Use these links to rapidly review the document
Table of Contents
ITEM 8FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One) | ||
ý |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
For the fiscal year-ended December 31, 2017 |
||
OR |
||
o |
TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
For the transition period from to |
Commission file number 1-35015
ACNB CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania (State or other jurisdiction of incorporation or organization) |
23-2233457 (I.R.S. Employer Identification No.) |
|
16 Lincoln Square, Gettysburg, Pennsylvania (Address of principal executive offices) |
17325 (Zip Code) |
Registrant's telephone number, including area code: (717) 334-3161
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
---|---|---|
Common Stock, $2.50 par value per share |
The NASDAQ Stock Market, LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
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). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer o | Accelerated filer ý | Non-accelerated filer o (Do not check if a smaller reporting company) |
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 Act). Yes o No ý
The aggregate market value of the voting stock held by nonaffiliates of the registrant at June 30, 2017, was approximately $208,794,290.
The number of shares of the registrant's common stock outstanding on March 9, 2018, was 7,023,658.
Documents Incorporated by Reference
Portions of the registrant's 2018 definitive Proxy Statement are incorporated by reference into Part III of this report.
2
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Form 10-K 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 governmental and fiscal policies, as well as legislative and regulatory changes; the effects of new laws and regulations, specifically the impact of the Tax Cuts and Jobs Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act; impacts of the new capital and liquidity requirements of the Basel III standards; the effects of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters; ineffectiveness of the business strategy due to changes in current or future market conditions; future actions or inactions of the United States government, including the effects of short-and long-term federal budget and tax negotiations and a failure to increase the government debt limit or a prolonged shutdown of the federal government; 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; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest rate protection agreements, as well as interest rate risks; difficulties in acquisitions and integrating and operating acquired business operations, including information technology difficulties; challenges in establishing and maintaining operations in new markets; the effects of technology changes; volatilities in the securities markets; the effect of general economic conditions and more specifically in the Corporation's market area; the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities; acts of war or terrorism; disruption of credit and equity markets; the ability to manage current levels of impaired assets; the loss of certain key officers; the ability to maintain the value and image of the Corporation's brand and protect the Corporation's intellectual property rights; continued relationships with major customers; and, potential impacts to the Corporation from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses. 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 Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
3
ACNB CORPORATION
ACNB Corporation (the Corporation or ACNB), headquartered in Gettysburg, Pennsylvania, is the financial holding company for the wholly-owned subsidiaries of ACNB Bank, Gettysburg, Pennsylvania, and Russell Insurance Group, Inc. (RIG), Westminster, Maryland. Originally founded in 1857, ACNB Bank serves its marketplace with banking and wealth management services, including trust and retail brokerage, via a network of 22 community banking offices located in the four southcentral Pennsylvania counties of Adams, Cumberland, Franklin and York, as well as one loan production office in York County, Pennsylvania. In addition, NWSB Bank, a division of ACNB Bank, serves its marketplace via a network of seven community banking offices located in Carroll County, Maryland. RIG, the Corporation's insurance subsidiary, offers a broad range of commercial and personal insurance lines through offices in Westminster, Carroll County, and Germantown, Montgomery County, Maryland.
ACNB Corporation was formed in 1982, then became the holding company for Adams County National Bank (now ACNB Bank) in 1983. The Corporation purchased RIG, its insurance subsidiary, in 2005. And, effective July 1, 2017, ACNB Corporation completed the acquisition of New Windsor Bancorp, Inc. and its wholly-owned subsidiary, New Windsor State Bank, a Maryland state-chartered, FDIC-insured community bank headquartered in Taneytown, Maryland.
ACNB's major source of unconsolidated operating funds is dividends that it receives from its subsidiaries. ACNB's expenses consist principally of losses from low-income housing investments, as well as interest paid in 2015 on a term loan for the purchase of RIG that was paid off in July 2015. Dividends that ACNB pays to stockholders consist of dividends declared and paid to ACNB by the subsidiary bank.
ACNB and its subsidiaries are not dependent upon a single customer or a small number of customers, the loss of which would have a material adverse effect on the Corporation. ACNB does not depend on foreign sources of funds, nor does it make foreign loans.
The common stock of ACNB is listed on The NASDAQ Capital Market under the symbol ACNB.
New Windsor Bancorp, Inc. Acquisition
On July 1, 2017, ACNB completed its acquisition of New Windsor Bancorp, Inc. (New Windsor), a bank holding company based in Taneytown, Maryland. In addition, New Windsor State Bank, a Maryland state-chartered bank and New Windsor's wholly-owned subsidiary, merged with and into ACNB Bank. The acquisition was valued at $33.3 million and resulted in ACNB issuing $4.5 million in cash and 938,360 shares to New Windsor shareholders.
BANKING SUBSIDIARY
ACNB Bank
ACNB Bank is a full-service commercial bank operating under charter from the Pennsylvania Department of Banking and Securities. The Bank's principal market areas include Adams County, Pennsylvania, and its environs in southcentral Pennsylvania, as well as Carroll County, Maryland, in northern Maryland. This geographic area depends on agriculture, industry, tourism, education and healthcare to provide employment for its residents. No single sector dominates the area's economy. At December 31, 2017, ACNB Bank had total assets of $1,584,000,000, total gross loans of $1,244,000,000, total deposits of $1,584,000,000, and total equity capital of $143,000,000. In October 2010, the Bank converted from a national banking association to a Pennsylvania state-chartered bank and trust company.
4
The main community banking office of the Bank is located at 16 Lincoln Square, Gettysburg, Pennsylvania. In addition to its main office, as of December 31, 2017, the Bank has 13 community banking offices in Adams County, five community banking offices in York County, one community banking office in Cumberland County, and two community banking offices in Franklin County, as well as a loan production office in York County, Pennsylvania. In Maryland, ACNB Bank operated seven community banking offices in Carroll County branded as NWSB Bank, a division of ACNB Bank. The Bank's service delivery channels for its customers also include the ATM network, Customer Contact Center, and Online, Telephone and Mobile Banking. The Bank is subject to regulation and periodic examination by the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation (FDIC). The FDIC, as provided by law, insures the Bank's deposits.
Commercial lending includes commercial mortgages, real estate development and construction loans, accounts receivable and inventory financing, and agricultural and governmental loans. Consumer lending programs include home equity loans and lines of credit, automobile and recreational vehicle loans, manufactured housing loans, and personal lines of credit. Mortgage lending programs include personal residential mortgages, residential construction loans, and investment mortgage loans.
A trust is a legal fiduciary agreement whereby ACNB Bank, through its Trust & Investment Services function, is named as trustee of financial assets. As trustee, ACNB Bank invests, protects, manages and distributes financial assets as defined in the agreement. Estate settlement governed by the last will and testament of an individual constitutes another line of business for ACNB Bank Trust & Investment Services. One purpose of having a will is to name an executor to settle the estate. ACNB Bank has the knowledge and expertise to act as executor. Other services include, but are not limited to, those related to testamentary trusts, life insurance trusts, charitable remainder trusts, guardianships, powers of attorney, custodial accounts, and investment management and advisory accounts. Total trust assets under management were $224,000,000 at December 31, 2017.
In addition to ACNB Bank Trust & Investment Services, under the umbrella of ACNB Wealth Management, ACNB offers retail brokerage services through a third-party provider as a result of the acquisition of New Windsor State Bank effective July 1, 2017. This third-party provider is a broker/dealer, unaffiliated with ACNB Bank. At December 31, 2017, total assets under management with the broker/dealer were $103,000,000.
NONBANKING SUBSIDIARIES
Russell Insurance Group, Inc.
ACNB Corporation's wholly-owned subsidiary, Russell Insurance Group, Inc. (RIG), is a full-service insurance agency that offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients with licenses in 44 states. Based in Westminster, Maryland, RIG has served the needs of its clients since its founding as an independent insurance agency by Frank C. Russell, Jr. in 1978. The agency was purchased by the Corporation in 2005. RIG operates a second office location in Germantown, Maryland. Total assets of RIG as of December 31, 2017, were $9,368,000.
RIG is managed separately from the banking and related financial services that the Corporation offers and is reported as a separate segment. Financial information on this segment is included in the Notes to Consolidated Financial Statements, Note S"Segment and Related Information".
MARKET AREA ECONOMIC FEATURES AND CONDITIONS
ACNB Corporation's major operations are in the more rural areas of the Harrisburg-Carlisle MSA and the York-Hanover MSA in Pennsylvania, along with all of Adams County, Pennsylvania, parts of Franklin County, Pennsylvania, and all of Carroll County, Maryland. Approximately 60% of the
5
population resides in areas designated rural. Major types of employers include those focused on manufacturing, education, healthcare, agriculture, tourism, and transportation/warehousing, as well as local governments. A material amount of land surrounding Gettysburg, Pennsylvania, is under the control of the National Park Service, limiting certain types of development. Unemployment figures in the subsidiary bank's market recently, and historically, have been better than those for Pennsylvania and the United States. Per capita and household incomes are generally under Pennsylvania averages. The unemployment rate averaged 3.74% in the subsidiary bank's five-county marketplace, while it was 4.70% overall in Pennsylvania and 4.10% in the United States.
COMPETITION
The financial services industry in ACNB's market area is highly competitive, including competition for similar products and services from commercial banks, thrifts, credit unions, finance and mortgage companies, and other nonbank providers of financial services. Several of ACNB's competitors have legal lending limits that exceed those of ACNB's subsidiary bank, as well as funding sources in the capital markets that exceed ACNB's availability. The high level of competition has resulted from changes in the legal and regulatory environment, as well as from the economic climate, customer expectations, and service alternatives via the internet. There are 91 publicly-traded banks in Pennsylvania and Maryland, 17 have greater market share than ACNB. In addition, there are 17 thrift institutions and numerous credit unions in Pennsylvania and Maryland, some with greater market share.
SUPERVISION AND REGULATION
Regulation of Bank Holding Company and Subsidiaries
BANK HOLDING COMPANY ACT OF 1956ACNB is a financial holding company and is subject to the regulations of the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve.
The Federal Reserve has issued regulations under the Bank Holding Company Act that require a financial holding company to serve as a source of financial and managerial strength to its subsidiary bank. As a result, the Federal Reserve may require ACNB to stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. In addition, the Federal Reserve may require a financial holding company to end a nonbanking business if the nonbanking business constitutes a serious risk to the financial soundness and stability of any banking subsidiary of the financial holding company.
The Bank Holding Company Act prohibits ACNB from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any bank, or substantially all of the assets of any bank, or merging with another bank holding company, without the prior approval of the Federal Reserve. The Bank Holding Company Act allows interstate bank acquisitions and interstate branching by acquisition and consolidation in those states that had not elected to opt out by the required deadline. The Pennsylvania Department of Banking and Securities also must approve any similar consolidation. Pennsylvania law permits Pennsylvania financial holding companies to control an unlimited number of banks.
Further, the Bank Holding Company Act restricts ACNB's nonbanking activities to those that are determined by the Federal Reserve Board to be financial in nature, incidental to such financial activity, or complementary to a financial activity. The Bank Holding Company Act does not place territorial restrictions on the activities of nonbanking subsidiaries of financial holding companies.
GRAMM-LEACH-BLILEY ACT OF 1999 (GLBA)The Gramm-Leach-Bliley Act of 1999 eliminated many of the restrictions placed on the activities of bank holding companies that become
6
financial holding companies. Among other things, the Gramm-Leach-Bliley Act repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the Bank Holding Company Act to permit bank holding companies that are financial holding companies to engage in activities, and acquire companies engaged in activities, that are: financial in nature (including insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities); incidental to financial activities; or, complementary to financial activities if the Federal Reserve determines that they pose no substantial risk to the safety or soundness of depository institutions or the financial system in general.
REGULATION WTransactions between a bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve has also issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act, and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules, but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank's holding company and companies that are under common control with the bank. ACNB Corporation and Russell Insurance Group, Inc. are considered to be affiliates of ACNB Bank.
USA PATRIOT ACT OF 2001 (Patriot Act)In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
SARBANES-OXLEY ACT OF 2002 (SOA)In 2002, the Sarbanes-Oxley Act of 2002 became law. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly-traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities law.
The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, or the Exchange Act.
The SOA includes very specific additional disclosure requirements and corporate governance rules, as well as requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance, and other related rules. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
The SOA addresses, among other matters:
7
The SEC has been delegated the task of enacting rules to implement various provisions of the SOA with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.
TAX CUTS AND JOBS ACTOn December 22, 2017, the Tax Cuts and Jobs Act was signed into law. Among other changes, the Tax Cuts and Jobs Act reduces the federal corporate tax rate from 35% to 21% effective January 1, 2018. ACNB anticipates that this tax rate change should reduce its federal income tax liability in future years beginning with 2018. However, the Corporation did recognize certain effects of the tax law changes in 2017. U.S. generally accepted accounting principles require companies to re-value their deferred tax assets and liabilities as of the date of enactment, with resulting tax effects accounted for in the reporting period of enactment. Since the enactment took place in December 2017, the Corporation revalued its net deferred tax assets in the fourth quarter of 2017, resulting in an approximately $1.7 million reduction to earnings in 2017.
AMERICAN JOBS CREATION ACT OF 2004In 2004, the American Jobs Creation Act was enacted as the first major corporate tax act in years. The act addresses a number of areas of corporate taxation including executive deferred compensation restrictions. The impact of the act on ACNB is not material.
BANK SECRECY ACT (BSA)Under the Bank Secrecy Act, banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which a bank is aware in any one day that aggregate in excess of $10,000 and to report suspicious transactions under specified criteria. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA, or for filing a false or fraudulent report.
DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT (DODD-FRANK)In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. Dodd-Frank was intended to effect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank created the Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally created a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank has had and will continue to have a significant impact on ACNB's business operations as its provisions take effect. It is expected that, as various implementing rules and regulations are released, they will increase ACNB's operating and
8
compliance costs and could increase the Bank's interest expense. Among the provisions that are likely to affect ACNB are the following:
Holding Company Capital Requirements
Dodd-Frank requires the Federal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010, by a bank holding company with less than $15 billion in assets as of December 31, 2009. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion, consistent with safety and soundness. For further information, please refer to Regulatory Capital Changes in Management's Discussion and Analysis.
Deposit Insurance
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to $250,000 per depositor. Dodd-Frank also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. Dodd-Frank requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Dodd-Frank also eliminated the federal statutory prohibition against the payment of interest on business checking accounts.
Corporate Governance
Dodd-Frank requires publicly-traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on "golden parachute" payments in connection with approvals of mergers and acquisitions unless previously voted on by stockholders. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded. Dodd-Frank also gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.
Prohibition Against Charter Conversions of Troubled Institutions
Dodd-Frank prohibits a depository institution from converting from a state to a federal charter, or vice versa, while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator, which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks are able to enter new markets more freely.
9
Limits on Interstate Acquisitions and Mergers
Dodd-Frank precludes a bank holding company from engaging in an interstate acquisitionthe acquisition of a bank outside its home stateunless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with another bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and adequately managed.
Limits on Interchange Fees
Dodd-Frank amended the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
Consumer Financial Protection Bureau
Dodd-Frank created the independent federal agency called the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, Dodd-Frank allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a "qualified mortgage" as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
ABILITY-TO-REPAY AND QUALIFIED MORTGAGE RULEPursuant to Dodd-Frank as highlighted above, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine the consumer's ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and, (8) credit history. Alternatively, the mortgage lender can originate "qualified mortgages", which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a "qualified mortgage" is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Loans which meet these criteria will be considered qualified mortgages and, as a result, generally protect lenders from fines or litigation in the event of foreclosure. Qualified mortgages that are "higher-priced"
10
(e.g., subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not "higher-priced" (e.g., prime loans) are given a safe harbor of compliance. The impact of the final rule, and the subsequent amendments thereto, on the Corporation's lending activities and the Corporation's statements of income or condition has had little or no impact; however, management will continue to monitor the implementation of the rule for any potential effects on the Corporation's business.
DEPARTMENT OF DEFENSE MILITARY LENDING RULEIn 2015, the U.S. Department of Defense issued a final rule which restricts pricing and terms of certain credit extended to active duty military personnel and their families. This rule, which was implemented effective October 3, 2016, caps the interest rate on certain credit extensions to an annual percentage rate of 36% and restricts other fees. The rule requires financial institutions to verify whether customers are military personnel subject to the rule. The impact of this final rule, and any subsequent amendments thereto, on the Corporation's lending activities and the Corporation's statements of income or condition has had little or no impact; however, management will continue to monitor the implementation of the rule for any potential effects on the Corporation's business.
FEDERAL DEPOSIT INSURANCE CORPORATION ACT OF 1991Under the Federal Deposit Insurance Corporation Act of 1991, any depository institution, including the subsidiary bank, is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy the minimum capital requirement.
FEDERAL RESERVE ACTA subsidiary bank of a bank holding company is subject to certain restrictions and reporting requirements imposed by the Federal Reserve Act, including:
COMMUNITY REINVESTMENT ACT OF 1977 (CRA)Under the Community Reinvestment Act of 1977, the FDIC is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community, including low- and moderate-income neighborhoods, which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, merger, or acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 amended the CRA to require, among other things, that the FDIC make publicly available the evaluation of a bank's record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods. This evaluation includes a descriptive rating like "outstanding", "satisfactory", "needs to improve" or "substantial noncompliance" and a statement describing the basis for the rating. These ratings are publicly disclosed.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 (FDICIA)The Federal Deposit Insurance Corporation Improvement Act requires that institutions be classified, based on their risk-based capital ratios, into one of five defined categories, as follows and as
11
illustrated below: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized.
|
Total Risk-Based Ratio |
Tier 1 Risk-Based Ratio |
Tier 1 Leverage Ratio |
Under a Capital Order or Directive |
|||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Capital Category |
|||||||||||
Well capitalized |
³10.0 | % | ³6.0 | % | ³5.0 | % | NO | ||||
Adequately capitalized |
³8.0 | % | ³4.0 | % | ³4.0 | %* | |||||
Undercapitalized |
<8.0 | % | <4.0 | % | <4.0 | %* | |||||
Significantly undercapitalized |
<6.0 | % | <3.0 | % | <3.0 | % | |||||
Critically undercapitalized |
<2.0 | % |
In the event an institution's capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including the institution of a capital restoration plan and a guarantee of the plan by a parent institution and the placement of a hold on increases in assets, number of branches, or lines of business. If capital reaches the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management, and, in critically undercapitalized situations, appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention when the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards established by Federal Reserve Board regulations.
In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance on January 1, 2014. The final rules call for the following capital requirements:
In addition, the final rules establish a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations began on January 1, 2016.
A more in-depth discussion of how these new capital rules affect ACNB Corporation appears under Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations.
12
JUMPSTART OUR BUSINESS STARTUPS ACT (JOBS ACT)In 2012, the JOBS Act became law. The JOBS Act is aimed at facilitating capital raising by smaller companies and banks and bank holding companies by implementing the following changes:
While the JOBS Act was not expected to have any immediate application to the Corporation, and since 2012 has had no material impact, management will continue to monitor the implementation rules for potential effects which might benefit the Corporation.
Dividends
ACNB is a legal entity separate and distinct from its subsidiary bank. ACNB's revenues, on a parent company only basis, result primarily from dividends paid to the Corporation by its subsidiaries. Federal and state laws regulate the payment of dividends by ACNB's subsidiary bank. For further information, please refer to Regulation of Bank below.
Regulation of Bank
The operations of the subsidiary bank are subject to statutes applicable to banks chartered under the banking laws of Pennsylvania, to state nonmember banks of the Federal Reserve, and to banks whose deposits are insured by the FDIC. The subsidiary bank's operations are also subject to regulations of the Pennsylvania Department of Banking and Securities, Federal Reserve, and FDIC.
The Pennsylvania Department of Banking and Securities, which has primary supervisory authority over banks chartered in Pennsylvania, regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. The subsidiary bank is also subject to examination by the FDIC for safety and soundness, as well as consumer compliance. These examinations are designed for the protection of the subsidiary bank's depositors rather than ACNB's shareholders. The subsidiary bank must file quarterly and annual reports to the Federal Financial Institutions Examination Council, or FFIEC.
Monetary and Fiscal Policy
ACNB and its subsidiary bank are affected by the monetary and fiscal policies of government agencies, including the Federal Reserve and FDIC. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors of the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature and impact of monetary and fiscal policies on future business and earnings of ACNB cannot be
13
predicted at this time. From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of ACNB and the subsidiary bank, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of ACNB.
ACCOUNTING POLICY DISCLOSURE
Disclosure of the Corporation's significant accounting policies is included in Note A"Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by management. Additional information is contained in Management's Discussion and Analysis for the most sensitive of these issues, including the provision and allowance for loan losses which is located in Note D"Loans and Allowance for Loan Losses" in the Notes to Consolidated Financial Statements.
Management, in determining the allowance for loan losses, makes significant judgments. Consideration is given to a variety of factors in establishing this estimate. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan review, financial and managerial strengths of borrowers, adequacy of collateral if collateral dependent or present value of future cash flows, and other relevant factors.
STATISTICAL DISCLOSURES
The following statistical disclosures are included in Management's Discussion and Analysis, Item 7 hereof, and are incorporated by reference in this Item 1:
AVAILABLE INFORMATION
The Corporation's reports, proxy statements, and other information are available for inspection and copying at the SEC Office of Investor Education and Advocacy at 100 F Street, N.E., Washington, DC 20549, at prescribed rates. The public may obtain information from the Office of Investor Education and Advocacy by calling the Commission at 1-800-SEC-0330. The Corporation is an electronic filer with the Commission. The Commission maintains a website that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the Commission. The address of the Commission's website is https://www.sec.gov.
Upon a shareholder's written request, a copy of the Corporation's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Securities Exchange Act Rule 13a-1, may be obtained, without charge, from Lynda L. Glass, Executive Vice President/Secretary & Chief Governance Officer, ACNB Corporation, 16 Lincoln
14
Square, P.O. Box 3129, Gettysburg, PA 17325, or visit our website at https://www.acnb.com and click on "Investor Relations".
EMPLOYEES
As of December 31, 2017, ACNB had 358 full-time equivalent employees. None of these employees are represented by a collective bargaining agreement, and ACNB believes it enjoys good relations with its personnel.
ACQUISITION
ACNB Corporation and its subsidiaries have experienced stable organic growth. In addition, on July 1, 2017, New Windsor Bancorp, Inc. was acquired as discussed further in this Form 10-K.
ACNB IS SUBJECT TO INTEREST RATE RISK.
ACNB's earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond ACNB's control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the amount of interest ACNB receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) ACNB's ability to originate loans and obtain deposits, (ii) the fair value of ACNB's financial assets and liabilities, and (iii) the average duration of ACNB's mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, ACNB's net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on ACNB's results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on ACNB's financial condition and results of operations.
ACNB IS SUBJECT TO CREDIT RISK.
As of December 31, 2017, approximately 56% of ACNB's loan portfolio consisted of commercial and industrial, construction, and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans. Because ACNB's loan portfolio contains a significant number of commercial and industrial, construction, and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on ACNB's financial condition and results of operations.
15
ACNB'S ALLOWANCE FOR LOAN LOSSES MAY BE INSUFFICIENT.
ACNB maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management's continuing evaluation of the following: industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and, unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires ACNB to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of ACNB's control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review ACNB's allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Further, if charge-offs in future periods exceed the allowance for loan losses, ACNB will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income, and possibly capital, and may have a material adverse effect on ACNB's financial condition and results of operations.
COMPETITION FROM OTHER FINANCIAL INSTITUTIONS MAY ADVERSELY AFFECT ACNB'S PROFITABILITY.
ACNB's banking subsidiary faces substantial competition in originating both commercial and consumer loans. This competition comes principally from other banks, credit unions, mortgage banking companies, and other lenders. Many of its competitors enjoy advantages, including greater financial resources with higher lending limits, wider geographic presence, more branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, and lower origination and operating costs. This competition could reduce the Corporation's net income by decreasing the number and size of loans that its banking subsidiary originates and the interest rates it may charge on these loans.
In attracting business and consumer deposits, its banking subsidiary faces substantial competition from other insured depository institutions such as banks, savings institutions, and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of ACNB's competitors enjoy advantages, including greater financial resources, wider geographic presence, more aggressive marketing campaigns, better brand recognition, more branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, and lower origination and operating costs. These competitors may offer higher interest rates than ACNB, which could decrease the deposits that it attracts or require it to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect the subsidiary's ability to generate the funds necessary for lending operations. As a result, it may need to seek other sources of funds that may be more expensive to obtain and could increase its cost of funds.
ACNB's banking subsidiary also competes with nonbank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and agencies, and governmental organizations which may offer more favorable terms. Some of its nonbank competitors are not subject to the same extensive regulations that govern ACNB's banking operations. As a result, such nonbank competitors may have advantages over ACNB's banking subsidiary in providing certain products and services. This competition may reduce or limit ACNB's margins on banking services, reduce its market share, and adversely affect its earnings and financial condition.
16
THE BASEL III CAPITAL REQUIREMENTS MAY REQUIRE ACNB TO MAINTAIN HIGHER LEVELS OF CAPITAL, WHICH COULD REDUCE ACNB'S PROFITABILITY.
Basel III targets higher levels of base capital, certain capital buffers, and a migration toward common equity as the key source of regulatory capital. Although the new capital requirements are phased in over future years and may change substantially before final implementation, Basel III signals a growing effort by domestic and international bank regulatory agencies to require financial institutions, including depository institutions, to maintain higher levels of capital. The direction of the Basel III implementation activities or other regulatory viewpoints could require additional capital to support the Corporation's business risk profile prior to final implementation of the Basel III standards. If ACNB and the subsidiary bank are required to maintain higher levels of capital, ACNB and the subsidiary bank may have fewer opportunities to invest capital into interest-earning assets, which could limit the profitable business operations available to ACNB and the subsidiary bank and adversely impact ACNB's financial condition and results of operations.
THE CORPORATION'S OPERATIONS OF ITS BUSINESS, INCLUDING ITS TRANSACTIONS WITH CUSTOMERS, ARE INCREASINGLY DONE VIA ELECTRONIC MEANS, AND THIS HAS INCREASED ITS RISKS RELATED TO CYBERSECURITY.
The Corporation is exposed to the risk of cyberattacks in the normal course of business. In addition, the Corporation is exposed to cyberattacks on vendors and merchants that affect the Corporation and its customers. In general, cyber incidents can result from deliberate attacks or unintentional events. The Corporation has observed an increased level of attention in the industry focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. To combat against these attacks, policies and procedures are in place to prevent or limit the effect of the possible security breach of its information systems. While ACNB maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. While the Corporation has not incurred any material losses related to cyberattacks, nor is it aware of any specific or threatened cyber incidents as of the date of this report, it may incur substantial costs and suffer other negative consequences if it falls victim to successful cyberattacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; deploying additional personnel and protection technologies, training employees, and engaging third-party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; disruption or failures of physical infrastructure, operating systems or networks that support ACNB's business and customers resulting in the loss of customers and business opportunities; additional regulatory scrutiny and possible regulatory penalties; litigation; and, reputational damage adversely affecting customer or investor confidence.
ACNB'S CONTROLS AND PROCEDURES MAY FAIL OR BE CIRCUMVENTED.
Management regularly reviews and updates ACNB's internal controls, disclosure controls, and procedures, as well as corporate governance policies and procedures. Any system of controls, 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 system are met. Any failure or circumvention of ACNB's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on ACNB's business, financial condition, and results of operations.
17
ACNB'S ABILITY TO PAY DIVIDENDS DEPENDS PRIMARILY ON DIVIDENDS FROM ITS BANKING SUBSIDIARY, WHICH ARE SUBJECT TO REGULATORY LIMITS AND THE BANKING SUBSIDIARY PERFORMANCE.
ACNB is a financial holding company and its operations are conducted by its subsidiaries. Its ability to pay dividends depends on its receipt of dividends from its subsidiaries. Dividend payments from its banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of its subsidiaries to pay dividends is also subject to their profitability, financial condition, capital expenditures, and other cash flow requirements. There is no assurance that its subsidiaries will be able to pay dividends in the future or that ACNB will generate adequate cash flow to pay dividends in the future. ACNB's failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.
ACNB'S PROFITABILITY DEPENDS SIGNIFICANTLY ON ECONOMIC CONDITIONS IN THE COMMONWEALTH OF PENNSYLVANIA AND THE STATE OF MARYLAND.
ACNB's success depends primarily on the general economic conditions of the Commonwealth of Pennsylvania, the State of Maryland, and the specific local markets in which ACNB operates. Unlike larger national or other regional banks that are more geographically diversified, ACNB provides banking and financial services to customers primarily in the southcentral Pennsylvania and northern Maryland region of the country. The local economic conditions in these areas have a significant impact on the demand for ACNB's products and services, as well as the ability of ACNB's customers to repay loans, the value of the collateral securing the loans, and the stability of ACNB's deposit funding sources. A significant decline in general economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, in turn, have a material adverse effect on ACNB's financial condition and results of operations.
THE EARNINGS OF FINANCIAL SERVICES COMPANIES ARE SIGNIFICANTLY AFFECTED BY GENERAL BUSINESS AND ECONOMIC CONDITIONS.
ACNB's operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which ACNB operates, all of which are beyond ACNB's control. Deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values, and a decrease in demand for ACNB's products and services, among other things, any of which could have a material adverse impact on ACNB's financial condition and results of operations.
The regulatory environment for the financial services industry is being significantly impacted by financial regulatory reform initiatives in the United States and elsewhere, including Dodd-Frank and regulations promulgated to implement it.
Dodd-Frank, which was signed into law on July 21, 2010, comprehensively reforms the regulation of financial institutions, products and services. Dodd-Frank requires various federal regulatory agencies to implement numerous rules and regulations. Because the federal agencies are granted broad discretion in drafting these rules and regulations, many of the details and the impact of Dodd-Frank may not be known for many months or years.
While much of how Dodd-Frank and other financial industry reforms will change ACNB's current business operations depends on the specific regulatory reforms and interpretations, many of which have
18
yet to be released or finalized, it is clear that the reforms, both under Dodd-Frank and otherwise, will have a significant effect on the entire industry. Although Dodd-Frank and other reforms will affect a number of the areas in which ACNB does business, it is not clear at this time the full extent of the adjustments that will be required and the extent to which ACNB will be able to adjust its businesses in response to the requirements. Although it is difficult to predict the magnitude and extent of these effects at this stage, ACNB believes compliance with Dodd-Frank and implementing its regulations and initiatives will negatively impact revenue and increase the cost of doing business, both in terms of transition expenses and on an ongoing basis, and it may also limit ACNB's ability to pursue certain business opportunities.
NEW LINES OF BUSINESS OR NEW PRODUCTS AND SERVICES MAY SUBJECT ACNB TO ADDITIONAL RISKS.
From time to time, ACNB may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, ACNB may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of ACNB's system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and new products or services could have a material adverse effect on ACNB's business, financial condition, and results of operations.
ACNB MAY NOT BE ABLE TO ATTRACT AND RETAIN SKILLED PEOPLE.
ACNB's success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by ACNB can be intense, and ACNB may not be able to hire people or to retain them. The unexpected loss of services of one or more of ACNB's key personnel could have a material adverse impact on ACNB's business because the Corporation would no longer have the benefit of their skills, knowledge of ACNB's market, as well as years of industry experience, and it would be difficult to promptly find qualified replacement personnel. ACNB and/or one of its subsidiaries currently has employment agreements, including covenants not to compete, with the following named executive officers: its President & Chief Executive Officer; Executive Vice President/Secretary & Chief Governance Officer; Executive Vice President/Treasurer & Chief Financial Officer; the President & Chief Executive Officer of Russell Insurance Group, Inc.; and, the Executive Vice President/Chief Lending & Revenue Officer of ACNB Bank.
ACNB IS SUBJECT TO CLAIMS AND LITIGATION PERTAINING TO FIDUCIARY RESPONSIBILITY.
From time to time, customers make claims and take legal action pertaining to ACNB's performance of its fiduciary responsibilities. Whether customer claims and legal action related to ACNB's performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to ACNB, they may result in significant financial liability and/or adversely affect the market perception of ACNB and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on ACNB's business, which, in turn, could have a material adverse effect on ACNB's financial condition and results of operations.
19
THE TRADING VOLUME IN ACNB'S COMMON STOCK IS LESS THAN THAT OF OTHER LARGER FINANCIAL SERVICES COMPANIES.
ACNB's common stock trades on NASDAQ, and the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of ACNB's common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which ACNB has no control. Given the lower trading volume of ACNB's common stock, significant sales of ACNB's common stock, and the expectation of these sales, could cause ACNB's stock price to fall.
ACNB OPERATES IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY CHANGES IN FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS.
ACNB, primarily through its banking subsidiary, is subject to extensive regulation, supervision and/or examination by federal and state banking authorities. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on ACNB and its operations. Additional legislation and regulations that could significantly affect ACNB's powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on its financial condition and results of operations. Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank and financial holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority may have a negative impact on ACNB's financial condition and results of operations.
Like other financial holding companies and financial institutions, ACNB must comply with significant anti-money laundering and anti-terrorism laws. Under these laws, ACNB is required, among other things, to enforce a customer identification program and file currency transaction and suspicious activity reports with the federal government. Government agencies have substantial discretion to impose significant monetary penalties on institutions which fail to comply with these laws or make required reports. While ACNB has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
THE SOUNDNESS OF OTHER FINANCIAL INSTITUTIONS MAY ADVERSELY AFFECT ACNB.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. ACNB has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and institutional clients. Many of these transactions expose ACNB to credit risk in the event of a default by a counterparty or customer. In addition, ACNB's credit risk may be exacerbated when the collateral held by ACNB cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit exposure due to ACNB. Any such losses could have a material adverse effect on ACNB's financial condition and results of operations.
MARKET VOLATILITY MAY HAVE MATERIALLY ADVERSE EFFECTS ON ACNB'S LIQUIDITY AND FINANCIAL CONDITION.
The capital and credit markets have experienced extreme volatility and disruption. Over the last several years, in some cases, the markets have exerted downward pressure on stock prices, security prices, and credit capacity for certain issuers without regard to those issuers' underlying financial strength. If the market disruption and volatility returns, there can be no assurance that ACNB will not
20
experience adverse effects, which may be material, on its liquidity, financial condition and results of operations.
ACNB MAY NEED OR BE COMPELLED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE WHICH COULD DILUTE SHAREHOLDERS OR BE UNAVAILABLE WHEN NEEDED OR AT UNFAVORABLE TERMS.
ACNB's regulators or market conditions may require it to increase its capital levels. If ACNB raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of current investors and would likely dilute the per share book value and earnings per share of its common stock. Furthermore, it may have an adverse impact on ACNB's stock price. New investors may also have rights, preferences and privileges senior to ACNB's current shareholders, which may adversely impact its current shareholders. ACNB's ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. Accordingly, ACNB cannot be assured of its ability to raise additional capital on terms and/or in time frames acceptable to it, or to raise additional capital at all. If ACNB cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect ACNB's operations, financial condition, and results of operations.
ACNB'S FUTURE ACQUISITIONS COULD DILUTE SHAREHOLDER OWNERSHIP AND MAY CAUSE IT TO BECOME MORE SUSCEPTIBLE TO ADVERSE ECONOMIC EVENTS.
ACNB may use its common stock to acquire other companies or make investments in banks and other complementary businesses in the future. ACNB may also issue additional shares of common stock to pay for future acquisitions, which would dilute current investors' ownership interest in ACNB. Future business acquisitions could be material to ACNB, and the degree of success achieved in acquiring and integrating these businesses into ACNB could have a material effect on the value of ACNB's common stock. In addition, any acquisition could require it to use substantial cash or other liquid assets or to incur debt. In those events, ACNB could become more susceptible to economic downturns and competitive pressures.
PENNSYLVANIA BUSINESS CORPORATION LAW AND VARIOUS ANTI-TAKEOVER PROVISIONS UNDER ACNB'S ARTICLES AND BYLAWS COULD IMPEDE THE TAKEOVER OF ACNB.
Various Pennsylvania laws affecting business corporations may have the effect of discouraging offers to acquire ACNB, even if the acquisition would be advantageous to shareholders. In addition, ACNB has various anti-takeover measures in place under its articles of incorporation and bylaws, including a supermajority vote requirement for mergers, a staggered Board of Directors, and the absence of cumulative voting. Any one or more of these measures may impede the takeover of ACNB without the approval of the Board of Directors and may prevent shareholders from taking part in a transaction in which they could realize a premium over the current market price of ACNB common stock.
IF ACNB CONCLUDES THAT THE DECLINE IN VALUE OF ANY OF ITS INVESTMENT SECURITIES IS AN OTHER-THAN-TEMPORARY IMPAIRMENT, ACNB IS REQUIRED TO WRITE DOWN THE VALUE OF THAT SECURITY THROUGH A CHARGE TO EARNINGS.
ACNB reviews its investment securities portfolio at each quarter-end to determine whether the fair value is below the current carrying value. When the fair value of any of its investment securities has declined below its carrying value, ACNB is required to assess whether the decline is an other-than-temporary impairment. If ACNB determines that the decline is an other-than-temporary
21
impairment, it is required to write down the value of that security through a charge to earnings for credit related impairment. Non-credit related reductions in the value of a security do not require a write down of the value through earnings unless ACNB intends to, or is required to, sell the security. Changes in the expected cash flows related to the credit related piece of the investment of a security in ACNB's investment portfolio or a prolonged price decline may result in ACNB's conclusion in future periods that an impairment is other than temporary, which would require a charge to earnings to write down the security to fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset has an impairment that is other than temporary, the impairment disclosed may not accurately reflect the actual impairment in the future.
ACNB IS SUBJECT TO POTENTIAL IMPAIRMENT OF GOODWILL AND INTANGIBLES.
ACNB has certain long-lived assets including purchased intangible assets subject to amortization 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 pursuant to ASC Topic 350, IntangiblesGoodwill and Other, 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. 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 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 the 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. Further, a new FASB update eliminates the second step test, thus basing impairment on the estimated fair value to the carrying value including goodwill.
ACNB IS SUBJECT TO ENVIRONMENTAL LIABILITY RISK ASSOCIATED WITH LENDING ACTIVITIES.
A significant portion of ACNB's banking subsidiary loan portfolio is secured by real property. During the ordinary course of business, ACNB may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, ACNB may be liable for remediation costs, as
22
well as for personal injury and property damage. Environmental laws may require ACNB to incur substantial expense and may materially reduce the affected property's value or limit ACNB's ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase ACNB's exposure to environmental liability. Although ACNB has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on ACNB's financial condition and results of operations.
THE SEVERITY AND DURATION OF A FUTURE ECONOMIC DOWNTURN AND THE COMPOSITION OF THE BANKING SUBSIDIARY'S LOAN PORTFOLIO COULD IMPACT THE LEVEL OF LOAN CHARGE-OFFS AND THE PROVISION FOR LOAN LOSSES AND MAY AFFECT ACNB'S NET INCOME OR LOSS.
Lending money is a substantial part of ACNB's business through its banking subsidiary. However, every loan that ACNB makes carries a certain risk of non-payment. ACNB cannot assure that its allowance for loan losses will be sufficient to absorb actual loan losses. ACNB also cannot assure that it will not experience significant losses in its loan portfolio that may require significant increases to the allowance for loan losses in the future.
Although ACNB evaluates every loan that it makes against its underwriting criteria, ACNB may experience losses by reasons of factors beyond its control. Some of these factors include changes in market conditions affecting the value of real estate and unexpected problems affecting the creditworthiness of ACNB's borrowers.
ACNB determines the adequacy of its allowance for loan losses by considering various factors, including:
Local economic conditions could impact the loan portfolio of ACNB. For example, an increase in unemployment, a decrease in real estate values, or increases in interest rates, as well as other factors, could weaken the economies of the communities ACNB serves. Weakness in the market areas served by ACNB could depress the Corporation's earnings and, consequently, its financial condition because:
23
Although, based on the aforementioned procedures implemented by ACNB, management believes the current allowance for loan losses is adequate, ACNB may have to increase its provision for loan losses should local economic conditions deteriorate which could negatively impact its financial condition and results of operations.
CHANGES IN REAL ESTATE VALUES MAY ADVERSELY IMPACT ACNB'S BANKING SUBSIDIARY LOANS THAT ARE SECURED BY REAL ESTATE.
A significant portion of ACNB's banking subsidiary loan portfolio consists of residential and commercial mortgages, as well as consumer loans, secured by real estate. These properties are concentrated in Adams County, Pennsylvania. Real estate values and real estate markets generally are affected by, among other things, changes in national, regional or local economic conditions, fluctuations in interest rates, the availability of loans to potential purchasers, changes in the tax laws and other government statutes, regulations and policies, and acts of nature. If real estate prices decline, particularly in ACNB's market area, the value of the real estate collateral securing ACNB's loans could be reduced. This reduction in the value of the collateral could increase the number of non-performing loans and could have a material adverse impact on ACNB's financial condition and results of operations.
ACNB'S INFORMATION SYSTEMS MAY EXPERIENCE AN INTERRUPTION OR BREACH IN SECURITY.
ACNB relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in ACNB's customer relationship management, general ledger, deposit, loan and other systems. While ACNB has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Although ACNB maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. The occurrence of any failures, interruptions or security breaches of ACNB's information systems could damage ACNB's reputation adversely affecting customer or investor confidence, result in a loss of customer business, subject ACNB to additional regulatory scrutiny and possible regulatory penalties, or expose ACNB to civil litigation and possible financial liability, any of which could have a material adverse effect on ACNB's financial condition and results of operations.
ACNB CONTINUALLY ENCOUNTERS TECHNOLOGICAL CHANGE.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. ACNB's future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in ACNB's operations. Many of ACNB's competitors have substantially greater resources to invest in technological improvements. ACNB may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on ACNB's business and, in turn, ACNB's financial condition and results of operations.
24
FINANCIAL SERVICES COMPANIES DEPEND ON THE ACCURACY AND COMPLETENESS OF INFORMATION ABOUT CUSTOMERS AND COUNTERPARTIES.
In deciding whether to extend credit or enter into other transactions, ACNB may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. ACNB may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could have a material adverse impact on ACNB's business and, in turn, ACNB's financial condition and results of operations.
CONSUMERS MAY DECIDE NOT TO USE BANKS TO COMPLETE THEIR FINANCIAL TRANSACTIONS.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as "disintermediation", could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on ACNB's financial condition and results of operations.
FUTURE ECONOMIC CONDITIONS MAY ADVERSELY AFFECT SECONDARY SOURCES OF LIQUIDITY.
In addition to primary sources of liquidity in the form of deposits and principal and interest payments on outstanding loans and investments, ACNB maintains secondary sources that provide it with additional liquidity. These secondary sources include secured and unsecured borrowings from sources such as the Federal Reserve Bank, Federal Home Loan Bank of Pittsburgh, and third-party commercial banks. However, market liquidity conditions have been negatively impacted by past disruptions in the capital markets and could, in the future, have a negative impact on ACNB's secondary sources of liquidity.
SEVERE WEATHER, NATURAL DISASTERS, ACTS OF WAR OR TERRORISM, AND OTHER EXTERNAL EVENTS COULD SIGNIFICANTLY IMPACT ACNB'S BUSINESS.
The unpredictable nature of events such as severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on ACNB's ability to conduct business. If any of its financial, accounting, network or other information processing systems fail or have other significant shortcomings due to external events, ACNB could be materially adversely affected. Third parties with which ACNB does business could also be sources of operational risk to ACNB, including the risk that the third parties' own network and information processing systems could fail. Any of these occurrences could materially diminish ACNB's ability to operate one or more of the Corporation's businesses, or result in potential liability to customers, reputational damage, and regulatory intervention, any of which could materially adversely affect ACNB. Such events could affect the stability of ACNB's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, impair ACNB's liquidity, cause significant property damage, result in loss of revenue, and/or cause ACNB to incur additional expenses.
ACNB may be subject to disruptions or failures of the financial, accounting, network and/or other information processing systems arising from events that are wholly or partially beyond ACNB's control,
25
which may include, for example, computer viruses, electrical or telecommunications outages, natural disasters, disease pandemics, damage to property or physical assets, or terrorist acts. ACNB has developed a comprehensive business continuity plan which includes plans to maintain or resume operations in the event of an emergency, such as a power outage or disease pandemic, and contingency plans in the event that operations or systems cannot be resumed or restored. The business continuity plan is updated as needed, periodically reviewed, and components are regularly tested. ACNB also reviews and evaluates the business continuity plans of critical third-party service providers. While ACNB believes its business continuity plan and efforts to evaluate the business continuity plans of critical third-party service providers help mitigate risks, disruptions or failures affecting any of these systems may cause interruptions in service to customers, damage to ACNB's reputation, and loss or liability to the Corporation.
CHANGES IN CONTROL OF THE UNITED STATES GOVERNMENT AND ISSUES RELATING TO DEBT AND THE DEFICIT MAY ADVERSELY AFFECT THE CORPORATION.
The Republican Party controlling of the White House, as well as the Republican Party maintaining or losing control of both the House of Representatives and Senate of the United States in the next congressional election, could result in significant changes or uncertainty in governmental policies, regulatory environments, spending sentiment, and many other factors and conditions, some of which could adversely impact the Corporation's business, financial condition, and results of operations. In addition, as a result of past difficulties of the federal government to reach agreement over federal debt and issues connected with the debt ceiling, certain rating agencies placed the United States government's long-term sovereign debt rating on their equivalent of negative watch and announced the possibility of a rating downgrade. The rating agencies, due to constraints related to the rating of the United States, also placed government-sponsored enterprises in which the Corporation invests and receives lines of credit on negative watch, and a downgrade of the Unites States government's credit rating would trigger a similar downgrade in the credit rating of these government-sponsored enterprises. Furthermore, the credit rating of other entities, such as state and local governments, may also be downgraded should the United States government's credit rating be downgraded. The impact that a credit rating downgrade may have on the national and local economy could have an adverse effect on ACNB's financial condition and results of operations.
ACNB'S BANKING SUBSIDIARY MAY BE REQUIRED TO PAY HIGHER FDIC INSURANCE PREMIUMS OR SPECIAL ASSESSMENTS WHICH MAY ADVERSELY AFFECT ITS EARNINGS.
Poor economic conditions and the resulting bank failures increased the costs of the FDIC and adversely impacted its Deposit Insurance Fund. Any additional bank failures may prompt the FDIC to increase its premiums or to issue special assessments. ACNB is generally unable to control the amount of premiums or special assessments that its banking subsidiary is required to pay for FDIC insurance. Any future changes in the calculation or assessment of FDIC insurance premiums may have a material adverse effect on ACNB's financial condition and results of operations.
FEDERAL INCOME TAX REFORM COULD HAVE UNFORESEEN EFFECTS ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
On December 22, 2017, the President of the United States signed into law H.R. 1, originally known as the "Tax Cuts and Jobs Act." ACNB is still in the process of analyzing the Tax Cuts and Jobs Act and its possible effects on ACNB. The Tax Cuts and Jobs Act includes a number of provisions, including the lowering of the U.S. corporate tax rate from 35 percent to 21 percent, effective January 1, 2018. There are also provisions that may partially offset the benefit of such rate reduction. Financial statement impacts include adjustments for, among other things, the remeasurement of deferred tax assets and liabilities. While there are benefits, there is also substantial uncertainty regarding the details
26
of U.S. Tax Reform. The intended and unintended consequences of the Tax Cuts and Jobs Act on the Corporation's business and on holders of ACNB common shares is uncertain and could be adverse. ACNB anticipates that the impact of the Tax Cuts and Jobs Act may be material to its business, financial condition, and results of operations.
THE INCREASING USE OF SOCIAL MEDIA PLATFORMS PRESENTS NEW RISKS AND CHALLENGES AND THE INABILITY OR FAILURE TO RECOGNIZE, RESPOND TO, AND EFFECTIVELY MANAGE THE ACCELERATED IMPACT OF SOCIAL MEDIA COULD MATERIALLY ADVERSELY IMPACT ACNB'S BUSINESS.
There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Social media practices in the banking industry are evolving, which creates uncertainty and risk of noncompliance with regulations applicable to ACNB's business. Consumers value readily-available information concerning businesses and their goods and services and often act on such information without further investigation and without regard to its accuracy. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to ACNB's interests and/or may be inaccurate. The dissemination of information online could harm ACNB's business, prospects, financial condition, and results of operations, regardless of the information's accuracy. The harm may be immediate without affording ACNB an opportunity for redress or correction.
Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about ACNB's business, exposure of personally identifiable information, fraud, out-of-date information, and improper use by employees and customers. The inappropriate use of social media by ACNB's employees or customers could result in negative consequences such as remediation costs including training for employees, additional regulatory scrutiny, and possible regulatory penalties, litigation, or negative publicity that could damage ACNB's reputation adversely affecting customer or investor confidence.
A NEW ACCOUNTING STANDARD MAY REQUIRE ACNB TO INCREASE THE ALLOWANCE FOR LOAN LOSSES AND MAY HAVE A MATERIAL ADVERSE EFFECT ON ACNB'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Corporation after December 15, 2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require ACNB to increase its allowance for loan losses, and to greatly increase the types of data ACNB would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in ACNB's allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on ACNB's financial condition and results of operations.
27
RISKS RELATING TO THE ACQUISITION OF NEW WINDSOR BANCORP, INC. (NEW WINDSOR) BY ACNB CORPORATION
THE ACQUISITION MAY DISTRACT ACNB'S MANAGEMENT TEAM FROM THEIR OTHER RESPONSIBILITIES.
Continuing acquisition-related matters could cause the management of ACNB to focus their time and energies on matters related to the acquisition that otherwise would be directed to the Corporation's business and operations. Any such distraction on the part of management, if significant, could affect management's ability to service existing business, develop new business, and adversely affect the combined company's post-acquisition business and earnings.
POST-ACQUISITION INTEGRATION AND CHANGE OF ACNB'S HISTORICAL BUSINESS MODEL MAY FAIL TO ACHIEVE EXPECTED RESULTS.
The success of the transaction depends heavily on a smooth integration and post-acquisition operations of ACNB. Benefits of the transaction to shareholders may not be realized if the post-acquisition integration is not well executed or well received by each company's historical customers.
ACNB MAY FAIL TO REALIZE THE COST SAVINGS IT EXPECTED TO ACHIEVE FROM THE ACQUISITION.
The success of the acquisition depends, in part, on ACNB's ability to realize the estimated cost savings from combining the businesses of ACNB and New Windsor. While ACNB believes that the cost savings estimates are achievable, it is possible that the potential cost savings could be more difficult to achieve than ACNB anticipated. ACNB's cost savings estimates also depend on its ability to combine the businesses of ACNB and New Windsor in a manner that permits those cost savings to be realized. If ACNB's estimates are incorrect or it is unable to combine the two successfully, the anticipated cost savings may not be realized fully or at all, or may take longer to realize than expected.
POTENTIAL ACQUISITIONS MAY DISRUPT THE CORPORATION'S BUSINESS AND DILUTE SHAREHOLDER VALUE.
We regularly evaluate opportunities to acquire and invest in banks and in other complementary businesses. As a result, we may engage in negotiations or discussions that, if they were to result in a transaction, could have a material effect on our operating results and financial condition, including short- and long-term liquidity and capital structure. Our acquisition activities could be material to us. For example, we could issue additional shares of common stock in a purchase transaction, which could dilute current shareholders' ownership interest. These activities could require us to use a substantial amount of cash, other liquid assets, and/or incur debt. In addition, if goodwill recorded in connection with our prior or potential future acquisitions were determined to be impaired, then we would be required to recognize a charge against our earnings, which could materially and adversely affect our results of operations during the period in which the impairment was recognized. Any potential charges for impairment related to goodwill would not impact cash flow, tangible capital or liquidity but would decrease shareholders' equity.
Our acquisition activities could involve a number of additional risks, including the risks of:
28
We may not be successful in overcoming these risks or any other problems encountered in connection with potential acquisitions. Our inability to overcome these risks could have an adverse effect on our ability to achieve our business strategy and maintain our market value.
RISKS RELATED TO THE WEALTH MANAGEMENT AND INSURANCE INDUSTRIES
REVENUES AND PROFITABILITY FROM OUR WEALTH MANAGEMENT BUSINESS MAY BE ADVERSELY AFFECTED BY ANY REDUCTION IN ASSETS UNDER MANAGEMENT AND SUPERVISION AS A RESULT OF EITHER A DECLINE IN MARKET VALUE OF SUCH ASSETS OR NET OUTFLOWS, WHICH COULD REDUCE TRUST, INVESTMENT ADVISORY AND BROKERAGE AND OTHER SERVINGS FEES EARNED.
The wealth management business derives the majority of its revenue from noninterest income which consists of trust, investment advisory and brokerage and other servicing fees. Substantial revenues are generated from investment management contracts with clients. Under these contracts, the investment advisory fees paid to us are typically based on the market value of assets under management. Assets under management and supervision may decline for various reasons including declines in the market value of the assets in the funds and accounts managed or supervised, which could be caused by price declines in the securities markets generally or by price declines in specific market segments. Assets under management may also decrease due to redemptions and other withdrawals by clients or termination of contracts. This could be in response to adverse market conditions or in pursuit of other investment opportunities.
THE WEALTH MANAGEMENT INDUSTRY IS SUBJECT TO EXTENSIVE REGULATION, SUPERVISION AND EXAMINATION BY REGULATORS, AND ANY ENFORCEMENT ACTION OR ADVERSE CHANGES IN THE LAWS OR REGULATIONS GOVERNING OUR BUSINESS COULD DECREASE OUR REVENUES AND PROFITABILITY.
The wealth management business is subject to regulation by a number of regulatory agencies that are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of customers participating in those markets. In the event of non-compliance with an applicable regulation, governmental regulators, including the SEC, and FINRA, may institute administrative or judicial proceedings that may result in censure, fines, civil penalties, the issuance of cease-and-desist orders or the deregistration or suspension of the non-compliant broker-dealer or investment adviser or other adverse consequences. The imposition of any such penalties or orders could have a material adverse effect on the wealth management segment's operating results and financial condition. We may be adversely affected as a result of new or revised legislation or regulations. Regulatory changes have imposed and may continue to impose additional costs, which could adversely impact our profitability.
REVENUES AND PROFITABILITY FROM OUR INSURANCE BUSINESS MAY BE ADVERSELY AFFECTED BY MARKET CONDITIONS, WHICH COULD REDUCE INSURANCE COMMISSIONS AND FEES EARNED.
The revenues of our fee based insurance business are derived primarily from commissions from the sale of insurance policies, which commissions are generally calculated as a percentage of the policy premium. These insurance policy commissions can fluctuate as insurance carriers from time to time
29
increase or decrease the premiums on the insurance products we sell. Due to the cyclical nature of the insurance market and the impact of other market and macro economic conditions on insurance premiums, commission levels may vary. The reduction of these commission rates, along with general volatility and/or declines in premiums, may adversely impact our profitability.
ITEM 1BUNRESOLVED STAFF COMMENTS
None.
ACNB Bank, in addition to its main community banking office in Gettysburg, Adams County, Pennsylvania, had a community banking office network of 28 offices in Pennsylvania and Maryland at December 31, 2017. Including the main office, 14 community banking offices are located in Adams County, one is located in Cumberland County, two are located in Franklin County, and five are located in York County, Pennsylvania. There is also a loan production office situated in York County, Pennsylvania. In Maryland, there are seven community banking offices located in Carroll County, all branded as NWSB Bank, a division of ACNB Bank. Bank offices at 19 locations are owned, while 11 are leased. All real estate owned by the subsidiary bank is free and clear of encumbrances. RIG owns an office, free and clear of encumbrances, located in Carroll County, Maryland, and leases an office in Montgomery County, Maryland.
As of December 31, 2017, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which ACNB or its subsidiaries are a party or by which any of their assets are the subject, which could have a material adverse effect on ACNB or its subsidiaries or their results of operations. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation or its subsidiaries by governmental authorities.
ITEM 4MINE SAFETY DISCLOSURES
Not Applicable.
30
ITEM 5MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ACNB Corporation's common stock trades on NASDAQ under the symbol ACNB. At December 31, 2017 and 2016, there were 20,000,000 shares of common stock authorized, 7,086,258 and 6,126,738 shares issued, respectively, and 7,023,658 and 6,064,138 shares outstanding, respectively. As of December 31, 2017, ACNB had approximately 2,341 stockholders of record. At December 31, 2017 and 2016, there were 62,600 shares of treasury stock purchased by the Corporation through the common stock repurchase program approved in October 2008. There have been no shares purchased during the most recent quarter and 57,400 shares can still be purchased under the program. ACNB is restricted as to the amount of dividends that it can pay to stockholders by virtue of the restrictions on the banking subsidiary's ability to pay dividends to ACNB under the Pennsylvania Banking Code, the Federal Deposit Insurance Corporation Act, and the regulations of the FDIC. For further information, please refer to Note J"Regulatory Restrictions on Dividends" and Note N"Regulatory Matters" in the Notes to Consolidated Financial Statements.
On May 5, 2009, stockholders approved and ratified the ACNB Corporation 2009 Restricted Stock Plan, effective as of February 24, 2009, in which awards shall not exceed, in the aggregate, 200,000 shares of common stock. As of December 31, 2017, there were 19,301 shares of common stock granted as restricted stock awards to employees of the subsidiary bank. The maximum number of shares that may yet be granted under the restricted stock plan is 180,699. The Corporation's Registration Statement under the Securities Act of 1933 on Form S-8 for the ACNB Corporation 2009 Restricted Stock Plan was filed with the Securities and Exchange Commission on January 4, 2013.
On May 5, 2009, stockholders approved and adopted the amendment to the Articles of Incorporation of ACNB Corporation to authorize up to 20,000,000 shares of preferred stock, par value $2.50 per share. As of December 31, 2017, there were no issued or outstanding shares of preferred stock.
On January 24, 2011, the ACNB Corporation Dividend Reinvestment and Stock Purchase Plan was introduced for stockholders of record. This plan provides registered holders of ACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. As of December 31, 2017, there were 137,654 shares of common stock issued through the ACNB Corporation Dividend Reinvestment and Stock Purchase Plan.
There have been no unregistered sales of stock in 2017, 2016 or 2015.
The following table reflects the quarterly high and low prices of ACNB's common stock and the cash dividends on the common stock for the periods indicated.
|
Price Range Per Share |
|
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Per Share Dividend |
|||||||||
|
High | Low | ||||||||
2017: |
||||||||||
First Quarter |
$ | 31.45 | $ | 28.45 | $ | 0.20 | ||||
Second Quarter |
31.35 | 28.10 | 0.20 | |||||||
Third Quarter |
30.65 | 26.00 | 0.20 | |||||||
Fourth Quarter |
30.45 | 27.15 | 0.20 |
31
|
Price Range Per Share |
|
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Per Share Dividend |
|||||||||
|
High | Low | ||||||||
2016: |
||||||||||
First Quarter |
$ | 22.65 | $ | 21.10 | $ | 0.20 | ||||
Second Quarter |
25.35 | 21.81 | 0.20 | |||||||
Third Quarter |
27.48 | 24.98 | 0.20 | |||||||
Fourth Quarter |
32.50 | 25.75 | 0.20 |
The Corporation used the Mid-Atlantic Custom Peer GroupAsset $700M-$2B performance graph below, which management believes better represents the Corporation's performance versus other financial institutions of similar size.
|
Period Ending | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Index
|
12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | |||||||||||||
ACNB Corporation |
100.00 | 116.64 | 146.12 | 148.74 | 225.05 | 218.94 | |||||||||||||
NASDAQ Composite Index |
100.00 | 140.12 | 160.78 | 171.97 | 187.22 | 242.71 | |||||||||||||
Mid-Atlantic Custom Peer GroupAsset $700M-$2B* |
100.00 | 126.74 | 134.00 | 142.84 | 179.92 | 212.27 |
32
Company
|
City | State | Company | City | State | |||||
---|---|---|---|---|---|---|---|---|---|---|
1st Constitution Bancorp |
Cranbury | NJ | First Keystone Corporation | Berwick | PA | |||||
1st Summit Bancorp of Johnstown, Inc. |
Johnstown | PA | First United Corporation | Oakland | MD | |||||
ACNB Corporation |
Gettysburg | PA | FNB Bancorp, Inc. | Newtown | PA | |||||
Adirondack Trust Company |
Saratoga Springs | NY | FNCB Bancorp, Inc. | Dunmore | PA | |||||
AmeriServ Financial, Inc. |
Johnstown | PA | Franklin Financial Services Corporation | Chambersburg | PA | |||||
Bancorp of New Jersey, Inc. |
Fort Lee | NJ | Howard Bancorp, Inc. | Ellicott City | MD | |||||
Bank of Princeton |
Princeton | NJ | Kish Bancorp, Inc. | Belleville | PA | |||||
Bank of Utica |
Utica | NY | Lyons Bancorp, Inc. | Lyons | NY | |||||
BCB Bancorp, Inc. |
Bayonne | NJ | Marlin Business Services Corp. | Mount Laurel | NJ | |||||
CB Financial Services, Inc. |
Carmichaels | PA | Meridian Bank | Malvern | PA | |||||
CCFNB Bancorp, Inc. |
Bloomsburg | PA | Metropolitan Bank Holding Corp. | New York | NY | |||||
Chemung Financial Corporation |
Elmira | NY | Mid Penn Bancorp, Inc. | Millersburg | PA | |||||
Citizens & Northern Corporation |
Wellsboro | PA | Norwood Financial Corp. | Honesdale | PA | |||||
Citizens Financial Services, Inc. |
Mansfield | PA | Orange County Bancorp, Inc. | Middletown | NY | |||||
Codorus Valley Bancorp, Inc. |
York | PA | Orrstown Financial Services, Inc. | Shippensburg | PA | |||||
Community Financial Corporation |
Waldorf | MD | Parke Bancorp, Inc. | Sewell | NJ | |||||
DNB Financial Corporation |
Downingtown | PA | Pathfinder Bancorp, Inc. | Oswego | NY | |||||
Embassy Bancorp, Inc. |
Bethlehem | PA | Penns Woods Bancorp, Inc. | Williamsport | PA | |||||
Emclaire Financial Corp |
Emlenton | PA | QNB Corp. | Quakertown | PA | |||||
Empire Bancorp Inc. |
Islandia | NY | Shore Bancshares, Inc. | Easton | MD | |||||
ENB Financial Corp |
Ephrata | PA | Solvay Bank Corporation | Solvay | NY | |||||
Evans Bancorp, Inc. |
Hamburg | NY | Somerset Trust Holding Company | Somerset | PA | |||||
Fidelity D & D Bancorp, Inc |
Dunmore | PA | Stewardship Financial Corporation | Midland Park | NJ | |||||
First American International Corp. |
Brooklyn | NY | Sussex Bancorp | Rockaway | NJ | |||||
First Bank |
Hamilton | NJ | Two River Bancorp | Tinton Falls | NJ | |||||
First Commerce Bank |
Lakewood | NJ | Unity Bancorp, Inc. | Clinton | NJ |
33
ITEM 6SELECTED FINANCIAL DATA
|
For the Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Dollars in thousands, except per share data |
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||
INCOME STATEMENT DATA |
||||||||||||||||
Interest income |
$ | 51,785 | $ | 40,500 | $ | 39,464 | $ | 37,526 | $ | 37,601 | ||||||
Interest expense |
5,433 | 3,934 | 3,858 | 3,646 | 3,989 | |||||||||||
| | | | | | | | | | | | | | | | |
Net interest income |
46,352 | 36,566 | 35,606 | 33,880 | 33,612 | |||||||||||
Provision for loan losses |
| | | 150 | 1,450 | |||||||||||
| | | | | | | | | | | | | | | | |
Net interest income after provision for loan losses |
46,352 | 36,566 | 35,606 | 33,730 | 32,162 | |||||||||||
Other income |
14,149 | 13,208 | 12,406 | 11,904 | 11,703 | |||||||||||
Other expenses |
44,079 | 35,137 | 33,234 | 32,264 | 32,015 | |||||||||||
| | | | | | | | | | | | | | | | |
Income before income taxes |
16,422 | 14,637 | 14,778 | 13,370 | 11,850 | |||||||||||
Provision for income taxes |
6,634 | 3,768 | 3,761 | 3,080 | 2,535 | |||||||||||
| | | | | | | | | | | | | | | | |
Net income |
$ | 9,788 | $ | 10,869 | $ | 11,017 | $ | 10,290 | $ | 9,315 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
BALANCE SHEET DATA (AT YEAR-END) |
||||||||||||||||
Assets |
$ | 1,595,432 | $ | 1,206,320 | $ | 1,147,925 | $ | 1,089,808 | $ | 1,046,047 | ||||||
Securities |
$ | 203,880 | $ | 198,558 | $ | 197,235 | $ | 191,346 | $ | 224,356 | ||||||
Loans, net |
$ | 1,230,194 | $ | 893,716 | $ | 838,213 | $ | 784,100 | $ | 712,557 | ||||||
Deposits |
$ | 1,298,492 | $ | 967,621 | $ | 912,980 | $ | 844,876 | $ | 800,643 | ||||||
Borrowings |
$ | 131,508 | $ | 108,840 | $ | 111,702 | $ | 126,636 | $ | 131,755 | ||||||
Stockholders' equity |
$ | 153,966 | $ | 120,061 | $ | 114,715 | $ | 110,022 | $ | 106,802 | ||||||
COMMON SHARE DATA |
||||||||||||||||
Earnings per sharebasic |
$ | 1.50 | $ | 1.80 | $ | 1.83 | $ | 1.71 | $ | 1.56 | ||||||
Cash dividends declared |
$ | 0.80 | $ | 0.80 | $ | 0.80 | $ | 0.77 | $ | 0.76 | ||||||
Book value per share |
$ | 21.92 | $ | 19.80 | $ | 18.99 | $ | 18.29 | $ | 17.83 | ||||||
Weighted average number of common shares |
6,543,756 | 6,051,579 | 6,026,224 | 6,002,240 | 5,976,960 | |||||||||||
Dividend payout ratio |
53.46 | % | 44.53 | % | 43.75 | % | 44.92 | % | 48.76 | % | ||||||
PROFITABILITY RATIOS AND CONDITION |
||||||||||||||||
Return on average assets |
0.69 | % | 0.93 | % | 0.99 | % | 0.97 | % | 0.90 | % | ||||||
Return on average equity |
7.12 | % | 9.17 | % | 9.77 | % | 9.32 | % | 9.00 | % | ||||||
Average stockholders' equity to average assets |
9.69 | % | 10.10 | % | 10.10 | % | 10.43 | % | 9.95 | % | ||||||
SELECTED ASSET QUALITY RATIOS |
||||||||||||||||
Non-performing loans to total loans |
0.63 | % | 0.64 | % | 0.68 | % | 1.04 | % | 1.44 | % | ||||||
Net charge-offs to average loans outstanding |
0.02 | % | 0.06 | % | 0.05 | % | 0.14 | % | 0.31 | % | ||||||
Allowance for loan losses to total loans |
1.12 | % | 1.56 | % | 1.73 | % | 1.90 | % | 2.21 | % | ||||||
Allowance for loan losses to non-performing loans |
177.77 | % | 242.76 | % | 252.91 | % | 183.15 | % | 153.26 | % |
34
ITEM 7MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
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 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, IntangiblesGoodwill 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 RIG's outstanding goodwill from its most recent testing, which was performed as of October 1, 2017. 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 resulting from the acquisition of New Windsor Bancorp, Inc. (New Windsor) for impairment during the year ended December 31, 2017. ACNB plans on testing New Windsor goodwill during 2018. 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.
35
EXECUTIVE OVERVIEW
On July 1, 2017, ACNB Corporation acquired New Windsor Bancorp, Inc. (New Windsor) and New Windsor State Bank. The acquisition was part of ACNB Corporation's long-term strategic plan to enhance shareholder value by systematically and methodically expanding into new geographic markets and growing our customer base. Nonrecurring expenses normally associated with the acquisition amounted to $3.0 million net of the corresponding tax impact at the marginal tax rate. The acquisition added to top line revenue and, after giving effect to the nonrecurring merger-related expenses accounted for under GAAP, the acquisition positively impacted and accreted to the Corporation's bottom line and earnings per share. A second nonrecurring event that caused 2017 additional expense, but will produce a subsequent immediate positive net income effect, was federal tax legislation known as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act made broad and complex changes to the U.S. tax code, including a reduction in the base federal corporate tax rate from the prior existing statutory rate, which was 35% for ACNB Corporation, to 21%. As with most Banking companies, the Tax Act resulted in a one-time, noncash charge against 2017 net income of approximately $1.7 million for the Corporation, due to the write-down of the Corporation's net deferred tax assets.
ACNB Corporation uses non-GAAP financial measures to provide information useful to investors in understanding our operating performance and trends, and to facilitate comparisons with the performance of our peers. The non-GAAP financial measures and key performance indicators we use may differ from the non-GAAP financial measures and key performance indicators other financial institutions use to measure their performance and trends. Reconciliations of GAAP to non-GAAP operating measures to the most directly comparable GAAP financial measures are included in the tables below.
|
For the Years Ended December 31, | ||||||
---|---|---|---|---|---|---|---|
Dollars in thousands, except per share data |
2017 | 2016 | |||||
INCOME STATEMENT DATA |
|||||||
Interest income |
$ | 51,785 | $ | 40,500 | |||
Interest expense |
5,433 | 3,934 | |||||
| | | | | | | |
Net interest income |
46,352 | 36,566 | |||||
Provision for loan losses |
| | |||||
| | | | | | | |
Net interest income after provision for loan losses |
46,352 | 36,566 | |||||
Other income |
14,149 | 13,208 | |||||
Merger-related expenses |
4,728 | 472 | |||||
Other expenses |
39,351 | 34,665 | |||||
| | | | | | | |
Income before income taxes |
16,422 | 14,637 | |||||
Deferred tax write-down due to Tax Act |
1,700 | | |||||
Provision for income taxes |
4,934 | 3,768 | |||||
| | | | | | | |
Net income |
$ | 9,788 | $ | 10,869 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
Basic earnings per share |
$ | 1.50 | $ | 1.80 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
NON-GAAP MEASURES |
|||||||
INCOME STATEMENT DATA |
|||||||
Net Income |
$ | 9,788 | $ | 10,869 | |||
Merger-related expenses, net of income taxes |
3,010 | 300 | |||||
Deferred tax write-down due to Tax Act |
1,700 | | |||||
| | | | | | | |
Net income without nonrecurring items (non-GAAP) |
$ | 14,498 | $ | 11,169 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
Basic earnings per share (non-GAAP) |
$ | 2.22 | $ | 1.85 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
36
This non-GAAP 2017 net income figure of $14,498,000 represents a 29.8% increase over the comparable results for the year ended December 31, 2016. Basic earnings per share on the 2017 non-GAAP measures increased 20.0% over the non-GAAP earnings per share for 2016.
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 2017 continued to be challenging for financial institutions with new expensive compliance regulations, slowly recovering housing markets, lingering wage stagnation, and slow uneven growth. ACNB continued to be profitable and well capitalized despite the legacy effects of the United States economy's recent past.
In alignment with the Corporation's strategic plan for long-term geographic expansion, ACNB acquired New Windsor Bancorp, Inc. of Taneytown, Maryland, and its subsidiary bank, New Windsor State Bank. Banking operations in the new south region include seven community banking offices located in Carroll County, Maryland, and branded as NWSB Bank, a division of ACNB Bank. The operating results of this new division are included with ACNB's other operations as of July 1, 2017. Before and after the acquisition, ACNB incurred $4,728,000 and $472,000 in merger-related expenses for the years ended December 31, 2017 and 2016, respectively. Higher net interest income and improved fee income offset increased expenses resulting in increased income before income taxes of $16,422,000 in 2017, compared to $14,637,000 and $14,778,000 in 2016 and 2015, respectively. In addition, the Tax Cuts and Jobs Act resulted in a charge against 2017 net income of approximately $1,700,000 due to the write-down of net deferred tax assets. This one-time charge along with the recurring income tax expense decreased net income to $9,788,000, or $1.50 per share, in 2017, compared to $10,869,000, or $1.80 per share, in 2016 and $11,017,000, or $1.83 per share, in 2015. Returns on average equity were 7.12%, 9.17% and 9.77% in 2017, 2016 and 2015, respectively.
In 2017, the Corporation's net interest margin increased to 3.51%, compared to 3.35% and 3.45% in 2016 and 2015, respectively. Net interest income was $46,352,000 in 2017, as compared to $36,566,000 in 2016 and $35,606,000 in 2015.
Other income was $14,149,000, $13,208,000 and $12,406,000 in 2017, 2016 and 2015, respectively. The largest source of other income is commissions from insurance sales attributable to Russell Insurance Group, Inc. (RIG). Commissions from insurance sales increased by 4.2% in 2017 to $5,024,000, boosted by higher personal lines insurance volume and contingent commissions as a result of specific actions of the insurance carriers. In 2017, no gain was recognized on sold investments. In 2016, a $26,000 gain was recognized on sold or merged investments compared to a gain of $261,000 in 2015. In 2016, a $449,000 gain was recognized on the sale of a bank office building, which was sold in order to gain better efficiencies. Income from fiduciary, investment management and brokerage activities totaled $2,012,000 for 2017, as compared to $1,684,000 for 2016 and $1,589,000 for 2015. This income increased from new account relationships and increased market values in accounts. Service charges on deposit accounts increased 24.1% to $2,940,000 for 2017 due to the business combination as of July 1, 2017, as well as concerted management of this fee source; while revenue from ATM and debit card transactions increased 17.5% to $1,762,000 due to increased combined customer volume.
Other expenses increased to $44,079,000, or by 25.4%, in 2017, as compared to $35,137,000 in 2016. Other expenses totaled $33,234,000 in 2015. The largest component of other expenses is salaries and employee benefits, which increased 11.1% to $24,654,000 in 2017, compared to $22,200,000 in 2016, due to an increase in combined organization employees, annual merit increases, and the increased cost of benefits despite lower pension expense. Compared to 2016, occupancy expense increased 16.3% in 2017 due to the seven new community banking office locations in Maryland and
37
normal repair and maintenance variations, and equipment expense rose 23.3% from maintenance of technology assets. Professional services expense increased 33.1% from increasing risk, loan, legal and corporate governance engagements. Marketing and corporate relations expense decreased by 24.6% due to less specific campaigns and brand awareness activities. FDIC and regulatory expense increased by 5.4% based on these agencies' formulas. In 2017, foreclosed real estate expenses increased $38,000, or 69.1%, resulting from variation in carrying cost. Merger-related expenses were $4,728,000 in 2017, compared to $472,000 in 2016, as the acquisition of New Windsor was finalized in 2017. A more thorough discussion of the Corporation's results of operations is included in the following pages.
RESULTS OF OPERATIONS
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.
38
The following table includes average balances, rates, interest income and expense, interest rate spread, and net interest margin:
Table 1Average Balances, Rates and Interest Income and Expense
|
2017 | 2016 | 2015 | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Dollars in thousands |
Average Balance |
Interest | Yield/ Rate |
Average Balance |
Interest | Yield/ Rate |
Average Balance |
Interest | Yield/ Rate |
|||||||||||||||||||
INTEREST EARNING ASSETS |
||||||||||||||||||||||||||||
Loans |
$ | 1,096,631 | $ | 47,522 | 4.33 | % | $ | 870,898 | $ | 36,339 | 4.17 | % | $ | 819,866 | $ | 35,090 | 4.28 | % | ||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable securities |
184,655 | 3,389 | 1.84 | % | 168,789 | 3,179 | 1.88 | % | 158,685 | 3,127 | 1.97 | % | ||||||||||||||||
Tax-exempt securities |
17,918 | 428 | 2.39 | % | 24,520 | 651 | 2.65 | % | 31,045 | 859 | 2.77 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Securities |
202,573 | 3,817 | 1.88 | % | 193,309 | 3,830 | 1.98 | % | 189,730 | 3,986 | 2.10 | % | ||||||||||||||||
Other |
19,537 | 446 | 2.28 | % | 26,119 | 331 | 1.27 | % | 22,328 | 388 | 1.74 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Interest Earning Assets |
1,318,741 | 51,785 | 3.93 | % | 1,090,326 | 40,500 | 3.71 | % | 1,031,924 | 39,464 | 3.82 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and due from banks |
16,312 | 13,804 | 13,283 | |||||||||||||||||||||||||
Premises and equipment |
19,675 | 17,426 | 17,427 | |||||||||||||||||||||||||
Other assets |
78,224 | 66,404 | 69,418 | |||||||||||||||||||||||||
Allowance for loan losses |
(14,837 | ) | (14,580 | ) | (14,942 | ) | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 1,418,115 | $ | 1,173,380 | $ | 1,117,110 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY |
||||||||||||||||||||||||||||
INTEREST BEARING LIABILITIES |
||||||||||||||||||||||||||||
Interest bearing demand deposits |
$ | 252,673 | $ | 306 | 0.12 | % | $ | 212,029 | $ | 168 | 0.08 | % | $ | 184,869 | $ | 120 | 0.06 | % | ||||||||||
Savings deposits |
359,336 | 383 | 0.11 | % | 301,635 | 255 | 0.08 | % | 288,369 | 227 | 0.08 | % | ||||||||||||||||
Time deposits |
302,499 | 2,858 | 0.94 | % | 244,442 | 1,946 | 0.80 | % | 250,550 | 1,773 | 0.71 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Interest Bearing Deposits |
914,508 | 3,547 | 0.39 | % | 758,106 | 2,369 | 0.31 | % | 723,788 | 2,120 | 0.29 | % | ||||||||||||||||
Short-term borrowings |
35,832 | 83 | 0.23 | % | 37,470 | 51 | 0.14 | % | 40,217 | 47 | 0.12 | % | ||||||||||||||||
Long-term borrowings |
91,126 | 1,803 | 1.98 | % | 78,989 | 1,514 | 1.92 | % | 78,453 | 1,691 | 2.16 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Interest Bearing Liabilities |
1,041,466 | 5,433 | 0.52 | % | 874,565 | 3,934 | 0.45 | % | 842,458 | 3,858 | 0.46 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Non-interest bearing demand deposits |
231,803 | 178,084 | 153,660 | |||||||||||||||||||||||||
Other liabilities |
7,405 | 2,265 | 8,227 | |||||||||||||||||||||||||
Stockholders' equity |
137,441 | 118,466 | 112,765 | |||||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Liabilities and Stockholders' Equity |
$ | 1,418,115 | $ | 1,173,380 | $ | 1,117,110 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
NET INTEREST INCOME |
$ | 46,352 | $ | 36,566 | $ | 35,606 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
INTEREST RATE SPREAD |
3.41 | % | 3.26 | % | 3.36 | % | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
NET INTEREST MARGIN |
3.51 | % | 3.35 | % | 3.45 | % | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
For yield calculation purposes, nonaccruing loans are included in average loan balances. Loan fees (expense) of $(48,000), $11,000 and $(172,000) as of December 31, 2017, 2016 and 2015, 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, 2017, 2016 and 2015. Table 2 analyzes the relative impact on net interest income for changes in the volume of interest earning assets
39
and interest bearing liabilities and changes in rates earned and paid by the Corporation on such assets and liabilities.
Net interest income totaled $46,352,000 in 2017, as compared to $36,566,000 in 2016 and $35,606,000 in 2015. During 2017, net interest income increased from higher loan volume (including acquired loans) in the earning asset mix and positive rate variances in earning assets from the acquired loans and from purchase accounting adjustments. Funding costs increased from higher volume (including acquired funding) and from higher rates paid. The increase in net interest income in 2016 was due to increases in loan volume in the earning asset mix offset by negative rate variances in earning assets and funding costs.
The net interest margin during 2017 was 3.51% compared to 3.35% during 2016. The margin increased as a result of purchased accounting adjustments which added 11 basis point to the margin, and acquiring and originating loans at the current market rate in order to increase loan volume and attempt to maintain total net interest income net of purchasing lower yielding investments to properly collateralize local government accounts and repurchase agreements. The Federal Open Market Committee repeatedly decreased the federal funds rate from September 2007 to December 2008 and had maintained it at 0% to 0.25% until mid-December 2015 when this rate was increased in stages to its current range of 1.25% to 1.50%. In addition, the Federal Reserve Bank 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 (CD's) over the intervening years; however, economic progress allowed the Federal Reserve to end new Quantitative Easing and to signal rates they control would eventually increase. ACNB took steps to ameliorate the effect of rising rates including promoting longer term CD's however interest in low cost transaction accounts increased; the result was a 0.07% increase in funding costs in 2017. In addition to the slightly higher cost of funds in 2017, earning asset yields continued up, increasing 0.22% from purchase accounting adjustments and a higher mix of lending. The decreased earning asset yields in 2016 were 0.11% compared to funding cost declines of 0.01%. Maintaining the net interest margin going forward will be challenged by the fact that substantial amounts of deposits rates are increasing, while loans rate increases are restrained due to competition. 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 $1,318,741,000 in 2017, an increase of 20.9% from the balance of $1,090,326,000 in 2016, which was an increase from $1,031,924,000 in 2015. Loan growth and the $263,450,000 New Windsor loans acquired, represented the largest increase in average assets in 2017, 2016 and 2015, in conjunction with changes in the investment portfolio in those years to balance liquidity needs and to collateralize eligible deposits. Average interest bearing liabilities were $1,041,466,000 in 2017, up from $874,565,000 in 2016 and up from $842,458,000 in 2015. Average non-interest bearing demand deposits increased 30.2% in 2017, continuing the upward trend from 2016 and 2015. This increase in deposits was attributed to $283,333,000 of relationships from the New Windsor acquisition and the value placed on stability and FDIC insurance by depositors. On average, deposits (including non-interest bearing) were up 22.4%, while borrowings increased by 9.0% due to acquired subordinated debt in the New Windsor acquisition. Lower-cost transaction and savings deposits increased in 2017 as a result of the New Windsor acquisition. The increase in time deposit was a result of the New Windsor acquisition and an effort to retain funding by offering higher time deposit rates. Lower time deposits from prior years was attributed to depositors dissatisfied by the Federal Reserve induced low rate environment and perhaps investing in equity markets.
The rate/volume analysis detailed in Table 2 shows that the increase in net interest income in 2017 was due to loan volume increases and rate increases in earning asset offsetting rate and volume increases in funding cost. Earning asset yields increased due to New Windsor acquired assets, purchase accounting adjustments and market rate increases. Interest expense increased due to higher deposit volumes and rates and the acquired subordinated debt.
40
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 2Rate/Volume Analysis
|
2017 versus 2016 | 2016 versus 2015 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Due to Changes in | |
Due to Changes in | |
|||||||||||||||
In thousands |
Volume | Rate | Total | Volume | Rate | Total | |||||||||||||
INTEREST EARNING ASSETS |
|||||||||||||||||||
Loans |
$ | 9,735 | $ | 1,448 | $ | 11,183 | $ | 2,145 | $ | (896 | ) | $ | 1,249 | ||||||
Taxable securities |
293 | (83 | ) | 210 | 194 | (142 | ) | 52 | |||||||||||
Tax-exempt securities |
(162 | ) | (61 | ) | (223 | ) | (174 | ) | (34 | ) | (208 | ) | |||||||
| | | | | | | | | | | | | | | | | | | |
Total Securities |
131 | (144 | ) | (13 | ) | 20 | (176 | ) | (156 | ) | |||||||||
Other |
(99 | ) | 214 | 115 | 59 | (116 | ) | (57 | ) | ||||||||||
| | | | | | | | | | | | | | | | | | | |
Total |
$ | 9,767 | $ | 1,518 | $ | 11,285 | $ | 2,224 | $ | (1,188 | ) | $ | 1,036 | ||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
INTEREST BEARING LIABILITIES |
|||||||||||||||||||
Interest bearing demand deposits |
$ | 37 | $ | 101 | $ | 138 | $ | 19 | $ | 29 | $ | 48 | |||||||
Savings deposits |
54 | 74 | 128 | 11 | 17 | 28 | |||||||||||||
Time deposits |
511 | 401 | 912 | (44 | ) | 217 | 173 | ||||||||||||
Short-term borrowings |
(2 | ) | 34 | 32 | (3 | ) | 7 | 4 | |||||||||||
Long-term borrowings |
239 | 50 | 289 | 11 | (188 | ) | (177 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | |
Total |
839 | 660 | 1,499 | (6 | ) | 82 | 76 | ||||||||||||
| | | | | | | | | | | | | | | | | | | |
Change in Net Interest Income |
$ | 8,928 | $ | 858 | $ | 9,786 | $ | 2,230 | $ | (1,270 | ) | $ | 960 | ||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
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 $0 in 2017, 2016 and 2015. The determination of no need for additional provision was a result of the analysis of the adequacy of the allowance for loan losses calculation. The allowance for loan and lease losses does not include the loans acquired from the New Windsor acquisition which were recorded at fair value as of the acquisition date. 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. Management concluded that the loan portfolio exhibited continued general improvement in quantitative and qualitative measurements as shown in the tables and narrative in this Management's Discussion and Analysis and the Notes to the Consolidated Financial Statements. This assessment concluded that credit quality was stable, charge offs were low and past due loans manageable. This same analysis concluded that the unallocated allowance was appropriate.
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. ACNB charges confirmed loan losses to the allowance and credits the allowance for recoveries of previous loan charge-offs. For 2017, the Corporation had net charge-offs of $218,000 as compared to net charge-offs of $553,000 for 2016.
Other Income
Other income was $14,149,000 for the year ended December 31, 2017, a $941,000, or 7.1%, increase from 2016. Other income was $13,208,000 for the year ended December 31, 2016, an $802,000,
41
or 6.5%, increase from 2015. The largest source of other income is commissions from insurance sales from RIG, which increased 4.2% to $5,024,000 in 2017, and increased 4.1% to $4,822,000 in 2016. The increases were due to higher contingent commission payments and an increase in personal lines commission income. The contingent, or extra, commissions 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.
In 2017, no gain was recognized on sold or merged securities compared to a gain of $26,000 in 2016, and a gain of $261,000 in 2015. Securities were sold in 2015 to balance state and local geographic mix. In addition, an equity position recognized a $158,000 gain from a merger transaction in 2015 and an additional $26,000 in 2016 when the position was liquidated. Income from fiduciary, investment management and brokerage activities, which includes fees from both institutional and personal trust, investment management services, estate settlement and brokerage services, totaled $2,012,000 for the year ended December 31, 2017, as compared to $1,684,000 for 2016 and $1,589,000 for 2015. At December 31, 2017, ACNB had total assets under administration of approximately $327,000,000, compared to $195,000,000 at the end of 2016 and $178,000,000 at the end of 2015. $103,000,000 in brokerage relationships were brought over in the New Windsor acquisition. The variations in income were in part due to more assets under management and higher estate settlement income which varies with specific activity.
Service charges on deposit accounts increased 24.1% to $2,940,000, after increasing 2.6% in 2016, due to the acquired New Windsor deposit base and 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 17.5% to $1,762,000 due to higher volume including the acquired New Windsor deposit base. The longer term trend of increased fees 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. Another threat to this revenue source is the security breaches in the merchant base that are negatively affecting consumer confidence in the debit card channel. Income from sold mortgages, included in other income, decreased by $156,000, or 23.6%, to $505,000 in 2017 as customer demand moved to mortgage types that cannot be sold in the secondary market and must be retained in portfolio. This revenue source is subject to wide divergence due to national and local economic trends. 2016 experienced a $449,000 gain on the sale of a bank administrative office building in order to gain better efficiencies.
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. 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
42
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 the 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. Further, a new FASB update eliminates the second step test, thus basing impairment on the estimated fair value to the carrying value including goodwill.
As noted above, commissions from insurance sales were up 4.2% in 2017, and RIG's stand alone net income increased 3.4% in 2017 compared to 2016 (exclusive of income from deferred tax liability revaluing in conjunction with the Tax Act). The testing for potential impairment involves methods that include both current and projected income amounts, and RIG's fair value remained above the carrying value as of the most recent annual impairment test date. Thus, the results of the annual evaluations determined that there was no impairment of RIG's goodwill, including the testing at October 1, 2017. However, 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. The Corporation has not identified any such events, and, accordingly, has not tested goodwill resulting from the acquisition of New Windsor for impairment during the year ended December 31, 2017. ACNB plans on testing New Windsor goodwill during 2018. Should it be determined in a future period that the goodwill has been impaired, then a charge to earnings will be recorded in the period that such a determination is made.
Other Expenses
Other expenses increased 25.4% to $44,079,000 for the year ended December 31, 2017. The largest component of other expenses is salaries and employee benefits, which increased 11.1% in 2017 to $24,654,000 compared to $22,200,000 in 2016, and increased $1,268,000, or 6.1%, from 2015 to 2016. The reasons for the increase in salaries and employee benefits expenses include the following:
43
The Corporation reduced the benefit formula for the defined benefit pension plan effective January 1, 2010, in order to manage total benefit costs. Subsequently, 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 pension plan and no inactive or former plan participant shall be eligible to again participate in the pension plan. 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 fair value volatility and low discount rates. The expense will be lower in 2018 due to the improved plan return in 2017 and changes in discount rates. 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. In addition, the ACNB plan has maintained a well-funded status under ERISA rules.
Net occupancy expense was up 16.3% at $2,403,000 in 2017, $2,066,000 in 2016, and $2,170,000 in 2015. Equipment expense totaled $3,757,000 during 2017, as compared to $3,046,000 during 2016 and $3,007,000 during 2015. Occupancy expense was up in 2017 mostly due to seven more offices from the New Windsor acquisition and equipment expense increased in 2017 due to ongoing support and maintenance of financial systems applications and security technology. Equipment expense is subject to ever-increasing technology demands and the need for system upgrades for security and reliability purposes.
Professional services expense totaled $1,134,000 for 2017, as compared to $852,000 for 2016 and $844,000 for 2015. The variation in expense from year to year included varying legal costs associated with problem loans and corporate governance, as well as the expense of heightened compliance monitoring on existing regulations and the expense of implementing new regulations including the Dodd-Frank Act. Other tax expense increased $6,000 or 0.8% in 2017 compared to 2016 due to a rate increase mostly offset by recoveries on sales tax challenges, and increased from 2015 to 2016 due to increased net equity base. The 2018 expense will increase due to the addition of the equity increase from the New Windsor acquisition. Supplies and postage expense increased in 2017 compared to the prior year due to new offices and postage for the customer base of the NWSB Bank division. 2016 also increased from 2015 due to growth.
Marketing and corporate relations expense decreased 24.6% from 2016 to 2017, and increased 27.0% from 2015 to 2016. Marketing expense varies with the timing and amount of planned advertising production and media expenditures, typically related to the promotion of certain in-market banking and trust products.
FDIC and regulatory expense for 2017 was $644,000, an increase of $33,000 from $611,000 in 2016. FDIC and regulatory expense in 2015 was $665,000. FDIC expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.
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 expenses were $93,000, $55,000 and $119,000 for the years ended December 31, 2017, 2016 and 2015, respectively. Expenses increased in 2017 due to high carrying cost (maintenance, taxes, etc.) of the few properties held. The higher expense in 2015 was a result of properties that suffered decreases in value after acquisition (requiring write-downs to fair value) during the prolonged marketing cycles for these
44
distressed properties and, in some cases, during which the debtor remained in physical possession while eviction actions were contested and finally executed. Values are written down based upon updated appraisals less selling costs (which in the often extended marketing periods can create multiple year expenses) and other fair value adjustments, or in some cases properties are written down based on sales agreements that do not subsequently close. In all, the historically high costs of all years consisted of these write-downs and other costs to carry and was due to the increased number and varying mix of commercial and residential collateral for which such carrying costs include insurance, property maintenance, unpaid and ongoing property taxes, and deferred maintenance required upon acquisition. Foreclosed real estate expenses will vary in 2018 depending on the successful sales on some existing properties and the unknown expenses related to new properties acquired.
Intangible assets amortization increased 55.7% from the core deposit intangible in the New Windsor acquisition and to a lesser extent from small insurance books purchased. Other operating expense increased $689,000 or 19.8% in 2017 as a result of a variety of increases including various data channels, corporate governance and risk management (including training) expenditures. Other operating expense increased 5.9% in 2016 from 2015 as a result of a variety of variances in the same categories.
Acquisition and integration costs related to the New Windsor acquisition totaled $4,728,000 in 2017 compared to $472,000 in 2016. Merger expenses included legal and consulting expenses to effect the legal merger, investment banking and preparing purchase accounting adjustments. Integration expenses included certain severance payments to New Windsor staff separated by the merger, consultant costs to integrate New Windsor bank systems into ACNB's, and the cost to terminate all New Windsor core banking and electronic technology systems contracts. These costs were all necessary to provide requisite internal controls and cost effective core banking technology systems going forward. The costs of integrating all systems into one system was important to the acquisition viability and ongoing system integrity and quality.
Provision for Income Taxes
ACNB recognized income taxes of $6,634,000, or 40.4% of pretax income, during 2017, as compared to $3,768,000, or 25.7%, during 2016 and $3,761,000, or 25.5%, during 2015. The variances from the federal statutory rate 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), investment in bank-owned life insurance, and investments in low-income housing partnerships (which qualify for federal tax credits).
On December 22, 2017, the United States government enacted comprehensive tax legislation, known as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act made broad and complex changes to the U.S. tax code, including a reduction in the base corporate tax rate from the prior existing statutory rate, which was 35% for ACNB, to 21%. Based on estimates and current accounting guidance, the Corporation estimated that the Tax Act resulted in a charge against 2017 net income of approximately $1.7 million, due to the write down of ACNB's net deferred tax assets due to the Tax Act's reduction in the base corporate tax rate to 21%. This estimate was based on a review and analysis of the Corporation's net deferred tax assets at December 31, 2017, as well as adjustments to various deferred tax assets and deferred tax liabilities in the fourth quarter, including those accounted for in accumulated other comprehensive income.
Otherwise, the increasing effective tax rate during 2017, 2016, and 2015 was a result of increasing pretax income in relationship to expiration of tax credits and lower levels of tax-exempt investments. Pretax income increased due to internal growth and the New Windsor acquisition. At December 31, 2017, net deferred tax assets amounted to $2,739,000. Deferred tax assets are realizable primarily through future reversal of existing taxable temporary differences and future earnings. Management
45
currently anticipates timing difference reversals will be adequate to utilize deferred tax assets. Accordingly, no valuation allowance has been established for deferred tax assets at December 31, 2017.
FINANCIAL CONDITION
Average earning assets increased in 2017 to $1,318,741,000, or by 20.9%, from $1,090,326,000 in 2016 following $1,031,924,000 in 2015. ACNB's overnight interest bearing deposits decreased in 2017 on average, as more funds were allocated into investments. On average, investments increased in 2017 and 2016 to properly collateralize public deposits. Average loans increased 25.9% and 6.2% on average in 2017 and 2016, respectively. Besides $263,450,000 in loans acquired from New Windsor, growth in loans was funded by increased deposits, investment cash flow and term FHLB borrowings. Average deposits increased 22.4% in 2017 to $1,146,311,000 from $936,190,000 in 2016 and $877,448,000 in 2015. Deposit growth was the result of the New Windsor acquisition. Average borrowings increased in 2017 to $126,958,000 from $116,459,000 in 2016 and $118,670,000 in 2015. Fluctuations in borrowings are term borrowing to fund loan demand and variations in local customer repurchase accounts, which are akin to deposits.
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 changes in the securities portfolio in 2017 were mainly to provide proper collateral for public deposits. Investing into investment security portfolio assets over the last several years was made more challenging due to the Federal Reserve Bank's program commonly called Quantitative Easing in which, by the Federal Reserve's open market purchases, the yields were maintained at a lower level than would otherwise be the case. Fair value of $21,264,000 was acquired through the New Windsor acquisition. These securities were similar to the portfolio mix of ACNB. 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 December 31, 2017, the securities balance included a net unrealized loss on available for sale securities of $957,000, net of taxes, on amortized cost of $160,290,000 versus a net unrealized loss of $266,000, net of taxes, on amortized cost of $143,393,000 at December 31, 2016. The change in fair value of available for sale securities during 2017 was a result of the securities acquired from New Windsor and the higher amount of investments in the available for sale portfolio, offset in part by a decrease in fair value from an increase in the U.S. Treasury yield curve rates and the spread from this yield curve required by investors on the types of investment securities that ACNB owns. The Federal Reserve ceased their rate-decreasing Quantitative Easing program in 2014 and increased the fed funds rate in mid-December 2015 through 2017, along with an U.S. presidential election result that, at least to date, has caused the U. S. Treasury yield curve to increase in the time terms relevant to the investment securities in the Corporation's portfolio. Previously, after a prolonged period of inaction by the Federal Reserve after lowering rates on the yield curve most conducive to stimulating the housing market and to boost employment and consumption was augmented by a combination of weak domestic and international economic conditions, leading to generally lower rates on the yield curve. However, fair values were volatile on any given day in 2017 and such volatility will continue.
At December 31, 2017, the securities balance included held to maturity securities with an amortized cost of $44,829,000 and a fair value of $44,549,000, as compared to an amortized cost of $55,568,000 and a fair value of $55,425,000 at December 31, 2016. The held to maturity securities are U.S. government agency debentures and pass-through mortgage-backed securities in which the full payment of principal and interest is guaranteed; however, they were not classified as available for sale because these securities are generally used as required collateral for certain eligible government accounts or repurchase agreements. They are also held for possible pledging to access additional liquidity for banking subsidiary needs in the form of FHLB borrowings. No held to maturity securities were acquired from New Windsor.
46
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 but rather by relying on the security's relationship to other benchmark quoted prices. The Corporation uses independent service providers to provide matrix pricing. Please refer to Note C"Securities" in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note L"Fair Value Measurements" in the Notes to Consolidated Financial Statements for more information about fair value.
The following tables set forth the composition of the securities portfolio and the securities maturity schedule, including weighted average yield, as of the end of the years indicated:
Table 3Investment Securities
In thousands |
2017 | 2016 | 2015 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
AVAILABLE FOR SALE SECURITIES AT FAIR VALUE |
||||||||||
U.S. Government and agencies |
$ | 104,083 | $ | 79,579 | $ | 46,029 | ||||
Mortgage-backed securities |
34,833 | 31,973 | 42,839 | |||||||
State and municipal |
13,294 | 24,660 | 28,078 | |||||||
Corporate bonds |
5,057 | 5,062 | 6,955 | |||||||
CRA mutual fund |
1,035 | 1,035 | 1,053 | |||||||
Stock in other banks |
749 | 681 | 739 | |||||||
| | | | | | | | | | |
|
159,051 | 142,990 | 125,693 | |||||||
| | | | | | | | | | |
HELD TO MATURITY SECURITIES AT AMORTIZED COST |
||||||||||
U.S. Government and agencies |
19,000 | 23,017 | 31,044 | |||||||
Mortgage-backed securities |
25,829 | 32,551 | 40,498 | |||||||
| | | | | | | | | | |
|
44,829 | 55,568 | 71,542 | |||||||
| | | | | | | | | | |
TOTAL |
$ | 203,880 | $ | 198,558 | $ | 197,235 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Table 4 discloses investment securities at the scheduled maturity date at December 31, 2017. Many securities have call features that make their redemption possible before the stated maturity date.
Table 4Securities Maturity Schedule
|
1 Year or Less | Over 1 - 5 Years | Over 5 - 10 Years |
Over 10 Years or No Maturity |
Total | ||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Dollars in thousands |
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||
U.S. Government and agencies |
$ | 18,996 | 1.22 | % | $ | 99,713 | 1.96 | % | $ | 6,119 | 2.20 | % | $ | 71 | 1.45 | % | $ | 124,899 | 1.86 | % | |||||||||||
Mortgage-backed securities |
183 | 5 | 5,821 | 3.35 | 24,184 | 2.74 | 30,114 | 2.42 | 60,302 | 2.65 | |||||||||||||||||||||
State and municipal |
1,655 | 2.07 | 9,774 | 3.20 | 1,798 | 3.33 | | | 13,227 | 3.08 | |||||||||||||||||||||
Corporate bonds |
| | | | 5,000 | 2.36 | | | 5,000 | 2.36 | |||||||||||||||||||||
CRA mutual fund |
| | | | | | 1,044 | | 1,044 | | |||||||||||||||||||||
Stock in other banks |
| | | | | | 647 | | 647 | | |||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
$ | 20,834 | 1.32 | % | $ | 115,308 | 2.13 | % | $ | 37,101 | 2.63 | % | $ | 31,876 | 2.29 | % | $ | 205,119 | 2.16 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Securities are at amortized cost. Mortgage-backed securities are allocated based upon scheduled maturities.
47
Loans
Year over year, loans outstanding increased by $336,260,000, or 37.0%, in 2017, as compared to 6.4% growth experienced in 2016; the increase in 2017 was primarily from the fair value acquired from New Windsor of $263,450,000 and the balance was a net increase of new loans net of payoff and paydowns. Both years demonstrated the determined efforts by management to lend to creditworthy borrowers subject to the Corporation's disciplined underwriting standards, despite the generally slow economic conditions and intense competition. The higher percentage increase in 2017 was largely due to the increase in loan value from the New Windsor acquisition. Within the portfolio, higher growth was centered in increased commercial purpose loans/commercial construction loans, while lower growth was in local market residential mortgages. The commercial purpose segments increased $219,553,000, or 46.3%, during 2017, spread among diverse categories that include farmland secured, loans to local government units, and other types of commercial lending. Residential real estate mortgage lending, which includes smaller commercial purpose loans secured by the owner's home, increased by $115,074,000, or 27.5%, to local borrowers who preferred loan types that would not be sold into the secondary mortgage market. Included in the mortgage increase were $44,205,000 in residential mortgage loans secured by junior liens or home equity loans, which are also in many cases junior liens. Junior liens inherently have more credit risk by virtue of the fact that another financial institution may have a senior security position in the case of foreclosure liquidation of collateral to extinguish the debt. Generally, foreclosure actions could become more prevalent if the real estate market weakens, property values deteriorate, or rates increase sharply. Included in commercial purpose were real estate construction loans up $20,289,000, or 132.9% in 2017, as a result of some stabilization in the residential real estate market despite stricter underwriting on this loan type due to the category's credit attributes.
A similar higher mix of commercial purpose loans was included in the $54,950,000 or 6.4% increase in 2016 compared to 2015 as the result of efforts in commercial real estate lending as residential mortgages were mostly sold.
Included in the commercial, financial and agricultural category are loans to Pennsylvania school districts, municipalities (including townships) and essential purpose authorities. In most cases, these loans are backed by the general obligation of the local government body. In many cases, these loans are obtained through a bid process with other local and regional banks. The loans are bank qualified for mostly tax-free interest income treatment for federal income taxes. These loans totaled $88,484,000 in 2017, an increase of 20.8% over $73,242,000 held at the end of 2016. The amount outstanding at the end of 2015 was $59,948,000, an increase of $12,595,000 over 2014.
Table 5Loan Portfolio
Loans at December 31 were as follows:
In thousands |
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial, financial and agricultural |
$ | 165,829 | $ | 140,344 | $ | 117,692 | $ | 74,855 | $ | 59,217 | ||||||
Real estate: |
||||||||||||||||
Commercial |
492,759 | 318,980 | 289,899 | 281,582 | 239,186 | |||||||||||
Construction |
35,560 | 15,271 | 13,429 | 12,210 | 11,196 | |||||||||||
Residential |
533,685 | 418,611 | 417,352 | 415,348 | 404,861 | |||||||||||
Consumer |
16,337 | 14,704 | 14,588 | 15,277 | 14,188 | |||||||||||
| | | | | | | | | | | | | | | | |
Total Loans |
$ | 1,244,170 | $ | 907,910 | $ | 852,960 | $ | 799,272 | $ | 728,648 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
48
The repricing range of the loan portfolio at December 31, 2017, and the amounts of loans with predetermined and fixed rates are presented in the tables below:
Table 6Loan Sensitivities
LOANS MATURING
In thousands |
Less than 1 Year |
1 - 5 Years | Over 5 Years |
Total | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial, financial and agricultural |
$ | 16,019 | $ | 54,683 | $ | 95,127 | $ | 165,829 | |||||
Real estate: |
|||||||||||||
Commercial |
19,713 | 150,781 | 322,265 | 492,759 | |||||||||
Construction |
10,459 | 12,017 | 13,084 | 35,560 | |||||||||
Residential |
58,836 | 120,005 | 354,844 | 533,685 | |||||||||
| | | | | | | | | | | | | |
Total |
$ | 105,027 | $ | 337,486 | $ | 785,320 | $ | 1,227,833 | |||||
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
LOANS BY REPRICING OPPORTUNITY
In thousands |
Less than 1 Year |
1 - 5 Years | Over 5 Years |
Total | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial, financial and agricultural |
$ | 39,503 | $ | 44,910 | $ | 81,416 | $ | 165,829 | |||||
Real estate: |
|||||||||||||
Commercial |
159,095 | 239,117 | 94,547 | 492,759 | |||||||||
Construction |
11,777 | 6,800 | 16,983 | 35,560 | |||||||||
Residential |
165,104 | 92,705 | 275,876 | 533,685 | |||||||||
| | | | | | | | | | | | | |
Total |
$ | 375,479 | $ | 383,532 | $ | 468,822 | $ | 1,227,833 | |||||
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Loans with a fixed interest rate |
$ | 12,814 | $ | 74,658 | $ | 392,875 | $ | 480,347 | |||||
Loans with a variable interest rate |
362,665 | 308,874 | 75,947 | 747,486 | |||||||||
| | | | | | | | | | | | | |
Total |
$ | 375,479 | $ | 383,532 | $ | 468,822 | $ | 1,227,833 | |||||
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Most of the Corporation's lending activities are with customers located within southcentral Pennsylvania and in the northern Maryland area. This region currently and historically has lower unemployment than the U.S. as a whole. Included in commercial real estate loans are loans made to lessors of non-residential properties that total $269,080,000, or 21.6% of total loans, at December 31, 2017. These borrowers are geographically dispersed throughout ACNB's marketplace and are leasing commercial properties to a varied group of tenants including medical offices, retail space, and other commercial purpose facilities. Because of the varied nature of the tenants, in aggregate, management believes that these loans present an acceptable risk when compared to commercial loans in general. ACNB does not originate or hold Alt-A or subprime mortgages in its loan portfolio.
Asset Quality
The ACNB loan portfolio is subject to varying degrees of credit risk. Credit risk is mitigated through prudent underwriting standards, ongoing credit review, and monitoring and reporting asset quality measures. Additionally, loan portfolio diversification, limiting exposure to a single industry or borrower, and requiring collateral also reduces ACNB's credit risk.
ACNB's commercial, consumer and residential mortgage loans are principally to borrowers in southcentral Pennsylvania and northern Maryland. As the majority of ACNB's loans are located in this area, a substantial portion of the debtor's ability to honor the obligation may be affected by the level of economic activity in the market area.
49
The unemployment rate in ACNB's market area remained below the state and national average during 2017. Additionally, low interest rates, a less volatile local economy, and minimal inflation continued to provide some support to the economic conditions in the area. During 2017, continued low activity in new residential real estate development/construction and general lower economic activity lingered from the 2007 to 2009 major recession, challenging the Corporation's marketplace commercial activity. Slower growth areas such as ACNB's marketplace generally do not retract in economic recessions as quickly and as low as other areas of the country, however the recovery from low economic cycles are also generally slower.
Non-performing assets include nonaccrual loans and restructured loans (troubled debt restructures or TDRs), accruing loans past due 90 days or more, and other foreclosed assets. The accrual of interest on residential mortgage and commercial loans (consisting of commercial and industrial, commercial real estate, and commercial real estate construction loan categories) is discontinued at the time the loan is 90 days past due unless the credit is well secured and in the process of collection. Consumer loans (consisting of home equity lines of credit and consumer loan categories) are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. ACNB occasionally returns nonaccrual loans to performing status when the borrower brings the loan current and performs in accordance with contractual terms for a reasonable period of time. ACNB categorizes a loan as a TDR if it changes the terms of the loan, such as interest rate, repayment schedule or both, to terms that it otherwise would not have granted to a borrower, for economic or legal reasons related to the borrower's financial difficulties.
The following table sets forth the Corporation's non-performing assets as of the end of the years indicated:
Table 7Non-Performing Assets
Dollars in thousands |
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Nonaccrual loans, including TDRs |
$ | 6,355 | $ | 4,502 | $ | 3,699 | $ | 6,648 | $ | 8,573 | ||||||
Accruing loans 90 days past due |
1,507 | 1,345 | 2,132 | 1,636 | 1,926 | |||||||||||
| | | | | | | | | | | | | | | | |
Total Non-Performing Loans |
7,862 | 5,847 | 5,831 | 8,284 | 10,499 | |||||||||||
| | | | | | | | | | | | | | | | |
Foreclosed assets |
436 | 256 | 580 | 1,617 | 1,762 | |||||||||||
| | | | | | | | | | | | | | | | |
Total Non-Performing Assets |
$ | 8,298 | $ | 6,103 | $ | 6,411 | $ | 9,901 | $ | 12,261 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total Accruing Troubled Debt Restructurings |
$ | 3,982 | $ | 7,443 | $ | 6,792 | $ | 6,968 | $ | 7,139 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Ratios: |
||||||||||||||||
Non-performing loans to total loans |
0.63 | % | 0.64 | % | 0.68 | % | 1.04 | % | 1.44 | % | ||||||
Non-performing assets to total assets |
0.52 | % | 0.51 | % | 0.56 | % | 0.91 | % | 1.17 | % | ||||||
Allowance for loan losses to non-performing loans |
177.77 | % | 242.76 | % | 252.91 | % | 183.15 | % | 153.26 | % |
If interest due on all nonaccrual loans had been accrued at original contract rates, it is estimated that income before income taxes would have been greater by $437,000 in 2017, $369,000 in 2016, and $456,000 in 2015. The increase in nonaccrual loans from 2016 to 2017 is discussed further below.
Impaired loans at December 31, 2017 and 2016, totaled $10,337,000 and $11,945,000, respectively. At December 31, 2017 and 2016, $3,405,000 and $377,000, respectively, of the impaired loans were troubled debt restructured loans, which were also classified as nonaccrual. $3,982,000 and $7,443,000 of the impaired loans were accruing troubled debt restructured loans at December 31, 2017 and 2016, respectively. Loans whose terms are modified are classified as troubled debt restructurings if the borrowers have been granted concessions and it is deemed that those borrowers are experiencing
50
financial difficulty. Concessions granted under a troubled debt restructuring generally involve interest rates being granted below current market rates for the credit risk of the loan or an extension of a loan's stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired. The related allowance for loan losses on impaired loans totaled $1,229,000 and $932,000 at December 31, 2017 and 2016, respectively. The decrease in accruing troubled debt restructurings was due to a retreat property that was moved to nonaccrual status in 2017 when continued payments were in doubt. The increase in nonaccrual loans was related to the retreat property and smaller credits net of payments received. Potential problem loans are defined as performing loans that have characteristics that cause management to have doubts as to the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as non-performing loans in the future. Total additional potential problem loans approximated $1,064,000 at December 31, 2017, compared to $2,768,000 at December 31, 2016.
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 such real estate in lieu of the foreclosure process. Fair values are based on appraisals that consider the sale prices of similar properties in the proximate vicinity less estimated selling costs. Foreclosed assets held for resale totaled $436,000 at December 31, 2017. One construction real estate property was brought into foreclosed real estate in 2015 with an aggregate fair value of $63,000. In addition, the fair value of $373,000 for foreclosed real estate at December 31, 2017, represented one business and two residential real estate single family homes, which were taken into foreclosed real estate in 2017. All properties are being actively marketed to targeted buyers by external and internal resources. The total of $256,000 in foreclosed real estate at December 31, 2016, represented one construction real estate property, and three single family homes.
Allowance for Loan Losses
ACNB maintains the allowance for loan losses at a level believed to be adequate by management to absorb probable losses in the loan portfolio, and it is funded through a provision for loan losses charged to earnings. On a quarterly basis, ACNB utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan losses, historical experience, and qualitative factors. This methodology results in an allowance that is considered appropriate in light of the high degree of judgment required and that is prudent and conservative, but not excessive.
Management assigns internal risk ratings for each commercial lending relationship. Utilizing historical loss experience, adjusted for changes in trends, conditions and other relevant factors, management derives estimated losses for non-rated and non-classified loans. When management identifies impaired loans with uncertain collectibility of principal and interest, it evaluates a specific reserve on a quarterly basis in order to estimate potential losses. Management's analysis considers:
If management determines a loan is not impaired, a specific reserve allocation is not required. Management then places the loan in a pool of loans with similar risk factors and assigns the general loss factor to determine the reserve. For homogeneous loan types, such as consumer and residential mortgage loans, management bases specific allocations on the average loss ratio for the previous three
51
years for each specific loan pool. Additionally, management adjusts projected loss ratios for other factors, including the following:
Management determines the unallocated portion of the allowance for loan losses, which represents the difference between the reported allowance for loan losses and the calculated allowance for loan losses, based on the following criteria:
The unallocated portion of the allowance is deemed to be appropriate as it reflects an uncertainty that remains in the loan portfolio; specifically reserves where the Corporation believes that tertiary losses are probable above the loss amount derived using appraisal-based loss estimation, where such additional loss estimates are in accordance with regulatory and GAAP guidance. Appraisal-based loss derivation does not fully develop the loss present in certain unique, ultimately bank-owned collateral. The Corporation has determined that the amount of provision in 2017 and the resulting allowance at December 31, 2017, are appropriate given the continuing level of risk in the loan portfolio. Further, management believes the unallocated allowance is appropriate, because even though the impaired loans added since 2016 demonstrate generally low risk due to adequate real estate collateral, the value of such collateral can decrease; plus, the growth in the loan portfolio is centered around commercial real estate which continues to have little increase in value and low liquidity. In addition, there are certain loans that, although they did not meet the criteria for impairment, management believes there was a strong possibility that these loans represented potential losses at December 31, 2017. The amount of unallocated decreased at December 31, 2017 as management concluded that the loan portfolio exhibited continued general improvement in quantitative and qualitative measurements. This assessment concluded that credit quality was stable, charge offs were low and past due loans manageable.
Management believes the above methodology accurately reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology and the assumptions discussed above.
Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the methodology discussed above, which is consistent with recent improvement in the
52
credit quality in the loan portfolio. The provision for 2017 was $0, or the same as the provision for 2016 and 2015. The decrease in the allowance for loan losses to total loans of 1.56% at December 31, 2016 to 1.12% at December 31, 2017, is primarily related to the acquisition of New Windsor loans at fair value with no allowance for loan losses accordingly at the acquisition date.
Federal and state regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management's comprehensive analysis of the loan portfolio and economic conditions, management believes the current level of the allowance for loan losses is adequate.
The following tables set forth information on the analysis of the allowance for loan losses and the allocation of the allowance for loan losses as of the dates indicated:
Table 8Analysis of Allowance for Loan Losses
|
Years Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Dollars in thousands |
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||
Beginning balance |
$ | 14,194 | $ | 14,747 | $ | 15,172 | $ | 16,091 | $ | 16,825 | ||||||
Provision for loan losses |
| | | 150 | 1,450 | |||||||||||
Loans charged-off: |
||||||||||||||||
Commercial, financial and agricultural |
181 | 318 | 150 | 132 | 178 | |||||||||||
Commercial real estate and construction |
| 135 | 39 | 121 | 996 | |||||||||||
Residential mortgage |
141 | 263 | 637 | 874 | 1,062 | |||||||||||
Consumer |
139 | 50 | 111 | 64 | 191 | |||||||||||
| | | | | | | | | | | | | | | | |
Total Loans Charged-Off |
461 | 766 | 937 | 1,191 | 2,427 | |||||||||||
| | | | | | | | | | | | | | | | |
Recoveries: |
||||||||||||||||
Commercial, financial and agricultural |
21 | 45 | 369 | 15 | 235 | |||||||||||
Commercial real estate and construction |
141 | 132 | | | | |||||||||||
Residential mortgage |
62 | 25 | 136 | 97 | 4 | |||||||||||
Consumer |
19 | 11 | 7 | 10 | 4 | |||||||||||
| | | | | | | | | | | | | | | | |
Total Recoveries |
243 | 213 | 512 | 122 | 243 | |||||||||||
| | | | | | | | | | | | | | | | |
Net charge-offs |
218 | 553 | 425 | 1,069 | 2,184 | |||||||||||
| | | | | | | | | | | | | | | | |
Ending balance |
$ | 13,976 | $ | 14,194 | $ | 14,747 | $ | 15,172 | $ | 16,091 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Ratios: |
||||||||||||||||
Net charge-offs to average loans |
0.02 | % | 0.06 | % | 0.05 | % | 0.14 | % | 0.31 | % | ||||||
Allowance for loan losses to total loans |
1.12 | % | 1.56 | % | 1.73 | % | 1.90 | % | 2.21 | % |
53
Table 9Allocation of the Allowance for Loan Losses
|
2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Dollars in thousands |
Amount | Percent of Loan Type to Total Loans |
Amount | Percent of Loan Type to Total Loans |
Amount | Percent of Loan Type to Total Loans |
Amount | Percent of Loan Type to Total Loans |
Amount | Percent of Loan Type to Total Loans |
|||||||||||||||||||||
Commercial, financial and agricultural |
$ | 3,219 | 13.3 | % | $ | 3,055 | 15.5 | % | $ | 2,508 | 13.8 | % | $ | 2,048 | 9.4 | % | $ | 1,915 | 8.1 | % | |||||||||||
Real estate: |
|||||||||||||||||||||||||||||||
Commercial |
5,228 | 39.6 | 4,968 | 35.1 | 5,216 | 34.0 | 5,872 | 35.2 | 5,819 | 32.8 | |||||||||||||||||||||
Construction |
126 | 2.9 | 147 | 1.7 | 112 | 1.6 | 194 | 1.5 | 247 | 1.5 | |||||||||||||||||||||
Residential |
3,838 | 42.9 | 4,126 | 46.1 | 3,968 | 48.9 | 4,402 | 52.0 | 4,550 | 55.6 | |||||||||||||||||||||
Consumer |
749 | 1.3 | 923 | 1.6 | 1,083 | 1.7 | 1,050 | 1.9 | 947 | 2.0 | |||||||||||||||||||||
Unallocated |
816 | N/A | 975 | N/A | 1,860 | N/A | 1,606 | N/A | 2,613 | N/A | |||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total |
$ | 13,976 | 100.0 | % | $ | 14,194 | 100.0 | % | $ | 14,747 | 100.0 | % | $ | 15,172 | 100.0 | % | $ | 16,091 | 100.0 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The allowance for loan losses at December 31, 2017, was $13,976,000, or 1.12% of loans, as compared to $14,194,000, or 1.56% of loans, at December 31, 2016. The ratio of non-performing loans plus foreclosed assets to total assets was 0.52% at December 31, 2017, as compared to 0.51% at December 31, 2016.
Loans past due 90 days and still accruing were $1,507,000 and nonaccrual loans were $6,355,000 as of December 31, 2017. Loans past due 90 days and still accruing were $1,345,000 at December 31, 2016, while nonaccruals were $4,502,000.
Additional information on nonaccrual loans at December 31, 2017 and 2016, is as follows:
Dollars in thousands |
Number of Credit Relationships |
Balance | Current Specific Loss Allocations |
Current Year Charge-Offs |
Location | Originated | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31, 2017 |
||||||||||||||||
Owner occupied commercial real estate |
9 | 4,378 | 60 | | In market | 1995 - 2012 | ||||||||||
Investment/rental residential real estate |
2 | 478 | 377 | | In market | 2003 - 2011 | ||||||||||
Commercial and industrial |
3 | 1,499 | 792 | | In market | 2006 - 2015 | ||||||||||
| | | | | | | | | | | | | | | | |
Total |
14 | $ | 6,355 | $ | 1,229 | $ | | |||||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
December 31, 2016 |
||||||||||||||||
Commercial real estate construction |
1 | $ | 300 | $ | | $ | | In market | 2014 | |||||||
Owner occupied commercial real estate |
7 | 1,593 | | | In market | 1995 - 2012 | ||||||||||
Investment/rental residential real estate |
3 | 483 | 333 | 61 | In market | 2003 - 2011 | ||||||||||
Commercial and industrial |
3 | 2,126 | 599 | | In market | 2006 - 2015 | ||||||||||
| | | | | | | | | | | | | | | | |
Total |
14 | $ | 4,502 | $ | 932 | $ | 61 | |||||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
All nonaccrual impaired loans are to borrowers located within the market area served by the Corporation in southcentral Pennsylvania and nearby areas of northern Maryland. All nonaccrual impaired loans were originated by ACNB's banking subsidiary, except for one participation loan discussed below, between 1995 and 2015 for purposes listed in the classifications in the table above.
54
Included in commercial real estate construction at December 31, 2017, the Corporation had no impaired and nonaccrual loans. On another loan previously in this category, foreclosure was held in abeyance while allowing the pursuit of a workout plan. The workout plan resulted in payment of the impaired nonaccrual balance concluding in the second quarter of 2016.
Owner occupied commercial real estate and construction includes nine unrelated loan relationships, all of which, except for a $2,256,000 loan relationship for a retreat property, have balances of less than $833,000 each, for which the real estate is collateral and is used in connection with a business enterprise that is suffering economic stress or is out of business. The retreat property loan originated in 2008 was added to nonaccrual in the second quarter of 2017 and is current with modified terms and is supported by adequate collateral. One of two improved parcels is being actively marketed for sale. Another property added in the second quarter of 2017 is an $832,000 loan with modified terms and conditions originated in 2011 secured by a tourism related lodging real estate that was assigned $60,000 in specific allocation based on sales contract. The property was sold subsequent to year end at a smaller loss. A third property added in the second quarter of 2017 is a $597,000 loan relationship ($444,000 in commercial and industrial and $153,000 in owner occupied commercial real estate) with normal terms and conditions secured by a construction business assets that was assigned $247,000 in specific allocation based on bankruptcy filings. All assets including real estate are being liquidated with bankruptcy court supervision. The other loans in this category were originated between 1995 and 2012 and are business loans impacted by specific borrower credit situations. Most loans in this category are making principal payments. Collection efforts will continue unless it is deemed in the best interest of the Corporation to initiate foreclosure procedures. One loan was removed in 2017 after the borrower established an extended period of regular payments.
Investment/rental residential real estate includes two loan relationships totaling $478,000 for which the real estate is collateral and the purpose of which is for speculation, rental, or other non-owner occupied uses. One $377,000 loan with multiple separate rental houses was added in the second quarter of 2016 and has a $377,000 specific loss allocation based on a current appraisal adjusted for partial sales. One unrelated loan for approximately $100,000, in this category at April 2015, was stayed from further foreclosure action by a bankruptcy filing.
Included in impaired commercial and industrial loans is a participation loan with standard terms and conditions including repayment from conversion of trade assets for a business in southcentral Pennsylvania in Chapter 11 bankruptcy that has a balance of $188,000, which is net of $1,528,000 in principal payments since it was moved to nonaccrual in the third quarter of 2014 after becoming delinquent. Liquidation of trade assets is in process. Besides trade assets, the loan is fully guaranteed by a government sponsored entity so no specific allocation was deemed to be necessary. An unrelated $868,000 commercial loan relationship to finance a subcontract and change orders was moved to nonaccrual in the fourth quarter of 2016 with a $517,000 specific allocation when part of the amount due to the subcontractor to perform on the loan was in dispute with the contractor and continues to be litigated.
The Corporation utilizes a systematic review of its loan portfolio on a quarterly basis in order to determine the adequacy of the allowance for loan losses. In addition, ACNB engages the services of an outside independent loan review function and sets the timing and coverage of loan reviews during the year. The results of this independent loan review are included in the systematic review of the loan portfolio. The allowance for loan losses consists of a component for individual loan impairment, primarily based on the loan's collateral fair value and expected cash flow. A watch list of loans is identified for evaluation based on internal and external loan grading and reviews. Loans other than those determined to be impaired are grouped into pools of loans with similar credit risk characteristics. These loans are evaluated as groups with allocations made to the allowance based on historical loss experience adjusted for current trends in delinquencies, trends in underwriting and oversight, concentrations of credit, and general economic conditions within the Corporation's trading area. The
55
provision expense was based on the loans discussed above, as well as current trends in the watch list and the local economy as a whole. The charge-offs discussed elsewhere in this Management's Discussion and Analysis create the recent l