITIES HELD
(DOLLARS IN THOUSANDS)
Net
Amortized Unrealized Fair
Cost Gains (Losses) Value
$ $ $
March 31, 2021
U.S. government agencies 29,623 (443 ) 29,180U.S. agency mortgage-backed securities 67,875 708 68,583 U.S. agency collateralized mortgage obligations 40,214
572 40,786 Asset-backed securities 96,592 408 97,000 Corporate bonds 66,376 768 67,144
Obligations of states and political subdivisions 227,217 1,690 228,907 Total debt securities, available for sale 527,897
3,703 531,600 Equity securities 7,117 100 7,217 Total securities 535,014 3,803 538,817 December 31, 2020 U.S. government agencies 54,224 137 54,361
U.S. agency mortgage-backed securities 69,777 1,275 71,052 U.S. agency collateralized mortgage obligations 34,449
586 35,035 Asset-backed securities 60,387 88 60,475 Corporate bonds 60,387 1,336 61,723
Obligations of states and political subdivisions 187,132 6,650 193,782
Total debt securities 466,356 10,072 476,428
Equity securities 7,158 (53 ) 7,105
Total securities 473,514 10,019 483,533
47
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
Net
Amortized Unrealized Fair
Cost Gains (Losses) Value
$ $ $
March 31, 2020
U.S. government agencies 10,378 150 10,528
U.S. agency mortgage-backed securities 60,464 1,052 61,516
U.S. agency collateralized mortgage obligations 55,834 787 56,621 Asset-backed securities 28,969 (1,854 ) 27,115 Corporate bonds 64,429 (1,623 ) 62,806
Obligations of states and political subdivisions 99,098
2,884 101,982 Total debt securities 319,172 1,396 320,568 Equity securities 6,847 (207 ) 6,640
Total securities available for sale 326,019
1,189 327,208
Interest rate changes and the perceived forward direction of interest rates generally have a close relationship to the valuation of the Corporation's fixed income securities portfolio. There are also a number of other market factors that impact bond prices. During the second half of 2019, theFederal Reserve decreased short-term rates three times for a total of 75 basis points, and during the first quarter of 2020, theFederal Reserve decreased short-term rates two times for a total of 150 basis points. Market conditions in the first quarter of 2020 were very unpredictable and fast changing due to the start of COVID-19 and the declaration of a global pandemic onMarch 11, 2020 .The Fed's reduction of interest rates was in response to this pandemic and caused short-term and long-termTreasury rates to decline at a rapid pace to reach all-time lows. During the first quarter of 2021, rates on the longer end of the yield curve did increase causing slight declines in the unrealized gains on the investment portfolio. The COVID-19 pandemic continues to have significant impacts on rates and the economy and management believes this will continue throughout 2021, but the absolute value and direction ofTreasury rates could fluctuate as the pandemic recovery reaches new levels. Beyond interest rate movements, there are also a number of other factors that influence bond pricing including regulatory changes, financial performance of issuers, changes to credit rating of insurers of bonds, changes in market perception of certain classes of securities, and many more. Management monitors the changes in interest rates and other market influences to assist in management of the securities portfolio. Any material increase in market interest rates would have a negative impact on the market value of the Corporation's fixed income debt securities. As ofMarch 31, 2021 , approximately 75% of the Corporation's debt securities were fixed rate securities with the other 25% variable rate. The variable rate instruments generally experience very little impact to valuation based on a change in rates because they trade on a spread over overnight rates such as LIBOR. However, with theFederal Reserve drastically reducing the Federal Funds rate by 1.50% in March of 2020 to 0.25%, caused the market to view floating rate bonds differently, as the new effective yields on those securities would be significantly reduced upon the next rate reset. Whereas fixed rate securities without call options could maintain their effective yield in a new bond market with sharply lower yields. Therefore, the valuation of the fixed rate securities held up better when the securities portfolio was valued forMarch 31, 2020 . Since that time, the pricing of variable rate instruments has become more rational and most bonds have experienced an increase in unrealized gain since March of 2020. Generally the longer the bond and the longer the call protection, the better the bond did in terms of valuation. The municipal bond sector is the largest of the portfolio and, as a result, management will closely monitor the 10-yearU.S. Treasury yield due to its impact on these securities. The other sectors of the portfolio have shorter lives and duration and would be more influenced by the 2-year and 5-yearU.S. Treasury rates. The change in value of unrealized gains and losses for the remainder of 2021 will be impacted by movements inU.S. Treasury rates and could increase and decrease throughout the remainder of the year asTreasury rates fluctuate. The Corporation's effective duration increased in the first quarter of 2021 to 3.5, from 2.7 atDecember 31, 2020 . Effective duration is a measurement of the length of the securities portfolio with a higher level indicating more length and more exposure to an increase in interest rates. The securities portfolio base case effective duration was 2.2 as ofMarch 31, 2020 . Duration is expected to remain stable or increase slightly throughout the remainder of 2021. The Corporation increased effective duration by purchasing longer asset backed and municipal securities in the first quarter of 2021. Additionally, with increasing rates, pass-through structures of MBS and CMO instruments typically lengthen in duration as principal payments decrease. 48 IndexENB FINANCIAL CORP Management's Discussion and Analysis Management's actions to maintain reasonable effective duration of the securities portfolio are part of a broader asset liability plan to continually work to mitigate future interest rate risk and fair value risk to the Corporation. Part of that strategy is to retain higher levels of cash and cash equivalents to increase liquidity and provide an immediate hedge against higher interest rates and fair value risk. However, despite taking actions to mitigate the Corporation's future risk, these risks are inherent to the banking model. Unrealized gains and losses on securities will vary significantly according to market forces. Management's focus will continue to be on the long-term performance of these securities. While management has and will continue to take gains from the portfolio when opportunities exist, the broader securities strategy remains to buy and hold debt securities until maturity. Because market interest rates were declining rapidly in 2020, there was some opportunity to realize gains from the sales of securities. As a result, gains from the sales of debt securities were higher in the first quarter of 2020 than the first quarter of 2021. The Corporation typically invests excess liquidity into securities, primarily fixed-income bonds. The securities portfolio provides interest and dividend income to supplement the interest income on loans. Additionally, the securities portfolio assists in the management of both liquidity risk and interest rate risk. In order to provide maximum flexibility for management of liquidity and interest rate risk, the securities portfolio is classified as available for sale and reported at fair value. Management adjusts the value of all the Corporation's securities on a monthly basis to fair market value as determined in accordance withU.S. generally accepted accounting principles. Management has the ability and intent to hold all debt securities until maturity, and does not generally record impairment on bonds that are currently valued below book value. In addition to the fixed and variable rate bonds, the Corporation's equity holdings consist of a small CRA-qualified mutual fund with a book and fair market value of$6.2 million . The CRA fund is aSmall Business Association (SBA) variable rate fund with a stable dollar price. The Corporation also has a small portfolio of bank stocks with a book value of$927,000 and fair market value of$1,027,000 as ofMarch 31, 2021 . The fair value of the bank stocks was significantly impacted by the COVID-19 pandemic and the drastic devaluation of bank stocks during 2020 but has rebounded as ofMarch 31, 2021 , and is responsible for the large increase in gains on equity securities reported as ofMarch 31, 2021 .
All securities and bonds are evaluated for impairment on a quarterly basis. Should any impairment occur, management would write down the security to a fair market value in accordance withU.S. generally accepted accounting principles, with the amount of the write down recorded as a loss on securities.
Each quarter, management sets portfolio allocation guidelines and adjusts the security portfolio strategy generally based on the following factors:
· ALCO positions as to liquidity, credit risk, interest rate risk, and fair value
risk
· Growth of the loan portfolio
· Slope of the
· Relative performance of the various instruments, including spread to
Treasuries
· Duration and average length of the portfolio
· Volatility of the portfolio
· Direction of interest rates
· Economic factors impacting debt securities
The investment policy of the Corporation imposes guidelines to ensure diversification within the portfolio. The diversity specifications provide opportunities to shorten or lengthen duration, maximize yield, and mitigate credit risk. The composition of the securities portfolio based on fair market value is shown in the following table.
49
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
SECURITIES PORTFOLIO
(DOLLARS IN THOUSANDS)
Period Ending
March 31, 2021 December 31, 2020 March 31, 2020
$ % $ % $ %
U.S. government agencies 29,180 5.4 54,361 11.2 10,528 3.2U.S. agency mortgage-backed securities 68,583 12.7 71,052 14.7 61,516 18.8 U.S. agency collateralized mortgage obligations 40,786 7.6
35,035 7.2 56,621 17.3
Asset-backed securities 97,000 18.0 60,475 12.5 27,115 8.3
Corporate debt securities 67,144 12.5 61,723 12.8 62,806 19.2Obligations of states and political subdivisions 228,907 42.5 193,782 40.1 101,982 31.2 Total debt securities, available for sale 531,600 98.7
476,428 98.5 320,568 98.0
Marketable equity securities 7,217 1.3
7,105 1.5 6,640 2.0
Total securities 538,817 100.0 483,533 100.0 327,208 100.0
The largest movements within the securities portfolio were shaped by market factors, such as:
· slope of the
· interest spread versus
· pricing of the instruments, including supply and demand for the product
· structure of the instruments, including duration and average life
· portfolio weightings versus policy guidelines
· prepayment speeds on mortgage-backed securities and collateralized mortgage
obligations
· credit risk of each instrument and risk-based capital considerations
· Federal income tax considerations with regard to obligations of tax-free states
and political subdivisions.
The Corporation'sU.S. government agency sector decreased by$25.2 million , or 46.3%, sinceDecember 31, 2020 , with the weighting decreased from 11.2% of the portfolio to 5.4%. Management had purchased$35.5 million of short-term discount notes at the end of 2020 to offset the Corporation's shares tax expense. These bonds were sold in the first quarter of 2021 and are responsible for the decline in this category. In the past, management's goal was to maintain agency securities at approximately 10% of the securities portfolio. In the current rate environment, management is comfortable maintaining agencies below this level. In the past, this sector was important in maintaining adequate risk weightings of the portfolio and to ensure sufficientU.S. government securities for pledging purposes, as was utilizing both mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs) to do the same. Instead, Management has increased the allocations of both asset-backed securities (ABS) and obligations of states and political subdivisions (municipals) sinceMarch 31, 2020 . The Corporation's ABS and municipal sectors have increased significantly sinceMarch 31, 2020 , with ABS increasing$69.9 million , or 257.7%, and municipals increasing$126.9 million , or 124.5%. ABS securities are floating rate student loan pools which are instruments that will perform well in a rates-up environment and offset the interest rate risk of the longer fixed-rate municipal bonds. These securities provide a variable rate return materially above the overnight Federal funds rate in a safe investment with a risk rating very similar to that ofU.S. Agency bonds. The asset-backed securities generally provide monthly principal and interest payments to complement the Corporation's ongoing cash flows. With liquidity and cash levels remaining high, management views the ABS sector as a safe, higher yielding option than cash with the qualities of cash in a rates-up environment. Obligations of states and political subdivisions, or municipal bonds, are tax-free and taxable securities that generally provide the highest yield in the securities portfolio. They also carry the longest duration on average of any instrument in the securities portfolio. Municipal tax-equivalent yields generally start well above other taxable bonds. These instruments also experience significant fair market value gains and losses when interest rates decrease and increase. Municipal securities were purchased throughout 2020 and the first quarter of 2021 due to market conditions that led to favorable yields on some instruments. The Corporation also began purchasing some taxable municipal securities that added to the value of this sector. Municipal bonds represented 42.5% of the securities portfolio as ofMarch 31, 2021 , compared to 31.2% as ofMarch 31, 2020 . The Corporation's investment policy limits municipal holdings to 150% of Tier 2 capital. As ofMarch 31, 2021 , municipal holdings amounted to 153% of Tier 2 capital, slightly above this limit. The Corporation plans to sell some municipal bonds to be back within policy guidelines byJune 30, 2021 . 50 Index ENB FINANCIAL CORP Management's Discussion and Analysis The Corporation'sU.S. agency MBS and CMO sectors have fluctuated sinceMarch 31, 2020 , with MBS increasing$7.1 million , or 11.5%, and CMOs decreasing$15.8 million , or 28.0%. These two security types both consist of mortgage instruments that pay monthly interest and principal, however the behavior of the two types vary according to the structure of the mortgage pool or CMO instrument. Management desires to maintain a substantial amount of MBS and CMOs in order to assist in adding to and maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity and interest rate risk positions. Unlike the typicalU.S. agency paper, corporate bonds, and obligations of states and political subdivisions, which only pay principal at final maturity, theU.S. agency MBS and CMO securities pay contractual monthly principal and interest, but are also subject to additional prepayment of principal. The combined effect of all of these instruments paying monthly principal and interest provides the Corporation with a reasonably stable base cash flow of approximately$2.5 -$3.0 million per month. Cash flows coming off of MBS and CMOs do slow down and speed up as interest rates increase or decrease, which has an impact on the portfolio's length and yield. As interest rates decline, prepayment of principal on securities increases, the duration of the security shortens, and the yield declines as more amortization is required on premium bonds. When interest rates increase, the opposite of this occurs. Despite the fluctuations that occur in terms of monthly cash flow as a result of changing prepayment speeds, the monthly cash flow generated byU.S. agency MBS and CMO securities is reasonably stable and as a group is material, and helps to soften or smooth out the Corporation's total monthly cash flow from all securities. As ofMarch 31, 2021 , the fair value of the Corporation's corporate bonds increased by$4.3 million , or 6.9%, from balances atMarch 31, 2020 . Like any security, corporate bonds have both positive and negative qualities and management must evaluate these securities on a risk versus reward basis. Corporate bonds add diversity to the portfolio and provide strong yields for short maturities; however, by their very nature, corporate bonds carry a high level of credit risk should the entity experience financial difficulties. Management stands to possibly lose the entire principal amount if the entity that issued the corporate paper fails. As a result of the higher level of credit risk taken by purchasing a corporate bond, management has in place procedures to closely analyze the financial health of the company as well as policy guidelines. The guidelines include both maximum investment by issuer and minimal credit ratings that must be met in order for management to purchase a corporate bond. Financial analysis is conducted prior to every corporate bond purchase with ongoing monitoring performed on all securities held. By policy, management is to identify and recommend whether to hold or sell securities with credit ratings that have fallen below minimum policy credit ratings required at the time of purchase, or below investment grade. Management monitors the security ratings on a monthly basis and reviews quarterly with the Board of Directors. Management, with Board approval, determines whether it is in the Corporation's best interest to continue to hold any security that has fallen below policy guidelines or below investment grade based on the expectation of recovery of market value or improved performance. At this time management has elected, and the Board has approved, holding all securities that have fallen below initial policy guidelines. As ofMarch 31, 2021 , no securities have fallen below investment grade. As ofMarch 31, 2021 , two of the 35 corporate securities held by the Corporation showed an unrealized holding loss. These securities with unrealized holding losses were valued at 99.7% of book value. The Corporation's investment policy requires that corporate bonds have a minimum credit rating of A3 by Moody's or A- by S&P or Fitch at the time of purchase, or an average or composite rating of A-. As ofMarch 31, 2021 , all but one of the corporate bonds had at least one A3 or A- rating by one of the two predominate credit rating services, Moody's and S&P. One corporate bond had a total book value of$2.0 million , and did not have an A3 or A- rating as ofMarch 31, 2021 . The bond was rated Moody's Baa1 and S&P BBB+, which are two levels above the minimum required to be considered investment grade. Management conducts ongoing monitoring of this security and has chosen to continue to hold the bond with Board approval. In addition, there are fifteen corporate bond instruments that have split ratings with the highest rating within the Corporation's initial purchase policy guidelines and the lower rating outside of management guidelines, but all are still investment grade. The fifteen bonds have a book value of$24.4 million with a$391,000 unrealized gain as ofMarch 31, 2021 . Management conducts ongoing monitoring of these bonds with the Board approving holding these securities on a quarterly basis. In addition, the Corporation purchased$1,000,000 of a 4% subordinated debt note in the fourth quarter of 2020 and$750,000 of a$3 .5% subordinated debt note in the first quarter of 2021, both of which are unrated. These are considered corporate bonds as they each are subordinated debt of a domestic community bank but are unrated because they are not a typical corporate issuance. Currently, there are no indications that any of these bonds would discontinue contractual payments. The Corporation's investment policy requires that municipal bonds not carrying any insurance coverage have a minimum credit rating of A3 by Moody's or A- by S&P or Fitch at the time of purchase. As ofMarch 31, 2021 , one municipal bond with a par value of$500,000 was unrated, and no other municipal bonds carried a credit rating under these levels. 51 Index ENB FINANCIAL CORP Management's Discussion and Analysis Management utilizes several municipal surveillance reports and engages an independent non-brokerage service third party to perform enhanced municipal credit evaluation. Management will typically sell municipal securities if negative trends in financial performance are found and/or ratings have declined to levels deemed unacceptable. As a result of the above monitoring and actions taken to proactively sell weaker municipal credits, the Corporation's entire municipal bond portfolio consists of investment grade credits. The entire securities portfolio is reviewed monthly for credit risk and evaluated quarterly for possible impairment. The Corporation's municipal and corporate bonds present the largest credit risk and highest likelihood for any possible impairment. Due to the ability for corporate credit situations to change rapidly and ongoing nationwide concerns of pension obligations impacting municipalities, management continues to closely monitor all corporate and municipal securities. Loans Net loans outstanding increased by 9.9%, to$829.2 million atMarch 31, 2021 , from$754.3 million atMarch 31, 2020 . Net loans increased by 2.2%, an annualized rate of 9.0%, from$811.0 million atDecember 31, 2020 . The following table shows the composition of the loan portfolio as ofMarch 31, 2021 ,December 31, 2020 , andMarch 31, 2020 . LOANS BY MAJOR CATEGORY (DOLLARS IN THOUSANDS) March 31 December 31, March 31 2021 2020 2020 $ % $ % $ % Commercial real estate Commercial mortgages 144,939 17.2 142,698 17.4 120,080 15.8 Agriculture mortgages 178,070 21.2 176,005 21.4 177,368 23.2 Construction 21,317 2.5 23,441 2.9 18,778 2.5 Total commercial real estate 344,326 40.9 342,144 41.7 316,226 41.5 Consumer real estate (a) 1-4 family residential mortgages 265,127 31.5 263,569
32.0 259,937 34.1
Home equity loans 10,614 1.3 10,708 1.3 10,741 1.4
Home equity lines of credit 70,898 8.4 71,290 8.7 68,633 9.0
Total consumer real estate 346,639 41.2 345,567 42.0 339,311 44.5
Commercial and industrial
Commercial and industrial 111,036 13.2 97,896 11.9 63,670 8.4
Tax-free loans 16,233 1.9 10,949 1.3 16,582 2.2
Agriculture loans 18,466 2.2 20,365 2.5 20,733 2.7Total commercial and industrial 145,735 17.3 129,210
15.7 100,985 13.3
Consumer 4,827 0.6 5,155 0.6 5,557 0.7
Total loans 841,527 100.0 822,076 100.0 762,079 100.0
Less:Deferred loan fees (costs), net (407 ) (1,294 )
(2,041 )
Allowance for credit losses 12,690 12,327 9,803
Total net loans 829,244 811,043 754,317
(a) Residential real estate loans do not include mortgage loans serviced for
others which totaled
December 31, 2020 , and$162,246,000 as ofMarch 31, 2020 . There was significant growth in the loan portfolio sinceMarch 31, 2020 , and moderate growth sinceDecember 31, 2020 . Most major loan categories showed an increase in balances from both time periods. Loan growth was significant in 2020 and continued with moderate growth in the first three months of 2021, primarily due to the PPP loans which were put on the books beginning in the second quarter of 2020 and continued into the first quarter of 2021. 52 IndexENB FINANCIAL CORP Management's Discussion and Analysis
The consumer residential real estate category represents the largest group of loans for the Corporation. The consumer residential real estate category of total loans increased from$339.3 million onMarch 31, 2020 , to$346.6 million onMarch 31, 2021 , a 2.2% increase. This category includes closed-end fixed rate or adjustable-rate residential real estate loans secured by 1-4 family residential properties, including first and junior liens, and floating rate home equity loans. The 1-4 family residential mortgages account for the vast majority of residential real estate loans with fixed and floating home equity loans making up the remainder. Historically, the entire consumer residential real estate component of the loan portfolio has averaged close to 40% of total loans. As ofMarch 31, 2020 , this percentage was 44.5%, and as ofMarch 31, 2021 , it decreased to 41.2%. Management expects the consumer residential real estate category to increase throughout the remainder of 2021 due to a continued effort to increase mortgage volume, and the strategic decision to keep some shorter-term mortgages on the books as opposed to selling them on the secondary market. Although economic conditions for consumers have deteriorated with the COVID-19 pandemic, increased unemployment, and decreased consumer spending, the mortgage market continues to remain relatively strong as consumers refinance existing debt to lower rates. Market conditions have been changing rapidly throughout the first quarter of 2021 and the rest of the year is unpredictable, but management would expect mortgage volume to continue at fairly high levels from a historic perspective. The first lien 1-4 family mortgages increased by$5.2 million , or 2.0%, fromMarch 31, 2020 , toMarch 31, 2021 . These first lien 1-4 family loans made up 76.6% of the residential real estate total as ofMarch 31, 2020 , and 76.5% as ofMarch 31, 2021 . The vast majority of the first lien 1-4 family closed end loans consist of single family personal first lien residential mortgages and home equity loans, with the remainder consisting of 1-4 family residential non-owner-occupied mortgages. In the first quarter of 2021, mortgage production increased 3% over the previous quarter and was up 76% over the first quarter of 2020. Purchase money origination constituted 55% of the Corporation's mortgage originations for the quarter, with construction-only and construction-permanent loans making up 51% of that mix. With continued heavy refinance activity, the percentage of mortgage originations going in the Corporation's held for investment mortgage portfolio declined quarter-over-quarter, with more customers opting for held-for-sale fixed rate products. In the first quarter of 2021, 47% of all mortgage originations were held in the mortgage portfolio, 46% of which were adjustable rate mortgages. As ofMarch 31, 2021 , ARM balances were$124.7 million , representing 47.0% of the 1-4 family residential loan portfolio of the Corporation. The ARM product is beneficial to the Corporation as it limits the interest rate risk to a much shorter time period. Low rates continued to drive overall strong production volume and the gains on the sale of mortgages increased by 25% quarter-over-quarter. As ofMarch 31, 2021 , the remainder of the residential real estate loans consisted of$10.6 million of fixed rate junior lien home equity loans, and$70.9 million of variable rate home equity lines of credit (HELOCs). This compares to$10.7 million of fixed rate junior lien home equity loans, and$68.6 million of HELOCs as ofMarch 31, 2020 . Therefore, combined, these two types of home equity loans increased from$79.3 million to$81.5 million , an increase of 2.8%. The majority of borrowers have been choosing variable rate HELOC loans in the historically low rate environment. With no sign of theFederal Reserve moving to increase rates, management expects HELOC activity to increase with customers choosing variable rate product over fixed rate product until rates begin to increase again.
Commercial real estate makes up 40.9% of total loans as ofMarch 31, 2021 , compared to 41.5% of total loans as ofMarch 31, 2020 . Within the commercial real estate segment, the increase has primarily been in commercial mortgages, with agriculture mortgages and construction loans remaining fairly stable. Agricultural mortgages increased marginally, by$0.7 million , or 0.4%, from$177.4 million as ofMarch 31, 2020 , to$178.1 million as ofMarch 31, 2021 . Dairy lending remains constrained with milk prices at three-year lows and it does not appear pricing will improve materially in the immediate future. There have been overcapacity issues resulting in some consolidation of the area's larger milk producers. Several dairy farmers have left the industry or are in the process of doing so. While dairy remains the largest agricultural loan concentration, management believes dairy loans will decline as a percentage of total agricultural loans with other non-dairy agricultural areas growing. Currently, management is experiencing more growth in specialty crops and other areas outside of dairy like poultry and layers. Management anticipates that agricultural mortgages may increase through the remainder of 2021 as the economy stabilizes and more farmers move forward with capital improvements or expansion of current operations. Commercial mortgages increased$24.9 million , or 20.7%, from balances atMarch 31, 2020 . Commercial mortgages as a percentage of the total loan portfolio increased to 17.2% as ofMarch 31, 2021 , compared to 15.8% atMarch 31, 2020 . New loan production in this segment is currently outpacing normal principal payments, pay downs, and payoffs. Commercial real estate loans have shown solid growth as a number of businesses move ahead on commercial projects. Management expects commercial real estate loans to remain stable as a percentage of the Corporation's loans for the remainder of 2021. 53 IndexENB FINANCIAL CORP Management's Discussion and Analysis The Corporation's commercial construction loan balances increased by$2.5 million , or 13.5%, fromMarch 31, 2020 toMarch 31, 2021 . Management was experiencing some demand for smaller residential builds like construction on existing lots but no new large scale projects. Commercial construction loans were 2.5% of the total loan portfolio as ofMarch 31, 2020 and 2021. The other area of commercial lending is non-real estate secured commercial lending, referred to as commercial and industrial lending. Commercial and industrial loans not secured by real estate accounted for 17.3% of total loans as ofMarch 31, 2021 , compared to 13.3% as ofMarch 31, 2020 . In scope, the commercial and industrial loan sector, at 17.3% of total loans, is significantly smaller than the commercial real estate sector at 40.9% of total loans. This is consistent with management's credit preference for obtaining real estate collateral when making commercial loans. The balance of total commercial and industrial loans increased from$101.0 million atMarch 31, 2020 , to$145.7 million atMarch 31, 2021 , a 44.3% increase. This category of loans generally includes unsecured lines of credit, truck, equipment, and receivable and inventory loans, in addition to tax-free loans to municipalities. The balance atMarch 31, 2021 , also includes the PPP loans, which has declined rapidly as these loans are forgiven by the SBA after businesses prove they used the funds for qualified expenses. Management anticipates that these loans will experience a significant decline in the remainder of 2021. The Corporation provides credit to many small and medium-sized businesses. Much of this credit is in the form of Prime-based lines of credit to local businesses where the line may not be secured by real estate, but is based on the health of the borrower with other security interests on accounts receivable, inventory, equipment, or through personal guarantees. Commercial and industrial loans, including PPP loans, increased to$111.0 million atMarch 31, 2021 , a$47.3 million , or 74.3% increase, from the$63.7 million atMarch 31, 2020 . This increase was driven solely by the generation of PPP loans during the second and third quarters of 2020 and then again during the first quarter of 2021. The outstanding PPP loan balances were impacted by the forgiveness of some of the first round of PPP loans during the fourth quarter of 2020 and the first quarter of 2021, but new loan generation during the first quarter of 2021 offset some of the forgiven balances. The tax-free loans declined by$0.3 million , or 2.1%, from balances atMarch 31, 2020 , and the commercial and industrial agricultural loans declined by$2.3 million , or 10.9%. The consumer loan portfolio decreased to$4.8 million atMarch 31, 2021 , from$5.6 million atMarch 31, 2020 . Consumer loans made up 0.6% of total loans onMarch 31 2021 , and 0.7% onMarch 31, 2020 . The long-term trend over the past decade has seen homeowners turning to the equity in their homes to finance cars and education rather than traditional consumer loans that are generally unsecured. Slightly higher demand for unsecured credit is being outpaced by principal payments on existing loans resulting in the decrease in balances. Management anticipates that the Corporation's level of consumer loans will likely remain stable as a percentage of the portfolio, as the need for additional unsecured credit is generally offset by those borrowers wishing to reduce debt levels and move away from the higher cost of unsecured financing relative to other forms of real estate secured financing. Non-Performing Assets
Non-performing assets include:
· Nonaccrual loans
· Loans past due 90 days or more and still accruing
· Non-performing troubled debt restructurings
· Other real estate owned
54
Index
ENB FINANCIAL CORP
Management's Discussion and Analysis
NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
March 31, December 31, March 31,
2021 2020 2020
$ $ $
Nonaccrual loans 681 725 1,953Loans past due 90 days or more and still accruing 152 1,373 146 Troubled debt restructurings, non-performing - - 1,117 Total non-performing loans 833
2,098 3,216 Other real estate owned - - -
Total non-performing assets 833
2,098 3,216
Non-performing assets to net loans 0.10%
0.25% 0.43% The total balance of non-performing assets decreased by$2.4 million , or 74.1%, and$1.3 million , or 60.3%, from balances atMarch 31, 2020 andDecember 31, 2020 , respectively. The decrease from the prior periods was primarily due to lower levels of loans past due 90 days or more as well as a decrease in non-performing troubled debt restructurings (TDRs). There were no non-performing TDR loans as ofMarch 31, 2021 orDecember 31, 2020 . A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial position of the borrower and improve the likelihood of full collection by the lender. There were two non-performing TDRs as ofMarch 31, 2020 ; an agriculture mortgage with a balance of$677,000 which had cash flow difficulties and a modification in payment terms; and a$439,000 real estate secured loan with a payment modification to allow annual interest and principal payments. Non-accrual loans decreased, by$1.3 million , or 65.1%, sinceMarch 31, 2020 , and loans past due 90 days or more and still accruing were up slightly from the prior year period, and down more significantly, by$1.2 million , or 89.0% sinceDecember 31, 2020 . The$1.3 million of non-accrual reduction that occurred betweenMarch 31, 2020 andDecember 31, 2020 was due to two commercial borrowers paying off their loans during the remainder of 2020. One commercial borrower with three non-accrual loans totaling over$1.0 million paid them off in the second quarter of 2020, while another commercial borrower with a$92,000 non-accrual loan was paid
off inDecember 2020 .
Management continues to monitor delinquency trends and the level of non-performing loans closely. At this time, management believes that the potential for material losses related to non-performing loans is decreasing with the level of delinquencies and non-performing loans lower than what was experienced throughout 2020.
There was no other real estate owned (OREO) as of
Allowance for Credit Losses The allowance for credit losses is established to cover any losses inherent in the loan portfolio. Management reviews the adequacy of the allowance each quarter based upon a detailed analysis and calculation of the allowance for credit losses. This calculation is based upon a systematic methodology for determining the allowance for credit losses in accordance with generally accepted accounting principles. The calculation includes estimates and is based upon losses inherent in the loan portfolio. The allowance calculation includes specific provisions for under-performing loans and general allocations to cover anticipated losses on all loan types based on historical losses. The calculation is also influenced by nine qualitative factors that are adjusted on a quarterly basis as needed. Based on the quarterly credit loss calculation, management will adjust the allowance for credit losses through the provision as necessary. Changes to the allowance for credit losses during the year are primarily affected by five main factors: · Historical loan losses
· Qualitative factor adjustments including levels of delinquent and
non-performing loans
· Growth trends of the loan portfolio
· Recovery of loans previously charged off
· Provision for loan losses
Strong credit and collateral policies have been instrumental in producing a favorable history of loan losses for the Corporation. The Allowance for Credit Losses table below shows the activity in the allowance for credit losses for the three-month periods endedMarch 31, 2021 andMarch 31, 2020 . At the bottom of the table, two benchmark percentages are shown. The first is net charge-offs as a percentage of average loans outstanding for the year. The second is the total allowance for credit losses as a percentage of total loans. 55 IndexENB FINANCIAL CORP Management's Discussion and Analysis
ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
Three Months Ended
March 31
2021 2020
$ $
Balance at January 1, 12,327 9,447
Loans charged off:
Real estate - -
Commercial and industrial - -
Consumer 14 6
Total charged off 14 6
Recoveries of loans previously charged off:
Real estate - (11 )
Commercial and industrial (1 ) (1 )
Consumer (1 ) -
Total recovered (2 ) (12 )Net loans charged off (recovered) 12
(6 )
Provision charged to operating expense 375
350
Balance at March 31, 12,690 9,803
Net charge-offs as a % of average total loans outstanding 0.00%
0.00%
Allowance at end of period as a % of total loans 1.51%
1.28% Charge-offs for the three months endedMarch 31, 2021 , were$14,000 , compared to$6,000 for the same period in 2020. Management typically charges off unsecured debt over 90 days delinquent with little likelihood of recovery. In the first three months of 2021 and 2020, the Corporation charged off several smaller amounts related to consumer loans. Recoveries were also low in the first three months of 2020 and 2021 with only total recoveries of$2,000 in the first quarter of 2021 and$12,000 in the first quarter of 2020. The allowance as a percentage of total loans represents the portion of the total loan portfolio for which an allowance has been provided. Management regularly reviews the overall risk profile of the loan portfolio and the impact that current economic trends have on the Corporation's loans. The financial industry typically evaluates the quality of loans on a scale with "unclassified" representing healthy loans, "special mention" being the first indication of credit concern, and several successive classified ratings indicating further credit declines of "substandard," "doubtful," and, ultimately, "loss." The Corporation's level of classified loans was$21.9 million onMarch 31, 2021 , compared to$25.8 million onMarch 31, 2020 . Total classified loans increased during 2020 but then decreased byDecember 31, 2020 , and into the first quarter of 2021. Having more loans in a classified status could result in a larger allowance as higher amounts of projected historical losses and qualitative factors are attached to these loans. In addition to this impact, management performs a specific allocation test on these classified loans. There was$1.1 million of specifically allocated allowance against the classified loans as ofMarch 31, 2021 ,$1.1 million of specific allocation as ofDecember 31, 2020 , and$114,000 of specific allocation as ofMarch 31, 2020 . The higher specific allocation atMarch 31, 2021 andDecember 31, 2020 , is related to a customer with ongoing business concerns. Typically, as the classified loan balances fluctuate, the associated specific allowance applied to them fluctuates, resulting in a lower or higher required allowance. The net charge-offs as a percentage of average total loans outstanding indicates the percentage of the Corporation's total loan portfolio that has been charged off during the period, after reducing charge-offs by recoveries. The Corporation continues to experience low net charge-off percentages due to strong credit practices. Management continually monitors delinquencies, classified loans, and non-performing loans closely in regard to how they may impact charge-offs in the future. The actual charge-offs have been running at low levels, and management expects this to continue through the remainder of 2021. Management practices are in place to reduce the number and severity of losses. In regard to severely delinquent loans, management attempts to improve the Corporation's collateral or credit position and, in the case of a loan workout, intervene to minimize additional charge-offs. 56 IndexENB FINANCIAL CORP Management's Discussion and Analysis The allowance as a percentage of total loans was 1.51% as ofMarch 31, 2021 , 1.50% as ofDecember 31, 2020 , and 1.28% as ofMarch 31, 2020 . Management anticipates that the allowance percentage will remain fairly stable during the remainder of 2021, as the allowance balance is increased with additional provision expense to account for loan growth throughout the year. It is typical for the allowance for credit losses to contain a small amount of excess reserves. Over the long term, management targets and excess reserve at approximately 5% knowing that the reserve can fluctuate. The excess reserve stood at 6.0% as ofMarch 31, 2021 . Management would anticipate that this unallocated portion of the allowance will decrease throughout the remainder
of 2021. Premises and Equipment
Premises and equipment, net of accumulated depreciation, decreased by$0.3 million , or 1.2%, to$24.7 million as ofMarch 31, 2021 , from$25.0 million as ofMarch 31, 2020 . As ofMarch 31, 2021 ,$335,000 was classified as construction in process compared to$239,000 as ofMarch 31, 2020 . Fixed assets declined as a result of depreciation outpacing new purchases in 2021. Regulatory Stock
The Corporation owns multiple forms of regulatory stock that is required in order to be a member of theFederal Reserve Bank (FRB) and members of banks such as theFederal Home Loan Bank (FHLB) andAtlantic Community Bankers Bank (ACBB). The Corporation's$6.2 million of regulatory stock holdings as ofMarch 31, 2021 , consisted of$5.6 million of FHLB ofPittsburgh stock,$531,000 of FRB stock, and$37,000 ofAtlantic Community Bancshares, Inc. stock, theBank Holding Company of ACBB. All of these stocks are valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the investment is carried at book value and there is no fair market value adjustment. The Corporation's investment in FHLB stock is required for membership in the organization. The amount of stock required is dependent upon the relative size of outstanding FHLB borrowings and mortgage activity. Excess stock is typically repurchased from the Corporation at par if the borrowings decline to a predetermined level. The Corporation's FHLB stock position was$5.6 million onMarch 31, 2021 ,$5.9 million onDecember 31, 2020 , and$7.0 million onMarch 31, 2020 , with no excess capital stock position. Any future stock repurchases would be the result of lower borrowing balances. Stock repurchases by the FHLB occur every quarter.
The 2021 first quarter dividend declaration made on FHLB stock by FHLB of
Deposits The Corporation's total ending deposits atMarch 31, 2021 , increased by$72.6 million , or 5.8%, and by$342.5 million , or 34.9%, fromDecember 31, 2020 , andMarch 31, 2020 , respectively. Customer deposits are the Corporation's primary source of funding for loans and securities. In the past few years, the economic concerns and volatility of the equity markets continued to lead customers to banks for safe places to invest money, despite historically low interest rates. The mix of the Corporation's deposit categories has changed moderately sinceMarch 31, 2020 , with the changes being a$216.2 million , or 59.4% increase in non-interest bearing demand deposit accounts, an$18.0 million , or 63.3% increase in interest bearing demand balances, a$29.5 million , or 30.9% increase in NOW balances, a$10.5 million , or 7.5% increase in money market account balances, an$81.1 million , or 36.5% increase in savings account balances, and a$12.8 million , or 9.7% decrease in time deposit balances. 57 IndexENB FINANCIAL CORP Management's Discussion and Analysis The growth across most categories of core deposit accounts is a direct result of the PPP funding, government stimulus payments, and the change in customer's spending habits during the uncertain economic conditions brought on by COVID-19. Due to limited safe investment options outside of banks, the Corporation saw customers bring deposit funds back to regular core checking and savings accounts in an effort to provide safety and financial flexibility. With the decrease in rates that occurred during 2020, customer deposits increased with few options in the market to earn a higher return. Customers view demand deposit, money market and savings accounts as the safest, most convenient place to maintain funds for maximum flexibility. Management believes deposit balances may continue to increase, but at a slower pace, through the remainder of 2021.
The Deposits by Major Classification table, shown below, provides the balances
of each category for
DEPOSITS BY MAJOR CLASSIFICATION
(DOLLARS IN THOUSANDS)
March 31, December 31, March 31,
2021 2020 2020
$ $ $
Non-interest bearing demand 580,003 534,853 363,766
Interest bearing demand 46,509 47,092 28,479
NOW accounts 125,101 137,279 95,604
Money market deposit accounts 151,297 140,113 140,781
Savings accounts 303,324 274,386 222,241
Time deposits 119,153 119,088 131,981
Total deposits 1,325,387 1,252,811 982,852
The growth and mix of deposits is often driven by several factors including:
· Convenience and service provided
· Current rates paid on deposits relative to competitor rates
· Level of and perceived direction of interest rates
· Financial condition and perceived safety of the institution
· Possible risks associated with other investment opportunities
· Level of fees on deposit products
The Corporation has been a stable presence in the local market area that has experienced several large bank mergers over the past several years. Three new convenient locations were added since 2016, significantly expanding the Corporation's footprint, with a presence in three counties with a total of thirteen branch locations. The Corporation has a history of offering competitive interest rates and fair and understandable service fees because of a strong commitment to the customers and the communities that it serves. Management has always priced products and services in a manner that makes them affordable for all customers. This in turn creates a high degree of customer loyalty and a stable deposit base. Additionally, as financial institutions have come under increased scrutiny from both regulators and customers, the Corporation has maintained an outstanding reputation. Management believes the Corporation's deposit base has benefited as a result of a growing desire by customers to seek a longstanding, reliable financial institution as a partner to meet their financial needs. Time deposits are typically a more rate-sensitive product, making them a source of funding that is prone to balance variations depending on the interest rate environment and how the Corporation's time deposit rates compare with the local market rates. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution. As ofMarch 31, 2021 , time deposit balances had decreased$12.8 million , or 9.7%, fromMarch 31, 2020 , and increased slightly fromDecember 31, 2020 . The Corporation has experienced a slow and steady shift in deposit trends over the past five years as customers have moved money from time deposits into core checking and savings accounts. With theFederal Reserve rate decreases in 2020, there is minimal differences between shorter term CD rates and interest bearing non-maturity deposits, influencing customers to accumulate their funds in a liquid account that can be accessed at any time. This has resulted in declining time deposit balances and more significant growth in the core deposit areas. 58 IndexENB FINANCIAL CORP Management's Discussion and Analysis Borrowings
Total borrowings were$72.4 million ,$74.4 million , and$75.0 million as ofMarch 31, 2021 ,December 31, 2020 , andMarch 31, 2020 , respectively. Of these amounts,$3.5 million reflect short-term funds as ofMarch 31, 2020 , with no short-term funds outstanding as ofMarch 31, 2021 andDecember 31, 2020 . Short-term funds are used for immediate liquidity needs and are not typically part of an ongoing liquidity or interest rate risk strategy; therefore, they fluctuate more rapidly. When short-term funds are used, they are purchased through correspondent and member bank relationships as overnight borrowings or through the FHLB for terms less than one year. Total long-term borrowings, borrowings initiated for terms longer than one year, were$52.8 million as ofMarch 31, 2021 ,$54.8 million as ofDecember 31, 2020 , and$71.5 million as ofMarch 31, 2020 . The long-term borrowings for the Corporation were made up entirely of FHLB long-term advances atMarch 31, 2021 ,December 31, 2020 , andMarch 31, 2020 . FHLB advances are used as a secondary source of funding and to mitigate interest rate risk. These long-term funding instruments are typically a more effective funding instrument in terms of selecting the exact amount, rate, and term of funding rather than trying to source the same through deposits. In this manner, management can efficiently meet known liquidity and interest rate risk needs. The decrease in FHLB borrowings sinceMarch 31, 2020 , can be attributed to management taking advantage of declining rates by prepaying FHLB advances and incurring penalties in order to save on interest expense in future years. In order to limit the Corporation's exposure and reliance to a single funding source, the Corporation's Asset Liability Policy sets a goal of maintaining the amount of borrowings from the FHLB to 15% of asset size. As ofMarch 31, 2021 , the Corporation was significantly under this policy guideline at 6.4% of asset size with$52.8 million of total FHLB borrowings. The Corporation also has a policy that limits total borrowings from all sources to 150% of the Corporation's capital. As ofMarch 31, 2021 , the Corporation was significantly under this policy guideline at 56.2% of capital with$72.4 million total borrowings from all sources. The Corporation has maintained FHLB borrowings and total borrowings well within these policy guidelines throughout all of 2020 and through the first three months of 2021. The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently$449.3 million . The Corporation's two internal policy limits mentioned above are far more restrictive than the FHLB MBC, which is calculated and set quarterly by FHLB. In addition to the long-term advances funded through the FHLB, onDecember 30, 2020 , the Corporation completed the sale of a subordinated debt note offering. The Corporation sold$20.0 million of subordinated debt notes with a maturity date ofDecember 30, 2030 . These notes are non-callable for 5 years and carry a fixed interest rate of 4% per year for 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As ofMarch 31, 2021 ,$15.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date on a pro-rata basis. Stockholders' Equity Federal regulatory authorities require banks to meet minimum capital levels. The Corporation, as well as the Bank, as the solely owned subsidiary of the Corporation, maintains capital ratios well above those minimum levels. The risk-weighted capital ratios are calculated by dividing capital by total risk-weighted assets. Regulatory guidelines determine the risk-weighted assets by assigning assets to specific risk-weighted categories. The calculation of tier I capital to risk-weighted average assets does not include an add-back to capital for the amount of the allowance for credit losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio.
The following tables reflect the capital ratios for the Corporation and Bank compared to the regulatory capital requirements.
59
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ENB FINANCIAL CORP
Management's Discussion and Analysis
REGULATORY CAPITAL RATIOS:
Regulatory Requirements
Adequately Well
As of March 31, 2021 Capital Ratios Capitalized CapitalizedTotal Capital to Risk-Weighted Assets
Consolidated 16.8% 8.0% 10.0%
Bank 16.2% 8.0% 10.0%
Tier 1 Capital to Risk-Weighted Assets
Consolidated 13.4% 6.0% 8.0%
Bank 14.9% 6.0% 8.0%
Common Equity Tier 1 Capital to Risk-Weighted Assets
Consolidated 13.4% 4.5% 6.5%
Bank 14.9% 4.5% 6.5%
Tier 1 Capital to Average Assets
Consolidated 8.6% 4.0% 5.0%
Bank 9.5% 4.0% 5.0%
As of December 31, 2020
Total Capital to Risk-Weighted Assets
Consolidated 16.1% 8.0% 10.0%
Bank 15.3% 8.0% 10.0%
Consolidated 12.8% 6.0% 8.0%
Bank 14.0% 6.0% 8.0%
Consolidated 12.8% 4.5% 6.5%
Bank 14.0% 4.5% 6.5%
Consolidated 9.0% 4.0% 5.0%
Bank 9.8% 4.0% 5.0%
As of March 31, 2020
Total Capital to Risk-Weighted Assets
Consolidated 14.3% 8.0% 10.0%
Bank 14.2% 8.0% 10.0%
Tier 1 Capital to Risk-Weighted Assets
Consolidated 13.1% 6.0% 8.0%
Bank 13.0% 6.0% 8.0%
Common Equity Tier 1 Capital to Risk-Weighted Assets
Consolidated 13.1% 4.5% 6.5%
Bank 13.0% 4.5% 6.5%
Tier 1 Capital to Average Assets
Consolidated 9.9% 4.0% 5.0%
Bank 9.8% 4.0% 5.0%
60
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ENB FINANCIAL CORP
Management's Discussion and Analysis
On December 30, 2020 , the Corporation issued $20 million of subordinated debt in
order to support capital levels which had declined due to the sharp balance
sheet growth that had occurred during 2020. The $20 million of subordinated debt
qualifies as Tier 2 capital at the Holding Company level. Amounts of the
subordinated debt can be transferred to the Bank where it qualifies as Tier 1
Capital. As of March 31, 2021 , $15.0 million of this subordinated debt funding
was transferred down to the Bank to rebuild the Bank's capital levels. As of
March 31, 2021 the Bank's Tier 1 Leverage Ratio stood at 9.5% while the
Corporation's Tier 1 Leverage Ratio was 8.6%. The Bank's Tier 1 Leverage Ratio
policy range is 9.0% to 12.0% while the Corporation's Tier 1 Leverage Ratio
policy range is 8.0% - 12.0%. Tier 1 Capital levels at the Corporation level
were not impacted by the subordinated debt issue since subordinated debt only
qualifies as Tier 2 Capital at the Corporate level. As such, in terms of the
Corporation's regulatory capital ratios, only the Total Capital to Risk-Weighted
Assets ratio was enhanced as a result of the $20 million subordinated debt
issue. Most of the marked improvement in capital ratios occurred at the Bank
level.
Dividends play a vital role in the management of capital levels of the
Corporation. Management seeks a balance between maintaining a sufficient cushion
of excess capital above regulatory limits versus the payment of dividends to the
shareholders as a direct return of their investment. Due to a constant stream of
stable earnings, the payment of a dividend is needed to maintain capital at
acceptable levels in order to provide an adequate return of equity to the
shareholders.
The Corporation's dividends per share for the three months ended March 31, 2021 ,
were $0.16 , the same as the dividend paid out in the first three months of 2020.
Dividends are paid from current earnings and available retained earnings. The
Corporation's current capital plan calls for management to maintain tier I
capital to average assets between 8.0% and 12.0%. As a secondary measurement,
the capital plan also targets a long-term dividend payout ratio in the range of
30% to 45%. This ratio will vary according to income, but over the long term,
the Corporation's goal is to maintain and target a payout ratio within this
range. For the three months ended March 31, 2021 , the payout ratio was 19.8%.
This dividend payout ratio is low as a result of the higher earnings in the
first quarter of 2021, some of which are non-recurring. Management currently
anticipates that the payout ratio will return to more normal levels as 2021
progresses. Management's goal is to maintain all regulatory capital ratios at
current levels. Future dividend payout ratios are dependent on the future level
of earnings and other factors that impact the level of capital.
The amount of unrealized gain or loss on the securities portfolio is reflected,
net of tax, as an adjustment to capital, as required by U.S. generally accepted
accounting principles. This is recorded as accumulated other comprehensive
income or loss in the capital section of the consolidated balance sheet. An
unrealized gain increases capital, while an unrealized loss reduces capital.
This requirement takes the position that, if the Corporation liquidated the
securities portfolio at the end of each period, the current unrealized gain or
loss on the securities portfolio would directly impact the Corporation's
capital. As of March 31, 2021 , the Corporation showed an unrealized gain, net of
tax, of $2,924,000 , compared to an unrealized gain of $7,958,000 at December 31,
2020 , and an unrealized gain of $1,103,000 as of March 31, 2020 . These
unrealized gains, net of tax are excluded from capital when calculating the tier
I capital to average assets numbers above. The amount of unrealized gain or loss
on the securities portfolio, shown net of tax, as an adjustment to capital, does
not include any actual impairment taken on securities, which is shown as a
reduction to income on the Corporation's Consolidated Statements of Income. No
impairment was recorded in the three months ended March 31, 2021 , or in the same
prior year period. The changes in unrealized gains and losses are due to normal
changes in market valuations of the Corporation's securities as a result ofinterest rate movements.
Off-Balance Sheet Arrangements
In the normal course of business, the Corporation typically has off-balance sheet arrangements related to loan funding commitments. These arrangements may impact the Corporation's financial condition and liquidity if they were to be exercised within a short period of time. As discussed in the following liquidity section, the Corporation has in place sufficient liquidity alternatives to meet these obligations. The following table presents information on the commitments by the Corporation as ofMarch 31, 2021 . 61 IndexENB FINANCIAL CORP Management's Discussion and Analysis
OFF-BALANCE SHEET ARRANGEMENTS
(DOLLARS IN THOUSANDS)
March 31,
2021
$
Commitments to extend credit:
Revolving home equity 133,009
Construction loans 2,634
Real estate loans 123,820
Business loans 163,725
Consumer loans 1,273
Other 5,064
Standby letters of credit 9,696
Total 439,221
Significant Legislation
Dodd-Frank Wall Street Reform and Consumer Protection Act
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law. Dodd-Frank is intended to affect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank creates a newFinancial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally creates a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank is expected to have a significant impact on the Corporation's business operations as its provisions take effect. It is difficult to predict at this time what specific cumulative impact Dodd-Frank and the yet-to-be-written implementing rules and regulations will have on community banks. However, it is expected that, at a minimum, they will increase the Corporation's operating and compliance costs and could increase interest expense. Among the provisions that have already or are likely to affect the Corporation are the following:
Holding Company Capital Requirements
Dodd-Frank requires theFederal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from tier I capital unless such securities were issued prior toMay 19, 2010 , by a bank holding company with less than$15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, are consistent with safety and soundness.
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to$250,000 per depositor. Additionally, onFebruary 7, 2011 , the Board of Directors of theFDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which was effective inApril 2011 , saved the Corporation a significant amount ofFDIC insurance premiums from the significantly higherFDIC insurance premiums placed into effect after the financial crisis.
Corporate Governance
Dodd-Frank requires publicly traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on "golden parachute" payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. TheSEC has finalized the rules implementing these requirements which took effect onJanuary 21, 2011 . The Corporation was exempt from these requirements untilJanuary 21, 2013 , due to its status as a smaller reporting company. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of$1.0 billion , regardless of whether the company is publicly traded. Dodd-Frank also gives theSEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters. 62 IndexENB FINANCIAL CORP Management's Discussion and Analysis
Limits on Interchange Fees
Dodd-Frank amended the Electronic Fund Transfer Act to, among other things, give theFederal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over$10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
Dodd-Frank created theConsumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. TheCFPB has examination and primary enforcement authority with respect to depository institutions with$10 billion or more in assets. Smaller institutions will be subject to rules promulgated by theCFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. TheCFPB will have authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes theCFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a "qualified mortgage" as defined by theCFPB . Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Prohibition Against Charter Conversions of Troubled Institutions
Dodd-Frank prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.
Limits on Interstate Acquisitions and Mergers
Dodd-Frank precludes a bank holding company from engaging in an interstate acquisition - the acquisition of a bank outside its home state - unless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with another bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and
adequately managed.
63
Index
ENB FINANCIAL CORP © Edgar Online, source
