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ACNB > SEC Filings for ACNB > Form 10-K on 7-Mar-2014All Recent SEC Filings

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Form 10-K for ACNB CORP


Annual 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.


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 Standards 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, 2013. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested for impairment when such events occur. 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.

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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.


The primary source of the Corporation's revenues is net interest income derived from interest earned on loans and investments, less deposit and borrowing funding costs. Revenues are influenced by general economic factors, including market interest rates, the economy of the markets served, stock market conditions, as well as competitive forces within the markets.

The Corporation's overall strategy is to increase loan growth in local markets, while maintaining a reasonable funding base by offering competitive deposit products and services. The year 2013 continued to be challenging for many financial institutions with new expensive compliance regulations, slowly recovering housing markets, lingering high unemployment, and slow uneven growth. ACNB continued to be profitable and well capitalized despite expenses elevated from the aftershocks of this unprecedented challenge to the United States economy. Lower provision for loan losses offset declining revenues resulting in increased net income of $9,315,000, or $1.56 per share, in 2013, compared to $8,886,000, or $1.49 per share, in 2012 and $8,502,000, or $1.43 per share, in 2011. Returns on average equity were 9.00%, 8.91% and 8.80% in 2013, 2012 and 2011, respectively.

Because funding costs were near practical floors, they could not be decreased at the same rate as earning asset decreases; therefore, the Corporation's net interest margin decreased to 3.48% in 2013, compared to 3.56% and 3.74% in 2012 and 2011, respectively. Net interest income was $33,612,000 in 2013, as compared to $34,344,000 in 2012 and $34,370,000 in 2011.

Other income was $11,703,000, $11,867,000 and $11,737,000 in 2013, 2012 and 2011, respectively. The largest source of other income is commissions from insurance sales from Russell Insurance Group, Inc. (RIG), which decreased by 3.4% in 2013 to $4,671,000, slowed by the effects of lower contingent commissions and reduced commercial insurance volume due to continued weak economic conditions. In 2013, no gains or losses were recognized on sold or called investments compared to net gains of $7,000 in 2012 and $1,000 in 2011. Income from fiduciary activities totaled $1,299,000 for 2013, as compared to $1,224,000 for 2012 and $1,396,000 for 2011. Trust fiduciary income increased from improved market values and new account relationships. Service charges on deposit accounts decreased 7.7% to $2,246,000 for 2013 due to changes in customer behaviors, while revenue from ATM and debit card transactions increased 11.1% to $1,434,000 due to higher volume.

Other expenses increased to $32,015,000, or by 5.6%, in 2013, as compared to $30,331,000 in 2012. Other expenses totaled $30,016,000 in 2011. The largest component of other expenses is salaries and employee benefits, which increased 2.1% to $18,950,000 in 2013 compared to $18,553,000 in 2012, due to higher employee retirement expenses, merit increases, and the increased cost of benefits. Compared to 2012, occupancy expense increased 0.3% in 2013 due to normal maintenance, and equipment expense increased 11.4% from an outsourced processing conversion in 2013. Professional services expense increased 8.5% due to higher problem loan-related legal expenses and regulatory compliance costs in 2013. Marketing and corporate relations expense increased by 6.5% due to product specific campaigns and brand awareness activities. FDIC and regulatory expense decreased by 8.9%; however, it

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is still a significant expense as the result of a requirement of all FDIC-insured banks to restore and maintain the Deposit Insurance Fund due to protecting depositors' accounts. In 2013, foreclosed real estate expenses increased $695,000 or 585.2% on final sale losses from physical deterioration while attempting to gain physical control of the subject properties. A more thorough discussion of the Corporation's results of operations is included in the following pages.


Net Interest Income

The primary source of ACNB's traditional banking revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, and interest bearing deposits with banks. Interest bearing liabilities include deposits and borrowings.

Net interest income is affected by changes in interest rates, volume of interest bearing assets and liabilities, and the composition of those assets and liabilities. The "interest rate spread" and "net interest margin" are two common statistics related to changes in net interest income. The interest rate spread represents the difference between the yields earned on interest earning assets and the rates paid for interest bearing liabilities. The net interest margin is defined as the percentage of net interest income to average earning assets, which also considers the Corporation's net non-interest bearing funding sources, the largest of which are non-interest bearing demand deposits and stockholders' equity.

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The following table includes average balances, rates, interest income and expense, interest rate spread, and net interest margin:

Table 1-Average Balances, Rates and Interest Income and Expense

                              2013                                2012                               2011
Dollars in        Average                 Yield/      Average                 Yield/     Average                Yield/
thousands         Balance     Interest     Rate       Balance     Interest     Rate      Balance    Interest     Rate

Loans           $   711,841   $  32,084      4.51 % $   701,243   $  33,990      4.85 % $ 674,897   $  34,493      5.11 %

securities          186,900       4,230      2.26 %     178,783       4,876      2.73 %   184,642       6,006      3.25 %
securities           41,597       1,197      2.88 %      45,952       1,457      3.17 %    33,681       1,252      3.72 %

Securities          228,497       5,427      2.38 %     224,735       6,333      2.82 %   218,323       7,258      3.32 %
Other                25,107          90      0.36 %      37,907         116      0.31 %    26,826          81      0.30 %

Assets              965,445      37,601      3.89 %     963,885      40,439      4.20 %   920,046      41,832      4.55 %

Cash and due
from banks           13,663                              13,197                            13,556
Premises and
equipment            14,603                              14,302                            13,898
Other assets         63,099                              62,345                            62,301
Allowance for
loan losses         (17,072 )                           (15,761 )                         (15,369 )

Total Assets    $ 1,039,738                         $ 1,037,968                         $ 994,432

deposits        $   183,341   $     140      0.08 % $   165,569   $     139      0.08 % $ 138,242   $     115      0.08 %
deposits            260,093         197      0.08 %     243,050         280      0.12 %   230,221         354      0.15 %
Time deposits       251,312       1,840      0.73 %     282,568       3,022      1.07 %   292,381       3,988      1.36 %

Deposits            694,746       2,177      0.31 %     691,187       3,441      0.50 %   660,844       4,457      0.67 %
borrowings           53,184          61      0.11 %      48,300          76      0.16 %    43,124          91      0.21 %
borrowings           55,311       1,751      3.17 %      74,942       2,578      3.44 %    76,776       2,914      3.80 %

Liabilities         803,241       3,989      0.50 %     814,429       6,095      0.75 %   780,744       7,462      0.96 %

deposits            126,047                             116,507                           109,070
liabilities           6,969                               7,255                             8,005
equity              103,481                              99,777                            96,613

Equity          $ 1,039,738                         $ 1,037,968                         $ 994,432

INCOME                        $  33,612                           $  34,344                         $  34,370

SPREAD                                       3.39 %                              3.45 %                            3.59 %

MARGIN 3.48 % 3.56 % 3.74 %

For yield calculation purposes, nonaccruing loans are included in average loan balances. Loan fees of $154,000, $6,000 and $48,000 as of December 31, 2013, 2012 and 2011, respectively, are included in interest income. Yields on tax-exempt securities and loans are not tax effected.

Table 1 presents balance sheet items on a daily average basis, net interest income, interest rate spread, and net interest margin for the years ending December 31, 2013, 2012 and 2011. Table 2 analyzes the relative impact on net interest income for changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by the Corporation on such assets and liabilities.

Net interest income totaled $33,612,000 in 2013, as compared to $34,344,000 in 2012 and $34,370,000 in 2011. During 2013, net interest income decreased as a result of lower interest income exceeding lower funding cost due to the inability to lower deposit rates further after several years of

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continued record low interest rates. The decrease in net interest income in 2012 was also due to declines in rates on earning assets exceeding the ability to decrease low deposit rates.

The net interest margin during 2013 was 3.48% compared to 3.56% during 2012. The margin decreased due to continued decreasing earning asset yields that exceeded decreasing funding costs from lower rates on new or renewed time deposits and lower market rates on savings products. The Federal Open Market Committee repeatedly decreased the federal funds rate from September 2007 to December 2008 and has maintained it at 0% to 0.25% since that time. In addition, the Federal Reserve Bank has embarked on various programs referred to as Quantitative Easing which, in effect, attempted to lower rates on longer term portions of the yield curve. These decreases allowed interest rate reductions on lower-cost transactional deposit products and higher-cost certificates of deposit; the result was a 0.25% decrease in funding costs in 2013. Overtaking the benefit of a lower cost of funds in 2013, however, was earning asset yields decreasing 0.31% from declines in the investment portfolio as new purchases were at lower rates, as well as declines in the loan portfolio from new originations at lower market rates and existing adjustable-rate loans resetting at lower rates based on declines in index rates. The decreased earning asset yields in 2012 were 0.35% compared to funding cost declines of 0.21%. Maintaining the net interest margin going forward will be challenged by the fact that substantial amounts of deposits are at practical rate floors, while loans and the investment securities portfolio will most likely continue to decrease in yields. The cost and availability of wholesale funding could also be affected by a variety of internal and external factors resulting from interest rate market factors and the creditworthiness of the Corporation and the credit providers.

Average earning assets were $965,445,000 in 2013, an increase of 0.2% from the balance of $963,885,000 in 2012, which was an increase from $920,046,000 in 2011. Loan growth represented the largest increase in average assets in 2013, 2012 and 2011, along with smaller increases in the investment portfolio in those years. Average interest bearing liabilities were $803,241,000 in 2013, down from $814,429,000 in 2012 and up from $780,774,000 in 2011. Average non-interest bearing demand deposits increased 8.2% in 2013, continuing the upward trend for 2012 and 2011. This increase was attributed to new relationships and the value placed on stability and FDIC insurance by depositors. On average, deposits (including non-interest bearing) were up 1.6%, while borrowings decreased by 12.0% due to paying off maturing Federal Home Loan Bank (FHLB) advances in the first half of 2013. Lower-cost transaction and savings deposits grew while time deposits decreased in 2013, continuing a trend started in 2008. This lower time deposit trend is attributed to depositors dissatisfied by the Federal Reserve-induced low rate environment and perhaps investing in equity markets that generally increased in value during 2013.

The rate/volume analysis detailed in Table 2 shows that the decrease in net interest income in 2013 was due to earning asset rate decreases exceeding funding cost rate decreases. Earning asset yields declined due to new purchases at lower rates in the investment portfolio and declines in the loan portfolio from existing adjustable-rate loans resetting at lower rates and new lower-rate originations replacing loan amortizations at higher rates. In 2013, the decrease in interest income was 34.8% higher than the decrease in interest expense. Interest expense decreased due to less time deposit and borrowed fund volume, as well as decreases as a result of changes in rates for all interest bearing liability categories.

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The following table shows changes in net interest income attributed to changes in rates and changes in average balances of interest earning assets and interest bearing liabilities:

Table 2-Rate/Volume Analysis

                                     2013 versus 2012                   2012 versus 2011
                               Due to Changes in                  Due to Changes in
In thousands                   Volume       Rate      Total       Volume       Rate      Total
Loans                        $      507   $ (2,413 ) $ (1,906 ) $    1,317   $ (1,820 ) $   (503 )
Taxable securities                  213       (859 )     (646 )       (186 )     (944 )   (1,130 )
Tax-exempt securities              (132 )     (128 )     (260 )        408       (203 )      205

Total Securities                     81       (987 )     (906 )        222     (1,147 )     (925 )
Other                               (44 )       18        (26 )         34          1         35

Total                        $      544   $ (3,382 ) $ (2,838 ) $    1,573   $ (2,966 ) $ (1,393 )

Interest bearing demand
deposits                     $       14   $    (13 ) $      1   $       23   $      1   $     24
Savings deposits                     18       (101 )      (83 )         19        (93 )      (74 )
Time deposits                      (307 )     (875 )   (1,182 )       (130 )     (836 )     (966 )
Short-term borrowings                 7        (22 )      (15 )         10        (25 )      (15 )
Long-term borrowings               (634 )     (193 )     (827 )        (68 )     (268 )     (336 )

Total                              (902 )   (1,204 )   (2,106 )       (146 )   (1,221 )   (1,367 )

Change in Net Interest
Income                       $    1,446   $ (2,178 ) $   (732 ) $    1,719   $ (1,745 ) $    (26 )

The net change attributable to the combination of rate and volume has been allocated on a consistent basis between volume and rate based on the absolute value of each. For yield calculation purposes, nonaccruing loans are included in average balances.

Provision for Loan Losses

The provision for loan losses charged against earnings was $1,450,000 in 2013, as compared to $4,675,000 in 2012 and $5,435,000 in 2011. The decrease was a result of the analysis of the adequacy of the allowance for loan losses. More specifically, even though nonaccrual loans increased, provision expense decreased due to the scaling back of the unallocated portion of the allowance in proportion to substandard loans as a result of management's analysis, based on independent appraisals, that adequate collateralization exists for substandard loans in accordance with GAAP. Each quarter, the Corporation assesses risk in the loan portfolio compared with the balance in the allowance for loan losses and the current evaluation factors.

For additional discussion of the provision and the loans associated therewith, please refer to the Asset Quality section of this Management's Discussion and Analysis.

Other Income

Other income was $11,703,000 for the year ended December 31, 2013, a $164,000, or 1.4%, decrease from 2012. Other income was $11,867,000 for the year ended December 31, 2012, a $130,000, or 1.1%, increase from 2011. The largest source of other income is commissions from insurance sales from RIG, which decreased 3.4% to $4,671,000 in 2013, and was stable from 2012 to 2011. The decrease was due to lost customers in continued weak economic conditions and lower contingent commission payments from insurance carriers. These contingent, or extra, commissions are mostly received in the first quarter of each year, and the amount is at the discretion of various insurance

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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.

In 2013, no gains or losses were recognized on sold or called securities compared to gains of $7,000 and $1,000 in 2012 and 2011, respectively. Income from fiduciary activities, which includes fees from both institutional and personal trust and investment management services and estate settlement services, totaled $1,299,000 for the year ended December 31, 2013, as compared to $1,224,000 for 2012 and $1,396,000 for 2011. At December 31, 2013, ACNB had total assets under administration of approximately $151,000,000, compared to $141,000,000 at the end of 2012 and $135,000,000 at the end of 2011. The variations in income were in part due to more assets under management in 2013 and the result of higher estate settlement income in 2011 which varies with specific activity.

Service charges on deposit accounts decreased 7.7% to $2,246,000, after increasing 0.6% in 2012, based upon varying customer actions that affect the volume of fees. Further, certain government regulations and policies effective since 2010 limited service charge increases and make future revenue levels uncertain. Revenue from ATM and debit card transactions increased 11.1% to $1,434,000 due to higher volume. The increase resulted from more consumer desire to use 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. Another more recent threat to this revenue source is the security breaches in the merchant base that can affect consumer confidence in the debit card channel. Fee income from sold mortgages increased by $134,000, or 45.0%, to $430,000 in 2013; however, approximately 82% of this income was earned in the first half of 2013 after which new originations markedly decreased with increased interest rates. This revenue source is projected to be significantly lower in 2014 compared to 2013.

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

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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 . . .

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