UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2020

OR

 

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

 

For the transition period from________________________________ to ________________________________

 

ENB Financial Corp

(Exact name of registrant as specified in its charter)

 

Pennsylvania	000-53297	51-0661129
(State or Other Jurisdiction of Incorporation)	(Commission File Number)	(IRS Employer Identification No)
31 E. Main St., Ephrata, PA	17522-0457
(Address of principal executive offices)	(Zip Code)

 

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

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
None.		N/A		N/A

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒          No ☐

 

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

Yes ☒          No ☐

 

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

	Large accelerated filer	☐	Accelerated filer	☐
	Non-accelerated filer	☐	Smaller reporting company	☒
	Emerging growth company	☐

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

 

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

Yes ☐          No ☒

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 1, 2020, the registrant had 5,592,101 shares of $0.10 (par) Common Stock outstanding.

 

ENB FINANCIAL CORP

INDEX TO FORM 10-Q

March 31, 2020

 

 

Part I – FINANCIAL INFORMATION
	Item 1.	Financial Statements
	Consolidated Balance Sheets at March 31, 2020 and 2019, and December 31, 2019 (Unaudited)		3
	Consolidated Statements of Income for the Three Months Ended March 31, 2020 and 2019 (Unaudited)		4
	Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2020 and 2019 (Unaudited)		5
	Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2020 and 2019 (Unaudited)		6
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019 (Unaudited)		7
	Notes to the Unaudited Consolidated Interim Financial Statements		8-33
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34-67
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	68-73
	Item 4.	Controls and Procedures	74
Part II – OTHER INFORMATION			75
	Item 1.	Legal Proceedings	75
	Item 1A.	Risk Factors	75
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
	Item 3.	Defaults upon Senior Securities	76
	Item 4.	Mine Safety Disclosures	76
	Item 5.	Other Information	76
	Item 6.	Exhibits	77
SIGNATURE PAGE			78

 

Part I - Financial Information

Item 1. Financial Statements

 

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

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

 

		March 31,				December 31,				March 31,
		2020				2019				2019
		$				$				$
ASSETS
Cash and due from banks			14,346				24,304				17,957
Interest-bearing deposits in other banks			9,066				16,749				22,468
Total cash and cash equivalents			23,412				41,053				40,425
Securities available for sale (at fair value)			320,568				308,097				291,186
Equity securities (at fair value)			6,640				6,708				6,081
Loans held for sale			2,419				2,342				2,688
Loans (net of unearned income)			764,120				753,618				710,135
Less: Allowance for loan losses			9,803				9,447				8,886
Net loans			754,317				744,171				701,249
Premises and equipment			25,044				25,033				25,409
Regulatory stock			7,222				7,291				6,705
Bank owned life insurance			29,012				28,818				28,273
Other assets			9,362				8,237				10,182
Total assets			1,177,996				1,171,750				1,112,198
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest-bearing			363,766				363,857				329,007
Interest-bearing			619,086				610,231				600,794
Total deposits			982,852				974,088				929,801
Short-term borrowings			3,500				200				—
Long-term debt			71,531				77,872				72,478
Other liabilities			3,607				2,902				3,061
Total liabilities			1,061,490				1,055,062				1,005,340
Stockholders' equity:
Common stock, par value $0.10
Shares:  Authorized 24,000,000
Issued 5,739,114 and Outstanding  5,598,501 as of  3/31/20,
5,640,742 as of 12/31/19, and 5,694,452 as of 3/31/19			574				574				574
Capital surplus			4,476				4,482				4,438
Retained earnings			113,207				111,944				105,818
Accumulated other comprehensive income (loss) net of tax			1,103				1,600				(3,189	)
Less: Treasury stock cost on 140,613 shares as of 3/31/20, 98,372 as of 12/31/19,
and 44,662 as of 3/31/19			(2,854	)			(1,912	)			(783	)
Total stockholders' equity			116,506				116,688				106,858
Total liabilities and stockholders' equity			1,177,996				1,171,750				1,112,198

 

See Notes to the Unaudited Consolidated Interim Financial Statements      

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

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

 

		Three Months ended March 31,
		2020				2019
		$				$
Interest and dividend income:
Interest and fees on loans			8,452				8,023
Interest on securities available for sale
Taxable			1,221				1,275
Tax-exempt			566				647
Interest on deposits at other banks			60				47
Dividend income			188				170
Total interest and dividend income			10,487				10,162
Interest expense:
Interest on deposits			809				824
Interest on borrowings			462				355
Total interest expense			1,271				1,179
Net interest income			9,216				8,983
Provision for loan losses			350				180
Net interest income after provision for loan losses			8,866				8,803
Other income:
Trust and investment services income			622				537
Service fees			679				630
Commissions			686				655
Gains on the sale of debt securities, net			282				81
(Losses) gains on equity securities, net			(230	)			17
Gains on sale of mortgages			541				349
Earnings on bank-owned life insurance			206				178
Other income			(19	)			97
Total other income			2,767				2,544
Operating expenses:
Salaries and employee benefits			5,696				5,188
Occupancy			591				630
Equipment			290				287
Advertising & marketing			274				250
Computer software & data processing			706				658
Shares tax			239				233
Professional services			623				475
Other expense			691				561
Total operating expenses			9,110				8,282
Income before income taxes			2,523				3,065
Provision for federal income taxes			358				462
Net income			2,165				2,603
Earnings per share of common stock			0.38				0.46
Weighted average shares outstanding			5,627,257				5,694,340

 

See Notes to the Unaudited Consolidated Interim Financial Statements      

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(DOLLARS IN THOUSANDS)

 

		Three Months ended March 31,
		2020				2019
		$				$
Net income			2,165				2,603
Other comprehensive (loss) income, net of tax:
Securities available for sale not other-than-temporarily impaired:
Unrealized (losses) gains arising during the period			(349	)			3,231
Income tax effect			75				(678	)
			(274	)			2,553
Gains recognized in earnings			(282	)			(81	)
Income tax effect			59				17
			(223	)			(64	)
Other comprehensive (loss) income, net of tax			(497	)			2,489
Comprehensive Income			1,668				5,092

 

See Notes to the Unaudited Consolidated Interim Financial Statements

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

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

  

														Accumulated
														Other								Total
		Common				Capital				Retained				Comprehensive				Treasury				Stockholders'
		Stock				Surplus				Earnings				Income (Loss)				Stock				Equity
		$				$				$				$				$				$
Balances, December 31, 2018			574				4,435				104,067				(5,678	)			(596	)			102,802
Net income			—				—				2,603				—				—				2,603
Other comprehensive income net of tax			—				—				—				2,489				—				2,489
Treasury stock purchased - 18,800 shares			—				—				—				—				(330	)			(330	)
Treasury stock issued - 8,188 shares			—				3				—				—				143				146
Cash dividends paid, $0.15 per share			—				—				(852	)			—				—				(852	)
Balances, March 31, 2019			574				4,438				105,818				(3,189	)			(783	)			106,858
Balances, December 31, 2019			574				4,482				111,944				1,600				(1,912	)			116,688
Net income			—				—				2,165				—				—				2,165
Other comprehensive loss net of tax			—				—				—				(497	)			—				(497	)
Treasury stock purchased - 49,911 shares			—				—				—				—				(1,098	)			(1,098	)
Treasury stock issued - 7,670 shares			—				(6	)			—				—				156				150
Cash dividends paid, $0.16 per share			—				—				(902	)			—				—				(902	)
Balances, March 31, 2020			574				4,476				113,207				1,103				(2,854	)			116,506

 

See Notes to the Unaudited Consolidated Interim Financial Statements

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)		Three Months Ended March 31,
		2020				2019
		$				$
Cash flows from operating activities:
Net income			2,165				2,603
Adjustments to reconcile net income to net cash
provided by operating activities:
Net amortization of securities premiums and discounts and loan fees			845				827
Amortization of operating leases right-of-use assets			44				43
Increase in interest receivable			(24	)			(85	)
Increase (decrease) in interest payable			(36	)			58
Provision for loan losses			350				180
Gains on sale of debt securities, net			(282	)			(81	)
(Gain) loss on equity securities, net			230				(17	)
Gains on sale of mortgages			(541	)			(349	)
Loans originated for sale			(14,037	)			(9,026	)
Proceeds from sales of loans			14,501				8,116
Earnings on bank-owned life insurance			(206	)			(178	)
Depreciation of premises and equipment and amortization of software			384				391
Deferred income tax			(143	)			(94	)
Other assets and other liabilities, net			(145	)			(105	)
Net cash provided by operating activities			3,105				2,283
Cash flows from investing activities:
Securities available for sale:
Proceeds from maturities, calls, and repayments			24,372				2,997
Proceeds from sales			27,409				10,246
Purchases			(65,490	)			(7,970	)
Purchase of regulatory bank stock			(570	)			(550	)
Redemptions of regulatory bank stock			639				193
Net increase in loans			(10,614	)			(16,142	)
Purchases of premises and equipment, net			(364	)			(221	)
Purchase of computer software			(1	)			(29	)
Net cash used for investing activities			(24,619	)			(11,476	)
Cash flows from financing activities:
Net increase in demand, NOW, and savings accounts			11,968				6,928
Net increase (decrease) in time deposits			(3,204	)			3,139
Net (decrease) increase in short-term borrowings			3,300				(7,870	)
Proceeds from long-term debt			10,000				11,562
Repayments of long-term debt			(16,341	)			(4,470	)
Dividends paid			(902	)			(852	)
Proceeds from sale of treasury stock			150				146
Treasury stock purchased			(1,098	)			(330	)
Net cash provided by financing activities			3,873				8,253
Decrease in cash and cash equivalents			(17,641	)			(940	)
Cash and cash equivalents at beginning of period			41,053				41,365
Cash and cash equivalents at end of period			23,412				40,425
Supplemental disclosures of cash flow information:
Interest paid			1,307				1,121
Income taxes paid			—				—
Supplemental disclosure of non-cash investing and financing activities:
Fair value adjustments for securities available for sale			631				(3,150	)
Initial recognition of operating right-of-use assets			—				1,075
Initial recognition of operating lease liabilities			—				1,075

 

See Notes to the Unaudited Consolidated Interim Financial Statements

1.       Summary of Significant Accounting Policies

 

Basis of Presentation

 

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

 

ENB Financial Corp (“the Corporation”) is the bank holding company for its wholly-owned subsidiary Ephrata National Bank (the “Bank”). This Form 10-Q, for the first quarter of 2020, is reporting on the results of operations and financial condition of ENB Financial Corp.

 

Operating results for the three months ended March 31, 2020, are not necessarily indicative of the results that may be expected for the year ended December 31, 2020. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Revenue from Contracts with Customers

 

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

 

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

 

2.       Securities Available for Sale

  

The amortized cost, gross unrealized gains and losses, and fair value of securities held at March 31, 2020, and December 31, 2019, are as follows:

 

						Gross				Gross
(DOLLARS IN THOUSANDS)		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		$				$				$				$
March 31, 2020
U.S. government agencies			10,378				152				(2	)			10,528
U.S. agency mortgage-backed securities			60,464				1,107				(55	)			61,516
U.S. agency collateralized mortgage obligations			55,834				907				(120	)			56,621
Asset-backed securities			28,969				—				(1,854	)			27,115
Corporate bonds			64,429				188				(1,811	)			62,806
Obligations of states and political subdivisions			99,098				3,096				(212	)			101,982
Total securities available for sale			319,172				5,450				(4,054	)			320,568
December 31, 2019
U.S. government agencies			32,621				31				(28	)			32,624
U.S. agency mortgage-backed securities			48,859				215				(448	)			48,626
U.S. agency collateralized mortgage obligations			60,124				323				(194	)			60,253
Asset-backed securities			23,646				7				(391	)			23,262
Corporate bonds			54,604				316				(40	)			54,880
Obligations of states and political subdivisions			86,216				2,245				(9	)			88,452
Total securities available for sale			306,070				3,137				(1,110	)			308,097

 

 

The amortized cost and fair value of securities available for sale at March 31, 2020, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.

 

CONTRACTUAL MATURITY OF DEBT SECURITIES
(DOLLARS IN THOUSANDS)
		Amortized
		Cost				Fair Value
		$				$
Due in one year or less			31,045				31,321
Due after one year through five years			122,474				122,000
Due after five years through ten years			45,499				45,029
Due after ten years			120,154				122,218
Total debt securities			319,172				320,568

  

Securities available for sale with a par value of $85,824,000 and $66,712,000 at March 31, 2020, and December 31, 2019, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $90,733,000 at March 31, 2020, and $68,732,000 at December 31, 2019.

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

 

PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE

(DOLLARS IN THOUSANDS)

 

		Three Months Ended March 31,
		2020				2019
		$				$
Proceeds from sales			27,409				10,246
Gross realized gains			297				96
Gross realized losses			(15	)			(15	)

 

 

Management evaluates all of the Corporation’s securities for other than temporary impairment (OTTI) on a periodic basis. No securities in the portfolio had other-than-temporary impairment recorded in the first three months of 2020 or 2019.

 

Information pertaining to securities with gross unrealized losses at March 31, 2020, and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

 

TEMPORARY IMPAIRMENTS OF SECURITIES

(DOLLARS IN THOUSANDS)  

 

		Less than 12 months								More than 12 months								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
		$				$				$				$				$				$
As of March 31, 2020
U.S. government agencies			1,194				(2	)			—				—				1,194				(2	)
U.S. agency mortgage-backed securities			—				—				5,794				(55	)			5,794				(55	)
U.S. agency collateralized mortgage obligations			12,458				(106	)			1,545				(14	)			14,003				(120	)
Asset-backed securities			18,510				(1,145	)			8,605				(709	)			27,115				(1,854	)
Corporate bonds			39,679				(1,586	)			2,812				(225	)			42,491				(1,811	)
Obligations of states & political subdivisions			7,271				(212	)			—				—				7,271				(212	)
Total temporarily impaired securities			79,112				(3,051	)			18,756				(1,003	)			97,868				(4,054	)
As of December 31, 2019
U.S. government agencies			1,222				(3	)			15,971				(25	)			17,193				(28	)
U.S. agency mortgage-backed securities			5,040				(32	)			24,027				(416	)			29,067				(448	)
U.S. agency collateralized mortgage obligations			17,457				(50	)			17,512				(144	)			34,969				(194	)
Asset-backed securities			10,278				(169	)			9,126				(222	)			19,404				(391	)
Corporate bonds			2,562				(4	)			13,041				(36	)			15,603				(40	)
Obligations of states & political subdivisions			2,642				(9	)			—				—				2,642				(9	)
Total temporarily impaired securities			39,201				(267	)			79,677				(843	)			118,878				(1,110	)

 

In the debt security portfolio there were 62 positions that were carrying unrealized losses as of March 31, 2020. There were no instruments considered to be other-than-temporarily impaired at March 31, 2020.

 

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

 

3.       Equity Securities

 

The following table summarizes the amortized cost, gross unrealized gains and losses, and fair value of equity securities held at March 31, 2020 and December 31, 2019.

 

						Gross				Gross
(DOLLARS IN THOUSANDS)		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		$				$				$				$
March 31, 2020
CRA-qualified mutual funds			6,113				—				—				6,113
Bank stocks			734				—				(207	)			527
Total equity securities			6,847				—				(207	)			6,640

 

						Gross				Gross
(DOLLARS IN THOUSANDS)		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		$				$				$				$
December 31, 2019
CRA-qualified mutual funds			6,071				—				—				6,071
Bank stocks			614				26				(3	)			637
Total equity securities			6,685				26				(3	)			6,708

  

The following table presents the net gains and losses on the Corporation’s equity investments recognized in earnings during the three months ended March 31, 2020 and 2019, and the portion of unrealized gains and losses for the period that relates to equity investments held as of March 31, 2020 and 2019.

 

NET GAINS AND LOSSES ON EQUITY INVESTMENTS RECOGNIZED IN EARNINGS

(DOLLARS IN THOUSANDS)  

		Three Months Ended
		March 31, 2020				March 31, 2019
		$				$
Net gains (losses) recognized in equity securities during the period			(230	)			17
Less:  Net gains realized on the sale of equity securities during the period			—				—
Unrealized gains (losses) recognized in equity securities held at reporting date			(230	)			17

4.        Loans and Allowance for Loan Losses

 

The following table presents the Corporation’s loan portfolio by category of loans as of March 31, 2020, and December 31, 2019:

 

LOAN PORTFOLIO

(DOLLARS IN THOUSANDS)

		March 31,				December 31,
		2020				2019
		$				$
Commercial real estate
Commercial mortgages			120,080				120,212
Agriculture mortgages			177,368				175,367
Construction			18,778				16,209
Total commercial real estate			316,226				311,788
Consumer real estate (a)
1-4 family residential mortgages			259,937				258,676
Home equity loans			10,741				9,770
Home equity lines of credit			68,633				70,809
Total consumer real estate			339,311				339,255
Commercial and industrial
Commercial and industrial			63,670				58,019
Tax-free loans			16,582				16,388
Agriculture loans			20,733				20,804
Total commercial and industrial			100,985				95,211
Consumer			5,557				5,416
Gross loans prior to deferred fees			762,079				751,670
Deferred loan costs, net			2,041				1,948
Allowance for loan losses			(9,803	)			(9,447	)
Total net loans			754,317				744,171

 

(a)	Real estate loans serviced for others, which are not included in the Consolidated Balance Sheets, totaled $162,246,000 and $154,577,000 as of March 31, 2020, and December 31, 2019, respectively.

 

The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of March 31, 2020 and December 31, 2019. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.

 

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

 

·

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

 

·

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

 

·

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

 

·

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

 

·

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

 

COMMERCIAL CREDIT EXPOSURE

CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE

(DOLLARS IN THOUSANDS)

 

March 31, 2020		Commercial Mortgages				Agriculture Mortgages				Construction				Commercial and Industrial				Tax-free Loans				Agriculture Loans				Total
		$				$				$				$				$				$				$
Grade:
Pass			117,329				160,221				18,778				57,634				16,582				18,671				389,215
Special Mention			818				4,133				—				842				—				836				6,629
Substandard			1,933				13,014				—				5,141				—				1,226				21,314
Doubtful			—				—				—				53				—				—				53
Loss			—				—				—				—				—				—				—
Total			120,080				177,368				18,778				63,670				16,582				20,733				417,211

 

 

December 31, 2019		Commercial Mortgages				Agriculture Mortgages				Construction				Commercial and Industrial				Tax-free Loans				Agriculture Loans				Total
		$				$				$				$				$				$				$
Grade:
Pass			117,875				158,896				16,209				52,028				16,388				18,530				379,926
Special Mention			827				4,546				—				618				—				939				6,930
Substandard			1,510				11,925				—				5,293				—				1,335				20,063
Doubtful			—				—				—				80				—				—				80
Loss			—				—				—				—				—				—				—
Total			120,212				175,367				16,209				58,019				16,388				20,804				406,999

 

Substandard loans increased by $1.2 million, or 6.0%, while special mention loans have declined minimally from December 31, 2019 to March 31, 2020. Substandard loans increased from $20.1 million to $21.3 million from December 31, 2019, to March 31, 2020 while special mention loans decreased from $6.9 million to $6.6 million during this same period. During the first quarter of 2020, agricultural dairy loans amounting to $2.0 million to two separate borrowers were downgraded to substandard. Of that $2.0 million, $1.0 million was downgraded from special mention to substandard. Additionally, two residential mortgages totaling $1.2 million were downgraded to substandard.

 

For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and nonaccrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of March 31, 2020 and December 31, 2019:

CONSUMER CREDIT EXPOSURE

CREDIT RISK PROFILE BY PAYMENT PERFORMANCE

(DOLLARS IN THOUSANDS)    

 

March 31, 2020		1-4 Family Residential Mortgages				Home Equity Loans				Home Equity Lines of Credit				Consumer				Total
Payment performance:		$				$				$				$				$
Performing			259,318				10,649				68,623				5,547				344,137
Non-performing			619				92				10				10				731
Total			259,937				10,741				68,633				5,557				344,868

 

 

December 31, 2019		1-4 Family Residential Mortgages				Home Equity Loans				Home Equity Lines of Credit				Consumer				Total
Payment performance:		$				$				$				$				$
Performing			257,374				9,678				70,799				5,412				343,263
Non-performing			1,302				92				10				4				1,408
Total			258,676				9,770				70,809				5,416				344,671

 

The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of March 31, 2020 and December 31, 2019:

 

AGING OF LOANS RECEIVABLE

(DOLLARS IN THOUSANDS)

 

										Greater
		30-59 Days				60-89 Days				than 90				Total Past								Total Loans
March 31, 2020		Past Due				Past Due				Days				Due				Current				Receivable
		$				$				$				$				$				$
Commercial real estate
Commercial mortgages			121				—				227				348				119,732				120,080
Agriculture mortgages			1,154				—				1,046				2,200				175,168				177,368
Construction			—				—				—				—				18,778				18,778
Consumer real estate
1-4 family residential mortgages			1,029				186				619				1,834				258,103				259,937
Home equity loans			28				3				92				123				10,618				10,741
Home equity lines of credit			9				—				10				19				68,614				68,633
Commercial and industrial
Commercial and industrial			—				—				534				534				63,136				63,670
Tax-free loans			—				—				—				—				16,582				16,582
Agriculture loans			—				—				—				—				20,733				20,733
Consumer			26				10				10				46				5,511				5,557
Total			2,367				199				2,538				5,104				756,975				762,079

 

 

AGING OF LOANS RECEIVABLE

(DOLLARS IN THOUSANDS)

 

										Greater
		30-59 Days				60-89 Days				than 90				Total Past								Total Loans
December 31, 2019		Past Due				Past Due				Days				Due				Current				Receivable
		$				$				$				$				$				$
Commercial real estate
Commercial mortgages			—				—				228				228				119,984				120,212
Agriculture mortgages			962				—				1,070				2,032				173,335				175,367
Construction			—				—				—				—				16,209				16,209
Consumer real estate
1-4 family residential mortgages			2,254				161				1,302				3,717				254,959				258,676
Home equity loans			52				—				92				144				9,626				9,770
Home equity lines of credit			43				—				10				53				70,756				70,809
Commercial and industrial
Commercial and industrial			68				—				538				606				57,413				58,019
Tax-free loans			—				—				—				—				16,388				16,388
Agriculture loans			2				—				—				2				20,802				20,804
Consumer			14				12				4				30				5,386				5,416
Total			3,395				173				3,244				6,812				744,858				751,670

The following table presents nonaccrual loans by classes of the loan portfolio as of March 31, 2020 and December 31, 2019:

 

NONACCRUAL LOANS BY LOAN CLASS

(DOLLARS IN THOUSANDS)  

		March 31,				December 31,
		2020				2019
		$				$
Commercial real estate
Commercial mortgages			227				228
Agriculture mortgages			1,046				1,070
Construction			—				—
Consumer real estate
1-4 family residential mortgages			493				495
Home equity loans			92				92
Home equity lines of credit			—				—
Commercial and industrial
Commercial and industrial			534				538
Tax-free loans			—				—
Agriculture loans			—				—
Consumer			—				—
Total			2,392				2,423

 

 

As of March 31, 2020 and December 31, 2019, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three months ended March 31, 2020 and March 31, 2019, is as follows:

 

IMPAIRED LOANS

(DOLLARS IN THOUSANDS)

		Three Months Ended March 31,
		2020				2019
		$				$
Average recorded balance of impaired loans			3,937				2,697
Interest income recognized on impaired loans			35				11

 

 

There were no loan modifications made during the first quarter of 2020. There was one loan modification that occurred during the first quarter of 2019, constituting a troubled debt restructuring (TDR). A modification of the payment terms to a loan customer are considered a TDR if a concession was made to a borrower that is experiencing financial difficulty. A concession is generally defined as more favorable payment or credit terms granted to a borrower in an effort to improve the likelihood of the lender collecting principal in its entirety. Concessions usually are in the form of interest only for a period of time, or a lower interest rate offered in an effort to enable the borrower to continue to make normally scheduled payments.

 

In the first quarter of 2019, a loan modification was made on a $718,000 agricultural mortgage which moved the timing of the annual principal payment and changed interest payments from monthly to annually. The farmer had suffered a fire loss in late 2018 impacting one year’s harvest. The principal and interest payment due date was reset to November 15, 2019, when it was paid. No other loans were modified during 2019.

 

Included in the impaired loan portfolio are three loans that are being reported as TDRs. The balance of these three TDR loans was $1,949,000 as of March 31, 2020. One of these TDR loans with a balance of $439,000 is also on nonaccrual and is included under agricultural mortgages shown in the nonaccrual table above. For both of these TDR loans the borrowers have a history of being delinquent. Management will continue to report these loans as TDR loans until they have been paid off or charged off.

The following tables summarize information regarding impaired loans by loan portfolio class as of March 31, 2020, and December 31, 2019:

 

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
March 31, 2020		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
		$				$				$				$				$
With no related allowance recorded:
Commercial real estate
Commercial mortgages			720				763				—				723				—
Agriculture mortgages			1,879				1,909				—				1,894				24
Construction			—				—				—				—				—
Total commercial real estate			2,599				2,672				—				2,617				24
Commercial and industrial
Commercial and industrial			—				—				—				—				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			—				—				—				—				—
Total with no related allowance			2,599				2,672				—				2,617				24
With an allowance recorded:
Commercial real estate
Commercial mortgages			92				100				49				92				—
Agriculture mortgages			677				677				12				692				5
Construction			—				—				—				—				—
Total commercial real estate			769				777				61				784				5
Commercial and industrial
Commercial and industrial			534				549				53				536				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			534				549				53				536				—
Total with a related allowance			1,303				1,326				114				1,320				5
Total by loan class:
Commercial real estate
Commercial mortgages			812				863				49				815				—
Agriculture mortgages			2,556				2,586				12				2,586				29
Construction			—				—				—				—				—
Total commercial real estate			3,368				3,449				61				3,401				29
Commercial and industrial
Commercial and industrial			534				549				53				536				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			534				549				53				536				—
Total			3,902				3,998				114				3,937				29

IMPAIRED LOAN ANALYSIS
(DOLLARS IN THOUSANDS)
December 31, 2019		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
		$				$				$				$				$
With no related allowance recorded:
Commercial real estate
Commercial mortgages			724				765				—				859				—
Agriculture mortgages			1,912				1,928				—				1,903				43
Construction			—				—				—				—				—
Total commercial real estate			2,636				2,693				—				2,762				43
Commercial and industrial
Commercial and industrial			—				—				—				—				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			—				—				—				—				—
Total with no related allowance			2,636				2,693				—				2,762				43
With an allowance recorded:
Commercial real estate
Commercial mortgages			92				100				49				93				—
Agriculture mortgages			718				718				60				760				—
Construction			—				—				—				—				—
Total commercial real estate			810				818				109				853				—
Commercial and industrial
Commercial and industrial			538				549				80				261				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			538				549				80				261				—
Total with a related allowance			1,348				1,367				189				1,114				—
Total by loan class:
Commercial real estate
Commercial mortgages			816				865				49				952				—
Agriculture mortgages			2,630				2,646				60				2,663				43
Construction			—				—				—				—				—
Total commercial real estate			3,446				3,511				109				3,615				43
Commercial and industrial
Commercial and industrial			538				549				80				261				—
Tax-free loans			—				—				—				—				—
Agriculture loans			—				—				—				—				—
Total commercial and industrial			538				549				80				261				—
Total			3,984				4,060				189				3,876				43

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2020:

 

ALLOWANCE FOR CREDIT LOSSES

(DOLLARS IN THOUSANDS)

		Commercial Real Estate				Consumer Real Estate				Commercial and Industrial				Consumer				Unallocated				Total
		$				$				$				$				$				$
Allowance for credit losses:
Beginning balance - December 31, 2019			4,319				2,855				1,784				41				448				9,447
Charge-offs			—				—				—				(6	)			—				(6	)
Recoveries			11				—				1				—				—				12
Provision			252				296				171				21				(390	)			350
Balance - March 31, 2020			4,582				3,151				1,956				56				58				9,803

 

 

During the three months ended March 31, 2020, management charged off $6,000 in loans while recovering $12,000 and added $350,000 to the provision. The unallocated portion of the allowance decreased from 4.7% of total reserves as of December 31, 2019, to 0.6% as of March 31, 2020. Management monitors the unallocated portion of the allowance with a desire to maintain it at approximately 5% over the long term, with a requirement of it not to exceed 10%.

 

During the three months ended March 31, 2020, net provision expense was recorded for all sectors. The higher provision was primarily caused by increasing the qualitative factors across all industry lines to various degrees as a result of the impact from COVID-19. A qualitative factor was increased for business loans specifically related to the special federal governmental lending programs developed as a result of COVID-19. There were minimal charge-offs and recoveries recorded during the three months ended March 31, 2020, so the provision expense was primarily related to this change in economic conditions and potential for credit declines moving forward. The total amount of substandard loans at the end of the first quarter of 2020 was slightly higher resulting in slightly more provision expense.

 

As of March 31, 2020, the Corporation’s total delinquencies were 0.67%, a decline from 0.91% at December 31, 2019. The Corporation’s total delinquencies continue to compare favorably to the national uniform bank performance group, which was at 1.05% as of December 31, 2019.

 

The Corporation reduced one qualitative factor for residential mortgages in the first quarter of 2020; this factor had been increased in the fourth quarter of 2019 because of higher delinquency. However, mortgage loan delinquency declined in the first quarter of 2020.  Delinquency among agriculture loans, excluding loans to dairy farmers, has continued to increase, and ended at 2.32% at March 31, 2020. A total of six agriculture loans were delinquent at this time.

 

Outside of the above measurements and indicators, management continues to utilize nine qualitative factors to continually refine the potential credit risks across the Corporation’s various loan types.  In addition, the loan portfolio is sectored out into nine different categories to evaluate these qualitative factors.   A total score of the qualitative factors for each loan sector is calculated to utilize in the allowance for loan loss calculation.  The agricultural dairy sector carries the highest level of qualitative factors due to the long-term weakness in milk prices. While the dairy market had improved recently, COVID-19 caused a sharp decline in milk prices.

 

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2019:

 

ALLOWANCE FOR CREDIT LOSSES

(DOLLARS IN THOUSANDS)

		Commercial Real Estate				Consumer Real Estate				Commercial and Industrial				Consumer				Unallocated				Total
		$				$				$				$				$				$
Allowance for credit losses:
Beginning balance - December 31, 2018			4,296				2,408				1,428				102				432				8,666
Charge-offs			—				—				—				(17	)			—				(17	)
Recoveries			44				—				13				—				—				57
Provision			148				(140	)			128				16				28				180
Balance - March 31, 2019			4,488				2,268				1,569				101				460				8,886

 

 

During the three months ended March 31, 2019, management charged off $17,000 in loans while recovering $57,000 and added $180,000 to the provision. The growth in the loan portfolio was primarily responsible for the $180,000 of additional provision.

 

During the three months ended March 31, 2019, provision expenses were primarily recorded for the commercial real estate and commercial and industrial segments, while a credit provision was recorded in the consumer real estate segment due to very low historical loss experience. In the two quarters prior to the first quarter of 2019, management had adjusted the qualitative factors across the loan portfolio to better reflect the forward risk in each loan segment. This resulted in more provision expense being allocated to commercial real estate loans and less to residential real estate loans. While the Corporation had been experiencing more residential real estate growth than commercial real estate growth, when the performance of these respective borrowers declines, the potential for loan losses is more pronounced with commercial real estate loans. The impact of negative economic events is more volatile with commercial real estate loans. Supporting this conclusion, the Corporation’s level of delinquencies remained higher with commercial real estate loans than residential real estate loans. The Corporation’s commercial real estate and commercial and industrial loan provision allocations are also influenced by the levels of classified loans. For both of these categories the level of classified loans increased significantly since December 31, 2018, with commercial real estate increasing 31.7% and commercial and industrial increasing over four fold, but on a much smaller loan segment. This is what caused the Corporation to allocate $148,000 of provision expense to commercial real estate and $128,000 to commercial and industrial, while reducing consumer real estate by $140,000. The smallest out of all the loan segments is the unsecured consumer loan segment, where the $16,000 provision allocation was nearly a match to the $17,000 of consumer charge-offs that occurred in the first quarter of 2019.

 

The following tables present the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of March 31, 2020 and December 31, 2019:

 

ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE

(DOLLARS IN THOUSANDS)

 

As of March 31, 2020:		Commercial Real Estate				Consumer Real Estate				Commercial and Industrial				Consumer				Unallocated				Total
		$				$				$				$				$				$
Allowance for credit losses:
Ending balance: individually evaluated
for impairment			61				—				53				—				—				114
Ending balance: collectively evaluated
for impairment			4,521				3,151				1,903				56				58				9,689
Loans receivable:
Ending balance			316,226				339,311				100,985				5,557								762,079
Ending balance: individually evaluated
for impairment			3,368				—				534				—								3,902
Ending balance: collectively evaluated
for impairment			312,858				339,311				100,451				5,557								758,177

 

As of December 31, 2019:		Commercial Real Estate				Consumer Real Estate				Commercial and Industrial				Consumer				Unallocated				Total
		$				$				$				$				$				$
Allowance for credit losses:
Ending balance: individually evaluated
for impairment			109				—				80				—				—				189
Ending balance: collectively evaluated
for impairment			4,210				2,855				1,704				41				448				9,258
Loans receivable:
Ending balance			311,788				339,255				95,211				5,416								751,670
Ending balance: individually evaluated
for impairment			3,446				—				538				—								3,984
Ending balance: collectively evaluated
for impairment			308,342				339,255				94,673				5,416								747,686

 

COVID-19 Loan Forbearance Programs

 

As of March 31, 2020, over 105 of the Corporation’s customers had requested payment deferrals or payments of interest only on loans totaling $17.4 million. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (TDRs) unless the borrower was previously experiencing financial difficulty. In addition, the risk-rating on COVID-19 modified loans did not change, and these loans will not be considered past due until after the deferral period is over and scheduled payments resume. The credit quality of these loans will be reevaluated after the deferral period ends.

 

Through April 30, 2020, the Corporation has modified an additional 150 loans totaling $46.6 million, which are primarily commercial loans. Therefore, including the loans modified in March, a total of $64.0 million of loans have had payments deferred under the COVID-19 guidance. Of the $64.0 million of loan balances with payments being deferred, $52.6 million, or 82.2% were in the form of commercial or agricultural loan deferments, with vast majority of these commercial loan deferrals. The remaining $11.4 million of loan balances with payments being deferred were in the form of residential mortgage deferrals. Nearly all of the COVID-19 loan payment deferrals were for a 90-day period.

 

 

As of March 31, 2010, the Corporation’s delinquent, non-performing, and impaired loans were not yet materially impacted by the rapidly declining economic conditions brought on by COVID-19. However, due to the magnitude of this economic interruption, management does anticipate that these levels will rise in the second quarter of 2020, and will likely show further deterioration as the year progresses, depending on the length of time business operations are curtailed or limited and the amount of time it takes for consumer confidence to rebuild and engage into increased purchasing activities. Therefore, it is likely the Corporation’s provision for loan losses would also increase over the next several quarters should the level of these credit measurements increase.

 

 

5. Fair Value Presentation

 

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

 

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

 

The following tables provide the fair market value for assets required to be measured and reported at fair value on a recurring basis on the Consolidated Balance Sheets as of March 31, 2020, and December 31, 2019, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

ASSETS MEASURED ON A RECURRING BASIS

(DOLLARS IN THOUSANDS)  

		March 31, 2020
		Level I				Level II				Level III				Total
		$				$				$				$
U.S. government agencies			—				10,528				—				10,528
U.S. agency mortgage-backed securities			—				61,516				—				61,516
U.S. agency collateralized mortgage obligations			—				56,621				—				56,621
Asset-backed securities			—				27,115				—				27,115
Corporate bonds			—				62,806				—				62,806
Obligations of states & political subdivisions			—				101,982				—				101,982
Equity securities			6,640				—				—				6,640
Total securities			6,640				320,568				—				327,208

  

On March 31, 2020, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of March 31, 2020, the CRA fund investments had a $6,113,000 book and fair market value and the bank stock portfolio had a book value of $734,000, and fair market value of $528,000.

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

 

ASSETS MEASURED ON A RECURRING BASIS

(DOLLARS IN THOUSANDS)

		December 31, 2019
		Level I				Level II				Level III				Total
		$				$				$				$
U.S. government agencies			—				32,624				—				32,624
U.S. agency mortgage-backed securities			—				48,626				—				48,626
U.S. agency collateralized mortgage obligations			—				60,253				—				60,253
Asset-backed securities			—				23,262				—				23,262
Corporate bonds			—				54,880				—				54,880
Obligations of states & political subdivisions			—				88,452				—				88,452
Equity securities			6,708				—				—				6,708
Total securities			6,708				308,097				—				314,805

 

On December 31, 2019, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of December 31, 2019, the CRA fund investments had a $6,071,000 book and market value and the bank stocks had a book value of $614,000 and a market value of $637,000.

 

The following tables provide the fair value for each class of assets required to be measured and reported at fair value on a nonrecurring basis on the Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019, by level within the fair value hierarchy:

 

ASSETS MEASURED ON A NONRECURRING BASIS

(Dollars in Thousands)

		March 31, 2020
		Level I				Level II				Level III				Total
		$				$				$				$
Assets:
Impaired Loans		$	—			$	—			$	3,788			$	3,788
Total		$	—			$	—			$	3,788			$	3,788

 

 

		December 31, 2019
		Level I				Level II				Level III				Total
		$				$				$				$
Assets:
Impaired Loans		$	—			$	—			$	3,795			$	3,795
Total		$	—			$	—			$	3,795			$	3,795

 

 

The Corporation had a total of $3,902,000 of impaired loans as of March 31, 2020, with $114,000 of specific allocation against these loans and $3,984,000 of impaired loans as of December 31, 2019, with $189,000 of specific allocation against these loans. The value of impaired loans is generally determined through independent appraisals of the underlying collateral.

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

 

QUANTITATIVE INFORMATION ABOUT LEVEL III FAIR VALUE MEASUREMENTS

(DOLLARS IN THOUSANDS)    

	March 31, 2020
	Fair Value	Valuation	Unobservable	Range
	Estimate	Techniques	Input	(Weighted Avg)
Impaired loans	3,788	Appraisal of	Appraisal	-20% (-20%)
		collateral (1)	adjustments (2)
			Liquidation	-10% (-10%)
			expenses (2)

 

	December 31, 2019
	Fair Value	Valuation	Unobservable	Range
	Estimate	Techniques	Input	(Weighted Avg)
Impaired loans	3,795	Appraisal of	Appraisal	-20% (-20%)
		collateral (1)	adjustments (2)
			Liquidation	-10% (-10%)
			expenses (2)

 

 

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

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

The following table provides the carrying amount for each class of assets and liabilities and the fair value for certain financial instruments that are not required to be measured or reported at fair value on the Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019:

 

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

(DOLLARS IN THOUSANDS)

		March 31, 2020
										Quoted Prices in
										Active Markets				Significant Other				Significant
										for Identical				Observable				Unobservable
		Carrying								Assets				Inputs				Inputs
		Amount				Fair Value				(Level 1)				(Level II)				(Level III)
		$				$				$				$				$
Financial Assets:
Cash and cash equivalents			23,412				23,412				23,412				—				—
Regulatory stock			7,222				7,222				7,222				—				—
Loans held for sale			2,419				2,419				2,419				—				—
Loans, net of allowance			754,317				759,337				—				—				759,337
Mortgage servicing assets			691				691				—				—				691
Accrued interest receivable			3,792				3,792				3,792				—				—
Bank owned life insurance			29,012				29,012				29,012				—				—
Financial Liabilities:
Demand deposits			363,766				363,766				363,766				—				—
Interest-bearing demand deposits			28,479				28,479				28,479				—				—
NOW accounts			95,604				95,604				95,604				—				—
Money market deposit accounts			140,781				140,781				140,781				—				—
Savings accounts			222,241				222,241				222,241				—				—
Time deposits			131,981				135,159				—				—				135,159
Total deposits			982,852				986,030				850,871				—				135,159
Short-term borrowings			3,500				3,500				3,500				—				—
Long-term debt			71,531				68,375				—				—				68,375
Accrued interest payable			485				485				485				—				—

 

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

(DOLLARS IN THOUSANDS)

		December 31, 2019
										Quoted Prices in
										Active Markets				Significant Other				Significant
										for Identical				Observable				Unobservable
		Carrying								Assets				Inputs				Inputs
		Amount				Fair Value				(Level 1)				(Level II)				(Level III)
		$				$				$				$				$
Financial Assets:
Cash and cash equivalents			41,053				41,053				41,053				—				—
Regulatory stock			7,291				7,291				7,291				—				—
Loans held for sale			2,342				2,342				2,342				—				—
Loans, net of allowance			744,171				759,011				—				—				759,011
Mortgage servicing assets			892				1,049				—				—				1,049
Accrued interest receivable			3,768				3,768				3,768				—				—
Bank owned life insurance			28,818				28,818				28,818				—				—
Financial Liabilities:
Demand deposits			363,857				363,857				363,857				—				—
Interest-bearing demand deposits			25,171				25,171				25,171				—				—
NOW accounts			96,941				96,941				96,941				—				—
Money market deposit accounts			141,649				141,649				141,649				—				—
Savings accounts			211,285				211,285				211,285				—				—
Time deposits			135,185				136,781				—				—				136,781
Total deposits			974,088				975,684				838,903				—				136,781
Short-term borrowings			200				200				200				—				—
Long-term debt			77,872				76,825				—				—				76,825
Accrued interest payable			521				521				521				—				—

 

 

7.       Commitments and Contingent Liabilities

 

In order to meet the financing needs of its customers in the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of March 31, 2020, firm loan commitments were $69.7 million, unused lines of credit were $276.1 million, and open letters of credit were $8.7 million. The total of these commitments was $354.5 million, which represents the Corporation’s exposure to credit loss in the event of nonperformance by its customers with respect to these financial instruments. The actual credit losses that may arise from these commitments are expected to compare favorably with the Corporation’s loan loss experience on its loan portfolio taken as a whole. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for balance sheet financial instruments.

8. Accumulated Other Comprehensive Income (Loss)

 

The activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2020 and 2019 is as follows:

 

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (1) (2)

(DOLLARS IN THOUSANDS)  

		Unrealized
		Gains (Losses)
		on Securities
		Available-for-Sale
		$
Balance at December 31, 2019			1,600
Other comprehensive loss before reclassifications			(274	)
Amount reclassified from accumulated other comprehensive income (loss)			(223	)
Period change			(497	)
Balance at March 31, 2020			1,103
Balance at December 31, 2018			(5,678	)
Other comprehensive income before reclassifications			2,553
Amount reclassified from accumulated other comprehensive income (loss)			(64	)
Period change			2,489
Balance at March 31, 2019			(3,189	)

 

(1) All amounts are net of tax.  Related income tax expense or benefit is calculated using a Federal income tax rate of 21%.

(2) Amounts in parentheses indicate debits.

 

DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) COMPONENTS (1)

(DOLLARS IN THOUSANDS)        

 

	Amount Reclassified from
	Accumulated Other Comprehensive
	Income (Loss)
	For the Three Months
	Ended March 31,
	2020	2019		Affected Line Item in the
	$	$		Consolidated Statements of Income
Securities available-for-sale:
Net securities gains,	282	81		Gains on the sale of
reclassified into earnings				debt securities, net
Related income tax expense	(59)	(17)		Provision for federal income taxes
Net effect on accumulated other comprehensive
income (loss) for the period	223	64

 

(1) Amounts in parentheses indicate debits.        

9. Leases

 

A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Corporation adopted ASU No. 2016-02 “Leases” (Topic 842) and all subsequent ASUs that modified Topic 842. For the Corporation, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Corporation is the lessee.

 

All of these leases in which the Corporation is the lessee are comprised of real estate property for branches and office space with terms extending through 2026. All of the Corporation’s leases are classified as operating leases, and therefore, were previously not recognized on the Corporation’s Consolidated Balance Sheets. With the adoption of Topic 842, operating lease agreements are required to be recognized on the Consolidated Balance Sheets as a right-of use (“ROU”) asset and a corresponding lease liability.

 

The following table represents the Consolidated Balance Sheet classification of the Corporation’s ROU assets and lease liabilities.

 

Lease Consolidated Balance Sheets Classification
(Dollars in Thousands)		Classification		March 31, 2020
Lease Right-of-Use Assets
Operating lease right-of use assets		Other Assets		$	864
Lease Liabilities
Operating lease liabilties		Other Liabilities		$	872

 

The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to determine the present value of the minimum lease payments. The Corporation’s lease agreements often include one or more options to renew at the Corporation’s discretion. If at lease inception, the Corporation considers the exercising of a renewal option to be reasonably certain, the Corporation will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As the rate is rarely determinable, the Corporation utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used.

 

		March 31, 2020
Weighted-average remaining lease term
Operating leases			5.1 years
Weighted-average discount rate
Operating leases			3.09	%

 

The following table represents lease costs and other lease information. As the Corporation elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities.

 

Future minimum payments for operating leases with initial or remaining terms of one year or more as of March 31, 2020 were as follows:

Lease Payment Schedule
(Dollars in Thousands)		Operating Leases
Twelve Months Ended:
March 31, 2021		$	202
March 31, 2022			206
March 31, 2023			155
March 31, 2024			154
March 31, 2025			155
Thereafter			74
Total Future Minimum Lease Payments			946
Amounts Representing Interests			(74	)
Present Value of Net Future Minimum Lease Payments		$	872

 

10. Change in Capital Structure

 

On April 17, 2019 ENB Financial Corp announced the Board of Directors declared a two-for-one stock split of the Corporation’s issued and outstanding common stock pursuant to which one (1) additional share of common stock was issued for each share of common stock held by shareholders of record as of the close of business on May 31, 2019. The additional shares were issued on June 28, 2019. The stock split was effected pursuant to articles of amendment to the articles of incorporation to reduce the par value of the common stock from $0.20 to $0.10 and increase the authorized shares of common stock proportionately from 12,000,000 to 24,000,000. Per share data reflected on the Corporation’s consolidated statements of income are restated as if the stock split had occurred at the beginning of the earliest period presented.

 

 

11. Subsequent Events

 

Paycheck Protection Program (PPP)

 

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and provides over $2 trillion in economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP). As a qualified SBA lender, the Corporation was authorized to originate PPP loans.

 

In terms of qualifying for a PPP loan, an eligible business can apply for a PPP loan up to the greater of: (1) 2.5 times its average monthly payroll costs; or (2) $10 million. The PPP loans have the following terms: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the PPP loan, including any accrued interest, is eligible to be reduced by the amount of loan forgiveness available under the PPP, provided the employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses such as utilities.

 

In the initial CARES Act, $349 billion of funds were made available for PPP loans. This amount was fully exhausted prior to the end of April. Congress then passed an additional allocation of funds for the PPP loans, allowing a second round of applications to begin. As of April 30, 2020, the Corporation had approved and originated 618 PPP loans totaling $68,848,000. Management’s focus has been to serve the customers and market area that the Corporation serves. Management believes the Corporation’s total PPP loan funding will reach $78.0 million when the second round of PPP funding is exhausted.

 

In accordance with the SBA terms and conditions on these PPP loans, the Corporation expects to receive approximately $3.1 million in fees associated with the processing of these loans. The Corporation is awaiting guidance from the SBA on how to submit the required reporting to support the amount of fee income expected to be received. It is anticipated that this reporting will occur in June of 2020, followed by a period of time to process this reporting. When the Corporation does eventually receive this fee income it will be deferred over the expected life of the loans. To this regard, the financial community is also waiting on further accounting guidance as to how this fee income will be recognized. While the PPP loans have a two-year maturity, it is expected that the vast majority of these PPP borrowers will provide the necessary support in order to have their principal balances forgiven in a period of time significantly shorter than the two-year life of the loan.

 

12. Recently Issued Accounting Standards

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  The final ASU is expected to be issued in mid-November. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

 

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

 

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments – Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  The final ASU is expected to be issued in mid-November. Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017-12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  The final ASU is expected to be issued in mid-November. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. This ASU amends various SEC paragraphs pursuant to the issuance of SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization. Other miscellaneous updates to agree to the electronic Code of Federal Regulations also have been incorporated.

 

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Corporation qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or was a separate transaction. The Update also changes current guidance for making an intraperiod allocation if there is a loss in continuing operations and gains outside of continuing operations, determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting, accounting for tax law changes and year-to-date losses in interim periods, and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This Update is not expected to have a significant impact on the Corporation’s financial statements.

 

In January 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Corporation’s financial statements.

 

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. The Corporation is currently evaluating the impact the adoption of the standard will have on the Corporation’s financial position or results of operations.

 

In January 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Corporation’s financial statements.

 

 

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 2019 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.

 

Forward-Looking Statements

 

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

 

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

 

 

·

National and local economic conditions

·

Effects of economic conditions particularly with regard to the negative impact of severe and wide-ranging disruptions caused by the spread of coronavirus (COVID-19), specifically the effect on loan customers to repay loans

·

Health of the housing market

·

Real estate valuations and its impact on the loan portfolio

·

Interest rate and monetary policies of the Federal Reserve Board

·

Volatility of the securities markets including the valuation of securities

·

Future actions or inactions of the United States government, including a failure to increase the government debt limit or a prolonged shutdown of the federal government

·

Political changes and their impact on new laws and regulations

·

Competitive forces

·

Impact of mergers and acquisition activity in the local market and the effects thereof

·

Potential impact from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses

·

Changes in customer behavior impacting deposit levels and loan demand

·

Changes in accounting principles, policies, or guidelines as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standards setters

·

Ineffective business strategy due to current or future market and competitive conditions

·

Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk

·

Operation, legal, and reputation risk

·

Results of the regulatory examination and supervision process

·

The impact of new laws and regulations

·

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

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

 

Results of Operations

 

Overview

 

The first quarter of 2020 was impacted by a number of unprecedented items caused by the onset of the COVID-19 pandemic. The spread of COVID-19 quickly became global and impacted the global economy. This impact was felt rather quickly due to China’s large role in the world economy, second in GDP but first in terms of supply chain impact for basic goods. The immediate impact and forward risk posed by the pandemic caused the Federal Reserve to take the unusual step of reducing the Federal Funds rate by 50 basis points to 1.25% on March 3, 2020, at a special Fed meeting ahead of the regularly scheduled March 18, 2020 meeting. On March 11, 2020, the World Health Organization (WHO) recognized COVID-19 as a pandemic. The quick further expansion of the pandemic then caused the Federal Reserve to take an unprecedented step of a second special meeting on Sunday afternoon of March 15, 2020, to further reduce the Federal Funds rate 100 basis points to 0.25%. This importantly gave all banks easy access to very cheap funds. On March 15, 2020, the Fed also reduced the Discount Window rate by 150 basis points which took this rate down to 0.25%. This move took the Federal Funds rate to the same historic low of 0.25% that occurred due to the Financial Crisis of 2008. On March 16, 2020, the Fed also announced that they will take steps to inject more liquidity into the financial system by purchasing up to $500 billion of U.S. Treasuries and $200 billion of mortgage-backed securities. All major stock exchanges experienced dramatic sell-offs. The DOW which had peaked at 29,568 in February, closed on Friday, March 20, 2020 at 19,174, down 10,394 points, or 35%. NASDAQ was down 30%, while the S&P 500 was down 32%. Closer to home, as COVID-19 spread and has impacted every state with confirmed cases, Pennsylvania’s cases spread to 100 by March 19, 2020, when Governor Wolf announced the required closing of all non-essential businesses. These closures will cause further economic impact that will be long lasting. The U.S. Government worked on a massive Coronavirus Relief Bill that included direct small business aid for employers with fewer than 500 employees; direct deposit stimulus payments to American households; enhanced unemployment compensation benefits; and direct aid to hospitals and health care providers.

 

The economic impact of COVID-19 had an impact on first quarter results for the Corporation, but will have much more measurable results as the year progresses. The Corporation recorded net income of $2,165,000 for the three-month period ended March 31, 2020, a 16.8% decrease from the $2,603,000 earned during the same period in 2019. The earnings per share, basic and diluted, were $0.38 for the three months ended March 31, 2020, compared to $0.46 for the same period in 2019, a 17.4% decrease. The decrease in the Corporation’s 2020 earnings was caused primarily by an increase in operating expenses, an increase in the provision for loan losses, and higher-than-normal amortization on mortgage servicing assets.

 

The Corporation’s NII increased by $233,000, or 2.6%, for the three months ended March 31, 2020, compared to the same period in 2019. The increase in NII primarily resulted from an increase in interest and fees on loans of $429,000, or 5.3%, for the first quarter of 2020, compared to the first quarter of the prior year. The increase in interest and fees on loans was partially offset by a decrease of $135,000, or 7.0%, on interest earned on securities. Additionally, the Corporation’s interest expense on deposits and borrowings increased by $92,000, or 7.8%, for the three-month period ended March 31, 2020, compared to 2019. This increase was primarily driven by approximately $50,000 of prepayment penalties on FHLB advances that were taken in order to position the Corporation with lower-rate advances going forward.

 

The Corporation recorded a $170,000 additional provision expense in the first quarter of 2020 compared to the same quarter of 2019, with $350,000 of provision compared to $180,000 of provision for the first quarter of 2019. The gains from the sale of debt securities were $282,000 for the three months ended March 31, 2020, compared to gains of $81,000 for the first quarter of 2019. Market interest rates were lower in 2020, making it more conducive to achieving gains from the sale of securities. There were unrealized losses of $230,000 on the Corporation’s portfolio of equity securities that consists of stocks held in other banks. This loss flows through the income statement and was the result of the devaluation of bank stocks given the economic environment that began with the COVID-19 pandemic. For the first quarter of 2019, there was an unrealized gain of $17,000 on this portfolio, resulting in a negative impact to income of $247,000 for the first quarter of 2020 compared to the prior year. The gain on the sale of mortgages increased by $192,000, or 55.0%, for the three-month period ended March 31, 2020, compared to the prior year’s period. The volume of mortgages sold was higher during the first three months of 2020 compared to the same period in the prior year due to the very low interest rate environment. Total operating expenses increased by $828,000, or 10.0%, for the three months ended March 31, 2020, compared to the same period in 2019. This increase was primarily driven by a $508,000, or 9.8%, increase in salaries and benefits caused by a performance bonus paid out in the first quarter of 2020 that resulted in additional expense of approximately $205,000. Outside of this performance bonus, first quarter salaries and benefit expense would have increased by $303,000, or 5.8%.

 

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 three months ended March 31, 2020, compared to the same period in the prior year due primarily to lower earnings.

 

Key Ratios		Three Months Ended
		March 31,
		2020				2019
Return on Average Assets			0.74%				0.97%
Return on Average Equity			7.42%				10.22%

 

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 three months of 2020, NII generated 76.9% of the Corporation’s gross revenue stream, which consists of net interest income and non-interest income, compared to 77.9% in the first three months of 2019. 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 $166,000 for the three months ended March 31, 2020, compared to $202,000 for the same period in 2019.

NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
		Three Months Ended
		March 31,
		2020				2019
		$				$
Total interest income			10,487				10,162
Total interest expense			1,271				1,179
Net interest income			9,216				8,983
Tax equivalent adjustment			166				202
Net interest income (fully taxable equivalent)			9,382				9,185

 

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

 

·

The rates earned on interest earning assets and paid on interest bearing liabilities

·

The average balance of interest earning assets and interest bearing liabilities

 

The Federal funds rate, the Prime rate, the shape of the U.S. Treasury curve, and other wholesale funding curves, all affect NII. The Federal Reserve controls the Federal funds rate, which is one of a number of tools available to the Federal Reserve to conduct monetary policy. The Federal funds rate, and guidance on when the rate might be changed, is often the focal point of discussion regarding the direction of interest rates. For the first half of 2019 the Federal funds rate remained at 2.50%, however, in the second half of 2019 the Federal Reserve decreased rates three times, by 25 basis points each, beginning in July of 2019. By December 31, 2019, the Fed funds rate stood at 1.75%. On March 3, 2020, the Federal Reserve dropped the Fed funds rate by 50 basis points to 1.25%, and on March 15, 2020, the Fed dropped the rate by 100 basis points to 0.25%. These rate drops were in response to the COVID-19 global pandemic.

 

The expectations for the remainder of the year are that there will be no further rate drops or increases. Management anticipates a reduction in interest income in the remaining quarters of 2020 as a result of the significant Federal Reserve rate decreases. All of the Corporation’s Prime-based floating rate loans reset lower in March, while floating rate securities will reset when the the quarterly reset dates are reached. Therefore, it will be several months before the full impact of lower asset yields will be felt.

 

The shape of the U.S. Treasury curve also directly impacts the Corporation’s net interest income. The U.S. Treasury curve was flat coming into 2020, and after the rapid decline in short and long-term rates driven by the COVID-19 environment and the Federal Reserve rate drops, the yield curve remained flat, but rates also reached historic lows. This is detrimental to banks as funding sources are typically shorter terms than the assets invested in and asset yields are much lower than they were even a year ago. A sharper yield curve is beneficial to financial institutions as a larger spread can be made on the asset versus the liability utilized. For the first two months of 2020, the spread between the 2-year and 10-year U.S. Treasury averaged around 21 basis points. For the month of March, this spread averaged 42 basis points but the Treasury rates were at much lower levels. Both of these spreads are very low from a historical context.

 

The combination of lower rates, and a generally flat yield curve out to longer rates, makes it more difficult for the Corporation to generate higher net interest income. The Corporation’s net interest margin declined slightly in the first quarter of 2020 and it is likely it will continue to decline in the remaining quarters of 2020. Any increase in net interest income will need to come from growth of interest earning assets.

 

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 was 5.50% as of March 31, 2019, 4.75% as of December 31, 2019, and 3.25% as of March 31, 2020, after the 150 basis points of Federal Reserve rate drops in March of 2020. The Corporation’s Prime-based loans, including home equity lines of credit and some variable rate commercial loans, reprice a day after the Federal Reserve rate movement.

 

As a result of the significant growth of the loan portfolio, the Corporation’s NII on a tax equivalent basis has been increasing. Despite a lower net interest margin, the Corporation still achieved a slightly higher NII in the first quarter of 2020 than the fourth quarter of 2019. However, both of these quarters were down from the recent quarterly high in NII of $9,289,000 for the third quarter of 2019. The net interest margin began decreasing on a quarterly basis in the latter part of 2019 after the Federal Reserve dropped rates by 75 basis points. This margin decreased slightly in the first quarter of 2020 as well with the drastic rate drops in March. However, management expects the margin to decline more significantly throughout the remainder of 2020 with the full impact of these rate drops. The Corporation’s NII on a tax-equivalent basis increased for the three months ended March 31, 2020, by $289,000, or 2.8%, over the same period in 2019. Management’s asset liability sensitivity measurements continue to show a benefit to both margin and NII given Federal Reserve rate increases. Actual results over the past two years have confirmed the asset sensitivity of the Corporation’s balance sheet. Management expects that any improvements in NII will be driven primarily by loan growth since asset yields will continue to decline.

 

The Corporation has maintained a low average cost of funds over the past few years but funding costs had increased slightly throughout the first part of 2019 before the Fed rate drops. Deposit rates had been increasing slightly and the cost of borrowings was up due to a higher rate environment. However, with the recent steep drops in market rates, funding costs are once again declining and the Corporation is achieving savings on both the deposit and borrowings side. With a very low Prime rate projected throughout the remainder of 2020, the Corporation’s asset yields will see a decrease, but helping to offset this decline will be a stabilization of costs on the interest expense side. The recent sharp Federal Reserve rate decreases has already reduced the Corporation’s NII and net interest margin (NIM), primarily because of the variable rate portion of the loan portfolio, which resets every time the Prime rate changes. Variable rate loans have averaged just over 20% of the loan portfolio for the first quarter of 2020.

 

Security yields will generally fluctuate more rapidly than loan yields based on changes to the U.S. Treasury rates and yield curve. With lower Treasury rates in the first three months of 2020 compared to the same period in 2019, security reinvestment has genereally been occurring at lower yield levels. Because of the lower market interest rates and very flat yield curve, it is difficult to achieve substantially higher yields in the securities portfolio but there have been some pockets of opportunities to reposition the portfolio by selling securities at gains and reinvesting in slightly higher yielding instruments to benefit the Corporation’s earnings going forward.

 

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 each Federal Reserve rate movement and some fixed rate borrowers requested loan modifications to reset their rates lower in the current record low market rate environment. The vast majority of the Corporation’s commercial Prime-based loans were priced at the Prime rate, which was 4.75% to start 2020, and then 4.25% as of March 4, 2020, and 3.25% as of March 16, 2020. The pricing for the most typical five-year fixed rate commercial loans is currently slightly higher than the Prime rate. With the significant March Federal 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 the Federal Reserve lowers rates any further and would reprice higher if the Federal 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 much lower in 2020 compared to 2019. The average rate of the 10-year U.S. Treasury was 1.37% in the first three months of 2020 compared to 2.65% in the first three months of 2019, and it stood at 0.70% on March 31, 2020, compared to 2.41% on March 31, 2019. The slope of the yield curve has been compressed throughout 2019 and 2020. As of March 31, 2019, the U.S. Treasury curve was inverted with the 10-year U.S. Treasury rate nine basis points lower than the Fed funds rate. As of March 31, 2020, the 10-year U.S. Treasury rate was only 45 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-year U.S. Treasury yield as high as 1.88% in the first three months of 2020 and 2.79% in the first three months of 2019, and as low as 0.54% in 2020, and 2.39% in 2019.

 

While the Corporation’s overall cost of funds remains low, there were increases in 2019 due to higher interest expense on both deposits and borrowings. The Corporation’s cost of funds remained stable through the first quarter of 2020 influenced by lower costs on deposits, but slightly elevated costs on borrowings with $50,000 of prepayment penalties recorded on FHLB long-term advances. Management expects the cost of funds will decline during the remainder of 2020 as deposits continue to reprice to lower rates and the new FHLB advances initiated in the first quarter of 2020 are at lower rates than those that were paid off early. Core deposit interest rates were reduced four times throughout the first quarter of 2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core deposit products. A further rate decrease was implemented in April which will have an impact on the second quarter results and management does not anticipate significant deposit rate movements in the remainder of the year 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 increases in the pricing of new or reissued time deposits. Borrowing costs, and the wholesale borrowing curves that they are based on, generally follow the direction and slope of the U.S. Treasury curve. However, these curves can be quicker to rise and slower to fall as the providers of these funds seek to protect themselves from rate movements. The Corporation refinanced the maturing or paid off borrowings at lower rates in 2020, so the interest expense on borrowings will decline moving forward.

 

Management currently anticipates that the overnight interest rate and Prime rate will stay at the current level for the remainder of 2020. It is likely that mid and long-term U.S. Treasury rates will remain relatively suppressed throughout the remainder of the year. This very low and flat yield curve makes it more difficult for management to lend out or reinvest at higher interest rates out further on the yield curve. However, the recent decline in rates provides the ability to hold deposit rates at current levels to help to mitigate the lower interest income.

 

The following table provides an analysis of year-to-date changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.

 

RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME

(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)

 

		Three Months Ended March 31,												Three Months Ended March 31,
		2020 vs. 2019												2019 vs. 2018
		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			25				(12	)			13				(51	)			(15	)			(66	)
Securities available for sale:
Taxable			116				(179	)			(63	)			(6	)			192				186
Tax-exempt			(66	)			(35	)			(101	)			(157	)			11				(146	)
Total securities			50				(214	)			(164	)			(163	)			203				40
Loans			622				(202	)			420				1,102				530				1,632
Regulatory stock			19				1				20				9				(5	)			4
Total interest income			716				(427	)			289				897				713				1,610
INTEREST EXPENSE
Deposits:
Demand deposits			28				(152	)			(124	)			20				307				327
Savings deposits			2				(4	)			(2	)			1				—				1
Time deposits			(5	)			116				111				(33	)			50				17
Total deposits			25				(40	)			(15	)			(12	)			357				345
Borrowings:
Total borrowings			57				50				107				(3	)			63				60
Total interest expense			82				10				92				(15	)			420				405
NET INTEREST INCOME			634				(437	)			197				912				293				1,205

 

 

During the first three months of 2020, the Corporation’s NII on an FTE basis increased by $197,000, or 2.1%, over the same period in 2019. Total interest income on an FTE basis for the three months ended March 31, 2020, increased $289,000, or 2.8%, from 2019, while interest expense increased $92,000, or 7.8%, for the three months ended March 31, 2020, compared to the same period in 2019. The FTE interest income from the securities portfolio decreased by $164,000, or 7.8%, while loan interest income increased $420,000, or 5.2%. During the first three months of 2020, additional loan volume caused by loan growth added $622,000 to net interest income, but the lower yields caused a $202,000 decrease, resulting in a total increase of $420,000. Higher balances in the securities portfolio caused an increase of $50,000 in NII, while lower yields on securities caused a $214,000 decrease, resulting in a net decrease of $164,000.

 

The average balance of interest bearing liabilities increased by 6.2% during the three months ended March 31, 2020, 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 demand and savings deposits partially offset by higher rates on time deposits caused a $40,000 decrease in interest expense while slightly higher balances of demand and savings deposits caused an increase in expense of $25,000 resulting in a total decrease of $15,000.

 

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 $5,000 reduction to expense, and time deposits repricing to higher interest rates increased interest expense by $116,000, causing a net total increase of $111,000 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 increased by 14.4% from the prior year, which resulted in an increase in interest expense of $57,000. Although interest rates were lower in the first quarter of 2020 compared to the prior year, the Corporation paid off a number of long-term advances with prepayment penalties of $50,000 which increased interest expense by that amount. The aggregate of these amounts was an increase in interest expense of $107,000 related to total borrowings.

 

The following table shows a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation’s balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency of not giving credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, management emphasizes the net yield on interest earning assets, also referred to as the NIM. The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. The NIM is generally the benchmark used by analysts to measure how efficiently a bank generates NII.

 

 

COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME

(DOLLARS IN THOUSANDS)  

		For the Three Months Ended March 31,
		2020												2019
										(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			18,860				60				1.29				11,339				47				1.67
Securities available for sale:
Taxable			229,149				1,256				2.19				209,715				1,320				2.52
Tax-exempt			86,695				701				3.23				94,733				802				3.39
Total securities (d)			315,844				1,957				2.48				304,448				2,122				2.79
Loans (a)			759,998				8,491				4.48				704,621				8,070				4.60