10-K
1
form10k-25640_enb.htm
10-K
UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington,
D.C. 20549
FORM 10-K
(Mark One)
x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended December 31, 2020
OR
For
the transition period from to
Commission
File Number 000-53297
ENB
Financial Corp
(Exact
name of registrant as specified in its charter)
(Address of principal executive offices) (Zip Code)
Registrant’s
telephone number, including area code (717) 733-4181
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
Securities
registered pursuant to Section 12(g) of the Act:
Title of
each class
Common Stock,
Par Value $0.20 Per Share
Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ̈
No x
Indicate by
check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ̈
No x
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 x No
̈
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant
to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit such files).
Yes x
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 x Smaller reporting company x
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 has filed a report on and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered
public accounting firm that prepared or issued its audit report. ̈
Indicate by
check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ̈
No x
The aggregate
market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2020, was approximately
$62,943,166.
The number of
shares of the registrant’s Common Stock outstanding as of March 15, 2021, was 5,561,499.
DOCUMENTS
INCORPORATED BY REFERENCE
The Registrant’s
Definitive Proxy Statement for its 2021 Annual Meeting of Shareholders to be held on May 11, 2021, is incorporated into Parts III
and IV hereof.
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ENB FINANCIAL
CORP
Table of Contents
Part I
Item 1. Business 5
Item 1A. Risk Factors 17
Item 1B. Unresolved Staff Comments 27
Item 2. Properties 27
Item 3. Legal Proceedings 29
Item 4. Mine Safety Disclosures 29
Part II
Item 6. Selected Financial Data 32
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 70
Item 8. Financial Statements and Supplementary Data 77
Item 9A. Controls and Procedures 130
Item 9B. Other Information 131
Part III
Item 10. Directors, Executive Officers, and Corporate Governance 132
Item 11. Executive Compensation 132
Item 14. Principal Accountant Fees and Services 132
Part IV
Item 15. Exhibits and Financial Statement Schedules 133
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ENB FINANCIAL CORP
Part I
Forward-Looking Statements
The U.S. Private Securities Litigation Reform Act of 1995 provides
safe harbor in regard 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
predictions, these forward-looking statements should not be construed to be indicative of actual future results. Additionally,
management may change estimates of future performance, or the likelihood of future events, as additional information is obtained.
This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative
of actual results.
Readers should note that many factors affect this forward-looking
information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into
this document. These factors include, but are not limited to, the following:
· Economic conditions
· Monetary and interest rate policies of the Federal Reserve Board
· Volatility of the securities markets
· Political changes and their impact on new laws and regulations
· Competitive forces
· Operation, legal, and reputation risk
Readers should be aware if any of the above factors change significantly,
the statements regarding future performance could also change materially. The safe harbor provision provides that ENB Financial
Corp is not required to publicly update or revise forward-looking statements to reflect events or circumstances that arise after
the date of this report. Readers should review any changes in risk factors in documents filed by ENB Financial Corp periodically
with the Securities and Exchange Commission, including Item 1A. of this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
and Current Reports on Form 8-K.
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ENB FINANCIAL CORP
Item 1. Business
General
ENB Financial Corp (“the Corporation”) is a bank holding
company that was formed on July 1, 2008. The Corporation’s wholly owned subsidiary, Ephrata National Bank (“the Bank”),
also referred to as ENB, is a full service commercial bank organized under the laws of the United States. Presently, no other subsidiaries
exist under the bank holding company. The Corporation and the Bank are both headquartered in Ephrata, Lancaster County, Pennsylvania.
The Bank was incorporated on April 11, 1881, pursuant to The National Bank Act under a charter granted by the Office of the Comptroller
of the Currency (OCC). The Federal Deposit Insurance Corporation (FDIC) insures deposit accounts to the maximum extent provided
by law. The Corporation’s retail, operational, and administrative offices are predominantly located in Lancaster County,
southeastern Lebanon County, and southern Berks County, Pennsylvania. Ten full service offices are located in Lancaster County
with one full service office in Lebanon County and one full service office in Berks County, Pennsylvania.
The basic business of the Corporation is to provide a broad range
of financial services to individuals and small-to-medium-sized businesses in Lancaster County as well as Berks and Lebanon Counties.
The Corporation utilizes funds gathered through deposits from the general public to originate loans. The Corporation offers a range
of demand accounts, in addition to savings and time deposits. The Corporation also offers secured and unsecured commercial, real
estate, and consumer loans. Ancillary services that provide added convenience to customers include direct deposit and direct payments
of funds through Electronic Funds Transfer, ATMs linked to the Star® network, telephone banking, MasterCard® debit cards,
Visa® or MasterCard credit cards, and safe deposit box facilities. In addition, the Corporation offers internet banking including
bill pay and wire transfer capabilities, remote deposit capture, and an ENB Bank on the Go! app for iPhones or Android phones.
The Corporation also offers a full complement of trust and investment advisory services through ENB’s Money Management Group.
As of December 31, 2020, the Corporation employed 276 persons, consisting
of 252 full-time and 24 part-time employees. The number of full-time employees decreased by two employees, and the number
of part-time employees decreased by two from the previous year-end. The decrease in the number of full-time and part-time
employees is attributable to streamlining processes across departments and restructuring initiatives that has resulted in improved
headcount efficiency, a process that continues as of the date of this filing. The Bank expects to continue reviewing and
implementing opportunities to align headcount with operational efficiencies in 2021. A collective bargaining agent does not
represent the employees.
Operating Segments
The Corporation’s business is providing financial products
and services. These products and services are provided through the Corporation’s wholly owned subsidiary, the Bank. The Bank
is presently the only subsidiary of the Corporation, and the Bank only has one reportable operating segment, community banking,
as described in Note A of the Notes to the Consolidated Financial Statements included in this Report. The segment reporting information
in Note A is incorporated by reference into this Part I, Item 1.
Business Operations
Products and Services with Reputation Risk
The Corporation offers a diverse range of financial and banking
products and services. In the event one or more customers and/or governmental agencies becomes dissatisfied with or objects to
any product or service offered by the Corporation, negative publicity with respect to any such product or service, whether legally
justified or not, could have a negative impact on the Corporation’s reputation. The discontinuance of any product or service,
whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on
the Corporation’s reputation.
Market Area and Competition
The Corporation’s primary
market area is Lancaster County, Pennsylvania, where ten full service offices are located. However, the Corporation’s market
area also extends into contiguous Lebanon and Berks Counties. The Corporation opened a full service office in southeastern Lebanon
County in 2013 and a full service office in southern Berks County in 2016 to extend physical presence to those counties. The Corporation’s
greater service
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ENB FINANCIAL CORP
area is considered to be Lancaster, Lebanon, and southern and western Berks Counties of Pennsylvania. The area
served by the Corporation is a mix of rural communities and small to mid-sized towns.
The Corporation’s headquarters
and main campus are located in Ephrata, Pennsylvania. The Corporation’s main office and drive-up are located in downtown
Ephrata, while the Cloister office is also located within Ephrata Borough. As such, the Corporation has a very strong presence
in Ephrata Borough, a community with a population of approximately 14,000. When surrounding areas that also share an Ephrata address
and zip code are included, the population is over 34,000 based on 2019 census data. The Corporation ranks a commanding first in
deposit market share in the Ephrata area with 37.8% of deposits as of June 30, 2020, based on data compiled annually by the Federal
Deposit Insurance Corporation (FDIC). The Corporation’s deposit market share in the Ephrata area was 40.3% as of June 30,
2019. The Corporation’s very high market share in the Ephrata area equates to a saturation of the local market that has led
to the expansion of the Corporation’s branch network.
In the past 15 years, the Corporation’s
market area has expanded beyond the greater Ephrata area to encompass most of northern Lancaster County, with the exception of
the most western parts of the County. The majority of this expansion has occurred in recent history with the addition of eight
new branch offices since 1999, bringing the total offices to twelve. Lancaster County ranks high nationally as a favored place
to reside due to its scenic and fertile farmland, low cost of living, diverse local economy, and proximity to several large metropolitan
areas. As a result, the area has experienced significant population growth and development. The population growth of Lancaster
County has remained above both Pennsylvania and national growth levels over the past fifty years. Additionally, the population
of Lancaster County has eclipsed half a million, with 2019 census information showing an estimated population of 546,000. The FDIC
deposit market share data ranked the Corporation 4th in deposit market share in Lancaster County, with 7.4% of deposits
as of June 30, 2020. The Corporation held 7.6% of deposit market share as of June 30, 2019.
In the course of attracting and
retaining deposits and originating loans, the Corporation faces considerable competition. The Corporation competes with other commercial
banks, savings and loan institutions, and credit unions for traditional banking products, such as deposits and loans. Based on
FDIC summary of deposit data, there were 22 banks and savings associations and 13 credit unions operating in Lancaster County as
of June 30, 2020, representing the same number of banks and one more credit union compared to the prior year. The Corporation competes
with consumer finance companies for loans, mutual funds, and other investment alternatives for deposits. The Corporation competes
for deposits based on the ability to provide a range of products, low fees, quality service, competitive rates, and convenient
locations and hours. The competition for loan origination generally relates to interest rates offered, products available, quality
of service, and loan origination fees charged. Several competitors within the Corporation’s primary market have substantially
higher legal lending limits that enable them to service larger loans and larger commercial customers.
The Corporation continues to assess the competition and market area
to determine the best way to meet the financial needs of the communities it serves. Management also continues to pursue new market
opportunities based on the strategic plan to efficiently grow the Corporation, improve earnings performance, and bring the Corporation’s
products and services to customers currently not being reached. Management strategically addresses growth opportunities versus
competitive issues by determining the new products and services to be offered, expansion of existing footprint with new locations,
as well as investing in the expertise of staffing for expansion of these services.
Concentrations and Seasonality
The Corporation does not have any portion of its businesses dependent
on a single or limited number of customers, the loss of which would have a material adverse effect on its businesses. No substantial
portion of loans or investments is concentrated within a single industry or group of related industries, although a significant
amount of loans are secured by real estate located in northern Lancaster County, Pennsylvania. Agricultural purpose loans make
up approximately 24% of the loan portfolio; however, these loans are further diversified according to type of agriculture, of which
dairy is the largest component accounting for approximately 9% of the loan portfolio. Furthermore, no customer accounts for more
than 2.0% of the outstanding total loans. The business activities of the Corporation are generally not seasonal in nature. The
sizable agricultural portfolio has minority elements that are predominately seasonal in nature due to typical farming operations.
Financial instruments with concentrations of credit risk are described in Note P of the Notes to Consolidated Financial Statements
included in this Report. The concentration of credit risk information in Note P is incorporated by reference into this Part I,
Item 1.
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ENB FINANCIAL CORP
Supervision and Regulation
Bank holding companies operate in a highly regulated environment
and are routinely examined by federal and state regulatory authorities. The following discussion concerns various federal and state
laws and regulations and the potential impact of such laws and regulations on the Corporation and the Bank.
To the extent that the following information describes statutory
or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves.
Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various
bank regulatory agencies. The Corporation cannot determine the likelihood or timing of any such proposals or legislation, or the
impact they may have on the Corporation and the Bank. A change in law, regulations, or regulatory policy may have a material effect
on the Corporation and the Bank’s business.
The operations of the Bank are subject to federal and state statutes
applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks
whose deposits are insured by the FDIC. Bank operations are subject to regulations of the OCC, the Consumer Financial Protection
Bureau (CFPB), the Board of Governors of the Federal Reserve System, and the FDIC.
Bank Holding Company Supervision and Regulation
The Bank Holding Company Act of 1956
The Corporation is subject to the provisions of the Bank Holding
Company Act of 1956, as amended, and to supervision by the Federal Reserve Board. The following restrictions apply:
General Supervision by the Federal Reserve Board
As a bank holding company, the Corporation’s activities are
limited to the business of banking and activities closely related or incidental to banking. Bank holding companies are required
to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has adopted
a risk-focused supervision program for small shell bank holding companies that is tied to the examination results of the subsidiary
bank. The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to
serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board may require
that the Corporation stand ready to provide adequate capital funds to the Bank during periods of financial stress or adversity.
Restrictions on Acquiring Control of Other Banks and Companies
A bank holding company may not:
In addition, a bank holding company may not:
· engage in a non-banking business, or
unless the Federal Reserve Board determines the business to be so
closely related to banking as to be a proper incident to banking. In making this determination, the Federal Reserve Board considers
whether these activities offer benefits to the public that outweigh any possible adverse effects.
Anti-Tie-In Provisions
A bank holding company and its subsidiaries may not engage in tie-in
arrangements in connection with any extension of credit or provision of any property or services. These anti-tie-in provisions
state generally that a bank may not:
· extend credit,
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· lease or sell property, or
· furnish any service to a customer,
on the condition that the customer provides additional credit or
service to a bank or its affiliates, or on the condition that the customer not obtain other credit or service from a competitor
of the bank.
Restrictions on Extensions of Credit by Banks to their Holding
Companies
Subsidiary banks of a holding company are also subject to restrictions
imposed by the Federal Reserve Act on:
· investments in the stock or other securities of the Corporation, and
· taking these stock or securities as collateral for loans to any borrower.
Risk-Based Capital Guidelines
Bank holding companies must comply with the Federal Reserve Board’s
current risk-based capital guidelines, which are amended provisions of the Bank Holding Company Act of 1956. The required minimum
ratio of total capital to risk-weighted assets, including some off-balance sheet activities, such as standby letters of credit,
is 8%. At least half of the total capital is required to be Tier I Capital, consisting principally of common shareholders’
equity, less certain intangible assets. The remainder, Tier II Capital, may consist of:
· some types of preferred stock,
· a limited amount of subordinated debt,
· some hybrid capital instruments,
· other debt securities, and
· a limited amount of the general loan loss allowance.
The risk-based capital guidelines are required to take adequate
account of interest rate risk, concentrations of credit risk, and risks of nontraditional activities.
Capital Leverage Ratio Requirements
The Federal Reserve Board requires a bank holding company to maintain
a leverage ratio of a minimum level of Tier I capital, as determined under the risk-based capital guidelines, equal to 3% of average
total consolidated assets for those bank holding companies that have the highest regulatory examination rating and are not contemplating
or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least
1% to 2% above the stated minimum. The Bank is subject to similar capital requirements pursuant to the Federal Deposit Insurance
Act.
In 2019, the federal banking agencies issued a final rule to provide
an optional simplified measure of capital adequacy for qualifying community banking organizations, including the community bank
leverage ratio (“CBLR”) framework. Generally, under the CBLR framework, qualifying community banking organizations
with total assets of less than $10 billion, and limited amounts of off-balance-sheet exposures and trading assets and liabilities,
may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9%. Qualifying community banking organizations
that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to
risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to
have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework. The CBLR
framework was available for banks to use in their March 31, 2020, Call Report. The Corporation did not opt into the CBLR framework.
Restrictions on Control Changes
The Change in Bank Control Act of 1978 requires persons seeking
control of a bank or bank holding company to obtain approval from the appropriate federal banking agency before completing the
transaction. The law contains a presumption that the power to vote 10% or more of voting stock confers control of a bank or bank
holding company. The Federal Reserve Board is responsible for reviewing changes in control of bank holding companies. In doing
so, the Federal Reserve Board reviews the financial position, experience and integrity of the acquiring person, and the effect
the change of control will have on the financial condition of the Corporation, relevant markets, and federal deposit insurance
funds.
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ENB FINANCIAL CORP
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act (SOX), also known as the “Public Company
Accounting Reform and Investor Protection Act,” was established in 2002 and introduced major changes to the regulation of
financial practice. SOX was established as a reaction to the outbreak of corporate and accounting scandals, including Enron and
WorldCom. SOX represents a comprehensive revision of laws affecting corporate governance, accounting obligations, and corporate
reporting. SOX is applicable to all companies with equity or debt securities that are either registered, or file reports under
the Securities Exchange Act of 1934.
Section 404 of SOX requires publicly held companies to document
and test their internal controls that impact financial reporting and report on the findings. These requirements fall under two
main sections, 404a and 404b. The provisions of these sections vary according to the size and market capitalization of public companies,
referred to as accelerated or non-accelerated filers. For those companies subject to the requirements, external auditors must test
and report on the effectiveness of a company’s internal controls to ensure accurate financial reporting. Companies must report
any deficiencies or material weaknesses in their internal controls, as well as their remediation efforts. To ensure greater investor
confidence in corporate disclosures from public companies, SOX restricts the services that public accounting firms can provide
to publicly traded companies. The Corporation does not engage the same professional accounting firm for external and internal auditing.
In 2008, the SEC expanded the definitions of smaller public companies
beyond non-accelerated filers to include a new definition of a smaller reporting company (SRC). The smaller reporting company definition
was more favorable to smaller businesses that qualified under certain conditions. On July 1, 2008, the Corporation came into existence
as ENB Financial Corp, which succeeded Ephrata National Bank. Companies could now be both a SRC and non-accelerated or accelerated
filer. The Corporation continues to meet the definition of a non-accelerated filer as it has a public equity float of approximately
$62.9 million as of June 30, 2020.
While accelerated filers had to comply with Section 404a and 404b
since 2004, with their auditors required to report on the effectiveness of internal controls, the Corporation only became subject
to Section 404b in 2018 and 2019, after assets exceeded $1 billion in 2017. The Corporation has always been subject to Section
404a.
In 2010, when the Dodd-Frank Act was signed into law, Section 404b
was permanently deferred for all smaller reporting companies. However, effective December 2016, Statement of Auditing Standards
(SAS) No. 130, An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of the Financial Statements,
changed how annual reporting requirements under the Federal Deposit Insurance Corporation Improvement Act (FDICIA) Part 363 are
applied. Insured Depository Institutions over the $1 billion asset level became subject to a much more rigorous audit, similar
to many public institutions subject to SEC oversight. The Corporation went over $1 billion in assets in 2017 and became subject
to this requirement in 2018, causing the Corporation to be subject to the SOX requirements or Section 404b for both 2018 and 2019.
These requirements include:
After 2019, the SOX Section 404b requirement of including the opinion
from the Corporation’s external auditors on the effectiveness of the Corporation’s ICFR in the Form 10-K, no longer
applied to the Corporation. Therefore, this opinion is not included in the Corporation’s 2020 Form 10-K. However, the Corporation
is now required to include the opinion from the Corporation’s external auditors on the effectiveness of the Corporation’s
ICFR in the Corporation’s 2020 FDICIA filing.
Bank Supervision and Regulation
Safety and Soundness
The primary regulator for the Bank is the OCC. The OCC has the authority
under the Financial Institutions Supervisory Act and the Federal Deposit Insurance Act to prevent a national bank from engaging
in any unsafe or unsound practice in conducting business or from otherwise conducting activities in violation of the law.
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ENB FINANCIAL CORP
Federal and state banking laws and regulations govern, but are not
limited to, the following:
· Scope of a bank’s business
· Investments a bank may make
· Reserves that must be maintained against certain deposits
· Loans a bank makes and collateral it takes
· Merger and consolidation activities
· Establishment of branches
The Corporation is a member of the Federal Reserve System. Therefore,
the policies and regulations of the Federal Reserve Board have a significant impact on many elements of the Corporation’s
operations, including:
· Loan and deposit growth
· Rate of interest earned and paid
· Types of securities
· Breadth of financial services provided
· Levels of liquidity
· Levels of required capital
Management cannot predict the effect of changes to such policies
and regulations upon the Corporation’s business model and the corresponding impact they may have on future earnings.
FDIC Insurance Assessments
The FDIC imposes a risk-related premium schedule for all insured
depository institutions that results in the assessment of premiums based on the Bank’s capital and supervisory measures.
Under the risk-related premium schedule, the FDIC assigns, on a semi-annual basis, each depository institution to one of three
capital groups, the best of these being “Well Capitalized.” For purposes of calculating the insurance assessment, the
Bank was considered “Well Capitalized” as of December 31, 2020, and December 31, 2019. This designation has benefited
the Bank in the past and continues to benefit it in terms of a lower quarterly FDIC rate. The FDIC adjusts the insurance rates
when necessary. FDIC insurance rates have been significantly higher in recent years compared to years prior to the financial crisis.
In 2008, during the financial crisis, the FDIC insurance limit was increased from $100,000 to $250,000 along with unlimited insurance
coverage on non-interest bearing deposits and interest bearing deposit balances with interest rates less than or equal to 0.50%.
Significant increases in the FDIC insurance costs were assessed in 2009 to both cover the increased level of bank failures that
were occurring and the higher level of coverage. Since then the number of bank failures has significantly declined and the FDIC
has been able to decrease the cost of the insurance. The total FDIC assessments paid by the Bank in 2020 were $232,000, compared
to $172,000 in 2019.
In addition to FDIC insurance costs, the Bank is subject to assessments
to pay the interest on Financing Corporation Bonds. Congress created the Financing Corporation to issue bonds to finance the resolution
of failed thrift institutions. These assessment rates are set quarterly. In 2020, the Corporation recorded a credit for Financing
Corporation assessments due to credits received for prior periods in the amount of $9,000. This compared to total Financing Corporation
assessments paid by the Bank in 2019 of $30,000.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection
Act made the temporary $250,000 FDIC insurance coverage the permanent standard maximum deposit insurance amount. Additionally,
in February 2011, the Board of Directors of the FDIC approved a final rule based on the Dodd-Frank Act that revises the assessment
base from one based on domestic deposits to one based on assets. This change, which was effective in April 2011, saved the Corporation
a significant amount of FDIC insurance premiums.
Community Reinvestment Act
Under the Community Reinvestment Act (CRA), as amended, the OCC
is required to assess all financial institutions that it regulates to determine whether these institutions are meeting the credit
needs of the community that they serve. The Act focuses specifically on low and moderate income neighborhoods. The OCC takes an
institution’s CRA record into account in its evaluation of any application made by any of such institutions for, among other
things:
· Approval of a new branch or other deposit facility
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· Closing of a branch or other deposit facility
· An office relocation or a merger
· Any acquisition of bank shares
The CRA, as amended, also requires that the OCC make publicly available
the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income
neighborhoods. This evaluation includes a descriptive rating of either outstanding, satisfactory, needs to improve, or substantial
noncompliance, along with a statement describing the basis for the rating. These ratings are publicly disclosed. The Bank received
a satisfactory rating on the most recent CRA Performance Evaluation completed on June 4, 2018.
The Federal Deposit Insurance Corporation Improvement Act
of 1991
Capital Adequacy
Under the Federal Deposit Insurance Corporation Improvement Act
of 1991 (FDICIA), institutions are classified in one of five defined categories as illustrated below:
Tier I Capital Common Equity Tier I
Capital Category Total Capital Ratio Ratio Capital Ratio Leverage Ratio
Adequately Capitalized > 8.0 > 6.0 > 4.5 > 4.0*
Undercapitalized < 8.0 < 6.0 < 4.5 < 4.0*
Significantly Undercapitalized < 6.0 < 4.0 < 3.5 < 3.0
Critically Undercapitalized < 2.0
*3.0 for those banks having the highest available regulatory rating.
The Bank’s and Corporation’s capital ratios exceed the
regulatory requirements to be considered well capitalized for Total Risk-Based Capital, Tier I Risk-Based Capital, Common Equity
Tier I Capital, and Tier I Leverage Capital. The capital ratio table and Consolidated Financial Statement Note M – Regulatory
Matters and Restrictions, are incorporated by reference herein, from Item 8, and made a part hereof. Note M discloses capital ratios
for both the Bank and the Corporation, shown as Consolidated.
Regulatory Capital Changes
In July 2013, the federal banking agencies issued final rules to
implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community
banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began
compliance on January 1, 2014. The final rules call for the following capital requirements:
· A minimum ratio of tier I capital to risk-weighted assets of 6%
· A minimum ratio of total capital to risk-weighted assets of 8%
· A minimum leverage ratio of 4%
In addition, the final rules established a common equity tier I
capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization
fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions
on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical
capital buffers for all banking organizations began on January 1, 2016.
Under the initially proposed rules, accumulated other comprehensive
income (AOCI) would have been included in a banking organization’s common equity tier I capital. The final rules allowed
community banks to make a one-time election not to include these additional components of AOCI in regulatory capital and instead
use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital.
The opt-out election was made by the Corporation with the filing of the first quarter Call Report as of March 31, 2015.
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The final rules permanently grandfather non-qualifying capital instruments
(such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the tier
I capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009, and banking organizations
that were mutual holding companies as of May 19, 2010. The Corporation does not have trust preferred securities or cumulative perpetual
preferred stock with no plans to add these to the capital structure.
The proposed rules would have modified the risk-weight framework
applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposures into two
categories in order to determine the applicable risk weight. In response to commenter concerns about the burden of calculating
the risk weights and the potential negative effect on credit availability, the final rules do not adopt the proposed risk weights
but retain the current risk weights for mortgage exposures under the general risk-based capital rules.
Consistent with the Dodd-Frank Act, the new rules replace the ratings-based
approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach
in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing
gross-up approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250 percent
risk weight. The Corporation does not securitize assets and has no plans to do so.
Under the new rules, mortgage servicing assets (MSAs) and certain
deferred tax assets (DTAs) are subject to stricter limitations than those applicable under the current general risk-based capital
rule. The new rules also increase the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures,
and makes selected other changes in risk weights and credit conversion factors.
Management has evaluated the impact of the above rules on levels
of the Corporation’s capital. The final rulings were highly favorable in terms of the items that would have a more significant
impact to the Corporation and community banks in general. Specifically, the AOCI final ruling, which would have had the greatest
impact, now provides the Corporation with an opt-out provision. The final ruling on the risk weightings of mortgages was favorable
and did not have a material negative impact. The rulings as to trust preferred securities, preferred stock, and securitization
of assets are not applicable to the Corporation, and presently the revised treatment of MSAs is not material to capital. The remaining
changes to risk weightings on several items mentioned above such as past-due loans and certain commercial real estate loans do
not have a material impact to capital presently, but could change as these levels change.
Real Estate Lending Standards
Pursuant to the FDICIA, federal banking agencies adopted real estate
lending guidelines which would set loan-to-value (“LTV”) ratios for different types of real estate loans. The LTV ratio
is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated.
If the institution does not hold a first lien position, the total loan amount would be combined with the amount of all junior liens
when calculating the ratio. In addition to establishing the LTV ratios, the guidelines require all real estate loans to be based
upon proper loan documentation and a recent appraisal or certificate of inspection of the property.
Prompt Corrective Action
In the event that an institution’s capital deteriorates to
the Undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including:
If capital reaches the significantly or critically undercapitalized
level, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management,
and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, FDICIA provides authority
for regulatory intervention where they deem the institution to be engaging in unsafe or unsound practices, or if the institution
receives a less than satisfactory examination report rating for asset quality, management, earnings, liquidity, or sensitivity
to market risk.
Other FDICIA Provisions
Each depository institution must submit audited financial statements
to its primary regulator and the FDIC, whose reports are made publicly available. In addition, the audit committee of each depository
institution must consist of outside directors and the audit committee at “large institutions” (as defined by FDIC regulation)
must include
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members with banking or financial management expertise. The audit committee at “large institutions” must
also have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution’s primary
regulator of any change in the institution’s independent auditor, and annual management letters must be provided to the FDIC
and the depository institution’s primary regulator. The regulations define a “large institution” as one with
over $500 million in assets, which does include the Bank. Also, under the rule, an institution's independent public accountant
must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance
with laws and regulations concerning safety and soundness.
Under the FDICIA, each federal banking agency must prescribe certain
safety and soundness standards for depository institutions and their holding companies. Three types of standards must be prescribed:
· asset quality and earnings
· operational and managerial, and
· compensation
Such standards would include a ratio of classified assets to capital,
minimum earnings, and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of
such institutions and holding companies. Operational and managerial standards must relate to:
· internal controls, information systems and internal audit systems
· loan documentation
· credit underwriting
· interest rate exposure
· asset growth, and
· compensation, fees and benefits
The FDICIA also sets forth Truth in Savings disclosure and advertising
requirements applicable to all depository institutions.
USA PATRIOT Act of 2001/Bank Secrecy Act
In October 2001, the USA Patriot Act of 2001 (Patriot Act) was enacted
in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The
Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively
to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions of all kinds is significant
and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations,
including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions,
regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Under the Bank Secrecy Act (BSA), banks and other financial institutions
are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which
a bank is aware in any one day that aggregate in excess of $10,000 and to report suspicious transactions under specified criteria.
Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information
required by the BSA, or for filing a false or fraudulent report.
Loans to Insiders/Regulation O
Regulation O, also known as Loans to Insiders, governs the permissible
lending relationships between a bank and its executive officers, directors, and principal shareholders and their related interests.
The primary restriction of Regulation O is that loan terms and conditions, including interest rates and collateral coverage, can
be no more favorable to the insider than loans made in comparable transactions to non-covered parties. Additionally, the loan may
not involve more than normal risk. The regulation requires quarterly reporting to regulators of the total amount of credit extended
to insiders.
Under Regulation O, a bank is not required to obtain approval from
the bank’s Board of Directors prior to making a loan to an executive officer or Board of Director member as long as a first
lien on the executive officer’s residence secures the loan. The Corporation’s policy requires prior Board of Director
approval of any Executive Officer or Director loan that when aggregated with other outstanding extensions of credit to the Insider
and their related interests exceeds $500,000. Loans to any Executive Officer or Director with aggregate exposure of under $500,000
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must be reported at the next scheduled Board of Director meeting. Further amendments allow bank insiders to take advantage of preferential
loan terms that are available to substantially all employees. Regulation O does permit an insider to participate in a plan that
provides more favorable credit terms than the bank provides to non-employee customers provided that the plan:
· Is widely available to employees
· Does not give preference to any insider over other employees
The Bank has a policy in place that offers general employees more
favorable loan terms than those offered to non-employee customers. The Bank’s policy on loans to insiders allows insiders
to participate in the same favorable rate and terms offered to all other employees; however, any loan to an insider that does not
fall within permissible regulatory exceptions must receive the prior approval of the Bank’s Board of Directors.
Dodd-Frank Wall Street Reform and Consumer Protection Act
Dodd-Frank Act, was the culmination of the legislative efforts in
response to the financial crisis of 2007 - 2008. The act reshaped Wall Street and the American banking industry by bringing the
most significant changes to financial regulation in the United States since the regulatory reform that followed the Great Depression.
The Act’s numerous provisions were to be implemented over a period of several years and were intended to decrease various
risks in the U.S. financial system. Dodd-Frank created a new Financial Stability Oversight Council to identify systemic risks in
the financial system and gave federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank was
expected to and did have an impact on the Corporation’s business operations as its provisions began to take effect. To date
the provisions that did go into effect, or began to phase in, did at a minimum increase the Corporation’s operating and compliance
costs.