UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

Commission file number 1-35015

 

ACNB CORPORATION

(Exact name of Registrant as specified in its charter)

 

Pennsylvania

 

23-2233457

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

16 Lincoln Square, Gettysburg, Pennsylvania

 

17325

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (717) 334-3161

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $2.50 par value per share

 

The NASDAQ Stock Market, LLC

 

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 x 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 x No o

 

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.

 

Large accelerated filer o

Accelerated filer x

 

 

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 Exchange Act).  Yes o No x

 

The number of shares of the Registrant’s Common Stock outstanding on August 3, 2018, was 7,038,768.

 

 

 



 

PART I - FINANCIAL INFORMATION

 

ACNB CORPORATION

ITEM 1 - FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)

 

Dollars in thousands, except per share data

 

June 30,
2018

 

June 30,
2017

 

December 31,
2017

 

 

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

18,403

 

$

17,384

 

$

19,304

 

Interest bearing deposits with banks

 

44,650

 

8,896

 

15,137

 

 

 

 

 

 

 

 

 

Total Cash and Cash Equivalents

 

63,053

 

26,280

 

34,441

 

 

 

 

 

 

 

 

 

Equity securities with readily determinable fair values

 

1,767

 

 

 

Debt securities available for sale

 

152,424

 

133,719

 

159,051

 

Securities held to maturity, fair value $39,145; $50,000; $44,549

 

39,894

 

50,088

 

44,829

 

Loans held for sale

 

1,265

 

1,278

 

1,736

 

Loans, net of allowance for loan losses $13,143; $14,148; $13,976

 

1,233,655

 

955,527

 

1,230,194

 

Premises and equipment

 

26,379

 

18,170

 

26,774

 

Restricted investment in bank stocks

 

4,849

 

4,899

 

4,773

 

Investment in bank-owned life insurance

 

45,973

 

41,273

 

44,935

 

Investments in low-income housing partnerships

 

2,213

 

2,690

 

2,446

 

Goodwill

 

19,580

 

6,308

 

19,580

 

Intangible assets

 

2,801

 

526

 

2,569

 

Foreclosed assets held for resale

 

287

 

63

 

436

 

Other assets

 

29,202

 

21,115

 

23,668

 

 

 

 

 

 

 

 

 

Total Assets

 

$

1,623,342

 

$

1,261,936

 

$

1,595,432

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Non-interest bearing

 

$

288,215

 

$

190,572

 

$

279,413

 

Interest bearing

 

1,045,760

 

809,582

 

1,019,079

 

 

 

 

 

 

 

 

 

Total Deposits

 

1,333,975

 

1,000,154

 

1,298,492

 

 

 

 

 

 

 

 

 

Short-term borrowings

 

26,418

 

30,837

 

36,908

 

Long-term borrowings

 

89,816

 

95,850

 

94,600

 

Other liabilities

 

12,826

 

11,251

 

11,466

 

 

 

 

 

 

 

 

 

Total Liabilities

 

1,463,035

 

1,138,092

 

1,441,466

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Preferred stock, $2.50 par value; 20,000,000 shares authorized; no shares outstanding

 

 

 

 

Common stock, $2.50 par value; 20,000,000 shares authorized; 7,101,368, 6,139,499 and 7,086,258 shares issued; 7,038,768, 6,076,899 and 7,023,658 shares outstanding

 

17,753

 

15,349

 

17,716

 

Treasury stock, at cost (62,600 shares)

 

(728

)

(728

)

(728

)

Additional paid-in capital

 

38,193

 

11,287

 

37,777

 

Retained earnings

 

113,772

 

103,488

 

106,293

 

Accumulated other comprehensive loss

 

(8,683

)

(5,552

)

(7,092

)

 

 

 

 

 

 

 

 

Total Stockholders’ Equity

 

160,307

 

123,844

 

153,966

 

 

 

 

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

$

1,623,342

 

$

1,261,936

 

$

1,595,432

 

 

 The accompanying notes are an integral part of the consolidated financial statements.

 

2



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Dollars in thousands, except per share data

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

INTEREST AND DIVIDEND INCOME

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

14,623

 

$

9,964

 

$

28,780

 

$

19,494

 

Securities:

 

 

 

 

 

 

 

 

 

Taxable

 

929

 

784

 

1,832

 

1,584

 

Tax-exempt

 

59

 

117

 

124

 

267

 

Dividends

 

74

 

64

 

152

 

113

 

Other

 

179

 

33

 

231

 

37

 

 

 

 

 

 

 

 

 

 

 

Total Interest Income

 

15,864

 

10,962

 

31,119

 

21,495

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Deposits

 

1,206

 

687

 

2,340

 

1,322

 

Short-term borrowings

 

11

 

15

 

27

 

60

 

Long-term borrowings

 

556

 

429

 

1,099

 

816

 

 

 

 

 

 

 

 

 

 

 

Total Interest Expense

 

1,773

 

1,131

 

3,466

 

2,198

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

14,091

 

9,831

 

27,653

 

19,297

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR LOAN LOSSES

 

320

 

 

570

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income after Provision for Loan Losses

 

13,771

 

9,831

 

27,083

 

19,297

 

 

 

 

 

 

 

 

 

 

 

OTHER INCOME

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

810

 

617

 

1,626

 

1,187

 

Income from fiduciary, investment management and brokerage activities

 

559

 

478

 

1,130

 

920

 

Earnings on investment in bank-owned life insurance

 

281

 

276

 

538

 

531

 

Gain on life insurance proceeds

 

 

 

52

 

 

Net gains on sales of securities

 

13

 

 

13

 

 

Net gains (losses) on equity securities

 

6

 

 

(27

)

 

Service charges on ATM and debit card transactions

 

614

 

381

 

1,144

 

739

 

Commissions from insurance sales

 

1,707

 

1,564

 

2,908

 

2,718

 

Other

 

327

 

212

 

645

 

515

 

 

 

 

 

 

 

 

 

 

 

Total Other Income

 

4,317

 

3,528

 

8,029

 

6,610

 

 

 

 

 

 

 

 

 

 

 

OTHER EXPENSES

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

6,683

 

5,934

 

13,310

 

11,682

 

Net occupancy

 

720

 

496

 

1,499

 

1,033

 

Equipment

 

1,321

 

844

 

2,483

 

1,627

 

Other tax

 

235

 

168

 

441

 

379

 

Professional services

 

344

 

344

 

713

 

583

 

Supplies and postage

 

177

 

168

 

392

 

337

 

Marketing and corporate relations

 

165

 

138

 

268

 

202

 

FDIC and regulatory

 

164

 

140

 

348

 

279

 

Merger related expenses

 

 

208

 

 

370

 

Intangible assets amortization

 

182

 

82

 

366

 

162

 

Foreclosed real estate expenses (income)

 

84

 

(14

)

132

 

16

 

Other operating

 

1,176

 

1,126

 

2,285

 

1,964

 

 

 

 

 

 

 

 

 

 

 

Total Other Expenses

 

11,251

 

9,634

 

22,237

 

18,634

 

 

 

 

 

 

 

 

 

 

 

Income before Income Taxes

 

6,837

 

3,725

 

12,875

 

7,273

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

1,330

 

1,003

 

2,455

 

1,914

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

5,507

 

$

2,722

 

$

10,420

 

$

5,359

 

 

 

 

 

 

 

 

 

 

 

PER SHARE DATA

 

 

 

 

 

 

 

 

 

Basic earnings

 

$

0.78

 

$

0.45

 

$

1.48

 

$

0.88

 

Cash dividends declared

 

$

0.23

 

$

0.20

 

$

0.43

 

$

0.40

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Dollars in thousands

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

5,507

 

$

2,722

 

$

10,420

 

$

5,359

 

 

 

 

 

 

 

 

 

 

 

OTHER COMPREHENSIVE (LOSS) INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECURITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses) gains arising during the period, net of income taxes of $(228), $52, $(603) and $131, respectively

 

(430

)

95

 

(1,719

)

252

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment for net gains included in net income, net of income taxes of $3, $0, $3 and $0, respectively (A) (C)

 

10

 

 

10

 

 

 

 

 

 

 

 

 

 

 

 

PENSION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of pension net loss, transition liability, and prior service cost, net of income taxes of $29, $59, $58 and $118, respectively (B) (C)

 

100

 

110

 

200

 

220

 

 

 

 

 

 

 

 

 

 

 

TOTAL OTHER COMPREHENSIVE (LOSS) INCOME

 

(320

)

205

 

(1,509

)

472

 

 

 

 

 

 

 

 

 

 

 

TOTAL COMPREHENSIVE INCOME

 

$

5,187

 

$

2,927

 

$

8,911

 

$

5,831

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 


(A) Gross amounts are included in net gains on sales or calls of securities on the Consolidated Statements of Income in total other income.

 

(B) Gross amounts are included in the computation of net periodic benefit cost and are included in salaries and employee benefits on the Consolidated Statements of Income in total other expenses.

 

(C) Income tax amounts are included in the provision for income taxes on the Consolidated Statements of Income.

 

4



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

Six Months Ended June 30, 2018 and 2017

 

Dollars in thousands

 

Common
Stock

 

Treasury
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE — JANUARY 1, 2017

 

$

15,317

 

$

(728

)

$

10,941

 

$

100,555

 

$

(6,024

)

$

120,061

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

5,359

 

 

5,359

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of taxes

 

 

 

 

 

472

 

472

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock shares issued (6,568 shares)

 

17

 

 

121

 

 

 

138

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock grants (6,193 shares)

 

15

 

 

105

 

 

 

120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock compensation expense

 

 

 

120

 

 

 

120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared

 

 

 

 

(2,426

)

 

(2,426

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE — JUNE 30, 2017

 

$

15,349

 

$

(728

)

$

11,287

 

$

103,488

 

$

(5,552

)

$

123,844

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE — JANUARY 1, 2018

 

$

17,716

 

$

(728

)

$

37,777

 

$

106,293

 

$

(7,092

)

$

153,966

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

10,420

 

 

10,420

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss, net of taxes

 

 

 

 

 

(1,509

)

(1,509

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification of certain income tax effects from AOCI (1)

 

 

 

 

82

 

(82

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock shares issued (8,366 shares)

 

20

 

 

234

 

 

 

254

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock grants (6,744 shares)

 

17

 

 

(4

)

 

 

13

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock compensation expense

 

 

 

186

 

 

 

186

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared

 

 

 

 

(3,023

)

 

(3,023

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE — JUNE 30, 2018

 

$

17,753

 

$

(728

)

$

38,193

 

$

113,772

 

$

(8,683

)

$

160,307

 

 


(1) In January 2018, the Corporation adopted ASU 2018-02, as a result, the Corporation made a policy election to release income tax effects, as a result of the Tax Act, from AOCI to retained earnings.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

Six Months Ended June 30,

 

Dollars in thousands

 

2018

 

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

10,420

 

$

5,359

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Gain on sales of loans originated for sale

 

(272

)

(206

)

Loss (gain) on sales of foreclosed assets held for resale, including writedowns

 

45

 

(36

)

Earnings on investment in bank-owned life insurance

 

(538

)

(531

)

Gain on sales or calls of securities

 

(13

)

 

Loss on equity securities

 

27

 

 

Restricted stock compensation expense

 

186

 

120

 

Depreciation and amortization

 

1,418

 

942

 

Provision for loan losses

 

570

 

 

Net amortization of investment securities premiums

 

238

 

264

 

Increase in accrued interest receivable

 

(698

)

(103

)

Increase in accrued interest payable

 

284

 

103

 

Mortgage loans originated for sale

 

(15,975

)

(12,102

)

Proceeds from sales of loans originated for sale

 

16,718

 

12,800

 

Decrease (increase) in other assets

 

440

 

(943

)

Decrease (increase) in deferred tax expense

 

396

 

(159

)

Increase in other liabilities

 

1,334

 

1,688

 

Net Cash Provided by Operating Activities

 

14,580

 

7,196

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Proceeds from maturities of investment securities held to maturity

 

4,932

 

5,438

 

Proceeds from maturities of investment securities available for sale

 

7,418

 

13,456

 

Proceeds from sales of investment securities available for sale

 

1,446

 

 

Purchase of investment securities available for sale

 

(11,459

)

(4,024

)

Purchase of restricted investment in bank stocks

 

(76

)

(550

)

Net increase in loans

 

(4,266

)

(61,811

)

Purchase of bank-owned life insurance

 

(500

)

 

Insurance book- acquisition

 

(600

)

 

Capital expenditures

 

(655

)

(803

)

Proceeds from sales of premises and equipment

 

 

6

 

Proceeds from sales of foreclosed real estate

 

339

 

229

 

Net Cash Used in Investing Activities

 

(3,421

)

(48,059

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Net increase in demand deposits

 

8,802

 

9,979

 

Net increase in time certificates of deposits and interest bearing deposits

 

26,681

 

22,554

 

Net decrease in short-term borrowings

 

(10,490

)

(3,753

)

Proceeds from long-term borrowings

 

8,716

 

24,600

 

Repayments on long-term borrowings

 

(13,500

)

(3,000

)

Dividends paid

 

(3,023

)

(2,426

)

Common stock issued

 

267

 

258

 

Net Cash Provided by Financing Activities

 

17,453

 

48,212

 

Net Increase in Cash and Cash Equivalents

 

28,612

 

7,349

 

CASH AND CASH EQUIVALENTS — BEGINNING

 

34,441

 

18,931

 

CASH AND CASH EQUIVALENTS — ENDING

 

$

63,053

 

$

26,280

 

Supplemental disclosures of cash flow information

 

 

 

 

 

Interest paid

 

$

3,182

 

$

2,095

 

Income taxes paid

 

$

1,700

 

$

1,750

 

Loans transferred to foreclosed assets held for resale and other foreclosed transactions

 

$

235

 

$

 

 

 The accompanying notes are an integral part of the consolidated financial statements.

 

6



 

ACNB CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.              Basis of Presentation and Nature of Operations

 

ACNB Corporation (the Corporation or ACNB), headquartered in Gettysburg, Pennsylvania, provides banking, insurance, and financial services to businesses and consumers through its wholly-owned subsidiaries, ACNB Bank (Bank) and Russell Insurance Group, Inc. (RIG). The Bank engages in full-service commercial and consumer banking and wealth management services, including trust and retail brokerage, through twenty-two community banking office locations in Adams, Cumberland, Franklin and York Counties, Pennsylvania. There is also a loan production office situated in York County, Pennsylvania, as well as plans to establish, subject to regulatory requirements, another loan production office in Hunt Valley, Maryland.

 

On July 1, 2017, ACNB completed its acquisition of New Windsor Bancorp, Inc. (New Windsor) of Taneytown, Maryland. At the effective time of the acquisition, New Windsor merged with and into a wholly-owned subsidiary of ACNB, immediately followed by the merger of New Windsor State Bank (NWSB) with and into ACNB Bank. ACNB Bank now operates in the Maryland market as “NWSB Bank, A Division of ACNB Bank” and serves this marketplace with banking and wealth management services via a network of seven community banking offices located in Carroll County, Maryland.

 

RIG is a full-service insurance agency based in Westminster, Maryland, with a second location in Germantown, Maryland. The agency offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients.

 

The Corporation’s primary source of revenue is interest income on loans and investment securities and fee income on its products and services. Expenses consist of interest expense on deposits and borrowed funds, provisions for loan losses, and other operating expenses.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly ACNB Corporation’s financial position and the results of operations, comprehensive income, changes in stockholders’ equity, and cash flows. All such adjustments are of a normal recurring nature.

 

The accounting policies followed by the Corporation are set forth in Note A to the Corporation’s consolidated financial statements in the 2017 ACNB Corporation Annual Report on Form 10-K, filed with the SEC on March 9, 2018. It is suggested that the consolidated financial statements contained herein be read in conjunction with the consolidated financial statements and notes included in the Corporation’s Annual Report on Form 10-K. The results of operations for the three and six month periods ended June 30, 2018, are not necessarily indicative of the results to be expected for the full year.

 

On January 1, 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers, and all subsequent amendments to the ASU (collectively “ASC 606”), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as OREO. The majority of the Corporation’s revenue comes from interest income, including loans and securities, that are outside the scope of ASC 606. The Corporation’s services that fall within the scope of ASC 606 are presented within other income on the consolidated statement of income and are recognized as revenue as the Corporation satisfies its obligation to the customer. Services within the scope of ASC 606 include service charges on deposit accounts, service charges on ATM and debit card transactions, income from fiduciary, investment management and brokerage activities and commissions from insurance sales. ASC 606 did not result in a change to the accounting for any in-scope revenue streams; as such, no cumulative effect adjustment was recorded.

 

On January 1, 2018, the Corporation adopted ASU 2016-01, Financial Instruments—Overall (Topic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amended the guidance on the classification and measurement of financial instruments. Upon adoption of ASU 2016-01, the Corporation recognized the equity securities fair value change in net income. Previously, the fair value changes were recognized, net of tax, in other comprehensive income (loss). The adoption of this ASU did not have a material effect on the Corporation’s consolidated financial condition or results of operations.

 

7



 

The Corporation early adopted ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU required a reclassification from accumulated other comprehensive income to retained earnings for tax effects resulting from the newly enacted federal corporate income tax rate. The amount of the reclassification would be the difference between the historical corporate income tax rate and the newly enacted 21% corporate income tax rate. The amendments in this ASU would be effective for the Corporation for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The adoption of this ASU did not have a material effect on the Corporation’s consolidated financial condition or results of operations.

 

The Corporation has evaluated events and transactions occurring subsequent to the balance sheet date of June 30, 2018, for items that should potentially be recognized or disclosed in the consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

2.              Acquisition of New Windsor Bancorp, Inc.

 

On July 1, 2017, ACNB completed its acquisition of New Windsor Bancorp Inc. (New Windsor) of Taneytown, Maryland. New Windsor was a locally owned and managed institution with seven locations in north central Maryland that complemented, enhanced and expanded ACNB’s physical presence in north central Maryland. ACNB transacted the acquisition to enhance its competitive strategic position, potential prospective business opportunities, operations, management, prospective financial condition, future earnings and business prospects. Specifically, ACNB believes that the acquisition will enhance its business opportunities in Northern Maryland due to the combined company having a greater market share, market presence and the ability to offer more diverse (i.e. Trust Services) and more profitable products, as well as a broader based and geographically diversified branch system to enhance deposit collection and potentially improve funding costs. The fair value of total assets acquired as a result of the acquisition totaled $319.8 million, loans totaled $263.5 million and deposits totaled $293.3 million. Goodwill recorded in the acquisition was $13.3 million. In accordance with the terms of the Reorganization Agreement, dated November 21, 2016, as amended, New Windsor shareholders received, in aggregate, $4.5 million in cash and 938,360 shares or approximately 13% of the post transaction outstanding shares of the Corporation’s common stock. The transaction was valued at $33.3 million based on the Corporation’s June 30, 2017 closing price of $30.50 as quoted on NASDAQ. The results of the combined entity’s operations are included in the Corporation’s Consolidated Financial Statements from the date of acquisition.

 

The acquisition of New Windsor is being accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at estimated fair values on the acquisition date.

 

The following table summarizes the consideration paid for New Windsor and the fair value of assets acquired and liabilities assumed as of the acquisition date:

 

Purchase Price Consideration in Common Stock

 

New Windsor shares outstanding

 

1,003,703

 

Shares paid cash consideration

 

150,555

 

Cash consideration (per New Windsor share)

 

$

30.00

 

Cash portion of purchase price

 

$

4,519,995

 

New Windsor shares outstanding

 

1,003,703

 

Shares paid stock consideration

 

853,148

 

Exchange ratio

 

1.10

 

Total ACNB shares issued

 

938,360

 

ACNB’s share price for purposes of calculation

 

$

30.50

 

Equity portion of purchase price

 

$

28,619,980

 

Cost of shares owned by buyer

 

$

150,000

 

Total consideration paid

 

$

33,289,975

 

 

8



 

 

 

In thousands

 

 

 

Allocation of Purchase Price

 

 

 

 

 

 

Total Purchase Price

 

 

 

$

33,290

 

 

 

 

 

 

 

Fair Value of Assets Acquired

 

 

 

 

 

Cash and cash equivalents

 

10,964

 

 

 

Investment securities

 

21,624

 

 

 

Loans held for sale

 

1,463

 

 

 

Loans

 

263,450

 

 

 

Restricted stock

 

486

 

 

 

Premises and equipment

 

8,624

 

 

 

Core deposit intangible asset

 

2,418

 

 

 

Other assets

 

10,792

 

 

 

Total assets

 

319,821

 

 

 

 

 

 

 

 

 

Fair Value of Liabilities Assumed

 

 

 

 

 

Non-interest bearing deposits

 

80,006

 

 

 

Interest bearing deposits

 

213,327

 

 

 

Subordinated debt

 

4,688

 

 

 

Other liabilities

 

1,782

 

 

 

Total liabilities

 

299,803

 

 

 

 

 

 

 

 

 

Net Assets Acquired

 

 

 

20,018

 

Goodwill Recorded in Acquisition

 

 

 

$

13,272

 

 

Pursuant to the accounting requirements, the Corporation assigned a fair value to the assets acquired and liabilities assumed of New Windsor. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

 

Goodwill and core deposit intangibles are allocated to the banking business segment.

 

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

 

Investment securities available-for-sale

 

The estimated fair values of the investment securities available for sale, primarily comprised of U.S. Government agency mortgage-backed securities, U.S. government agencies and municipal bonds, were determined using Level 2 inputs in the fair value hierarchy. The fair values were determined using independent pricing services. The Corporation’s independent pricing service utilized matrix pricing, 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 relying on the security’s relationship to other benchmark quoted prices. Management reviewed the data and assumptions used in pricing the securities.

 

Loans

 

Acquired loans (impaired and non-impaired) are initially recorded at their acquisition-date fair values using Level 3 inputs. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected life time losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Corporation has prepared three separate loan fair value adjustments that it believed a market participant might employ in estimating the entire fair value adjustment necessary under ASC 820-10 for the acquired loan portfolio. The three-separate fair valuation methodology employed are: 1) an interest rate loan fair value adjustment, 2) a general credit fair value adjustment, and 3) a specific credit fair value adjustment for purchased credit impaired loans subject to ASC 310-30 procedures. The acquired loans were recorded at fair value at the acquisition date without carryover of New Windsor’s previously established allowance for loan losses. The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $272,646,000. The table below illustrates the fair value adjustments made to the amortized cost basis in order to present a fair value of the loans acquired. The credit adjustment on purchased credit impaired loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that has been deemed uncollectible based on the Corporation’s expectations of future cash flows for each respective loan.

 

9



 

In thousands

 

 

 

Gross amortized cost basis at July 1, 2017

 

$

272,646

 

Interest rate fair value adjustment on pools of homogeneous loans

 

(731

)

Credit fair value adjustment on pools of homogeneous loans

 

(4,501

)

Credit fair value adjustment on purchased credit impaired loans

 

(3,964

)

Fair value of acquired loans at July 1, 2017

 

$

263,450

 

 

For loans acquired without evidence of credit quality deterioration, ACNB prepared the interest rate loan fair value and credit fair value adjustments. Loans were grouped into homogeneous pools by characteristics such as loan type, term, collateral and rate. Market rates for similar loans were obtained from various internal and external data sources and reviewed by management for reasonableness. The average of these rates was used as the fair value interest rate a market participant would utilize. A present value approach was utilized to calculate the interest rate fair value discount of $731,000.

 

Additionally for loans acquired without credit deterioration, a credit fair value adjustment was calculated using a two-part credit fair value analysis: 1) expected lifetime credit migration losses; and 2) estimated fair value adjustment for certain qualitative factors. The expected lifetime losses were calculated using historical losses observed at the Bank, NWSB and peer banks. ACNB also estimated an environmental factor to apply to each loan type. The environmental factor represents a potential discount which may arise due to general credit and economic factors. A credit fair value discount of $4.5 million was determined. Both the interest rate and credit fair value adjustments relate to loans acquired without evidence of credit quality deterioration will be substantially recognized as interest income on a level yield amortization method over the expected life of the loans.

 

The following table presents the acquired purchased credit impaired loans receivable at the Acquisition Date:

 

In thousands

 

 

 

Contractual principal and interest at acquisition

 

$

13,439

 

Nonaccretable difference

 

(5,651

)

Expected cash flows at acquisition

 

7,788

 

Accretable yield

 

(1,458

)

Fair value of purchased impaired loans

 

$

6,330

 

 

Premises and Equipment

 

The Corporation acquired seven branches from New Windsor. The fair value of New Windsor’s premises, including land, buildings, and improvements, was determined based upon independent third-party appraisals and other data in the market in which the premises are located. The Corporation prepared an internal analysis to compare the lease contract obligations to comparable market rental rates. The Corporation believed that the leased contract rates were in a reasonable range of market rental rates and concluded that no fair market value adjustment related to leasehold interest was necessary.

 

Core Deposit Intangible

 

The fair value of the core deposit intangible was determined based on a discounted cash flow analysis using a discount rate commensurate with market participants. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through national brokered CD offering rates. The projected cash flows were developed using projected deposit attrition rates. The core deposit intangible will be amortized over ten years using the sum-of-years digits method.

 

Time Deposits

 

The fair value adjustment for time deposits represents a discount from the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar-term time deposits. The time deposit discount of approximately $847,500 is being amortized into income on a level yield amortization method over the contractual life of the deposits.

 

10



 

Long-term Borrowings

 

The Corporation assumed a trust preferred subordinated debt in connection with the acquisition. The fair value of the trust preferred subordinated debt was determined based upon an estimated fair value from an independent brokerage firm. The trust preferred capital note was valued at a discount of $312,500, which is being amortized into income on a level yield amortization method based upon the assumed market rate, and the term of the trust preferred subordinated debt instrument.

 

3.              Earnings Per Share and Restricted Stock Plan

 

The Corporation has a simple capital structure. Basic earnings per share of common stock is computed based on 7,030,441 and 6,066,675 weighted average shares of common stock outstanding for the six months ended June 30, 2018 and 2017, respectively, and 7,035,237 and 6,068,673 for the three months ended June 30, 2018 and 2017, respectively. All outstanding unvested restricted stock awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation.

 

The Corporation has a restricted stock plan available to selected employees and directors of the Corporation and the  Bank to advance the best interests of the Corporation and its stockholders. The plan provides those persons who have responsibility for its growth with additional incentives by allowing them to acquire ownership in the Corporation and, thereby, encouraging them to contribute to the success of the Corporation and the Bank. Plan expense is recognized over the vesting period of the stock issued under the plan. As of June 30, 2018, 26,045 shares were issued to employees under this plan, of which 19,485 were fully vested, no shares vested during the quarter, and the remaining 6,560 will vest over the next two years. $42,000 and $61,000 of compensation expenses related to the grants were recognized during the three months ended June 30, 2018 and 2017, respectively. $118,000 and $120,000 of compensation expenses related to the grants were recognized during the six months ended June 30, 2018 and 2017, respectively.

 

4.              Retirement Benefits

 

The components of net periodic benefit expense related to the non-contributory, defined benefit pension plan for the three and six month periods ended June 30 were as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30

 

In thousands

 

2018

 

2017

 

2018

 

2017

 

Service cost

 

$

215

 

$

210

 

$

430

 

$

420

 

Interest cost

 

274

 

284

 

548

 

568

 

Expected return on plan assets

 

(692

)

(630

)

(1,384

)

(1,260

)

Amortization of net loss

 

129

 

169

 

257

 

338

 

 

 

 

 

 

 

 

 

 

 

Net Periodic Benefit Expense

 

$

(74

)

$

33

 

$

(149

)

$

66

 

 

The Corporation previously disclosed in its consolidated financial statements for the year ended December 31, 2017, that it had not yet determined the amount the Bank planned on contributing to the defined benefit plan in 2018. As of June 30, 2018, this contribution amount had still not been determined. Effective April 1, 2012, no inactive or former participant in the plan is eligible to again participate in the plan, and no employee hired after March 31, 2012, is eligible to participate in the plan. As of the last annual census, ACNB Bank had a combined 353 active, vested, terminated and retired persons in the plan.

 

5.              Guarantees

 

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $4,980,000 in standby letters of credit as of June 30, 2018. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The current amount of the liability, as of June 30, 2018, for guarantees under standby letters of credit issued is not material.

 

11



 

6.              Accumulated Other Comprehensive Loss

 

The components of accumulated other comprehensive loss, net of taxes, are as follows:

 

In thousands

 

Unrealized
Losses on
Securities

 

Pension
Liability

 

Accumulated Other
Comprehensive
Loss

 

BALANCE — JUNE 30, 2018

 

$

(2,748

)

$

(5,935

)

$

(8,683

)

BALANCE DECEMBER 31, 2017

 

$

(957

)

$

(6,135

)

$

(7,092

)

BALANCE — JUNE 30, 2017

 

$

(13

)

$

(5,539

)

$

(5,552

)

 

7.              Segment Reporting

 

The Corporation has two reporting segments, the Bank and RIG. RIG is managed separately from the banking segment, which includes the Bank and related financial services that the Corporation offers through its banking subsidiary. RIG offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients.

 

Segment information for the six month periods ended June 30, 2018 and 2017, is as follows:

 

In thousands

 

Banking

 

Insurance

 

Total

 

2018

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

32,780

 

$

2,902

 

$

35,682

 

Income before income taxes

 

12,031

 

844

 

12,875

 

Total assets

 

1,613,462

 

9,880

 

1,623,342

 

Capital expenditures

 

614

 

41

 

655

 

 

 

 

 

 

 

 

 

2017

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

23,215

 

$

2,692

 

$

25,907

 

Income before income taxes

 

6,675

 

598

 

7,273

 

Total assets

 

1,252,723

 

9,213

 

1,261,936

 

Capital expenditures

 

803

 

 

803

 

 

12



 

Segment information for the three month periods ended June 30, 2018 and 2017, is as follows:

 

In thousands

 

Banking

 

Insurance

 

Total

 

2018

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

16,706

 

$

1,702

 

$

18,408

 

Income before income taxes

 

6,213

 

624

 

6,837

 

Total assets

 

1,613,462

 

9,880

 

1,623,342

 

Capital expenditures

 

257

 

41

 

298

 

 

 

 

 

 

 

 

 

2017

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

11,821

 

$

1,538

 

$

13,359

 

Income before income taxes

 

3,237

 

488

 

3,725

 

Total assets

 

1,252,723

 

9,213

 

1,261,936

 

Capital expenditures

 

436

 

 

436

 

 

Customer renewal lists are amortized over their estimated useful lives which range from eight to thirteen years. Core deposit intangible assets are primarily amortized over 10 years using accelerated methods. Goodwill is not amortized, but rather is analyzed annually for impairment. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested for impairment when such events occur. Tax amortization of goodwill and the intangible assets is deductible for tax purposes. Tax amortization of the goodwill associated with the New Windsor acquisition is not deductible for federal income tax purposes.

 

8.              Securities

 

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity or trading are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported, net of tax, in other comprehensive income (loss). As of January 1, 2018, equity securities with readily determined fair values are recorded at fair value with changes in fair value recognized in net income. Prior to 2018, fair value changes were reported, net of tax, in other comprehensive income (loss).

 

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses on debt securities, management considers (1) whether management intends to sell the security, or (2) if it is more likely than not that management will be required to sell the security before recovery, or (3) if management does not expect to recover the entire amortized cost basis. In assessing potential other-than-temporary impairment for equity securities, consideration is given to management’s intention and ability to hold the securities until recovery of unrealized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

 

13



 

Amortized cost and fair value of securities at June 30, 2018, and December 31, 2017, were as follows:

 

In thousands

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

 

 

 

 

 

 

 

 

 

 

SECURITIES AVAILABLE FOR SALE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

115,580

 

$

2

 

$

3,159

 

$

112,423

 

Mortgage-backed securities, residential

 

29,110

 

145

 

551

 

28,704

 

State and municipal

 

11,282

 

76

 

61

 

11,297

 

 

 

$

155,972

 

$

223

 

$

3,771

 

$

152,424

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2017

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

105,899

 

$

2

 

$

1,818

 

$

104,083

 

Mortgage-backed securities, residential

 

34,473

 

461

 

101

 

34,833

 

State and municipal

 

13,227

 

109

 

42

 

13,294

 

Corporate bonds

 

5,000

 

57

 

 

5,057

 

CRA mutual fund

 

1,044

 

 

9

 

1,035

 

Stock in other banks

 

647

 

102

 

 

749

 

 

 

$

160,290

 

$

731

 

$

1,970

 

$

159,051

 

 

 

 

 

 

 

 

 

 

 

SECURITIES HELD TO MATURITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

17,000

 

$

 

$

128

 

$

16,872

 

Mortgage-backed securities, residential

 

22,894

 

 

621

 

22,273

 

 

 

$

39,894

 

$

 

$

749

 

$

39,145

 

DECEMBER 31, 2017

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

19,000

 

$

2

 

$

99

 

$

18,903

 

Mortgage-backed securities, residential

 

25,829

 

55

 

238

 

25,646

 

 

 

$

44,829

 

$

57

 

$

337

 

$

44,549

 

 

The Corporation adopted ASU 2016-01, Financial Instruments—Overall (Topic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities effective January 1, 2018. The required fair value disclosures are as follows:

 

In thousands

 

Fair Value at
January 1, 2018

 

Unrealized
Gains

 

Unrealized
Losses

 

Fair Value at
June 30, 2018

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

Equity securities with a readily determinable fair value

 

$

1,793

 

$

22

 

$

48

 

$

1,767

 

 

14



 

The following table shows the Corporation’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2018, and December 31, 2017:

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

In thousands

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECURITIES AVAILABLE FOR SALE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

47,707

 

$

892

 

$

62,246

 

$

2,267

 

$

109,953

 

$

3,159

 

Mortgage-backed securities, residential

 

19,950

 

496

 

1,378

 

55

 

21,328

 

551

 

State and municipal

 

1,475

 

8

 

1,925

 

53

 

3,400

 

61

 

 

 

$

69,132

 

$

1,396

 

$

65,549

 

$

2,375

 

$

134,681

 

$

3,771

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

42,775

 

$

445

 

$

58,279

 

$

1,373

 

$

101,054

 

$

1,818

 

Mortgage-backed securities, residential

 

7,228

 

56

 

2,845

 

45

 

10,073

 

101

 

State and municipal

 

1,042

 

8

 

1,950

 

34

 

2,992

 

42

 

CRA Mutual Fund

 

 

 

1,035

 

9

 

1,035

 

9

 

 

 

$

51,045

 

$

509

 

$

64,109

 

$

1,461

 

$

115,154

 

$

1,970

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECURITIES HELD TO MATURITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

2,966

 

$

34

 

$

12,906

 

$

94

 

$

15,872

 

$

128

 

Mortgage-backed securities, residential

 

12,322

 

210

 

9,951

 

411

 

22,273

 

621

 

 

 

$

15,288

 

$

244

 

$

22,857

 

$

505

 

$

38,145

 

$

749

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

4,985

 

$

15

 

$

10,916

 

$

84

 

$

15,901

 

$

99

 

Mortgage-backed securities, residential

 

4,946

 

29

 

11,070

 

209

 

16,016

 

238

 

 

 

$

9,931

 

$

44

 

$

21,986

 

$

293

 

$

31,917

 

$

337

 

 

All mortgage-backed security investments are government sponsored enterprise (GSE) pass-through instruments issued by the Federal National Mortgage Association (FNMA), Government National Mortgage Association (GNMA) or Federal Home Loan Mortgage Corporation (FHLMC), which guarantee the timely payment of principal on these investments.

 

At June 30, 2018, sixty-eight available for sale U.S. Government and agency securities had unrealized losses that individually did not exceed 7% of amortized cost. Thirty-five of these securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

At June 30, 2018, thirty-four available for sale residential mortgage-backed securities had unrealized losses that individually did not exceed 5% of amortized cost. Two of these securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

At June 30, 2018, twelve available for sale state and municipal securities had unrealized losses that individually did not exceed 9% of amortized cost. Eight of these securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

15



 

At June 30, 2018, nine held to maturity U.S. Government and agency securities had unrealized losses that individually did not exceed 2% of amortized cost. Seven of these securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

At June 30, 2018, thirty-four held to maturity residential mortgage-backed securities had unrealized losses that individually did not exceed 5% of amortized cost. Thirteen of these securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

In analyzing the issuer’s financial condition, management considers industry analysts’ reports, financial performance, and projected target prices of investment analysts within a one-year time frame. Based on the above information, management has determined that none of these investments are other-than-temporarily impaired.

 

The fair values of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or 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 securities but rather by relying on the security’s relationship to other benchmark quoted prices. The Corporation uses independent service providers to provide matrix pricing.

 

Management routinely sells securities from its available for sale portfolio in an effort to manage and allocate the portfolio. At June 30, 2018, management had not identified any securities with an unrealized loss that it intends to sell or will be required to sell. In estimating other-than-temporary impairment losses on debt securities, management considers (1) whether management intends to sell the security, or (2) if it is more likely than not that management will be required to sell the security before recovery, or (3) if management does not expect to recover the entire amortized cost basis. In assessing potential other-than-temporary impairment for equity securities, consideration is given to management’s intention and ability to hold the securities until recovery of unrealized losses.

 

Amortized cost and fair value at June 30, 2018, by contractual maturity, where applicable, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay with or without penalties.

 

 

 

Available for Sale

 

Held to Maturity

 

In thousands

 

Amortized
Cost

 

Fair
Value

 

Amortized
Cost

 

Fair
Value

 

 

 

 

 

 

 

 

 

 

 

1 year or less

 

$

9,349

 

$

9,321

 

$

10,000

 

$

9,973

 

Over 1 year through 5 years

 

110,627

 

107,677

 

7,000

 

6,899

 

Over 5 years through 10 years

 

6,886

 

6,721

 

 

 

Over 10 years

 

 

 

 

 

Mortgage-backed securities, residential

 

29,110

 

28,705

 

22,894

 

22,273

 

 

 

$

155,972

 

$

152,424

 

$

39,894

 

$

39,145

 

 

The Corporation realized $12,500 gross gains on sales of securities available for sale during the three and six month periods ended June 30, 2018. The corporation did not realize any gross gains or losses on sales of securities during the three and six month period ended June 30, 2017.

 

At June 30, 2018, and December 31, 2017, securities with a carrying value of $160,460,000 and $157,601,000, respectively, were pledged as collateral as required by law on public and trust deposits, repurchase agreements, and for other purposes.

 

16



 

9.              Loans

 

The Corporation grants commercial, residential, and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout southcentral Pennsylvania and northern Maryland. The ability of the Corporation’s debtors to honor their contracts is dependent upon the real estate values and general economic conditions in this area.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

 

The loans receivable portfolio is segmented into commercial, residential mortgage, home equity lines of credit, and consumer loans. Commercial loans consist of the following classes: commercial and industrial, commercial real estate, and commercial real estate construction.

 

The accrual of interest on residential mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Consumer loans (consisting of home equity lines of credit and consumer loan classes) are typically charged off no later than 120 days past due. Past due status is based on the 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.

 

All interest accrued, but not collected, for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Credit Losses

 

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses (the “allowance”) is established as losses are estimated to occur through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated statement of condition. The amount of the reserve for unfunded lending commitments is not material to the consolidated financial statements.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity, and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for the previous twelve quarters for each of these categories of loans, adjusted for qualitative risk factors. These qualitative risk factors include:

 

·                  lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices;

 

·                  national, regional and local economic and business conditions, as well as the condition of various market segments, including the impact on the value of underlying collateral for collateral dependent loans;

 

17



 

·                  the nature and volume of the portfolio and terms of loans;

 

·                  the experience, ability and depth of lending management and staff;

 

·                  the volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications; and,

 

·                  the existence and effect of any concentrations of credit and changes in the level of such concentrations.

 

Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

 

The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. It covers risks that are inherently difficult to quantify including, but not limited to, collateral risk, information risk, and historical charge-off risk.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal and/or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and/or interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

 

A specific allocation within the allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of the Corporation’s impaired loans are measured based on the estimated fair value of the loan’s collateral or the discounted cash flows method.

 

It is the policy of the Corporation to order an updated valuation on all real estate secured loans when the loan becomes 90 days past due and there has not been an updated valuation completed within the previous 12 months. In addition, the Corporation orders third-party valuations on all impaired real estate collateralized loans within 30 days of the loan being classified as impaired. Until the valuations are completed, the Corporation utilizes the most recent independent third-party real estate valuation to estimate the need for a specific allocation to be assigned to the loan. These existing valuations are discounted downward to account for such things as the age of the existing collateral valuation, change in the condition of the real estate, change in local market and economic conditions, and other specific factors involving the collateral. Once the updated valuation is completed, the collateral value is updated accordingly.

 

For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging reports, equipment appraisals, or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

 

The Corporation actively monitors the values of collateral as well as the age of the valuation of impaired loans. Management believes that the Corporation’s market area is not as volatile as other areas throughout the United States, therefore valuations are ordered at least every 18 months, or more frequently if management believes that there is an indication that the fair value has declined.

 

For impaired loans secured by collateral other than real estate, the Corporation considers the net book value of the collateral, as recorded in the most recent financial statements of the borrower, and determines fair value based on estimates made by management.

 

18



 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a troubled debt restructure.

 

Loans whose terms are modified are classified as troubled debt restructured loans if the Corporation grants such borrowers concessions that it would not otherwise consider and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate, a below market interest rate given the risk associated with the loan, or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings may be restored to accrual status if principal and interest payments, under the modified terms, are current for a sustained period of time and, based on a well-documented credit evaluation of the borrower’s financial condition, there is reasonable assurance of repayment. Loans classified as troubled debt restructurings are generally designated as impaired.

 

The allowance calculation methodology includes further segregation of loan classes into credit quality rating categories. The borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are generally evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments.

 

Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful, and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.

 

In addition, 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.

 

Commercial and Industrial Lending — The Corporation originates commercial and industrial loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes which include short-term loans and lines of credit to finance machinery and equipment purchases, inventory, and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and may be renewed annually.

 

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum values have been established by the Corporation and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, collateral appraisals, etc.

 

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower’s character and capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Corporation’s analysis.

 

Commercial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions.

 

Commercial Real Estate Lending — The Corporation engages in commercial real estate lending in its primary market area and surrounding areas. The Corporation’s commercial loan portfolio is secured primarily by commercial retail space, office buildings, and hotels. Generally, commercial real estate loans have terms that do not exceed 20 years, have loan-to-value ratios of up to 80% of the appraised value of the property, and are typically secured by personal guarantees of the borrowers.

 

19



 

In underwriting these loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. Appraisals on properties securing commercial real estate loans originated by the Corporation are performed by independent appraisers.

 

Commercial real estate loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions and the complexities involved in valuing the underlying collateral.

 

Commercial Real Estate Construction Lending — The Corporation engages in commercial real estate construction lending in its primary market area and surrounding areas. The Corporation’s commercial real estate construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans.

 

The Corporation’s commercial real estate construction loans are generally secured with the subject property. Terms of construction loans depend on the specifics of the project, such as estimated absorption rates, estimated time to complete, etc.

 

In underwriting commercial real estate construction loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the project using feasibility studies, market data, etc. Appraisals on properties securing commercial real estate construction loans originated by the Corporation are performed by independent appraisers.

 

Commercial real estate construction loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions and the uncertainties surrounding total construction costs.

 

Residential Mortgage Lending — One-to-four family residential mortgage loan originations, including home equity closed-end loans, are generated by the Corporation’s marketing efforts, its present customers, walk-in customers, and referrals. These loans originate primarily within the Corporation’s market area or with customers primarily from the market area.

 

The Corporation offers fixed-rate and adjustable-rate mortgage loans with terms up to a maximum of 30 years for both permanent structures and those under construction. The Corporation’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The majority of the Corporation’s residential mortgage loans originate with a loan-to-value of 80% or less. Loans in excess of 80% are required to have private mortgage insurance.

 

In underwriting one-to-four family residential real estate loans, the Corporation evaluates both the borrower’s financial ability to repay the loan as agreed and the value of the property securing the loan. Properties securing real estate loans made by the Corporation are appraised by independent appraisers. The Corporation generally requires borrowers to obtain an attorney’s title opinion or title insurance, as well as fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. The Corporation has not engaged in subprime residential mortgage originations.

 

Residential mortgage loans present a moderate level of risk due primarily to general economic conditions, as well as a continued weak housing market.

 

Home Equity Lines of Credit Lending — The Corporation originates home equity lines of credit primarily within the Corporation’s market area or with customers primarily from the market area. Home equity lines of credit are generated by the Corporation’s marketing efforts, its present customers, walk-in customers, and referrals.

 

Home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of 90% and a maximum term of 20 years. In underwriting home equity lines of credit, the Corporation evaluates both the value of the property securing the loan and the borrower’s financial ability to repay the loan as agreed. The ability to repay is determined by the borrower’s employment history, current financial condition, and credit background.

 

Home equity lines of credit generally present a moderate level of risk due primarily to general economic conditions, as well as a continued weak housing market.

 

20



 

Junior liens inherently have more credit risk by virtue of the fact that another financial institution may have a higher 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 continues to be weak and property values deteriorate.

 

Consumer Lending — The Corporation offers a variety of secured and unsecured consumer loans, including those for vehicles and mobile homes and loans secured by savings deposits. These loans originate primarily within the Corporation’s market area or with customers primarily from the market area.

 

Consumer loan terms vary according to the type and value of collateral and the creditworthiness of the borrower. In underwriting consumer loans, a thorough analysis of the borrower’s financial ability to repay the loan as agreed is performed. The ability to repay is determined by the borrower’s employment history, current financial condition, and credit background.

 

Consumer loans may entail greater credit risk than residential mortgage loans or home equity lines of credit, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Acquired Loans

 

Acquired loans (impaired and non-impaired) are initially recorded at their acquisition-date fair values using Level 3 inputs. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Corporation has prepared three separate loan fair value adjustments that it believed a market participant might employ in estimating the entire fair value adjustment necessary under ASC 820-10 for the acquired loan portfolio. The three-separate fair valuation methodology employed are: 1) an interest rate loan fair value adjustment, 2) a general credit fair value adjustment, and 3) a specific credit fair value adjustment for purchased credit impaired loans subject to ASC 310-30 procedures.

 

The carryover of allowance for loan losses related to acquired loans is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. The allowance for loan losses on acquired loans reflects only those losses incurred after acquisition and represents the present value of cash flows expected at acquisition that is no longer expected to be collected. Acquired loans are marked to fair value on the date of acquisition. In conjunction with the quarterly evaluation of the adequacy of the allowance for loan losses, the Corporation performs an analysis on acquired loans to determine whether or not there has been subsequent deterioration in relation to those loans. If deterioration has occurred, the Corporation will include these loans in the calculation of the allowance for loan losses after the initial valuation, and provide accordingly.

 

Upon acquisition, in accordance with US GAAP, the Corporation has individually determined whether each acquired loan is within the scope of ASC 310-30. The Corporation’s senior lending management reviewed the accounting seller’s loan portfolio on a loan by loan basis to determine if any loans met the two-part definition of an impaired loan as defined by ASC 310-30: 1) Credit deterioration on the loan from its inception until the acquisition date, and 2) It is probable that not all of the contractual cash flows will be collected on the loan.

 

Acquired ASC 310-20 loans, which are loans that did not meet the criteria above, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. For these pools, the Corporation used certain loan information, including outstanding principal balance, estimated expected losses, weighted average maturity, weighted average margin, and weighted average interest rate along with estimated prepayment rates, expected lifetime losses, environment factors to estimate the expected cash flow for each loan pool. With regards to ASC 310-30 loans, for external disclosure purposes, the aggregate contractual cash flows less the aggregate expected cash flows resulted in a credit related non-accretable yield amount. The aggregate expected cash flows less the acquisition date fair value resulted in an accretable yield amount. The accretable yield reflects the contractual cash flows management expects to collect above the loan’s acquisition date fair value and will be recognized over the life of the loan on a level-yield basis as a component of interest income.

 

21



 

Over the life of the acquired ASC 310-30 loan, the Corporation continues to estimate cash flows expected to be collected. Decreases in expected cash flows, other than from prepayments or rate adjustments, are recognized as impairments through a charge to the provision for credit losses resulting in an increase in the allowance for credit losses. Subsequent improvements in cash flows result in first, reversal of existing valuation allowances recognized subsequent to acquisition, if any, and next, an increase in the amount of accretable yield to be subsequently recognized on a prospective basis over the loan’s remaining life.

 

Acquired ASC 310-30 loans that met the criteria for non-accrual of interest prior to acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if we can reasonably estimate the timing and amount of expected cash flows on such loans. Accordingly, we do not consider acquired contractually delinquent loans to be non-accruing and continue to recognize interest income on these loans using the accretion model.

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard, and doubtful within the Corporation’s internal risk rating system as of June 30, 2018, and December 31, 2017:

 

In thousands

 

Pass

 

Special
Mention

 

Substandard

 

Doubtful

 

Total

 

JUNE 30, 2018

 

 

 

 

 

 

 

 

 

 

 

Originated Loans

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

151,426

 

$

3,170

 

$

178

 

$

 

$

154,774

 

Commercial real estate

 

355,784

 

16,948

 

8,094