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ACNB > SEC Filings for ACNB > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for ACNB CORP


2-Nov-2012

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION AND FORWARD-LOOKING STATEMENTS

Introduction

The following is management's discussion and analysis of the significant changes in the financial condition, results of operations, comprehensive income, capital resources, and liquidity presented in its accompanying consolidated financial statements for ACNB Corporation (the Corporation or ACNB), a financial holding company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee, assure or indicate similar performance in the future.

Forward-Looking Statements

In addition to historical information, this Form 10-Q contains forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure, and other financial terms,
(b) statements of plans and objectives of management or the Board of Directors, and (c) statements of assumptions, such as economic conditions in the Corporation's market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "intends", "will", "should", "anticipates", or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties such as local economic conditions, competitive factors, and regulatory limitations. Actual results may differ materially from those projected in the forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: the effects of new laws and regulations, specifically the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act; ineffectiveness of the business strategy due to changes in current or future market conditions; the effects of economic deterioration on current customers, specifically the effect of the economy on loan customers' ability to repay loans; the effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; interest rate movements; the inability to achieve merger-related synergies; difficulties in integrating distinct business operations, including information technology difficulties; disruption from the transaction making it more difficult to maintain relationships with customers and employees, and challenges in establishing and maintaining operations in new markets; volatilities in the securities markets; and, deteriorating economic conditions. We caution readers not to place undue reliance on these forward-looking statements. They only reflect management's analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time to time with the Securities and Exchange Commission, including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and any Current Reports on Form 8-K.

CRITICAL ACCOUNTING POLICIES

The accounting policies that the Corporation's management deems to be most important to the portrayal of its financial condition and results of operations, and that require management's most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management:

The allowance for loan losses represents management's estimate of probable losses inherent in the loan portfolio. Management makes numerous assumptions, estimates and adjustments in determining an adequate allowance. The Corporation assesses the level of potential loss associated with its loan portfolio and provides for that exposure through an allowance for loan losses. The allowance is established through a provision for loan losses charged to earnings. The allowance is an estimate of the losses inherent in the loan portfolio as of the end of each reporting period. The Corporation assesses the adequacy of its allowance on a quarterly basis. The specific methodologies applied on a consistent basis are discussed in greater detail under the caption, Allowance for Loan Losses, in a subsequent section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.


The evaluation of securities for other-than-temporary impairment requires a significant amount of judgment. In estimating other-than-temporary impairment losses, management considers various factors including the length of time the fair value has been below cost, the financial condition of the issuer, and the Corporation's intent to sell, or requirement to sell, the securities before recovery of their value. Declines in fair value that are determined to be other than temporary are charged against earnings.

Accounting Standard Codification (ASC) Topic 350, Intangibles - Goodwill and Other, requires that goodwill is not amortized to expense, but rather that it be tested for impairment at least annually. Impairment write-downs are charged to results of operations in the period in which the impairment is determined. The Corporation did not identify any impairment of its recorded goodwill from its most recent testing, which was performed as of December 31, 2011. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested for impairment when such events occur. The Corporation has not identified any such events and, accordingly, has not tested goodwill for impairment during the nine months ended September 30, 2012. During the quarter ended June 30, 2012, the Corporation changed its method of applying ASC 350 such that the annual goodwill impairment testing date will be changed from December 31 to October 1. This new testing date is preferable in the circumstances, because it will allow the Corporation more time to accurately complete its impairment testing process in order to incorporate the results in its annual consolidated financial statements and timely file those statements with the Securities and Exchange Commission in accordance with its accelerated filing requirements. Other acquired intangible assets with finite lives, such as customer lists, are required to be amortized over the estimated lives. These intangibles are generally amortized using the straight line method over estimated useful lives of ten years.

RESULTS OF OPERATIONS

Quarter ended September 30, 2012, compared to quarter ended September 30, 2011

Executive Summary

Net income for the three months ended September 30, 2012, was $2,304,000 compared to $2,180,000 for the same quarter in 2011, an increase of $124,000 or 6%. Earnings per share was $0.39 in 2012 and $0.37 in 2011. Net interest income decreased $17,000, or less than 1%, as decreases in interest income were not entirely matched by decreases in interest expense. Provision for loan losses decreased $75,000, or 6%, based on the adequacy analysis of the allowance for loan losses at the end of each period. Other income increased $90,000, or 3%, due to higher quarter-over-quarter fees from sold mortgages, but which remain lower year-over-year. Other expenses decreased $6,000, or less than 1%, due to cost savings in a variety of categories offsetting increased full-time equivalent employees and higher pension expense.

Net Interest Income

Net interest income totaled $8,541,000 for the quarter ended September 30, 2012, compared to $8,558,000 for the same period in 2011, a decrease of $17,000 or less than 1%. Net interest income decreased due to a decrease in interest income to a greater degree than the decrease in interest expense, both resulting from reductions in market rates associated with the continued low rates maintained by the Federal Reserve Bank. Interest income decreased $354,000, or 3%, due to declines in the Federal Funds Target Rate and other market driver rates. These driver rates are indexed to a portion of the loan portfolio in that a decrease in the driver rates decreases the yield on the loans at subsequent interest rate reset dates. In this manner, interest income will continue to decrease as new loans replace paydowns on existing loans and variable rate loans reset to new lower rates. In addition, interest income was lower as a result of investment securities paydowns that were reinvested at much lower market rates resulting from uneven domestic and even worse European economic conditions, compounded by Federal Reserve Bank buying activities. A significant share of earning assets was left in short-term money market type accounts because of the interest rate risk and liquidity tolerances set for the current mix of deposit funding sources. As to funding costs, alternative funding sources, such as the Federal Home Loan Bank (FHLB), and other market driver rates are factors in rates the Corporation and the local market pay for deposits. However, during the third quarter of 2012, several of the core deposit rates continued at practical floors after the Federal Open Market Committee decreased the Federal Funds Target Rate by 400 basis points during 2008 and has maintained it at 0% to 0.25% since that time.


Interest expense decreased $337,000 or 18%. For more information about interest rate risk, please refer to Item 7A - Quantitative and Qualitative Disclosures about Market Risk in the Annual Report on Form 10-K for the fiscal year-ended December 31, 2011, and filed with the SEC on March 12, 2012. Over the longer term, the Corporation continues its strategic direction to increase asset yield and interest income by means of loan growth and rebalancing the composition of earning assets.

The net interest spread for the third quarter of 2012 was 3.38% compared to 3.46% during the same period in 2011. Also comparing the third quarter of 2012 to 2011, the yield on interest earning assets decreased by 0.29% and the cost of interest bearing liabilities decreased by 0.20%. The net interest margin was 3.49% for the third quarter of 2012 and 3.62% for the third quarter of 2011. The net interest margin decline was mainly a result of the rate of decline in the yield on assets decreasing to a greater degree than the decline in funding rates due to rates approaching practical floors on deposits as described above.

Average earning assets were $973,736,000 during the third quarter of 2012, an increase of $33,171,000 from the average for the third quarter of 2011. Average interest bearing liabilities were $824,804,000 in the third quarter of 2012, an increase of $38,331,000 from the same quarter in 2011.

Provision for Loan Losses

The provision for loan losses was $1,125,000 in the third quarter of 2012 compared to $1,200,000 in the third quarter of 2011, a decrease of $75,000 or 6%. The decrease was a result of analysis of the adequacy of the allowance for loan losses; however, this decrease is not necessarily indicative of future provisioning. Each quarter, the Corporation measures risk in the loan portfolio compared with the balance in the allowance for loan losses and the current evaluation factors. For more information, please refer to Allowance for Loan Losses in the following Financial Condition section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. ACNB charges confirmed loan losses to the allowance and credits the allowance for recoveries of previous loan charge-offs. For the third quarter of 2012, the Corporation had net charge-offs of $454,000, as compared to net charge-offs of $488,000 for the third quarter of 2011.

Other Income

Total other income was $2,972,000 for the three months ended September 30, 2012, up $90,000, or 3%, from the third quarter of 2011. Fees from deposit accounts increased by $27,000, or 4%, due to higher volume as the fee schedules did not change. Certain government regulations effectively limit fee assessments related to deposit accounts, making future revenue levels uncertain. Revenue from ATM and debit card transactions increased 1% to $323,000 due to higher volume. The increase resulted from consumer desire to use more electronic delivery channels; however, regulations or legal challenges for large financial institutions may impact industry pricing for such transactions in future periods, the effect of which cannot be currently quantified. Income from fiduciary activities, which include both institutional and personal trust management services, totaled $288,000 for the three months ended September 30, 2012, as compared to $323,000 during the third quarter of 2011, an 11% decrease as a result of lower estate fee income in the third quarter of 2012 and lower assets under management. Estate fee income is inherently sporadic in nature. Earnings on bank-owned life insurance increased by $11,000, or 5%, as a result of increased investment in this asset. In addition, a gain on life insurance proceeds during the quarter added another $63,000 to income. The Corporation's wholly-owned insurance subsidiary, Russell Insurance Group, Inc. (RIG), earned revenue of $1,133,000 this quarter, down from $1,186,000 for the same quarter in 2011. This decrease was due in part to variations in billings, but in the longer term revenue is down due to a "soft" insurance market and the effects of the prolonged economic slowdown on business clients. Other income in the quarter ended September 30, 2012, was higher due to fees related to sales of residential mortgages in 2012, but which continue to be at a lower volume in 2012 compared to 2011.

Impairment Testing

RIG has certain long-lived assets including purchased intangible assets subject to amortization, such as insurance books of business, and associated goodwill assets, which are not amortized but instead reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset.


If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount in which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the consolidated statements of condition and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Goodwill, that has an indefinite useful life, is evaluated for impairment annually and is evaluated for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. The purpose of this ASU is to simplify how entities test goodwill for impairment by adding a new first step to the preexisting goodwill impairment test under ASC Topic 350, Intangibles - Goodwill and Other. This amendment gives the entity the option to first assess a variety of qualitative factors such as economic conditions, cash flows, and competition to determine whether it was more likely than not that the fair value of goodwill has fallen below its carrying value. If the entity determines that it is not likely that the fair value has fallen below its carrying value, then the entity will not have to complete the original two-step test under Topic 350. If the entity determines that it is more likely than not that the fair value has fallen below its carrying value, then the goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit's estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds the estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment. If required, the second step involves calculating an implied fair value of goodwill for the reporting unit for which the first step indicated potential impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit to a group of likely buyers whose cash flow estimates could differ from those of the reporting entity, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. Subsequent reversal of goodwill impairment losses is not permitted. ACNB performs an annual evaluation to determine if there is goodwill impairment related to RIG. For the year ended December 31, 2011, compared to 2010, commissions from insurance sales decreased by 3%, while agency expenses decreased by 8%. RIG's stand-alone net income increased by 50% in 2011 compared to 2010. Since the testing for potential impairment involves methods that include current and projected income amounts as well as market average multiples paid for similar agencies, the fair value increased at December 31, 2011, as compared to previous years' impairment testing results.

The results of the annual evaluations determined that there was no impairment of goodwill, including the testing at December 31, 2011. However, future declines in RIG's net income or changes in external market factors, including cash flow estimates of likely buyers that are assumed in impairment testing, may require an impairment charge to goodwill. A liability incurred at year-end 2011 for contingent consideration owed on the previous purchase of another insurance agency did not unfavorably impact the fair value of RIG. Should it be determined in a future period that RIG goodwill has been impaired, then a charge to earnings will be recorded in the period such determination is made.

During the quarter ended June 30, 2012, the Corporation changed its method of applying ASC 350 such that the annual goodwill impairment testing date will be changed from December 31 to October 1. This new testing date is preferable in the circumstances, because it will allow the Corporation more time to accurately complete its impairment testing process in order to incorporate the results in its annual consolidated financial statements and timely file those statements with the Securities and Exchange Commission in accordance with its accelerated filing requirements.

Other Expenses

The largest component of other expenses is salaries and employee benefits, which increased by $294,000, or 7%, when comparing the third quarter of 2012 to the same quarter a year ago. Overall, the net increase in salaries and employee benefits was the result of:


increases from normal promotion and production-based incentive/bonus compensation to employees;

an increase in the number of full-time equivalent employees, including those hired for the opening of a new retail banking office;

         increased payroll taxes including higher unemployment tax assessments;

         increased costs associated with employee benefit plans; and,

         increased defined benefit pension expense, which is up by $142,000

when comparing the three months ended September 30, 2012, to September 30, 2011, resulting from low 2011 investment performance and a significant decrease in the discount rate from the Federal Reserve Bank's multi-year policy of keeping market rates at historically low levels.

The Corporation's overall pension investment strategy is to achieve a mix of investments to meet the long-term rate of return assumption and near-term pension obligations with a diversification of asset types, fund strategies, and fund managers. The mix of investments is adjusted periodically by retaining an advisory firm to recommend appropriate allocations after reviewing the Corporation's risk tolerance on contribution levels, funded status, plan expense, as well as any applicable regulatory requirements. However, the determination of upcoming benefit expense is also dependent on the expected return on assets and the discount rate on the year-end measurement date; specifically, with low discount rates and fair value volatility, the expense can be negatively impacted by conditions on that particular measurement date. The Corporation amended the defined benefit pension plan effective April 1, 2012, in that no employee hired after March 31, 2012, shall be eligible to participate in the plan and no inactive or former plan participant shall be eligible to again participate in the plan. In addition, a pension provision in a public law known as MAP-21, enacted in July 2012, will have no effect on reducing the GAAP expense associated with the pension plan in upcoming periods as the ACNB plan has had in the past and continues to have well-funded status.

Net occupancy expense decreased by $18,000, or 4%, due to lower preventative maintenance costs. Equipment expense decreased by $78,000, or 12%, as a result of fewer replacement equipment and software purchases in 2012 compared to 2011.

Professional services expense totaled $186,000 during the third quarter of 2012, as compared to $267,000 for the same period in 2011, a decrease of $81,000 or 30%. The decrease was due to timing on outsourced engagements and the migration of certain expenses to the foreclosed real estate category.

Marketing and corporate relations expenses decreased by $56,000, or 46%, in the third quarter of 2012 compared to the same period of 2011. Lower marketing expense in 2012 reflected varying levels of outsourced advertising production and media expenditures in accordance with the marketing plan, which included support for the opening of a new retail banking office in 2011.

FDIC and regulatory expense for the third quarter of 2012 was $189,000, a decrease of $36,000 from the third quarter of 2011. The decrease was due in part to improved risk ratings. Over the last several years, much higher expense was required of all FDIC-insured banks to restore the deposit insurance fund due to the cost of protecting depositors' accounts at failed banks during the severe recession. At the end of the third quarter of 2009, the FDIC announced a plan in which most banks prepaid an estimated three years of regular quarterly premiums at year-end 2009, as opposed to a special assessment similar to which was levied on all insured banks in the second quarter of 2009. The prepaid assessments did not immediately affect ACNB earnings. ACNB recorded its prepaid assessments as a prepaid expense (an asset) as of December 30, 2009, in the amount of $3,956,000, the date the payment was made. For the quarter ended December 31, 2009, and each quarter thereafter, each institution records an expense for its regular quarterly assessment and an offsetting credit to the prepaid expense until the asset is exhausted. Once the asset is exhausted, the institution will record an accrued expense payable each quarter for the assessment payment, which would be made to the FDIC at the end of the following quarter. Even though an estimated premium is prepaid under this plan, the actual expense will vary based on several factors and risk ratings.


Foreclosed assets held for resale consists of the fair value of real estate acquired through foreclosure on real estate loan collateral or the acceptance of ownership of real estate in lieu of the foreclosure process. Fair values are based on appraisals that consider the sales prices of similar properties in the proximate vicinity less estimated selling costs. Foreclosed real estate expenses were $116,000 and $251,000 for the quarters ended September 30, 2012 and 2011, respectively. The 2012 expense was lower due to the sale of a property at a gain; whereas, 2011 expense was higher due to a write-down in value based on a new listing price. Nevertheless, foreclosed assets held for resale expenses are projected to remain high in 2012 due to the existing inventory of properties and projected additions based on information derived from the estimation process of the allowance for loan losses. Net gains on properties sold in October 2012, however, are expected to offset a substantial portion of the entire 2012 expense.

Other tax expenses increased by $11,000, or 5%, due to a state shareholders' equity-based tax that increases annually regardless of income. Supplies and postage decreased by $22,000, or 13%, due to timing on postage expenditures. Other operating expenses increased by $115,000, or 16%, in the third quarter of 2012, as compared to the third quarter of 2011. The increases included the cost of improved data lines to facilitate more electronic commerce.

Provision for Income Taxes

The Corporation recognized income taxes of $592,000, or 20.4% of pretax income, during the third quarter of 2012, as compared to $562,000, or 20.5% of pretax income, during the same period in 2011. The variances from the federal statutory rate of 34% in both periods are generally due to tax-exempt income (from investments in and loans to state and local units of government at below-market rates, an indirect form of taxation) and investments in low-income housing partnerships which qualify for federal tax credits. The income tax provision during the third quarters ended September 30, 2012 and 2011, included low-income housing tax credits of $139,000.

Nine months ended September 30, 2012, compared to nine months ended September 30, 2011

Executive Summary

Net income for the nine months ended September 30, 2012, was $6,668,000 compared to $6,746,000 for the same nine months in 2011, a decrease of $78,000 or 1%. Earnings per share was $1.12 in 2012 and $1.14 in 2011 for the respective nine month periods. Net interest income increased $33,000, or less than 1%, as the decrease in interest expense was slightly higher than the decrease in interest income. Provision for loan losses decreased $235,000, or 7%, based on the adequacy analysis of the allowance for loan losses at the end of each period. Other income increased $7,000, or less than 1%, due to a gain on life insurance proceeds. Other expenses increased $502,000, or 2%, due to higher full-time equivalent employees and higher pension expense offset by generally lower expenses including FDIC insurance.

Net Interest Income

Net interest income totaled $25,749,000 for the nine months ended September 30, 2012, compared to $25,716,000 for the same period in 2011, an increase of $33,000 or less than 1%. Net interest income increased due to a decrease in interest expense to a slightly greater degree than the decrease in interest income, both resulting from reductions in market rates associated with the continued low rates due to economic conditions and actions by the Federal . . .

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