XOTC:ENBP ENB Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2012

 

OR

 

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

 

For the transition period from ________________ to__________________

 

ENB Financial Corp
(Exact name of registrant as specified in its charter)

 

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

 

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

 

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

 

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

 

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

Yes S No £

 

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

Yes S No £

 

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

 

  Large Accelerated filer £ Accelerated filer £
     
  Non-accelerated filer £ (Do not check if a smaller reporting company) Smaller reporting company S

 

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

Yes £ No S

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 1, 2012, the registrant had 2,857,084 shares of $0.20 (par) Common Stock outstanding.

 


TABLE OF CONTENTS

 

 

ENB FINANCIAL CORP

INDEX TO FORM 10-Q

March 31, 2012

 

Part I – FINANCIAL INFORMATION    
       
Item 1. Financial Statements  
       
  Consolidated Balance Sheets at March 31, 2012 and 2011 and December 31, 2011 (Unaudited)   3
       
  Consolidated Statements of Income for the Three Months Ended March 31, 2012 and 2011 (Unaudited)   4
       
  Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 (Unaudited)   5
       
  Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (Unaudited)   6
       
  Notes to the Unaudited Consolidated Interim Financial Statements   7-27
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   28-55
       
Item 3. Quantitative and Qualitative Disclosures about Market Risk   56-59
       
Item 4. Controls and Procedures   60
       
Part II – OTHER INFORMATION   61
       
Item 1. Legal Proceedings   61
       
Item 1A. Risk Factors   61
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   61
       
Item 3. Defaults Upon Senior Securities   61
       
Item 4. Mine Safety Disclosures   61
       
Item 5. Other Information   61
       
Item 6. Exhibits   62
       
SIGNATURE PAGE   63
       
EXHIBIT INDEX   64

 

2

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ENB Financial Corp

Consolidated Balance Sheets (Unaudited)

 

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)  March 31,  December 31,  March 31,
   2012  2011  2011
   $  $  $
ASSETS               
Cash and due from banks   9,839    12,511    9,801 
Intererest-bearing deposits in other banks   23,070    19,375    23,948 
Total cash and cash equivalents   32,909    31,886    33,749 
                
Securities available for sale (at fair value)   280,342    284,011    254,807 
                
Loans held for sale   1,042    1,926    376 
                
Loans (net of unearned income)   410,353    412,638    423,297 
                
Less: Allowance for loan losses   8,208    8,480    7,583 
                
Net loans   402,145    404,158    415,714 
                
Premises and equipment   21,154    21,366    20,420 
                
Regulatory stock   4,378    4,148    4,455 
                
Bank owned life insurance   18,688    16,552    16,045 
                
Other assets   7,833    7,099    10,000 
                
Total assets   768,491    771,146    755,566 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY               
                
Liabilities:               
Deposits:               
Noninterest-bearing   147,592    149,510    140,342 
Interest-bearing   458,602    456,168    454,509 
                
Total deposits   606,194    605,678    594,851 
                
Long-term debt   75,500    73,000    82,000 
Accounts payable for security purchases not yet settled   —      6,964    —   
Other liabilities   2,860    3,033    3,251 
                
Total liabilities   684,554    688,675    680,102 
                
Stockholders’ equity:               
Common stock, par value $0.20; Shares: Authorized 12,000,000               
Issued 2,869,557 and Outstanding 2,857,084               
(Issued 2,869,557 and Outstanding 2,858,831 as of 12-31-11)               
(Issued 2,869,557 and Outstanding 2,858,213 as of 3-31-11)   574    574    574 
Capital surplus   4,301    4,304    4,315 
Retained earnings   75,107    73,632    70,238 
Accumulated other comprehensive income, net of tax   4,255    4,221    614 
Less: Treasury stock shares at cost 12,473 (10,726 shares as of 12-31-11 and 11,344 shares as of 3-31-11)   (300)   (260)   (277)
                
Total stockholders’ equity   83,937    82,471    75,464 
                
Total liabilities and stockholders’ equity   768,491    771,146    755,566 

 

See Unaudited Notes to the Consolidated Interim Financial Statements

 

3

 

ENB Financial Corp

Consolidated Statements of Income (Unaudited)

Periods Ended March 31, 2012 and 2011

 

   Three Months
   2012  2011
(Dollars in thousands, except share data)  $  $
Interest and dividend income:          
           
Interest and fees on loans   5,190    5,441 
Interest on securities available for sale          
Taxable   1,200    1,500 
Tax-exempt   895    862 
Interest on federal funds sold       5 
Interest on deposits at other banks   16     
Dividend income   29    35 
           
Total interest and dividend income   7,330    7,843 
           
Interest expense:          
Interest on deposits   1,128    1,434 
Interest on long-term debt   613    762 
           
Total interest expense   1,741    2,196 
           
Net interest income   5,589    5,647 
           
Provision (credit) for loan losses   (250)   450 
           
Net interest income after provision/(credit) for loan losses   5,839    5,197 
           
Other income:          
Trust and investment services income   298    278 
Service fees   429    430 
Commissions   478    425 
Gains on securities transactions, net   431    484 
Impairment losses on securities:          
Impairment losses on investment securities   (55)   (403)
Non-credit related (gains) losses on securities not expected to be sold in other comprehensive income before tax   (31)   256 
Net impairment losses on investment securities   (86)   (147)
Gains on sale of mortgages   68    54 
Earnings on bank owned life insurance   415    146 
Other income   132    110 
           
Total other income   2,165    1,780 
           
Operating expenses:          
Salaries and employee benefits   3,227    2,852 
Occupancy   427    411 
Equipment   209    196 
Advertising & marketing   85    71 
Computer software & data processing   396    386 
Bank shares tax   214    208 
Professional services   280    301 
FDIC insurance   91    222 
Other expense   503    359 
           
Total operating expenses   5,432    5,006 
           
Income before income taxes   2,572    1,971 
           
Provision for federal income taxes   383    274 
           
Net income   2,189    1,697 
           
Earnings per share of common stock   0.77    0.59 
           
Cash dividends paid per share   0.25    0.24 
           
Weighted average shares outstanding   2,855,893    2,855,760 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

 

4

 

ENB Financial Corp

Consolidated Statements of Comprehensive Income (Unaudited)

Periods Ended March 31, 2012 and 2011

 

 

   Three Months
   2012  2011
(DOLLARS IN THOUSANDS)  $  $
       
Net income   2,189    1,697 
           
Other comprehensive (income) loss, net of tax:          
Net change in unrealized (gains) losses:          
           
Other-than-temporarily impaired securities available for sale:          
           
Gains (losses) arising during the quarter   31    (256)
Income tax effect   (11)   87 
    20    (169)
           
Losses recognized in earnings   86    147 
Income tax effect   (29)   (50)
    57    97 
Unrealized holding gains (losses) on other-than-temporarily impaired securities          
  available for sale, net of tax   77    (72)
           
Securities available for sale not other-than-temporarily impaired:          
           
Gains arising during the quarter   366    854 
Income tax effect   (124)   (290)
    242    564 
           
Gains recognized in earnings   (431)   (484)
 Income tax effect   147    164 
    (284)   (320)
Unrealized holding (losses) gains on securities available for sale not          
  other-than-temporarily impaired, net of tax   (43)   244 
           
Other comprehensive income   34    172 
           
Comprehensive Income   2,223    1,869 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

 

5

 

 ENB Financial Corp

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

(DOLLARS IN THOUSANDS)   Three Months Ended March 31, 
   2012  2011
   $  $
Cash flows from operating activities:          
Net income   2,189    1,697 
Adjustments to reconcile net income to net cash (used for) provided by operating activities:          
Net amortization of securities and loan fees   769    491 
Decrease (increase) in interest receivable   107    (342)
Decrease in interest payable   (77)   (123)
Provision (credit) for loan losses   (250)   450 
Gains on securities transactions, net   (431)   (484)
Impairment losses on securities   86    147 
Gains on sale of mortgages   (68)   (54)
Loans originated for sale   (3,699)   (3,872)
Proceeds from sales of loans   4,651    4,321 
Earnings on bank-owned life insurance   (415)   (146)
Depreciation of premises and equipment and amortization of software   337    343 
Deferred income tax   121    (57)
Decrease in federal deposit insurance   80    204 
Decrease in accounts payable for securities purchased not yet settled   (6,964)    
Other assets and other liabilities, net   (353)   (553)
Net cash (used for) provided by operating activities   (3,917)   2,022 
           
Cash flows from investing activities:          
Securities available for sale:          
Proceeds from maturities, calls, and repayments   19,402    16,117 
Proceeds from sales   15,733    22,240 
Purchases   (31,838)   (33,923)
Purchase of other real estate owned   (28)    
Purchase of regulatory bank stock   (230)    
Redemptions of regulatory bank stock       225 
Purchase of bank-owned life insurance   (2,527)   (8)
Net decrease (increase) in loans   2,242    (8,058)
Purchases of premises and equipment   (67)   (201)
Purchase of computer software   (6)   (10)
Net cash provided by (used for) investing activities   2,681    (3,618)
           
Cash flows from financing activities:          
Net increase in demand, NOW, and savings accounts   4,531    11,008 
Net decrease in time deposits   (4,015)   (11,751)
Proceeds from long-term debt   10,000    7,500 
Repayments of long-term debt   (7,500)    
Dividends paid   (714)   (685)
Treasury stock sold   104    104 
Treasury stock purchased   (147)   (57)
Net cash provided by financing activities   2,259    6,119 
Increase in cash and cash equivalents   1,023    4,523 
Cash and cash equivalents at beginning of period   31,886    29,226 
Cash and cash equivalents at end of period   32,909    33,749 
           
Supplemental disclosures of cash flow information:          
Interest paid   1,818    2,319 
Income taxes paid   275    300 
           
Supplemental disclosure of non-cash investing and financing activities:          
Net transfer of other real estate owned held for sale from loans   20     
Purchase of other real estate owned not yet settled   84     — 
Fair value adjustments for securities available for sale   51    261 

 

See Notes to the Unaudited Consolidated Interim Financial Statements

 

6

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

1.       Basis of Presentation

 

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

 

ENB Financial Corp (“the Corporation”) is the bank holding company for Ephrata National Bank (the “Bank”), which is a wholly-owned subsidiary of ENB Financial Corp. This Form 10-Q, for the first quarter of 2012, is reporting on the results of operations and financial condition of ENB Financial Corp.

 

Operating results for the three months ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ended December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

2.       Securities Available for Sale

 

The amortized cost and fair value of securities held at March 31, 2012, and December 31, 2011, are as follows:

 

     Gross  Gross   
(DOLLARS IN THOUSANDS)   Amortized   Unrealized  Unrealized   Fair 
   Cost  Gains  Losses  Value
   $  $  $  $
March 31, 2012            
U.S. government agencies   41,059    1,594    (50)   42,603 
U.S. agency mortgage-backed securities   47,312    871    —      48,183 
U.S. agency collateralized mortgage obligations   53,883    495    (279)   54,099 
Private collateralized mortgage obligations   7,893    106    (882)   7,117 
Corporate bonds   35,747    505    (138)   36,114 
Obligations of states and political subdivisions   84,002    4,417    (143)   88,276 
Total debt securities   269,896    7,988    (1,492)   276,392
Marketable equity securities   4,000    —      (50)   3,950 
Total securities available for sale   273,896    7,988    (1,542)   280,342 
                     
December 31, 2011                    
U.S. government agencies   44,669    1,959    (14)   46,614 
U.S. agency mortgage-backed securities   54,264    874    (9)   55,129 
U.S. agency collateralized mortgage obligations   55,908    462    (321)   56,049 
Private collateralized mortgage obligations   8,251    25    (1,051)   7,225 
Corporate bonds   25,579    230    (511)   25,298 
Obligations of states and political subdivisions   84,945    4,852    (52)   89,745 
Total debt securities   273,616    8,402    (1,958)   280,060 
Marketable equity securities   4,000    —      (49)   3,951 
Total securities available for sale   277,616    8,402    (2,007)   284,011 

 

7

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The amortized cost and fair value of debt securities available for sale at March 31, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.

CONTRACTUAL MATURITY OF DEBT SECURITIES

(DOLLARS IN THOUSANDS)

 

   Amortized   
   Cost  Fair Value
   $  $
Due in one year or less   33,817    34,109 
Due after one year through five years   100,990    102,273 
Due after five years through ten years   64,266    65,847 
Due after ten years   70,823    74,163 
Total debt securities   269,896    276,392 

 

Securities available for sale with a par value of $81,240,000 and $73,049,000 at March 31, 2012, and December 31, 2011, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $86,052,000 at March 31, 2012, and $77,874,000 at December 31, 2011.

 

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

 

PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE

(DOLLARS IN THOUSANDS)

 

   Three Months Ended March 31,
   2012  2011
   $   $ 
Proceeds from sales   15,733    22,240 
Gross realized gains   486    577 
Gross realized losses   55    93 

 

SUMMARY OF GAINS AND LOSSES ON SECURITIES AVAILABLE FOR SALE

(DOLLARS IN THOUSANDS) 

 

   Three Months Ended March 31,
   2012  2011
   $   $ 
Gross realized gains   486    577 
           
Gross realized losses   55    93 
Impairment on securities   86    147 
Total gross realized losses   141    240 
           
Net gains on securities   345    337 

 

The bottom portion of the above chart shows the net gains on security transactions, including any impairment taken on securities held by the Corporation. Unlike the sale of a security, impairment is a write-down of the book value of the security which produces a loss and does not provide any proceeds. The net gain or loss from security transactions is also reflected on the Corporation’s consolidated statements of income and consolidated statements of cash flows.

 

8

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

Management evaluates all of the Corporation’s securities for other than temporary impairment (OTTI) on a periodic basis. As of March 31, 2012, four private collateralized mortgage obligations (PCMOs) were considered to be other-than-temporarily impaired, of which the cash flow analysis on these securities indicated a need to take additional impairment of $86,000 on two of these securities as of March 31, 2012. As of March 31, 2011, the same four PCMOs were considered to be other-than-temporarily impaired. Impairment was taken on each of these four securities in the first quarter of 2011 that amounted to $147,000. Cumulative impairment on the two PCMO securities with additional impairment in the first quarter of 2012 was $247,000. Information pertaining to securities with gross unrealized losses at March 31, 2012, and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

 

TEMPORARY IMPAIRMENTS OF SECURITIES

(DOLLARS IN THOUSANDS) 

   Less than 12 months  More than 12 months  Total
         Gross         Gross         Gross 
    Fair    Unrealized    Fair    Unrealized    Fair    Unrealized 
    Value    Losses    Value    Losses    Value    Losses 
    $    $    $    $    $    $ 
As of March 31, 2012                              
U.S. government agencies   4,946    (50)           4,946    (50)
U.S. agency mortgage-backed securities                        
U.S. agency collateralized mortgage obligations   27,548    (279)           27,548    (279)
Private collateralized mortgage obligations           4,827    (882)   4,827    (882)
Corporate bonds   10,098    (138)           10,098    (138)
Obligations of states & political subdivisions   4,637    (95)   2,961    (48)   7,598    (143)
                               
Total debt securities   47,229    (562)   7,788    (930)   55,017    (1,492)
                               
Marketable equity securities           950    (50)   950    (50)
                               
Total temporarily impaired securities   47,229    (562)   8,738    (980)   55,967    (1,542)
                               
As of December 31, 2011                              
U.S. government agencies   5,995    (14)           5,995    (14)
U.S. agency mortgage-backed securities   4,998    (9)           4,998    (9)
U.S. agency collateralized mortgage obligations   23,631    (321)           23,631    (321)
Private collateralized mortgage obligations           4,919    (1,051)   4,919    (1,051)
Corporate bonds   12,392    (497)   491    (14)   12,883    (511)
Obligations of states & political subdivisions   2,767    (17)   2,977    (35)   5,744    (52)
                               
Total debt securities   49,783    (858)   8,387    (1,100)   58,170    (1,958)
                               
Marketable equity securities           951    (49)   951    (49)
                               
Total temporarily impaired securities   49,783    (858)   9,338    (1,149)   59,121    (2,007)

 

In the debt security portfolio, there are 42 positions that are considered temporarily impaired at March 31, 2012. Of those 42 positions, the four PCMOs which have had impairment recorded at some point in time are the only instruments considered other-than-temporarily impaired at March 31, 2012.

 

The Corporation evaluates both equity and fixed maturity positions for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluation. The Corporation adopted a provision of U.S. generally accepted accounting principles which provides for the bifurcation of OTTI into two categories: (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss), which is recognized in earnings, and (b) the amount of total OTTI related to all other factors, which is recognized, net of taxes, as a component of accumulated other comprehensive income. The adoption of this provision was only applicable to four of the Corporation’s PCMOs since these were the only instruments management deemed to be other-than-temporarily impaired and have experienced some impairment.

 

9

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

With the $86,000 of impairment recorded in the first quarter of 2012, a cumulative total of $1,143,000 of impairment has been recorded on four impaired PCMO securities currently held. Impairment of $340,000 was first recorded in 2009 on two of these securities. Additional impairment was recorded in 2010 for a total of $393,000 on the same two PCMO securities. During 2011, there was an additional $324,000 of impairment recorded on all four PCMO securities, currently identified as other than temporarily impaired.

 

The impairment on the PCMOs is a result of a deterioration of expected cash flows on these securities due to higher projected credit losses than the amount of credit protection carried by these securities. Specifically, the foreclosure and severity rates have been running at levels where expected principal losses are in excess of the remaining credit protection on these instruments. The projected principal losses are based on prepayment speeds that are equal to or slower than the actual last twelve-month prepayment speeds the particular securities have experienced. Every quarter, management evaluates third-party reporting that shows projected principal losses based on various prepayment speed and severity rate scenarios. Based on the assumption that all loans over 60 days delinquent will default and at a severity rate equal to or above that previously experienced, and based on historical and expected prepayment speeds, management determined that it was appropriate to take additional impairment on two PCMOs in the quarter ended March 31, 2012.

 

The following tables reflect the book value, market value, and unrealized loss as of March 31, 2012 and 2011, on the PCMO securities held which had impairment taken in each respective year. The values shown are after the Corporation recorded year-to-date impairment charges of $86,000 through March 31, 2012, and $147,000 through March 31, 2011. The $86,000 and $147,000 are deemed to be credit losses and are the amounts that management expects the principal losses will be by the time these securities mature. The remaining $591,000 and $776,000 of unrealized losses are deemed to be market value losses that are considered temporary.

 

SECURITY IMPAIRMENT CHARGES

(DOLLARS IN THOUSANDS) 

 

   As of March 31, 2012
    Book    Market    Unrealized    Impairment 
    Value    Value    Loss    Charge 
    $    $    $    $ 
Private collateralized mortgage obligations   3,906    3,315    (591)   (86)

 

   As of March 31, 2011
    Book    Market    Unrealized    Impairment 
    Value    Value    Loss    Charge 
    $    $    $    $ 
Private collateralized mortgage obligations   8,247    7,471    (776)   (147)

 

 

The following table provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:

 

(DOLLARS IN THOUSANDS)  Three months ended March 31,
    2012    2011 
    $    $ 
           
Beginning balance   1,057    733 
Credit losses on debt securities for which other-than-temporary impairment has not been previously recognized       105 
Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized   86    42 
Reductions on debt securities sold during the period        
           
Ending balance   1,143    880 

 

10

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

Recent market conditions throughout the financial sector have made the evaluation regarding the possible impairment of PCMOs difficult to fully determine given the volatility of their pricing, based not only on interest rate changes, but on collateral uncertainty as well. The Corporation’s mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO) holdings are backed by the U.S. government, and therefore, experience significantly less volatility and uncertainty than the PCMO securities. The Corporation’s PCMO holdings make up a minority of the total MBS, CMO, and PCMO securities held. As of March 31, 2012, on an amortized cost basis, PCMOs accounted for 7.2% of the Corporation’s total MBS, CMO, and PCMO holdings, compared to 7.0% as of December 31, 2011. As of March 31, 2012, five PCMOs were held with one of the five rated AAA by either Moody’s or S&P. The remaining four securities were rated below investment grade. Impairment charges, as detailed above, were taken on two of these securities in the first quarter of 2012.

 

Management conducts impairment analysis on a quarterly basis and currently plans to continue to hold these securities as cash flow analysis performed under severe stress testing does not indicate a need to take further impairment on the bonds that are considered impaired. The unrealized loss position of all of the Corporation’s PCMOs has improved since December 31, 2011. The PCMO net unrealized losses stood at $1.0 million as of December 31, 2011, and improved to a $776,000 net unrealized loss as of March 31, 2012. Two of the five PCMOs are carrying unrealized gains. Management has concluded that, as of March 31, 2012, the unrealized losses outlined in the above table represent temporary declines. Management currently does not intend to sell these securities as a result of unrealized holding losses carried and impairment taken, and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. While management does not intend to sell these securities related to their impairment, it is standard practice to sell off smaller MBS, CMO, and PCMO instruments once normal principal payments have reduced the size of the security to less than $1 million. This is done to reduce the administrative costs and improve the efficiency of the portfolio. Two PCMO instruments, of which one is impaired, will be below $1 million of book value in the second quarter of 2012.

 

11

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

3.        Loans and Allowance for Loan Losses

 

The following tables present the Corporation’s loan portfolio by category of loans as of March 31, 2012, and December 31, 2011, and the summary of the allowance for loan losses for the first quarters of 2012 and 2011.

 

LOAN PORTFOLIO

(DOLLARS IN THOUSANDS) 

    March 31,    December 31, 
    2012    2011 
    $    $ 
Commercial real estate          
Commercial mortgages   91,937    95,347 
Agriculture mortgages   72,591    73,287 
Construction   17,404    18,957 
Total commercial real estate   181,932    187,591 
           
Consumer real estate (a)          
1-4 family residential mortgages   137,307    133,959 
Home equity loans   14,332    14,687 
Home equity lines of credit   15,020    15,004 
Total consumer real estate   166,659    163,650 
           
Commercial and industrial          
Commercial and industrial   27,061    25,913 
Tax-free loans   19,327    19,072 
Agriculture loans   12,299    12,884 
Total commercial and industrial   58,687    57,869 
           
Consumer   3,105    3,590 
Gross loans prior to deferred fees   410,383    412,700 
Less:          
Deferred loan fees, net   30    62 
Allowance for loan losses   8,208    8,480 
Total net loans   402,145    404,158 

 

(a) Real estate loans serviced for Fannie Mae, which are not included in the Consolidated Balance Sheets, totaled $8,679,000 and $8,904,000 as of March 31, 2012 and December 31, 2011, respectively.

 

ALLOWANCE FOR LOAN LOSSES SUMMARY 

(DOLLARS IN THOUSANDS) 

 

  Three Months Ended March 31,
   2012  2011
   $  $ 
Balance at January 1   8,480    7,132 
Amounts charged off   (47)   (149)
Recoveries of amounts previously charged off   25    150 
Balance before current year provision   8,458    7,133 
Provision (credit) charged (reversed) to operating expense   (250)   450 
Balance at March 31   8,208    7,583 

 

The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of March 31, 2012, and December 31, 2011. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled or at all. The Corporation’s internal commercial credit risk grading system is based on experiences with similarly graded loans.

 

12

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

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

 

  Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
   
  Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
   
  Substandard – loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
   
  Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
   
  Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

 

COMMERCIAL CREDIT EXPOSURE

CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE

(DOLLARS IN THOUSANDS) 

 

                   Commercial    Tax-            
    Commercial    Agriculture         and    free    Agriculture      
March 31, 2012   Mortgages    Mortgages    Construction    Industrial    Loans    Loans    Total 
    $    $    $    $    $    $    $ 
Grade:                                   
Pass   72,532    67,025    11,475    23,141    19,084    11,307    204,564 
Special Mention   4,908    675    1,095    962        70    7,710 
Substandard   14,497    4,891    4,834    2,958    243    922    28,345 
Doubtful                            
Loss                            
Total   91,937    72,591    17,404    27,061    19,327    12,299    240,619 

 

                   Commercial    Tax-            
    Commercial    Agriculture         and    free    Agriculture      
December 31, 2011   Mortgages    Mortgages    Construction    Industrial    Loans    Loans    Total 
    $    $    $    $    $    $    $ 
Grade:                                   
Pass   76,532    67,235    13,869    21,561    19,072    11,943    210,212 
Special Mention   3,872    773    132    1,173        65    6,015 
Substandard   14,943    5,279    4,956    3,179        876    29,233 
Doubtful                            
Loss                            
Total   95,347    73,287    18,957    25,913    19,072    12,884    245,460 

 

For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of March 31, 2012, and December 31, 2011:

 

13

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

CONSUMER CREDIT EXPOSURE

CREDIT RISK PROFILE BY PAYMENT PERFORMANCE

(DOLLARS IN THOUSANDS) 

    1-4 Family    Home     Home Equity           
March 31, 2012   Residential     Equity    Lines of           
    Mortgages    Loans    Credit    Consumer    Total 
Payment performance:   $    $    $    $    $ 
Performing   137,155    14,332    15,020    3,105    169,612 
Non-performing   152                152 
Total   137,307    14,332    15,020    3,105    169,764 

 

    1-4 Family    Home    Home Equity          
December 31, 2011   Residential     Equity    Lines of          
    Mortgages    Loans    Credit    Consumer    Total 
Payment performance:   $    $    $    $    $ 
Performing   133,643    14,541    15,004    3,590    166,778 
Non-performing   316    146            462 
Total   133,959    14,687    15,004    3,590    167,240 

 

14

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of March 31, 2012, and December 31, 2011:

 

AGING OF LOANS RECEIVABLE

(DOLLARS IN THOUSANDS)

 

                                  Loans 
                                 Receivable>  
    30-59 Days    60-89 Days    Greater
than 90
    Total Past         Total Loans    90 Days
and
 
March 31, 2012   Past Due    Past Due    Days    Due    Current    Receivable    Accruing 
    $    $    $    $    $    $    $ 
Commercial real estate                                   
Commercial mortgages   154    233        387    91,550    91,937     
Agriculture mortgages                   72,591    72,591     
Construction                   17,404    17,404     
Consumer real estate                                   
1-4 family residential mortgages   871    69    152    1,092    136,215    137,307    152 
Home equity loans   120            120    14,212    14,332     
Home equity lines of credit                   15,020    15,020     
Commercial and industrial                                   
Commercial and industrial   67    6    101    174    26,887    27,061     
Tax-free loans                   19,327    19,327     
Agriculture loans                   12,299    12,299     
Consumer   2    1        3    3,102    3,105     
Total   1,214    309    253    1,776    408,607    410,383    152 

 

                                  Loans 
                                 Receivable>  
    30-59 Days    60-89 Days    Greater
than 90
    Total Past         Total Loans    90 Days
and
 
December 31, 2011   Past Due    Past Due    Days    Due    Current    Receivable    Accruing 
    $    $    $    $    $    $    $ 
Commercial real estate                                   
Commercial mortgages   390            390    94,957    95,347     
Agriculture mortgages                   73,287    73,287     
Construction   132            132    18,825    18,957     
Consumer real estate                                   
1-4 family residential mortgages   1,684    140    107    1,931    132,028    133,959    107 
Home equity loans   79    101        180    14,507    14,687     
Home equity lines of credit       15        15    14,989    15,004     
Commercial and industrial                                   
Commercial and industrial   49        101    150    25,763    25,913     
Tax-free loans                   19,072    19,072     
Agriculture loans                   12,884    12,884     
Consumer   18    5        23    3,567    3,590     
Total   2,352    261    208    2,821    409,879    412,700    107 

 

15

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following table presents nonaccrual loans by classes of the loan portfolio as of March 31, 2012, and December 31, 2011:

 

NONACCRUAL LOANS BY LOAN CLASS

(DOLLARS IN THOUSANDS) 

    March 31,    December 31, 
    2012    2011 
    $    $ 
Commercial real estate          
Commercial mortgages   1,556    1,265 
Agriculture mortgages        
Construction        
Consumer real estate          
1-4 family residential mortgages       209 
Home equity loans       146 
Home equity lines of credit        
Commercial and industrial          
Commercial and industrial   165    242 
Tax-free loans        
Agriculture loans        
Consumer        
Total   1,721    1,862 

 

As of March 31, 2012, and December 31, 2011, all of the Corporation’s loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three months ended March 31, 2012, and March 31, 2011, is as follows:

 

IMPAIRED LOANS

(DOLLARS IN THOUSANDS) 

    March 31,    March 31, 
    2012    2011 
    $    $ 
Impaired loans:          
Average recorded balance of impaired loans   3,465    3,732 
Interest income recognized on impaired loans   29    72 

 

Interest income on loans would have increased by approximately $31,000 for the first quarter of 2012, and $15,000 for the first quarter of 2011, had these loans performed in accordance with their original terms.

 

16

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following tables summarize information in regards to impaired loans by loan portfolio class as of March 31, 2012, and December 31, 2011:

 

IMPAIRED LOAN ANALYSIS

(DOLLARS IN THOUSANDS) 

         Unpaid         Average    Interest 
March 31, 2012   Recorded    Principal    Related    Recorded    Income 
    Investment    Balance    Allowance    Investment    Recognized 
    $    $    $    $    $ 
With no related allowance recorded:                         
Commercial real estate                         
Commercial mortgages   457    457        464     
Agriculture mortgages   1,648    1,648        1,654    29 
Construction                    
Total commercial real estate   2,105    2,105        2,118    29 
                          
Commercial and industrial                         
Commercial and industrial   165    206        224     
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial   165    206        224     
                          
Total with no related allowance   2,270    2,311        2,342    29 
                          
With an allowance recorded:                         
Commercial real estate                         
Commercial mortgages   1,099    1,196    117    1,123     
Agriculture mortgages                    
Construction                    
Total commercial real estate   1,099    1,196    117    1,123     
                          
Commercial and industrial                         
Commercial and industrial                    
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial                    
                          
Total with a related allowance   1,099    1,196    117    1,123     
                          
Total by loan class:                         
Commercial real estate                         
Commercial mortgages   1,556    1,653    117    1,587     
Agriculture mortgages   1,648    1,648        1,654    29 
Construction                    
Total commercial real estate   3,204    3,301    117    3,241    29 
                          
Commercial and industrial                         
Commercial and industrial   165    206        224     
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial   165    206        224     
Total   3,369    3,507    117    3,465    29 

 

17

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

IMPAIRED LOAN ANALYSIS

(DOLLARS IN THOUSANDS) 

 

         Unpaid         Average    Interest
December 31, 2011   Recorded    Principal    Related    Recorded    Income 
    Investment    Balance    Allowance    Investment    Recognized 
    $    $    $    $    $ 
With no related allowance recorded:                         
Commercial real estate                         
Commercial mortgages   473    473        641     
Agriculture mortgages   1,658    1,658        1,667    119 
Construction       67        44     
Total commercial real estate   2,131    2,198        2,352    119 
                          
Commercial and industrial                         
Commercial and industrial   137    137        226     
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial   137    137        226     
Total with no related allowance   2,268    2,335        2,578    119 
                          
With an allowance recorded:                         
Commercial real estate                         
Commercial mortgages   1,147    1,244    140    1,245     
Agriculture mortgages                    
Construction                    
Total commercial real estate   1,147    1,244    140    1,245     
                          
Commercial and industrial                         
Commercial and industrial   105    105    61    71     
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial   105    105    61    71     
Total with a related allowance   1,252    1,349    201    1,316     
                          
Total by loan class:                         
Commercial real estate                         
Commercial mortgages   1,620    1,717    140    1,886     
Agriculture mortgages   1,658    1,658        1,667    119 
Construction       67        44     
Total commercial real estate   3,278    3,442    140    3,597    119 
                          
Commercial and industrial                         
Commercial and industrial   242    242    61    297     
Tax-free loans                    
Agriculture loans                    
Total commercial and industrial   242    242    61    297     
Total   3,520    3,684    201    3,894    119 

 

18

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following tables detail activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012, and March 31, 2011:

 

ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE

(DOLLARS IN THOUSANDS) 

 

March 31, 2012  Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
                         
Allowance for credit losses:                        
Beginning balance   3,441    1,424    2,825    61    729    8,480 
                               
   Charge-offs           42    5        47 
   Recoveries           20    5        25 
   Provision   (371)   (103)   214   (6)   16    (250)(1)
                               
Ending balance   3,070    1,321    3,017    55    745    8,208 
                               
Ending balance: individually                              
   evaluated for impairment   117                    117 
Ending balance: collectively                              
   evaluated for impairment   2,953    1,321    3,017    55    745    8,091 
Ending balance: loans acquired                              
   with deteriorated credit quality                        

 

(1)The Corporation recognized a $250,000 credit provision in the first quarter of 2012 as a result of lower levels of non-performing and delinquent loans, minimum charge-offs, and a decline in loan balances.

 

March 31, 2011  Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
                         
Allowance for credit losses:                              
Beginning balance   2,605    1,254    2,816    75    382    7,132 
                               
   Charge-offs   97    13    30    9        149 
   Recoveries       2    145    3        150 
   Provision   527    39    (165)       49    450 
                               
Ending balance   3,035    1,282    2,766    69    431    7,583 
                               
Ending balance: individually                              
   evaluated for impairment   251        119            370 
Ending balance: collectively                              
   evaluated for impairment   2,784    1,282    2,647    69    431    7,213 
Ending balance: loans acquired                              
   with deteriorated credit quality                        

 

 

19

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

 

The following tables present, by portfolio segment, the recorded investment in loans at March 31, 2012, and December 31, 2011.

 

LOANS BY PORTFOLIO SEGMENT

(DOLLARS IN THOUSANDS)

 

                         
   Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
March 31, 2012                              
                               
Loans receivable:                              
Ending balance   181,932    166,659    58,687    3,105          410,383 
Ending balance: individually                               
   evaluated for impairment   3,204        165            3,369 
Ending balance: collectively                               
   evaluated for impairment   178,728    166,659    58,522    3,105          407,014 
Ending balance: loans acquired                               
   with deteriorated credit quality                          

 

 

   Commercial
Real Estate
   Consumer
Real Estate
   Commercial
and
Industrial
   Consumer   Unallocated   Total 
   $   $   $   $   $   $ 
December 31, 2011                              
                               
Loans receivable:                              
Ending balance   187,591    163,650    57,869    3,590         412,700 
Ending balance: individually                              
   evaluated for impairment   3,278        242            3,520 
Ending balance: collectively                                
   evaluated for impairment   184,313    163,650    57,627    3,590        409,180 
Ending balance: loans acquired                                
   with deteriorated credit quality                        

 

In the first quarter of 2012 there was no loan modification made that would cause a loan to be considered a troubled debt restructuring (TDR). A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial condition of the borrower and improve the likelihood of full collection by the lender.

 

4.       Fair Value Presentation

 

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

 

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
   
Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.
   
Level III: Assets and liabilities that have little to no observable pricing as of the reported date.  These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

20

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present the assets reported on the consolidated balance sheets at their fair value as of March 31, 2012, and December 31, 2011, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

Fair Value Measurements:

(DOLLARS IN THOUSANDS) 

   March 31, 2012
   Level I   Level II   Level III   Total 
U.S. government agencies  $   $42,603   $   $42,603 
U.S. agency mortgage-backed securities       48,183        48,183 
U.S. agency collateralized mortgage obligations       54,099        54,099 
Private collateralized mortgage obligations       7,117        7,117 
Corporate bonds       36,114        36,114 
Obligations of states & political subdivisions       88,276        88,276 
Marketable equity securities   3,950            3,950 
Total securities  $3,950   $276,392   $   $280,342 

 

On March 31, 2012, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of March 31, 2012, the CRA fund investments had a $4,000,000 book value with a fair market value of $3,950,000.

 

Fair Value Measurements:

(DOLLARS IN THOUSANDS)

   December 31, 2011
   Level I   Level II   Level III   Total 
U.S. government agencies  $   $46,614   $   $46,614 
U.S. agency mortgage-backed securities       55,129        55,129 
U.S. agency collateralized mortgage obligations       56,049        56,049 
Private collateralized mortgage obligations       7,225        7,225 
Corporate bonds       25,298        25,298 
Obligations of states & political subdivisions       89,745        89,745 
Marketable equity securities   3,951            3,951 
Total securities  $3,951   $280,060   $   $284,011 

 

On December 31, 2011, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. As of December 31, 2011, the Corporation’s CRA fund investments had a book value of $4,000,000 and a fair market value of $3,951,000 utilizing level I pricing.

 

Financial instruments are considered level III when their values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. There were no level III securities as of March 31, 2012, or December 31, 2011.

 

21

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The following tables present the assets measured on a nonrecurring basis on the consolidated balance sheets at their fair value as of March 31, 2012, and December 31, 2011, by level within the fair value hierarchy:

 

ASSETS MEASURED ON A NONRECURRING BASIS

(Dollars in Thousands)

   March 31, 2012
    Level I    Level II    Level III    Total 
Assets:                    
Impaired Loans  $   $   $3,252   $3,252 
OREO           132    132 
Total  $   $   $3,384   $3,384 

 

   December 31, 2011
    Level I    Level II    Level III    Total 
Assets:                    
Impaired Loans  $   $   $3,319   $3,319 
OREO                
Total  $   $   $3,319   $3,319 

 

The Corporation had a total of $3,369,000 of impaired loans as of March 31, 2012, with $117,000 of specifically allocated allowance against these loans. The Corporation had a total of $3,520,000 of impaired loans as of December 31, 2011, with $201,000 of specifically allocated allowance against these loans. Impaired loans are valued based on a discounted present value of expected future cash flows.

 

Other real estate owned (OREO) is measured at fair value, less estimated costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management. The assets are carried at the lower of carrying amount or fair value, less estimated costs to sell. The Corporation’s OREO balance consists of one residential property that was classified as OREO in the first quarter of 2012. Management has estimated the current value of the OREO property at $132,000 utilizing level III pricing. Income and expenses from operations and changes in valuation allowance are included in the net expenses from OREO.

 

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

 

(DOLLARS IN THOUSANDS)

    Fair Value   Valuation   Unobservable   Range
March 31, 2012:   Estimate   Techniques   Input   (Weighted Avg)
                 
Impaired loans   3,252   Appraisal of   Appraisal   0% to -20% (-20%)
        collateral (1)   adjustments (2)    
            Liquidation   0% to -10% (-10%)
            expenses (2)    
OREO   132   Appraisal of    Liquidation    -2% to -10% (-6%)
        collateral (1),(3)    expenses (2)    

 

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

 

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

 

(3) Includes qualitiative adjustments by management and estimated liquidation expenses.

 

22

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

5.       Interim Disclosures about Fair Value of Financial Instruments

 

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

 

Cash and Cash Equivalents

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Securities Available for Sale

Management utilizes quoted market pricing for the fair value of the Corporation’s securities that are available for sale, if available. If a quoted market rate is not available, fair value is estimated using quoted market prices for similar securities.

 

Regulatory Stock

Regulatory stock is valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore the carrying amount is a reasonable estimate of fair value.

 

Loans Held for Sale

Loans held for sale are individual loans for which the Corporation has a firm sales commitment; therefore, the carrying value is a reasonable estimate of the fair value.

 

Loans

The fair value of fixed and variable rate loans is estimated by discounting back the scheduled future cash flows of the particular loan product, using the market interest rates of comparable loan products in the Corporation’s greater market area, with the same general structure, comparable credit ratings, and for the same remaining maturities.

 

Accrued Interest Receivable

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

 

Bank Owned Life Insurance

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

 

Mortgage Servicing Assets

The fair value of mortgage servicing assets is based on the present value of future cash flows for pools of mortgages, stratified by rate and maturity date.

 

Deposits

The fair value of non-interest bearing demand deposit accounts and interest bearing demand, savings, and money market deposit accounts is based on the amount payable on demand at the reporting date. The fair value of fixed-maturity time deposits is estimated by discounting back the expected cash flows of the time deposit using market interest rates from the Corporation’s greater market area currently offered for similar time deposits with similar remaining maturities.

 

Long-term Borrowings

The fair value of a long-term borrowing is estimated by comparing the rate currently offered for the same type of borrowing instrument with a matching remaining term.

 

Accrued Interest Payable

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

 

Firm Commitments to Extend Credit, Lines of Credit, and Open Letters of Credit

These financial instruments are generally not subject to sale and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment, using fees currently charged to enter into similar agreements with similar credit risk, is not considered material for disclosure purposes. The contractual amounts of unfunded commitments are presented in Note 6.

 

23

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of the Corporation’s financial instruments at March 31, 2012, are summarized as follows:

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

(DOLLARS IN THOUSANDS) 

   March 31, 2012
              Quoted Prices           
               in Active Markets    Significant Other    Significant 
              for Identical    Observable    Unobservable 
    Carrying         Assets    Inputs    Inputs 
    Amount    Fair Value    (Level 1)    (Level II)    (Level III) 
    $    $    $    $    $ 
Financial Assets:                         
Cash and cash equivalents   32,909    32,909    32,909         
Securities available for sale   280,342    280,342    3,950    276,392     
Regulatory stock   4,378    4,378    4,378           
Loans held for sale   1,042    1,042        1,042     
Loans, net of allowance   402,145    413,144            413,144 
Accrued interest receivable   3,050    3,050    3,050         
Bank owned life insurance   18,688    18,688    18,688         
Mortgage servicing assets   26    26        26     
                          
Financial Liabilities:                         
Demand deposits   147,592    147,592    147,592         
Interest-bearing demand deposits   5,728    5,728    5,728         
NOW accounts   59,099    59,099    59,099         
Savings accounts   107,342    107,342    107,342         
Money market deposit accounts   52,775    52,775    52,775         
Time deposits   233,658    238,833        238,833     
Total deposits   606,194    611,369    372,536    238,833     
                          
Long-term borrowings   75,500    79,387        79,387     
                          
Accrued interest payable   928    928    928         

 

24

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

The carrying amounts and estimated fair values of the Corporation’s financial instruments at December 31, 2011, and March 31, 2011, are summarized as follows:

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

(DOLLARS IN THOUSANDS) 

   December 31,  March 31,
   2011  2011
    Carrying         Carrying      
    Amount    Fair Value    Amount    Fair Value 
    $    $    $    $ 
Financial Assets:                    
Cash and cash equivalents   31,886    31,886    33,749    33,749 
Securities available for sale   284,011    284,011    254,807    254,807 
Regulatory stock   4,148    4,148    4,455    4,455 
Loans held for sale   1,926    1,926    376    376 
Loans, net of allowance   404,158    412,796    415,714    421,271 
Accrued interest receivable   3,157    3,157    3,386    3,386 
Bank owned life insurance   16,552    16,552    16,045    16,045 
Mortgage servicing assets   26    26    31    31 
                     
Financial Liabilities:                    
Demand deposits   149,510    149,510    140,342    140,342 
NOW accounts   61,246    61,246    60,114    60,114 
Savings accounts   100,377    100,377    98,421    98,421 
Money market deposit accounts   56,872    56,872    55,617    55,617 
Time deposits   237,673    242,536    240,357    244,152 
Total deposits   605,678    610,541    594,851    598,646 
                     
Long-term borrowings   73,000    77,180    82,000    86,031 
                     
Accrued interest payable   1,005    1,005    1,145    1,145 

 

6.       Commitments and Contingent Liabilities

 

In order to meet the financing needs of its customers in the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of March 31, 2012, firm loan commitments were $10.3 million, unused lines of credit were $101.9 million, and open letters of credit were $7.5 million. The total of these commitments was $119.7 million, which represents the Corporation’s exposure to credit loss in the event of nonperformance by its customers with respect to these financial instruments. The actual credit losses that may arise from these commitments are expected to compare favorably with the Corporation’s loan loss experience on its loan portfolio taken as a whole. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for balance sheet financial instruments.

 

7.       Recently Issued Accounting Standards

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Corporation has provided the necessary disclosure in Note 5.

 

25

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Corporation has provided the necessary disclosure in the Consolidated Statements of Comprehensive Income.

 

In September 2011, the FASB issued ASU 2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan. The amendments in this Update will require additional disclosures about an employer’s participation in a multiemployer pension plan to enable users of financial statements to assess the potential cash flow implications relating to an employer’s participation in multiemployer pension plans. The disclosures also will indicate the financial health of all of the significant plans in which the employer participates and assist a financial statement user to access additional information that is available outside the financial statements. For public entities, the amendments in this Update are effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted. For nonpublic entities, the amendments are effective for annual periods of fiscal years ending after December 15, 2012, with early adoption permitted. The amendments should be applied retrospectively for all prior periods presented. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

 

In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary’s operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2013, and interim and annual periods thereafter. Early adoption is permitted. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

 

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Corporation’s financial statements.

 

26

 

ENB FINANCIAL CORP

Notes to the Unaudited Consolidated Interim Financial Statements 

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Corporation has provided the necessary disclosure in the Consolidated Statements of Comprehensive Income.

 

 

27

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

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

 

The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2011 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.

 

Forward-Looking Statements

 

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

 

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

 

  Economic conditions
  Monetary and interest rate policies of the Federal Reserve Board
  Volatility of the securities markets
  Effects of deteriorating economic conditions, specifically the effect on loan customers to repay loans
  Political changes and their impact on new laws and regulations
  Competitive forces
  Changes in deposit flows, loan demand, or real estate and investment securities values
  Changes in accounting principles, policies, or guidelines
  Ineffective business strategy due to current or future market and competitive conditions
  Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk
  Operation, legal, and reputation risk
  The risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful
  The impact of new laws and regulations, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations issued there under

 

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 ENB Financial Corp 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 ENB Financial Corp periodically with the Securities and Exchange Commission, including Item 1A of Part II of this Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports on Form 8-K.

 

Results of Operations

 

Overview

 

The Corporation recorded net income of $2,189,000 for the three-month period ended March 31, 2012, a 29.0% increase over the $1,697,000 earned during the same period in 2011. Earnings per share, basic and diluted, were $0.77 for the three months ended March 31, 2012, compared to $0.59 for the same period in 2011.

 

28

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

The Corporation’s net interest income for the three months ended March 31, 2012, was $5,589,000, compared to $5,647,000 for the same period in 2011, a 1.0% decrease. The Corporation’s net interest margin was 3.46% for the first quarter of 2012, compared to 3.57% for the first quarter of 2011.

 

The Corporation recorded a credit provision for loan losses of $250,000 for the first quarter of 2012, compared to an expense of $450,000 for the first quarter of 2011. Improvements in asset quality, as evidenced by lower levels of non-performing and delinquent loans, minimal charge-offs, and a decline in loan balances, allowed the Corporation to reverse a portion of the allowance for loan losses into earnings in 2012 while still maintaining strong coverage ratios. Previously, in 2010 and 2011, the provision expense was at an increased level to provide for high levels of classified loans. When classified loans first began to decline in late 2011, the provision for loan losses was initially reduced. With further declines in classified assets, along with low levels of non-performing and delinquent loans, the first quarter 2012 allowance for loan losses calculation supported a decrease in this balance. Despite the reduction in the allowance for loan losses for the first quarter of 2012, the allowance for loan losses as a percentage of total loans was 2.00% as of March 31, 2012, compared to 1.79% as of March 31, 2011. More detail is provided in the Provision for Loan Losses section that follows and the Allowance for Loan Losses section under Financial Condition.

 

Other income, excluding the gain or loss on the sale of securities and impairment losses on securities, increased 26.1%, or $377,000, for the first quarter of 2012, compared to 2011. Additionally, operational costs for the three months ended March 31, 2012, compared to the same period in 2011, increased 8.5%, or $426,000.

 

The financial services industry uses two primary performance measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders. The ROA and ROE increased for the three months ended March 31, 2012, compared to the same period in 2011, due to the increase in the Corporation’s income.

 

Key Ratios  Three Months Ended
   March 31,
   2012  2011
           
Return on Average Assets   1.15%   0.93%
Return on Average Equity   10.57%   9.30%

 

The results of the Corporation’s operations are best explained by addressing, in further detail, the five major sections of the income statement, which are as follows:

 

  Net interest income
  Provision for loan losses
  Non-interest income
  Non-interest expenses
  Provision for income taxes

 

The following discussion analyzes each of these five components.

 

Net Interest Income

 

Net interest income (NII) represents the largest portion of the Corporation’s operating income. Net interest income typically generates more than 75% of the Corporation’s gross revenue stream. 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. The amount of FTE adjustment totaled $536,000 for the three months ended March 31, 2012, compared to $530,000 for the same period in 2011.

 

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ENB FINANCIAL CORP

Management’s Discussion and Analysis

The amount of the tax adjustment varies depending on the amount of income earned on tax-free assets. The Corporation had been in an alternative minimum tax (AMT) position for years 2006 through 2009. As a result, tax–free loans and securities did not offer the full tax advantage they did when the Corporation was not subject to AMT. During 2008 and early 2009, management was actively reducing the tax-free municipal bond portfolio in an effort to reduce the Corporation’s AMT position, which acted to reduce the tax-equivalent adjustments. However, because of legislation that followed the credit crisis in the fall of 2008, financial institutions were permitted to treat 2009 and 2010 newly issued tax-free municipal bonds as AMT-exempt for the life of the bond. Additionally, financial institutions were still able to purchase AMT-exempt for life municipal bonds in 2011 and 2012 if they were first issued during 2009 and 2010. As a result, management resumed normal purchasing of municipal bonds, but only purchased AMT-exempt municipal bonds. This action began to increase the size of the tax-free municipal bond portfolio, which resulted in a higher tax-equivalent adjustment in 2011 and 2012. The tax-equivalent adjustment is expected to remain stable throughout 2012.

 

NET INTEREST INCOME

(DOLLARS IN THOUSANDS) 

   Three Months Ended
   March 31,
   2012  2011
   $   $ 
Total interest income   7,330    7,843 
Total interest expense   1,741    2,196 
           
Net interest income   5,589    5,647 
Tax equivalent adjustment   536    530 
Net interest income (fully taxable equivalent)   6,125    6,177 

 

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

 

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

 

The Federal funds rate, the Prime rate, and the shape of the U.S. Treasury curve all affect net interest income.

 

On December 16, 2008, the Federal Reserve Bank last cut the Federal funds rate from 1.00% to a target rate of 0.00% to 0.25%. The Federal funds rate has effectively remained at 0.25% ever since and is the rate at the time of this filing. The Federal funds rate is the overnight rate financial institutions charge other financial institutions to borrow or invest overnight funds. The historically low Federal funds rate, along with historically low U.S. Treasury and other market rates, has allowed the Corporation to reduce interest rates paid on deposit products and has reduced the cost of all types of borrowings, allowing management to reduce the cost of funds and reduce the Corporation’s interest expense. The Prime rate declined in tandem with the Federal funds rate over the same period mentioned above, reducing the loan rates for Prime-based loans. Market interest rates have remained very low from a historical perspective since 2009. This has resulted in lower fixed rates on loans and securities, which management purchases with excess liquidity. Therefore, the historically low rates have had offsetting positive and negative impacts, respectively, to the Corporation’s NII.

 

The decrease in the Prime rate, and a prolonged period with a Prime rate of 3.25%, has reduced the yield on the Corporation’s Prime-based loans, having a direct negative impact on the interest income for the Corporation. The Corporation’s fixed-rate loans do not reprice as rates change; however, with the historic decline in interest rates, more customers have moved into Prime-based loans or have refinanced into lower fixed-rate loans. Management instituted floors on consumer Prime-based loans at the end of 2008 and phased in floors on business and commercial Prime-based loans in 2009 and 2010 and revised pricing standards to counter balance the reduction of loan yield during this historically low-rate period.

 

30

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

Even though the Federal funds rate remains at a historic low of 0.25%, the Treasury yield curve has retained some slope to allow banks the ability to invest or lend at longer terms with slightly higher yields. Most Treasury rates have remained constant since the end of 2011, but the yield curve still offers close to 190 basis points of slope between the 2-year and 10-year Treasury. As of December 31, 2011, the two-year Treasury was 0.25%, the five-year Treasury was 0.83%, and the ten-year Treasury was 1.89%. As of March 31, 2012, the two-year rate was 0.33%, the five-year was 1.04%, and the ten-year rate was 2.23%. Since deposits and borrowings generally price off short-term rates, the extremely low cost of short-term funds permitted management to continue to reduce the overall cost of funds during the first quarter of 2012. Management continued to reprice time deposits and borrowings to lower levels. Meanwhile, management continued to invest in securities and originate loans at longer terms, where the U.S. Treasury curve and market rates are higher, but down from levels experienced in the first part of 2011.

 

Management anticipates that interest rates will remain near these historically low levels for the remainder of 2012 because of the current economic conditions. Recent concerns include elevated unemployment rates, slowing gross national product projections, and a major European Union debt crisis. These concerns will likely weigh on the market and result in the U.S. Treasury curve retaining a positive slope for the remainder of 2012, and into 2013. This allows management to continue to price the vast majority of liabilities off lower short-term rates, while pricing loans and investing in longer securities, which are based off the five-year and ten-year U.S. Treasury rates that are moderately higher. The Corporation’s margin was 3.46% for the first quarter of 2012, an eleven basis-point decrease from the 3.57% for the first quarter of 2011. Although it has become challenging to prevent margin declines, the Corporation has done well in consistently reducing its cost of funds in order to maintain a healthy margin.

 

For the first quarter of 2012, the Corporation’s NII on an FTE basis decreased by $52,000, or 0.8%, compared to the same period in 2011. As shown on the table that follows, interest income, on an FTE basis for the quarter ending March 31, 2012, decreased by $507,000, or 6.1%, and interest expense decreased by $455,000, or 20.7%, compared to the same period in 2011.

 

The following table shows a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation’s consolidated balance 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 rate paid on interest bearing liabilities. A deficiency of the net interest spread is that it does not give credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, management emphasizes the net yield on interest earning assets, also referred to as the net interest margin (NIM). The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. NIM is generally the benchmark used by analysts to measure how efficiently a bank generates net interest income. For example, a financial institution with a NIM of 3.75% would be able to use fewer interest-earning assets and still achieve the same level of net interest income as a financial institution with a NIM of 3.50%.

 

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ENB FINANCIAL CORP

Management’s Discussion and Analysis

COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME

(DOLLARS IN THOUSANDS) 

   For the Three Months Ended March 31,
      2012        2011   
              (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   16,370    16    0.39    11,315    5    0.18 
Securities available for sale:                              
Taxable   191,440    1,225    2.56    176,692    1,532    3.47 
Tax-exempt   83,961    1,337    6.37    79,759    1,282    6.43 
Total securities (d)   275,401    2,562    3.72    256,451    2,814    4.39 
Loans (a)   411,994    5,285    5.14    419,036    5,551    5.32 
Regulatory stock   4,336    3    0.34    4,587    3    0.23 
Total interest earning assets   708,101    7,866    4.45    691,389    8,373    4.86 
Non-interest earning assets (d)   56,090              50,401           
Total assets   764,191              741,790           
LIABILITIES & STOCKHOLDERS’ EQUITY                              
Interest bearing liabilities:                              
Demand deposits   118,646    78    0.26    116,861    96    0.33 
Savings deposits   103,547    27    0.10    95,117    24    0.10 
Time deposits   234,737    1,023    1.75    244,682    1,314    2.18 
Borrowed funds   79,595    613    3.10    78,748    762    3.92 
Total interest bearing liabilities   536,525    1,741    1.31    535,408    2,196    1.66 
Non-interest bearing liabilities:                              
Demand deposits   141,017              128,613           
Other   3,357              3,772           
Total liabilities   680,899              667,793           
Stockholders’ equity   83,292              73,997           
Total liabilities & stockholders’ equity   764,191              741,790           
Net interest income (FTE)        6,125              6,177      
Net interest spread (b)             3.14              3.20 
                               
Effect of non-interest bearing funds             0.32              0.37 
Net yield on interest earning assets (c)             3.46              3.57 

 

(a) Includes balances of nonaccrual loans and the recognition of any related interest income. The quarter-to-date average balances include net deferred loan fees and costs of ($50,000) as of March 31, 2012, and ($138,000) as of March 31, 2011. Such fees and costs recognized through income and included in the interest amounts totaled ($1,000) in 2012, and $4,000 in 2011.

(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.

 

32

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

Earnings and yields on loans have been negatively impacted by the very low Prime rate of 3.25% and the increased volume in Prime-based loans. However, because the negative impact began in 2009, the continued impact has lessened over time. Even with a Prime floor of 4.00% in place for the majority of new Prime-based loans, this rate is significantly below typical fixed-rate business and commercial loans, which generally range between 4.50% and 6.50%, depending on term and credit risk. While Prime-based loans will aid the Corporation when interest rates rise, any increase in Prime-based loans will generally cause the Corporation’s average loan yield to decrease. Currently, the increased levels of Prime-based loans continue to cause the Corporation’s average loan yield to decrease. There are times when sufficient growth in the loan portfolio can make up for decreases in yield and provide a higher overall interest income on loans. However, with the Prime rate at extremely low levels, even with Prime-plus loans being originated, the net impact is generally a reduction of loan yield. This occurs as more variable rate loan growth is occurring than fixed rate loan growth. Additionally, many consumers and businesses are taking the opportunity presented by the historically low Prime rate to borrow additional amounts on existing lines of credit not fully utilized. Nearly all of the Prime-plus rates on the Corporation’s business and commercial lines of credit are below the business and commercial fixed rates. Growth in this type of loan does not provide the amount of income generated on fixed rate loans.

 

Management instituted floors on certain types of consumer home equity lines of credit at the end of 2008, and instituted limited floors on business and commercial Prime-based loans in 2009. Effective January 1, 2010, all new Prime-based lines of credit were floored at 4.00%. Currently, as lines of credit are renewed, a Prime-plus tiered rating system will factor in downgrades in credit rating, resulting in an immediate impact to the rate. These actions were designed to preserve loan yield and more effectively assign higher Prime-based loan rates to weaker credits to be adequately compensated for the higher degree of credit risk. In 2011 and through the first quarter of 2012, due to lower loan growth, increased competition, and lower cost of funds, management did grant new Prime-based loans at Prime to customers with the highest credit ratings, and at 3.50% and 3.75% to strong-rated credits. However, the majority of new Prime-based loans were originated with a floor of 4.00%. Management believes Prime-based loan growth is critical to strengthen the Corporation’s asset liability position for higher interest rates. As such, management will remain competitive with Prime-based loans, as these loans will significantly outperform fixed rate loans given a rise in interest rates. Management also believes there is a very large opportunity cost in not booking Prime-based loans due to competitive reasons and therefore having to reinvest cash flows into securities that are at much lower yields and model as much longer instruments from an interest rate risk standpoint.

 

Earnings and yields on the Corporation’s securities have also been negatively impacted by the historically low interest rates. The Corporation’s securities portfolio consists of nearly all fixed income debt instruments. The U.S. Treasury rates have remained at historically low levels since the Federal funds rate was reduced to 0.25% in December 2008. As the low-rate period continues to extend, larger amounts of securities are maturing forcing the proceeds to be reinvested into lower-yielding instruments. The Corporation’s taxable securities experienced a 91 basis-point reduction in yield for the three months ended March 31, 2012, compared to the same period in 2011, due to reinvesting into lower-yielding instruments. Tax-exempt security yields decreased by six basis points for the three months ended March 31, 2012, compared to the same period in 2011.

 

The Corporation’s interest bearing liabilities grew steadily through 2009 and 2010, declined during 2011, and grew slightly again in the first quarter of 2012. With significantly lower interest rates, total interest expense declined significantly. Interest expense on deposits declined by $306,000 for the three months ended March 31, 2012, compared to the same period in 2011. Demand and savings deposits reprice in entirety whenever the offering rates are changed. This allows management to reduce interest costs rapidly; however, it becomes difficult to continue to gain cost savings once offering rates decline to these historically low levels. Due to the size of rate decreases relative to the initial interest rate, the percentage decreases in the actual interest rates are very high. The annualized rate on interest bearing demand accounts decreased seven basis points, or 21.2%, for the three-month period ended March 31, 2012, compared to the prior year’s period, while the annualized rate on savings accounts remained the same. Importantly, while the percentage of rate decreases is large, the scope of further reductions in dollar amount of interest expense is very limited since rates cannot conceivably be reduced much lower. The year-to-date average balances of interest bearing demand deposits increased by $1.8 million, or 1.5%, from March 31, 2011, to March 31, 2012, and the average balance of savings accounts increased by $8.4 million, or 8.9%, during the same period. This increase in balances of lower cost accounts has helped to reduce the Corporation’s overall interest expense in 2012 compared to 2011.

 

33

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. Historically, the Corporation has seen decreases in time deposit balances when the equity markets improve as customers are more willing to direct maturing time deposits into stocks. During 2011 and through the first quarter of 2012, time deposit balances decreased. More recently, the decrease can also be attributed to the lowest rates paid historically on time deposits, which has caused the differential between time deposit rates and interest rates on non-maturing deposits to be minimal. As a result, customers have elected to keep more of their funds in non-maturity deposits and fewer in time deposits. Because time deposits are the most expensive deposit product for the Corporation and the largest dollar expense from a funding standpoint, the reduction in time deposits, along with the increases in interest-bearing checking, savings, and non-interest bearing checking, has allowed the Corporation to achieve a lower cost and more balanced deposit funding position. The Corporation was able to reduce interest expense on time deposits by $291,000 for the first quarter of 2012, compared to the same period in 2011, with average balances declining by $9.9 million. This effectively reduced the annualized rate paid on time deposits by 43 basis points when comparing the three-month periods in both years.

 

The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. In 2012, the Corporation took advantage of some competitively priced short-term advances in addition to the normal portfolio of long-term borrowings. No short-term advances were utilized in the first quarter of 2011. The short-term borrowings at March 31, 2012, only accounted for $4.3 million of the average borrowings balance. Management has used long-term borrowings as part of an asset liability strategy to lengthen liabilities rather than as a source of liquidity. The Corporation increased average borrowings by $847,000 in the first quarter of 2012 compared to the same quarter in 2011, but interest expense was $149,000 lower for the first quarter of 2012 compared to the first quarter of 2011, as a result of lower interest rates on the outstanding borrowings.

 

The NIM was 3.46% for the first quarter of 2012, compared to 3.57% for the same period in 2011. For the three-month period ended March 31, 2012, the net interest spread decreased six basis points to 3.14%, from 3.20% for the same period in 2011. The effect of non-interest bearing funds dropped five basis points for the three-month period compared to the prior year. The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go lower, the benefit of non-interest bearing deposits is reduced because there is less difference between no-cost funds and interest bearing liabilities. For example, if a savings account with $10,000 earns 1%, the benefit for $10,000 non-interest bearing deposits is equivalent to $100; but if the rate is reduced to 0.20%, then the benefit is only $20. This assumes dollar-for-dollar replacement, which is not realistic, but demonstrates the way the lower cost of funds affects the benefit to non-interest bearing deposits.

 

The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in net interest income, the Corporation’s largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of rising rates, please see Quantitative and Qualitative Disclosures about Market Risk.

 

Provision for Loan Losses

 

The allowance for loan losses provides for losses inherent in the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The amount of the provision reflects the adjustment management determines necessary to ensure the allowance for loan losses is adequate to cover any losses inherent in the loan portfolio. The Corporation had a credit provision of $250,000 for the quarter ended March 31, 2012, compared to a provision expense of $450,000 for the quarter ended March 31, 2011. The Corporation gives special attention to the level of delinquent loans. The analysis of the loan loss allowance takes into consideration, among other things, the following factors:

 

  levels and trends in delinquencies, nonaccruals, and charge-offs,
  trends within the loan portfolio,
  changes in lending policies and procedures,
  experience of lending personnel and management oversight,
  national and local economic trends,
  concentrations of credit,
  external factors such as legal and regulatory requirements,
  changes in the quality of loan review and Board oversight,
  changes in the value of underlying collateral.

 

The provision for the first quarter of 2012 was lower than the provision for 2011 due to the following factors:

 

  Lower levels of delinquent and non-performing loans
  Decreased charge-offs
  Increased allowance as a percentage of total loans
  Declines in total loans

 

34

 

ENB FINANCIAL CORP

Management’s Discussion and Analysis

Coupled with the prolonged period of economic decline, specifically the weaker housing market and ongoing credit concerns, the Corporation had experienced a general increase in loan delinquencies since the beginning of 2009 through 2010. However, in 2011 and through the first quarter of 2012, delinquencies declined from a January 31, 2011 high of 1.45% of total loans to 0.81% of total loans as of March 31, 2012. The reduction in loan delinquencies was affected by the 2011 payoff of approximately $1.5 million related to a commercial borrower who had several loans on nonaccrual status. The Corporation’s total substandard and doubtful loans, which are considered classified loans, have stabilized and are down from the high of $36.2 million on September 30, 2011. Classified loans were $30.3 million as of March 31, 2011, $35.4 million as of December 31, 2011, and $35.9 million as of March 31, 2012.

 

The above two measurements show somewhat opposing trends in terms of delinquencies declining significantly over the past five quarters with classified loans increasing. Management has been closely tracking delinquencies and classified loans as a percentage of the loan portfolio and believes these opposite trends are best explained by evaluating what is behind each of these measurements. The vast majority of the Corporation’s loan customers have remained very steadfast in making their loan payments and avoiding delinquency, even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly, the character of the Corporation’s customers and lending practices. However, classified loans are determined strictly by the loan-to-value and debt-to-income ratios. The prolonged economic downturn, including devaluation of residential and commercial real estate, has stressed these ratios to the point that many long-term strong borrowers now fall below industry guidelines for loan-to-value ratios. To date, the trend of higher classified loans has not resulted in higher delinquencies and higher loan losses; however, management is committed to reversing the trend of higher classified loans. This includes seeking additional collateral, limiting the Corporation’s credit exposure, and working out of classified loans that are not in the Corporation’s best interests to continue to hold. The delinquency and classified loan information is utilized in the quarterly allowance for loan loss (ALLL) calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies and/or classified loans during the quarter would be cause for management to increase or decrease the provision expense. Generally, management will evaluate and adjust, if necessary, the provision expense each quarter upon completion of the quarterly ALLL calculation.

 

Improvements in asset quality, as evidenced by lower levels of non-performing and delinquent loans, minimal charge-offs, along with declines in total loans, allowed the Corporation to reverse a portion of the allowance for loan losses into earnings in 2012 while still maintaining strong coverage ratios. Previously, in 2010 and 2011, the provision expense was at an increased level to provide for high levels of classified loans. When classified loans first began to decline in late 2011, the provision for loan losses was initially reduced. With further declines in classified assets, along with low levels of non-performing and delinquent loans, the first quarter 2012 allowance for loan losses calculation supported a decrease in this balance. Despite the reduction in the allowance for loan losses for the first quarter of 2012, the allowance for loan losses as a percentage of total loans was 2.00% as of March 31, 2012, compared to 1.79% as of March 31, 2011. The charge-offs for the three months ended March 31, 2012, were $47,000 compared to $149,000 of charge-offs for the same period in 2011.

 

In addition to the above, provision expense is impacted by three major components that are all included in the quarterly calculation of the ALLL. First, specific allocations are made for any loans where management has determined an exposure that needs to be provided for. These specific allocations are reviewed each quarter to determine if adjustments need to be made. It is common for specific allocations to be reduced as additional principal payments are made, so while some specific allocations are being added, others are being reduced. Second, management provides for estimated losses on pools of similar loans based on historical loss experience. Finally, management utilizes qualitative factors every quarter to adjust historical loss experience to take into consideration the current trends in loan volume, delinquencies, charge-offs, changes in lending practices, and the quality of the Corporation’s underwriting, credit analysis, lending staff, and Board oversight. National and local economic trends and conditions are helpful to determine the amount of loan loss allowance the Corporation should be carrying on the various types of loans. Management evaluates and adjusts, if necessary, the qualitative factors on a quarterly basis.

 

Several qualitative adjustments were made in 2011 and 2012, specifically related to changes in the agriculture loan portfolio. Factors for more volume and increased risk in the agriculture portfolio were made due to an increased focus in this a