Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis represents management's view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2020 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance. Forward-Looking Statements TheU.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regards to the inclusion of forward-looking statements in this document and documents incorporated by reference. Forward-looking statements pertain to possible or assumed future results that are made using current information. These forward-looking statements are generally identified when terms such as: "believe," "estimate," "anticipate," "expect," "project," "forecast," and other similar wordings are used. The readers of this report should take into consideration that these forward-looking statements represent management's expectations as to future forecasts of financial performance, or the likelihood that certain events will or will not occur. Due to the very nature of estimates or predications, these forward-looking statements should not be construed to be indicative of actual future results. Additionally, management may change estimates of future performance, or the likelihood of future events, as additional information is obtained. This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative of actual results. Readers should note that many factors affect this forward-looking information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into this document. These factors include, but are not limited to, the following:
· National and local economic conditions
· Effects of economic conditions particularly with regard to the negative impact
of severe, wide-ranging and continuing disruptions caused by the spread of
coronavirus (COVID-19) and government and business responses thereto,
specifically the effect on loan customers to repay loans
· Health of the housing market
· Real estate valuations and its impact on the loan portfolio
· Interest rate and monetary policies of the
· Volatility of the securities markets including the valuation of securities
· Future actions or inactions of
failure to increase the government debt limit, a prolonged shutdown of the
federal government, increase in taxes or regulations, or increasing debt
balances
· Political changes and their impact on new laws and regulations
· Competitive forces
· Impact of mergers and acquisition activity in the local market and the effects
thereof
· Potential impact from continually evolving cybersecurity and other
technological risks and attacks, including additional costs, reputational
damage, regulatory penalties, and financial losses
· Changes in customer behavior impacting deposit levels and loan demand
· Changes in accounting principles, policies, or guidelines as may be adopted by
the regulatory agencies, as well as the Public Company Accounting Oversight
Board, the
setters
· Ineffective business strategy due to current or future market and competitive
conditions
· Management's ability to manage credit risk, liquidity risk, interest rate risk,
and fair value risk
· Operation, legal, and reputation risk
· Results of the regulatory examination and supervision process
· The impact of new laws and regulations
· Possible changes to the capital and liquidity requirements and other regulatory
pronouncements, regulations and rules
· Large scale global disruptions such as pandemics, terrorism, trade wars, and
armed conflict.
· Local disruptions due to flooding, severe weather, or other natural disasters
· The risk that our analyses of these risks and forces could be incorrect and/or
that the strategies developed to address them could be unsuccessful
34 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
· Business and competitive disruptions caused by new market and industry entrants
Readers should be aware if any of the above factors change significantly, the statements regarding future performance could also change materially. The safe harbor provision provides that the Corporation is not required to publicly update or revise forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should review any changes in risk factors in documents filed by the Corporation periodically with theSecurities and Exchange Commission , including Item 1A of Part II of this Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports on Form 8-K. Results of Operations Overview The first half of 2021 was positively impacted by a number of items resulting in very strong financial results. The COVID-19 pandemic continues to impact customer behavior and balance sheet growth, but as of the date of this report there has not been significant negative impacts on earnings or credit. Customers have adapted to changes in behavior and the Corporation continues to seek ways to manage the structure of the balance sheet to achieve positive financial results now and in future time periods. The Corporation recorded net income of$3,551,000 for the three-month period endedJune 30, 2021 , a$48,000 , or 1.3% decrease from the three months endedJune 30, 2020 . Net income for the six-month period was$8,055,000 , a$2,291,000 , or 39.7% increase over earnings in the six-month period endedJune 30, 2020 . The earnings per share, basic and diluted, were$0.64 for the three months endedJune 30, 2021 , compared to$0.64 for the same period in 2020, and for the year-to-date period, earnings per share were$1.45 compared to$1.03 in 2020, a 40.8% increase. The increase in the Corporation's 2021 earnings was caused primarily by growth in gains on mortgages sold, other income, and net interest income coupled with a decline in the provision for loan losses. The gains from the sale of mortgages were$1,245,000 for the three months endedJune 30, 2021 , compared to gains of$1,690,000 for the three months endedJune 30, 2020 , a decrease of$445,000 , or 26.3%. However, for the six-month period, gains were$3,175,000 , an increase of$944,000 , or 42.3%, over the six months endedJune 30, 2020 . This year-to-date increase in gains can be attributed to higher volume in the first half of 2021 compared to the first half of 2020, driven by low market rates, which has caused an increase in refinancing activity over the course of the past year. Additionally, margins received on sold mortgages have been at higher levels supporting this higher level of gains. Gains on securities in total decreased by$122,000 , or 32.8%, for the three months endedJune 30, 2021 , and increased by$161,000 , or 38.0%, for the six months endedJune 30, 2021 , compared to the same periods in the prior year. Outside of mortgage and security gains, other non-interest income increased by$576,000 , or 28.7%, and$1,455,000 , or 34.8%, for the three and six months endedJune 30, 2021 , due to many positive trends such as higher trust income, higher commissions on debit card interchange fees, and lower mortgage servicing asset amortization. The Corporation's NII increased by$262,000 , or 2.8%, and$725,000 , or 3.9%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. The increase in NII primarily resulted from an increase in interest on securities in the available for sale category of$532,000 , or 31.1%, for the three-month period endedJune 30, 2021 , and$777,000 , or 22.2%, for the six-month period endedJune 30, 2021 , compared to the three and six months endedJune 30, 2020 . In addition, interest expense on deposits and borrowings decreased by$193,000 , or 19.3%, and$613,000 , or 27.0%, for the three and six months endedJune 30, 2021 , compared to the same periods in the prior year. The low interest rate environment has caused a rapid decline in asset yield, but also a decline in the cost of funds, which has resulted in these much lower levels of interest expense. The 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 decreased for the quarter-to-date period endedJune 30, 2021 , but increased for the year-to-date period compared to the same periods in the prior year, due to lower quarterly earnings and higher year-to-date earnings as ofJune 30, 2021 . 35 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis Key Ratios Three Months Ended Six Months Ended June 30, June 30, 2021 2020 2021 2020
Return on Average Assets 0.92% 1.14% 1.07% 0.95% Return on Average Equity 10.86% 12.31% 12.43% 9.86% The results of the Corporation's operations are best explained by addressing, in further detail, the five major sections of the income statement, which are
as follows: · Net interest income
· Provision for loan losses
· Other income · Operating expenses
· Provision for income taxes
The following discussion analyzes each of these five components.
Net Interest Income NII represents the largest portion of the Corporation's operating income. In the first six months of 2021, NII generated 67.4% of the Corporation's revenue stream, which consists of net interest income and non-interest income, compared to 73.2% in the first six months of 2020. This significant decrease is a result of much higher levels of non-interest income primarily driven by mortgage gains in the first six months of 2021 which made up 11.0% of the Corporation's revenue stream, compared to 8.7% in the first six months of 2020. However, the overall performance of the Corporation is highly dependent on the changes in net interest income since it comprises such a significant portion of operating income. The following table shows a summary analysis of net interest income on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE net interest income shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis. The amount of FTE adjustment totaled$289,000 for the three months endedJune 30, 2021 , and$556,000 for the six months endedJune 30, 2021 , compared to$197,000 and$370,000 for the same periods in 2020. NET INTEREST INCOME (DOLLARS IN THOUSANDS) Three Months Ended Six Months Ended June 30, June 30, 2021 2020 2021 2020 $ $ $ $ Total interest income 10,537 10,468 21,067 20,955 Total interest expense 806 999 1,657 2,270 Net interest income 9,731 9,469 19,410 18,685 Tax equivalent adjustment 289 197 556 370 Net interest income (fully taxable equivalent) 10,020 9,666 19,966 19,055
NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect net interest income:
· The rates earned on interest earning assets and paid on interest bearing
liabilities
· The average balance of interest earning assets and interest bearing liabilities 36 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The Federal funds rate, the Prime rate, the shape of theU.S. Treasury curve, and other wholesale funding curves, all affect NII. TheFederal Reserve controls the Federal funds rate, which is one of a number of tools available to theFederal Reserve to conduct monetary policy. The Federal funds rate, and guidance on when the rate might be changed, is often the focal point of discussion regarding the direction of interest rates. During 2020, the Federal funds rate was decreased by 150 basis points in March taking the rate to 0.25% byMarch 31, 2020 . With the declines in the Federal funds rate, theU.S. Treasury yield curve became flatter. Long-term rates like the ten-yearU.S. Treasury were 232 basis points under the 3.25% Prime rate as ofDecember 31, 2020 . Long-termTreasury rates remained low throughout 2020, and with the decreases in theFederal Reserve short-term rates, the yield curve remained essentially flat throughout the year. Management had not anticipated the Fed rate decreases in the first quarter of 2020. During the first half of 2021, longer-termU.S. Treasury rates did increase adding some slope to the yield curve. The ten-yearTreasury rate was 1.45% as ofJune 30, 2021 , which was 180 basis points under the Prime rate. ThisTreasury rate movement makes it a little easier to get asset yield on the longer end of the curve, but yields are still compressed compared to years prior to 2020, making increasing asset yield much more difficult, which adds strain to NII and net interest margin (NIM). The Prime rate is generally used by commercial banks to extend variable rate loans to business and commercial customers. For many years, the Prime rate has been set at 300 basis points, or 3.00% higher, than the Federal funds rate and typically moves when the Federal funds rate changes. As such, the Prime rate decreased to 3.25% in March of 2020 after the 150 basis point Fed rate decline. The Corporation's Prime-based loans generally reprice a day after theFederal Reserve rate movement.
As a result of a larger balance sheet in the first half of 2021, even with much lower asset yields, the Corporation's NII on a tax equivalent basis increased while the Corporation's margin decreased to 2.72% for the quarter and 2.79% for the six months endedJune 30, 2021 , compared to 3.24% in the second quarter of 2020 and 3.32% for the year-to-date period. Loan yields were lower in the first half of 2021 due to the 150 basis point Fed rate decline during the first quarter of 2020. The Corporation's NII for the three and six months endedJune 30, 2021 , increased over the same periods in 2020, by$354,000 , or 3.7%, and$911,000 , or 4.8%, respectively. Management's asset liability sensitivity shows a small benefit to both margin and NII givenFederal Reserve rate increases. Actual results over the past two years have confirmed the asset sensitivity of the Corporation's balance sheet, however there was some decline in this asset sensitivity in the first half of 2021. In a down-rate environment, the margin and NII would suffer unless balance sheet growth is enough to offset lower
asset yields. Security yields will generally fluctuate more rapidly than loan yields based on changes to theU.S. Treasury rates and yield curve. With lowerTreasury rates in 2020, security reinvestment had generally been occurring at lower yields. With slightly higherTreasury rates in the first half of 2021, security yields have increased slightly, but still remain compressed compared to years prior to 2020. The Corporation's loan portfolio yield has decreased from the prior years' period as the variable rate portion of the loan portfolio repriced lower with the twoFederal Reserve rate decreases inMarch 2020 and some fixed rate borrowers requested loan modifications to reset their rates lower in the current record low market rate environment. The vast majority of the Corporation's commercial Prime-based loans were priced at the Prime rate, which was 4.75% to start 2020, and then 4.25% as ofMarch 4, 2020 , and 3.25% as ofMarch 16, 2020 throughJune 30, 2021 . The pricing for the most typical five-year fixed rate commercial loans is currently in line with the Prime rate. With the significant 2020Federal Reserve rate reductions, adding variable rate loans to the portfolio means they will be priced at very low rates to start but can reprice lower if theFederal Reserve lowers rates any further and would reprice higher if theFederal Reserve would increase rates. There are elements of the Corporation's Prime-based commercial loans priced above the Prime rate based on the level of credit risk of the borrower. Management does price a portion of consumer variable rate loans above the Prime rate, which also helps to improve loan yield. Both commercial and consumer Prime-based pricing continues to be influenced by local competition. Mid-term and long-term interest rates on average were higher in the first half of 2021 compared to the first half of 2020. The average rate of the 10-yearU.S. Treasury was 1.47% in the first half of 2021 compared to 1.02% in the first half of 2020, and it stood at 1.45% onJune 30, 2021 , compared to 0.66% onJune 30, 2020 . The slope of the yield curve has been compressed throughout 2020 and 2021 with a little more slope in the first half of 2021. As ofDecember 31, 2020 , the 10-yearU.S. Treasury rate was only 68 basis points higher than the Fed funds rate and as ofJune 30, 2021 , it was 120 basis points higher than the Fed funds rate. The slope of the yield curve has fluctuated many times in the past two years with the 10-yearU.S. Treasury yield as high as 1.88% in the first half of 2020 and 1.74% in the first half of 2021, and as low as 0.54% in the first half of 2020, and 0.93% in the first half of 2021. 37 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The Corporation's overall cost of funds, including non-interest bearing funds, remained stable through the first half of 2021 between 22 and 16 basis points. Management expects the cost of funds will decline slightly and then stabilize throughout 2021 as limited deposits reprice to lower rates. Core deposit interest rates were reduced nine times throughout 2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core deposit products. Management does not anticipate significant deposit rate movements in 2021 as deposits are now priced at very low rates. Typically, financial institutions will make small systematic moves on core interest bearing accounts while making larger rate movements in the pricing of new or reissued time deposits. The Corporation's costs on borrowings included$94,000 of prepayment penalties recorded onFederal Home Loan Bank (FHLB) long-term advances paid off early during the first half of 2021, and$154,000 of prepayment penalties recorded in the first half of 2020, accelerating the interest expense, but achieving savings in future time periods. While the average balance of borrowings was lower in the first half of 2021 than the first half of 2020, the interest expense was higher, as the new$20 million sub debt issue beginning onDecember 30, 2020 , carried a higher rate of interest than FHLB long-term advances that were paid off. As a result, the total cost of borrowings increased from the first half of 2020 to the first half of 2021
by$140,000 . The following table provides an analysis of year-to-date changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
Six Months Ended June 30, Six Months Ended June 30, 2021 vs. 2020 2020 vs. 2019 Increase (Decrease) Increase (Decrease) Due To Change In Due To Change In Net Net Average Interest Increase Average Interest Increase Balances Rates (Decrease) Balances Rates (Decrease) $ $ $ $ $ $ INTEREST INCOME Interest on deposits at other banks 50 (89 ) (39 ) 59 (144 ) (85 ) Securities available for sale: Taxable 957 (943 ) 14 217 (477 ) (260 ) Tax-exempt 1,237 (289 ) 948 (3 ) (49 ) (52 ) Total securities 2,194 (1,232 ) 962 214 (526 ) (312 ) Loans 1,141 (1,683 ) (542 ) 1,779 (1,039 ) 740 Regulatory stock (39 ) (44 ) (83 ) 28 (62 ) (34 ) Total interest income 3,346 (3,048 ) 298 2,080 (1,771 ) 309 INTEREST EXPENSE Deposits: Demand deposits 77 (415 ) (338 ) 51 (514 ) (463 ) Savings deposits 9 (14 ) (5 ) 6 (22 ) (16 ) Time deposits (78 ) (332 ) (410 ) (31 ) 125 94 Total deposits 8 (761 ) (753 ) 26 (411 ) (385 ) Borrowings: Total borrowings (64 ) 204 140 62 110 172 Total interest expense (56 ) (557 ) (613 ) 88 (301 ) (213 ) NET INTEREST INCOME 3,402 (2,491 ) 911 1,992 (1,470 ) 522
During the first six months of 2021, the Corporation's NII on an FTE basis increased by$911,000 , or 4.8%, over the same period in 2020. Total interest income on an FTE basis for the six months endedJune 30, 2021 , increased$298,000 , or 1.4%, from 2020, while interest expense decreased$613,000 , or 27.0%, for the six months endedJune 30, 2021 , compared to the same period in 2020. The FTE interest income from the securities portfolio increased by$962,000 , or 25.0%, while loan interest income decreased$542,000 , or 3.2%. During the first half of 2021, additional loan volume caused by loan growth added$1,141,000 to net interest income, but the lower yields caused a$1,683,000 decrease, resulting in a total decrease of$542,000 . Higher balances in the securities portfolio caused an increase of$2,194,000 in NII, while lower yields on securities caused a$1,232,000 decrease, resulting in a net increase of$962,000 . 38 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The average balance of interest bearing liabilities increased by 16.4% during the six months endedJune 30, 2021 , compared to the prior year driven by growth in deposit balances. The lower cost on deposit accounts resulted in a decrease in interest expense. Lower rates on all deposit types caused a$761,000 decrease in interest expense while higher balances of demand and savings deposits caused an increase in expense of$8,000 resulting in a total decrease of$753,000 . Out of all the Corporation's deposit types, interest-bearing demand deposits reprice the most rapidly, as nearly all accounts are immediately affected by rate changes. Time deposit balances decreased resulting in a$78,000 reduction to expense, and time deposits repricing to lower interest rates decreased interest expense by$332,000 , causing a net total decrease of$410,000 in time deposit interest expense. Even with the low rate environment, the Corporation was successful in increasing balances of other deposit types. The average balance of outstanding borrowings decreased by 7.3% from the prior year, due to early payoff of FHLB advances that occurred during 2020 and the first half of 2021. This resulted in a decrease in interest expense of$64,000 . Although interest rates were lower in the first half of 2021 compared to the prior year, the Corporation incurred interest prepayment penalites of$94,000 to pay off two long-term FHLB advances. The Corporation also issued subordinated debt at the end of 2020, which was at a higher interest rate than the FHLB advances. These two events increased interest expense by$204,000 . The combination of lower overall levels of borrowings at a materially higher weighted average interest rate caused an increase in interest expense of$140,000 on total borrowings. The sub debt issue was pursued because of the benefit of being treated as Tier 1 capital at the bank level and Tier II capital at the bank holding company level. The following tables show a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation's balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency of not giving credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, management emphasizes the net yield on interest earning assets, also referred to as the NIM. The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. The NIM is generally the benchmark used by analysts to measure how efficiently a bank generates NII. 39 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(DOLLARS IN THOUSANDS) For the Three Months Ended June 30, 2021 2020 (c) (c) Average Annualized Average Annualized Balance Interest Yield/Rate Balance Interest Yield/Rate $ $ % $ $ % ASSETS Interest earning assets: Federal funds sold and interest on deposits at other banks 49,710 20 0.16 31,764 21 0.26 Securities available for sale: Taxable 373,610 1,259 1.35 229,341 1,085 1.89 Tax-exempt 188,390 1,262 2.68 97,514 802 3.29 Total securities (d) 562,000 2,521 1.79 326,855 1,887 2.31 Loans (a) 858,183 8,207 3.83 827,386 8,674 4.20 Regulatory stock 6,054 78 5.15 7,429 83 4.47 Total interest earning assets 1,475,947 10,826 2.94 1,193,434 10,665 3.58 Non-interest earning assets (d) 80,235 71,016 Total assets 1,556,182 1,264,450 LIABILITIES & STOCKHOLDERS' EQUITY Interest bearing liabilities: Demand deposits 338,060 40 0.05 274,419 110 0.16 Savings deposits 312,504 15 0.02 238,056 12 0.02 Time deposits 117,887 230 0.78 128,109 421 1.32 Borrowed funds 72,235 521 2.89 76,051 456 2.41 Total interest bearing liabilities 840,686 806 0.39 716,635 999 0.56 Non-interest bearing liabilities: Demand deposits 579,007 425,773 Other 5,379 4,429 Total liabilities 1,425,072 1,146,837 Stockholders' equity 131,110 117,613 Total liabilities & stockholders' equity 1,556,182 1,264,450 Net interest income (FTE) 10,020 9,666 Net interest spread (b) 2.55 3.02 Effect of non-interest bearing deposits 0.17 0.22 Net yield on interest earning assets (c) 2.72 3.24 (a) Includes balances of nonaccrual loans and the recognition of any related interest income. The quarter-to-date average balances include net deferred loan costs of$435,000 as ofJune 30, 2021 , and$2,129,000 as ofJune 30, 2020 . Such fees and costs recognized through income and included in the interest amounts totaled$36,000 in 2021, and$168,000 in 2020.
(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities.
(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.
(d) Securities recorded at amortized cost. Unrealized holding gains and losses are included in non-interest earning assets.
40 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(DOLLARS IN THOUSANDS) For the Six Months Ended June 30, 2021 2020 (c) (c) Average Annualized Average Annualized Balance Interest Yield/Rate Balance Interest Yield/Rate $ $ % $ $ % ASSETS Interest earning assets: Federal funds sold and interest on deposits at other banks 53,820 42 0.16 25,312 81 0.64 Securities available for sale: Taxable 346,417 2,362 1.36 229,245 2,348 2.05 Tax-exempt 180,622 2,451 2.72 92,105 1,503 3.26 Total securities (d) 527,039 4,813 1.82 321,350 3,851 2.40 Loans (a) 848,622 16,623 3.93 793,692 17,165 4.33 Regulatory stock 6,043 145 4.80 7,449 228 6.13 Total interest earning assets 1,435,524 21,623 3.02 1,147,803 21,325 3.72 Non-interest earning assets (d) 80,066 71,700 Total assets 1,515,590 1,219,503 LIABILITIES & STOCKHOLDERS' EQUITY Interest bearing liabilities: Demand deposits 331,207 77 0.05 270,095 415 0.31 Savings deposits 299,719 30 0.02 226,973 35 0.03 Time deposits 118,594 492 0.84 130,907 902 1.39 Borrowed funds 73,317 1,058 2.91 79,085 918 2.33 Total interest bearing liabilities 822,837 1,657 0.41 707,060 2,270 0.65 Non-interest bearing liabilities: Demand deposits 556,878 390,775 Other 5,204 4,163 Total liabilities 1,384,919 1,101,998 Stockholders' equity 130,671 117,505 Total liabilities & stockholders' equity 1,515,590 1,219,503 Net interest income (FTE) 19,966 19,055 Net interest spread (b) 2.61 3.07 Effect of non-interest bearing deposits 0.18 0.25 Net yield on interest earning assets (c) 2.79 3.32 (a) Includes balances of nonaccrual loans and the recognition of any related interest income. The year-to-date average balances include net deferred loan costs of$815,000 as ofJune 30, 2021 , and$2,057,000 as ofJune 30, 2020 . Such fees and costs recognized through income and included in the interest amounts totaled$374,000 in 2021, and$49,000 in 2020.
(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities.
(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.
(d) Securities recorded at amortized cost. Unrealized holding gains and losses are included in non-interest earning assets.
41 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The Corporation's interest income increased primarily due to increased interest income on securities, but the increase in income was the result of growth in the securities portfolio, not an increase in asset yield, resulting in a lower NIM of 2.72% for the second quarter of 2021, compared to 3.24% for the second quarter of 2020, and 2.79% for the year-to-date period in 2021, compared to 3.32% for the prior year. The yield earned on assets decreased by 64 basis points during the three months endedJune 30, 2021 , and 70 basis points during the six months endedJune 30, 2021 , while the rate paid on liabilities decreased by 17 basis points and 24 basis points, respectively, when comparing both years. This resulted in a 47 basis point decrease in interest spread for the three-month period, and a 46 basis point decrease in spread for the six-month period, and the effect of non-interest bearing deposits decreased by five basis points during the three months endedJune 30, 2021 , and seven basis points during the six months endedJune 30, 2021 , compared to the same periods in the prior year, resulting in the decrease in NIM of 52 basis points and 53 basis points, respectively. Management anticipates a levelling out of NIM during the remainder of 2021 asTreasury rates have increased a little assisting with achieving higher yields in the securities portfolio and loan yields will benefit some by the remainder of the Paycheck Protection Program (PPP) fees that are accretive to loan interest income as PPP loans pay off or are forgiven. Loan yields decreased in the first half of 2021 compared to the prior year primarily as a result of the 150 basis points of Prime decline in the first quarter of 2020 that did not fully impact the loan yields until the second quarter of 2020. Growth in the loan portfolio will help to offset a declining asset yield moving through 2021. The Corporation's loan yield decreased 37 basis points in the second quarter of 2021 compared to the second quarter of 2020, and decreased by 40 basis points for the year-to-date period. Loan interest income decreased$467,000 , or 5.4%, and$1,009,000 , or 5.9%, for the three and six-month periods as a result of the decline in yields. Loan pricing was challenging in the first half of 2021 as a result of the very low rate environment and competition resulting in fixed-rate loans being priced at very low levels and variable-rate loans priced at the Prime rate or below. The Prime rate decreased by 1.50% in March of 2020 to 3.25%, which is now comparable to the typical rate of a five-year fixed-rate loan. The commercial or business fixed rates do increase with longer fixed terms or lower credit quality. In terms of the variable rate pricing, nearly all variable rate loans offered are Prime-based. Management is able to price loan customers with higher levels of credit risk at Prime plus pricing, such as Prime plus 0.75%, which amounted to 4.00% atJune 30, 2021 , still a relatively low rate. However, only a small minority of the loans in the commercial and agricultural portfolios are at these higher rates due to the strong credit quality of the Corporation's borrowers and market competition. Competitors in the immediate market area have been pricing select shorter-term fixed-rate commercial and agricultural lending rates below 3.25% for the strongest loan credits. Tax equivalent yields on the Corporation's securities decreased by 52 basis points for the three months endedJune 30, 2021 , and 58 basis points for the six months endedJune 30, 2021 , compared to the same periods in 2020. The Corporation's securities portfolio consists of approximately 76% fixed income debt instruments and 24% variable rate product as ofJune 30, 2021 . The Corporation's taxable securities experienced a 54 basis-point decrease in yield for the three months endedJune 30, 2021 , and a 69 basis point decrease in yield for the six months endedJune 30, 2021 , compared to 2020. Security reinvestment in 2021 has been occurring at slightly higher rates due to the increase inU.S. Treasury rates, but reinvestment throughout the majority of 2020 was at much lower yields. The sharp growth in the investment portfolio during a period of very low rates also contributed to the decline in average security yield. This large amount of new investment was caused by the significant influx of deposits, which caused excess liquidity. The sharpest growth in the securities portfolio occurred in the fourth quarter of 2020 and the first quarter of 2021. In addition to these negative influences, the Corporation'sU.S. agency mortgage-backed securities and collateralized mortgage obligations experience faster principal prepayments as market rates decrease, causing the amortization of premium to increase, effectively decreasing the yield. The yield on tax-exempt securities decreased by 61 basis points in the second quarter of 2021, and 54 basis points for the year-to-date period, compared to 2020. For the Corporation, these bonds consist entirely of tax-free municipal bonds. While the tax-exempt yields on municipal bonds declined with the tax rate change at the end of 2017, yields became more attractive again during 2020 and 2021. Management began investing in more of these bonds in 2020 as yields stood out and provided better returns than other sectors of the portfolio. The interest rate paid on deposits decreased for the three and six months endedJune 30, 2021 , from the same periods in 2020. Management follows a disciplined pricing strategy on core deposit products that are not rate sensitive, meaning that the balances do not fluctuate significantly when interest rates change. Rates on interest-bearing checking accounts and money market accounts were decreased in 2020, resulting in a decrease in the cost of funds on these accounts of 11 basis points for the three-month period and 26 basis points for the six-month period. The cost of funds on time deposits decreased by 54 basis points during the second quarter of 2021, and 55 basis points for the six-month period, compared to the same periods in the prior year. Typically, the Corporation sees increases in core deposit products during periods when consumers are not confident in the stock market or economic conditions deteriorate. During these periods, there is a "flight to safety" to federally insured deposits. This trend occurred again in early 2020 as the federal, state and local governmental bodies began rapidly instituting social distancing measures in an effort to control the spread of the coronavirus. These measures had an immediate signicant negative impact to the economy, which also resulted in theFederal Reserve quickly dropping interest rates back to historic lows. This in turn resulted in market interest rates declining again to historic lows, with the Corporation reducing offering rates on deposit products. As the rate difference between time deposits and core deposits narrowed, many customers chose to transfer funds from maturing time deposits into checking and savings accounts. 42 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
The Corporation's average deposits increased$281.1 million , or 26.4%, for the three-month period, and$287.6 million , or 28.2%, for the six-month period, with all types of interest-bearing deposits increasing$127.9 million , or 20.0%, and$121.5 million , or 19.4%, for the three and six-month periods endedJune 30, 2021 , compared to the same periods in the prior year, while non-interest bearing demand deposits increased$153.2 million , or 36.9%, and$166.1 million , or 42.5%, respectively. In the current rate environment, with short-term rates low and with small rate differences for longer-term deposits, the consumer generally elected to stay short and maintain funds in accessible deposit instruments. In addition to the consumer staying liquid with their available funds, there has been a general trend of funds flowing from time deposit accounts into non-interest checking, NOW, and savings accounts. The average balance of time deposits declined during the first six months of 2021 compared to 2020, but the other areas of NOW, MMDA, and savings grew sufficiently enough to compensate for the decline in time deposits, causing total interest bearing funds to increase significantly. Time deposit balances had been growing throughout 2018 and 2019 due to the odd-month CD promotions available at those times, but with the recent sharp decline in rates, time deposits declined throughout 2020 and management expects these time deposit balances to decrease throughout the remainder of 2021 as a result of customers electing to allow maturing time deposit balances to roll off and hold them in a liquid account until there is some sign of rate increases. Interest expense on deposits decreased by$258,000 , or 47.5%, and$753,000 , or 55.7%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Demand and savings deposits reprice in their entirety whenever the offering rates are changed, so with each successive rate drop in 2020, these deposits repriced lower. Interest rates on interest checking and money market accounts were decreased nine times in 2020. For the three and six months endedJune 30, 2021 , the average balances of interest bearing demand deposits increased by$63.6 million , or 23.2%, and$61.1 million , or 22.6%, over the same periods in 2020, while the average balance of savings accounts increased by$74.4 million , or 31.3%, and$72.7 million , or 32.1%, respectively. Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. During the six months endedJune 30, 2021 , time deposit balances decreased compared to balances atJune 30, 2020 . The decrease can be attributed to the low rates paid on time deposits, which has caused the differential between time deposit rates and rates on non-maturity deposits to be minimal. As a result, customers have elected to keep more of their funds in non-maturity deposits and less funds in time deposits. Because time deposits are the most expensive deposit product for the Corporation and the largest dollar expense from a funding standpoint, the reduction in time deposits, along with the increases in interest-bearing checking, savings, and non-interest bearing checking, has allowed the Corporation to achieve a more balanced deposit funding position and maintain a lower cost of funds. The Corporation's interest expense on time deposits decreased by$191,000 , or 45.4%, and$410,000 , or 45.5%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Management anticipates the interest expense on time deposits and annualized rate paid will decline throughout the remainder of 2021 as these higher-priced time deposits mature and reprice at lower levels or convert to non-maturity deposits. The Corporation's average rate on borrowed funds increased by 48 basis points from the second quarter of 2021 compared to the second quarter of 2020, and increased by 58 basis points for the year-to-date period. The Corporation's subordinated debt issued onDecember 30, 2020 , is included in this total borrowed funds amount and is at a rate of 4.00% for 5 years, so the increase in rate paid on borrowed funds is a direct result of this. The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. Average short-term advances of only$44,000 were utilized in the six months endedJune 30, 2021 , while average short-term advances of$4,638,000 were utilized in the six months endedJune 30, 2020 . Management has used FHLB long-term borrowings as part of an asset liability strategy to lengthen liabilities rather than as a source of liquidity. Average total long-term FHLB borrowings decreased by$21,646,000 , or 29.1%, for the six months endedJune 30, 2021 , compared to the same period in 2020. The average balance of subordinated debt increased by$19,620,000 , as subordinated debt was issued at the end of 2020 as a vehicle to support capital growth for the Corporation. This growth in debt balances contributed to an increase in interest expense for the three and six months endedJune 30, 2021 , compared to the same period in the prior year. Interest expense on borrowed funds increased$65,000 , or 14.3%, for the three-month period and$140,000 , or 15.3%, for the six-month period when comparing 2021 to 2020, driven higher by interest expense accrued on subordinated debt. 43 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
For the three months endedJune 30, 2021 , the net interest spread decreased by 47 basis points to 2.55%, compared to 3.02% for the three months endedJune 30, 2020 . For the six months endedJune 30, 2021 , the net interest spread decreased by 46 basis points to 2.61%, compared to 3.07% for the six months endedJune 30, 2020 . The effect of non-interest bearing funds decreased to 17 basis points from 22 basis points for the three months endedJune 30, 2021 , and decreased to 18 basis points from 25 basis points for the six months endedJune 30, 2021 , compared to the same periods in 2020. The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go higher, the benefit of non-interest bearing deposits increases because there is more difference between non-interest bearing funds and interest bearing liabilities. For example, if an interest checking account with$10,000 earns 1%, the benefit for$10,000 of non-interest bearing deposits is equivalent to$100 ; but if the interest-checking rate is increased to 1.50%, then the benefit of the non-interest bearing funds is$150 . This assumes dollar-for-dollar replacement, which is not realistic, but demonstrates the way the higher cost of funds affects the benefit to non-interest bearing deposits. The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in net interest income, the Corporation's largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of rising rates, refer to Item 7A: Quantitative and Qualitative Disclosures about Market Risk. Provision for Loan Losses The allowance for credit losses (ACL) provides for losses inherent in the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The amount of the provision reflects the adjustment management determines necessary to ensure the ACL is adequate to cover any losses inherent in the loan portfolio. The Corporation recorded no provision expense for the second quarter of 2021, and provision expense of$375,000 for the six months endedJune 30, 2021 , compared to$975,000 and$1,325,000 , respectively, for the three and six months endedJune 30, 2020 . The analysis of the ACL takes into consideration, among other things, the following factors:
· levels and trends in delinquencies, nonaccruals, charge-offs and recoveries,
· trends within the loan portfolio,
· changes in lending policies and procedures,
· experience of lending personnel and management oversight,
· national and local economic trends,
· concentrations of credit,
· external factors such as legal and regulatory requirements,
· changes in the quality of loan review and board oversight, and
· changes in the value of underlying collateral.
As ofJune 30, 2021 , total delinquencies represented 0.15% of total loans, compared to 0.41% as ofJune 30, 2020 . These ratios are very low compared to local and national peer groups. The vast majority of the Corporation's loan customers have remained steadfast in making their loan payments and avoiding delinquency, even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly, the character of the Corporation's customers and lending practices. Classified loans are primarily determined by loan-to-value and debt-to-income ratios. The level of classified loans has decreased fromJune 30, 2020 , toJune 30, 2021 , from 19.7% of regulatory capital to 14.3% of regulatory capital. The delinquency and classified loan information is utilized in the quarterly ACL calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies and/or classified loans during the quarter would be cause for management to increase or decrease the provision expense. The level of actual charge-offs relative to the amount of recoveries can also have a significant impact on the provision. Management had minimal charge-offs and recoveries in the first six months of 2021. 44 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
Generally, management will evaluate and adjust, if necessary, the provision expense each quarter based upon completion of the quarterly ACL calculation. Future provision amounts will generally depend on the amount of loan growth achieved versus levels of delinquent, non-performing, and classified loans, as well as charge-offs and recoveries. In addition to the above, provision expense is impacted by three major components that are all included in the quarterly calculation of the ACL. First, specific allocations are made for any loans where management has determined an exposure that needs to be provided for. These specific allocations are reviewed each quarter to determine if adjustments need to be made. It is common for specific allocations to be reduced as additional principal payments are made, so while some specific allocations are being added, others are being reduced. Second, management provides for estimated losses on pools of similar loans based on historical loss experience. Finally, management utilizes qualitative factors every quarter to adjust historical loss experience to take into consideration the current trends in loan volume, delinquencies, charge-offs, changes in lending practices, and the quality of the Corporation's underwriting, credit analysis, lending staff, and Board oversight. National and local economic trends and conditions are also helpful to determine the amount of loan loss allowance the Corporation should be carrying on the various types of loans. Management evaluates and adjusts, if necessary, the qualitative factors on a quarterly basis. In the first six months of 2021, qualitative factors were adjusted by management based on current internal information regarding trends in the nature and volume of the loan portfolio and delinquency. SinceDecember 31, 2020 , an increase in qualitative factors was made across four loan pools related to changes in lending policies and procedures and a decline was made across all loan pools related to an improvement in national and local economic trends. These factor changes were generally only 5 basis points. Other factors remained unchanged in the first six months of 2021. Management also monitors the allowance as a percentage of total loans. The percentage of the allowance to total loans has increased sinceJune 30, 2020 , and remains higher than the Bank's national peer group from theUniform Bank Performance Reports. As ofJune 30, 2021 , the allowance as a percentage of total loans was 1.46%, up from 1.29% atJune 30, 2020 . Management continues to evaluate the ACL in relation to the size of the loan portfolio and changes to the segments within the loan portfolio and their associated credit risk. Management believes the ACL is adequate to provide for future loan losses based on the current portfolio and the current economic environment. More detail is provided under Allowance for Credit Losses in the Financial Condition section that follows. Other Income
Other income for the second quarter of 2021 was$4,077,000 , an increase of$9,000 , or 0.2%, compared to the$4,068,000 earned during the second quarter of 2020. For the year-to-date period endedJune 30, 2021 , other income totaled$9,395,000 , an increase of$2,560,000 , or 37.5%, compared to the same period in 2020. The following tables detail the categories that comprise other income. OTHER INCOME (DOLLARS IN THOUSANDS) Three Months Ended June 30, Increase (Decrease) 2021 2020 $ $ $ % Trust and investment services 537 416 121 29.1 Service charges on deposit accounts 246 205 41 20.0 Other service charges and fees 438 430 8 1.9 Commissions 952 649 303 46.7 Gains on securities transactions, net 274 367 (93 ) (25.3 ) Gains (losses) on equity securities, net (24 ) 5 (29 ) >100% Gains on sale of mortgages 1,245 1,690 (445 ) (26.3 ) Earnings on bank owned life insurance 202 205 (3 ) (1.5 ) Other miscellaneous income 207 101 106 >100% Total other income 4,077 4,068 9 0.2 45 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis OTHER INCOME (DOLLARS IN THOUSANDS) Six Months Ended June 30, Increase (Decrease) 2021 2020 $ $ $ % Trust and investment services 1,207 1,038 169 16.3
Service charges on deposit accounts 494 520 (26 ) (5.0 ) Other service charges and fees 804 794 10 1.3 Commissions 1,816 1,335 481 36.0 Gains on securities transactions, net 362 649 (287 ) (44.2 ) Gains (losses) on equity securities, net 223 (225 ) 448 >100% Gains on sale of mortgages 3,175 2,231 944 42.3 Earnings on bank owned life insurance 418 411 7 1.7 Other miscellaneous income 896 82
814 >100%
Total other income 9,395 6,835
2,560 37.5 Trust and investment services income increased$121,000 , or 29.1%, and$169,000 , or 16.3%, for the three and six months endedJune 30, 2021 , compared to the same periods last year. This revenue consists of income from traditional trust services and income from alternative investment services provided through a third party. In the second quarter of 2021, traditional trust income increased by$4,000 , or 1.5%, while income from alternative investments increased by$116,000 , or 81.8%, compared to the second quarter of 2020. For the six months endedJune 30, 2021 , traditional trust services income increased by$65,000 , or 9.9%, while income from alternative investment services increased by$104,000 , or 27.0%, compared to the same period in 2020. The increase in income from the investment services area for both time periods can be partially attributed to transfer fees received from a new broker dealer that resulted in additional income of$60,000 in the first six months of 2021. The trust and investment services area continues to be an area of strategic focus for the Corporation. Management believes there continues to be great need for retirement, estate, small business succession planning, and personal investment services in the Corporation's service area. Management also sees these services as being a necessary part of a comprehensive line of financial solutions across the organization. Service charges on deposit accounts increased by$41,000 , or 20.0%, and decreased by$26,000 , or 5.0%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. The quarter-to-date increase and the year-to-date decrease can both be primarily attributed to changes in customer overdraft fees. With the onset of the COVID-19 pandemic in early 2020, overdraft fees declined significantly as customers were provided with government stimulus funds and were sitting on more cash and spending less. This caused overdraft fees to decline significantly in the second quarter of 2020. While the level of overdraft fees has increased by$28,000 , or 17.4% for the second quarter of 2021 compared to 2020, the year-to-date fees are still lower by$44,000 , or 10.4%. Various other fee income categories increased or decreased to lesser degrees making up the remainder of the variance compared to the prior year. Commissions increased by$303,000 , or 46.7%, and$481,000 , or 36.0%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. The increase was primarily caused by an increase in debit card interchange income of$241,000 , or 40.8%, for the three months endedJune 30, 2021 , and$404,000 , or 34.7%, for the six months endedJune 30, 2021 , compared to the same periods in the prior year. The interchange income is a direct result of the volume of debit card transactions processed and this income decreased during the second quarter of 2020 as customer spending changed with lower levels of purchases impacted by COVID-19, but increased again in late 2020 and throughout the first half of 2021.
For the three and six months endedJune 30, 2021 ,$274,000 and$362,000 of gains on securities transactions were recorded, respectively, compared to gains of$367,000 and$649,000 , respectively, for the same periods in 2020. Gains or losses on securities transactions fluctuate based on market opportunities to take gains and reposition the securities portfolio to improve long-term earnings, or as part of management's asset liability goals to improve liquidity or reduce interest rate risk or fair value risk. The gains or losses recorded by the Corporation depend heavily on market pricing and the volume of security sales. Generally, the lowerU.S. Treasury yields go, the more management will be motivated to pursue taking gains from the sale of securities. However, these market opportunities are evaluated subject to the Corporation's other asset liability measurements and goals. The yield curve in the first six months of 2021 and 2020 provided opportunities to take gains out of the portfolio. 46 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis Gains or losses on equity securities amounted to a loss of$24,000 during the second quarter of 2021, compared to a gain of$5,000 for the same period in the prior year. For the year-to-date period, gains on equity securities amounted to$223,000 in 2021, compared to a loss of$225,000 in 2020. Gains or losses on equity securities are impacted by actual sales of securities as well as changes in the market value of these securities since market value gains and losses are recorded through income. In the first six months of 2021,$95,000 of gains were recorded on the sale of bank stocks and$128,000 was recorded as an unrealized gain due to the increase in market value of the bank stock portfolio. During the first six months of 2020, unrealized losses of$225,000 were recorded due to the decline in bank stock prices as the COVID-19 pandemic began and negatively impacted the market. Gains on the sale of mortgages were$1,245,000 for the three-month period endedJune 30, 2021 , compared to$1,690,000 for the same period in 2020, a$445,000 , or 26.3% decrease. For the six-month period endedJune 30, 2021 , mortgage gains amounted to$3,175,000 , compared to$2,231,000 for the same period in 2020, a$944,000 , or 42.3% increase. While mortgage activity was slightly slower for the second quarter of 2021 compared to 2020, year-to-date activity was still higher resulting in the year-to-date increase in mortgage gains. The increased mortgage activity is the result of historically low interest rates and a surge in mortgage refinancing activity. Management currently anticipates that gains throughout the remainder of 2021 will decrease compared to the prior year as refinance activity slows down. The miscellaneous income category increased by$106,000 for the three months endedJune 30, 2021 , and$814,000 for the six months endedJune 30, 2021 , compared to the same periods in 2020. Net mortgage servicing income increased by$92,000 for the three months endedJune 30, 2021 , and$355,000 for the six months endedJune 30, 2021 , compared to the same periods in the prior year. This was due to much lower levels of mortgage servicing asset amortization in 2021. The slightly higher interest rate environment resulted in this lower level of amortization. Other miscellaneous income categories increased as well making up the remainder of the variance in this category. Operating Expenses Operating expenses for the second quarter of 2021 were$9,696,000 , an increase of$1,452,000 , or 17.6%, compared to the$8,244,000 for the second quarter of 2020. For the year-to-date period endedJune 30, 2021 , operating expenses totaled$18,883,000 , an increase of$1,529,000 , or 8.8%, compared to the same period in 2020. The following tables provide details of the Corporation's operating expenses for the three and six-month periods endedJune 30, 2021 , compared to the same periods in 2020. OPERATING EXPENSES (DOLLARS IN THOUSANDS) Three Months Ended June 30, 2021 2020 Increase (Decrease) $ $ $ %
Salaries and employee benefits 5,959
4,966 993 20.0 Occupancy expenses 635 616 19 3.1 Equipment expenses 285 316 (31 ) (9.8 )
Advertising & marketing expenses 245 218 27 12.4 Computer software & data processing expenses 1,102
768 334 43.5 Bank shares tax 275 239 36 15.1 Professional services 598 507 91 17.9 Other operating expenses 597 614 (17 ) (2.8 ) Total Operating Expenses 9,696 8,244 1,452 17.6 47 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis OPERATING EXPENSES (DOLLARS IN THOUSANDS) Six Months Ended June 30, 2021 2020 Increase (Decrease) $ $ $ % Salaries and employee benefits 11,658 10,662 996 9.3 Occupancy expenses 1,318 1,207 111 9.2 Equipment expenses 552 606 (54 ) (8.9 )
Advertising & marketing expenses 435 492 (57 ) (11.6 ) Computer software & data processing expenses 2,200
1,474 726 49.3 Bank shares tax 555 479 76 15.9 Professional services 1,036 1,130 (94 ) (8.3 ) Other operating expenses 1,129 1,304 (175 ) (13.4 ) Total Operating Expenses 18,883 17,354 1,529 8.8 Salaries and employee benefits are the largest category of operating expenses. In general, they comprise approximately 62% of the Corporation's total operating expenses. For the three months endedJune 30, 2021 , salaries and benefit costs increased by$993,000 , or 20.0%, from the second quarter of 2020. For the six months endedJune 30, 2021 , salaries and benefits increased by$996,000 , or 9.3%, from the year-to-date period in the prior year. The growth in salaries can primarily be attributed to higher mortgage commissions stemming from higher volume, merit and cost of living increases, additions to staff, and higher deferred salaries costs in the second quarter of 2020 stemming from higher levels of PPP loan production.
Occupancy expenses consist of the following:
· Depreciation of bank buildings
· Real estate taxes and property insurance
· Building lease expense · Utilities
· Building repair and maintenance
Occupancy expenses increased$19,000 , or 3.1%, and$111,000 , or 9.2%, for the three and six months endedJune 30, 2021 , compared to the same periods in the prior year. Utilities costs increased by$22,000 , or 13.4%, and$42,000 , or 12.1%, for the three and six months endedJune 30, 2021 , compared to the same periods in the prior year. For the year-to-date period, snow removal costs increased by$46,000 , or 321.7%, and building repair and maintenance costs increased by$22,000 , or 20.5%, compared to the year-to-date period in 2020. Various other occupancy expense categories increased or decreased by smaller amounts making up the remainder of the quarter and year-to-date variance. Equipment expenses decreased by$31,000 , or 9.8%, and$54,000 , or 8.9%, for the three and six months endedJune 30, 2021 , compared to the same periods in the prior year. Equipment depreciation costs decreased by$12,000 , or 6.6%, and$40,000 , or 10.8%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Additionally, equipment repair and maintenance costs decreased by$22,000 , or 59.5%, and$22,000 , or 37.8%, for the same time periods. Various other occupancy expense categories increased or decreased by smaller amounts making up the remainder of the quarter and year-to-date variance. Advertising and marketing expenses increased by$27,000 , or 12.4%, and decreased by$57,000 , or 11.6%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. These expenses can be further broken down into two categories, marketing expenses and public relations. The marketing expenses decreased by$17,000 , or 9.1%, for the quarter-to-date period, and$78,000 , or 21.4%, for the year-to-date period endedJune 30, 2021 , compared to the same periods in the prior year. Public relations expenses increased by$45,000 , or 169.0%, and$20,000 , or 15.8%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Marketing expenses support the overall business strategies of the Corporation; therefore, the timing of these expenses is highly dependent upon the execution of those strategies. 48 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis Computer software and data processing expenses increased by$334,000 , or 43.5%, for the second quarter of 2021 compared to 2020, and$726,000 , or 49.3%, for the six months endedJune 30, 2021 , compared to the same periods in 2020. Software-related expenses were up by$320,000 , or 71.8%, for the three months endedJune 30, 2021 , and by$656,000 , or 76.4%, for the six months endedJune 30, 2021 , compared to the same periods in the prior year. The increases were primarily as a result of of increased amortization on existing software as well as purchases of new software platforms to support the strategic initiatives of the Corporation. Software expenses are likely to continue to increase in 2021, but the actual increase will be dependent on how quickly new software platforms are identified, analyzed, approved and placed into service. Data processing fees were up$14,000 , or 4.4%, and$70,000 , or 11.4%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Bank shares tax expense was$275,000 for the second quarter of 2021, an increase of$36,000 , or 15.1%, from the second quarter of 2020. For the year-to-date period, shares tax increased by$76,000 , or 15.9%, compared to the prior year. Two main factors determine the amount of bank shares tax: the ending value of shareholders' equity and the ending value of tax-exemptU.S. obligations. The shares tax calculation uses a period-end balance of shareholders' equity and a tax rate of 0.95%. The increase in 2021 can be primarily attributed to the Corporation's growing value of shareholders' equity. Professional services expense increased by$91,000 , or 17.9%, and decreased by$94,000 , or 8.3%, for the three and six-month periods endedJune 30, 2021 , compared to the same periods in 2020. These services include accounting and auditing fees, legal fees, and fees for other third-party services. Payroll-related processing costs as well as contract employee expenses increased in total by$ 74,000 for the quarter-to-date period; accounting and auditing fees were higher by$29,000 , or 39.2%; and legal fees for the quarter increased by$24,000 , or 356.3%. The year-to-date decrease was caused by a decline in other outside service fees by$260,000 , or 47.2%, for the six months endedJune 30, 2021 , compared to the same period in 2020. Partially offsetting this decrease, payroll-related processing costs as well as contract employee expenses increased by$105,000 for the year-to-date period. Several other professional services expenses increased or decreased slightly making up the remainder of the variance. Other operating expenses decreased by$17,000 , or 2.8%, and$175,000 , or 13.4%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Contributing to this decrease, operating supplies costs declined by$66,000 , or 54.3%, for the quarter and$110,000 , or 49.5% for the year-to-date period when comparing both years. Loan related expenses decreased by$56,000 , or 35.8%, and$91,000 , or 35.8%, for the three and six months endedJune 30, 2021 , compared to the same periods in 2020. Partially offsetting these declines,FDIC and OCC assessment charges increased by$61,000 , or 53.1%, and$147,000 , or 85.4% for the quarter and year-to-date periods. Fraud-related charge-offs decreased by$25,000 for the quarter, and$63,000 for the year-to-date period endedJune 30, 2021 , compared to the same periods in the prior year. Several other operating expense categories increased or decreased by smaller amounts making up the remainder of this variance. Income Taxes For the six months endedJune 30, 2021 , the Corporation recorded Federal income tax expense of$1,492,000 , compared to$1,077,000 for the six months endedJune 30, 2020 . The effective tax rate for the Corporation was 15.6% for the six months endedJune 30, 2021 , and 15.7% for the six months endedJune 30, 2020 . Certain items of income are not subject to Federal income tax, such as tax-exempt interest income on loans and securities, and BOLI income; therefore, the effective income tax rate for the Corporation is lower than the stated tax rate. The effective tax rate is calculated by dividing the Corporation's provision for Federal income taxes on the Consolidated Statements of Income by the income before income taxes for the applicable period. The Corporation's effective tax rate has historically been maintained at low levels primarily due to a relatively high level of tax-free municipal bonds held in the securities portfolio. The fluctuation of the effective tax rate will occur as a result of total tax-free revenue as a percentage of total revenue. The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, the Corporation's Holding Company has very limited taxable corporate net income activities. The Corporation's wholly owned subsidiary,Ephrata National Bank , is subject to PennsylvaniaBank Shares Tax . Like Federal Corporate income tax, the PennsylvaniaBank Shares Tax is a significant expense for the Corporation, amounting to$555,000 in the first six months of 2021 compared to$479,000 in 2020. The Bank Shares Tax expense appears on the Corporation's Consolidated Statements of Income, under operating expenses.
49 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis Financial ConditionInvestment Securities The Corporation classifies all of its debt securities as available for sale and reports the portfolio at fair value. As ofJune 30, 2021 , the Corporation had$592.1 million of securities available for sale, which accounted for 37.5% of assets, compared to 33.1% as ofDecember 31, 2020 , and 26.3% as ofJune 30, 2020 . Based on ending balances, the securities portfolio increased 73.4% fromJune 30, 2020 , and 22.5% fromDecember 31, 2020 . The debt securities portfolio was showing a net unrealized gain of$9,319,000 as ofJune 30, 2021 , compared to an unrealized gain of$10,072,000 as ofDecember 31, 2020 , and$5,724,000 as ofJune 30, 2020 . The valuation of the Corporation's securities portfolio, predominately debt securities, is impacted by both theU.S. Treasury rates and the perceived forward direction of interest rates. The 10-yearU.S. Treasury yield was 0.66% as ofJune 30, 2020 , 0.93% as ofDecember 31, 2020 , and 1.45% as ofJune 30, 2021 . The lowerTreasury rates have caused an increase in market valuation, which has resulted in the unrealized gains recorded in all time periods. Gains were lower as ofJune 30, 2021 , compared to the end of 2020 due to the increase inTreasury rates experienced in the first and second quarters of 2021. Additionally, with theFederal Reserve's sudden overnight rate decreases in March of 2020, the variable rate portion of the Corporation's security portfolio lost market value due to the market's recognition that these instruments would yield materially less going forward which resulted in the lower levels of unrealized gains atJune 30, 2020 . The table below summarizes the Corporation's amortized cost, unrealized gain or loss position, and fair value for each sector of the securities portfolio for the periods endedJune 30, 2021 ,December 31, 2020 , andJune 30, 2020 .
AMORTIZED COST AND FAIR VALUE OF SECURITIES HELD
(DOLLARS IN THOUSANDS) Net Amortized Unrealized Fair Cost Gains (Losses) Value $ $ $June 30, 2021 U.S. treasuries 4,981 43 5,024 U.S. government agencies 29,620 (261 ) 29,359
U.S. agency mortgage-backed securities 62,258 649 62,907 U.S. agency collateralized mortgage obligations 36,911
617 37,528 Asset-backed securities 100,202 801 101,003 Corporate bonds 84,052 1,015 85,067
Obligations of states and political subdivisions 256,280 6,455 262,735 Total debt securities, available for sale 574,304
9,319 583,623 Equity securities 8,430 75 8,505 Total securities 582,734 9,394 592,128 December 31, 2020 U.S. government agencies 54,224 137 54,361
U.S. agency mortgage-backed securities 69,777 1,275 71,052 U.S. agency collateralized mortgage obligations 34,449
586 35,035 Asset-backed securities 60,387 88 60,475 Corporate bonds 60,387 1,336 61,723
Obligations of states and political subdivisions 187,132 6,650 193,782 Total debt securities 466,356 10,072 476,428 Equity securities 7,158 (53 ) 7,105 Total securities 473,514 10,019 483,533 50 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis Net Amortized Unrealized Fair Cost Gains (Losses) Value $ $ $ June 30, 2020 U.S. government agencies 8,217 162 8,379 U.S. agency mortgage-backed securities 71,241 1,312 72,553 U.S. agency collateralized mortgage obligations 45,854
708 46,562 Asset-backed securities 33,340 (1,389 ) 31,951 Corporate bonds 62,426 1,005 63,431
Obligations of states and political subdivisions 107,885
3,926 111,811 Total debt securities 328,963 5,724 334,687 Equity securities 6,977 (202 ) 6,775
Total securities available for sale 335,940
5,522 341,462
Interest rate changes and the perceived forward direction of interest rates generally have a close correlation to the valuation of the Corporation's fixed income securities portfolio. There are also a number of other market factors that impact bond prices. During the second half of 2019, theFederal Reserve decreased short-term rates three times for a total of 75 basis points, and during the first quarter of 2020, theFederal Reserve decreased short-term rates two times for a total of 150 basis points. Market conditions in the first quarter of 2020 were very unpredictable and fast changing due to the start of COVID-19 and the declaration of a global pandemic onMarch 11, 2020 .The Fed's reduction of interest rates was in response to this pandemic and caused short-term and long-termTreasury rates to decline at a rapid pace to reach all-time lows. During the first and second quarters of 2021, rates on the longer end of the yield curve did increase causing slight declines in the unrealized gains on the investment portfolio. The COVID-19 pandemic continues to have significant impacts on rates and the economy and management believes this will continue throughout 2021, but the absolute value and direction ofTreasury rates could fluctuate as the pandemic recovery reaches new levels. Beyond interest rate movements, there are also a number of other factors that influence bond pricing including regulatory changes, financial performance of issuers, changes to credit rating of insurers of bonds, changes in market perception of certain classes of securities, and many more. Management monitors the changes in interest rates and other market influences to assist in management of the securities portfolio. Any material increase in market interest rates would have a negative impact on the market value of the Corporation's fixed income debt securities. As ofJune 30, 2021 , approximately 76% of the Corporation's debt securities were fixed rate securities with the other 24% variable rate. The variable rate instruments generally experience very little impact to valuation based on a change in rates because they trade on a spread over overnight rates such as LIBOR. However, with theFederal Reserve drastically reducing the Federal Funds rate by 1.50% in March of 2020 to 0.25%, caused the market to view floating rate bonds differently, as the new effective yields on those securities would be significantly reduced upon the next rate reset. Fixed rate securities without call options could maintain their effective yield in a new bond market with sharply lower yields. Therefore, the valuation of the fixed rate securities held up better when the securities portfolio was valued forJune 30, 2020 . Since that time, the pricing of variable rate instruments has become more rational and most bonds have experienced an increase in unrealized gain since March of 2020. Generally the longer the bond and the longer the call protection, the better the bond did in terms of valuation. The municipal bond sector is the largest of the portfolio and, as a result, management will closely monitor the 10-yearU.S. Treasury yield due to its impact on these securities. The other sectors of the portfolio have shorter lives and duration and would be more influenced by the 2-year and 5-yearU.S. Treasury rates. The change in value of unrealized gains and losses for the remainder of 2021 will be impacted by movements inU.S. Treasury rates and could increase and decrease throughout the remainder of the year asTreasury rates fluctuate. The Corporation's effective duration increased in the second quarter of 2021 to 3.8, from 2.7 atDecember 31, 2020 , and 2.4 atJune 30, 2020 . Effective duration is a measurement of the length of the securities portfolio with a higher level indicating more length and more exposure to an increase in interest rates. Duration is expected to remain stable or increase slightly throughout the remainder of 2021. The Corporation increased effective duration by purchasing longer municipal securities in the first and second quarters of 2021. Additionally, with increasing rates, pass-through structures of mortgage backed securities (MBS) and collateralized mortgage obligations (CMO) instruments typically lengthen in duration as principal payments decrease. 51 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis Management's actions to maintain reasonable effective duration of the securities portfolio are part of a broader asset liability plan to continually work to mitigate future interest rate risk and fair value risk to the Corporation. Part of that strategy is to retain higher levels of cash and cash equivalents to increase liquidity and provide an immediate hedge against higher interest rates and fair value risk. However, despite taking actions to mitigate the Corporation's future risk, these risks are inherent to the banking model. Unrealized gains and losses on securities will vary significantly according to market forces. Management's focus will continue to be on the long-term performance of these securities. While management has and will continue to take gains from the portfolio when opportunities exist, the broader securities strategy remains to buy and hold debt securities until maturity. Because market interest rates were declining rapidly in 2020, there was some opportunity to realize gains from the sales of securities. As a result, gains from the sales of debt securities were higher in the second quarter of 2020 than the second quarter of 2021. The Corporation typically invests excess liquidity into securities, primarily fixed-income bonds. The securities portfolio provides interest and dividend income to supplement the interest income on loans. Additionally, the securities portfolio assists in the management of both liquidity risk and interest rate risk. In order to provide maximum flexibility for management of liquidity and interest rate risk, the securities portfolio is classified as available for sale and reported at fair value. Management adjusts the value of all the Corporation's securities on a monthly basis to fair market value as determined in accordance withU.S. generally accepted accounting principles. Management has the ability and intent to hold all debt securities until maturity, and does not generally record impairment on bonds that are currently valued below book value. In addition to the fixed and variable rate bonds, the Corporation's equity holdings consist of a small CRA-qualified mutual fund with a book and fair market value of$7.2 million . The CRA fund is aSmall Business Association (SBA) variable rate fund with a stable dollar price. The Corporation also has a small portfolio of bank stocks with a book value of$1,225,000 and fair market value of$1,300,000 as ofJune 30, 2021 . The fair value of the bank stocks was significantly impacted by the COVID-19 pandemic and the drastic devaluation of bank stocks during 2020 but has rebounded as ofJune 30, 2021 , and is responsible for the increase in gains on equity securities reported as ofJune 30, 2021 .
All securities and bonds are evaluated for impairment on a quarterly basis. Should any impairment occur, management would write down the security to a fair market value in accordance withU.S. generally accepted accounting principles, with the amount of the write down recorded as a loss on securities.
Each quarter, management sets portfolio allocation guidelines and adjusts the security portfolio strategy generally based on the following factors:
· ALCO positions as to liquidity, credit risk, interest rate risk, and fair value
risk
· Growth of the loan portfolio
· Slope of the
· Relative performance of the various instruments, including spread to
Treasuries
· Duration and average length of the portfolio
· Volatility of the portfolio
· Direction of interest rates
· Economic factors impacting debt securities
The investment policy of the Corporation imposes guidelines to ensure diversification within the portfolio. The diversity specifications provide opportunities to shorten or lengthen duration, maximize yield, and mitigate credit risk. The composition of the securities portfolio based on fair market value is shown in the following table.
52 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis SECURITIES PORTFOLIO (DOLLARS IN THOUSANDS) Period Ending June 30, 2021 December 31, 2020 June 30, 2020 $ % $ % $ % U.S. treasuries 5,024 0.8 - - - - U.S. government agencies 29,359 5.0 54,361 11.2 8,379 2.5U.S. agency mortgage-backed securities 62,907 10.6 71,052 14.7 72,553 21.2U.S. agency collateralized mortgage obligations 37,528 6.3 35,035 7.2 46,562 13.6 Asset-backed securities 101,003 17.1 60,475 12.5 31,951 9.4 Corporate debt securities 85,067 14.4 61,723 12.8 63,431 18.6 Obligations of states and political subdivisions 262,735 44.4 193,782 40.1 111,811 32.7 Total debt securities, available for sale 583,623 98.6 476,428 98.5 334,687 98.0 Marketable equity securities 8,505 1.4 7,105 1.5 6,775 2.0 Total securities 592,128 100.0 483,533 100.0 341,462 100.0
The largest movements within the securities portfolio were shaped by market factors, such as:
· slope of the
· interest spread versus
· pricing of the instruments, including supply and demand for the product
· structure of the instruments, including duration and average life
· portfolio weightings versus policy guidelines
· prepayment speeds on mortgage-backed securities and collateralized mortgage
obligations
· credit risk of each instrument and risk-based capital considerations
· Federal income tax considerations with regard to obligations of tax-free states
and political subdivisions.
The Corporation purchased$5.0 million ofU.S. treasuries during the second quarter of 2021 and held no treasuries in 2020, resulting in the increase in this sector which represents a safe credit at a market appropriate yield which added some diversity to the portfolio. The Corporation'sU.S. government agency sector decreased by$25.0 million , or 46.0%, sinceDecember 31, 2020 , with the weighting decreased from 11.2% of the portfolio to 5.0%. Management had purchased$35.5 million of short-term discount notes at the end of 2020 to offset the Corporation's shares tax expense. These bonds were sold in the first quarter of 2021 and are responsible for the decline in this category. In the past, management's goal was to maintain agency securities at approximately 10% of the securities portfolio. In the current rate environment, management is comfortable maintaining agencies below this level. In the past, this sector was important in maintaining adequate risk weightings of the portfolio and to ensure sufficientU.S. government securities for pledging purposes, but the Corporation is also utilizing both MBS and CMOs to do the same. Instead, Management has increased the allocations of both asset-backed securities (ABS) and obligations of states and political subdivisions (municipals) sinceJune 30, 2020 , in order to better structure the portfolio to achieve higher yields while also protecting in preparation for a rates-up environment. The Corporation's ABS and municipal sectors have increased significantly sinceJune 30, 2020 , with ABS increasing$69.1 million , or 216.1%, and municipals increasing$150.9 million , or 135.0%. ABS securities are floating rate student loan pools which are instruments that will perform well in a rates-up environment and offset the interest rate risk of the longer fixed-rate municipal bonds. These securities provide a variable rate return materially above the overnight Federal funds rate in a safe investment with a risk rating very similar to that ofU.S. Agency bonds. The asset-backed securities generally provide monthly principal and interest payments to complement the Corporation's ongoing cash flows. With liquidity and cash levels remaining high, management views the ABS sector as a safe, higher yielding option than cash, with the qualities of cash in a rates-up environment. Obligations of states and political subdivisions, or municipal bonds, are tax-free and taxable securities that generally provide the highest yield in the securities portfolio. They also carry the longest duration on average of any instrument in the securities portfolio. Municipal tax-equivalent yields generally start well above other taxable bonds. These instruments also experience significant fair market value gains and losses when interest rates decrease and increase. Municipal securities were purchased throughout 2020 and the first half of 2021 due to market conditions that led to favorable yields on some instruments. The Corporation also began purchasing some taxable municipal securities that added to the value of this sector. Municipal bonds represented 44.5% of the securities portfolio as ofJune 30, 2021 , compared to 32.7% as ofJune 30, 2020 . The Corporation's investment policy limits municipal holdings to 150% of Tier 2 capital. As ofJune 30, 2021 , municipal holdings amounted to 165% of Tier 2 capital, above this limit. The Corporation plans to sell some municipal bonds to be back within policy guidelines bySeptember 30, 2021 .
53 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis The Corporation'sU.S. agency MBS and CMO sectors have fluctuated sinceJune 30, 2020 , with MBS decreasing$9.6 million , or 13.3%, and CMOs decreasing$9.0 million , or 19.4%. These two security types both consist of mortgage instruments that pay monthly interest and principal, however the behavior of the two types vary according to the structure of the mortgage pool or CMO instrument. Management desires to maintain a substantial amount of MBS and CMOs in order to assist in adding to and maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity and interest rate risk positions. Unlike the typicalU.S. agency paper, corporate bonds, and obligations of states and political subdivisions, which only pay principal at final maturity, theU.S. agency MBS and CMO securities pay contractual monthly principal and interest, but are also subject to additional prepayment of principal. The combined effect of all of these instruments paying monthly principal and interest provides the Corporation with a reasonably stable base cash flow of approximately$2.5 -$3.0 million per month. Cash flows coming off of MBS and CMOs do slow down and speed up as interest rates increase or decrease, which has an impact on the portfolio's length and yield. As interest rates decline, prepayment of principal on securities increases, the duration of the security shortens, and the yield declines as more amortization is required on premium bonds. When interest rates increase, the opposite of this occurs. Despite the fluctuations that occur in terms of monthly cash flow as a result of changing prepayment speeds, the monthly cash flow generated byU.S. agency MBS and CMO securities is reasonably stable and as a group is material, and helps to soften or smooth out the Corporation's total monthly cash flow from all securities. As ofJune 30, 2021 , the fair value of the Corporation's corporate bonds increased by$21.6 million , or 34.1%, from balances atJune 30, 2020 . Like any security, corporate bonds have both positive and negative qualities and management must evaluate these securities on a risk versus reward basis. Corporate bonds add diversity to the portfolio and provide strong yields for short maturities; however, by their very nature, corporate bonds carry a high level of credit risk should the entity experience financial difficulties. Management stands to possibly lose the entire principal amount if the entity that issued the corporate paper fails. As a result of the higher level of credit risk taken by purchasing a corporate bond, management has in place procedures to closely analyze the financial health of the company as well as policy guidelines. The guidelines include both maximum investment by issuer and minimal credit ratings that must be met in order for management to purchase a corporate bond. Financial analysis is conducted prior to every corporate bond purchase with ongoing monitoring performed on all securities held. By policy, management is to identify and recommend whether to hold or sell securities with credit ratings that have fallen below minimum policy credit ratings required at the time of purchase, or below investment grade. Management monitors the security ratings on a monthly basis and reviews quarterly with the Board of Directors. Management, with Board approval, determines whether it is in the Corporation's best interest to continue to hold any security that has fallen below policy guidelines or below investment grade based on the expectation of recovery of market value or improved performance. At this time management has elected, and the Board has approved, holding all securities that have fallen below initial policy guidelines. As ofJune 30, 2021 , no securities have fallen below investment grade. As ofJune 30, 2021 , five of the 44 corporate securities held by the Corporation showed an unrealized holding loss. These securities with unrealized holding losses were valued at 99.7% of book value. The Corporation's investment policy requires that corporate bonds have a minimum credit rating of A3 by Moody's or A- by S&P or Fitch at the time of purchase, or an average or composite rating of A-. As ofJune 30, 2021 , all but two of the corporate bonds had at least one A3 or A- rating by one of the two predominate credit rating services, Moody's and S&P. Two corporate bonds had a total book value of$4.6 million , and did not have an A3 or A- rating as ofJune 30, 2021 . These bonds were rated Moody's Baa1 and S&P BBB+, which are two levels above the minimum required to be considered investment grade. Management conducts ongoing monitoring of these securities and has chosen to continue to hold the bonds with Board approval. In addition, there are fifteen corporate bond instruments that have split ratings with the highest rating within the Corporation's initial purchase policy guidelines and the lower rating outside of management guidelines, but all are still investment grade. The fifteen bonds have a book value of$24.4 million with a$391,000 unrealized gain as ofJune 30, 2021 . Management conducts ongoing monitoring of these bonds with the Board approving holding these securities on a quarterly basis. In addition, the Corporation purchased$4,900,000 of subordinated debt notes from six different entities during late 2020 and into 2021, all of which are unrated. These are considered corporate bonds as they each are subordinated debt of a domestic community bank but are unrated because they are not a typical corporate issuance. Currently, there are no indications that any of these bonds would discontinue contractual payments. 54 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis The Corporation's investment policy requires that municipal bonds not carrying any insurance coverage have a minimum credit rating of A3 by Moody's or A- by S&P or Fitch at the time of purchase. As ofJune 30, 2021 , one municipal bond with a par value of$500,000 was unrated, and no other municipal bonds carried a credit rating under these levels. Management utilizes several municipal surveillance reports and engages an independent non-brokerage service third party to perform enhanced municipal credit evaluation. Management will typically sell municipal securities if negative trends in financial performance are found and/or ratings have declined to levels deemed unacceptable. As a result of the above monitoring and actions taken to proactively sell weaker municipal credits, the Corporation's entire municipal bond portfolio consists of investment grade credits. The entire securities portfolio is reviewed monthly for credit risk and evaluated quarterly for possible impairment. The Corporation's municipal and corporate bonds present the largest credit risk and highest likelihood for any possible impairment. Due to the ability for corporate credit situations to change rapidly and ongoing nationwide concerns of pension obligations impacting municipalities, management continues to closely monitor all corporate and municipal securities. Loans Net loans outstanding increased by 3.9%, to$857.1 million atJune 30, 2021 , from$825.2 million atJune 30, 2020 . Net loans increased by 5.7%, an annualized rate of 11.4%, from$811.0 million atDecember 31, 2020 . The following table shows the composition of the loan portfolio as ofJune 30, 2021 ,December 31, 2020 , andJune 30, 2020 . LOANS BY MAJOR CATEGORY (DOLLARS IN THOUSANDS) June 30, December 31, June 30, 2021 2020 2020 $ % $ % $ % Commercial real estate Commercial mortgages 156,022 17.9 142,698 17.4 125,925 15.1 Agriculture mortgages 178,573 20.5 176,005 21.4 175,108 20.9 Construction 21,347 2.5 23,441 2.9 20,285 2.4 Total commercial real estate 355,942 40.9 342,144 41.7 321,318 38.4 Consumer real estate (a) 1-4 family residential mortgages 288,301 33.2 263,569
32.0 261,772 31.3 Home equity loans 11,525 1.3 10,708 1.3 10,688 1.3 Home equity lines of credit 71,694 8.2 71,290 8.7 69,507 8.3 Total consumer real estate 371,520 42.7 345,567 42.0 341,967 40.9 Commercial and industrial Commercial and industrial 102,533 11.8 97,896 11.9 129,459 15.5 Tax-free loans 16,268 1.9 10,949 1.3 16,607 2.0 Agriculture loans 17,824 2.1 20,365 2.5 21,581 2.6
Total commercial and industrial 136,625 15.8 129,210
15.7 167,647 20.1 Consumer 5,133 0.6 5,155 0.6 5,061 0.6 Total loans 869,220 100.0 822,076 100.0 835,993 100.0 Less:
Deferred loan fees (costs), net (535 ) (1,294 )
24 Allowance for credit losses 12,703 12,327 10,770 Total net loans 857,052 811,043 825,199
(a) Residential real estate loans do not include mortgage loans serviced for
others which totaled
December 31, 2020 , and$187,258,000 as ofJune 30, 2020 . 55 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis There was moderate growth in the loan portfolio sinceJune 30, 2020 , andDecember 31, 2020 . Most major loan categories showed an increase in balances from both time periods with the exception of the commercial and industrial loans which showed a decline due to the forgiveness of PPP loans sinceJune 30, 2020 . The consumer residential real estate category represents the largest group of loans for the Corporation. The consumer residential real estate category of total loans increased from$342.0 million onJune 30, 2020 , to$371.5 million onJune 30, 2021 , a 8.6% increase. This category includes closed-end fixed rate or adjustable-rate residential real estate loans secured by 1-4 family residential properties, including first and junior liens, and floating rate home equity loans. The 1-4 family residential mortgages account for the vast majority of residential real estate loans with fixed and floating home equity loans making up the remainder. Historically, the entire consumer residential real estate component of the loan portfolio has averaged close to 40% of total loans. As ofJune 30, 2020 , this percentage was 40.9%, and as ofJune 30, 2021 , it increased to 42.7%. Management expects the consumer residential real estate category to stabilize throughout the remainder of 2021. The strategic decision was made in the first half of 2021 to keep some shorter-term mortgages on the books as opposed to selling them on the secondary market, which resulted in an increase in 1-4 family portfolio mortgages. With a number of these long-term assets now on the balance sheet, management has backed off of this strategy in order to protect against rising interest rates in the future. Although economic conditions for consumers have deteriorated with the COVID-19 pandemic, increased unemployment, and decreased consumer spending, the mortgage market continues to remain relatively strong as consumers refinance existing debt to lower rates. Market conditions have been changing rapidly throughout the first half of 2021 and the rest of the year is unpredictable, but management would expect mortgage volume to continue at fairly high levels from a historic perspective. The first lien 1-4 family mortgages increased by$26.5 million , or 10.1%, fromJune 30, 2020 , toJune 30, 2021 . These first lien 1-4 family loans made up 76.5% of the residential real estate total as ofJune 30, 2020 , and 77.6% as ofJune 30, 2021 . The vast majority of the first lien 1-4 family closed end loans consist of single family personal first lien residential mortgages and home equity loans, with the remainder consisting of 1-4 family residential non-owner-occupied mortgages. In the second quarter of 2021, mortgage production increased 22% over the previous quarter and was up 16% over the second quarter of 2020. Purchase money origination constituted 70% of the Corporation's mortgage originations for the quarter, with construction-only and construction-permanent loans making up 50% of that mix. With a decrease in refinance activity as a percentage of overall volume, the percentage of mortgage originations going in the Corporation's held-for-investment mortgage portfolio increased quarter-over-quarter, particularly with respect to a higher volume of new construction business. In the second quarter of 2021, 70% of all mortgage originations were held in the mortgage portfolio, 55% of which were adjustable rate mortgages. As ofJune 30, 2021 , ARM balances were$129.9 million , representing 45.1% of the 1-4 family residential loan portfolio of the Corporation. The ARM product is beneficial to the Corporation as it limits the interest rate risk to a much shorter time period. With a small increase in interest rates, a decrease in volume being delivered into the secondary market, and a decision by management to move loans originally earmarked for sale on the secondary market into the bank's own portfolio, the gains on the sale of mortgages decreased by 35% quarter-over-quarter. As ofJune 30, 2021 , the remainder of the residential real estate loans consisted of$11.5 million of fixed rate junior lien home equity loans, and$71.7 million of variable rate home equity lines of credit (HELOCs). This compares to$10.7 million of fixed rate junior lien home equity loans, and$69.5 million of HELOCs as ofJune 30, 2020 . Therefore, combined, these two types of home equity loans increased from$80.2 million to$83.2 million , an increase of 3.7%. The majority of borrowers have been choosing variable rate HELOC loans in the historically low rate environment. With no sign of theFederal Reserve moving to increase rates, management expects HELOC activity to increase with customers choosing variable rate product over fixed rate product until rates begin to increase again. Commercial real estate makes up 40.9% of total loans as ofJune 30, 2021 , compared to 38.4% of total loans as ofJune 30, 2020 . Within the commercial real estate segment, the increase has primarily been in commercial mortgages, with agriculture mortgages and construction loans remaining fairly stable. Agricultural mortgages increased by$3.5 million , or 2.0%, from$175.1 million as ofJune 30, 2020 , to$178.6 million as ofJune 30, 2021 . Dairy lending is showing signs of improvement. Locally, 2021 milk prices are trending positively. Nationally, prices have seen some normality return which is reflected in the futures price. Over the past 12 months, there has been a small percentage of dairy farmers that have left the conventional dairy operation and have switched to organic and/or specialty products. This has opened up new financing opportunities. While dairy remains the largest agricultural loan concentration, management believes dairy loans will decline as a percentage of total agricultural loans with other non-dairy agricultural areas growing. Currently, management is experiencing more growth in specialty crops and other areas outside of dairy like poultry and layers. Management anticipates that agricultural mortgages may increase through the remainder of 2021 as the economy stabilizes and more farmers move forward with capital improvements or expansion of current operations. 56 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis Commercial mortgages increased$30.1 million , or 23.9%, from balances atJune 30, 2020 . Commercial mortgages as a percentage of the total loan portfolio increased to 17.9% as ofJune 30, 2021 , compared to 15.1% atJune 30, 2020 . New loan production in this segment is currently outpacing normal principal payments, pay downs, and payoffs. Commercial real estate loans have shown solid growth as a number of businesses move ahead on commercial projects. Management expects commercial real estate loans to remain stable as a percentage of the Corporation's loans for the remainder of 2021. The Corporation's commercial construction loan balances increased by$1.1 million , or 5.2%, fromJune 30, 2020 toJune 30, 2021 . Management was experiencing some demand for smaller residential builds like construction on existing lots but no new large scale projects. Commercial construction loans were 2.5% of the total loan portfolio as ofJune 30, 2021 and 2.4% as ofJune 30, 2020 .
The other area of commercial lending is non-real estate secured commercial lending, referred to as commercial and industrial lending. Commercial and industrial loans not secured by real estate accounted for 15.8% of total loans as ofJune 30, 2021 , compared to 20.1% as ofJune 30, 2020 . In scope, the commercial and industrial loan sector, at 15.8% of total loans, is significantly smaller than the commercial real estate sector at 40.9% of total loans. This is consistent with management's credit preference for obtaining real estate collateral when making commercial loans. The balance of total commercial and industrial loans decreased from$167.6 million atJune 30, 2020 , to$136.6 million atJune 30, 2021 , a 18.5% decrease. This category of loans generally includes unsecured lines of credit, truck, equipment, and receivable and inventory loans, in addition to tax-free loans to municipalities. The balance atJune 30, 2021 andJune 30, 2020 , also includes the PPP loans, which has declined rapidly as these loans are forgiven by the SBA after businesses prove they used the funds for qualified expenses. Management anticipates that these loans will experience a significant decline in the remainder of 2021. The Corporation provides credit to many small and medium-sized businesses. Much of this credit is in the form of Prime-based lines of credit to local businesses where the line may not be secured by real estate, but is based on the health of the borrower with other security interests on accounts receivable, inventory, equipment, or through personal guarantees. Commercial and industrial loans, including PPP loans, decreased to$102.5 million atJune 30, 2021 , a$27.0 million , or 20.8% decrease, from the$129.5 million atJune 30, 2020 . This decrease was driven primarily by the forgiveness of some of the first round of PPP loans during the fourth quarter of 2020 and the first quarter of 2021, but new loan generation during the first half of 2021 offset some of the forgiven balances. The tax-free loans declined by$0.3 million , or 2.0%, from balances atJune 30, 2020 , and the commercial and industrial agricultural loans declined by$3.8 million , or 17.4%. The consumer loan portfolio remained the same fromJune 30, 2020 , toJune 30, 2021 , at$5.1 million . Consumer loans made up 0.6% of total loans for both time periods. The long-term trend over the past decade has seen homeowners turning to the equity in their homes to finance cars and education rather than traditional consumer loans that are generally unsecured. Slightly higher demand for unsecured credit is being outpaced by principal payments on existing loans resulting in the decrease in balances. Management anticipates that the Corporation's level of consumer loans will likely remain stable as a percentage of the portfolio, as the need for additional unsecured credit is generally offset by those borrowers wishing to reduce debt levels and move away from the higher cost of unsecured financing relative to other forms of real estate secured financing. Non-Performing Assets
Non-performing assets include:
· Nonaccrual loans
· Loans past due 90 days or more and still accruing
· Non-performing troubled debt restructurings
· Other real estate owned 57 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
NON-PERFORMING ASSETS (DOLLARS IN THOUSANDS) June 30, December 31, June 30, 2021 2020 2020 $ $ $ Nonaccrual loans 651 725 886
Loans past due 90 days or more and still accruing 287 1,373 309 Troubled debt restructurings, non-performing - - 439 Total non-performing loans 938
2,098 1,634 Other real estate owned - - -
Total non-performing assets 938
2,098 1,634
Non-performing assets to net loans 0.11 %
0.25 % 0.38 % The total balance of non-performing assets decreased by$0.7 million , or 42.7%, and$1.2 million , or 55.3%, from balances atJune 30, 2020 andDecember 31, 2020 , respectively. The decrease from the prior periods was primarily due to lower levels of loans past due 90 days or more as well as a decrease in non-performing troubled debt restructurings (TDRs). There were no non-performing TDR loans as ofJune 30, 2021 orDecember 31, 2020 . A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial position of the borrower and improve the likelihood of full collection by the lender. There was one non-performing TDR as ofJune 30, 2020 ; a$439,000 real estate secured loan with a payment modification to allow annual interest and principal payments. Non-accrual loans decreased, by$0.2 million , or 26.5%, sinceJune 30, 2020 , and loans past due 90 days or more and still accruing were down slightly from the prior year period, and down more significantly, by$1.1 million , or 79.2% sinceDecember 31, 2020 . The$1.1 million of non-accrual reduction that occurred betweenJune 30, 2020 andDecember 31, 2020 was due to two commercial borrowers paying off their loans during the remainder of 2020. One commercial borrower with three non-accrual loans totaling over$1.0 million paid them off in the second quarter of 2020, while another commercial borrower with a$92,000 non-accrual loan was paid off inDecember 2020 .
Management continues to monitor delinquency trends and the level of non-performing loans closely. At this time, management believes that the potential for material losses related to non-performing loans is decreasing with the level of delinquencies and non-performing loans lower than what was experienced throughout 2020.
There was no other real estate owned (OREO) as of
Allowance for Credit Losses The allowance for credit losses is established to cover any losses inherent in the loan portfolio. Management reviews the adequacy of the allowance each quarter based upon a detailed analysis and calculation of the allowance for credit losses. This calculation is based upon a systematic methodology for determining the allowance for credit losses in accordance with generally accepted accounting principles. The calculation includes estimates and is based upon losses inherent in the loan portfolio. The allowance calculation includes specific provisions for under-performing loans and general allocations to cover anticipated losses on all loan types based on historical losses. The calculation is also influenced by nine qualitative factors that are adjusted on a quarterly basis as needed. Based on the quarterly credit loss calculation, management will adjust the allowance for credit losses through the provision as necessary. Changes to the allowance for credit losses during the year are primarily affected by five main factors: · Historical loan losses
· Qualitative factor adjustments including levels of delinquent and
non-performing loans
· Growth trends of the loan portfolio
· Recovery of loans previously charged off
· Provision for loan losses 58 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
Strong credit and collateral policies have been instrumental in producing a favorable history of loan losses for the Corporation. The Allowance for Credit Losses table below shows the activity in the allowance for credit losses for the six-month periods endedJune 30, 2021 andJune 30, 2020 . At the bottom of the table, two benchmark percentages are shown. The first is net charge-offs as a percentage of average loans outstanding for the year. The second is the total allowance for credit losses as a percentage of total loans. ALLOWANCE FOR CREDIT LOSSES (DOLLARS IN THOUSANDS) Six Months Ended June 30 2021 2020 $ $ Balance at January 1, 12,327 9,447 Loans charged off: Real estate - - Commercial and industrial - - Consumer 23 16 Total charged off 23 16 Recoveries of loans previously charged off: Real estate - (11 ) Commercial and industrial (17 ) (2 ) Consumer (7 ) (1 ) Total recovered (24 ) (14 )
Net loans charged off (recovered) (1 )
2
Provision charged to operating expense 375
1,325 Balance at June 30, 12,703 10,770
Net charge-offs as a % of average total loans outstanding 0.00 %
0.00 %
Allowance at end of period as a % of total loans 1.46 %
1.29 %
Charge-offs for the six months endedJune 30, 2021 , were$23,000 , compared to$16,000 for the same period in 2020. Management typically charges off unsecured debt over 90 days delinquent with little likelihood of recovery. In the first half of 2021 and 2020, the Corporation charged off several smaller amounts related to consumer loans. Recoveries were also low in the first half of 2020 and 2021with total recoveries of$24,000 in the first half of 2021 and$14,000 in the first quarter of 2020. The allowance as a percentage of total loans represents the portion of the total loan portfolio for which an allowance has been provided. Management regularly reviews the overall risk profile of the loan portfolio and the impact that current economic trends have on the Corporation's loans. The financial industry typically evaluates the quality of loans on a scale with "unclassified" representing healthy loans, "special mention" being the first indication of credit concern, and several successive classified ratings indicating further credit declines of "substandard," "doubtful," and, ultimately, "loss." The Corporation's level of classified loans was$22.2 million onJune 30, 2021 , compared to$25.1 million onJune 30, 2020 . Total classified loans increased during 2020 but then decreased byDecember 31, 2020 , and into the first half of 2021. Having more loans in a classified status could result in a larger allowance as higher amounts of projected historical losses and qualitative factors are attached to these loans. In addition to this impact, management performs a specific allocation test on these classified loans. There was$1.1 million of specifically allocated allowance against the classified loans as ofJune 30, 2021 ,$1.1 million of specific allocation as ofDecember 31, 2020 , and$64,000 of specific allocation as ofJune 30, 2020 . The higher specific allocation atJune 30, 2021 andDecember 31, 2020 , is related to a customer with ongoing business concerns. Typically, as the classified loan balances fluctuate, the associated specific allowance applied to them fluctuates, resulting in a lower or higher required allowance. 59 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The net charge-offs as a percentage of average total loans outstanding indicates the percentage of the Corporation's total loan portfolio that has been charged off during the period, after reducing charge-offs by recoveries. The Corporation continues to experience low net charge-off percentages due to strong credit practices. Management continually monitors delinquencies, classified loans, and non-performing loans closely in regard to how they may impact charge-offs in the future. The actual charge-offs have been running at low levels, and management expects this to continue through the remainder of 2021. Management practices are in place to reduce the number and severity of losses. In regard to severely delinquent loans, management attempts to improve the Corporation's collateral or credit position and, in the case of a loan workout, intervene to minimize additional charge-offs. The allowance as a percentage of total loans was 1.46% as ofJune 30, 2021 , 1.50% as ofDecember 31, 2020 , and 1.29% as ofJune 30, 2020 . Management anticipates that the allowance percentage will remain fairly stable during the remainder of 2021, as the allowance balance is increased with additional provision expense to account for loan growth throughout the year. It is typical for the allowance for credit losses to contain a small amount of excess reserves. Over the long term, management targets and excess reserve at approximately 5% knowing that the reserve can fluctuate. The excess reserve stood at 4.7% as ofJune 30, 2021 . Management would anticipate that this unallocated portion of the allowance will remain stable throughout the remainder of 2021. Premises and Equipment
Premises and equipment, net of accumulated depreciation, decreased by$0.2 million , or 0.8%, to$24.7 million as ofJune 30, 2021 , from$24.9 million as ofJune 30, 2020 . As ofJune 30, 2021 ,$379,000 was classified as construction in process compared to$178,000 as ofJune 30, 2020 . Fixed assets declined as a result of depreciation outpacing new purchases in 2021. Regulatory Stock
The Corporation owns multiple forms of regulatory stock that is required in order to be a member of theFederal Reserve Bank (FRB) and members of banks such as theFederal Home Loan Bank (FHLB) andAtlantic Community Bankers Bank (ACBB). The Corporation's$5.9 million of regulatory stock holdings as ofJune 30, 2021 , consisted of$5.3 million of FHLB ofPittsburgh stock,$601,000 of FRB stock, and$37,000 ofAtlantic Community Bancshares, Inc. stock, theBank Holding Company of ACBB. All of these stocks are valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the investment is carried at book value and there is no fair market value adjustment. The Corporation's investment in FHLB stock is required for membership in the organization. The amount of stock required is dependent upon the relative size of outstanding FHLB borrowings and mortgage activity. Excess stock is typically repurchased from the Corporation at par if the borrowings decline to a predetermined level. The Corporation's FHLB stock position was$5.2 million onJune 30, 2021 ,$5.9 million onDecember 31, 2020 , and$6.8 million onJune 30, 2020 , with no excess capital stock position. Any future stock repurchases would be the result of lower borrowing balances. Stock repurchases by the FHLB occur every quarter.
The 2021 second quarter dividend declaration made on FHLB stock by FHLB of
Deposits The Corporation's total ending deposits atJune 30, 2021 , increased by$116.1 million , or 9.3%, and by$261.0 million , or 23.6%, fromDecember 31, 2020 , andJune 30, 2020 , respectively. Customer deposits are the Corporation's primary source of funding for loans and securities. In the past few years, the economic concerns and volatility of the equity markets continued to lead customers to banks for safe places to invest money, despite historically low interest rates. The mix of the Corporation's deposit categories has changed moderately sinceJune 30, 2020 , with the changes being a$116.4 million , or 24.9% increase in non-interest bearing demand deposit accounts, a$14.3 million , or 34.9% increase in interest bearing demand balances, a$26.6 million , or 25.4% increase in NOW balances, a$39.0 million , or 31.7% increase in money market account balances, a$73.5 million , or 29.8% increase in savings account balances, and a$8.8 million , or 7.0% decrease in time deposit balances. 60 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis The growth across most categories of core deposit accounts is a direct result of the PPP funding, government stimulus payments, and the change in customer's spending habits during the uncertain economic conditions brought on by COVID-19. Due to limited safe investment options outside of banks, the Corporation saw customers bring deposit funds back to regular core checking and savings accounts in an effort to provide safety and financial flexibility. With the decrease in rates that occurred during 2020, customer deposits increased with few options in the market to earn a higher return. Customers view demand deposit, money market and savings accounts as the safest, most convenient place to maintain funds for maximum flexibility. Management believes deposit balances may continue to increase, but at a slower pace, through the remainder of 2021.
The Deposits by Major Classification table, shown below, provides the balances
of each category for
DEPOSITS BY MAJOR CLASSIFICATION
(DOLLARS IN THOUSANDS) June 30, December 31, June 30, 2021 2020 2020 $ $ $ Non-interest bearing demand 582,747 534,853 466,392 Interest bearing demand 55,419 47,092 41,083 NOW accounts 131,151 137,279 104,593 Money market deposit accounts 162,247 140,113 123,212 Savings accounts 320,252 274,386 246,762 Time deposits 117,068 119,088 125,872 Total deposits 1,368,884 1,252,811 1,107,914
The growth and mix of deposits is often driven by several factors including:
· Convenience and service provided
· Current rates paid on deposits relative to competitor rates
· Level of and perceived direction of interest rates
· Financial condition and perceived safety of the institution
· Possible risks associated with other investment opportunities
· Level of fees on deposit products
The Corporation has been a stable presence in the local market area that has experienced several large bank mergers over the past several years. Three new convenient locations were added since 2016, significantly expanding the Corporation's footprint, with a presence in three counties with a total of thirteen branch locations. The Corporation has a history of offering competitive interest rates and fair and understandable service fees because of a strong commitment to the customers and the communities that it serves. Management has always priced products and services in a manner that makes them affordable for all customers. This in turn creates a high degree of customer loyalty and a stable deposit base. Additionally, as financial institutions have come under increased scrutiny from both regulators and customers, the Corporation has maintained an outstanding reputation. Management believes the Corporation's deposit base has benefited as a result of a growing desire by customers to seek a longstanding, reliable financial institution as a partner to meet their financial needs. Time deposits are typically a more rate-sensitive product, making them a source of funding that is prone to balance variations depending on the interest rate environment and how the Corporation's time deposit rates compare with the local market rates. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution. As ofJune 30, 2021 , time deposit balances had decreased$8.8 million , or 7.0%, fromJune 30 2020 , and decreased$2.0 million , or 1.7% fromDecember 31, 2020 . The Corporation has experienced a slow and steady shift in deposit trends over the past five years as customers have moved money from time deposits into core checking and savings accounts. With theFederal Reserve rate decreases in 2020, there is minimal differences between shorter term CD rates and interest bearing non-maturity deposits, influencing customers to accumulate their funds in a liquid account that can be accessed at any time. This has resulted in declining time deposit balances and more significant growth in the core deposit areas. 61 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis Borrowings
Total borrowings were$69.8 million ,$74.4 million , and$65.1 million as ofJune 30, 2021 ,December 31, 2020 , andJune 30, 2020 , respectively. Of these amounts, there were no short-term funds outstanding as ofJune 30, 2021 ,December 31, 2020 orJune 30, 2020 . Short-term funds are used for immediate liquidity needs and are not typically part of an ongoing liquidity or interest rate risk strategy; therefore, they fluctuate more rapidly. When short-term funds are used, they are purchased through correspondent and member bank relationships as overnight borrowings or through the FHLB for terms less than one year. Total long-term borrowings, borrowings initiated for terms longer than one year, were$50.2 million as ofJune 30, 2021 ,$54.8 million as ofDecember 31, 2020 , and$65.1 million as ofJune 30, 2020 . The long-term borrowings for the Corporation were made up entirely of FHLB long-term advances atJune 30, 2021 ,December 31, 2020 , andJune 30, 2020 . FHLB advances are used as a secondary source of funding and to mitigate interest rate risk. These long-term funding instruments are typically a more effective funding instrument in terms of selecting the exact amount, rate, and term of funding rather than trying to source the same through deposits. In this manner, management can efficiently meet known liquidity and interest rate risk needs. The decrease in FHLB borrowings sinceJune 30, 2020 , can be attributed to management taking advantage of declining rates by prepaying FHLB advances and incurring penalties in order to save on interest expense in future years. In order to limit the Corporation's exposure and reliance to a single funding source, the Corporation's Asset Liability Policy sets a goal of maintaining the amount of borrowings from the FHLB to 15% of asset size. As ofJune 30, 2021 , the Corporation was significantly under this policy guideline at 3.2% of asset size with$50.2 million of total FHLB borrowings. The Corporation also has a policy that limits total borrowings from all sources to 150% of the Corporation's capital. As ofJune 30, 2021 , the Corporation was significantly under this policy guideline at 51.4% of capital with$69.8 million total borrowings from all sources. The Corporation has maintained FHLB borrowings and total borrowings well within these policy guidelines throughout all of 2020 and through the first six months of 2021. The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently$440.6 million . The Corporation's two internal policy limits mentioned above are far more restrictive than the FHLB MBC, which is calculated and set quarterly by FHLB. In addition to the long-term advances funded through the FHLB, onDecember 30, 2020 , the Corporation completed the sale of a subordinated debt note offering. The Corporation sold$20.0 million of subordinated debt notes with a maturity date ofDecember 30, 2030 . These notes are non-callable for 5 years and carry a fixed interest rate of 4% per year for 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As ofJune 30, 2021 ,$15.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date on a pro-rata basis. Stockholders' Equity Federal regulatory authorities require banks to meet minimum capital levels. The Corporation, as well as the Bank, as the solely owned subsidiary of the Corporation, maintains capital ratios well above those minimum levels. The risk-weighted capital ratios are calculated by dividing capital by total risk-weighted assets. Regulatory guidelines determine the risk-weighted assets by assigning assets to specific risk-weighted categories. The calculation of tier I capital to risk-weighted average assets does not include an add-back to capital for the amount of the allowance for credit losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio. 62 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
The following tables reflect the capital ratios for the Corporation and Bank compared to the regulatory capital requirements.
REGULATORY CAPITAL RATIOS: Regulatory Requirements Adequately Well As of June 30, 2021 Capital Ratios Capitalized Capitalized Total Capital to Risk-Weighted Assets Consolidated 16.1 % 8.0 % 10.0 % Bank 15.6 % 8.0 % 10.0 % Tier 1 Capital to Risk-Weighted Assets Consolidated 12.9 % 6.0 % 8.0 % Bank 14.3 % 6.0 % 8.0 % Common Equity Tier 1 Capital to Risk-Weighted Assets Consolidated 12.9 % 4.5 % 6.5 % Bank 14.3 % 4.5 % 6.5 % Tier 1 Capital to Average Assets Consolidated 8.3 % 4.0 % 5.0 % Bank 9.2 % 4.0 % 5.0 % As ofDecember 31, 2020 Total Capital to Risk-Weighted Assets Consolidated 16.1 % 8.0 % 10.0 % Bank 15.3 % 8.0 % 10.0 %Tier I Capital to Risk-Weighted Assets Consolidated 12.8 % 6.0 % 8.0 % Bank 14.0 % 6.0 % 8.0 %Common Equity Tier I Capital to Risk-Weighted Assets Consolidated 12.8 % 4.5 % 6.5 % Bank 14.0 % 4.5 % 6.5 %Tier I Capital to Average Assets Consolidated 9.0 % 4.0 % 5.0 % Bank 9.8 % 4.0 % 5.0 % As of June 30, 2020 Total Capital to Risk-Weighted Assets Consolidated 13.4 % 8.0 % 10.0 % Bank 13.3 % 8.0 % 10.0 % Tier 1 Capital to Risk-Weighted Assets Consolidated 12.3 % 6.0 % 8.0 % Bank 12.1 % 6.0 % 8.0 % Common Equity Tier 1 Capital to Risk-Weighted Assets Consolidated 12.3 % 4.5 % 6.5 % Bank 12.1 % 4.5 % 6.5 % Tier 1 Capital to Average Assets Consolidated 9.3 % 4.0 % 5.0 % Bank 9.2 % 4.0 % 5.0 % OnDecember 30, 2020 , the Corporation issued$20 million of subordinated debt in order to support capital levels which had declined due to the dramatic balance sheet growth that had occurred during 2020. The$20 million of subordinated debt qualifies as Tier 2 capital at the Holding Company level. Amounts of the subordinated debt can be transferred to the Bank where it qualifies as Tier 1 Capital. As ofJune 30, 2021 ,$15.0 million of this subordinated debt funding was transferred down to the Bank to rebuild the Bank's capital levels. As ofJune 30, 2021 the Bank's Tier 1 Leverage Ratio stood at 9.2% while the Corporation's Tier 1 Leverage Ratio was 8.3%. The Bank's Tier 1 Leverage Ratio policy range is 9.0% to 12.0% while the Corporation's Tier 1 Leverage Ratio policy range is 8.0% - 12.0%. Tier 1 Capital levels at the Corporation level were not impacted by the subordinated debt issue since subordinated debt only qualifies as Tier 2 Capital at the Corporate level. As such, in terms of the Corporation's regulatory capital ratios, only the Total Capital to Risk-Weighted Assets ratio was enhanced as a result of the$20 million subordinated debt issue. Most of the marked improvement in capital ratios occurred at the Bank level. 63 Table of Contents ENB FINANCIAL CORP Management's Discussion and Analysis Dividends play a vital role in the management of capital levels of the Corporation. Management seeks a balance between maintaining a sufficient cushion of excess capital above regulatory limits versus the payment of dividends to the shareholders as a direct return of their investment. Due to a constant stream of stable earnings, the payment of a dividend is needed to maintain capital at acceptable levels in order to provide an adequate return of equity to the shareholders. The Corporation's dividends per share for the six months endedJune 30, 2021 , were$0.33 , and the dividends per share for the six months endedJune 30, 2020 , were$0.32 . Dividends are paid from current earnings and available retained earnings. The Corporation's current capital plan calls for management to maintain tier I capital to average assets between 8.0% and 12.0%. As a secondary measurement, the capital plan also targets a long-term dividend payout ratio in the range of 30% to 45%. This ratio will vary according to income, but over the long term, the Corporation's goal is to maintain and target a payout ratio within this range. For the six months endedJune 30, 2021 , the payout ratio was 22.8%. This dividend payout ratio is low as a result of the higher earnings in the first half of 2021, some of which are non-recurring. Management currently anticipates that the payout ratio may return to more normal levels as 2021 progresses. Management's goal is to maintain all regulatory capital ratios at current levels. Future dividend payout ratios are dependent on the future level of earnings and other factors that impact the level of capital. The amount of unrealized gain or loss on the securities portfolio is reflected, net of tax, as an adjustment to capital, as required byU.S. generally accepted accounting principles. This is recorded as accumulated other comprehensive income or loss in the capital section of the consolidated balance sheet. An unrealized gain increases capital, while an unrealized loss reduces capital. This requirement takes the position that, if the Corporation liquidated the securities portfolio at the end of each period, the current unrealized gain or loss on the securities portfolio would directly impact the Corporation's capital. As ofJune 30, 2021 , the Corporation showed an unrealized gain, net of tax, of$7,362,000 , compared to an unrealized gain of$7,958,000 atDecember 31, 2020 , and an unrealized gain of$4,522,000 as ofJune 30, 2020 . These unrealized gains, net of tax are excluded from capital when calculating the tier I capital to average assets numbers above. The amount of unrealized gain or loss on the securities portfolio, shown net of tax, as an adjustment to capital, does not include any actual impairment taken on securities, which is shown as a reduction to income on the Corporation's Consolidated Statements of Income. No impairment was recorded in the six months endedJune 30, 2021 , or in the same prior year period. The changes in unrealized gains and losses are due to normal changes in market valuations of the Corporation's securities as a result of interest rate movements.
Off-Balance Sheet Arrangements
In the normal course of business, the Corporation typically has off-balance sheet arrangements related to loan funding commitments. These arrangements may impact the Corporation's financial condition and liquidity if they were to be exercised within a short period of time. As discussed in the following liquidity section, the Corporation has in place sufficient liquidity alternatives to meet these obligations. The following table presents information on the commitments by the Corporation as ofJune 30, 2021 . 64 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
OFF-BALANCE SHEET ARRANGEMENTS
(DOLLARS IN THOUSANDS)June 30, 2021 $ Commitments to extend credit: Revolving home equity 139,733 Construction loans 3,258 Real estate loans 133,014 Business loans 175,129 Consumer loans 1,279 Other 5,022 Standby letters of credit 11,295 Total 468,730 Significant Legislation
Dodd-Frank Wall Street Reform and Consumer Protection Act
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law. Dodd-Frank is intended to affect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank creates a newFinancial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally creates a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank is expected to have a significant impact on the Corporation's business operations as its provisions take effect. It is difficult to predict at this time what specific cumulative impact Dodd-Frank and the yet-to-be-written implementing rules and regulations will have on community banks. However, it is expected that, at a minimum, they will increase the Corporation's operating and compliance costs and could increase interest expense. Among the provisions that have already or are likely to affect the Corporation are the following:
Holding Company Capital Requirements
Dodd-Frank requires theFederal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from tier I capital unless such securities were issued prior toMay 19, 2010 , by a bank holding company with less than$15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, are consistent with safety and soundness.
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to$250,000 per depositor. Additionally, onFebruary 7, 2011 , the Board of Directors of theFDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which was effective inApril 2011 , saved the Corporation a significant amount ofFDIC insurance premiums from the significantly higherFDIC insurance premiums placed into effect after the financial crisis.
Corporate Governance
Dodd-Frank requires publicly traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on "golden parachute" payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. TheSEC has finalized the rules implementing these requirements which took effect onJanuary 21, 2011 . The Corporation was exempt from these requirements untilJanuary 21, 2013 , due to its status as a smaller reporting company. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of$1.0 billion , regardless of whether the company is publicly traded. Dodd-Frank also gives theSEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters. 65 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
Limits on Interchange Fees
Dodd-Frank amended the Electronic Fund Transfer Act to, among other things, give theFederal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over$10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
Dodd-Frank created theConsumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. TheCFPB has examination and primary enforcement authority with respect to depository institutions with$10 billion or more in assets. Smaller institutions will be subject to rules promulgated by theCFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. TheCFPB will have authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes theCFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a "qualified mortgage" as defined by theCFPB . Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Prohibition Against Charter Conversions of Troubled Institutions
Dodd-Frank prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.
Limits on Interstate Acquisitions and Mergers
Dodd-Frank precludes a bank holding company from engaging in an interstate acquisition - the acquisition of a bank outside its home state - unless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with another bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and
adequately managed. 66 Table of ContentsENB FINANCIAL CORP Management's Discussion and Analysis
© Edgar Online, source