ACNB CORPORATION INTRODUCTION AND FORWARD-LOOKING STATEMENTS
Introduction
The following is management's discussion and analysis of the significant changes in the financial condition, results of operations, comprehensive income, capital resources, and liquidity presented in its accompanying consolidated financial statements forACNB Corporation (the Corporation or ACNB), a financial holding company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee, assure or indicate similar performance in the future.
Forward-Looking Statements
In addition to historical information, this Form 10-Q may contain forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure, and other financial terms, (b) statements of plans and objectives of Management or the Board of Directors, and (c) statements of assumptions, such as economic conditions in the Corporation's market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "intends", "will", "should", "anticipates", or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties such as national, regional and local economic conditions, competitive factors, and regulatory limitations. Actual results may differ materially from those projected in the forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: short-term and long-term effects of inflation and rising costs on the Corporation, customers and the economy; the continuing banking crisis caused by the recent failures and continuing financial instability of certain banks which may adversely impact the Corporation and its securities and loan values, deposit stability, capital adequacy, financial condition, operations, liquidity, and results of operations; effects of governmental and fiscal policies, as well as legislative and regulatory changes; effects of new laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and their application with which the Corporation and its subsidiaries must comply; impacts of the capital and liquidity requirements of the Basel III standards; effects of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as theFinancial Accounting Standards Board and other accounting standard setters; ineffectiveness of the business strategy due to changes in current or future market conditions; future actions or inactions ofthe United States government, including the effects of short-term and long-term federal budget and tax negotiations and a failure to increase the government debt limit or a prolonged shutdown of the federal government; effects of economic conditions particularly with regard to the negative impact of any pandemics, epidemics or health-related crises and the responses thereto on the operations of the Corporation and current customers, specifically the effect of the economy on loan customers' ability to repay loans; effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; inflation, securities market and monetary fluctuations; risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest rate protection agreements, as well as interest rate risks; difficulties in acquisitions and integrating and operating acquired business operations, including information technology difficulties; challenges in establishing and maintaining operations in new markets; effects of technology changes; effects of general economic conditions and more specifically in the Corporation's market areas; failure of assumptions underlying the establishment of reserves for credit losses and estimations of values of collateral and various financial assets and liabilities; acts of war or terrorism or geopolitical instability; disruption of credit and equity markets; ability to manage current levels of impaired assets; loss of certain key officers; ability to maintain the value and image of the Corporation's brand and protect the Corporation's intellectual property rights; continued relationships with major customers; and, potential impacts to the Corporation from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses. We caution readers not to place undue reliance on these forward-looking statements. They only reflect Management's analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time to time with theSecurities and Exchange Commission , including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q. Please also carefully review any Current Reports on Form 8-K filed by the Corporation with theSecurities and Exchange Commission . 30
--------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The accounting policies that the Corporation's management deems to be most important to the portrayal of its financial condition and results of operations, and that require management's most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management: The allowance for credit losses (ACL) represents an amount which, in management's judgment, is adequate to absorb expected credit losses on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for credit losses, which is recorded as a current period operating expense. Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness of the ACL is reviewed quarterly by management. Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed. While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes in the interest rate environment which may directly impact prepayment and curtailment rate assumption, and changes in the financial condition of borrowers. The ACL "base case" model is derived from various economic forecasts provided by widely recognized sources. Management evaluates the variability of market conditions by examining the peak and trough of economic cycles. These peaks and troughs are used to stress the base case model to develop a range of potential outcomes. Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio.
RESULTS OF OPERATIONS
Quarter ended
Executive Summary
Net income for the three months endedMarch 31, 2023 , was$9,023,000 compared to a net income of$6,599,000 for the comparable period in 2022 an increase of$2,424,000 or 36.7%. Basic earnings per share for the three months endedMarch 31, 2023 and 2022, were$1.06 and$0.76 , respectively, a 39.5% increase. The increase in net income for the first quarter of 2023 was primarily driven by an increase in net interest income.
Net Interest Income
Net interest income totaled$23,092,000 for the three months endedMarch 31, 2023 compared to$17,053,000 for the comparable period in 2022, an increase of$6,039,000 , or 35.4%. The increase in net interest income can be attributed to a higher net interest margin that benefited from higher interest rates, deployment of excess liquidity, lower funding costs and a shift into higher-yielding assets. The net interest margin for the three months endedMarch 31, 2023 was 4.19%, a 152 basis points increase from 2.67% for the comparable period of 2022. Paycheck Protection Program (PPP) fees and purchase accounting accretion totaled$374,000 for the three months endedMarch 31, 2023 compared to$1,058,000 for the three months endedMarch 31, 2022 . Average earning assets declined year-over-year driven by cash balances decreasing attributed to anticipated deposit outflows as market rates increased in 2022 and 2023. However, interest income increased by$5,832,000 for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 driven by higher interest rates, deployment of excess liquidity and a shift into higher-yielding assets. The average yield on earnings assets was 4.33% for the three months endedMarch 31 , 31 -------------------------------------------------------------------------------- 2023, an increase of 150 basis points from the comparable quarter last year. Interest expense decreased by$207,000 for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 , driven by declining deposit balances and costs. The average rate paid on interest bearing deposits was 0.12% for the three months endedMarch 31, 2023 , a decrease of 5 basis points from the comparable quarter last year.
Provision for Credit Losses & Unfunded Commitments
EffectiveJanuary 1, 2023 , the Corporation adopted Accounting Standards Update 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," referred to as the current expected credit loss model (CECL). This accounting standard requires that credit losses for financial assets and off-balance-sheet credit exposures be measured based on expected credit losses, rather than on incurred credit losses as in prior periods. The Corporation recorded a net decrease to retained earnings of$2.4 million net of tax as ofJanuary 1, 2023 for the cumulative effect of adopting Topic 326. The allowance for credit losses increased$1.6 million , and the allowance for unfunded commitments, included in the liabilities section on the balance sheet, increased$1.9 million from the fourth quarter of 2022. Based on the forward-looking metrics utilized within the CECL model, combined with the current market environment applied to the Bank's loan portfolio, the provision for credit losses for the first three months of 2023 was$97,000 , and the provision for unfunded commitments was$276,000 . The determination of the provisions was a result of the analysis of the adequacy of the allowances for credit losses and unfunded commitments calculations. Each quarter, the Corporation assesses risks and reserves required compared with the balances in the allowance for credit losses and unfunded commitments. ACNB charges confirmed credit losses to the allowance and credits the allowance for credit losses for recoveries of previous loan charge-offs. For the first quarter of 2023, the Corporation had net loan charge-offs of$91,000 as compared to net loan charge-offs of$70,000 for the first quarter of 2022. For more information, please refer to Note 8 - "Loans and Allowance for Credit Losses" in the Notes to Consolidated Financial Statements as well as the Allowance for Credit Losses & Asset Quality in the following Financial Condition section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.
Other Income
Total other income was$4,984,000 for the three months endedMarch 31, 2023 , up$525,000 , or 11.8%, from the comparable period of 2022. At the Corporation's wholly-owned insurance subsidiary,ACNB Insurance Services, Inc. , commissions from insurance sales were up by$702,000 , or 58.5%, to$1,902,000 driven primarily by the acquisition of the business and assets of theHockley & O'Donnell Agency in the first quarter of 2022 and higher contingent income. Income from fiduciary, investment management and brokerage activities increased$30,000 , or 3.7%, due to strong fixed annuity sales and an increase in assets under management and administration. Income from mortgage loans held for sale decreased by$264,000 , or 94.0%, due to less mortgage activity as a result of an increase in the current rate environment. Bank-owned life insurance increased by$115,000 due to additional purchases of insurance with a cash surrender value of$12,200,000 during the second half of 2022. A net loss of$193,000 was recognized on the sales of securities during the first quarter of 2023, and no securities were sold during the first quarter of 2022. A$20,000 net gain on equity securities was recognized on local bank and CRA-related equity securities during the first quarter of 2023 compared to a$109,000 loss during the first quarter of 2022. Other income in the three months endedMarch 31, 2023 , was down by$68,000 , or 28.5%, to$171,000 due to a variety of other fee income variances.
Other Expenses
Other expenses for the quarter endedMarch 31, 2023 were$16,282,000 an increase of$3,000,000 , or 22.6%, from the comparable period in 2022. The largest expense is salaries and benefits, which increased by$2,883,000 , or 38.1%, from the comparable period in 2022. The increase in salaries and employee benefits expense was driven primarily by a partial reversal of incentive compensation of$750,000 and a reversal of$484,000 of loan expense in the first quarter of 2022, as well as an increase in stock expense of$252,000 , an increase in pension expense of$157,000 , additional expenses of$125,000 due to the acquisition of the business and assets of theHockley & O'Donnell Insurance Agency and a higher extended leave reserve adjustment of$214,000 . Net occupancy expense decreased by$122,000 , or 10.5%, during the period driven by the closure of a temporary banking facility, less snow removal expense and an increase in rental income. Equipment expense increased by$89,000 , or 5.9%, driven by the ongoing expenses related to the implementation of a new loan origination system in late 2022. Professional services expense totaled$382,000 during the first quarter of 2023 as compared to$309,000 for the comparable period in 2022, an increase of$73,000 , or 23.6%. The increase in professional services expense was a result of additional costs related to the change in the Corporation's independent audit firm in 2022. Marketing and corporate relations expenses were$154,000 for the first quarter of 2023, or 49.5% higher as compared to the comparable period of 2022. The increase was driven by$89,000 in expenses related to the rebranding ofACNB Bank's Maryland banking divisions. Other tax expense decreased by$79,000 , or 32 -------------------------------------------------------------------------------- 19.0%, during the first quarter of 2023 as compared to the comparable period in 2022 due to lowerPennsylvania shares tax. Supplies and postage expense increased by 13.8% due to variation in the timing of necessary replenishments and increased prepaid mailing costs.. Intangible amortization increased 16.5% due to the acquisition of the business and assets of theHockley & O'Donnell Agency in the first quarter of 2022.
Provision for Income Taxes
The Corporation recognized income taxes of$2,398,000 , or 21.0% of pretax income, during the first quarter of 2023 compared to$1,631,000 , or 19.8% of pretax income, during the comparable period in 2022. The variances from the federal statutory rate of 21% in the respective periods are generally due to tax-free income, which includes interest income on tax-free loans and investment securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expense. In addition, both years includeMaryland corporation income taxes. Low-income housing tax credits were$4,000 and$70,000 for the three months endedMarch 31, 2023 and 2022, respectively. FINANCIAL CONDITION Assets totaled$2,410,933,000 atMarch 31, 2023 compared to$2,525,507,000 atDecember 31, 2022 , and$2,746,156,000 atMarch 31, 2022 . The decrease fromMarch 31, 2022 was driven by a reduction in cash and cash equivalents of$363,554,000 as a result of management decisions late in the first quarter of 2022 to invest excess cash and cash equivalents into securities, and to fund loan growth and deposit outflows. The decrease fromDecember 31, 2022 was a result of reduction in cash and cash equivalents to fund deposit outflows driven by customers beginning to seek higher yielding alternative deposit and investment products as market interest rates rose during 2022 and 2023. Total loans outstanding were$1,531,626,000 atMarch 31, 2023 compared to$1,484,326,000 atMarch 31, 2022 , an increase of$47,300,000 and$1,538,610,000 atDecember 31, 2022 . Year-over-year, the increase was driven mainly by growth in the commercial loan portfolio. Loans decreased by$6,984,000 , or 0.45%, fromDecember 31, 2022 toMarch 31, 2023 , mainly from payoffs and paydowns in the loan portfolio. Total securities were$568,232,000 atMarch 31, 2023 compared to$620,250,000 atDecember 31, 2022 , a decrease of 8.4% and$606,879,000 atMarch 31, 2022 , a decrease of 6.4%. The decline in the securities portfolio was to fund deposit outflows. Total deposits were$2,055,822,000 atMarch 31, 2023 . Deposits decreased by$143,153,000 , or 6.5%, sinceDecember 31, 2022 and decreased$354,939,000 or 14.7% sinceMarch 31, 2022 . The decrease in deposits was a result of customers seeking higher yielding alternative investment or deposit products as market interest rates rose during 2022 and 2023.
ACNB uses investment securities to generate interest and dividend income, manage interest rate risk, provide collateral for certain funding products, and provide liquidity. The decision to change the securities portfolio in 2022 was to provide better yields on excess deposits. The investment portfolio is comprised ofU.S. Government agency, municipal, and corporate securities. These securities provide the appropriate characteristics with respect to credit quality, yield and maturity relative to the management of the overall balance sheet. AtMarch 31, 2023 , the securities balance included a net unrealized loss on available for sale securities of$46,730,000 , net of taxes, on amortized cost of$559,579,000 versus a net unrealized loss of$52,734,000 , net of taxes, on amortized cost of$617,641,000 atDecember 31, 2022 , and a net unrealized loss of$24,912,000 , net of taxes, on amortized cost of$608,393,000 atMarch 31, 2022 . The change in fair value of available for sale securities was a result of an increase in market interest rates in 2022 and 2023. The changes in value are deemed to be related solely to changes in market interest rates as the credit quality of the portfolio remained strong. AtMarch 31, 2023 , the securities balance included held to maturity securities with an amortized cost of$64,960,000 and a fair value of$59,998,000 as compared to an amortized cost of$64,977,000 and a fair value of$58,078,000 atDecember 31, 2022 , and an amortized cost of$28,019,000 and a fair value of$27,679,000 atMarch 31, 2022 . During the second quarter of 2022, approximately$39.7 million of municipal securities were transferred from available for sale to held to maturity to mitigate the unrealized loss on available for sale securities. The held to maturity securities also includeU.S. government pass-through mortgage-backed securities in which the full payment of principal and interest is guaranteed.
The Corporation does not own investments consisting of pools of Alt-A or subprime mortgages, private label mortgage-backed securities, or trust preferred investments.
During 2022, the Corporation deployed excess liquidity by moving approximately$250,000,000 from cash and cash equivalents into higher-yielding securities. These new purchases were consistent with the current investment portfolio, but with 33 -------------------------------------------------------------------------------- higher yields to enhance the net interest margin and net interest income in future quarters. Purchases were primarily in 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. The fair values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather by relying on the security's relationship to other benchmark quoted prices. The Corporation uses independent service providers to provide matrix pricing. Please refer to Note 7 - "Securities" in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note 9 - "Fair Value Measurements" in the Notes to Consolidated Financial Statements for more information about fair value.
Loans
Loans outstanding increased by$47,300,000 , or 3.2%, atMarch 31, 2023 fromMarch 31, 2022 , and decreased by$6,984,000 , or 0.5%, fromDecember 31, 2022 , toMarch 31, 2023 . The increase in loans from the same period last year is largely attributable to growth in the commercial lending portfolio. Total commercial purpose segments increased$33,715,000 , or 3.2%, as compared toMarch 31, 2022 . Commercial loans are spread among diverse categories that include municipal governments/school districts, commercial real estate, commercial real estate construction, and commercial and industrial. Residential real estate mortgage lending increased by$19,348,000 , or 5.7%, as compared toMarch 31, 2022 . The increase was driven by an increase in junior liens or home equity loans, which are also in many cases junior liens. Of the$360,878,000 total in residential mortgage loans atMarch 31, 2023 ,$44,867,000 were secured by Junior liens which inherently have more credit risk by virtue of the fact that another financial institution may have a senior security position in the case of foreclosure liquidation of collateral to extinguish the debt. Generally, foreclosure actions could become more prevalent if the real estate market weakens, property values deteriorate, or rates increase sharply. Non-real estate secured consumer loans comprise 0.7% of the portfolio, with automobile-secured loans representing less than 0.1% of the portfolio. Most of the Corporation's lending activities are with customers located within the Bank's market area of southcentralPennsylvania and northernMaryland . Unemployment rates in the subsidiary bank's market recently, and historically, have been better than those forPennsylvania andMaryland as a whole, and similar tothe United States . Included in commercial real estate loans are loans made to lessors of non-residential properties that total$436,228,000 , or 28.5% of total loans, atMarch 31, 2023 . These borrowers are geographically dispersed throughout ACNB's marketplace and are leasing commercial properties to a varied group of tenants including medical offices, retail space, and other commercial purpose facilities. Because of the varied nature of the tenants, in aggregate, management believes that these loans present an acceptable risk when compared to commercial loans in general. ACNB does not originate or hold Alt-A or subprime mortgages in its loan portfolio. For more information please see Note 8 - "Loans and Allowance for Credit Losses" in the Notes to Consolidated Financial Statements.
Allowance for Credit Losses & Asset Quality
The allowance for credit losses atMarch 31, 2023 , was$19,485,000 , or 1.27% of total loans as compared to$18,963,000 , or 1.28% of loans, atMarch 31, 2022 , and$17,861,000 , or 1.16% of loans, atDecember 31, 2022 . The increase from year-end was primarily driven by the adoption of CECL as shown in the table below. For more information please see Note 8 - "Loans and Allowance for Credit Losses" in the Notes to Consolidated Financial Statements.
Changes in the allowance for credit losses were as follows:
Three Months Ended Year Ended Three Months Ended
In thousands March 31, 2023 December 31, 2022 March 31, 2022
Beginning balance - January 1 $ 17,861 $ 19,033 $ 19,033
Impact of CECL adoption 1,618 - -
Provisions charged to operations 97 - -
Recoveries on charged-off loans 26 114 12
Loans charged-off (117) (1,286) (82)
Ending balance $ 19,485 $ 17,861 $ 18,963
34-------------------------------------------------------------------------------- Loans past due 90 days and still accruing were$860,000 and nonaccrual loans were$2,978,000 as ofMarch 31, 2023 . Loans past due 90 days and still accruing were$964,000 atMarch 31, 2022 , while nonaccrual loans were$4,543,000 . Loans past due 90 days and still accruing were$1,203,000 atDecember 31, 2022 , while nonaccrual loans were$2,654,000 .
Information on nonaccrual loans, by collateral type rather than loan class, at
Number of Current
Credit Specific Loss Year
Dollars in thousands Relationships Balance Allocations Charge-Offs Location Originated
Owner occupied commercial real estate 6$ 1,866 $ 202 $ - In market 2012 - 2020 Investment/rental residential real estate 1 98 - - In market 2016 Commercial and industrial 3 807 709 - In market 2017 - 2018 Home equity line of credit 1 207 - - In market 2016 Total 11$ 2,978 $ 911 $ - December 31, 2022 Owner occupied commercial real estate 5$ 1,772 $ 192 $ - In market 2012 - 2019 Investment/rental residential real estate 1 101 - - In market 2016 Commercial and industrial 2 781 628 - In market 2017 - 2018 Total 8$ 2,654 $ 820 $ -
All nonaccrual loans are to borrowers located within the market area served by
the Corporation in southcentral
Premises and Equipment
OnJanuary 12, 2022 ,ACNB Bank announced plans to build a full-service community banking office to serve the Upper Adams area ofAdams County, PA. The UpperAdams Office opened inOctober 2022 and, as a result, three offices were consolidated into the new community banking office. Two of the former office buildings were subsequently transferred to Assets Held for Sale at fair market value. Also, as part of the Bank's branch optimization program, in the third quarter of 2022, the Bank announced the planned closure of three additional community banking offices effectiveDecember 2022 . As a result, two of the former branch office buildings were transferred to Assets Held for Sale at fair market value. The total of the four branch office buildings transferred to Assets Held for Sale have a carrying value of$3,393,000 atMarch 31, 2023 .
Foreclosed Assets Held for Resale
The carrying value of real estate acquired through foreclosure was$474,000 with one property atMarch 31, 2023 , compared to$0 with no properties atMarch 31, 2022 . All acquired properties are actively marketed.
Deposits
ACNB relies on deposits as a primary source of funds for lending activities with total deposits of$2,055,822,000 as ofMarch 31, 2023 . Deposits decreased by$354,939,000 , or 14.7%, fromMarch 31, 2022 , toMarch 31, 2023 , and decreased by$143,153,000 , or 6.5%, fromDecember 31, 2022 , toMarch 31, 2023 . The decrease in deposits were in interest bearing and non-interest bearing deposits, and was a result of customers seeking higher yielding alternative investment or deposit products as market interest rates rose during 2022 and 2023. Historically, deposits vary between quarters mostly reflecting different levels held by local companies, government units and school districts during different times of the year. Despite the decline in deposits in 2023, the loan-to-deposit ratio was 74.50% atMarch 31, 2023 . ACNB's deposit pricing function employs a disciplined pricing approach based upon liquidity needs and alternative funding rates, but also strives to price deposits to be competitive with relevant local competition, including local government investment 35 -------------------------------------------------------------------------------- trusts, credit unions and larger regional banks. Given the Corporation's funding level, the Corporation made a decision to restrain deposit rates and thereby moderate deposit costs in 2022 and into 2023 despite an increase in market interest rates and an increase in rates by competitors. Interest bearing deposit costs for the first quarter of 2023 were 0.14% compared to 0.18 % for the first quarter of 2022. The ratio of uninsured and non-collateralized deposits to total deposits was approximately 19.2% atMarch 31, 2023 .
Borrowings
Short-term Bank borrowings are comprised primarily of securities sold under agreements to repurchase and short-term borrowings from the FHLB. As ofMarch 31, 2023 , short-term Bank borrowings were$30,294,000 , as compared to$41,954,000 atDecember 31, 2022 , and$30,028,000 atMarch 31, 2022 . Agreements to repurchase accounts are within the commercial and local government customer base and have attributes similar to core deposits. Investment securities are pledged in sufficient amounts to collateralize these agreements. Compared to year-end 2022, repurchase agreement balances were down$11,660,000 , or 27.8%, due to changes in the cash flow position of ACNB's commercial and local government customer base and lack of competition from non-bank sources. There were no short-term FHLB borrowings atMarch 31, 2023 and 2022, orDecember 31, 2022 . Short-term FHLB borrowings are used to even out Bank funding from seasonal and daily fluctuations in the deposit base. Long-term borrowings consist of longer-term advances from the FHLB that provides term funding for loan assets, and Corporate borrowings that were acquired or originated in regards to the acquisitions and to refund or extend such Corporation borrowings. Long-term borrowings totaled$46,000,000 atMarch 31, 2023 , versus$21,000,000 atDecember 31, 2022 , and$30,200,000 atMarch 31, 2022 . During the quarter, the bank borrowed$25,000,000 from the FHLB at a fixed rate of 4.629% for a term of 4.5 years. Further borrowings will be used when necessary for a variety of risk management and funding purposes. Please refer to the Liquidity discussion below for more information on the Corporation's ability to borrow. Capital ACNB's capital management strategies have been developed to provide an appropriate rate of return, in the opinion of management, to shareholders, while maintaining its "well-capitalized" regulatory position in relationship to its risk exposure. Total shareholders' equity was$255,841,000 atMarch 31, 2023 compared to$245,042,000 atDecember 31, 2022 and$256,009,000 atMarch 31, 2022 . Shareholders' equity decreased$2,368,000 due to the cumulative effect for adoption of CECL and increased$6,052,000 primarily due to the change in accumulated other comprehensive loss from unrealized losses in the securities portfolio. These changes, along with net income during the quarter of$9,023,000 , were the primary drivers of the increase in shareholders' equity fromDecember 31, 2022 toMarch 31, 2023 . The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During the first three months of 2023, ACNB earned$9,023,000 and paid dividends of$2,384,000 for a dividend payout ratio of 26.4%. During the first three months of 2022, ACNB earned$6,599,000 and paid dividends of$2,257,000 for a dividend payout ratio of 34.2%.ACNB Corporation has a Dividend Reinvestment and Stock Purchase Plan that provides registered holders ofACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. Year-to-dateMarch 31, 2023 , 5,889 shares were issued under this plan with proceeds in the amount of$188,000 . Year-to-dateMarch 31, 2022 , 5,587 shares were issued under this plan with proceeds in the amount of$183,000 . OnOctober 24, 2022 , the Corporation announced that the Board of Directors approved onOctober 18, 2022 , a new plan to repurchase, in open market and privately negotiated transactions, up to 255,575, or approximately 3%, of the outstanding shares of the Corporation's common stock. This new common stock repurchase program replaces and supersedes any and all earlier announced repurchase plans. As ofMarch 31, 2023 , 850 shares of common stock have been repurchased under this new plan. ACNB is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on ACNB. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, ACNB must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and 36 --------------------------------------------------------------------------------
reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require ACNB to maintain minimum amounts and ratios of total and Tier 1 capital to average and risk adjusted assets. Management believes, as ofMarch 31, 2023 , andDecember 31, 2022 , that ACNB's banking subsidiary met all minimum capital adequacy requirements to which it is subject and is categorized as "well capitalized" for regulatory purposes. There are no subsequent conditions or events that management believes have changed the banking subsidiary's category.
Regulatory Capital Changes
InJuly 2013 , the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations beganJanuary 1, 2015 , while larger institutions (generally those with assets of$250 billion or more) began compliance effectiveJanuary 1, 2014 . The final rules call for the following capital requirements:
•a minimum ratio of common Tier 1 capital to risk-weighted assets of 4.5%;
•a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%;
•a minimum ratio of total capital to risk-weighted assets of 8.0%; and,
•a minimum leverage ratio of 4.0%.
In addition, the final rules established a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations.
The Corporation calculated regulatory capital ratios as ofMarch 31, 2023 , and confirmed no material impact on the capital, operations, liquidity, and earnings of the Corporation and the banking subsidiary from the changes in the regulations.
InDecember 2018 , theFDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations' implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. The Corporation adopted CECL effectiveJanuary 1, 2023 and elected to implement the capital transition relief over the permissible three-year period.
In 2019, the federal banking agencies issued a final rule to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, including the community bank leverage ratio (CBLR) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than$10 billion , and limited amounts of off-balance sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9% (subsequently reduced to 8% as a COVID-19 relief measure). Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of theFDIC's Prompt Corrective Action framework. The CBLR framework was available for banks to use in theirMarch 31, 2020 Call Report. The Corporation has performed changes to capital adequacy and reporting requirements within the quarterly Call Report, and it opted out of the CBLR framework. 37 --------------------------------------------------------------------------------
The banking subsidiary's capital ratios are as follows:
To Be Well Capitalized
Under Prompt
Corrective Action
March 31, 2023 December 31, 2022 Regulations
Tier 1 leverage ratio (to average assets) 10.32 % 9.50 % 5.00 %
Common Tier 1 capital ratio (to risk-weighted
assets) 14.84 % 14.68 % 6.50 %
Tier 1 risk-based capital ratio (to risk-weighted
assets) 14.84 % 14.68 % 8.00 %
Total risk-based capital ratio 15.96 % 15.76 % 10.00 %
Liquidity
Effective liquidity management ensures the cash flow requirements of depositors
and borrowers, as well as the operating cash needs of ACNB, are met. ACNB's
funds are available from a variety of sources, including assets that are readily
convertible such as interest bearing deposits with banks, maturities and
repayments from the securities portfolio, scheduled repayments of loans
receivable, the core deposit base, the ability to raise brokered deposits, and
the ability to borrow from the FHLB and Federal Reserve Discount Window.
At March 31, 2023 , ACNB's banking subsidiary could borrow approximately
$814,924,000 from the FHLB, of which $789,853,000 was available. At March 31,
2023 , ACNB's banking subsidiary could borrow approximately $5,771,000 from the
Discount Window, of which the full amount was available. The underlying
collateral at the Discount Window is made up of investment securities held in a
joint-custody account under the Corporation's name.
A new Federal Reserve lending facility, named the Bank Term Funding Program, was
enacted in March 2023 that provides banks the ability to borrow on the par value
of certain investment securities used to collateralize the account. As of
March 31, 2023 , ACNB's banking subsidiary could borrow approximately
$262,000,000 from the Bank Term Funding Program, of which the full amount was
available.
ACNB's banking subsidiary maintains several unsecured Fed Funds lines with
correspondent banks. As of March 31, 2023 , Fed Funds line capacity at the
banking subsidiary was $75,000,000 , of which the full amount was available. In
2018, ACNB Corporation executed a guaranty for a note related to a $1,500,000
commercial line of credit from a local bank, with normal terms and conditions
for such a line, for ACNB Insurance Services, Inc. , the borrower and a
wholly-owned subsidiary of ACNB Corporation . The commercial line of credit is
for general working capital needs as they arise and did not have any outstanding
balance as of March 31, 2023 . The Corporation maintains a $5,000,000 unsecured
line of credit with a correspondent bank. The line of credit remains at full
capacity as of March 31, 2023 .
Another source of liquidity is securities sold under repurchase agreements to
customers of ACNB's banking subsidiary totaling approximately $30,294,000 and
$41,954,000 at March 31, 2023 , and December 31, 2022 , respectively. These
agreements vary in balance according to the cash flow needs of customers and
competing accounts at other financial organizations.
The liquidity of the parent company also represents an important aspect of
liquidity management. The parent company's cash outflows consist principally of
dividends to shareholders and corporate expenses. The main source of funding for
the parent company is the dividends it receives from its subsidiaries. Federal
and state banking regulations place certain legal restrictions and other
practicable safety and soundness restrictions on dividends paid to the parent
company from the subsidiary bank.
ACNB manages liquidity by monitoring projected cash inflows and outflows on a
daily basis, and believes it has sufficient funding sources to maintain
sufficient liquidity under varying degrees of business conditions for liquidity
and capital resource requirements for all material short- and long-term cash
requirements from known contractual and other obligations.
On March 30, 2021 , the Corporation issued $15 million of subordinated debt in
order to pay off existing higher rate debt, to potentially repurchase ACNB
common stock and to use for inorganic growth opportunities. Otherwise, the $15
million of subordinated debt qualifies as Tier 2 capital at the Holding Company
level, but can be transferred to the Bank where it qualifies as Tier 1 Capital.
The debt has a 4.00% fixed-to-floating rate and a stated maturity of March 31,
2031 . The debt is redeemable by the Corporation at its option, in whole or in
part, on or after March 30, 2026 , and at any time upon occurrences of certain
unlikely events such as receivership insolvency or liquidation of ACNB or ACNB
Bank .
38
--------------------------------------------------------------------------------Off-Balance Sheet Arrangements
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. AtMarch 31, 2023 , the Corporation had unfunded outstanding commitments to extend credit of$414,636,000 and outstanding standby letters of credit of$15,992,000 . Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.
Market Risks
During March andApril 2023 three significant bank failures occurred (Silicon Valley Bank , Signature Bank and First Republic Bank). This was and continues to be accompanied by financial instability at certain additional banks. These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including ACNB. These risks include, but are not limited to:
•market risk and loss of confidence in the financial services sector, and/or specific banks;
•deterioration of securities and loan portfolios;
•deposit volatility and/or reductions with higher volumes and occurring over shorter periods of time;
•increased liquidity demand and utilization of sources of liquidity; and,
•interest rate volatility and abrupt, sudden and greater than usual rate changes.
These factors individually, or in any combination, could materially and adversely affect:
•financial condition;
•operations and results thereof; and,
•stock price.
In addition, the previously mentioned bank failures and instabilities may result in an increase ofFDIC deposit insurance premiums and/or result in specialFDIC deposit insurance assessments, which may adversely affect the Corporation's financial condition, operations, results thereof or stock price.
The Corporation cannot predict the impact, timing or duration of such events.
Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of the organization. These risks involve interest rate risk, foreign currency exchange risk, commodity price risk, and equity market price risk. ACNB's primary market risk is interest rate risk. Interest rate risk is inherent because, as a financial institution, ACNB derives a significant amount of its operating revenue from "purchasing" funds (customer deposits and wholesale borrowings) at various terms and rates. These funds are then invested into earning assets (primarily loans and investments) at various terms and rates.
RECENT LEGAL AND REGULATORY DEVELOPMENTS
Management has reviewed the recent development sections that were previously disclosed in the Annual Report on Form 10-K for the fiscal period endedDecember 31, 2022 . There are no material changes in the recent legal and regulatory development section as previously disclosed in the recent developments section on the Form 10-K. SUPERVISION AND REGULATION Dividends ACNB is a legal entity separate and distinct from its subsidiary bank. ACNB's revenues, on a parent company only basis, result primarily from dividends paid to the Corporation by its subsidiaries. Federal and state laws regulate the payment of dividends 39 --------------------------------------------------------------------------------
by ACNB's subsidiary bank and state laws effect dividends by ACNB's insurance subsidiary. For further information, please refer to Regulation of Bank below.
Regulation of Bank
The operations of the subsidiary bank are subject to statutes applicable to banks chartered under the banking laws ofPennsylvania , to state nonmember banks of theFederal Reserve , and to banks whose deposits are insured by theFDIC . The subsidiary bank's operations are also subject to regulations of thePennsylvania Department of Banking and Securities ,Federal Reserve , andFDIC .The Pennsylvania Department of Banking and Securities , which has primary supervisory authority over banks chartered inPennsylvania , regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. The subsidiary bank is also subject to examination by theFDIC for safety and soundness, as well as consumer compliance. These examinations are designed for the protection of the subsidiary bank's depositors rather than ACNB's shareholders. The subsidiary bank must file quarterly and annual reports to theFederal Financial Institutions Examination Council , orFFIEC . Monetary and Fiscal Policy ACNB and its subsidiary bank are affected by the monetary and fiscal policies of government agencies, including theFederal Reserve andFDIC . Through open market securities transactions and changes in its discount rate and reserve requirements, theBoard of Governors of theFederal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature and impact of monetary and fiscal policies on future business and earnings of ACNB cannot be predicted at this time. From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of ACNB and the subsidiary bank, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of ACNB.
© Edgar Online, source
