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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

Commission File Number:  001-33912
 Enterprise Bancorp, Inc.
(Exact name of registrant as specified in its charter)
 
Massachusetts
04-3308902
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
222 Merrimack Street, Lowell, Massachusetts
01852
(Address of principal executive offices)
(Zip code)
 (978) 459-9000
(Registrant's telephone number, including area code)
 
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.     x Yes o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)      x Yes o 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 definition for "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act (Check one): 
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
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.     o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No

As of August 1, 2018, there were 11,694,962 shares of the issuer's common stock outstanding- par value $0.01 per share.




Table of Contents

ENTERPRISE BANCORP, INC.
INDEX

 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2

Table of Contents

PART I-FINANCIAL INFORMATION

Item 1 -
Financial Statements
ENTERPRISE BANCORP, INC.
Consolidated Balance Sheets
(Unaudited)

(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017
Assets
 
 

 
 

Cash and cash equivalents:
 
 

 
 

Cash and due from banks
 
$
41,172

 
$
40,310

Interest-earning deposits
 
97,161

 
14,496

Total cash and cash equivalents
 
138,333

 
54,806

Investment securities at fair value
 
422,174

 
405,206

Federal Home Loan Bank stock
 
2,618

 
5,215

Loans held for sale
 
657

 
208

Loans, less allowance for loan losses of $34,797 at June 30, 2018 and $32,915 at December 31, 2017
 
2,263,798

 
2,236,989

Premises and equipment, net
 
37,999

 
37,022

Accrued interest receivable
 
10,955

 
10,614

Deferred income taxes, net
 
13,223

 
10,751

Bank-owned life insurance
 
29,804

 
29,466

Prepaid income taxes
 
1,350

 
1,301

Prepaid expenses and other assets
 
7,396

 
20,330

Goodwill
 
5,656

 
5,656

Total assets
 
$
2,933,963

 
$
2,817,564

Liabilities and Stockholders' Equity
 
 

 
 

Liabilities
 
 

 
 

Customer deposits
 
$
2,481,554

 
$
2,293,872

Brokered deposits
 
178,800

 
147,490

            Total deposits
 
2,660,354

 
2,441,362

Borrowed funds
 
501

 
89,000

Subordinated debt
 
14,853

 
14,847

Accrued expenses and other liabilities
 
19,901

 
40,067

Accrued interest payable
 
777

 
478

Total liabilities
 
2,696,386

 
2,585,754

Commitments and Contingencies
 


 


Stockholders' Equity
 
 

 
 

Preferred stock, $0.01 par value per share; 1,000,000 shares authorized; no shares issued
 

 

Common stock, $0.01 par value per share; 40,000,000 shares authorized; 11,696,204 shares issued and outstanding at June 30, 2018 and 11,609,853 shares issued and outstanding at December 31, 2017
 
117

 
116

Additional paid-in capital
 
90,019

 
88,205

Retained earnings
 
154,094

 
143,073

Accumulated other comprehensive (loss) income
 
(6,653
)
 
416

Total stockholders' equity
 
237,577

 
231,810

Total liabilities and stockholders' equity
 
$
2,933,963

 
$
2,817,564



See the accompanying notes to the unaudited consolidated interim financial statements.

3


Table of Contents

ENTERPRISE BANCORP, INC.
Consolidated Statements of Income
(Unaudited)
 
 
Three months ended June 30,
 
Six months ended June 30,
(Dollars in thousands, except per share data)
 
2018
 
2017
 
2018
 
2017
Interest and dividend income:
 
 

 
 

 
 
 
 
Loans and loans held for sale
 
$
27,527

 
$
23,281

 
$
53,677

 
$
45,652

Investment securities
 
2,606

 
1,964

 
5,093

 
3,884

Other interest-earning assets
 
187

 
93

 
321

 
166

Total interest and dividend income
 
30,320

 
25,338

 
59,091

 
49,702

Interest expense:
 
 

 
 

 
 
 
 
Deposits
 
2,837

 
1,380

 
5,073

 
2,608

Borrowed funds
 
34

 
192

 
326

 
253

Subordinated debt
 
231

 
231

 
459

 
459

Total interest expense
 
3,102

 
1,803

 
5,858

 
3,320

Net interest income
 
27,218

 
23,535

 
53,233

 
46,382

Provision for loan losses
 
300

 
280

 
1,900

 
405

Net interest income after provision for loan losses
 
26,918

 
23,255

 
51,333

 
45,977

Non-interest income:
 
 

 
 

 
 
 
 
Investment advisory fees
 
1,418

 
1,267

 
2,826

 
2,492

Deposit and interchange fees
 
1,567

 
1,522

 
3,056

 
2,862

Income on bank-owned life insurance, net
 
170

 
177

 
338

 
353

Net gains on sales of investment securities
 

 
229

 
1

 
769

Net gains on sales of loans
 
48

 
138

 
132

 
271

Other income
 
530

 
606

 
1,171

 
1,326

Total non-interest income
 
3,733

 
3,939

 
7,524

 
8,073

Non-interest expense:
 
 

 
 

 
 
 
 
Salaries and employee benefits
 
13,267

 
11,792

 
25,375

 
24,484

Occupancy and equipment expenses
 
2,037

 
1,945

 
4,194

 
3,884

Technology and telecommunications expenses
 
1,639

 
1,606

 
3,192

 
3,188

Advertising and public relations expenses
 
1,112

 
797

 
1,832

 
1,416

Audit, legal and other professional fees
 
419

 
314

 
926

 
677

Deposit insurance premiums
 
346

 
376

 
846

 
759

Supplies and postage expenses
 
266

 
245

 
498

 
478

Other operating expenses
 
1,722

 
1,679

 
3,392

 
3,288

Total non-interest expense
 
20,808

 
18,754

 
40,255

 
38,174

Income before income taxes
 
9,843

 
8,440

 
18,602

 
15,876

Provision for income taxes
 
2,269

 
2,845

 
4,203

 
4,709

Net income
 
$
7,574

 
$
5,595

 
$
14,399

 
$
11,167

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.65

 
$
0.48

 
$
1.24

 
$
0.97

Diluted earnings per share
 
$
0.64

 
$
0.48

 
$
1.23

 
$
0.96

 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
11,687,182

 
11,572,430

 
11,658,046

 
11,540,796

Diluted weighted average common shares outstanding
 
11,764,411

 
11,652,689

 
11,733,391

 
11,625,712

 


See the accompanying notes to the unaudited consolidated interim financial statements.

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Table of Contents


ENTERPRISE BANCORP, INC.
Consolidated Statements of Comprehensive Income
(Unaudited)

 
 
 
Three months ended June 30,
 
Six months ended June 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
7,574

 
$
5,595

 
$
14,399

 
$
11,167

Other comprehensive (loss) income, net of taxes:
 
 
 
 
 
 
 
 
Gross unrealized holding (losses) gains on investments arising during the period
 
(1,035
)
 
4,911

 
(9,104
)
 
6,431

Income tax benefit (expense)
 
230

 
(1,772
)
 
2,035

 
(2,316
)
Net unrealized holding (losses) gains, net of tax
 
(805
)
 
3,139

 
(7,069
)
 
4,115

Less: reclassification adjustment for net gains included in net income
 
 
 
 
 
 
 
 
Net realized gains on sales of securities during the period
 

 
229

 
1

 
769

Income tax expense
 

 
(83
)
 
(1
)
 
(276
)
Reclassification adjustment for gains realized, net of tax
 

 
146

 

 
493

 
 
 
 
 
 
 
 
 
Total other comprehensive (loss) income, net
 
(805
)
 
2,993

 
(7,069
)
 
3,622

Comprehensive income
 
$
6,769

 
$
8,588

 
$
7,330

 
$
14,789



See the accompanying notes to the unaudited consolidated interim financial statements.

5

Table of Contents

ENTERPRISE BANCORP, INC.
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)

 
(Dollars in thousands)
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss)/Income
 
Total
Stockholders'
Equity
Balance at December 31, 2017
 
$
116

 
$
88,205

 
$
143,073

 
$
416

 
$
231,810

Net income
 
 
 
 
 
14,399

 
 
 
14,399

Other comprehensive loss, net
 
 
 
 
 
 
 
(7,069
)
 
(7,069
)
Common stock dividend paid ($0.29 per share)
 
 
 
 
 
(3,378
)
 
 
 
(3,378
)
Common stock issued under dividend reinvestment plan
 

 
793

 
 
 
 
 
793

Common stock issued other
 

 
68

 
 
 
 
 
68

Stock-based compensation
 
1

 
1,028

 
 
 
 
 
1,029

Net settlement for employee taxes on restricted stock and options
 

 
(362
)
 
 
 
 
 
(362
)
Stock options exercised, net
 

 
287

 
 
 
 
 
287

Balance at June 30, 2018
 
$
117


$
90,019

 
$
154,094

 
$
(6,653
)
 
$
237,577


See the accompanying notes to the unaudited consolidated interim financial statements.

6

Table of Contents

ENTERPRISE BANCORP, INC.
Consolidated Statements of Cash Flows
(Unaudited)
 
 
Six months ended June 30,
(Dollars in thousands)
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
14,399

 
$
11,167

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Provision for loan losses
 
1,900

 
405

Depreciation and amortization
 
3,434

 
3,468

Stock-based compensation expense
 
885

 
820

Income on bank-owned life insurance, net
 
(338
)
 
(353
)
Net gains on sales of investment securities
 
(1
)
 
(769
)
Mortgage loans originated for sale
 
(6,296
)
 
(11,610
)
Proceeds from mortgage loans sold
 
5,979

 
12,594

Net gains on sales of loans
 
(132
)
 
(271
)
Changes in:
 
 
 
 
Decrease in other assets
 
473

 
425

Increase (decrease) in other liabilities
 
693

 
(747
)
Net cash provided by operating activities
 
20,996

 
15,129

Cash flows from investing activities:
 
 
 
 
Proceeds from sales of investment securities
 
12,705

 
10,438

Net proceeds (purchases) from FHLB capital stock
 
2,597

 
(2,270
)
Proceeds from maturities, calls and pay-downs of investment securities
 
18,331

 
12,986

Purchase of investment securities
 
(66,969
)
 
(31,153
)
Net increase in loans
 
(28,709
)
 
(91,460
)
Additions to premises and equipment, net
 
(3,325
)
 
(3,949
)
Net cash used in investing activities
 
(65,370
)
 
(105,408
)
Cash flows from financing activities:
 
 
 
 
Net increase in deposits
 
218,992

 
84,861

Net (decrease) increase in borrowed funds
 
(88,499
)
 
33,584

Cash dividends paid
 
(3,378
)
 
(3,113
)
Proceeds from issuance of common stock
 
861

 
785

Net settlement for employee taxes on restricted stock and options
 
(362
)
 
(802
)
Proceeds from stock option exercises

 
287

 
252

Net cash provided by financing activities
 
127,901

 
115,567

 
 
 
 
 
Net increase in cash and cash equivalents
 
83,527

 
25,288

Cash and cash equivalents at beginning of period
 
54,806

 
50,475

Cash and cash equivalents at end of period
 
$
138,333

 
$
75,763

 
 
 
 
 
Supplemental financial data:
 
 
 
 
Cash paid for: interest
 
$
5,559

 
$
3,320

Cash paid for: income taxes
 
$
4,663

 
$
5,055

 
 
 
 
 
Supplemental schedule of non-cash investing activity:
 
 
 
 
Net purchases of investment securities not yet settled
 
$
351

 
$

 


See accompanying notes to the unaudited consolidated interim financial statements.

7






Table of Contents

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 
(1)
Summary of Significant Accounting Policies

(a) Organization of Holding Company and Basis of Presentation

The accompanying unaudited consolidated interim financial statements and these notes should be read in conjunction with the December 31, 2017 audited consolidated financial statements and notes thereto contained in the 2017 Annual Report on Form 10-K of Enterprise Bancorp, Inc. as filed with the Securities and Exchange Commission (the "SEC") on March 13, 2018 (the "2017 Annual Report on Form 10-K"). 

The accompanying unaudited consolidated interim financial statements of Enterprise Bancorp, Inc. (the "Company," "Enterprise," "we," or "our"), a Massachusetts corporation, include the accounts of the Company and its wholly owned subsidiary, Enterprise Bank and Trust Company, commonly referred to as Enterprise Bank (the "Bank").  The Bank is a Massachusetts trust company and state chartered commercial bank organized in 1989. Substantially all of the Company's operations are conducted through the Bank and its subsidiaries. The Company has not materially changed its accounting policies from those disclosed in its 2017 Annual Report on Form 10-K. See Item (f) "Recent Accounting Pronouncements" under the subheading "Accounting pronouncements adopted by the Company" below in this Note 1.

The Bank's subsidiaries include Enterprise Insurance Services, LLC and Enterprise Wealth Services, LLC, organized under the laws of the State of Delaware for the purposes of engaging in insurance sales activities and offering non-deposit investment products and services, respectively.  In addition, the Bank has the following subsidiaries that are incorporated in the Commonwealth of Massachusetts and classified as security corporations in accordance with applicable Massachusetts General Laws: Enterprise Security Corporation; Enterprise Security Corporation II; and Enterprise Security Corporation III.  The security corporations, which hold various types of qualifying securities, are limited to conducting securities investment activities that the Bank itself would be allowed to conduct under applicable laws.

The Company’s headquarters and the Bank’s main office are located at 222 Merrimack Street in Lowell, Massachusetts. At June 30, 2018, the Company had 24 full service branch banking offices serving the Greater Merrimack Valley and North Central regions of Massachusetts and Southern New Hampshire (Southern Hillsborough and Rockingham counties). Through the Bank and its subsidiaries, the Company offers a range of commercial, residential and consumer loan products, deposit products and cash management services, electronic banking options, and insurance services. The Company also provides a range of investment advisory, wealth management and trust services delivered via two channels, Enterprise Wealth Management and Enterprise Wealth Services. The services offered through the Bank and its subsidiaries are managed as one strategic unit and represent the Company's only reportable operating segment.

The Federal Deposit Insurance Corporation (the "FDIC") and the Massachusetts Division of Banks (the "Division") have regulatory authority over the Bank.  The Bank is also subject to certain regulatory requirements of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and, with respect to its New Hampshire branch operations, the New Hampshire Banking Department.  The business and operations of the Company are subject to the regulatory oversight of the Federal Reserve Board.  The Division also retains supervisory jurisdiction over the Company.

The accompanying unaudited consolidated interim financial statements and notes thereto have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and the instructions for SEC Form 10-Q through the rules and interpretive releases of the SEC under federal securities law. In the opinion of management, the accompanying unaudited consolidated interim financial statements reflect all necessary adjustments consisting of normal recurring accruals for a fair presentation.  All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated interim financial statements. Certain previous years' amounts in the consolidated financial statements, and notes thereto, have been reclassified to conform to the current year's presentation. Interim results are not necessarily indicative of results to be expected for the entire year, or any future period.

The Company has evaluated subsequent events and transactions from June 30, 2018 through the date this Quarterly Report on Form 10-Q was filed with the SEC for potential recognition or disclosure as required by GAAP and determined that there were no material subsequent events requiring recognition or disclosure.



8

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

(b) Uses of Estimates

In preparing the unaudited consolidated interim financial statements in conformity with GAAP, management is required to exercise judgment in determining many of the methodologies, assumptions and estimates to be utilized.  These assumptions and estimates affect the reported values of assets and liabilities as of the balance sheet date and income and expenses for the period then ended.  As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates should the assumptions and estimates used change over time due to changes in circumstances.  Changes in those estimates resulting from continuing change in the economic environment and other factors will be reflected in the consolidated financial statements and results of operations in future periods.

As discussed in the Company's 2017 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates are the estimates of the allowance for loan losses, impairment review of investment securities and the impairment review of goodwill.  Refer to Note 1, "Summary of Significant Accounting Policies," to the Company's consolidated financial statements included in the Company's 2017 Annual Report on Form 10-K for accounting policies related to these significant estimates. The Company has not changed its significant accounting policies from those disclosed in its 2017 Annual Report on Form 10-K.

(c) Restricted Instruments

Certain of the Company's derivative agreements contain provisions for collateral to be posted if the derivative exposure exceeds a threshold amount. When the Company has pledged cash as collateral for this purpose, the cash is carried as restricted cash within cash and cash equivalents. See Note 7, "Derivatives and Hedging Activities" for more information about the Company's collateral related to its derivatives.

The Bank is also required by the Federal Reserve Bank of Boston (the "FRB") to maintain in reserves certain amounts of vault cash and/or deposits with the FRB. The average daily cash balance on hand for reserve requirements included in “Cash and Due from Banks” was approximately $8.6 million, based on the two week computation period encompassing June 30, 2018.

As a member of the Federal Home Loan Bank of Boston (the "FHLB"), the Company is required to purchase certain levels of FHLB capital stock at par value in association with outstanding advances from the FHLB.  From time to time, the FHLB may initiate the repurchase, at par value, of "excess" levels of its capital stock held by member banks. This stock is classified as a restricted investment and carried at cost, which management believes approximates fair value.  FHLB stock represents the only restricted investment held by the Company.
 
Management regularly reviews its holdings of FHLB stock for other-than-temporary-impairment ("OTTI"). Based on management's periodic review, the Company has not recorded any OTTI charges on this investment to date. If it was determined that a write-down of FHLB stock was required, impairment would be recognized through a charge to earnings.

See Note 2, "Investment Securities," for additional information on management's OTTI review.

(d) Revenue Recognition-Accounting Standard Codification (“ASC”) Topic 606

On January 1, 2018, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers-Topic 606." ("ASC 606") The core principles require an entity to recognize revenue to depict the transfer of goods and services to customers as performance obligations are satisfied. While the majority of the Company’s revenue is generated from contracts with customers, our primary sources of revenue, interest and dividend income (primarily loan interest income), are outside of the scope of ASC 606 and accounted for under other ASC topics. We have not identified any material changes needed in our process of recording revenue or any income statement reclassifications necessary upon the adoption of the new revenue recognition standard.

The primary areas of non-interest income on the Company's Consolidated Statements of Income that are within the scope of ASC 606 are discussed below.

Investment advisory fees consist of income generated through Enterprise Wealth Management and Enterprise Wealth Services. Enterprise Wealth Management income is primarily generated by managing customers' financial assets. Revenue is recognized as our performance obligation is completed each month. Enterprise Wealth Services revenue is generated through a third-party arrangement to refer, manage and service customers. For new sales and referrals along with transactional type


9

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

charges, the performance obligation is based on a point in time and the payment is received and revenue is recognized in the same month as the revenue generating activity. For managing and servicing customers, revenue is recognized when our performance obligation is completed each month.

Deposit and interchange fees are comprised of deposit account related charges and income generated from electronic payment interchanges. Deposit account charges consist of certain transactional analysis fees net of earning balance credits, monthly account service fees, and transactional fees such as overdraft fees. Analysis and monthly services fees are recognized over the period the service is performed. For transactional fees, the performance obligation and the revenue is recognized at a point of time and payment is typically received as the service is rendered. Interchange income is generated primarily from retail debit card transactions processed through the card payment network. The performance obligation and the revenue are recognized when the service is performed.

The following non-interest income components are not subject to ASC 606: income on bank-owned life insurance, net gains on sales of investment securities, and net gains on sales of loans, and are covered under other ASC topics. The remaining revenue items in non-interest income are not material.

For further information on the Company's adoption of ASU 2014-09, see Item (f) "Recent Accounting Pronouncements" under the subheading "Accounting pronouncements adopted by the Company" below in this Note 1.

See also the Company's most recent 2017 Annual Report on Form 10-K Note 1, "Summary of Significant Accounting Policies," to the Company's consolidated financial statements for additional accounting policies on revenue recognition related to loans, investments, gains and losses on debt security sales, and net gains on loans held for sale.

(e) Income Taxes
 
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and in the states of Massachusetts and New Hampshire within the directives of the respective enacted tax legislation. The Company uses the asset and liability method of accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for the future tax expense or benefit attributable to differences between the financial statement carrying amounts and the tax basis of assets and liabilities.  The deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.  As changes in tax laws or rates are enacted, deferred tax assets and liabilities will be adjusted accordingly through the provision for income taxes in the period that includes the enactment date.

The Company's policy is to classify interest resulting from underpayment of income taxes as income tax expense in the first period the interest would begin accruing according to the provisions of the relevant tax law.  The Company classifies penalties resulting from underpayment of income taxes as income tax expense in the period for which the Company claims or expects to claim an uncertain tax position or in the period in which the Company's judgment changes regarding an uncertain tax position.
 
The income tax provisions will differ from the expense that would result from applying the federal statutory rate to income before taxes, due primarily to the impact of tax-exempt interest from certain investment securities, loans and bank-owned life insurance ("BOLI") and tax benefits from equity compensation deductions.

The Company did not have any unrecognized tax benefits accrued as income tax liabilities or receivables or as deferred tax items at June 30, 2018.  The Company is subject to U.S. federal and state income tax examinations by taxing authorities for the 2014 through 2017 tax years.

(f) Recent Accounting Pronouncements

Accounting pronouncements adopted by the Company

In May 2014, the Financial Accounting Standards Board ("FASB ") issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)." This ASU is intended to create a single source of revenue guidance which is more principles based than current revenue guidance. The guidance affects any entity that either enters into contracts with customers to transfer goods or services, or enters into contracts for the transfer of non-financial assets, unless those contracts are within the scope of other standards. In the first quarter of 2018, the Company adopted ASU 2014-09. Because the largest portion of the Company's revenue, interest income and various loan fees, is specifically excluded from the scope of this ASU, and because


10

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

the Company recognizes the majority of the remaining revenue sources in a manner that is consistent with this ASU, the adoption of this standard in the first quarter of 2018 did not materially impact the Company's consolidated financial statements, results of operations or disclosures.

For further information regarding the Company's revenue policies see Item (d) "Revenue Recognition-ASC Topic 606" above in this Note 1.

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," which updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments.

Among other things, ASU No. 2016-01:
Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income;
Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.

Because the Company's investment in equity securities at June 30, 2018 was immaterial, the adoption of this ASU by the Company in the first quarter of 2018 did not have a material impact on the Company's consolidated financial statements, results of operations or disclosures. The fair value changes of equity securities that will be recognized in net income in the future will depend on the amount of dollars invested and the magnitude of changes in equity market values.

For further information regarding the Company's recognition and measurement of financial assets and liabilities see Note 2, "Investment Securities," and Note 12, "Fair Value Measurements" in this Form 10-Q.

In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments." The amendments in this update are intended to reduce diversity in practice related to the presentation of eight specific cash flow issues. Because this amendment primarily impacts the presentation and classification of information, this ASU did not materially impact the Company's consolidated financial statements and results of operations upon adoption in the first quarter of 2018.

In November 2016, the FASB issued ASU No. 2016-18, "Statement of Cash flows-Restricted Cash (Topic 230)." The amendments in this update clarify the inclusion of restricted cash in the cash and cash equivalents beginning-of-period and end-of period reconciliation on the statement of cash flows. Because this amendment primarily impacts the presentation and classification of information, this ASU did not have a material impact on the Company's consolidated financial statements and results of operations upon adoption in the first quarter of 2018.
 
For further information regarding the Company's restricted cash see Item (c) "Restricted Instruments" above in this Note 1.

In March 2017, the FASB issued ASU No. 2017-07, "Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." The amendments in this update outline the presentation, classification and disclosure requirements for service cost and other components of net benefit costs. Because this amendment primarily impacts the presentation and classification of information, the adoption of this ASU in the first quarter of 2018 did not have a material impact on the Company's consolidated financial statements and results of operations.

For further information regarding the Company's compensation retirement benefits see Note 9, "Supplemental Retirement Plans and Other Post-retirement Benefit Obligations."

In May 2017, the FASB issued ASU No. 2017-09, "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting." The amendments in this update apply to entities that change the terms of an outstanding share-based payment award. The amendments are intended to reduce diversity in practice as well as cost and complexity when applying guidance in Topic 718 to the modification of the terms and conditions of a share-based payment award. This ASU provides guidance on the three modifications to share-based payment awards and conditions that must be met in order to


11

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

exempt an entity from modification accounting under topic 718. The adoption of this ASU in the first quarter of 2018 did not have an impact on the Company's consolidated financial statements, results of operations or disclosures because to date the Company has not made any such modifications.

For further information regarding the Company's stock compensation see Note 10, "Stock-Based Compensation."

Accounting pronouncements not yet adopted by the Company (in order of effective date of implementation)

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)," which supersedes previous leasing guidance in Topic 840. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The FASB has since issued additional related ASU amendments intended to clarify and improve certain aspects of the guidance and implementation of Topic 842 but do not change the core principles of the guidance in Topic 842. The effective dates are the same as the effective date in Topic 842. In accordance with the guidance as amended, the Company may elect to recognize a cumulative effect adjustment to retained earnings upon adoption or use the modified retrospective transition approach for lessees for capital and operating leases existing at, or entered into after, January 1, 2017 for the Company (the beginning of the earliest comparative period presented) in the consolidated financial statements, with certain practical expedients available.
  
The Company is currently evaluating the effects of this ASU on the Company's consolidated financial statements, results of operations and disclosures. Based on the Company's evaluation to date, management believes the only significant implication of this ASU on the Company relates to operating leases of our facilities, mainly branch leases. As of June 30, 2018, the Company had leases on 17 of its locations, including branches and part of its main campus, and upon adoption of this ASU the balance sheet will reflect both lease liabilities, equal to the present value of lease payments, and right-of-use assets, equal to the lease liability plus payments made to lessors adjusted for prepaid or accrued rent and any initial direct cost incurred. In addition, the Company will recognize lease expense in the income statement on a straight-line basis similar to current operating leases. The straight-line expense will reflect the interest expense on the lease liability (effective interest method) and amortization of the right-of-use asset. Lease expense will be presented as a single line item in the operating expense section of the income statement. Management believes that lease expense under the new standard will generally approximate lease expense under current GAAP. The foregoing observations are subject to change as management completes their evaluation.

In June 2018, the FASB issued ASU No. 2018-07, "Compensation-Stock-Based Compensation (Topic 718): Improvements to Nonemployee Shared-Based Payment Accounting." The amendments in the ASU expand the scope of Topic 718 to include share based payment transactions for acquiring goods and services from nonemployees except for share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract. Additionally, Topic 718 has been updated for specific guidance on inputs to an option pricing model and the attribution of cost (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted. From time to time, the Company issues shares to community members for consulting on regional advisory councils. These shares vest immediately and the cost, which is deemed to be immaterial, is expensed in the period in which the services are rendered and is based on the market price on the date of grant. The adoption of this standard will not have a material impact on the Company's consolidated financial statements, results of operations or disclosures.

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. Previously, when credit losses were measured under GAAP, an entity generally only considered past events and current conditions in measuring the incurred loss and generally recognition of the full amount of credit losses was delayed until the loss was probable of occurring. The amendments in this ASU eliminate the probable initial recognition threshold in current GAAP and, instead, reflect an entity’s current estimate of all expected credit losses (commonly known as "CECL").

The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected


12

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

increases or decreases of expected credit losses that have taken place during the period. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net fair value at the amount expected to be collected on the financial asset.

Credit losses on available-for-sale debt securities should be measured in a manner similar to current GAAP. However, the amendments in this Update require that credit losses be presented as an allowance rather than as a write-down. Unlike current GAAP, the ASU provides for reversals of credit losses in future period net income in situations where the estimate of loss declines.

An entity will apply the amendments in this Update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). For public business entities that are SEC filers, such as the Company, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption for fiscal years beginning after December 15, 2018 is permitted.
In April, 2018 banking regulators issued a proposed revision to their capital rules that addresses the regulatory capital treatment of credit loss allowances under the CECL methodology and, if enacted as proposed, would allow banking organizations to phase in the day-one regulatory capital effects of CECL adoption over three years.
The Company has established an implementation committee and an enterprise-wide implementation plan for this ASU, which will consider the impact to operations, financial results, capital, and disclosures and controls. The impact of the adoption of ASU No. 2016-13 on the Company's operations, financial results, disclosures, and controls is under evaluation.

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles-Goodwill and Other (Topic 350)-Simplifying the Test for Goodwill Impairment." The main provision in this ASU eliminated Step 2 of the goodwill impairment test and instead requires an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount. An impairment charge would be recognized for the amount the carrying value exceeds the reporting unit's fair value as long as the amount recognized doesn't exceed the amount of goodwill allocated to the reporting unit. For public business entities that are SEC filers, such as the Company, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for impairment tests performed on testing dates after January 1, 2017. Goodwill carried on the Company’s consolidated financial statements was $5.7 million at both June 30, 2018 and December 31, 2017. This asset is related to the Company’s acquisition of two branch offices in July 2000. The Company does not expect the adoption of ASU No. 2017-01 to have a material impact on the Company's consolidated financial statements and results of operations.

(2) Investment Securities
 
As of June 30, 2018, the investment portfolio was primarily comprised of debt securities, with a small portion of the portfolio invested in equity securities. The Company had only debt securities at December 31, 2017, as the equity portfolio was liquidated during 2017, in order to reduce the magnitude of the impact from market fluctuations on earnings due to new accounting rules in effect on January 1, 2018.

See Note 12, "Fair Value Measurements," below for further information regarding the Company's fair value measurements for available-for-sale securities and refer to Note 1, Item (c) "Restricted Instruments" for information regarding the Company's investment in FHLB stock.



13

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

Debt Securities

The amortized cost and fair values of debt securities at the dates specified are summarized as follows:
 
 
June 30, 2018
(Dollars in thousands)
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair Value
Federal agency obligations (1)
 
$
48,830

 
$

 
$
508

 
$
48,322

Residential federal agency MBS (1)
 
155,088

 
5

 
4,253

 
150,840

Commercial federal agency MBS(1)
 
74,403

 

 
2,238

 
72,165

Municipal securities
 
138,873

 
505

 
1,791

 
137,587

Corporate bonds
 
11,679


4


314


11,369

Certificates of deposits (2)
 
950

 

 
8

 
942

Total debt securities, at fair value
 
$
429,823

 
$
514

 
$
9,112

 
$
421,225

 
 
 
December 31, 2017
(Dollars in thousands)
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair Value
Federal agency obligations(1)
 
$
51,769

 
$
30

 
$
82

 
$
51,717

Residential federal agency MBS(1)
 
141,054

 
71

 
971

 
140,154

Commercial federal agency MBS(1)
 
66,777

 
9

 
286

 
66,500

Municipal securities
 
132,603

 
2,097

 
354

 
134,346

Corporate bonds
 
11,546

 
63

 
67

 
11,542

Certificates of deposits (2)
 
950

 

 
3

 
947

Total debt securities, at fair value
 
$
404,699

 
$
2,270

 
$
1,763

 
$
405,206

__________________________________________
(1)
These categories may include investments issued or guaranteed by government sponsored enterprises such as Fannie Mae ("FNMA"), Freddie Mac ("FHLMC"), Federal Farm Credit Bank ("FFCB"), or one of several Federal Home Loan Banks, as well as, investments guaranteed by Ginnie Mae ("GNMA"), a wholly-owned government entity. 
(2)
Certificates of deposit ("CDs") represent term deposits issued by banks that are subject to FDIC insurance and purchased on the open market.

Included in the residential and commercial federal agency mortgage-backed securities ("MBS") categories were collateralized mortgage obligations ("CMOs") issued by U.S. agencies with fair values totaling $189.7 million and $171.7 million at June 30, 2018 and December 31, 2017, respectively.

As of the dates reflected in the tables above, all of the Company’s debt securities were classified as available-for-sale and carried at fair value. Net unrealized appreciation and depreciation on debt securities available-for-sale, net of applicable income taxes, are reflected as a component of accumulated other comprehensive income (loss).

The net unrealized gain or loss in the Company's debt security portfolio fluctuates as market interest rates rise and fall.  Due to the predominantly fixed rate nature of this portfolio, as market rates fall, the value of the portfolio rises, and as market rates rise, the value of the portfolio declines.  The unrealized gains or losses on debt securities will also decline as the securities approach maturity. Unrealized losses on debt securities that are deemed OTTI are generally charged to earnings, as described further in Note 1, "Summary of Significant Accounting Policies" under Item (d) "Investments" to the Company's consolidated financial statements in the Company's recent 2017 Annual Report on Form 10-K. Gains or losses will be recognized in the income statement if the securities are sold.



14

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The following tables summarize debt securities having temporary impairment, due to the fair market values having declined below the amortized costs of the individual investments, and the period that the investments have been temporarily impaired at June 30, 2018 and December 31, 2017.
 
 
 
June 30, 2018
 
 
Less than 12 months
 
12 months or longer
 
Total
(Dollars in thousands)
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
# of holdings
Federal agency obligations
 
$
48,321

 
$
508

 
$

 
$

 
$
48,321

 
$
508

 
15

Residential federal agency MBS
 
142,321

 
3,939

 
6,031

 
314

 
148,352

 
4,253

 
44

Commercial federal agency MBS
 
67,146

 
2,004

 
5,019

 
234

 
72,165

 
2,238

 
20

Municipal securities
 
80,198

 
1,258

 
9,820

 
533

 
90,018

 
1,791

 
140

Corporate bonds
 
7,793

 
203

 
2,529

 
111

 
10,322

 
314

 
61

Certificates of deposit
 
942

 
8

 

 

 
942

 
8

 
4

Total temporarily impaired debt securities
 
$
346,721

 
$
7,920

 
$
23,399

 
$
1,192

 
$
370,120

 
$
9,112

 
284


 
 
December 31, 2017
 
 
Less than 12 months
 
12 months or longer
 
Total
(Dollars in thousands)
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
# of holdings
Federal agency obligations
 
$
34,344

 
$
82

 
$

 
$

 
$
34,344

 
$
82

 
9

Residential federal agency MBS
 
109,308

 
882

 
2,015

 
89

 
111,323

 
971

 
30

Commercial federal agency MBS
 
35,859

 
205

 
5,190

 
81

 
41,049

 
286

 
11

Municipal securities
 
16,983

 
129

 
10,210

 
225

 
27,193

 
354

 
50

Corporate bonds
 
2,802

 
23

 
2,913

 
44

 
5,715

 
67

 
33

Certificates of deposit
 
947

 
3

 

 

 
947

 
3

 
4

Total temporarily impaired debt securities
 
$
200,243

 
$
1,324

 
$
20,328

 
$
439

 
$
220,571

 
$
1,763

 
137


During the six months ended June 30, 2018 and 2017, the Company did not record any fair value impairment charges (OTTI) on its investments in debt securities. At June 30, 2018, management did not consider any debt securities to have OTTI and attributes the unrealized losses to increases in current market yields compared to the yields at the time the investments were purchased by the Company. Management regularly reviews the portfolio for debt securities with unrealized losses that are other-than-temporarily impaired. There have been no material changes to the Company's process for assessing investments for OTTI as reported in the 2017 Annual Report on Form 10-K. For more information about the Company's assessment for OTTI see Note 2, "Investment Securities" to the Company's consolidated financial statements in the Company's recent 2017 Annual Report on Form 10-K.

The contractual maturity distribution at June 30, 2018 of total debt securities was as follows:
(Dollars in thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
22,688

 
$
22,678

Due after one, but within five years
 
86,706

 
85,675

Due after five, but within ten years
 
137,030

 
133,927

Due after ten years
 
183,399

 
178,945

Total debt securities
 
$
429,823

 
$
421,225


Scheduled contractual maturities shown above may not reflect the actual maturities of the investments. The actual MBS/CMO cash flows likely will be faster than presented above due to prepayments and amortization. Similarly, included in the fair value of debt securities above are callable securities, comprised of municipal securities and corporate bonds totaling $75.7


15

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

million, which can be redeemed by the issuers prior to the maturity presented above.  Management considers these factors when evaluating the interest rate risk in the Company's asset-liability management program.

From time to time, the Company may pledge debt securities as collateral for deposit account balances of municipal customers, and for borrowing capacity with the FHLB and the FRB.  The fair value of debt securities pledged as collateral for these purposes was $420.2 million at June 30, 2018.

No sales on debt securities were recorded during the three months ended June 30, 2018 and June 30, 2017. Sales of debt securities, including pending trades based on trade date, if applicable, for the six months ended June 30, 2018 and June 30, 2017 are summarized as follows:
 
 
Six months ended June 30,
(Dollars in thousands)
 
2018
 
2017
Amortized cost of debt securities sold (1)
 
$
668

 
$
2,262

Gross realized gains on sales
 
3

 
32

Gross realized losses on sales
 
(2
)
 

Total proceeds from sales of debt securities
 
$
669

 
$
2,294

_________________________________________
(1)
Amortized cost of investments sold is determined on a specific identification basis.

Equity Securities
 
As of June 30, 2018, the Company held equity securities with a fair value of $949 thousand, compared to no equity securities at December 31, 2017. At June 30, 2018, the equity portfolio consisted primarily of investments in a diversified group of mutual funds, with a portion of the portfolio invested in individual common stock of entities in the financial services industry.

The Company adopted ASU 2016-01 in the first quarter of 2018. As a result, the fair market value fluctuations associated with the equity portfolio are recognized in the Company’s Consolidated Statement of Income in the "Other income" line item. During the three and six months ended June 30, 2018, the related fair value gain/loss on equity securities was immaterial.

There were no sales on equity securities in the three or six months ended June 30, 2018. For the three and six months ended June 30, 2017, the amortized cost of equity securities sold based on trade date, if applicable, amounted to $252 thousand and $7.1 million, resulting in net realized gains of $229 thousand and $737 thousand, respectively. The amortized cost of equity securities sold is determined on a specific identification basis.

(3)
Loans

The Company specializes in lending to business entities, non-profit organizations, professional practices and individuals. The Company's primary lending focus is on the development of high quality commercial relationships achieved through active business development efforts, long-term relationships with established commercial developers, strong community involvement and focused marketing strategies.  Loans made to businesses include commercial mortgage loans, construction and land development loans, secured and unsecured commercial loans and lines of credit, and letters of credit.  The Company also originates equipment lease financing for businesses. Loans made to individuals include conventional residential mortgage loans, home equity loans and lines, residential construction loans on owner-occupied primary and secondary residences, and secured and unsecured personal loans and lines of credit. The Company manages its loan portfolio to avoid concentration by industry, relationship size and source of repayment to lessen its credit risk exposure.

See Note 4, "Allowance for Loan Losses," for information on the Company's credit risk management, non-accrual, impaired and troubled debt restructured loans and the allowance for loan losses.


16

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
Major classifications of loans at the periods indicated were as follows:
(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017
Commercial real estate
 
$
1,246,501

 
$
1,201,351

Commercial and industrial
 
493,981

 
498,802

Commercial construction
 
246,865

 
274,905

Total commercial loans
 
1,987,347

 
1,975,058

Residential mortgages
 
205,781

 
195,492

Home equity loans and lines
 
98,176

 
91,706

Consumer
 
9,756

 
10,293

Total retail loans
 
313,713

 
297,491

 
 
 
 
 
Gross loans
 
2,301,060

 
2,272,549

Deferred loan origination fees, net
 
(2,465
)
 
(2,645
)
Total loans
 
2,298,595

 
2,269,904

Allowance for loan losses
 
(34,797
)
 
(32,915
)
Net loans
 
$
2,263,798

 
$
2,236,989

 
Loan Portfolio Classifications
 
-Commercial loans:

Commercial real estate loans include loans secured by both owner-use and non-owner occupied real estate.  These loans are typically secured by a variety of commercial and industrial property types, including one-to-four and multi-family apartment buildings, office, industrial or mixed-use facilities, strip shopping centers, or other commercial properties, and are generally guaranteed by the principals of the borrower. Commercial real estate loans generally have repayment periods of approximately fifteen to twenty-five years.  Variable interest rate loans have a variety of adjustment terms and underlying interest rate indices, and are generally fixed for an initial period before periodic rate adjustments begin.
 
Commercial and industrial loans include seasonal revolving lines of credit, working capital loans, equipment financing (including equipment leases), and term loans.  Also included in commercial and industrial loans are loans partially guaranteed by the U.S. Small Business Administration ("SBA"), and loans under various programs and agencies.  Commercial and industrial credits may be unsecured loans and lines to financially strong borrowers, loans secured in whole or in part by real estate unrelated to the principal purpose of the loan or secured by inventories, equipment, or receivables, and are generally guaranteed by the principals of the borrower.  Variable rate loans and lines in this portfolio have interest rates that are periodically adjusted, with loans generally having fixed initial periods.  Commercial and industrial loans have average repayment periods of one to seven years.
 
Commercial construction loans include the development of residential housing and condominium projects, the development of commercial and industrial use property, and loans for the purchase and improvement of raw land.  These loans are secured in whole or in part by the underlying real estate collateral and are generally guaranteed by the principals of the borrowers.  In many cases, these loans move into the permanent commercial real estate portfolio when the construction phase is completed.
Construction lenders work to cultivate long-term relationships with established developers. The Company limits the amount of financing provided to any single developer for the construction of properties built on a speculative basis.  Funds for construction projects are disbursed as pre-specified stages of construction are completed.  Regular site inspections are performed, prior to advancing additional funds, at each construction phase, either by experienced construction lenders on staff at the Bank or by independent outside inspection companies.  Commercial construction loans generally are variable rate loans and lines of credit with interest rates that are periodically adjusted and generally have terms of one to three years.

From time to time, the Company participates with other banks in the financing of certain commercial projects.  Participating loans with other institutions provide banks the opportunity to retain customer relationships and reduce credit risk exposure among each participating bank, while providing customers with larger credit vehicles than the individual bank might be willing or able to offer independently. In some cases, the Company may act as the lead lender, originating and servicing the


17

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

loans, but participating out a portion of the funding to other banks.  In other cases, the Company may participate in loans originated by other institutions. In each case, the participating bank funds a percentage of the loan commitment and takes on the related pro-rata risk.  In each case in which the Company participates in a loan, the rights and obligations of each participating bank are divided proportionately among the participating banks in an amount equal to their share of ownership and with equal priority among all banks.  When the participation qualifies as a sale under GAAP, the balances participated out to other institutions are not carried as assets on the Company's financial statements.  The Company performs an independent credit analysis of each commitment and a review of the participating institution prior to participation in the loan, and an annual review thereafter of each participating institution. Loans originated by other banks in which the Company is a participating institution are carried in the loan portfolio at the Company's pro-rata share of ownership.  Loans originated by other banks in which the Company is a participating institution amounted to $79.0 million at June 30, 2018 and $91.6 million at December 31, 2017. See also "Loans serviced for others" below for information related to commercial loans participated out to various other institutions.
 
Letters of credit are conditional commitments issued by the Company to guarantee the financial obligation or performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  If the letter of credit is drawn upon, a loan is created for the customer, generally a commercial loan, with the same criteria associated with similar commercial loans.
 
-Residential mortgage loans:

Enterprise originates conventional mortgage loans on one-to-four family residential properties.  These properties may serve as the borrower's primary residence, or as vacation homes or investment properties.  Loan-to-value limits vary, generally from 75% for multi-family, owner-occupied properties, up to 97% for single family, owner-occupied properties, with mortgage insurance coverage required for loan-to-value ratios greater than 80% based on program parameters.  In addition, financing is provided for the construction of owner-occupied primary and secondary residences.  Residential mortgage loans may have terms of up to 30 years at either fixed or adjustable rates of interest.  Fixed and adjustable rate residential mortgage loans are generally originated using secondary market underwriting and documentation standards.
 
Depending on the current interest rate environment, management projections of future interest rates and the overall asset-liability management program of the Company, management may elect to sell those fixed and adjustable rate residential mortgage loans which are eligible for sale in the secondary market, or hold some or all of this residential loan production for the Company's portfolio.  Mortgage loans are generally not pooled for sale, but instead sold on an individual basis. The Company may retain or sell the servicing when selling the loans.  Loans sold are subject to standard secondary market underwriting and eligibility representations and warranties over the life of the loan and are subject to an early payment default period covering the first four payments for certain loan sales. Loans classified as held for sale are carried as a separate line item on the balance sheet.

-Home equity loans and lines of credit:

Home equity term loans are originated for one-to-four family residential properties with maximum original loan-to-value ratios generally up to 80% of the automated valuation or appraised value of the property securing the loan.  Home equity loan payments consist of monthly principal and interest based on amortization ranging from three to fifteen years.  The rates may be variable or fixed.
 
The Company originates home equity revolving lines of credit for one-to-four family residential properties with maximum original loan-to-value ratios generally up to 80% of the automated valuation or appraised value of the property securing the loan.  Home equity lines generally have interest rates that adjust monthly based on changes in the Wall Street Journal Prime Rate, although minimum rates may be applicable.  Some home equity line rates may be fixed for a period of time and then adjusted monthly thereafter. The payment schedule for home equity lines requires interest only payments for the first ten years of the lines. Generally at the end of ten years, the line may be frozen to future advances, and principal plus interest payments are collected over a fifteen-year amortization schedule or, for eligible borrowers meeting certain requirements, the line availability may be extended for an additional interest only period.
 


18

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

-Consumer loans:

Consumer loans consist primarily of secured or unsecured personal loans, unsecured loans under energy efficiency financing programs in conjunction with Massachusetts public utilities, and unsecured overdraft protection lines on checking accounts extended to individual customers. The aggregate amount of overdrawn deposit accounts are reclassified as loan balances.
 
Loans serviced for others
 
At June 30, 2018 and December 31, 2017, the Company was servicing residential mortgage loans owned by investors amounting to $17.8 million and $18.4 million, respectively.  Additionally, the Company was servicing commercial loans originated by the Company and participated out to various other institutions amounting to $74.7 million and $70.7 million at June 30, 2018 and December 31, 2017, respectively. See the discussion above under the heading "Commercial loans" for further information regarding commercial participations.
 
Loans serving as collateral
 
Loans designated as qualified collateral and pledged to the FHLB for borrowing capacity for the periods indicated are summarized below:

(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017
Commercial real estate
 
$
211,661

 
$
224,703

Residential mortgages
 
187,266

 
187,524

Home equity
 
8,904

 
9,405

Total loans pledged to FHLB
 
$
407,831

 
$
421,632


See Note 12, "Fair Value Measurements," below for further information regarding the Company's fair value measurements for loans, and Note 7, "Derivatives and Hedging Activities," below for information regarding interest-rate swap agreements related to certain commercial loans.

(4)
Allowance for Loan Losses
 
Allowance for probable loan losses methodology

On a quarterly basis, management prepares an estimate of the allowance necessary to cover estimated probable credit losses.  The Company uses a systematic methodology to measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology makes use of specific reserves for loans individually evaluated and deemed impaired, and general reserves for larger groups of homogeneous loans, which are collectively evaluated relying on a combination of qualitative and quantitative factors that may affect credit quality of the pool.

There have been no material changes to the Company's underwriting practices, credit risk management system, or to the allowance assessment methodology used to estimate loan loss exposure as reported in the 2017 Annual Report on Form 10-K.  Refer to Note 4, "Allowance for Loan Losses," to the Company's consolidated financial statements contained in the 2017 Annual Report on Form 10-K for further discussion of management's methodology used to estimate a sufficient allowance for loan losses, the credit risk management function and adversely classified loan rating system.



19

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The balances of loans as of June 30, 2018 by portfolio classification and evaluation method are summarized as follows: 
(Dollars in thousands)
 
Loans individually
evaluated for
impairment
 
Loans collectively
evaluated for
impairment
 
Gross Loans
Commercial real estate
 
$
13,234

 
$
1,233,267

 
$
1,246,501

Commercial and industrial
 
12,571

 
481,410

 
493,981

Commercial construction
 
1,686

 
245,179

 
246,865

Residential mortgages
 
562

 
205,219

 
205,781

Home equity loans and lines
 
494

 
97,682

 
98,176

Consumer
 
164

 
9,592

 
9,756

Total gross loans
 
$
28,711

 
$
2,272,349

 
$
2,301,060


The balances of loans as of December 31, 2017 by portfolio classification and evaluation method are summarized as follows:

(Dollars in thousands)
 
Loans individually
evaluated for
impairment
 
Loans collectively
evaluated for
impairment
 
Gross Loans
Commercial real estate
 
$
13,739

 
$
1,187,612

 
$
1,201,351

Commercial and industrial
 
10,096

 
488,706

 
498,802

Commercial construction
 
1,624

 
273,281

 
274,905

Residential mortgages
 
397

 
195,095

 
195,492

Home equity loans and lines
 
371

 
91,335

 
91,706

Consumer
 
35

 
10,258

 
10,293

Total gross loans
 
$
26,262

 
$
2,246,287

 
$
2,272,549


See "Financial Condition," in Item 2, "Management's Discussion and Analysis," under the headings "Credit Risk" and "Allowance for Loan Losses" in this Form 10-Q for additional information about changes in the Company's credit quality indicators since December 31, 2017.

Credit quality indicators

Early detection of credit issues is critical to minimize credit losses. Accordingly, management regularly monitors internal credit quality indicators such as, among others, the risk classification of adversely classified loans, past due and non-accrual loans, impaired and restructured loans, and the level of foreclosure activity. These credit quality indicators are discussed below.

Adversely classified loans

The Company's loan risk rating system classifies loans depending on risk of loss characteristics. The classifications range from "substantially risk free" for the highest quality loans and loans that are secured by cash collateral, through a satisfactory range of "minimal," "moderate," "better than average," and "average" risk, to the regulatory problem-asset classifications of "criticized," for loans that may need additional monitoring, and the more severe adverse classifications of "substandard," "doubtful," and "loss" based on criteria established under banking regulations. Loans which are evaluated to be of weaker credit quality are placed on the "watch credit list" and reviewed on a more frequent basis by management.
 
Adversely classified loans may be accruing or in non-accrual status and may be additionally designated as impaired or restructured, or some combination thereof. 
 


20

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The following tables present the Company's credit risk profile for each portfolio classification by internally assigned adverse risk rating category as of the periods indicated:
 
 
June 30, 2018
 
 
Adversely Classified
 
Not Adversely
 
 
(Dollars in thousands)
 
Substandard
 
Doubtful
 
Loss
 
Classified
 
Gross Loans
Commercial real estate
 
$
16,933

 
$
493

 
$

 
$
1,229,075

 
$
1,246,501

Commercial and industrial
 
14,018

 

 

 
479,963

 
493,981

Commercial construction
 
1,686

 

 

 
245,179

 
246,865

Residential mortgages
 
1,502

 

 

 
204,279

 
205,781

Home equity loans and lines
 
543

 

 

 
97,633

 
98,176

Consumer
 
183

 
9

 

 
9,564

 
9,756

Total gross loans
 
$
34,865

 
$
502

 
$

 
$
2,265,693

 
$
2,301,060



 
 
December 31, 2017
 
 
Adversely Classified
 
Not Adversely
 
 
(Dollars in thousands)
 
Substandard
 
Doubtful
 
Loss
 
Classified
 
Gross Loans
Commercial real estate
 
$
12,895

 
$

 
$

 
$
1,188,456

 
$
1,201,351

Commercial and industrial
 
9,915

 
48

 
1

 
488,838

 
498,802

Commercial construction
 
1,624

 

 

 
273,281

 
274,905

Residential mortgages
 
1,355

 

 

 
194,137

 
195,492

Home equity loans and lines
 
513

 

 

 
91,193

 
91,706

Consumer
 
52

 
10

 

 
10,231

 
10,293

Total gross loans
 
$
26,354

 
$
58

 
$
1

 
$
2,246,136

 
$
2,272,549



Total adversely classified loans amounted to 1.54% of total loans at June 30, 2018, as compared to 1.16% at December 31, 2017.

Past due and non-accrual loans

 The following tables present an age analysis of past due loans by portfolio classification as of the dates indicated:  
 
 
Balance at June 30, 2018
(Dollars in thousands)
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Past Due 90 days or more
 
Total Past
Due Loans
 
Current Loans
 
Gross
Loans
 
Non-accrual Loans
Commercial real estate
 
$
5,209

 
$
137

 
$
4,149

 
$
9,495

 
$
1,237,006

 
$
1,246,501

 
$
6,512

Commercial and industrial
 
950

 
432

 
1,579

 
2,961

 
491,020

 
493,981

 
3,438

Commercial construction
 
1,710

 

 

 
1,710

 
245,155

 
246,865

 
187

Residential mortgages
 
547

 
946

 

 
1,493

 
204,288

 
205,781

 
429

Home equity loans and lines
 
442

 

 
38

 
480

 
97,696

 
98,176

 
494

Consumer
 
110

 
2

 

 
112

 
9,644

 
9,756

 
17

Total gross loans
 
$
8,968

 
$
1,517

 
$
5,766

 
$
16,251

 
$
2,284,809

 
$
2,301,060

 
$
11,077



21

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
 
Balance at December 31, 2017
(Dollars in thousands)
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Past Due 90 days or more
 
Total Past
Due Loans
 
Current Loans
 
Gross Loans
 
Non-accrual Loans
Commercial real estate
 
$
4,200

 
$
69

 
$
3,569

 
$
7,838

 
$
1,193,513

 
$
1,201,351

 
$
6,751

Commercial and industrial
 
374

 
527

 
327

 
1,228

 
497,574

 
498,802

 
1,294

Commercial construction
 
2,526

 
518

 

 
3,044

 
271,861

 
274,905

 
193

Residential mortgages
 
1,931

 
93

 
89

 
2,113

 
193,379

 
195,492

 
262

Home equity loans and lines
 
491

 
120

 
12

 
623

 
91,083

 
91,706

 
463

Consumer
 
51

 
5

 
45

 
101

 
10,192

 
10,293

 
69

Total gross loans
 
$
9,573

 
$
1,332

 
$
4,042

 
$
14,947

 
$
2,257,602

 
$
2,272,549

 
$
9,032

 
At June 30, 2018 and December 31, 2017, all loans past due 90 days or more were carried as non-accrual, in addition to those loans less than 90 days past due where reasonable doubt existed as to the full and timely collection of interest or principal that have also been designated as non-accrual, despite their payment due status shown in the tables above.

Non-accrual loans that were not adversely classified amounted to $64 thousand at June 30, 2018 and $21 thousand at December 31, 2017. These balances primarily represented the guaranteed portions of non-performing SBA loans. The majority of the non-accrual loan balances were also carried as impaired loans during the periods noted, and are discussed further below.

The ratio of non-accrual loans to total loans amounted to 0.48% at June 30, 2018 and 0.40% at December 31, 2017.

At June 30, 2018, additional funding commitments for non-accrual loans were not material.
 
Impaired loans
 
Impaired loans are individually significant loans for which management considers it probable that not all amounts due (principal and interest) will be collected in accordance with the original contractual terms. Impaired loans include loans that have been modified in a troubled debt restructuring ("TDR"), see "troubled debt restructurings" below. Impaired loans are individually evaluated for credit loss and a specific allowance reserve is assigned for the amount of the estimated probable credit loss.  

The carrying value of impaired loans amounted to $28.7 million and $26.3 million at June 30, 2018 and December 31, 2017, respectively.  Total accruing impaired loans amounted to $18.1 million and $17.4 million at June 30, 2018 and December 31, 2017, respectively, while non-accrual impaired loans amounted to $10.6 million and $8.9 million as of June 30, 2018 and December 31, 2017, respectively.
 
The following tables set forth the recorded investment in impaired loans and the related specific allowance allocated by portfolio classification as of the dates indicated:
 
 
Balance at June 30, 2018
(Dollars in thousands)
 
Unpaid
contractual
principal
balance
 
Total recorded
investment in
impaired loans
 
Recorded
investment
with no
allowance
 
Recorded
investment
with
allowance
 
Related specific
allowance
Commercial real estate
 
$
14,436

 
$
13,234

 
$
13,029

 
$
205

 
$
42

Commercial and industrial
 
13,003

 
12,571

 
7,539

 
5,032

 
2,621

Commercial construction
 
1,747

 
1,686

 
1,686

 

 

Residential mortgages
 
687

 
562

 
429

 
133

 
3

Home equity loans and lines
 
712

 
494

 
494

 

 

Consumer
 
165

 
164

 
147

 
17

 
17

Total
 
$
30,750

 
$
28,711

 
$
23,324

 
$
5,387

 
$
2,683



22

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
 
Balance at December 31, 2017
(Dollars in thousands)
 
Unpaid
contractual
principal 
balance
 
Total recorded
investment in
impaired loans
 
Recorded
investment
with no
allowance
 
Recorded
investment
with
allowance
 
Related specific
allowance
Commercial real estate
 
$
15,132

 
$
13,739

 
$
12,850

 
$
889

 
$
59

Commercial and industrial
 
10,458

 
10,096

 
7,053

 
3,043

 
1,284

Commercial construction
 
1,678

 
1,624

 
1,624

 

 

Residential mortgages
 
511

 
397

 
262

 
135

 
5

Home equity loans and lines
 
543

 
371

 
371

 

 

Consumer
 
36

 
35

 

 
35

 
35

Total
 
$
28,358

 
$
26,262

 
$
22,160

 
$
4,102

 
$
1,383



The following table presents the average recorded investment in impaired loans by portfolio classification and the related interest recognized during the three months indicated:
 
 
Three Months Ended June 30, 2018
 
Three Months Ended June 30, 2017
(Dollars in thousands)
 
Average recorded
investment
 
Interest income
recognized
 
Average recorded
investment
 
Interest income
recognized
Commercial real estate
 
$
13,506

 
$
95

 
$
14,403

 
$
78

Commercial and industrial
 
11,601

 
89

 
12,367

 
76

Commercial construction
 
1,676

 
23

 
1,622

 
22

Residential mortgages
 
644

 
1

 
279

 

Home equity loans and lines
 
499

 

 
565

 

Consumer
 
66

 

 
15

 

Total
 
$
27,992

 
$
208

 
$
29,251

 
$
176


The following table presents the average recorded investment in impaired loans by portfolio classification and the related interest recognized during the periods indicated:
 
 
Six Months Ended June 30, 2018
 
Six Months Ended June 30, 2017
(Dollars in thousands)
 
Average recorded
investment
 
Interest income
recognized
 
Average recorded
investment
 
Interest income recognized
Commercial real estate
 
$
13,611

 
$
189

 
$
13,891

 
$
179

Commercial and industrial
 
11,124

 
166

 
12,623

 
181

Commercial construction
 
1,656

 
45

 
2,017

 
49

Residential mortgages
 
629

 

 
283

 

Home equity loans and lines
 
487

 

 
552

 
(2
)
Consumer
 
49

 

 
14

 

Total
 
$
27,556

 
$
400

 
$
29,380

 
$
407


At June 30, 2018, additional funding commitments for impaired loans was not material. The Company's obligation to fulfill the additional funding commitments on impaired loans is generally contingent on the borrower's compliance with the terms of the credit agreement. If the borrower is not in compliance, additional funding commitments may or may not be made at the Company's discretion.



23

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

Troubled debt restructurings
 
Loans are designated as a TDR when, as part of an agreement to modify the original contractual terms of the loan as a result of financial difficulties of the borrower, the Bank grants the borrower a concession on the terms that would not otherwise be considered.  Typically, such concessions may consist of one or a combination of the following: a reduction in interest rate to a below market rate, taking into account the credit quality of the note; extension of additional credit based on receipt of adequate collateral; or a deferment or reduction of payments (principal or interest) which materially alters the Bank's position or significantly extends the note's maturity date, such that the present value of cash flows to be received is materially less than those contractually established at the loan's origination. All loans that are modified are reviewed by the Company to identify if a TDR has occurred. TDR loans are included in the impaired loan category and, as such, these loans are individually reviewed and evaluated and a specific reserve is assigned for the amount of the estimated probable credit loss. 

Total TDR loans, included in the impaired loan balances above, as of June 30, 2018 and December 31, 2017, were $21.0 million and $20.3 million, respectively. TDR loans on accrual status amounted to $18.1 million and $17.4 million at June 30, 2018 and December 31, 2017, respectively. TDR loans included in non-performing loans amounted to $2.9 million at both June 30, 2018 and December 31, 2017. The Company continues to work with customers, particularly commercial relationships, and enters into loan modifications (which may or may not be TDRs) to the extent deemed to be necessary or appropriate while attempting to achieve the best mutual outcome given the individual financial circumstances and future prospects of the borrower.

At June 30, 2018, additional funding commitments for TDR loans were not material. The Company's obligation to fulfill the additional funding commitments on TDR loans is generally contingent on the borrower's compliance with the terms of the credit agreement. If the borrower is not in compliance, additional funding commitments may or may not be made at the Company's discretion.

The following table sets forth the post modification balances of TDRs listed by type of modification for TDRs that occurred during the periods indicated:

 
 
Six months ended
 
 
June 30, 2018
 
June 30, 2017
(Dollars in thousands)
 
Number of
restructurings
 
Amount
 
Number of
restructurings
 
Amount
Loan advances with adequate collateral
 

 
$

 
1

 
$
367

Extended maturity date
 

 

 
6

 
5,739

Temporary payment reduction and payment re-amortization of remaining principal over extended term
 
5

 
222

 
5

 
1,086

Temporary interest only payment plan
 
2

 
148

 
7

 
1,016

Other payment concessions
 
1

 
12

 

 

  Total
 
8

 
$
382

 
19

 
$
8,208

Amount of specific reserves included in the allowance for loan losses associated with TDRs listed above
 
 
 
$
73

 
 
 
$
376




24

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

Loans modified as TDRs during the three month periods ended June 30, 2018 and June 30, 2017 are detailed below:
 
 
Three months ended
 
 
June 30, 2018
 
June 30, 2017
(Dollars in thousands)
 
Number of
restructurings
 
Pre-modification
outstanding recorded
investment
 
Post-modification
outstanding recorded
investment
 
Number of
restructurings
 
Pre-modification
outstanding recorded
investment
 
Post-modification
outstanding recorded
investment
Commercial real estate
 

 
$

 
$

 
3

 
$
929

 
$
928

Commercial and industrial
 
2

 
20

 
17

 
10

 
2,213

 
2,326

Commercial construction
 

 

 

 
2

 
1,420

 
1,419

Residential mortgages
 

 

 

 

 

 

Home equity loans and lines
 
2

 
112

 
104

 

 

 

Consumer
 

 

 

 

 

 

Total
 
4

 
$
132

 
$
121

 
15

 
$
4,562

 
$
4,673


Payment defaults, during the three month period ended June 30, 2018 and June 30, 2017 on loans modified as TDRs within the preceding twelve months are detailed below:
 
 
Three months ended
 
 
June 30, 2018
 
June 30, 2017
(Dollars in thousands)
 
Number of TDRs that defaulted
 
Post-
modification outstanding
recorded investment
 
Number of TDRs that defaulted
 
Post-
modification outstanding
recorded investment
Commercial real estate
 

 
$

 

 
$

Commercial and industrial
 
1

 
73

 
5

 
1,457

Commercial construction
 

 

 

 

Residential mortgages
 

 

 

 

Home equity loans and lines
 
1

 
12

 

 

Consumer
 

 

 

 

Total
 
2

 
$
85

 
5

 
$
1,457


Loans modified as TDRs during the six month periods ended June 30, 2018 and June 30, 2017 by portfolio classification are detailed below:
 
 
Six months ended
 
 
June 30, 2018
 
June 30, 2017
(Dollars in thousands)
 
Number of
restructurings
 
Pre-modification
outstanding recorded
investment
 
Post-modification
outstanding recorded
investment
 
Number of
restructurings
 
Pre-modification
outstanding recorded
investment
 
Post-modification
outstanding recorded
investment
Commercial real estate
 
2

 
$
131

 
$
148

 
4

 
$
1,304

 
$
1,299

Commercial and industrial
 
4

 
162

 
130

 
12

 
5,165

 
5,290

Commercial construction
 

 

 

 
3

 
1,626

 
1,619

Residential mortgages
 

 

 

 

 

 

Home equity loans and lines
 
2

 
112

 
104

 

 

 

Consumer
 

 

 

 

 

 

Total
 
8

 
$
405

 
$
382

 
19

 
$
8,095

 
$
8,208


There were $22 thousand subsequent charge-offs associated with the new TDRs noted in the table above during the six months ended June 30, 2018 and there were none for the six months ended June 30, 2017.


25

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 


Payment defaults by portfolio classification, during the six month period ended June 30, 2018 and June 30, 2017 on loans modified as TDRs within the preceding twelve months are detailed below:
 
 
Six months ended
 
 
June 30, 2018
 
June 30, 2017
(Dollars in thousands)
 
Number of TDRs that defaulted
 
Post-
modification outstanding
recorded investment
 
Number of TDRs that defaulted
 
Post-
modification outstanding
recorded investment
Commercial real estate
 

 
$

 
2

 
$
734

Commercial and industrial
 
1

 
73

 
6

 
1,687

Commercial construction
 

 

 

 

Residential mortgages
 

 

 

 

Home equity loans and lines
 
1

 
12

 

 

Consumer
 

 

 

 

Total
 
2

 
$
85

 
8

 
$
2,421


Other real estate owned ("OREO")

The Company carried no OREO at June 30, 2018, December 31, 2017 or June 30, 2017. There were no additions, sales or write downs on OREO during the six months ended June 30, 2018 or 2017.

At June 30, 2018, the Company had no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdictions compared with $101 thousand at December 31, 2017.

Allowance for loan loss activity
 
The allowance for loan losses is established through a provision for loan losses, a direct charge to earnings.  Loan losses are charged against the allowance when management believes that the collectability of the loan principal is unlikely.  Recoveries on loans previously charged-off are credited to the allowance.

The allowance for loan losses amounted to $34.8 million at June 30, 2018, compared to $32.9 million at December 31, 2017, and $32.0 million at June 30, 2017. For the six months ended June 30, 2018 and June 30, 2017, the provision for loan losses amounted to $1.9 million and $405 thousand, respectively. The increase in the provision for loan losses compared to the prior year periods, which was largely in the first quarter or 2018, was due primarily to an increase in the balance of the allowance for loan losses allocated to impaired and classified loans of $1.6 million for the six months ended June 30, 2018, compared to a decrease of $745 thousand during the six months ended June 30, 2017.

The allowance for loan losses to total loans ratio was 1.51% at June 30, 2018, 1.45% at December 31, 2017 and 1.51% at June 30, 2017. Based on management's judgment as to the existing credit risks inherent in the loan portfolio, as discussed above under the heading "Credit Quality Indicators," management believes that the Company's allowance for loan losses is adequate to absorb probable losses from specifically known and other probable credit risks associated with the portfolio as of June 30, 2018.





26

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

Changes in the allowance for loan losses by portfolio classification for the three months ended June 30, 2018 are presented below: 
(Dollars in thousands)
 
Cmml Real
Estate
 
Cmml and
Industrial
 
Cmml
Constr
 
Resid.
Mortgage
 
Home
Equity
 
Consumer
 
Total
Beginning Balance at March 31, 2018
 
$
18,300

 
$
11,171

 
$
3,283

 
$
914

 
$
629

 
$
227

 
$
34,524

Provision
 
114

 
(109
)
 
261

 
25

 
16

 
(7
)
 
300

Recoveries
 

 
57

 

 

 

 
12

 
69

Less: Charge offs
 

 
76

 

 

 

 
20

 
96

Ending Balance at June 30, 2018
 
$
18,414

 
$
11,043

 
$
3,544

 
$
939

 
$
645

 
$
212

 
$
34,797


Changes in the allowance for loan losses by portfolio classification for the six months ended June 30, 2018 are presented below: 
(Dollars in thousands)
 
Cmml Real
Estate
 
Cmml and
Industrial
 
Cmml
Constr
 
Resid.
Mortgage
 
Home
Equity
 
Consumer
 
Total
Beginning Balance at December 31, 2017
 
$
17,545

 
$
9,669

 
$
3,947

 
$
904

 
$
608

 
$
242

 
$
32,915

Provision
 
869

 
1,326

 
(403
)
 
35

 
36

 
37

 
1,900

Recoveries
 

 
165

 

 

 
1

 
17

 
183

Less: Charge offs
 

 
117

 

 

 

 
84

 
201

Ending Balance at June 30, 2018
 
$
18,414

 
$
11,043

 
$
3,544

 
$
939

 
$
645

 
$
212

 
$
34,797

Ending allowance balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocated to loans individually evaluated for impairment
 
$
42

 
$
2,621

 
$

 
$
3

 
$

 
$
17

 
$
2,683

Allocated to loans collectively evaluated for impairment
 
$
18,372

 
$
8,422

 
$
3,544

 
$
936

 
$
645

 
$
195

 
$
32,114


Changes in the allowance for loan losses by portfolio classification for the three months ended June 30, 2017 are presented below: 
(Dollars in thousands)
 
Cmml Real
Estate
 
Cmml and
Industrial
 
Cmml
Constr
 
Resid.
Mortgage
 
Home
Equity
 
Consumer
 
Total
Beginning Balance at March 31, 2017
 
$
15,294

 
$
11,178

 
$
3,364

 
$
978

 
$
635

 
$
234

 
$
31,683

Provision
 
295

 
(148
)
 
120

 
11

 
(14
)
 
16

 
280

Recoveries
 
56

 
71

 

 

 
1

 
2

 
130

Less: Charge offs
 

 
114

 

 

 

 
21

 
135

Ending Balance at June 30, 2017
 
$
15,645

 
$
10,987

 
$
3,484

 
$
989

 
$
622

 
$
231

 
$
31,958



27

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 


Changes in the allowance for loan losses by portfolio classification for the six months ended June 30, 2017 are presented below: 
(Dollars in thousands)
 
Cmml Real
Estate
 
Cmml and
Industrial
 
Cmml
Constr
 
Resid.
Mortgage
 
Home
Equity
 
Consumer
 
Total
Beginning Balance at December 31, 2016
 
$
14,902

 
$
11,204

 
$
3,406

 
$
960

 
$
634

 
$
236

 
$
31,342

Provision
 
611

 
(343
)
 
78

 
29

 
(14
)
 
44

 
405

Recoveries
 
132

 
343

 

 

 
2

 
5

 
482

Less: Charge offs
 

 
217

 

 

 

 
54

 
271

Ending Balance at June 30, 2017
 
$
15,645

 
$
10,987

 
$
3,484

 
$
989

 
$
622

 
$
231

 
$
31,958

Ending allowance balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocated to loans individually evaluated for impairment
 
$
393

 
$
1,771

 
$

 
$

 
$

 
$
13

 
$
2,177

Allocated to loans collectively evaluated for impairment
 
$
15,252

 
$
9,216

 
$
3,484

 
$
989

 
$
622

 
$
218

 
$
29,781


(5)
Deposits
 
Deposits are summarized as follows:
(Dollars in thousands)
 
June 30, 2018
 
December 31, 2017
Non-interest bearing demand deposits
 
$
739,890

 
$
705,846

Interest-bearing checking
 
442,944

 
391,111

Savings
 
198,666

 
193,385

Money market
 
859,611

 
807,931

Certificates of deposit $250,000 or less
 
184,858

 
150,445

Certificates of deposit more than $250,000
 
55,585

 
45,154

Total customer deposits
 
2,481,554

 
2,293,872

Brokered deposits (1)
 
178,800

 
147,490

Total deposits
 
$
2,660,354

 
$
2,441,362

___________________________________
(1)
Brokered CDs $250,000 and under.

Total customer deposits (deposits excluding brokered deposits) include reciprocal balances received from participating banks in nationwide deposit networks as a result of our customers electing to participate in Company offered programs which allow for enhanced FDIC insurance. Essentially, the equivalent of the customers' original deposited funds comes back to the Company as customer deposits within the appropriate category under total customer deposits. The Company's balances in these reciprocal products were $301.9 million and $249.6 million at June 30, 2018 and December 31, 2017, respectively.

See Note 12, "Fair Value Measurements," below for further information regarding the Company's fair value measurements for deposits.

(6)
Borrowed Funds and Subordinated Debt
 
The Company had $501 thousand in borrowed funds at June 30, 2018 linked to outstanding commercial loans under various community reinvestment programs of the FHLB. At December 31, 2017, borrowed funds consisted of FHLB borrowings amounting to $89.0 million.

The Company had $14.9 million of outstanding subordinated debt (net of deferred issuance costs) at June 30, 2018 and $14.8 million at December 31, 2017, which consisted of $15.0 million in aggregate principal amount of Fixed-to-Floating Rate Subordinated Notes (the "Notes") issued in January 2015, with a 15 year term. Original debt issuance costs were $190


28

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

thousand and have been netted against the subordinated debt on the consolidated balance sheet in accordance with accounting guidance. These costs are being amortized to interest expense over the life of the Notes.

The Notes are intended to qualify as Tier 2 capital for regulatory purposes and pay interest at a fixed rate of 6.00% per annum through January 30, 2025, after which floating rates apply. Refer to Note 7, "Borrowed Funds and Subordinated Debt," to the Company's consolidated financial statements contained in the 2017 Annual Report on Form 10-K for additional information about the Company's subordinated debt.

See Note 12, "Fair Value Measurements," below for further information regarding the Company's fair value measurements for borrowed funds and subordinated debt. See Note 2, "Investments," and Note 3, "Loans" above for further information regarding securities and loans pledged for borrowed funds. Refer to the "Liquidity" section in Item 2, "Management's Discussion and Analysis," for additional information about other sources of funding available to the Company.

(7)
Derivatives and Hedging Activities

Interest-rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments.  The commitments to sell loans are also considered derivative instruments. The Company generally does not pool mortgage loans for sale, but instead, sells the loans on an individual basis. To reduce the net interest-rate exposure arising from its loan sale activity, the Company enters into the commitment to sell these loans at essentially the same time that the interest-rate lock commitment is quoted on the origination of the loan. The Company estimates the fair value of these derivatives based on current secondary mortgage market prices. At June 30, 2018 and December 31, 2017, the estimated fair value of the Company's interest rate lock commitments and commitments to sell these mortgage loans were deemed immaterial.

The Company may use interest rate swaps as part of its interest rate risk management strategy. Interest rate swap agreements may be entered into as hedges against future interest rate fluctuations on specifically identified assets or liabilities. The Company had no derivative fair value hedges or derivative cash flow hedges at June 30, 2018 or December 31, 2017.

The Company has a “Back-to-Back Swap” program whereby the Bank enters into an interest rate swap with a qualified commercial banking customer and simultaneously enters into an equal and opposite interest rate swap with a swap counterparty. The customer interest rate swap agreement allows commercial banking customers to convert a floating-rate loan payment to a fixed-rate payment.

The transaction structure effectively minimizes the Bank’s net risk exposure resulting from such transactions. Customer-related credit risk is minimized by the cross collateralization of the loan and the interest rate swap agreement.

Back-to-Back Swaps are not speculative; rather, the transactions result from a service the Company provides to certain commercial customers. Back-to-Back Swaps do not meet hedge accounting requirements and therefore changes in the fair value of both the customer swaps and the counterparty swaps, which have an offsetting relationship, are recognized directly in earnings. As a result of this offsetting relationship, there were no net gains or losses recognized in income on Back-to-Back Swaps during the six months ended June 30, 2018 or June 30, 2017.

Each Back-to-Back Swap transaction consists of two interest-rate swaps (a customer swap and offsetting counterparty swap) and amounted to a total number of six interest rate swaps outstanding at both June 30, 2018 and December 31, 2017, with an aggregate notional amount of $29.0 million and $29.4 million on those respective dates.

Asset derivatives are included in the line item prepaid expenses and other assets and liability derivatives are included in the accrued expenses and other liabilities line item on the consolidated balance sheets, respectively.



29

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The table below presents the fair value and classification of the Company’s derivative financial instruments for the periods presented:
 
 
As of June 30, 2018
 
As of December 31, 2017
(Dollars in thousands)
 
Asset Derivatives
 
Liability Derivatives
 
Asset Derivatives
 
Liability Derivatives
Interest rate contracts - pay floating, received fixed
 
$

 
$
1,000

 
$
25

 
$
568

Interest rate contracts - pay fixed, receive floating
 
1,000

 

 
543

 

Total interest rate swaps
 
$
1,000

 
$
1,000

 
$
568

 
$
568


By using derivative financial instruments, the Company exposes itself to counterparty-credit risk. Credit risk is the risk of failure by the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk for the Company. When the fair value of a derivative is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that management believes to be creditworthy. The counterparty was rated A / A2 by S&P and Moody’s, respectively, at June 30, 2018. Additionally, counterparty interest rate swaps contain provisions for collateral to be posted if the derivative exposure exceeds a threshold amount.

The Company had credit risk exposure amounting to $1.0 million and $543 thousand at June 30, 2018 and December 31, 2017, respectively, relating to interest rate swaps with counterparties. The Company held cash collateral of $930 thousand at June 30, 2018 and $480 thousand at December 31, 2017. Collateral held by the Company is restricted and not considered an asset of the Company. Therefore, it is not carried on the Company's consolidated balance sheet.

Interest rate swaps with the counterparty are subject to master netting agreements. The table below presents the Company's asset derivative positions and the potential effect of those netting arrangements on its financial position, as of the periods presented. Interest rate swaps with customers are not subject to master netting agreements and therefore are not included in the table below.
 
 
As of June 30, 2018
(Dollars in thousands)
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Statement of Financial Position
 
Net Amounts of Assets Presented in the Statement of Financial Position
Asset Derivatives
 
 
 
 
 
 
Interest rate contracts - pay fixed, receive floating
 
$
1,000

 
$

 
$
1,000


 
 
As of December 31, 2017
(Dollars in thousands)
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Statement of Financial Position
 
Net Amounts of Assets Presented in the Statement of Financial Position
Asset Derivatives
 
 
 
 
 
 
Interest rate contracts - pay fixed, receive floating
 
$
568

 
$
25

 
$
543




30

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The Company's interest rate swaps with counterparties contain credit-risk-related contingent provisions. These provisions provide the counterparty with the right to terminate its derivative positions and require the Company to settle its obligations under the agreements if the Company defaults on certain of its indebtedness.

The Company also participates in loans originated by third party banks, where the originating bank utilizes a back-to-back interest rate swap structure; however, the Company is not a party to the swap agreements. Under the terms of the loan participations, the Company has accepted contingent liabilities that would only be realized if the swaps were terminated early and there were outstanding losses not covered by the underlying borrowers and the borrowers' pledged collateral.  If applicable, the Company’s swap-loss exposure would be equal to the percentage of the Company’s participation in the underlying loan applied to the originating bank's swap loss.  At June 30, 2018 the Company had one such participation loan and at December 31, 2017 the Company had two. Management considers the risk of material swap loss exposure related to these participation loans to be unlikely based on the swap market value, as well as the borrower's financial and collateral strength.

(8)
Stockholders' Equity

Shares Authorized and Share Issuance

The Company’s authorized capital is divided into common stock and preferred stock. The Company is authorized to issue 40,000,000 shares of common stock, with a par value of $0.01, and as of June 30, 2018 had 11,696,204 shares issued and outstanding. The Company is authorized to issue 1,000,000 shares of preferred stock, with a par value of $0.01. No preferred stock has been issued as of the date of this Form 10-Q. Holders of common stock are entitled to one vote per share, and are entitled to receive dividends if and when declared by the Company's Board of Directors (the "Board"). Dividend and liquidation rights of the common stock may be subject to the rights of any outstanding preferred stock.

The Company has a shareholders rights plan. Under the plan, each share of common stock includes a right to purchase under certain circumstances one one-hundredth of a share of the Company’s Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $122.50 per one one-hundredth of a preferred share, subject to adjustment, or, in certain circumstances, to receive cash, property, shares of common stock or other securities of the Company. The rights are not presently exercisable and remain attached to the shares of common stock until the occurrence of certain triggering events that would ordinarily be associated with an unsolicited acquisition or attempted acquisition of 10% or more of the Company’s outstanding shares of common stock. The rights have no voting or dividend privileges, and unless and until they become exercisable, have no dilutive effect on the earnings of the Company. The rights will expire, unless earlier redeemed, exchanged, or otherwise rescinded by the Company, on January 13, 2028.

The Company's stock incentive plans permit the Board to grant, under various terms, stock options (for the purchase of newly issued shares of common stock), restricted stock awards, restricted stock units and stock appreciation rights to officers and other employees, non-employee directors and consultants.

The Company issues stock options and restricted stock awards to officers and other employees and restricted stock awards and stock compensation in lieu of cash fees to non-employee directors. The restricted stock awards allow for the non-forfeitable receipt of dividends, and the voting of all shares, whether or not vested, throughout the vesting periods at the same proportional level as common shares outstanding. The unvested restricted stock awards are the Company's only participating securities and are included in shares outstanding. Unvested participating restricted awards amounted to 114,559 shares and 117,219 shares as of June 30, 2018 and December 31, 2017, respectively.

Upon vesting, restricted stock awards may be net share-settled to cover payment for employee tax obligations, resulting in shares of common stock being reacquired by the Company and returned to the pool of shares reserved for issuance under the incentive plans. Chapter 156D of the Massachusetts General Laws, a statute known as the Massachusetts Business Corporation Act, which applies to Massachusetts corporations such as the Company, eliminates the concept of “treasury stock” and provides that shares reacquired by a Massachusetts company will be treated as authorized but unissued shares.

The Company's stock incentive plans also allow for newly issued shares of common stock to be issued without restrictions to officers and other employees, non-employee directors and consultants. From time to time, the Company issues shares to community members for consulting on regional advisory councils and grants shares of fully vested stock as employee anniversary awards. These shares vest immediately and the cost, which is deemed to be immaterial, is expensed in the period in which the services are rendered and is based on the market price on the date of grant.


31

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 


In addition to shares issued to employees, non-employee directors and community members for consulting on regional advisory councils, and shares issued through equity offerings, the Company maintains a dividend reinvestment and direct stock purchase plan (“DRSPP”) for stockholders and new investors to reinvest or purchase additional shares of common stock directly from the Company.

See Note 10, "Stock-Based Compensation," below for additional information regarding the Company's stock incentive plans. See Note 11, "Earnings per Share," below for additional information regarding unvested participating restricted awards and the Company's earnings per share calculation.

Comprehensive Income

Comprehensive income is defined as all changes to stockholders' equity except investments by and distributions to stockholders.  Net income is one component of comprehensive income, with other components referred to in the aggregate as other comprehensive income.  At June 30, 2018, the Company's only other comprehensive income component is the net unrealized holding gains or losses on available-for-sale debt securities, net of deferred income taxes. Prior to the adoption of ASU No. 2016-01, other comprehensive income also included unrealized holding gains or losses on available-for-sale equity securities. Pursuant to GAAP, the Company initially excludes these unrealized holding gains and losses from net income; however, they are later reported as reclassifications out of accumulated other comprehensive income into net income when the debt securities are sold. When debt securities are sold, the reclassification of realized gains and losses on available-for-sale securities are included on the Consolidated Statements of Income under the "non-interest income" subheading on the line item "net gains on sales of investment securities" and the related income tax expense is included in the line item "provision for income taxes," both of which are also detailed on the Consolidated Statements of Comprehensive Income under the subheading "reclassification adjustment for net gains included in net income."

Refer to Note 10, "Stockholders' Equity," to the Company's consolidated financial statements included in the Company's 2017 Annual Report on Form 10-K for additional information relating to capital adequacy requirements, dividends and the DRSPP.

(9)
Supplemental Retirement Plan and Other Post-retirement Benefit Obligations
 
Supplemental Employee Retirement Plan ("SERP")
 
The Company has salary continuation agreements with two of its current executive officers and one former executive officer. These salary continuation agreements provide for predetermined fixed-cash supplemental retirement benefits to be provided for a period of 20 years after each individual reaches a defined "benefit age." The individuals covered under the SERP have reached the defined benefit age and are receiving payments under the plan. Additionally, the Company has not recognized service costs in the current or prior year as each officer had previously attained their individually defined benefit age and was fully vested under the plan.

This non-qualified plan represents a direct liability of the Company, and as such has no specific assets set aside to settle the benefit obligation.  The funded status is the aggregate amount accrued, or the "accumulated benefit obligation," which is equal to the present value of the benefits to be provided to the employee or any beneficiary.  Because the Company's benefit obligations provide for predetermined fixed-cash payments, the Company does not have any unrecognized costs to be included as a component of accumulated other comprehensive income.

Total net periodic benefit costs, comprised of interest costs only, were $26 thousand and $52 thousand for the three and six months ended June 30, 2018, respectively, compared to $29 thousand and $58 thousand for the three and six months ended June 30, 2017, respectively.

Benefits paid amounted to $69 thousand and $138 thousand for both the three and six months ended June 30, 2018 and June 30, 2017, respectively. The Company anticipates accruing an additional $52 thousand to the SERP during the remainder of 2018.
 
Supplemental Life Insurance
 
The Company has provided supplemental life insurance through split-dollar life insurance arrangements for certain executive and senior officers on whom the Bank owns bank-owned life insurance ("BOLI").

These arrangements provide a death benefit to the officer's designated beneficiaries that extend to postretirement periods for some of the supplemental life insurance plans. The Company has recognized a liability for these future postretirement benefits.


32

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 


These non-qualified plans represent a direct liability of the Company, and as such has no specific assets set aside to settle the benefit obligation.  The funded status is the aggregate amount accrued, or the "accumulated postretirement benefit obligation," which is the present value of the post-retirement benefits associated with this arrangement.

The following table illustrates the net periodic post-retirement benefit cost for the supplemental life insurance plans for the periods indicated:
 
 
Three months ended June 30,
 
Six months ended June 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Service Cost
 
$
(18
)
 
$
(3
)
 
$
(35
)
 
$
(6
)
Interest Cost
 
62

 
23

 
124

 
46

Net periodic benefit cost
 
$
44

 
$
20

 
$
89

 
$
40

 
(10)
Stock-Based Compensation
 
The Company currently has two individual stock incentive plans: the 2009 plan, as amended in 2015, and the 2016 plan. As of June 30, 2018, an aggregate of 412,212 shares remain available for future grants under the plans.
 
The Company's stock-based compensation expense related to these plans includes stock options and stock awards to officers and other employees included in salary and benefits expense, and stock awards and stock compensation in lieu of cash fees to non-employee directors both included in other operating expenses.  Total stock-based compensation expense was $500 thousand and $885 thousand for the three and six months ended June 30, 2018, compared to $496 thousand and $820 thousand for the three and six months ended June 30, 2017.

A tax benefit associated with employee exercises and vesting of stock compensation of approximately $235 thousand was recorded as a reduction of the Company's income tax expense for the six months ended June 30, 2018, compared with $788 thousand for the six months ended June 30, 2017. These amounts, treated as discrete tax items in the period in which they occur, will vary from year to year as a function of the volume of share-based payments vested or exercised and the then current market price of the Company's stock in comparison to the compensation cost recognized in the Company's consolidated financial statements.

 Stock Option Awards
 
The Company recognized stock-based compensation expense related to stock option awards of $51 thousand and $102 thousand for the three and six months ended June 30, 2018, respectively, compared to $41 thousand and $103 thousand for the three and six months ended June 30, 2017, respectively.

The table below provides a summary of the options granted, including the fair value as a percentage of the market value of the stock at the date of grant and the average assumptions used during the periods indicated:
 
Six Months Ended June 30,
 
2018
 
2017
Options granted
14,755

 
15,009

Term in years
10

 
10

Weighted average assumptions used in the fair value model:
 
 
 
Expected volatility
37
%
 
40
%
Expected dividend yield
2.10
%
 
2.09
%
Expected life in years
6.5

 
7

Risk-free interest rate
2.86
%
 
2.35
%
Weighted average market price on date of grants
$
34.33

 
$
30.46

Per share weighted average fair value
$
11.98

 
$
11.34

Fair value as a percentage of market value at grant date
35
%
 
37
%


33

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
Options granted during the first six months of 2018 and 2017 generally vest 50% in year two and 50% in year four, on the anniversary date of the awards.

The Company utilizes the Black-Scholes option valuation model in order to determine the per share grant date fair value of option grants.

Stock Awards
 
Stock-based compensation expense recognized in association with stock awards amounted to $387 thousand and $646 thousand for the three and six months ended June 30, 2018, respectively, compared to $384 thousand and $571 thousand for the three and six months ended June 30, 2017, respectively.

Restricted stock awards are granted at the market price on the date of the grant. Employee awards generally vest over four years in equal portions beginning on or about the first anniversary date of the award or are performance based awards that vest upon the Company achieving certain predefined performance objectives. Non-employee director awards generally vest over two years in equal portions beginning on or about the first anniversary date of the award.

The table below provides a summary of restricted stock awards granted during the periods indicated:
 
 
Six Months Ended June 30,
Restricted Stock Awards (Number of underlying shares)
 
2018
 
2017
Two year vesting
 
7,280

 
6,944

Four year vesting
 
16,666

 
16,253

Performance-based vesting
 
20,559

 
25,623

Total restricted stock awards granted
 
44,505

 
48,820

Weighted average grant date fair value
 
$
34.33

 
$
30.46


Stock in Lieu of Directors' Fees
 
In addition to restricted stock awards discussed above, the non-employee members of the Company's Board of Directors may opt to receive newly issued shares of the Company's common stock in lieu of cash compensation for attendance at Board and Board Committee meetings.  Stock-based compensation expense related to these directors' fees amounted to $62 thousand and $137 thousand for the three and six months ended June 30, 2018, respectively, compared to $71 thousand and $146 thousand for the three and six months ended June 30, 2017, respectively, and is included in other operating expenses. In January 2018, non-employee directors were issued 7,326 shares of common stock in lieu of 2017 annual cash fees of $281 thousand at a market value price of $38.39 per share, the market value of the common stock on the opt-in measurement date of January 3, 2017.

For further information regarding the Company's stock awards, see Note 8, "Stockholders' Equity," above under the caption "Shares Authorized and Share Issuance." There have been no material changes to the terms of the Company's stock incentive plans or the terms for vesting, forfeiture and settlement for options and restricted stock awards granted and outstanding under such plans as reported in the 2017 Annual Report on Form 10-K. Refer to Note 12 "Stock-Based Compensation Plans," in the Company's 2017 Annual Report on Form 10-K for further information on the Company's stock incentive plans, stock options and restricted awards including descriptions of the assumptions used in the valuation model for stock options.

(11)
Earnings per Share
 
Basic earnings per share are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding (including participating securities) during the year.  The Company's only participating securities are unvested restricted stock awards that contain non-forfeitable rights to dividends. See Note 8, "Stockholders' Equity," under the caption "Shares Authorized and Share Issuance," above for further information regarding the Company's participating securities. Diluted earnings per share reflects the effect on weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.



34

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

The table below presents the increase in average shares outstanding, using the treasury stock method, for the diluted earnings per share calculation for the periods indicated:

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Basic weighted average common shares outstanding
11,687,182

 
11,572,430

 
11,658,046

 
11,540,796

Dilutive shares
77,229

 
80,259

 
75,345

 
84,916

Diluted weighted average common shares outstanding
11,764,411

 
11,652,689

 
11,733,391

 
11,625,712



There were 29,260 options outstanding that were determined to be anti-dilutive and therefore excluded from the calculation of dilutive shares for the six months ended June 30, 2018.  These options, which were not dilutive at that date, may potentially dilute earnings per share in the future.

(12)
Fair Value Measurements

The FASB defines the fair value of an asset or liability to be the price which a seller would receive in an orderly transaction between market participants (an exit price) and also establishes a fair value hierarchy segregating fair value measurements using three levels of inputs: (Level 1) quoted market prices in active markets for identical assets or liabilities; (Level 2) significant other observable inputs, including quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs such as interest rates and yield curves, volatilities, prepayment speeds, credit risks and default rates which provide a reasonable basis for fair value determination or inputs derived principally from observed market data; and (Level 3) significant unobservable inputs for situations in which there is little, if any, market activity for the asset or liability.  Unobservable inputs must reflect reasonable assumptions that market participants would use in pricing the asset or liability, which are developed on the basis of the best information available under the circumstances.
 
The following tables summarize significant assets and liabilities carried at fair value and placement in the fair value hierarchy at the dates specified:
 
 
June 30, 2018
 
 
 
 
Fair Value Measurements using:
(Dollars in thousands)
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Debt securities
 
$
421,225

 
$

 
$
421,225

 
$

Equity securities
 
949

 
949

 

 

FHLB stock
 
2,618

 

 

 
2,618

Interest rate swaps
 
1,000

 

 
1,000

 

Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans (collateral dependent)
 
2,677

 

 

 
2,677

 
 
 
 
 
 
 
 
 
Liabilities measured on a recurring basis:
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
1,000

 
$

 
$
1,000

 
$

 


35

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
 
December 31, 2017
 
 
 
 
Fair Value Measurements using:
(Dollars in thousands)
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Debt securities
 
$
405,206

 
$

 
$
405,206

 
$

FHLB stock
 
5,215

 

 

 
5,215

Interest rate swaps
 
568

 

 
568

 

Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans (collateral dependent)
 
2,696

 

 

 
2,696

 
 
 
 
 
 
 
 
 
Liabilities measured on a recurring basis:
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
568

 
$

 
$
568

 
$

 
The Company did not transfer any assets between the fair value measurement levels during the six months ended June 30, 2018 or the year ended December 31, 2017.

All of the Company's debt securities are considered "available-for-sale" and are carried at fair value.  The debt security category above includes federal agency obligations, commercial and residential federal agency MBS, municipal securities, corporate bonds and certificates of deposits, as held at those dates.  The Company utilizes third-party pricing vendors to provide valuations on its debt securities.  Fair values provided by the vendors were generally determined based upon pricing matrices utilizing observable market data inputs for similar or benchmark securities in active markets and/or based on a matrix pricing methodology which employs The Bond Market Association's standard calculations for cash flow and price/yield analysis, live benchmark bond pricing and terms/condition data available from major pricing sources.  Therefore, management regards the inputs and methods used by third-party pricing vendors to be "Level 2 inputs and methods" as defined in the "fair value hierarchy." The Company periodically obtains a second price from an impartial third party on debt securities to assess the reasonableness of prices provided by the primary independent pricing vendor.

The Company's equity portfolio fair value is measured based on quoted market prices for the shares; therefore, these securities are categorized as Level 1 within the fair value hierarchy.
 
The Bank is required to purchase FHLB stock at par value in association with advances from the FHLB. This stock is classified as a restricted investment and carried at cost which management believes approximates fair value; therefore, these securities are categorized as Level 3 measures.  See Note 1, "Summary of Significant Accounting Policies," Item (c) "Restricted Instruments" for further information regarding the Company's fair value assessment of FHLB capital stock.
 
Impaired loan balances in the table above represent those collateral dependent impaired commercial loans where management has estimated the probable credit loss by comparing the loan's fair value against the expected realizable fair value of the collateral (appraised value, or internal analysis less estimated cost to sell, adjusted as necessary for changes in relevant valuation factors subsequent to the measurement date).  Certain inputs used in these assessments, and possible subsequent adjustments, are not always observable, and therefore, collateral dependent impaired loans are categorized as Level 3 within the fair value hierarchy.  A specific allowance is assigned to the collateral dependent impaired loan for the amount of management's estimated probable credit loss.  The specific allowances assigned to the collateral dependent impaired loans amounted to $1.6 million at June 30, 2018 compared to $872 thousand at December 31, 2017.

The fair values for the interest rate swap assets and liabilities represent a FASB Level 2 measurement and are based on settlement values adjusted for credit risks and observable market interest rate curves. The settlement values are based on discounted cash flow analysis, a widely accepted valuation technique, reflecting the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. Credit risk adjustments consider factors such as the likelihood of default by the Company and its counterparties, its net exposures and remaining contractual life. The change in value of interest rate swap assets and liabilities attributable to credit risk was not significant during the reported periods. Refer also to Note 7, "Derivatives and Hedging Activities," for additional information on the Company's interest rate swaps.

Letters of credit are conditional commitments issued by the Company to guarantee the financial obligation or performance of a customer to a third party.  The fair value of these commitments was estimated to be the fees charged to enter into similar agreements, and accordingly these fair value measures are deemed to be FASB Level 2 measurements.  In accordance with the


36

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

FASB, the estimated fair values of these commitments are carried on the consolidated balance sheet as a liability and amortized to income over the life of the letters of credit, which are typically one year.  The estimated fair value of these commitments carried on the consolidated balance sheet at June 30, 2018 and December 31, 2017 were deemed immaterial.

Interest rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments.  The commitments to sell loans are also considered derivative instruments. The Company generally does not pool mortgage loans for sale, but instead sells the loans on an individual basis. To reduce the net interest rate exposure arising from its loan sale activity, the Company enters into the commitment to sell these loans at essentially the same time that the interest rate lock commitment is quoted on the origination of the loan. The Company estimates the fair value of these derivatives based on current secondary mortgage market prices. These commitments are accounted for in accordance with FASB guidance.  The fair values of the Company's derivative instruments are deemed to be FASB Level 2 measurements. At June 30, 2018 and December 31, 2017, the estimated fair value of the Company's interest rate lock commitments and commitments to sell these mortgages loans were deemed immaterial.

The following table presents additional quantitative information about assets measured at fair value on a recurring and non-recurring basis for which the Company utilized Level 3 inputs (significant unobservable inputs for situations in which there is little, if any, market activity for the asset or liability) to determine fair value as of June 30, 2018:
(Dollars in thousands)
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Unobservable Input Value or Range
Assets measured on a recurring basis:
 
 
 
 
 
 
 
 
  FHLB stock
 
$
2,618

 
FHLB Stated Par Value
 
N/A
 
N/A
Assets measured on a non-recurring basis:
 
 
 
 
 
 
 
 
  Impaired loans (collateral dependent)
 
$
2,677

 
Appraisal of collateral
 
Appraisal adjustments (1)
 
5% - 50%
__________________________________________
(1)    Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

Estimated Fair Values of Assets and Liabilities

In addition to disclosures regarding the measurement of assets and liabilities carried at fair value on the consolidated balance sheet, the Company is also required to disclose fair value information about financial instruments for which it is practicable to estimate that value, whether or not recognized on the consolidated balance sheet. 

The carrying values, estimated fair values and placement in the fair value hierarchy of the Company's consolidated financial instruments for which fair value is only disclosed but not recognized on the consolidated balance sheet at the dates indicated are summarized as follows:
 
 
June 30, 2018
 
 
 
 
 
 
Fair value measurement
(Dollars in thousands)
 
Carrying
Amount
 
Fair Value
 
Level 1 Inputs
 
Level 2 Inputs
 
Level 3 Inputs
Financial assets:
 
 

 
 

 
 
 
 
 
 
Loans held for sale
 
$
657

 
$
657

 
$

 
$
657

 
$

Loans, net
 
2,263,798

 
2,237,361

 

 

 
2,237,361

Financial liabilities:
 
 

 
 

 
 
 
 
 
 
Certificates of deposit (including brokered)
 
419,243

 
416,821

 

 
416,821

 

Borrowed funds
 
501

 
500

 

 
500

 

Subordinated debt
 
14,853

 
13,848

 

 

 
13,848

 


37

ENTERPRISE BANCORP, INC.
Notes to the Unaudited Consolidated Interim Financial Statements
 

 
 
December 31, 2017
 
 
 
 
Fair value measurement
(Dollars in thousands)
 
Carrying
Amount
 
Fair Value
 
Level 1 Inputs
 
Level 2 Inputs
 
Level 3 Inputs
Financial assets:
 
 

 
 

 
 
 
 
 
 
Loans held for sale
 
$
208

 
$
208

 
$

 
$
208

 
$

Loans, net
 
2,236,989

 
2,236,169

 

 

 
2,236,169

Financial liabilities:
 
 

 
 

 
 
 
 
 
 
Certificates of deposit (including brokered)
 
343,089

 
341,765

 

 
341,765

 

Borrowed funds
 
89,000

 
88,996

 

 
88,996

 

Subordinated debt
 
14,847

 
14,208

 

 

 
14,208


Excluded from the tables above are certain financial instruments with carrying values that approximated their fair value at the dates indicated, as they were short-term in nature or payable on demand.  These include cash and cash equivalents, and non-term deposit accounts. The respective carrying values of these instruments would all be considered to be classified within Level 1 of their fair value hierarchy.

Also excluded from these tables are the fair values of commitments for unused portions of lines of credit and commitments to originate loans that were short-term, at current market rates and estimated to have no significant change in fair value.




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Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion and analysis should be read in conjunction with the Company's (also referred to herein as "Enterprise," "us," "we," or "our") unaudited consolidated interim financial statements and notes thereto contained in this report and the consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2017 (the "2017 Annual Report on Form 10-K").

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q (this "Form 10-Q") contains certain forward-looking statements concerning plans, objectives, future events or performance and assumptions and other statements that are other than statements of historical fact. Forward-looking statements may be identified by reference to a future period or periods or by use of forward-looking terminology such as "will," "should," "could," "anticipates," "believes," "expects," "intends," "may," "plans," "pursue," "views" and similar terms or expressions. Various statements contained in Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 3 - "Quantitative and Qualitative Disclosures About Market Risk" of this Form 10-Q including, but not limited to, statements related to management's views on the banking environment and the economy, competition and market expansion opportunities, the interest rate environment, credit risk and the level of future non-performing assets and charge-offs, potential asset and deposit growth, future non-interest expenditures and non-interest income growth, and borrowing capacity are forward-looking statements. The Company cautions readers that such forward-looking statements reflect numerous assumptions and involve a number of risks and uncertainties that could cause the Company's actual results to differ materially from those expressed in, or implied by, the forward-looking statement. Any forward-looking statements in this Form 10-Q are based on information available to the Company as of the date of this Form 10-Q, and the Company undertakes no obligation to publicly update or otherwise revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by applicable law. The following important factors, among others, could cause the Company's results for subsequent periods to differ materially from those expressed in any forward-looking statement made herein: (i) changes in interest rates could negatively impact net interest income; (ii) changes in the business cycle and downturns in the local, regional or national economies, including deterioration in the local real estate market, could negatively impact credit and/or asset quality and result in credit losses and increases in the Company's allowance for loan losses; (iii) changes in consumer spending could negatively impact the Company's credit quality and financial results; (iv) increasing competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services could adversely affect the Company's competitive position within its market area and reduce demand for the Company's products and services; (v) deterioration of securities markets could adversely affect the value or credit quality of the Company's assets and the availability of funding sources necessary to meet the Company's liquidity needs; (vi) technology-related risk, including technological changes and technology service interruptions or failure could adversely impact the Company's operations and increase technology-related expenditures; (vii) cyber-security risk including security breaches and identity theft could impact the Company's reputation, increase regulatory oversight and impact the financial results of the Company; (viii) increases in employee compensation and benefit expenses could adversely affect the Company's financial results; (ix) changes in laws and regulations that apply to the Company's business and operations, including without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), and the Tax Cuts and Jobs Act enacted on December 22, 2017, the Economic Growth, Regulatory Relief and Consumer Protection Act enacted on May 24, 2018 and the additional regulations or repeals that may be forthcoming as a result thereof, could cause the Company to incur additional costs and adversely affect the Company's business environment, operations and financial results; (x) changes in accounting and/or auditing standards, policies and practices, as may be adopted or established by the regulatory agencies, FASB, or the Public Company Accounting Oversight Board could negatively impact the Company's financial results; (xi) our ability to enter new markets successfully and capitalize on growth opportunities, including the receipt of required regulatory approvals; (xii) future regulatory compliance costs, including any increase caused by new regulations imposed by the government's current administration; and (xiii) the risks and uncertainties described in the documents that the Company files or furnishes to the SEC, including those discussed under Item 1A, "Risk Factors" of the Company's 2017 Annual Report on Form 10-K, which could have a material adverse effect on the Company's business, financial condition and results of operations.  Therefore, the Company cautions readers not to place undue reliance on any such forward-looking information and statements.


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Table of Contents

Overview

Executive Summary

Net income for the three months ended June 30, 2018 amounted to $7.6 million, an increase of $2.0 million, or 35%, compared to the same three-month period in 2017. Diluted earnings per share were $0.64 for the three months ended June 30, 2018, as compared to $0.48 for the same three-month period in 2017, an increase of 33%. Net income for the six months ended June 30, 2018 amounted to $14.4 million, an increase of $3.2 million, or 29%, compared to the same six-month period in 2017. Diluted earnings per share were $1.23 for the six months ended June 30, 2018, as compared to $0.96 for the same six-month period in 2017, an increase of 28%.

The increase in 2018 earnings as compared to 2017 is largely attributable to growth over the last twelve months and the positive impact of lower federal income tax rates in 2018 from the 2017 Tax Cuts and Jobs Act (the "2017 Tax Act"). Total assets, loans, and customer deposits as of June 30, 2018 have increased 10%, 9%, and 9%, respectively, as compared to June 30, 2017.

Strategically, our focus remains on organic growth and continually planning for and investing in our future, as we continue to actively look for new branch locations. The relocation of our Leominster, MA branch was completed in the second quarter of 2018. This branch, along with our new Windham, NH branch and our recently relocated branch in Salem, NH, are in prime locations and will provide improved, state-of-the-art experiences in these communities to better serve our customers.

Composition of Earnings

The Company's earnings are largely dependent on its net interest income, which is the difference between interest earned on loans and investments and the cost of funding (primarily deposits and borrowings).  Net interest income expressed as a percentage of average interest earning assets is referred to as net interest margin.  The Company reports net interest margin on a tax equivalent basis ("margin").

Net interest income for the three months ended June 30, 2018 amounted to $27.2 million, an increase of $3.7 million, or 16%, compared to the same period in 2017. Net interest income for the six months ended June 30, 2018 amounted to $53.2 million, an increase of $6.9 million, or 15%, compared to the six months ended June 30, 2017. The increase in net interest income was due largely to loan growth. Average loan balances (including loans held for sale) increased $196.4 million for the three months ended June 30, 2018, and $211.3 million for the six months ended June 30, 2018, compared to the same 2017 respective period averages. Additionally, margin was 4.03% for the three months ended June 30, 2018 compared to 3.90% for the three months ended June 30, 2017. Margin was 3.99% for the six months ended June 30, 2018, compared to 3.90% for the six months ended June 30, 2017. See the discussion under the heading "Results of Operations" below, in this Item 2, for further information regarding changes in margin.

The re-pricing frequency of the Company’s assets and liabilities are not identical, and therefore subject the Company to the risk of adverse changes in interest rates. This is often referred to as “interest rate risk” and is reviewed in more detail in Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk,” of this Form 10-Q and in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of the Company's 2017 Annual Report on Form 10-K.

For the three months ended June 30, 2018, the provision to the allowance for loan losses amounted to $300 thousand, compared to $280 thousand for the three months ended June 30, 2017. For the six months ended June 30, 2018 and June 30, 2017, the provision to the allowance for loan losses amounted to $1.9 million and $405 thousand, respectively.

The primary factor in the increase in the year-to-date provision for loan losses compared to the prior year was a $1.6 million increase in the balance of the allowance for loan losses allocated to impaired and classified loans during the six months ended June 30, 2018, compared to a decrease of $745 thousand during the six months ended June 30, 2017. This increase in 2018 was primarily due to credit deterioration of impaired and classified commercial relationships for which management determined that the additional provisions were necessary based on a review of underlying collateral values, individual business circumstances, and credit metrics.
Also affecting the provision compared to the prior year was:
Net charge-offs of $18 thousand for the six months ended June 30, 2018, compared to net recoveries of $211 thousand for the six months ended June 30, 2017.



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Total non-performing loans as a percentage of total loans amounted to 0.48% at June 30, 2018, compared to 0.63% at June 30, 2017.

The ratio of adversely classified loans (substandard, doubtful, loss) to total loans amounted to 1.54% at June 30, 2018, compared to 1.48% at June 30, 2017.

Loan growth for the six months ended June 30, 2018 was $28.7 million, compared to $91.7 million during the six months ended June 30, 2017.

The allowance for loan losses to total loans ratio was 1.51% at June 30, 2018, 1.45% at December 31, 2017 and 1.51% at June 30, 2017.
For further information regarding loan quality statistics and the allowance for loan losses, see the sections below under the heading "Financial Condition" titled "Asset Quality" and "Allowance for Loan Losses."

Non-interest income for the three months ended June 30, 2018 amounted to $3.7 million, a decrease of $206 thousand, or 5%, compared to the same quarter in the prior year. Non-interest income for the six months ended June 30, 2018 amounted to $7.5 million, a decrease of $549 thousand, or 7%, compared to the six months ended June 30, 2017. The decreases compared to the prior year periods were due primarily to decreases in net gains on sales of investment securities, partially offset by increases in investment advisory fees.
Non-interest expense for the quarter ended June 30, 2018 amounted to $20.8 million, an increase of $2.1 million, or 11%, compared to the same quarter in the prior year. For the six months ended June 30, 2018, non-interest expense amounted to $40.3 million, an increase of $2.1 million, or 5%, compared to the six months ended June 30, 2017. Increases in expenses over the same periods in the prior year primarily related to the Company's strategic growth and market initiatives, particularly salaries and benefits expense, occupancy and equipment expenses, other professional costs, and advertising and public relations, which included the Company's Celebration of Excellence, a bi-annual community recognition event, in the second quarter of 2018.

The provision for income taxes for the quarter ended June 30, 2018 amounted to $2.3 million, a decrease of $576 thousand, or 20%, compared to the same quarter in the prior year. The provision for income taxes amounted to $4.2 million for the six months ended June 30, 2018, a decrease of $506 thousand, or 11%, compared to the six months ended June 30, 2017. Decreases in the income tax provision were primarily due to the positive impact of the 2017 Tax Act, partially offset by lower tax benefits from equity compensation deductions in the current year ($235 thousand for the six months ended June 30, 2018, compared to $788 thousand for the six months ended June 30, 2017) and higher taxable income levels.

Sources and Uses of Funds
 
The Company's primary sources of funds are customer and brokered deposits, Federal Home Loan Bank ("FHLB") borrowings, current earnings and proceeds from the sales, maturities and pay-downs on loans and investment securities.  The Company may also, from time to time, utilize overnight borrowings from correspondent banks. Additionally, funding for the Company may be generated through equity transactions, including the dividend reinvestment and direct stock purchase plan or exercise of stock options, and occasionally the issuance of debt securities or the sale of new stock. The Company's sources of funds are intended to be used to originate loans, purchase investment securities, conduct operations, expand the branch network, and pay dividends to stockholders.
 
The investment portfolio is primarily used to provide liquidity, manage the Company's asset-liability position and to invest excess funds, providing additional sources of revenue. Total investments, one of the key components of interest earning assets, amounted to $422.2 million at June 30, 2018, an increase of $17.0 million, or 4%, since December 31, 2017, and comprised 14% of total assets at both June 30, 2018 and December 31, 2017.

Enterprise's main asset strategy is to grow loans, the largest component of interest earning assets, with a focus on high quality commercial lending relationships.  Total loans, comprising 78% of total assets at June 30, 2018 compared to 81% at December 31, 2017, amounted to $2.30 billion at June 30, 2018, compared to $2.27 billion at December 31, 2017, an increase of $28.7 million, or 1%. Total commercial loans amounted to $1.99 billion, or 86% of gross loans, at June 30, 2018, which was consistent with the composition at December 31, 2017.
 
Management's preferred strategy for funding asset growth is to grow relationship-based deposit balances, preferably transactional deposits (comprised of demand deposit accounts, checking accounts and traditional savings accounts).  Asset


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growth in excess of transactional deposits is typically funded through non-transactional deposits (comprised of money market accounts, commercial tiered rate or "investment savings" accounts and term certificates of deposit) and wholesale funding (brokered deposits and borrowed funds).
 
At June 30, 2018, customer deposits (total deposits excluding brokered deposits) amounted to $2.48 billion, or 85% of total assets, compared to $2.29 billion, or 81% of total assets, at December 31, 2017. Customer deposits increased $187.7 million, or 8%, with growth achieved across all deposit categories, with the largest growth in checking account balances.

Wholesale funding amounted to $179.3 million at June 30, 2018, or 6% of total assets, compared to $236.5 million at December 31, 2017, or 8% of total assets. Since December 31, 2017, wholesale funding has decreased $57.2 million, or 24%. Wholesale funding included primarily brokered deposits at June 30, 2018. At December 31, 2017, wholesale funding included FHLB advances of $89.0 million and brokered deposits of $147.5 million. The Company's level of wholesale funding has decreased since December 31, 2017 as increases in customer deposit balances have exceeded loan growth.

Opportunities and Risks

This Opportunities and Risks discussion should be read in conjunction with Item 1A "Risk Factors," and the section titled "Opportunities and Risks" contained in Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations" included in the Company's 2017 Annual Report on Form 10-K, which addresses other factors and details that could adversely affect the Company's business, reputation, its future results of operations and financial condition.

The Company's business model is to provide a full range of diversified financial products and services through a highly-trained staff of knowledgeable banking professionals, with an in-depth understanding of our markets, and a commitment to open and honest communication with customers.

Enterprise faces robust competition to attract and retain customers within existing and neighboring geographic markets. The Company's ability to achieve its long-term strategic growth and market share objectives will depend in part upon management's continued success in differentiating the Company in the marketplace and its ability to strengthen its competitive position. Management believes the Company has differentiated itself from the competition by building a solid reputation within the local market as a dependable commercial-focused community bank, delivering consistent and exceptional customer service, offering competitive products and taking an active role in support of the communities we serve. The Company actively seeks to increase market share and strengthen its competitive position through continuous reviews of deposit product offerings, cash management and ancillary services and state-of-the-art delivery channels, targeted to businesses, non-profits, professional practice groups, municipalities and consumers' needs. In addition, Enterprise carefully plans market expansion through active development of new branch locations, identifying markets strategically located to complement existing locations while expanding the Company's geographic market footprint. In July 2017, the Company opened its 24th branch office, located in Windham, NH, its seventh branch in Southern New Hampshire. In addition, the Company recently relocated the Salem, NH and Leominster, MA branches. These new and enlarged branches in prime locations will provide improved, state-of-the-art experiences in these communities to better serve and attract customers. Our consistent branch expansion is aimed at achieving not only deposit market share growth, but also is intended to contribute to loan originations and generate referrals for investment advisory and wealth management, trust and insurance services, and cash management products.

Management continues to undertake significant strategic initiatives, including investments in employee hiring, training and development; marketing and public relations; technology and electronic delivery methods; ongoing improvements, renovations or strategic relocation of existing facilities; and the continued cultivation of recently added branches.  Industry consolidation also provides management the opportunity to recruit experienced banking professionals with market knowledge who complement the Enterprise sales and service culture. While management recognizes that such investments increase expenses in the short term, Enterprise believes that such initiatives are a necessary investment in the long-term growth and earnings potential of the Company and will help the Company to capitalize on current opportunities in the marketplace for community banks such as Enterprise. However, lower than expected returns on these investments, such as slower than anticipated loan and deposit growth in new branches and/or lower than expected adoption rates or income generated from new technology or initiatives, could decrease anticipated revenues and net income on such investments in the future.

Changes in government regulation or oversight could affect the Company in substantial and unpredictable ways. The current administration's legislative agenda is not yet fully known, but it may include certain deregulatory measures for the banking industry, including the structure and powers of the Consumer Finance Protection Bureau and other areas under the Dodd-Frank Act, in addition to extensive corporate tax reform contained in the 2017 Tax Act enacted in December 2017 and the Economic Growth, Regulatory Relief and Consumer Protection Act enacted on May 24, 2018. Accordingly, it is difficult to anticipate the continued impact that this expansive legislation, if or when fully enacted, will have on the Company, its customers and the


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financial industry generally. The Company maintains a Compliance Management Program (the "CMP") designed to meet regulatory and legislative requirements.  The CMP provides a framework for tracking and implementing regulatory changes, monitoring the effectiveness of policies and procedures, conducting compliance risk assessments, and educating employees in matters relating to regulatory compliance. 

Operational risk includes the threat of loss from inadequate or failed internal processes, people, systems or external events, due to, among other things: fraud or error; the inability to deliver products or services; failure to maintain a competitive position; lack of, or insufficient information security, cyber-security or physical security; inadequate procedures or controls followed by third-party service providers; or violations of ethical standards. In addition to intensive and ongoing employee training and employee and customer awareness campaigns, controls to manage operational risk include, but are not limited to, technology administration, information security, third-party management, and disaster recovery and business continuity planning. Any system of controls or contingency plan, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the controls and procedures will be met. Any breakdown in the integrity of these information systems, infrastructure, or cyber-security measures, or the Company's inability to identify, respond and correct such breakdown, could result in a loss of customer business, expose customers' personal information to unauthorized parties, damage the Company's reputation, subject the Company to increased costs and additional regulatory scrutiny, and expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company's business, financial condition and results of operations.

Accounting Policies/Critical Accounting Estimates

As discussed in the Company's 2017 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses, impairment review of investment securities and the impairment review of goodwill.  The Company has not changed its significant accounting and reporting policies from those disclosed in its 2017 Annual Report on Form 10-K.


Financial Condition
 
Total assets increased $116.4 million, or 4%, since December 31, 2017, to $2.93 billion at June 30, 2018.  The balance sheet composition and changes since December 31, 2017 are discussed below.

Cash and cash equivalents

Cash and cash equivalents is comprised of cash on hand and cash items due from banks, interest-earning deposits (deposit accounts, excess reserve cash balances, money markets, and money market mutual funds accounts) and federal funds ("fed funds") sold. Cash and cash equivalents amounted to 5% of total assets at June 30, 2018 compared to 2% at December 31, 2017. Balances in cash and cash equivalents will fluctuate due primarily to the timing of net deposit flows, borrowing and loan inflows and outflows, investment purchases and maturities, calls and sales proceeds, and the immediate liquidity needs of the Company.

Investments
 
At June 30, 2018, the fair value of the investment portfolio amounted to $422.2 million, an increase of $17.0 million, or 4%, since December 31, 2017. The investment portfolio represented 14% of total assets at June 30, 2018 and December 31, 2017.  The Company had only debt securities at December 31, 2017, as the equity portfolio was liquidated during 2017 in order to reduce the magnitude of the impact from market fluctuations on earnings due to new accounting rules in effect January 1, 2018. As of June 30, 2018, the investment portfolio was primarily comprised of debt securities, with a small portion of the portfolio invested in equity securities.

During the six months ended June 30, 2018, the Company purchased $46.1 million in securities. The Company had principal pay downs, calls and maturities totaling $18.3 million during the six months ended June 30, 2018. In addition, management sold securities with an amortized cost of approximately $668 thousand realizing net gains on sales of $1 thousand during the six months ended June 30, 2018.

See also Note 2, "Investment Securities," and Note 12, "Fair Value Measurements," to the Company's unaudited consolidated interim financial statements contained in Item 1 above for further information regarding the Company's unrealized gains and losses on debt securities, including information about investments in an unrealized loss position for which an other-than-


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temporary impairment has or has not been recognized, and investments pledged as collateral, as well as the Company's fair value measurements for investment securities.

Debt Securities

The following table summarizes the fair value of debt securities at the dates indicated:
 
 
 
June 30,
2018
 
December 31,
2017
 
June 30,
2017
(Dollars in thousands)
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Federal agency obligations(1)
 
$
48,322

 
11.5
%
 
$
51,717

 
12.8
%
 
$
75,189

 
19.7
%
Residential federal agency MBS(1)
 
150,840

 
35.8
%
 
140,154

 
34.6
%
 
95,714

 
25.1
%
Commercial federal agency MBS(1)
 
72,165

 
17.1
%
 
66,500

 
16.4
%
 
76,437

 
20.0
%
Municipal securities
 
137,587

 
32.7
%
 
134,346

 
33.2
%
 
122,158

 
32.0
%
Corporate bonds
 
11,369

 
2.7
%
 
11,542

 
2.8
%
 
11,367

 
3.0
%
Certificates of deposits(2)
 
942

 
0.2
%
 
947

 
0.2
%
 
953

 
0.2
%
Total debt securities
 
$
421,225

 
100.0
%
 
$
405,206

 
100.0
%
 
$
381,818

 
100.0
%
__________________________________________ 
(1)
These categories may include investments issued or guaranteed by government sponsored enterprises such as Fannie Mae ("FNMA"), Freddie Mac ("FHLMC"), Federal Farm Credit Bank ("FFCB"), or one of several Federal Home Loan Banks, as well as, investments guaranteed by Ginnie Mae ("GNMA"), a wholly-owned government entity.  
(2)
Certificates of deposits ("CDs") represent term deposits issued by banks that are subject to FDIC insurance and purchased on the open market.

Included in the residential and commercial federal agency MBS categories were collateralized mortgage obligations (“CMOs”) issued by U.S. agencies totaling $189.7 million, $171.7 million, and $106.0 million at June 30, 2018, December 31, 2017 and June 30, 2017, respectively.

Net unrealized losses on the debt securities portfolio amounted to $8.6 million at June 30, 2018 compared to net unrealized gains of $507 thousand at December 31, 2017 and $2.2 million at June 30, 2017. The Company attributes the increase in net unrealized losses in the current period to the impact of increases in current market yields. Unrealized gains or losses on debt securities will only be recognized in the statements of income if the investments are sold. However, should an investment be deemed "other-than-temporarily impaired" ("OTTI"), the Company is required to write-down the fair value of the investment.  See “Impairment Review of Securities” under the heading “Critical Accounting Estimates” in Item 7 of the Company's 2017 Annual Report on Form 10-K for additional information regarding the accounting for OTTI.
 
Equity Securities

As of June 30, 2018, the Company held equity securities with a fair value of $949 thousand, compared to no equity securities at December 31, 2017 and $6.2 million at June 30, 2017. In the first quarter of 2018, the Company adopted ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," and as a result the fair value fluctuations associated with the equity portfolio is recognized in the Company’s consolidated statement of income, in the "Other income" line item. During the three and six months ended June 30, 2018, the Company’s fair value gain (loss) on equity securities was immaterial. The fair value changes of equity securities that will be recognized in net income in the future will depend on the amount of dollars invested in equities and the magnitude of changes in equity market values.

Federal Home Loan Bank Stock
 
The Bank is required to purchase stock of the FHLB at par value in association with advances from the FHLB; this stock is classified as a restricted investment and carried at cost, which management believes approximates fair value.  The Company's investment in FHLB stock was $2.6 million at June 30, 2018, $5.2 million at December 31, 2017 and $4.4 million at June 30, 2017.



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See Note 1, "Summary of Significant Accounting Policies," Item (c), "Restricted Instruments," to the Company's unaudited consolidated interim financial statements contained in Item 1 above for further information regarding the Company's investment in FHLB stock.

Loans
 
Total loans represented 78% of total assets at June 30, 2018 and 81% of total assets at December 31, 2017.  Total loans increased $28.7 million, or 1%, compared to December 31, 2017, and $184.2 million, or 9%, since June 30, 2017.  The mix of loans within the portfolio remained relatively unchanged with commercial loans amounting to approximately 86% of gross loans at June 30, 2018, reflecting a continued focus on commercial loan growth.
 
The following table sets forth the loan balances by certain loan categories at the dates indicated and the percentage of each category to gross loans:


 
 
June 30, 2018
 
December 31, 2017
 
June 30, 2017
(Dollars in thousands)
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Commercial real estate
 
$
1,246,501

 
54.2
%
 
$
1,201,351

 
52.9
%
 
$
1,107,714

 
52.3
%
Commercial and industrial
 
493,981

 
21.5
%
 
498,802

 
21.9
%
 
505,240

 
23.9
%
Commercial construction
 
246,865

 
10.7
%
 
274,905

 
12.1
%
 
218,277

 
10.3
%
Total commercial loans
 
1,987,347

 
86.4
%
 
1,975,058

 
86.9
%
 
1,831,231

 
86.5
%
Residential mortgages
 
205,781

 
8.9
%
 
195,492

 
8.6
%
 
188,941

 
8.9
%
Home equity loans and lines
 
98,176

 
4.3
%
 
91,706

 
4.0
%
 
86,394

 
4.1
%
Consumer
 
9,756

 
0.4
%
 
10,293

 
0.5
%
 
10,064

 
0.5
%
Total retail loans
 
313,713

 
13.6
%
 
297,491

 
13.1
%
 
285,399

 
13.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross loans
 
2,301,060

 
100.0
%
 
2,272,549

 
100.0
%
 
2,116,630

 
100.0
%
Deferred fees, net
 
(2,465
)
 
 

 
(2,645
)
 
 

 
(2,230
)
 
 

Total loans
 
2,298,595

 
 

 
2,269,904

 
 

 
2,114,400

 
 

Allowance for loan losses
 
(34,797
)
 
 

 
(32,915
)
 
 

 
(31,958
)
 
 

Net loans
 
$
2,263,798

 
 

 
$
2,236,989

 
 

 
$
2,082,442

 
 



As of June 30, 2018, commercial real estate loans increased $45.2 million, or 4%, compared to December 31, 2017, and increased 13% compared to June 30, 2017. Commercial real estate loans are typically secured by a variety of owner-use and non-owner occupied (investor) commercial and industrial property types including one-to-four and multi-family apartment buildings, office, industrial or mixed-use facilities, strip shopping centers or other commercial properties and are generally guaranteed by the principals of the borrower.

As of June 30, 2018, commercial and industrial loans balances decreased $4.8 million, or 1%, compared to December 31, 2017 and decreased 2% compared to June 30, 2017.  These loans include seasonal revolving lines of credit, working capital loans, equipment financing (including equipment leases), and term loans.  Also included in commercial and industrial loans are loans partially guaranteed by the U.S. Small Business Administration ("SBA"), and loans under various programs and agencies. Commercial and industrial credits may be unsecured loans and lines to financially strong borrowers, loans secured in whole or in part by real estate unrelated to the principal purpose of the loan or secured by inventories, equipment, or receivables, and are generally guaranteed by the principals of the borrower. 

Commercial construction loans decreased by $28.0 million, or 10%, since December 31, 2017, but increased 13% as compared to June 30, 2017. Commercial construction loans include the development of residential housing and condominium projects, the development of commercial and industrial use property and loans for the purchase and improvement of raw land. These loans are secured in whole or in part by underlying real estate collateral and are generally guaranteed by the principals of the borrowers. In many cases, these loans move into the permanent commercial real estate portfolio when the construction phase is completed.



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Retail loan balances increased by $16.2 million, or 5%, since December 31, 2017, and have increased by 10% since June 30, 2017.  The increase over the same period in the prior year was primarily with loans secured by residential property.

At June 30, 2018, commercial loan balances participated out to various banks amounted to $74.7 million, compared to $70.7 million at December 31, 2017, and $65.8 million at June 30, 2017.  These balances participated out to other institutions are not carried as assets on the Company's financial statements. Commercial loans originated by other banks in which the Company is a participating institution are carried at the pro-rata share of ownership and amounted to $79.0 million, $91.6 million and $86.6 million at June 30, 2018, December 31, 2017, and June 30, 2017, respectively. In each case, the participating bank funds a percentage of the loan commitment and takes on the related pro-rata risk. The rights and obligations of each participating bank are divided proportionately among the participating banks in an amount equal to their share of ownership and with equal priority among all banks. Participating loans with other institutions provide banks the opportunity to retain customer relationships and reduce credit risk exposure among each participating bank, while providing customers with larger credit vehicles than the individual bank might be willing or able to offer independently.
 
See Note 3, "Loans," to the Company's unaudited consolidated interim financial statements contained in Item 1 of this Form 10-Q for information on loans serviced for others and loans pledged as collateral.

Credit Risk
 
Inherent in the lending process is the risk of loss due to customer non-payment, or "credit risk." The Company's commercial lending focus may entail significant additional credit risks compared to long-term financing on existing, owner-occupied residential real estate.  The Company seeks to lessen its credit risk exposure by managing its loan portfolio to avoid concentration by industry, relationship size, and source of repayment, and through sound underwriting practices and the risk management function; however, management recognizes that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio and economic conditions.

Non-performing assets are comprised of non-accrual loans, deposit account overdrafts that are more than 90 days past due and OREO.  The designation of a loan or other asset as non-performing does not necessarily indicate that loan principal and interest will ultimately be uncollectible.  However, management recognizes the greater risk characteristics of these assets and therefore considers the potential risk of loss on assets included in this category in evaluating the adequacy of the allowance for loan losses.  The level of delinquent and non-performing assets is largely a function of economic conditions and the overall banking environment and the individual business circumstances of borrowers.  Despite prudent loan underwriting, adverse changes within the Company's market area, or deterioration in local, regional or national economic conditions, could negatively impact the Company's level of non-performing assets in the future.


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Table of Contents

Asset Quality

The following table sets forth information regarding non-performing assets, trouble debt restructuring ("TDR") loans and delinquent loans 60-89 days past due as to interest or principal, held by the Company at the dates indicated:

(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017
 
June 30,
2017
Non-accrual loan summary:
 
 
 
 
 
 
Commercial real estate
 
$
6,512

 
$
6,751

 
$
8,446

Commercial and industrial
 
3,438

 
1,294

 
3,744

Commercial construction
 
187

 
193

 
200

Residential
 
429

 
262

 
272

Home equity
 
494

 
463

 
594

Consumer
 
17

 
34

 
13

Total non-accrual loans
 
11,077

 
8,997

 
13,269

Overdrafts > 90 days past due
 

 
35

 
7

Total non-performing loans
 
11,077

 
9,032

 
13,276

OREO
 

 

 

Total non-performing assets
 
$
11,077

 
$
9,032

 
$
13,276

Total Loans
 
$
2,298,595

 
$
2,269,904

 
$
2,114,400

Accruing TDR loans not included above
 
$
18,077

 
$
17,356

 
$
17,316

Delinquent loans 60-89 days past due and still accruing
 
$
1,054

 
$
1,026

 
$
111

Loans 60-89 days past due and still accruing to total loans
 
0.05
%
 
0.05
%
 
0.01
%
Adversely classified loans to total loans
 
1.54
%
 
1.16
%
 
1.48
%
Non-performing loans to total loans
 
0.48
%
 
0.40
%
 
0.63
%
Non-performing assets to total assets
 
0.38
%
 
0.32
%
 
0.50
%
Allowance for loan losses
 
$
34,797

 
$
32,915

 
$
31,958

Allowance for loan losses to non-performing loans
 
314.14
%
 
364.43
%
 
240.72
%
Allowance for loan losses to total loans
 
1.51
%
 
1.45
%
 
1.51
%
 
The net increase in non-accrual loans since the prior periods was due primarily to the migration of commercial relationships in the commercial and industrial portfolio. These additions, among others, were partially offset by principal paydowns and credit rating upgrades during the period. The majority of non-accrual loans were also carried as impaired loans during the periods and the changes since December 31, 2017 are discussed further below.

At June 30, 2018 and December 31, 2017, the Company had adversely classified loans (loans carrying "substandard," "doubtful" or "loss" classifications) amounting to $35.4 million and $26.4 million, respectively. Total adversely classified loans amounted to 1.54% of total loans at June 30, 2018 as compared to 1.16% at December 31, 2017. Adversely classified loans that were performing but possessed potential weaknesses and, as a result, could ultimately become non-performing loans amounted to $24.4 million at June 30, 2018 and $17.4 million at December 31, 2017.  The remaining balances of adversely classified loans were non-accrual loans, amounting to $11.0 million at June 30, 2018 and $9.0 million at December 31, 2017.  Non-accrual loans that were not adversely classified amounted to $64 thousand and $21 thousand at June 30, 2018 and December 31, 2017, respectively, and primarily represented the guaranteed portions of non-performing SBA loans.

Total impaired loans amounted to $28.7 million and $26.3 million at June 30, 2018 and December 31, 2017, respectively.  Total accruing impaired loans amounted to $18.1 million and $17.4 million at June 30, 2018 and December 31, 2017, respectively, while non-accrual impaired loans amounted to $10.6 million and $8.9 million as of June 30, 2018 and December 31, 2017, respectively.





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Table of Contents

In management's opinion, the majority of impaired loan balances at June 30, 2018 and December 31, 2017 were supported by expected future cash flows or, for those collateral dependent loans, the net realizable value of the underlying collateral. Based on management's assessment at June 30, 2018, impaired loans totaling $23.3 million required no specific reserves and impaired loans totaling $5.4 million required specific reserve allocations of $2.7 million.  At December 31, 2017, impaired loans totaling $22.2 million required no specific reserves and impaired loans totaling $4.1 million required specific reserve allocations of $1.4 million.  The increase in impaired reserves was primarily due to the credit deterioration of commercial relationships, which, based on a review of the individual business circumstances, and underlying collateral values, management determined that additional reserves were necessary as of June 30, 2018. Management closely monitors impaired relationships for collateral or credit deterioration.

Total TDR loans included in the impaired loan amounts above as of June 30, 2018 and December 31, 2017 were $21.0 million and $20.3 million, respectively.  TDR loans on accrual status amounted to $18.1 million and $17.4 million at June 30, 2018 and December 31, 2017, respectively. TDR loans included in non-performing loans amounted to $2.9 million at both June 30, 2018 and December 31, 2017, respectively.  The Company continues to work with customers, particularly commercial relationships, and enters into loan modifications (which may or may not be TDRs) to the extent deemed to be necessary or appropriate while attempting to achieve the best mutual outcome given the individual financial circumstances and future prospects of the borrower.

The Company carried no OREO at June 30, 2018, December 31, 2017 and June 30, 2017. There were no additions, sales or write-downs on OREO during the six months ended June 30, 2018 or 2017.

Allowance for Loan Losses

The allowance for loan losses is an estimate of probable credit risk inherent in the loan portfolio as of the specified balance sheet dates. On a quarterly basis, management prepares an estimate of the allowance necessary to cover estimated probable credit losses.  The Company maintains the allowance at a level that it deems adequate to absorb all reasonably anticipated probable losses from specifically known and other credit risks associated with the portfolio. Management closely monitors the credit quality of individual delinquent and non-performing relationships, industry concentrations, the local and regional real estate market and current economic conditions. 

There have been no material changes to the Company's underwriting practices, credit risk management system, or to the allowance assessment methodology used to estimate loan loss exposure as reported in the 2017 Annual Report on Form 10-K.  Please refer to Note 4 "Allowance for Loan Losses," to the Company's consolidated financial statements contained in the 2017 Annual Report on Form 10-K for further discussion of management's methodology used to estimate a sufficient allowance for loan losses, the credit risk management function and adversely classified loan rating system.

The allowance for loan losses to total loans ratio was 1.51% at June 30, 2018, 1.45% at December 31, 2017, and 1.51% at June 30, 2017. Based on management's judgment as to the existing credit risks inherent in the loan portfolio, as discussed above under the headings "Credit Risk" and "Asset Quality," management believes that the Company's allowance for loan losses is adequate to absorb probable losses from specifically known and other probable credit risks associated with the portfolio as of June 30, 2018.


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Table of Contents

The following table summarizes the activity in the allowance for loan losses for the periods indicated: 
 
 
Six Months Ended June 30,
(Dollars in thousands)
 
2018
 
2017
Balance at beginning of year
 
$
32,915

 
$
31,342

 
 
 
 
 
Provision charged to operations
 
1,900

 
405

  Recoveries on charged-off loans:
 
 

 
 

Commercial real estate
 

 
132

Commercial and industrial
 
165

 
343

Commercial construction
 

 

Residential
 

 

Home equity
 
1

 
2

Consumer
 
17

 
5

Total recoveries
 
183

 
482

  Charged-off loans
 
 
 
 
Commercial real estate
 

 

Commercial and industrial
 
117

 
217

Commercial construction
 

 

Residential
 

 

Home equity
 

 

Consumer
 
84

 
54

Total charged off
 
201

 
271

 
 
 
 
 
Net loans charged off (recovered)
 
18

 
(211
)
Ending Balance
 
$
34,797

 
$
31,958

Annualized net loans charged off (recovered): Average loans outstanding
 
%
 
(0.02
)%
 
See Note 4, “Allowance for Loan Losses” to the Company's consolidated financial statements, contained in Item 1 in this Form 10-Q, for further information regarding credit quality and the allowance for loan losses.




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Table of Contents

Deposits
 
Total deposits amounted to $2.66 billion as of June 30, 2018, an increase of $219.0 million, or 9%, compared to December 31, 2017. Total deposits as a percentage of total assets were 91% at June 30, 2018 and 87% at December 31, 2017.

The following table sets forth the deposit balances by certain categories at the dates indicated and the percentage of each category to total deposits:
 
 

June 30, 2018

December 31, 2017

June 30, 2017
(Dollars in thousands)

Amount

Percent

Amount

Percent

Amount

Percent
Non-interest bearing demand deposits

$
739,890


27.8
%

$
705,846


28.9
%

$
700,415


29.7
%
Interest-bearing checking

442,944


16.7
%

391,111


16.0
%

406,077


17.3
%
Total checking

1,182,834


44.5
%

1,096,957


44.9
%

1,106,492


47.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings
 
198,666

 
7.5
%
 
193,385

 
7.9
%
 
199,018

 
8.5
%
Money markets
 
859,611

 
32.3
%
 
807,931

 
33.1
%
 
793,131

 
33.7
%
Total savings/money markets
 
1,058,277

 
39.8
%
 
1,001,316

 
41.0
%
 
992,149

 
42.2
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit (CD's)
 
240,443

 
9.0
%
 
195,599

 
8.0
%
 
167,681

 
7.1
%
Total customer deposits
 
2,481,554

 
93.3
%
 
2,293,872

 
93.9
%
 
2,266,322

 
96.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Brokered deposits (1)
 
178,800

 
6.7
%
 
147,490

 
6.1
%
 
87,460

 
3.7
%
Total deposits
 
$
2,660,354

 
100.0
%
 
$
2,441,362

 
100.0
%
 
$
2,353,782

 
100.0
%
__________________________________________
(1) 
Brokered CDs $250,000 and under.

As of June 30, 2018, customer deposits (deposits, excluding brokered deposits) increased $187.7 million, or 8%, since December 31, 2017, and $215.2 million, or 9%, since June 30, 2017. There were increases across all deposit categories since December 31, 2017, with the largest growth in checking account balances.

Total customer deposits include reciprocal balances received from participating banks in nationwide deposit networks as a result of our customers electing to participate in Company offered programs which allow for enhanced FDIC insurance. Essentially, the equivalent of the original deposited funds comes back to the Company as customer deposits within the appropriate category under total customer deposits. The Company's balances in these reciprocal products were $301.9 million, $249.6 million and $252.4 million at June 30, 2018, December 31, 2017 and June 30, 2017, respectively.

Management utilizes brokered deposits as cost effective wholesale funding sources to support continued loan growth and as part of the Company's asset-liability management strategy to protect against rising rates. At June 30, 2018, December 31, 2017, and June 30, 2017 brokered deposits were comprised only of selected term brokered CDs from large money center banks in increments of $250,000 or less. As of June 30, 2018, brokered deposits increased $31.3 million, or 21%, compared to December 31, 2017. Brokered CDs outstanding at June 30, 2018 had a weighted average remaining life of less than 6 months. See also "Wholesale Funding" below.

Borrowed Funds
 
The Company had borrowed funds of $501 thousand at June 30, 2018 linked to outstanding commercial loans under a community reinvestment program of the FHLB. At December 31, 2017 and June 30, 2017, borrowed funds, comprised wholly of FHLB borrowings, amounted to $89.0 million and $44.3 million, respectively.

At June 30, 2018, the Bank had the capacity to borrow additional funds from the FHLB of up to approximately $515.0 million and capacity to borrow from the FRB Discount Window of approximately $130.0 million.
 


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Table of Contents

Wholesale Funding

Wholesale funding includes brokered deposits and borrowed funds as discussed above. Since December 31, 2017, wholesale funding has decreased $57.2 million, or 24% as customer deposit growth has exceeded loan growth.

The following table sets forth the breakout of wholesale funding by composition at the dates indicated and the percentage of each category to total wholesale funding:
 
 
June 30, 2018
 
December 31, 2017
 
June 30, 2017
(Dollars in thousands)
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Brokered deposits
 
$
178,800

 
99.7
%
 
$
147,490

 
62.4
%
 
$
87,460

 
66.4
%
Borrowed funds
 
501

 
0.3
%
 
89,000

 
37.6
%
 
44,255

 
33.6
%
Wholesale funding
 
$
179,301

 
100.0
%
 
$
236,490

 
100.0
%
 
$
131,715

 
100.0
%

See "Liquidity" below for additional information.

Subordinated Debt

The Company had $14.9 million (net of deferred issuance costs) of outstanding subordinated debt at June 30, 2018, compared to $14.8 million at both December 31, 2017 and June 30, 2017, which consisted of $15.0 million in aggregate principal amount of Fixed-to-Floating Rate Subordinated Notes (the "Notes") issued in January 2015, in a private placement to an accredited investor. See also Note 6, "Borrowed Funds and Subordinated Debt," to the Company's unaudited consolidated interim financial statements contained in Item 1 above for further information regarding the Company's subordinated debt.

Liquidity
 
Liquidity is the ability to meet cash needs arising from, among other things, fluctuations in loans, investments, deposits and borrowings.  Liquidity management is the coordination of activities so that cash needs are anticipated and met readily and efficiently.  The Company's liquidity policies are set and monitored by the Company's Board of Directors.  The duties and responsibilities related to asset-liability management matters are also covered by the Board of Directors. The Company's asset-liability objectives are to engage in sound balance sheet management strategies, maintain liquidity, provide and enhance access to a diverse and stable source of funds, provide competitively priced and attractive products to customers and conduct funding at a low cost relative to current market conditions.  Funds gathered are used to support current commitments, to fund earning asset growth, and to take advantage of selected leverage opportunities.
 
The Company's liquidity is maintained by projecting cash needs, balancing maturing assets with maturing liabilities, monitoring various liquidity ratios, monitoring deposit flows, maintaining cash flow within the investment portfolio, and maintaining wholesale funding resources. 

At June 30, 2018, the Company's wholesale funding sources primarily included borrowing capacity at the FHLB (generally overnight and short-term advances) and brokered deposits (generally short or long term CDs). In addition, the Company maintains overnight fed fund purchase arrangements with correspondent banks and has access to the FRB Discount Window.

Management believes that the Company has adequate liquidity to meet its obligations. However, if, as a result of general economic conditions or other events, these sources of external funding become restricted or are eliminated, the Company may not be able to raise adequate funds or may incur substantially higher funding costs or operating restrictions in order to raise the necessary funds to support the Company's operations and growth.

The Company has in the past also increased capital and liquidity by offering shares of the Company's common stock for sale to its existing stockholders and new investors and through the issuance of subordinated debt. See "Capital Resources," below for information on the Company's capital planning.



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Table of Contents

Capital Resources
 
Capital planning by the Company and the Bank considers current capital needs and anticipated future growth.  Historically, the primary sources of capital for the Company and the Bank have been proceeds from the issuance of common stock and subordinated debt. Ongoing sources of capital include the retention of earnings, less dividends paid, proceeds from the exercise of employee stock options and proceeds from purchases of shares pursuant to the Company’s dividend reinvestment plan and direct stock purchase plan (together, the "DRSPP"). The Company believes its current capital is adequate to support ongoing operations.


Management believes, as of June 30, 2018, that the Company and the Bank met all capital adequacy requirements to which they were subject. As of June 30, 2018, the Company met the definition of "well capitalized" under the applicable Federal Reserve Board regulations and the Bank qualified as "well capitalized" under the prompt corrective action regulations of Basel III and the FDIC. The Company's and the Bank's actual capital amounts and ratios are presented as of June 30, 2018 in the tables below.
 
 
Actual
 
Minimum Capital
for Capital Adequacy
Purposes (1)
 
Minimum Capital
To Be
Well Capitalized  (2)
 
(Dollars in thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
The Company
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to risk weighted assets)
 
$
283,907


11.66
%

$
194,734


8.00
%

N/A
 
N/A
 
Tier 1 Capital (to risk weighted assets)
 
$
238,573


9.80
%

$
146,050


6.00
%

N/A
 
N/A
 
Tier 1 Capital (to average assets) or Leverage ratio
 
$
238,573


8.35
%

$
114,261


4.00
%

N/A
 
N/A
 
Common equity tier 1 capital (to risk weighted assets)
 
$
238,573

 
9.80
%
 
$
109,538

 
4.50
%
 
N/A
 
N/A
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Bank
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to risk weighted assets)
 
$
283,505

 
11.67
%
 
$
194,376

 
8.00
%
 
$
242,970

 
10.00
%
 
Tier 1 Capital (to risk weighted assets)
 
$
253,079

 
10.42
%
 
$
145,782

 
6.00
%
 
$
194,376

 
8.00
%
 
Tier 1 Capital (to average assets) or Leverage ratio
 
$
253,079

 
8.86
%
 
$
114,258

 
4.00
%
 
$
142,822

 
5.00
%
 
Common equity tier 1 capital (to risk weighted assets)
 
$
253,079

 
10.42
%
 
$
109,337

 
4.50
%
 
$
157,931

 
6.50
%
 
_________________________________________
(1) Before application of the capital conservation buffer of 1.875% as of June 30, 2018, see discussion below.
(2) For the Bank to qualify as “well capitalized," it must maintain at least the minimum ratios listed.  This prompt corrective action framework does not apply to the Company.


Under regulations adopted by the federal bank regulatory agencies known as the “Basel III Rules,” capital ratio requirements increased in January 2015 for all banking organizations, and also include a "capital conservation buffer," of 2.50% above the regulatory minimum risk-based capital adequacy requirements shown above. The capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. If a banking organization dips into its capital conservation buffer it may be restricted in its ability to pay dividends and discretionary bonus payments to its executive officers. Both the Company's and the Bank's actual ratios, as outlined in the table above, would exceed the Basel III risk-based capital requirement with full capital conservation buffer as of June 30, 2018.



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Table of Contents

The Basel III minimum capital ratio requirements as applicable to the Company and the Bank in 2019 after the full phase-in period are summarized in the table below:
 
 
Basel III Minimum for Capital Adequacy Purposes
 
Basel III Additional Capital Conservation Buffer
 
Basel III "Adequate" Ratio with Capital Conservation Buffer
(Dollars in thousands)
 
 
 
Total Capital (to risk weighted assets)
 
8.00%
 
2.50%
 
10.50%
Tier 1 Capital (to risk weighted assets)
 
6.00%
 
2.50%
 
8.50%
Tier 1 Capital (to average assets) or Leverage ratio
 
4.00%
 
—%
 
4.00%
Common equity tier 1 capital (to risk weighted assets)
 
4.50%
 
2.50%
 
7.00%

The Company maintains a DRSPP which enables stockholders, at their discretion, to elect to reinvest cash dividends paid on their shares of the Company's common stock by purchasing additional shares of common stock from the Company at a purchase price equal to fair market value.  Under the DRSPP, stockholders and new investors also have the opportunity to purchase shares of the Company's common stock without brokerage fees, subject to monthly minimums and maximums.
 
For the six months ended June 30, 2018, the Company paid $3.4 million in cash dividends. Stockholders utilized the dividend reinvestment portion of the DRSPP to purchase an aggregate of 22,650 shares of the Company's common stock totaling $793 thousand. The direct purchase component of the DRSPP was used by stockholders to purchase 1,629 shares of the Company's common stock totaling $56 thousand during the six months ended June 30, 2018.

On July 17, 2018, the Company announced a quarterly dividend of $0.145 per share to be paid on September 4, 2018 to stockholders of record as of August 13, 2018. The 2018 dividend rate represents a 7.4% increase over the 2017 dividend rate.

For further information about the Company's capital, see Note 8 and Note 10 both titled "Stockholders' Equity," to the Company's unaudited consolidated financial statements contained in Item 1 of this Form 10-Q and to the Company's consolidated financial statements contained in the 2017 Annual Report on Form 10-K, respectively.

Assets Under Management
 
Total assets under management includes total assets, loans serviced for others and investment assets under management. Loans serviced for others and investment assets under management are not carried as assets on the Company's consolidated balance sheet, and as such, total assets under management is not a financial measurement recognized under GAAP, however management believes its disclosure provides information useful in understanding the trends in total assets under management.

The Company provides a wide range of investment advisory and wealth management services, including brokerage, trust, and investment management (together, "investment advisory services").  Also included in the investment assets under management total are customers' commercial sweep arrangements that are invested in third-party money market mutual funds.
 
As of June 30, 2018, investment assets under management, which are reflected at fair market value, increased $3.2 million since December 31, 2017 and increased $67.1 million, or 9%, since June 30, 2017

As of June 30, 2018, total assets under management increased $123.0 million, or 3%, since December 31, 2017 and $353.7 million, or 10%, since June 30, 2017.

The following table sets forth the value of assets under management and its components at the dates indicated: 
(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017
 
June 30,
2017
Total assets
 
$
2,933,963

 
$
2,817,564

 
$
2,656,547

Loans serviced for others
 
92,465

 
89,059

 
83,268

Investment assets under management
 
848,181

 
844,977

 
781,052

Total assets under management
 
$
3,874,609

 
$
3,751,600

 
$
3,520,867





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Results of Operations
Three Months Ended June 30, 2018 vs. Three Months Ended June 30, 2017
 
Unless otherwise indicated, the reported results are for the three months ended June 30, 2018 with the "same period," the "comparable period," and "prior period" being the three months ended June 30, 2017. Average yields are presented on a tax equivalent basis.
 
The Company's net income for the second quarter of 2018 amounted to $7.6 million, compared to $5.6 million for the same period in 2017, an increase of $2.0 million, or 35%.  Diluted earnings per share were $0.64 and $0.48 for the three months ended June 30, 2018 and June 30, 2017, respectively, an increase of 33%.

Net Interest Income

The Company's net interest income for the quarter ended June 30, 2018 amounted to $27.2 million, compared to $23.5 million for the quarter ended June 30, 2017, an increase of $3.7 million, or 16%.  The increase in net interest income over the comparable period was due primarily to revenue generated from loan growth and to a lesser extent an increase in margin.
 
Net Interest Margin
 
The Company's margin was 4.03% for the three months ended June 30, 2018 compared to 3.90% for the quarter ended June 30, 2017. Margin was 3.95% for the quarter ended March 31, 2018. Margin has increased since the same period in the prior year primarily due to loan and investment yields increasing at a faster rate than cost of funds.

Rate / Volume Analysis
 
The following table sets forth the extent to which changes in interest rates and changes in the average balances of interest-earning assets and interest-bearing liabilities have affected interest income and expense during the three months ended June 30, 2018 compared to the three months ended June 30, 2017.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) volume (change in average portfolio balance multiplied by prior period average rate); (2) interest rate (change in average interest rate multiplied by prior period average balance); and (3) rate and volume (the remaining difference).
 
 
 
 
 
Increase (decrease) due to
(Dollars in thousands)
 
Net
Change
 
Volume
 
Rate
 
Rate/
Volume
Interest Income
 
 

 
 

 
 

 
 

Loans and loans held for sale
 
$
4,246

 
$
2,229

 
$
1,680

 
$
337

Investment securities
 
642

 
308

 
82

 
252

Other interest earning assets (1)
 
94

 
33

 
45

 
16

Total interest-earning assets
 
4,982

 
2,570

 
1,807

 
605

Interest Expense
 
 

 
 

 
 

 
 

Interest checking, savings and money market
 
461

 
37

 
410

 
14

Certificates of deposit
 
481

 
134

 
244

 
103

Brokered CDs
 
515

 
286

 
103

 
126

Borrowed funds
 
(158
)
 
(172
)
 
134

 
(120
)
Subordinated debt
 

 

 

 

Total interest-bearing funding
 
1,299

 
285

 
891

 
123

Change in net interest income
 
$
3,683

 
$
2,285

 
$
916

 
$
482

__________________________________________
(1) 
Income on other interest-earning assets includes interest on deposits and fed funds sold, and dividends on FHLB stock.



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The following table presents the Company's average balance sheet, net interest income and average rates for the three months ended June 30, 2018 and 2017.

AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
 
 
Three Months Ended June 30, 2018
 
Three Months Ended June 30, 2017
(Dollars in thousands)
 
Average
Balance
 
Interest
 
Average
Yield(1)
 
Average
Balance
 
Interest
 
Average
Yield(1)
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Loans and loans held for sale (2)
 
$
2,294,931

 
$
27,527

 
4.84
%
 
$
2,098,528

 
$
23,281

 
4.50
%
Investments (3)
 
425,373

 
2,606

 
2.74
%
 
379,138

 
1,964

 
2.63
%
Other interest earning assets (4)
 
35,936

 
187

 
2.09
%
 
26,687

 
93

 
1.41
%
Total interest-earning assets
 
2,756,240

 
30,320

 
4.48
%
 
2,504,353

 
25,338

 
4.19
%
Other assets
 
97,524

 
 

 
 

 
108,632

 
 

 
 

Total assets
 
$
2,853,764

 
 

 
 

 
$
2,612,985

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and stockholders' equity:
 
 

 
 

 
 

 
 

 
 

 
 

Int chkg, savings and money market
 
$
1,433,531

 
1,292

 
0.36
%
 
$
1,371,650

 
831

 
0.24
%
Certificates of deposit
 
232,872

 
795

 
1.37
%
 
163,057

 
314

 
0.77
%
Brokered CDs
 
176,700

 
750

 
1.70
%
 
79,452

 
235

 
1.18
%
Borrowed funds
 
7,164

 
34

 
1.90
%
 
68,653

 
192

 
1.12
%
Subordinated debt (5)
 
14,851

 
231

 
6.23
%
 
14,839

 
231

 
6.23
%
Total interest-bearing funding
 
1,865,118

 
3,102

 
0.67
%
 
1,697,651

 
1,803

 
0.43
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest rate spread
 
 

 
 

 
3.81
%
 
 

 
 

 
3.76
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
737,656

 

 


 
676,364

 

 


Total deposits, borrowed funds and subordinated debt
 
2,602,774

 
3,102

 
0.48
%
 
2,374,015

 
1,803

 
0.30
%
Other liabilities
 
17,659

 
 

 
 

 
15,234

 
 

 
 

Total liabilities
 
2,620,433

 
 

 
 

 
2,389,249

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
233,331

 
 

 
 

 
223,736

 
 

 
 

Total liabilities and stockholders' equity
 
$
2,853,764

 
 

 
 

 
$
2,612,985

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 

 
$
27,218

 
 

 
 

 
$
23,535

 
 

Net interest margin (tax equivalent)
 
 

 
 

 
4.03
%
 
 

 
 

 
3.90
%
__________________________________________
(1) 
Average yields are presented on a tax equivalent basis.  The tax equivalent effect associated with loans and investments, which was not included in the interest amount above, was $460 thousand and $824 thousand for the quarters ended June 30, 2018 and June 30, 2017, respectively.
(2) 
Average loans and loans held for sale include non-accrual loans and are net of average deferred loan fees.
(3) 
Average investments are presented at average amortized cost.
(4) 
Average other interest earning assets include interest earning deposits, fed funds sold and FHLB stock.
(5) 
The subordinated debt issued in January 2015 is net of average deferred debt issuance costs.



55

Table of Contents

Interest and Dividend Income

For the second quarter of 2018, total interest and dividend income amounted to $30.3 million, an increase of $5.0 million, or 20%, compared to the prior period.  The increase resulted primarily from an increase of $251.9 million, or 10%, in the average balance of interest earning assets, mainly loans, and a 29 basis point increase in the average yield. The yield on interest earning assets has increased since the prior period primarily from increases in market rates and loans repricing at higher rates.
 
Interest income on loans and loans held for sale, which accounts for the majority of interest income, amounted to $27.5 million for the three months ended June 30, 2018, an increase of $4.2 million, or 18%, over the comparable period, due to loan growth and an increase in the average yields on loans and loans held for sale. The average balances of loans and loans held for sale increased $196.4 million, or 9%, for the three months ended June 30, 2018 compared to the same period in 2017, and average yields increased 34 basis points.

Income on investment securities amounted to $2.6 million, an increase of $642 thousand, or 33%, compared to the same period in 2017. This increase primarily resulted from an increase of $46.2 million, or 12%, in the average balance of investment securities. Average investment yields also increased 11 basis points due primarily to the debt security portfolio restructuring during the second half of 2017.

Income on other interest-earning assets amounted to $187 thousand for the three months ended June 30, 2018, an increase of $94 thousand, compared to the same quarter in the prior year. This increase was primarily due to an increase of 68 basis points in the average yield on other interest-earning assets due mainly to higher rates earned since the prior period and to a lesser extent an increase of $9.2 million, or 35%, in the average balance of other interest-earning assets.

Interest Expense
 
For the three months ended June 30, 2018, total interest expense amounted to $3.1 million, an increase of $1.3 million, or 72%, compared to the prior period. The increase in total interest expense was primarily due to an increase in average rates and to a lesser extent increases in average balances. Average rates on interest-bearing funding increased 24 basis points over the same period in the prior year, primarily in response to higher market rates, and the average balance of interest-bearing funding increased $167.5 million, or 10%, over the same period in 2017.

Interest expense on interest checking, savings and money market accounts amounted to $1.3 million, an increase of $461 thousand, or 55%, compared to the same period due primarily to an increase in average rates of 12 basis points. Average balances also increased $61.9 million, or 5%.

Interest expense on CDs amounted to $795 thousand, an increase of $481 thousand, compared to the same period in the prior year, primarily due to an increase in average rates, and to a lesser extent increases in average balances. Average rates increased 60 basis points and average balances increased $69.8 million, or 43%.

Interest expense on brokered CDs amounted to $750 thousand, an increase of $515 thousand, compared to the 2017 period, mainly due to higher average brokered CD balances and to a lesser extent an increase in average rates. Average balances increased $97.2 million and average rates increased 52 basis points.
 
Interest expense on borrowed funds amounted to $34 thousand, a decrease of $158 thousand, or 82%, due to a decrease in the average balances, partially offset by an increase in average rates. Average balances decreased $61.5 million, or 90%, while average rates increased 78 basis points compared to prior period. Average rates increased mainly due to higher FHLB borrowing rates since the prior period.

The average balance of non-interest bearing demand deposits increased $61.3 million, or 9%, as compared to the same period in 2017.  Non-interest bearing demand deposits are an important component of the Company's core funding strategy.  This non-interest bearing funding source represented 29% and 30% of total average deposit balances for the three months ended June 30, 2018 and June 30, 2017, respectively.

Provision for Loan Loss
 
The provision for loan losses amounted to $300 thousand for the three months ended June 30, 2018, an increase of $20 thousand compared to the prior period. 



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Table of Contents

The provision for loan losses is a significant factor in the Company's operating results. For further discussion regarding the provision for loan losses and management's assessment of the adequacy of the allowance for loan losses see "Credit Risk," "Asset Quality," and "Allowance for Loan Losses" under "Financial Condition" in this Item 2 above, and "Credit Risk," "Asset Quality," and "Allowance for Loan Losses" in the Financial Condition section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2017 Annual Report on Form 10-K.

There have been no material changes to the Company's underwriting practices or to the allowance for loan loss methodology used to estimate loan loss exposure as reported in the Company's 2017 Annual Report on Form 10-K.
 
Non-Interest Income
 
Non-interest income for the three months ended June 30, 2018 amounted to $3.7 million, a decrease of $206 thousand, or 5%, as compared to the same period in 2017. The significant changes are discussed below:
 
Investment advisory fees increased by $151 thousand, or 12%, primarily driven by asset growth due to changes in market values.

Net gains on sales of investment securities decreased by $229 thousand. Gains on investment sales in the prior period were primarily from equity securities. The equity portfolio was liquidated by the end of 2017 in order to reduce the magnitude of the impact from market changes on earnings due to new accounting rules in effect January 1, 2018.

Non-Interest Expense
 
Non-interest expense for the three months ended June 30, 2018 amounted to $20.8 million, an increase of $2.1 million, or 11%, compared to the prior period. The significant changes are discussed below:
 
Salaries and employee benefits increased by $1.5 million, or 13%, primarily to support the Company's strategic growth and market expansion initiatives since the prior period.

Advertising and public relations expenses increased $315 thousand, or 40%, primarily due to the Company's Celebration of Excellence, a community recognition event, in the second quarter of 2018.

Audit, legal and other professional fees increased $105 thousand, or 33%, largely in other professional costs to further support the Company's strategic initiatives.

Income Taxes

The effective tax rate for the three months ended June 30, 2018 was 23.1%, compared to 33.7% for the three months ended June 30, 2017. The decrease in rate was primarily due to the positive impact of the 2017 Tax Act.

Results of Operations
Six Months Ended June 30, 2018 vs. Six Months Ended June 30, 2017
 
Unless otherwise indicated, the reported results are for the six months ended June 30, 2018 with the "same period," the "comparable period," "prior year," and "prior period" being the six months ended June 30, 2017. Average yields are presented on a tax equivalent basis.
 
The Company's net income for the six months ended June 30, 2018 amounted to $14.4 million, compared to $11.2 million for the same period in 2017, an increase of $3.2 million, or 29%.  Diluted earnings per share were $1.23 and $0.96 for the six months ended June 30, 2018 and June 30, 2017, respectively, an increase of 28%.

Net Interest Income
 
The Company's net interest income for the six months ended June 30, 2018 was $53.2 million, compared to $46.4 million for the six months ended June 30, 2017, an increase of $6.9 million, or 15%.  The increase in net interest income over the comparable period was due primarily to income generated from loan growth. Additionally, margin has increased since the same period in the prior year.
 


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Table of Contents

Net Interest Margin 

The Company's margin was 3.99% for the six months ended June 30, 2018, compared to a margin of 3.90% for the six months ended June 30, 2017. Yields on interest-earnings assets and average rates on interest-bearing funding have increased due to changes in the economic environment as compared the same period in the prior year.

Rate / Volume Analysis
 
The following table sets forth the extent to which changes in interest rates and changes in the average balances of interest-earning assets and interest-bearing liabilities have affected interest income and expense during the six months ended June 30, 2018 compared to the six months ended June 30, 2017.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) volume (change in average portfolio balance multiplied by prior period average rate); (2) interest rate (change in average interest rate multiplied by prior period average balance); and (3) rate and volume (the remaining difference).

 
 
 
 
Increase (decrease) due to
(Dollars in thousands)
 
Net
Change
 
Volume
 
Rate
 
Rate/
Volume
Interest Income
 
 

 
 

 
 

 
 

Loans and loans held for sale
 
$
8,025

 
$
4,765

 
$
2,687

 
$
573

Investment securities
 
1,209

 
584

 
167

 
458

Other interest-earning assets (1)
 
155

 
27

 
110

 
18

Total interest-earning assets
 
9,389

 
5,376

 
2,964

 
1,049

 
 
 
 
 
 
 
 
 
Interest Expense
 
 

 
 

 
 

 
 

Interest checking, savings and money market
 
724

 
28

 
685

 
11

Certificates of deposit
 
816

 
222

 
441

 
153

Brokered CDs
 
925

 
618

 
124

 
183

Borrowed funds
 
73

 
(45
)
 
143

 
(25
)
Subordinated debt
 

 

 

 

Total interest-bearing funding
 
2,538

 
823

 
1,393

 
322

Change in net interest income
 
$
6,851

 
$
4,553

 
$
1,571

 
$
727

_________________________________
(1) 
Income on other interest-earning assets includes interest on deposits and fed funds sold, and dividends on FHLB stock.





58

Table of Contents

The following table presents the Company's average balance sheet, net interest income and average rates for the six months ended June 30, 2018 and 2017

AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
 
 
 
Six months ended June 30, 2018
 
Six months ended June 30, 2017
(Dollars in thousands)
 
Average
Balance
 
Interest
 
Average
Yield
(1)
 
Average
Balance
 
Interest
 
Average
Yield(1)
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Loans and loans held for sale (2)
 
$
2,284,674

 
$
53,677

 
4.76
%
 
$
2,073,388

 
$
45,652

 
4.49
%
Investment Securities (3)
 
419,650

 
5,093

 
2.72
%
 
378,309

 
3,884

 
2.61
%
Other interest-earning assets (4)
 
30,661

 
321

 
2.11
%
 
26,432

 
166

 
1.27
%
Total interest-earnings assets
 
2,734,985

 
59,091

 
4.42
%
 
2,478,129

 
49,702

 
4.17
%
Other assets
 
98,391

 
 

 
 

 
105,912

 
 

 
 

Total assets
 
$
2,833,376

 
 

 
 

 
$
2,584,041

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and stockholders' equity:
 
 

 
 

 
 

 
 

 
 

 
 

Interest checking, savings and money market
 
$
1,405,729

 
2,308

 
0.33
%
 
$
1,380,960

 
1,584

 
0.23
%
Certificates of deposit
 
224,234

 
1,430

 
1.29
%
 
164,536

 
614

 
0.75
%
Brokered CDs
 
174,233

 
1,335

 
1.55
%
 
69,468

 
410

 
1.19
%
Borrowed funds
 
40,061

 
326

 
1.64
%
 
48,654

 
253

 
1.05
%
Subordinated debt (5)
 
14,850

 
459

 
6.23
%
 
14,837

 
459

 
6.24
%
Total interest-bearing funding
 
1,859,107

 
5,858

 
0.64
%
 
1,678,455

 
3,320

 
0.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest rate spread
 
 

 
 

 
3.78
%
 
 

 
 

 
3.77
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
723,542

 

 
 
 
668,944

 

 
 
Total deposits, borrowed funds and subordinated debt
 
2,582,649

 
5,858

 
0.46
%
 
2,347,399

 
3,320

 
0.29
%
Other liabilities
 
18,676

 
 

 
 

 
16,234

 
 

 
 

Total liabilities
 
2,601,325

 
 

 
 

 
2,363,633

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
232,051

 
 

 
 

 
220,408

 
 

 
 

Total liabilities and stockholders' equity
 
$
2,833,376

 
 

 
 

 
$
2,584,041

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 

 
$
53,233

 
 

 
 

 
$
46,382

 
 

Net interest margin (tax equivalent)
 
 

 
 

 
3.99
%
 
 

 
 

 
3.90
%
_______________________________
(1) 
Average yields are presented on a tax equivalent basis.  The tax equivalent effect associated with loans and investments, which was not included in the interest amount above, was $918 thousand for the six months ended June 30, 2018 and $1.6 million for the comparable period in 2017.
(2) 
Average loans and loans held for sale include non-accrual loans and are net of average deferred loan fees.
(3) 
Average investment balances are presented at average amortized cost.
(4) 
Average other interest earning assets includes interest-earning deposits, fed funds sold, and FHLB stock.
(5) 
The subordinated debt is net of average deferred debt issuance costs.





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Table of Contents

Interest and Dividend Income
 
Total interest and dividend income amounted to $59.1 million for the six months ended June 30, 2018, an increase of $9.4 million, or 19%, compared to the prior period.  The increase resulted primarily from an increase of $256.9 million, or 10%, in the average balance of interest-earning assets, mainly loans, as well as a 25 basis point increase in average yields. The yield on interest earning assets has increased since the prior period primarily from increases in market rates and loans repricing at higher rates.

Interest income on loans and loans held for sale, which accounts for the majority of interest income, amounted to $53.7 million, an increase of $8.0 million, or 18%, over the comparable period, due mainly to an increase of average loans and loans held for sale balances by $211.3 million, or 10%, compared to the prior period. Additionally, the average yield on loans and loans held for sale also increased 27 basis points since the same period in 2017 and amounted to 4.76% for the six months ended June 30, 2018,

Income on investment securities amounted to $5.1 million, an increase of $1.2 million, or 31%, compared to the same period in 2017. This increase primarily resulted from both an increase in the average balance of investment securities by $41.3 million, or 11%, and an 11 basis points increase in the average yield on investment securities, primarily due to the restructuring of the debt portfolio during the second half of 2017.

Other interest-earning assets income amounted to $321 thousand for the six months ended June 30, 2018, an increase of $155 thousand compared to the prior period. The increase resulted primarily from an 84 basis point increase in the average yield, mainly due to an increase in the Federal Funds rates since the prior period. Average balances also increased $4.2 million, or 16%.

Interest Expense
 
For the six months ended June 30, 2018, total interest expense amounted to $5.9 million, an increase of $2.5 million, or 76%, over the same period in 2017 due to increases in both the cost of funds and average interest-bearing balances. The average rate on interest-bearing funding increased by 24 basis points and the average balances increased $180.7 million, or 11%.
 
Interest expense on interest checking, savings and money market accounts amounted to $2.3 million, an increase of $724 thousand, or 46%, compared to the prior period due primarily to an increase in rates of 10 basis points over the comparable period.

Interest expense on CDs amounted to $1.4 million, an increase of $816 thousand over the same period in 2017 due primarily to an increase in the average rate of 54 basis points. Average balances also increased $59.7 million, or 36%.

Interest expense on brokered CDs amounted to $1.3 million, an increase of $925 thousand, due primarily to an increase in the average balances and to a lesser extent an increase in rates. Average balances increased $104.8 million and the average rate increased 36 basis points.

Interest expense on borrowed funds amounted to $326 thousand, an increase of $73 thousand, or 29%, due to an increase in average rates of borrowed funds since the prior year, partially offset by lower average balances. Average rates increased 59 basis points since the prior period, mainly due to higher FHLB borrowing rates, while average balances decreased $8.6 million, or 18%.

For the six months ended June 30, 2018, the average balance of non-interest bearing demand deposits increased $54.6 million, or 8%, as compared to the same period in 2017.  Non-interest bearing demand deposits are an important component of the Company's core funding strategy.  This non-interest bearing funding represented 29% of total average deposit balances for both the six months ended June 30, 2018 and 2017.
 
Provision for Loan Loss
 
The provision for loan losses amounted to $1.9 million for the six months ended June 30, 2018, an increase of $1.5 million compared to the same period in 2017.  This increase in the provision compared to the prior period, which was largely in the first quarter or 2018, was due primarily to an increase in the balance of the allowance for loan losses allocated to impaired and classified loans for the six months ended June 30, 2018, compared to a decrease during the six months ended June 30, 2017.




60

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The provision for loan losses is a significant factor in the Company's operating results. For further discussion regarding the provision for loan losses and management's assessment of the adequacy of the allowance for loan losses see "Credit Risk," "Asset Quality," and "Allowance for Loan Losses" under "Financial Condition" in this Item 2 above, and "Credit Risk," "Asset Quality," and "Allowance for Loan Losses" in the Financial Condition section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2017 Annual Report on Form 10-K.
 
There have been no material changes to the Company's underwriting practices or to the allowance for loan loss methodology used to estimate loan loss exposure as reported in the Company's 2017 Annual Report on Form 10-K.

Non-Interest Income
 
Non-interest income for the six months ended June 30, 2018 amounted to $7.5 million, a decrease of $549 thousand, or 7%, as compared to the six months ended June 30, 2017. The significant changes are discussed below:

Investment advisory fees increased $334 thousand, or 13%, and was primarily driven by asset growth due to changes in market values.

Deposit and interchange fees increased $194 thousand, or 7%, primarily due to increases in ATM interchange fee income in the current year.

Net gain on sales of investment securities decreased $768 thousand. Gains on investment sales in the prior year-to-date period were primarily from equity securities. The equity portfolio was liquidated by the end of 2017 in order to reduce the magnitude of the impact from market changes on earnings due to new accounting rules in effect January 1, 2018.

Net gain on sales of loans decreased $139 thousand, or 51%, due to a lower volume of activity in the current year.
 
Non-Interest Expense
 
Non-interest expense for the six months ended June 30, 2018 amounted to $40.3 million, an increase of $2.1 million, or 5%, compared to the same period in 2017.  The significant changes are discussed below:

Salaries and employee benefits increased $891 thousand, or 4%, primarily to support the Company's strategic growth and market expansion initiatives since the prior period.
 
Occupancy and equipment expenses increased $310 thousand, or 8%, due in large part to the addition of the Windham, NH branch and the relocation of the Salem, NH and Leominster, MA branches.

Advertising and public relations expenses increased $416 thousand, or 29%, primarily due to the Company's Celebration of Excellence, a community recognition event, in the second quarter of 2018.

Audit, legal and other professional fees increased $249 thousand, or 37%, largely in other professional costs to further support the Company's strategic initiatives.

Income Taxes

The effective tax rate for the six months ended June 30, 2018 was 22.6%, compared to 29.7% for the six months ended June 30, 2017. The 2017 Tax Act, among other changes, reduced the Company’s federal statutory tax rate beginning in 2018 to 21% from its 2017 level of approximately 35%. Partially offsetting the impact of the federal tax rate change were lower tax benefits from equity compensation deductions in the current year (approximately $235 thousand for the six months ended June 30, 2018 compared to $788 thousand for the six months ended June 30, 2017).

Recent Accounting Pronouncements

See Note 1, Item (f), “Recent Accounting Pronouncements” to the Company's unaudited consolidated financial statements in this Form 10-Q for information regarding recent accounting pronouncements.



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Item 3 -
Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the results of the Company's net interest income sensitivity analysis as reported in the Company's 2017 Annual Report on Form 10-K. The Company can be subject to margin compression depending on the economic environment and the shape of the yield curve. Under the Company's current balance sheet position, the Company's margin generally performs slightly better over time in a rising rate environment, while it generally decreases in a declining rate environment and when the yield curve is flattening or inverted. At June 30, 2018, management continues to consider the Company's primary interest rate risk exposure to be margin compression that may result from changes in interest rates and/or changes in the mix of the Company's balance sheet components. This would include the mix of fixed versus variable rate loans and investments on the asset side, and higher cost versus lower cost deposits and overnight borrowings versus term borrowings and certificates of deposit on the liability side. Refer to heading “Results of Operations” contained within Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion of margin.

Item 4 -
Controls and Procedures

Evaluation of Disclosure Controls and Procedures
 
The Company maintains a set of disclosure controls and procedures and internal controls designed to ensure that the information required to be disclosed in reports that it files or furnishes to the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
 
The Company carried out an evaluation as of the end of the period covered by this Form 10-Q under the supervision and with the participation of the Company's management, including its principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b).  Based upon that evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective as of June 30, 2018.
 
Changes in Internal Control over Financial Reporting

There has been no change in the Company's internal control over financial reporting that has occurred during the Company's most recent fiscal quarter (i.e., the three months ended June 30, 2018) that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.






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PART II - OTHER INFORMATION
 
Item 1 -
Legal Proceedings

There are no material pending legal proceedings to which the Company or its subsidiaries are a party or to which any of its property is subject, other than ordinary routine litigation incidental to the business of the Company. Management does not believe resolution of any present litigation will have a material adverse effect on the business, consolidated financial condition or results of operations of the Company.

Item 1A -
Risk Factors
 
Management believes that there have been no material changes in the Company's risk factors as reported in the Company's 2017 Annual Report on Form 10-K.

Item 2 -
Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table represents information with respect to repurchases of common stock made by the Company during the three months ended June 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
Total number of shares repurchased (1)
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Announced
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
April
 
1,558
 
$36.74
 
 
May
 
 
 
 
June
 
53
 
$40.75
 
 
            
(1) Amounts include shares repurchased that were not part of a publicly announced repurchase plan or program. These shares were owned and tendered by employees as payment for taxes on vesting restricted stock (net settlement of shares).

Item 3 -
Defaults upon Senior Securities
 
Not Applicable.
 
Item 4 -
Mine Safety Disclosures

Not Applicable.
 
Item 5 -
Other Information

Not Applicable.



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Item 6 -
Exhibits
 
EXHIBIT INDEX
_____________
Exhibit No.    Description


3.1.1    Amended and Restated Articles of Organization of the Company, as amended as of June 4, 2013 incorporated by reference to the Company's Current Report on Form 8-K filed June 10, 2013 (File No. 001-33912).

3.1.2    Articles of Amendment to the Restated Articles of Organization of the Company, as amended as of May 16, 2017 incorporated by reference to the Company's Current Report on Form 8-K filed May 18, 2017 (File No. 001-33912).

3.1.3    Articles of Amendment to the Amended and Restated Articles of Organization of the Company, as amended as of January 5, 2018, incorporated by reference to the Company’s Current Report on Form 8-K filed January 11, 2018 (File No. 001-33912).

3.2    Amended and Restated Bylaws of the Company, as amended as of January 15, 2013, incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K filed on January 22, 2013 (File No. 001-33912).

31.1*    Certification of Principal Executive Officer under Securities Exchange Act Rule 13a-14(a)

31.2*    Certification of Principal Financial Officer under Securities Exchange Act Rule 13a-14(a)

32*    Certification of Principal Executive Officer and Principal Financial Officer under 18 U.S.C. § 1350 Furnished Pursuant to Securities Exchange Act Rule 13a-14(b)

101*
The following materials from Enterprise Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 were formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018 and 2017; (iv) Consolidated Statements of Changes in Equity for the six months ended June 30, 2018; (v) Consolidated Statements of Cash Flows for the six months ended months ended June 30, 2018 and 2017; and (vi) Notes to Unaudited Consolidated Interim Financial Statements.
____________________
*Filed herewith


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
ENTERPRISE BANCORP, INC.
 
 
 
 
DATE:
August 7, 2018
By:
/s/ James A. Marcotte
 
 
 
James A. Marcotte
 
 
 
Executive Vice President,
 
 
 
Chief Financial Officer and Treasurer
 
 
 
(Principal Financial Officer)


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