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 September 30, 2017

 

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 November 3, 2017, was 7,019,645.

 

 

 



 

PART I - FINANCIAL INFORMATION

 

ACNB CORPORATION

ITEM 1 - FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)

 

Dollars in thousands, except per share data

 

September 30,
2017

 

September 30,
2016

 

December 31,
2016

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

17,882

 

$

13,705

 

$

13,796

Interest bearing deposits with banks

 

31,609

 

41,686

 

5,135

 

 

 

 

 

 

 

Total Cash and Cash Equivalents

 

49,491

 

55,391

 

18,931

 

 

 

 

 

 

 

Securities available for sale

 

158,392

 

143,940

 

142,990

Securities held to maturity, fair value $47,373; $58,566; $55,425

 

47,369

 

57,562

 

55,568

Loans held for sale

 

1,873

 

1,877

 

1,770

Loans, net of allowance for loan losses $14,105; $14,488; $14,194

 

1,222,265

 

857,535

 

893,716

Premises and equipment

 

26,590

 

18,224

 

18,153

Restricted investment in bank stocks

 

4,821

 

4,191

 

4,349

Investment in bank-owned life insurance

 

44,666

 

40,476

 

40,742

Investments in low-income housing partnerships

 

2,587

 

3,003

 

2,899

Goodwill

 

19,580

 

6,308

 

6,308

Intangible assets

 

2,752

 

774

 

688

Foreclosed assets held for resale

 

275

 

309

 

256

Other assets

 

26,974

 

19,279

 

19,950

 

 

 

 

 

 

 

Total Assets

 

$

1,607,635

 

$

1,208,869

 

$

1,206,320

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

Non-interest bearing

 

$

273,853

 

$

186,035

 

$

180,593

Interest bearing

 

1,038,031

 

779,512

 

787,028

 

 

 

 

 

 

 

Total Deposits

 

1,311,884

 

965,547

 

967,621

 

 

 

 

 

 

 

Short-term borrowings

 

33,806

 

35,503

 

34,590

Long-term borrowings

 

96,850

 

76,500

 

74,250

Other liabilities

 

11,839

 

10,565

 

9,798

 

 

 

 

 

 

 

Total Liabilities

 

1,454,379

 

1,088,115

 

1,086,259

 

 

 

 

 

 

 

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; 7,082,245, 6,123,662 and 6,126,738 shares issued; 7,019,645, 6,061,062 and 6,064,138 shares outstanding

 

17,705

 

15,310

 

15,317

Treasury stock, at cost (62,600 shares)

 

(728)

 

(728)

 

(728)

Additional paid-in capital

 

37,671

 

10,849

 

10,941

Retained earnings

 

103,997

 

99,196

 

100,555

Accumulated other comprehensive loss

 

(5,389)

 

(3,873)

 

(6,024)

 

 

 

 

 

 

 

Total Stockholders’ Equity

 

153,256

 

120,754

 

120,061

 

 

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

$

1,607,635

 

$

1,208,869

 

$

1,206,320

 

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

 

2



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

Dollars in thousands, except per share data

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

13,990

 

$

9,150

 

$

33,484

 

$

27,054

 

Securities:

 

 

 

 

 

 

 

 

 

Taxable

 

890

 

770

 

2,474

 

2,360

 

Tax-exempt

 

85

 

156

 

352

 

496

 

Dividends

 

61

 

53

 

174

 

159

 

Other

 

83

 

52

 

120

 

86

 

 

 

 

 

 

 

 

 

 

 

Total Interest Income

 

15,109

 

10,181

 

36,604

 

30,155

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Deposits

 

1,080

 

602

 

2,402

 

1,730

 

Short-term borrowings

 

9

 

10

 

69

 

38

 

Long-term borrowings

 

458

 

384

 

1,274

 

1,165

 

 

 

 

 

 

 

 

 

 

 

Total Interest Expense

 

1,547

 

996

 

3,745

 

2,933

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

13,562

 

9,185

 

32,859

 

27,222

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR LOAN LOSSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income after Provision for Loan Losses

 

13,562

 

9,185

 

32,859

 

27,222

 

 

 

 

 

 

 

 

 

 

 

OTHER INCOME

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

870

 

631

 

2,057

 

1,734

 

Income from fiduciary activities

 

489

 

416

 

1,409

 

1,244

 

Earnings on investment in bank-owned life insurance

 

276

 

276

 

807

 

834

 

Gain on sales of premises and equipment

 

 

 

 

449

 

Service charges on ATM and debit card transactions

 

490

 

381

 

1,229

 

1,127

 

Commissions from insurance sales

 

1,313

 

1,269

 

4,031

 

3,700

 

Other

 

492

 

328

 

1,007

 

896

 

 

 

 

 

 

 

 

 

 

 

Total Other Income

 

3,930

 

3,301

 

10,540

 

9,984

 

 

 

 

 

 

 

 

 

 

 

OTHER EXPENSES

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

6,715

 

5,580

 

18,397

 

16,609

 

Net occupancy

 

677

 

481

 

1,710

 

1,553

 

Equipment

 

1,039

 

740

 

2,666

 

2,212

 

Other tax

 

197

 

201

 

576

 

591

 

Professional services

 

224

 

217

 

807

 

670

 

Supplies and postage

 

187

 

178

 

524

 

491

 

Marketing and corporate relations

 

119

 

123

 

321

 

391

 

FDIC and regulatory

 

170

 

181

 

449

 

532

 

Merger related expenses

 

4,305

 

 

4,675

 

 

Intangible assets amortization

 

193

 

85

 

355

 

259

 

Foreclosed real estate expenses

 

35

 

72

 

51

 

112

 

Other operating

 

1,006

 

922

 

2,970

 

2,681

 

 

 

 

 

 

 

 

 

 

 

Total Other Expenses

 

14,867

 

8,780

 

33,501

 

26,101

 

 

 

 

 

 

 

 

 

 

 

Income before Income Taxes

 

2,625

 

3,706

 

9,898

 

11,105

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

713

 

938

 

2,627

 

2,808

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

1,912

 

$

2,768

 

$

7,271

 

$

8,297

 

 

 

 

 

 

 

 

 

 

 

PER SHARE DATA

 

 

 

 

 

 

 

 

 

Basic earnings

 

$

0.27

 

$

0.46

 

$

1.14

 

$

1.37

 

Cash dividends declared

 

$

0.20

 

$

0.20

 

$

0.60

 

$

0.60

 

 

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

 

3



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

Dollars in thousands

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

1,912

 

$

2,768

 

$

7,271

 

$

8,297

 

 

 

 

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECURITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period, net of income taxes of $28, $(158), $159 and $265, respectively

 

54

 

(308)

 

306

 

515

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PENSION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of pension net loss, transition liability, and prior service cost, net of income taxes of $60, $59, $178 and $175, respectively (B) (C)

 

109

 

113

 

329

 

338

 

 

 

 

 

 

 

 

 

 

 

TOTAL OTHER COMPREHENSIVE INCOME (LOSS)

 

163

 

(195)

 

635

 

853

 

 

 

 

 

 

 

 

 

 

 

TOTAL COMPREHENSIVE INCOME

 

$

2,075

 

$

2,573

 

$

7,906

 

$

9,150

 

 

 

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)

Nine Months Ended September 30, 2017 and 2016

 

Dollars in thousands

 

Common
Stock

 

Treasury
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE – JANUARY 1, 2016

 

$

15,256

 

$

(728)

 

$

10,387

 

$

94,526

 

$

(4,726)

 

$

114,715

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

8,297

 

 

8,297

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of taxes

 

 

 

 

 

853

 

853

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock shares issued (13,903 shares)

 

35

 

 

303

 

 

 

338

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock grants (7,435 shares)

 

19

 

 

100

 

 

 

119

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock compensation expense

 

 

 

59

 

 

 

59

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared

 

 

 

 

(3,627)

 

 

(3,627)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE – SEPTEMBER 30, 2016

 

$

15,310

 

$

(728)

 

$

10,849

 

$

99,196

 

$

(3,873)

 

$

120,754

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE – JANUARY 1, 2017

 

$

15,317

 

$

(728)

 

$

10,941

 

$

100,555

 

$

(6,024)

 

$

120,061

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

7,271

 

 

7,271

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of taxes

 

 

 

 

 

635

 

635

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock shares issued (949,314 shares)

 

2,373

 

 

26,505

 

 

 

28,878

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock grants (6,193 shares)

 

15

 

 

105

 

 

 

120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock compensation expense

 

 

 

120

 

 

 

120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared

 

 

 

 

(3,829)

 

 

(3,829)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE – SEPTEMBER 30, 2017

 

$

17,705

 

$

(728)

 

$

37,671

 

$

103,997

 

$

(5,389)

 

$

153,256

 

 

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

 

5



 

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

Nine Months Ended September 30,

 

Dollars in thousands

 

2017

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

7,271

 

$

8,297

 

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

 

 

 

 

 

Gain on sales of loans originated for sale

 

(398)

 

(477)

 

Gain on sales of foreclosed assets held for resale, including writedowns

 

(36)

 

(28)

 

Gain on sale of premises and equipment

 

 

(449)

 

Earnings on investment in bank-owned life insurance

 

(807)

 

(834)

 

Restricted stock compensation expense

 

120

 

59

 

Depreciation and amortization

 

1,622

 

1,324

 

Provision for loan losses

 

 

 

Net amortization of investment securities premiums

 

396

 

391

 

(Increase) decrease in accrued interest receivable

 

(637)

 

29

 

Increase (decrease) in accrued interest payable

 

235

 

(10)

 

Mortgage loans originated for sale

 

(21,344)

 

(29,761)

 

Proceeds from sales of loans originated for sale

 

21,639

 

30,196

 

Decrease (increase) in other assets

 

1,051

 

(887)

 

Increase in other liabilities

 

843

 

966

 

Net Cash Provided by Operating Activities

 

9,955

 

8,816

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Proceeds from maturities of investment securities held to maturity

 

8,148

 

13,809

 

Proceeds from maturities of investment securities available for sale

 

18,486

 

22,334

 

Purchase of investment securities available for sale

 

(12,144)

 

(39,127)

 

(Purchase) redemption of restricted investment in bank stocks

 

(136)

 

223

 

Net increase in loans

 

(63,636)

 

(19,660)

 

Bank acquisition, net of cash acquired

 

6,444

 

 

Capital expenditures

 

(1,087)

 

(2,025)

 

Proceeds from sales of premises and equipment

 

6

 

1,929

 

Proceeds from sales of foreclosed real estate

 

228

 

637

 

Net Cash Used in Investing Activities

 

(43,691)

 

(21,880)

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Net increase in demand deposits

 

13,254

 

19,811

 

Net increase in time certificates of deposits and interest bearing deposits

 

37,677

 

32,756

 

Net (decrease) increase in short-term borrowings

 

(784)

 

301

 

Proceeds from long-term borrowings

 

24,600

 

9,000

 

Repayments on long-term borrowings

 

(7,000)

 

(9,000)

 

Dividends paid

 

(3,829)

 

(3,627)

 

Common stock issued

 

378

 

457

 

Net Cash Provided by Financing Activities

 

64,296

 

49,698

 

Net Increase in Cash and Cash Equivalents

 

30,560

 

36,634

 

CASH AND CASH EQUIVALENTS — BEGINNING

 

18,931

 

18,757

 

CASH AND CASH EQUIVALENTS — ENDING

 

$

49,491

 

$

55,391

 

Supplemental disclosures of cash flow information

 

 

 

 

 

Interest paid

 

$

3,510

 

$

2,943

 

Income taxes paid

 

$

2,850

 

$

3,200

 

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

 

$

 

$

338

 

Transactions related to acquisition

 

 

 

 

 

Increase in assets and liabilities:

 

 

 

 

 

Securities

 

$

(21,624)

 

$

 

Loans

 

(264,913)

 

 

Premises and equipment

 

(8,624)

 

 

Investment in bank-owned life insurance

 

(3,118)

 

 

Restricted investments in bank stocks

 

(486)

 

 

Foreclosed assets held for resale

 

(211)

 

 

Goodwill

 

(13,272)

 

 

Intangibles

 

(2,418)

 

 

Other assets

 

(7,463)

 

 

Noninterest bearing deposits

 

80,006

 

 

Interest bearing deposits

 

213,327

 

 

Trust preferred debentures

 

4,688

 

 

Other liabilities

 

1,782

 

 

Common shares issued

 

28,620

 

 

 

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, is the financial holding company for the wholly-owned subsidiaries of ACNB Bank, Gettysburg, Pennsylvania, and Russell Insurance Group, Inc. (RIG), Westminster, Maryland. ACNB Bank serves its marketplace with banking and trust services via a network of twenty-two retail banking offices located in the four southcentral Pennsylvania counties of Adams, Cumberland, Franklin and York. There is also a loan production office situated in York County, Pennsylvania.

 

On July 1, 2017, ACNB completed its previously announced acquisition of New Windsor Bancorp, Inc. (“NW Bancorp”) of Taneytown, Maryland. At the effective time of the merger, NW Bancorp 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”. NWSB Bank, a division of ACNB Bank, serves its marketplace with banking and investment services via a network of seven retail 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 (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 2016 ACNB Corporation Annual Report on Form 10-K, filed with the SEC on March 15, 2017. 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 nine month periods ended September 30, 2017, are not necessarily indicative of the results to be expected for the full year.

 

The Corporation has evaluated events and transactions occurring subsequent to the statement of condition date of September 30, 2017, 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 previously-announced acquisition of NW Bancorp of Taneytown, Maryland. NW Bancorp 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 merger 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 merger 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 merger totaled $319.8 million, loans totaled $263.5 million and deposits totaled $293.3 million. Goodwill recorded in the merger was $13.3 million. In accordance with the terms of the Reorganization Agreement, dated November 21, 2016, as amended, NW Bancorp 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.

 

7



 

The acquisition of NW Bancorp 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. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition.

 

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

 

Purchase Price Consideration in Common Stock

 

NW Bancorp shares outstanding

 

1,003,703

 

Shares paid cash consideration

 

150,555

 

Cash consideration (per NW Bancorp share)

 

$

30.00

 

Cash portion of purchase price

 

$

4,519,995

 

NW Bancorp 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

 

 

Allocation of Purchase Price

 

In thousands

 

 

 

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 Merger

 

 

 

$

13,272

 

 

Pursuant to the accounting requirements, the Corporation assigned a fair value to the assets acquired and liabilities assumed of NW Bancorp. 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.”

 

8



 

The calculation of goodwill is subject to change for up to one year after the date of acquisition as additional information relative to the closing date estimates and uncertainties become available. 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. A fair value premium of $361,000 was recorded and will be amortized over the estimated life of the investments using the interest rate method.

 

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 (analysis available at request of the Corporation), 2) a general credit fair value adjustment (analysis available at request of the Corporation), 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 NWSB’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.

 

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 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 with 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.

 

9



 

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

 

 

Bank Premises

 

The Corporation acquired seven branches of NWSB. The fair value of NWSB’s premises, including land, buildings, and improvements, was determined based upon independent third-party appraisals performed by licensed appraisers 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.

 

Long-term Borrowings

 

The Corporation assumed a trust preferred subordinated debt in connection with the merger. 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 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.

 

The following table presents certain pro forma information as if NWSB had been acquired on December 31, 2016. These results combine the historical results of the Corporation in the Corporation’s Consolidated Statements of Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on December 31, 2016. In particular, no adjustments have been made to eliminate the amount of NWSB’s provision for loan losses that would not have been necessary had the acquired loans been recorded at fair value as of December 31, 2016. The Corporation expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below:

 

In thousands

 

For the Year Ended
December 31, 2016

 

Total revenues (net interest income plus noninterest income)

 

$

102,891

 

Net Income

 

13,591

 

 

Acquisition-related expenses associated with the acquisition of NWSB were $4.3 million for the three months ended September 30, 2017 and $4.7 million for the nine months ended September 30, 2017. Such costs include legal and accounting fees, lease and contract termination expenses, system conversion, operations integration, and employee severances, which have been expensed as incurred.

 

10



 

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 6,383,149 and 6,048,216 weighted average shares of common stock outstanding for the nine months ended September 30, 2017 and 2016, respectively, and 7,004,346 and 6,057,508 for the three months ended September 30, 2017 and 2016, 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 officers and employees of the Bank to advance the best interest of the Corporation and its shareholders. The plan provides those persons who have responsibility for its growth with additional incentive by allowing them to acquire ownership in the Corporation and, thereby, encouraging them to contribute to the success of the Corporation. Plan expense is recognized over the vesting period of the stock issued under the plan. As of September 30, 2017, 19,301 shares were issued under this plan, of which 12,693 were fully vested and the remaining 6,608 will vest over the next year. $120,000 and $59,000 of compensation expenses related to the grants were recognized during the nine months ended September 30, 2017 and 2016, respectively. No compensation expenses were recognized during the three months ended September 30, 2017 or 2016.

 

4.              Retirement Benefits

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30

In thousands

 

2017

 

2016

 

2017

 

2016

Service cost

 

$

210

 

 

$

199

 

 

$

630

 

 

$

597

 

Interest cost

 

284

 

 

284

 

 

852

 

 

852

 

Expected return on plan assets

 

(630

)

 

(609

)

 

(1,890

)

 

(1,824

)

Amortization of net loss

 

169

 

 

172

 

 

507

 

 

513

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Periodic Benefit Expense

 

$

33

 

 

$

46

 

 

$

99

 

 

$

138

 

 

The Corporation previously disclosed in its consolidated financial statements for the year ended December 31, 2016, that it had not yet determined the amount the Bank planned on contributing to the defined benefit plan in 2017. As of September 30, 2017, 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 358 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 $6,974,000 in standby letters of credit as of September 30, 2017. 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 September 30, 2017, 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 Gains
(Losses) on

Securities

 

 

Pension
Liability

 

 

Accumulated Other
Comprehensive
Loss

 

BALANCE — SEPTEMBER 30, 2017

 

$

40

 

 

$

(5,429

)

 

$

(5,389

)

BALANCE DECEMBER 31, 2016

 

$

(266

)

 

$

(5,758

)

 

$

(6,024

)

BALANCE — SEPTEMBER 30, 2016

 

$

1,679

 

 

$

(5,552

)

 

$

(3,873

)

 

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 nine month periods ended September 30, 2017 and 2016, is as follows:

 

In thousands

 

Banking

 

 

Insurance

 

 

Total

 

2017

 

 

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

39,536

 

 

$

3,863

 

 

$

43,399

 

Income before income taxes

 

9,099

 

 

799

 

 

9,898

 

Total assets

 

1,598,331

 

 

9,304

 

 

1,607,635

 

Capital expenditures

 

1,087

 

 

 

 

1,087

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

33,871

 

 

$

3,335

 

 

$

37,206

 

Income before income taxes

 

10,424

 

 

681

 

 

11,105

 

Total assets

 

1,199,365

 

 

9,504

 

 

1,208,869

 

Capital expenditures

 

2,013

 

 

12

 

 

2,025

 

 

Segment information for the three month periods ended September 30, 2017 and 2016, is as follows:

 

In thousands

 

Banking

 

 

Insurance

 

 

Total

 

2017

 

 

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

16,321

 

 

$

1,171

 

 

$

17,492

 

Income before income taxes

 

2,424

 

 

201

 

 

2,625

 

Total assets

 

1,598,331

 

 

9,304

 

 

1,607,635

 

Capital expenditures

 

284

 

 

 

 

284

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

 

 

Net interest income and other income from external customers

 

$

11,581

 

 

$

905

 

 

$

12,486

 

Income before income taxes

 

3,485

 

 

221

 

 

3,706

 

Total assets

 

1,199,365

 

 

9,504

 

 

1,208,869

 

Capital expenditures

 

326

 

 

 

 

326

 

 

Customer lists intangible assets are amortized over 10 years on a straight line basis. Core deposit intangible assets are amortized over 10 years using the sum-of-years digits method. 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 NW acquisition is not deductible for federal income tax purposes.

 

12



 

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, including equity securities with readily determinable fair values, 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).

 

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 September 30, 2017, and December 31, 2016, were as follows:

 

In thousands

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

 

 

 

 

 

 

 

 

 

 

SECURITIES AVAILABLE FOR SALE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SEPTEMBER 30, 2017

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

99,999

 

$

37

 

$

1,022

 

$

99,014

 

Mortgage-backed securities, residential

 

36,673

 

705

 

27

 

37,351

 

State and municipal

 

14,967

 

160

 

11

 

15,116

 

Corporate bonds

 

5,000

 

112

 

 

5,112

 

CRA mutual fund

 

1,044

 

 

2

 

1,042

 

Stock in other banks

 

647

 

110

 

 

757

 

 

 

$

158,330

 

$

1,124

 

$

1,062

 

$

158,392

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2016

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

81,065

 

$

43

 

$

1,529

 

$

79,579

 

Mortgage-backed securities, residential

 

31,272

 

782

 

81

 

31,973

 

State and municipal

 

24,514

 

240

 

94

 

24,660

 

Corporate bonds

 

5,000

 

62

 

 

5,062

 

CRA mutual fund

 

1,044

 

 

9

 

1,035

 

Stock in other banks

 

498

 

183

 

 

681

 

 

 

$

143,393

 

$

1,310

 

$

1,713

 

$

142,990

 

 

 

 

 

 

 

 

 

 

 

SECURITIES HELD TO MATURITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SEPTEMBER 30, 2017

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

20,004

 

$

25

 

$

54

 

$

19,975

 

Mortgage-backed securities, residential

 

27,365

 

156

 

123

 

27,398

 

 

 

$

47,369

 

$

181

 

$

177

 

$

47,373

 

DECEMBER 31, 2016

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

23,017

 

$

26

 

$

54

 

$

22,989

 

Mortgage-backed securities, residential

 

32,551

 

210

 

325

 

32,436

 

 

 

$

55,568

 

$

236

 

$

379

 

$

55,425

 

 

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 September 30, 2017, and December 31, 2016:

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SEPTEMBER 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

65,649

 

$

629

 

$

15,756

 

$

393

 

$

81,405

 

$

1,022

 

Mortgage-backed securities, residential

 

6,783

 

27

 

 

 

6,783

 

27

 

State and municipal

 

1,441

 

7

 

691

 

4

 

2,132

 

11

 

CRA Mutual Fund

 

1,042

 

2

 

 

 

1,042

 

2

 

 

 

$

74,915

 

$

665

 

$

16,447

 

$

397

 

$

91,362

 

$

1,062

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

71,454

 

$

1,529

 

$

 

$

 

$

71,454

 

$

1,529

 

Mortgage-backed securities, residential

 

8,966

 

81

 

 

 

8,966

 

81

 

State and municipal

 

4,933

 

94

 

 

 

4,933

 

94

 

CRA Mutual Fund

 

1,035

 

9

 

 

 

1,035

 

9

 

 

 

$

86,388

 

$

1,713

 

$

 

$

 

$

86,388

 

$

1,713

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECURITIES HELD TO MATURITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SEPTEMBER 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

12,948

 

$

52

 

$

1,998

 

$

2

 

$

14,946

 

$

54

 

Mortgage-backed securities, residential

 

10,496

 

114

 

1,168

 

9

 

11,664

 

123

 

 

 

$

23,444

 

$

166

 

$

3,166

 

$

11

 

$

26,610

 

$

177

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and agencies

 

$

12,946

 

$

54

 

$

 

$

 

$

12,946

 

$

54

 

Mortgage-backed securities, residential

 

12,956

 

325

 

 

 

12,956

 

325

 

 

 

$

25,902

 

$

379

 

$

 

$

 

$

25,902

 

$

379

 

 

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 September 30, 2017, fifty-six available for sale U.S. Government and agency securities had unrealized losses that individually did not exceed 4% of amortized cost. Nine 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 September 30, 2017, eight available for sale residential mortgage-backed securities had unrealized losses that individually did not exceed 1% of amortized cost. These securities have not 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 September 30, 2017, nine available for sale state and municipal securities had unrealized losses that individually did not exceed 2% of amortized cost. Three 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 September 30, 2017, the CRA Mutual Fund had an unrealized loss that did not exceed 1% of amortized cost. This security has not been in a continuous loss position for 12 months or more. This unrealized loss relates principally to changes in interest rates subsequent to the acquisition of the specific security.

 

At September 30, 2017, eight held to maturity U.S. Government and agency securities had unrealized losses that individually did not exceed 1% of amortized cost. One of these securities has 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 September 30, 2017, thirteen held to maturity residential mortgage-backed securities had unrealized losses that individually did not exceed 2% of amortized cost. One of these securities has 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 September 30, 2017, 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 September 30, 2017, 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

 

$

6,576

 

$

6,589

 

$

8,004

 

$

7,998

 

Over 1 year through 5 years

 

97,681

 

96,972

 

12,000

 

11,977

 

Over 5 years through 10 years

 

15,709

 

15,681

 

 

 

Over 10 years

 

 

 

 

 

Mortgage-backed securities, residential

 

36,673

 

37,351

 

27,365

 

27,398

 

CRA mutual fund

 

1,044

 

1,042

 

 

 

Stock in other banks

 

647

 

757

 

 

 

 

 

$

158,330

 

$

158,392

 

$

47,369

 

$

47,373

 

 

The Corporation did not sell any securities available for sale during the three and nine months ended September 30, 2017 and 2016.

 

16



 

At September 30, 2017, and December 31, 2016, securities with a carrying value of $177,259,000 and $134,763,000, respectively, were pledged as collateral as required by law on public and trust deposits, repurchase agreements, and for other purposes.

 

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:

 

17



 

·                    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;

 

·                    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.

 

18



 

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.

 

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 constructio