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ACNB > SEC Filings for ACNB > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for ACNB CORP


Quarterly Report




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; possible impacts of the capital and liquidity requirements proposed by the Basel III standards and other regulatory pronouncements, regulations, and rules; ineffectiveness of the business strategy due to changes in current or future market conditions; the effects of economic deterioration and the prolonged economic malaise 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; difficulties in integrating distinct business operations, including information technology difficulties; challenges in establishing and maintaining operations in new markets; volatilities in the securities markets; and, slow 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.


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 security before recovery of its 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 assessed or 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 on its outstanding goodwill from its most recent testing, which was performed as of October 1, 2012. 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 three months ended March 31, 2013. During the quarter ended June 30, 2012, the Corporation changed its method of applying ASC Topic 350 such that the annual goodwill impairment testing date was changed from December 31 to October 1. This new testing date is preferable under the circumstances, because it allows the Corporation more time to accurately complete its impairment testing process in order to incorporate the results in the annual consolidated financial statements. 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.

The Corporation recognizes deferred tax assets and liabilities for the future effects of temporary differences and tax credits. Enacted tax rates are applied to cumulative temporary differences based on expected taxable income in the periods in which the deferred tax asset or liability is anticipated to be realized. Future tax rate changes could occur that would require the recognition of income or expense in the consolidated statements of income in the period in which they are enacted. Deferred tax assets must be reduced by a valuation allowance if in management's judgment it is "more likely than not" that some portion of the asset will not be realized. Management may need to modify their judgments in this regard from one period to another should a material change occur in the business environment, tax legislation, or in any other business factor that could impair the Corporation's ability to benefit from the asset in the future.


Quarter ended March 31, 2013, compared to quarter ended March 31, 2012

Executive Summary

Net income for the three months ended March 31, 2013, was $2,418,000, compared to $2,236,000 for the same quarter in 2012, an increase of $182,000 or 8%. Earnings per share was $0.41 in 2013 and $0.38 in 2012. Net interest income decreased $106,000, or 1%, as decreases in interest income were not totally matched by decreases in interest expense. Provision for loan losses decreased $475,000, or 42%, based on adequacy analysis of the allowance for loan losses at the end of each period. Other income increased $129,000, or 5%, due to additional revenue from trust fiduciary activities and higher fees from mortgage sales. Other expenses increased $217,000, or 3%, due to a variety of higher expenditures.

Net Interest Income

Net interest income totaled $8,534,000 for the quarter ended March 31, 2013, compared to $8,640,000 for the same period in 2012, a decrease of $106,000 or 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 interest rates maintained by the Federal Reserve Bank. Interest income decreased $605,000, or 6%, due to declines in the Federal Funds Target Rate and other market driver rates. These driver rates affect new originations and are indexed to a portion of the loan portfolio in that a decrease in the driver rates decreases the yield on new loans and on existing 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 that were prevailing at the time of reinvestment due to uneven domestic and international economic conditions, compounded by Federal Reserve Bank buying activities referred to as Quantitative Easing. 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, interest rates on 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 first quarter of 2013, 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 $499,000, or 31%. 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, 2012, and filed with the SEC on March 15, 2013. 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 first quarter of 2013 was 3.51% compared to 3.60% during the same period in 2012. Also comparing the first quarter of 2013 to 2012, the yield on interest earning assets decreased by 0.34% and the cost of interest bearing liabilities decreased by 0.26%. The net interest margin was 3.60% for the first quarter of 2013 and 3.72% for the first quarter of 2012. 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 funding rates approaching practical floors on deposits as described above.

Average earning assets were $963,206,000 during the first quarter of 2013, an increase of $30,062,000 from the average for the first quarter of 2012. Average interest bearing liabilities were $808,206,000 in the first quarter of 2013, an increase of $16,976,000 from the same quarter in 2012.

Provision for Loan Losses

The provision for loan losses was $650,000 in the first quarter of 2013 compared to $1,125,000 in the first quarter of 2012, a decrease of $475,000 or 42%. The decrease was a result of analysis of the adequacy of the allowance for loan losses. 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 first quarter of 2013, the Corporation had net recoveries of $11,000, as compared to net charge-offs of $2,069,000 for the first quarter of 2012.

Other Income

Total other income was $2,945,000 for the three months ended March 31, 2013, up $129,000, or 5%, from the first quarter of 2012. Fees from deposit accounts decreased by $14,000, or 3%, due to varying volume. Various specific government regulations effectively limit fee assessments related to deposit accounts, making future revenue levels uncertain. Revenue from ATM and debit card transactions increased 3% to $319,000 due to higher volume. The current 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 and fees in connection therewith 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 $331,000 for the three months ended March 31, 2013, as compared to $288,000 during the first quarter of 2012, a 15% increase as a result of higher average asset market values under management and more estate fee income in the first quarter of 2013. Estate fee income is inherently sporadic in nature. Earnings on bank-owned life insurance increased by $3,000, or less than 1%, as a result of lower crediting rates mostly offsetting more insurance in force. At the Corporation's wholly-owned subsidiary, Russell Insurance Group, Inc. (RIG), revenue was down by $74,000, or 6%, to $1,131,000, due to lower "contingent" commissions. The contingent or extra commission payments from insurance carriers are mostly received in March and April of each year, and the amount is at the discretion of various insurance carriers in accordance with applicable insurance regulations. Heightened pressure on commissions is expected to continue in this business line, and contingent commissions are not predictable. Other income in the quarter ended March 31, 2013, was up by $165,000, or 75%, to $385,000 due to increased fees related to sales of residential mortgages.

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 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 cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its future cash flows, an impairment charge is recognized by the amount by 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 statement of condition and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Goodwill, which 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. Recent changes to accounting rules permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The goodwill impairment analysis currently used by the Corporation is a two-step test. The first step, used to identify potential impairment, involves comparing the reporting unit's estimated fair value to its carrying value including goodwill. If the estimated fair value of the 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. At the last test, commissions from insurance sales were up, although RIG's stand alone net income decreased because of startup costs of a new business line and earned incentive payments. The testing for potential impairment involves methods that include both current and projected income amounts, and the fair value remained above the carrying value as of the annual impairment test date.

The results of the annual evaluations determined that there was no impairment of goodwill, including the testing at October 1, 2012. However, future declines in RIG's net income or changes in external market factors, including likely buyers that are assumed in impairment testing, may require an impairment charge to goodwill. A liability incurred at December 31, 2011, for contingent consideration owed on previous purchases of additional insurance books of business, did not unfavorably impact the fair value of RIG. The liability for further contingent consideration incurred was $338,000 compared to a maximum aggregate liability of $1,800,000 on two purchases that had a contingent consideration measurement date at December 31, 2011. The actual liability was lower than the potential maximum aggregate liability due to the uncertainties in retaining books of business in the current economic cycle. Should it be determined in a future period that goodwill has been impaired, then a charge to earnings will be recorded in the period that such a determination is made.

Other Expenses

The largest component of other expenses is salaries and employee benefits, which increased by $175,000, or 4%, when comparing the first quarter of 2013 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;

increased payroll taxes including higher unemployment tax assessments;

increased costs associated with benefit plans other than the qualified pension plan; partially offset by,

decreased defined benefit pension expense, which was down by $15,000, or 13%, when comparing the three months ended March 31, 2013, to March 31, 2012, resulting from higher 2012 investment performance offsetting a significant decrease in the discount rate from market rates at historically low levels.

The Corporation's overall pension plan 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 future benefit expense is also dependent on the fair value of assets and the discount rate on the year-end measurement date, which in recent years has experienced low discount rates and fair value volatility. 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, had no effect on reducing the GAAP expense associated with the Plan. The ACNB Plan has maintained a well-funded status.

Net occupancy expense increased by $22,000, or 4%, in part due to higher winter season expenses in 2013. Equipment expense increased by $47,000, or 8%, as a result of higher outsourced processing costs in 2013.

Professional services expense totaled $244,000 during the first quarter of 2013, as compared to $191,000 for the same period in 2012, an increase of $53,000 or 28%. The increase was due to more vendor attest engagements and problem loan legal expenses on smaller residential loans that did not adversely affect the provision for loan loss expense in the first quarter of 2013 compared to the first quarter of 2012.

Marketing and corporate relations expenses were similar in the first quarter of 2013 compared to the same period of 2012. Marketing expense will vary with the timing of advertising production and media expenditures to promote certain in-market consumer loans.

FDIC and regulatory expense for the first quarter of 2013 was $209,000, a decrease of $24,000, or 10%, from the first quarter of 2012. The decrease was due in part to improved risk ratings and a revised deposit insurance computation method. 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 recession.

Foreclosed assets held for resale consist 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 (income) expenses were ($21,000) and $65,000 for the quarters ended March 31, 2013 and 2012, respectively. The higher cost in 2012 was due to the number and varying mix of commercial and residential real estate collateral, unpaid property taxes, and deferred maintenance required upon acquisition. In addition, some properties suffered decreases in value after acquisition, requiring write-downs to fair value during the prolonged marketing cycles for these distressed properties.The first quarter of 2013 saw a net recovery from the benefit of a sale and expense recovery. Foreclosed assets held for resale expenses or recoveries will vary in the remainder of 2013 depending on the successful closing of sales agreements on some existing properties and the unknown expenses related to new properties acquired.

Other tax expenses increased by $15,000, or 7%, due to a state shareholders' equity-based tax that increases annually regardless of income. Supplies and postage declined by 25% in part due to more electronic information delivery. Other operating expenses increased by $60,000, or 8%, in the first quarter of 2013, as compared to the first quarter of 2012. The increases were centered in technology and corporate governance expenditures.

Provision for Income Taxes

The Corporation recognized income taxes of $655,000, or 21% of pretax income, during the first quarter of 2013, as compared to $556,000, or 20% of pretax income, during the same period in 2012. 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 first quarters ended March 31, 2013 and 2012, included low-income housing tax credits of $170,000 and $139,000, respectively.


Assets totaled $1,036,000,000 at March 31, 2013, compared to $1,050,000,000 at December 31, 2012, and $1,021,000,000 at March 31, 2012. Average earning assets during the three months ended March 31, 2013, increased to $963,206,000 from $933,144,000 during the same period in 2012. Average interest bearing liabilities increased in 2013 to $808,206,000 from $791,230,000 in 2012, while average non-interest bearing deposits increased by $12,723,000.

Investment Securities

ACNB uses investment securities to generate interest and dividend income, manage interest rate risk, provide collateral for certain funding products, and provide liquidity. The decrease in the securities portfolio in 2013 was mainly to deploy growth in deposits into a more suitable allocation to Federal Reserve balances that combined the desired combination of yield, liquidity, and manageable interest rate risk sensitivity. Investing into investment security portfolio assets was made more challenging due to the Federal Reserve Bank's program called Quantitative Easing in which, by its open market purchases, the yields are maintained at a lower level than would otherwise be the case. The investment portfolio is comprised of U.S. Government agency, municipal, and corporate securities. These securities provide the appropriate characteristics with respect to credit quality, yield and maturity relative to the management of the overall balance sheet.

At March 31, 2013, the securities balance included a net unrealized gain of $5,165,000, net of taxes, on available for sale securities on $144,696,000 amortized cost versus a net unrealized gain of $5,614,000, net of taxes, on $157,288,000 amortized cost at December 31, 2012, and a net unrealized gain of $5,816,000, net of taxes, on available for sale securities on $198,102,000 amortized cost at March 31, 2012. The decrease in fair value of securities during 2013 was a result of a lower amount of investments in the available for sale portfolio and changes in the U.S. Treasury yield curve and the spread from this yield curve required by investors on the types of investment securities that ACNB owns. Actions by the Federal Reserve to lower rates on the yield curve most conducive to stimulating the housing market and separate concerns about European sovereign debt offset the bond markets' concern about the level of U.S. debt and inflation, leading to generally lower rates in the yield curve despite fair values being volatile on any given day in all periods presented. The Corporation does not own investments consisting of pools of Alt-A or subprime mortgages, private label mortgage-backed securities, or trust preferred investments. The fair values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security . . .

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