ACNB CORP (ACNB) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following is management’s discussion and analysis of the significant changes in the financial condition, results of operations, comprehensive income, capital resources, and liquidity presented in its accompanying consolidated financial statements for ACNB Corporation (the Corporation or ACNB), a financial holding company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee, assure or indicate similar performance in the future.
CRITICAL ACCOUNTING POLICIES
The accounting policies that the Corporation’s management deems to be most important to the portrayal of its financial condition and results of operations, and that require management’s most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management:
The allowance for loan losses represents management’s estimate of probable losses inherent in the loan portfolio. Management makes numerous assumptions, estimates and adjustments in determining an adequate allowance. The Corporation assesses the level of potential loss associated with its loan portfolio and provides for that exposure through an allowance for loan losses. The allowance is established through a provision for loan losses charged to earnings. The allowance is an estimate of the losses inherent in the loan portfolio as of the end of each reporting period. The Corporation assesses the adequacy of its allowance on a quarterly basis. The specific methodologies applied on a consistent basis are discussed in greater detail under the caption, Allowance for Loan Losses, in a subsequent section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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EXECUTIVE OVERVIEW
| For the Year Ended December 31, | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Dollars in thousands, except per share data | 2022 | 2021 | 2020 | 2019 | 2018 | |||||||||||||
| INCOME STATEMENT DATA | ||||||||||||||||||
| Interest income | $ | 87,049 | $ | 78,159 | $ | 85,290 | $ | 69,558 | $ | 64,494 | ||||||||
| Interest expense | 3,624 | 6,915 | 12,222 | 10,140 | 7,399 | |||||||||||||
| Net interest income | 83,425 | 71,244 | 73,068 | 59,418 | 57,095 | |||||||||||||
| Provision for loan losses | — | 50 | 9,140 | 600 | 1,620 | |||||||||||||
| Net interest income after provision for loan losses | 83,425 | 71,194 | 63,928 | 58,818 | 55,475 | |||||||||||||
| Other income | 21,807 | 22,776 | 20,090 | 18,169 | 15,948 | |||||||||||||
| Other expenses | 60,281 | 58,951 | 61,316 | 47,621 | 44,703 | |||||||||||||
| Income before income taxes | 44,951 | 35,019 | 22,702 | 29,366 | 26,720 | |||||||||||||
| Provision for income taxes | 9,199 | 7,185 | 4,308 | 5,645 | 4,972 | |||||||||||||
| Net income | $ | 35,752 | $ | 27,834 | $ | 18,394 | $ | 23,721 | $ | 21,748 | ||||||||
| BALANCE SHEET DATA (AT YEAR-END) | ||||||||||||||||||
| Assets | $ | 2,525,507 | $ | 2,786,987 | $ | 2,555,362 | $ | 1,720,253 | $ | 1,647,724 | ||||||||
| Securities | $ | 620,250 | $ | 446,161 | $ | 350,182 | $ | 212,177 | $ | 190,835 | ||||||||
| Loans, net | $ | 1,520,749 | $ | 1,449,394 | $ | 1,617,558 | $ | 1,258,766 | $ | 1,288,501 | ||||||||
| Deposits | $ | 2,198,975 | $ | 2,426,389 | $ | 2,185,525 | $ | 1,412,260 | $ | 1,348,092 | ||||||||
| Borrowings | $ | 62,954 | $ | 69,902 | $ | 92,209 | $ | 99,731 | $ | 118,164 | ||||||||
| Stockholders’ equity | $ | 245,042 | $ | 272,114 | $ | 257,972 | $ | 189,516 | $ | 168,137 | ||||||||
| COMMON SHARE DATA | ||||||||||||||||||
| Earnings per share — basic | $ | 4.15 | $ | 3.19 | $ | 2.13 | $ | 3.36 | $ | 3.09 | ||||||||
| Cash dividends declared | $ | 1.06 | $ | 1.03 | $ | 1.00 | $ | 0.98 | $ | 0.89 | ||||||||
| Book value per share | $ | 28.78 | $ | 31.35 | $ | 29.62 | $ | 26.77 | $ | 23.86 | ||||||||
| Weighted average number of common shares | 8,623,012 | 8,714,926 | 8,638,654 | 7,061,524 | 7,035,818 | |||||||||||||
| Dividend payout ratio | 25.50 | % | 32.22 | % | 47.22 | % | 29.17 | % | 28.79 | % | ||||||||
| PROFITABILITY RATIOS AND CONDITION | ||||||||||||||||||
| Return on average assets | 1.31 | % | 1.03 | % | 0.78 | % | 1.40 | % | 1.34 | % | ||||||||
| Return on average equity | 14.35 | % | 10.52 | % | 7.39 | % | 13.33 | % | 13.62 | % | ||||||||
| Average stockholders’ equity to average assets | 9.15 | % | 9.81 | % | 10.53 | % | 10.54 | % | 9.85 | % | ||||||||
| SELECTED ASSET QUALITY RATIOS | ||||||||||||||||||
| Non-performing loans to total loans | 0.25 | % | 0.42 | % | 0.48 | % | 0.40 | % | 0.52 | % | ||||||||
| Net charge-offs to average loans outstanding | 0.08 | % | 0.08 | % | 0.16 | % | 0.06 | % | 0.13 | % | ||||||||
| Allowance for loan losses to total loans | 1.16 | % | 1.30 | % | 1.23 | % | 1.09 | % | 1.07 | % | ||||||||
| Allowance for loan losses to non-performing loans | 463.08 | % | 306.05 | % | 256.16 | % | 269.27 | % | 206.51 | % |
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Consolidated Condensed Statements of Income for the three months and years ended December 31, 2022 and 2021 are as follows:
| Dollars in thousands, except per share data | Three Months Ended December 31, | Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| INCOME STATEMENT DATA | 2022 | 2021 | 2022 | 2021 | ||||||||||
| Interest income | $ | 24,894 | $ | 18,674 | $ | 87,049 | $ | 78,159 | ||||||
| Interest expense | 846 | 1,324 | 3,624 | 6,915 | ||||||||||
| Net interest income | 24,048 | 17,350 | 83,425 | 71,244 | ||||||||||
| Provision for loan losses | — | — | — | 50 | ||||||||||
| Net interest income after provision for loan losses | 24,048 | 17,350 | 83,425 | 71,194 | ||||||||||
| Other income | 5,423 | 5,633 | 21,807 | 22,776 | ||||||||||
| Other expenses | 16,673 | 17,457 | 60,281 | 58,951 | ||||||||||
| Income before income taxes | 12,798 | 5,526 | 44,951 | 35,019 | ||||||||||
| Provision for income taxes | 2,599 | 1,031 | 9,199 | 7,185 | ||||||||||
| Net income | $ | 10,199 | $ | 4,495 | $ | 35,752 | $ | 27,834 | ||||||
| Basic earnings per share | $ | 1.20 | $ | 0.52 | $ | 4.15 | $ | 3.19 |
The primary source of the Corporation’s revenues is net interest income derived from interest earned on loans and investments, less deposit and borrowing funding costs. Revenues are influenced by general economic factors, including market interest rates, the economy of the markets served, stock market conditions, as well as competitive forces within the markets.
The Corporation’s overall strategy is to increase loan growth in its local markets, while maintaining a reasonable funding base by offering competitive deposit products and services. ACNB reported record earnings in 2022 driven by strong growth in net interest income. The 2022 net income of $35,752,000 represents a 28.4% increase over the net income results for the year ended December 31, 2021. Basic earnings per share in 2022 increased 30.1% over the earnings per share for 2021.
In 2022, the Corporation’s net interest margin increased to 3.33% compared to 2.82% in 2021. Net interest income was $83,425,000 in 2022 compared to $71,244,000 in 2021. The increase was driven by higher interest rates, deployment of excess liquidity, lower funding costs and growth in higher-yielding assets. Other income was $21,807,000 and $22,776,000 in 2022 and 2021, respectively. The decrease was primarily a result of lower income from mortgage loans held for sale, as interest rates continued to increase in 2022, and losses from the changes in fair value of equity securities. Other expenses increased to $60,281,000, or by 2.3%, in 2022, as compared to $58,951,000 in 2021. The increase was driven primarily by equipment, professional services, FDIC and regulatory, intangible assets amortization and other operating expenses partially offset by a decrease in salary and employee benefits expense. A more thorough discussion of the Corporation’s results of operations is included in the following pages.
RESULTS OF OPERATIONS
Net Interest Income
The primary source of ACNB’s traditional banking revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, and interest bearing deposits with banks. Interest bearing liabilities include deposits and borrowings.
Net interest income is affected by changes in interest rates, volume of interest bearing assets and liabilities, and the composition of those assets and liabilities. The “interest rate spread” and “net interest margin” are two common statistics related to changes in net interest income. The interest rate spread represents the difference between the yields earned on interest earning assets and the rates paid for interest bearing liabilities. The net interest margin is defined as the percentage of net interest income to average earning assets, which also considers the Corporation’s net non-interest bearing funding sources, the largest of which are non-interest bearing demand deposits and stockholders’ equity.
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The following table includes average balances, rates, interest income and expense, interest rate spread, and net interest margin:
Table 1 — Average Balances, Rates and Interest Income and Expense
| 2022 | 2021 | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Dollars in thousands | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | |||||||||||||||
| INTEREST EARNING ASSETS | |||||||||||||||||||||
| Loans | $ | 1,506,354 | $ | 70,246 | 4.66 | % | $ | 1,552,074 | $ | 71,186 | 4.59 | % | |||||||||
| Taxable securities | 516,126 | 9,799 | 1.90 | % | 358,256 | 5,423 | 1.51 | % | |||||||||||||
| Tax-exempt securities | 53,242 | 1,144 | 2.15 | % | 38,829 | 543 | 1.40 | % | |||||||||||||
| Total Securities | 569,368 | 10,943 | 1.92 | % | 397,085 | 5,966 | 1.50 | % | |||||||||||||
| Other | 427,706 | 5,860 | 1.37 | % | 578,150 | 1,007 | 0.17 | % | |||||||||||||
| Total Interest Earning Assets | 2,503,428 | 87,049 | 3.48 | % | 2,527,309 | 78,159 | 3.09 | % | |||||||||||||
| Cash and due from banks | 31,511 | 23,799 | |||||||||||||||||||
| Premises and equipment | 29,205 | 30,742 | |||||||||||||||||||
| Other assets | 175,492 | 136,035 | |||||||||||||||||||
| Allowance for loan losses | (18,679) | (19,927) | |||||||||||||||||||
| Total Assets | $ | 2,720,957 | $ | 2,697,958 | |||||||||||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||||||||||||
| INTEREST BEARING LIABILITIES | |||||||||||||||||||||
| Interest bearing demand deposits | $ | 946,864 | $ | 1,091 | 0.12 | % | $ | 872,729 | $ | 911 | 0.10 | % | |||||||||
| Savings deposits | 409,839 | 167 | 0.04 | % | 367,543 | 664 | 0.18 | % | |||||||||||||
| Time deposits | 370,766 | 1,303 | 0.35 | % | 494,322 | 3,437 | 0.70 | % | |||||||||||||
| Total Interest Bearing Deposits | 1,727,469 | 2,561 | 0.15 | % | 1,734,594 | 5,012 | 0.29 | % | |||||||||||||
| Short-term borrowings | 35,882 | 77 | 0.21 | % | 35,153 | 39 | 0.11 | % | |||||||||||||
| Long-term borrowings | 24,814 | 986 | 3.97 | % | 49,935 | 1,864 | 3.73 | % | |||||||||||||
| Total Interest Bearing Liabilities | 1,788,165 | 3,624 | 0.20 | % | 1,819,682 | 6,915 | 0.38 | % | |||||||||||||
| Non-interest bearing demand deposits | 609,622 | 594,483 | |||||||||||||||||||
| Other liabilities | 74,096 | 19,119 | |||||||||||||||||||
| Stockholders’ equity | 249,074 | 264,674 | |||||||||||||||||||
| Total Liabilities and Stockholders’ Equity | $ | 2,720,957 | $ | 2,697,958 | |||||||||||||||||
| NET INTEREST INCOME | $ | 83,425 | $ | 71,244 | |||||||||||||||||
| INTEREST RATE SPREAD | 3.28 | % | 2.71 | % | |||||||||||||||||
| NET INTEREST MARGIN | 3.33 | % | 2.82 | % |
For yield calculation purposes, nonaccruing loans are included in average loan balances. Loan fees (including PPP fees) of $2,193,000 and $6,117,000 as of December 31, 2022 and 2021, respectively, are included in interest income. Yields on tax-exempt securities and loans are not tax effected.
Table 1 presents balance sheet items on a daily average basis, net interest income, interest rate spread, and net interest margin for the years ending December 31, 2022 and 2021. Table 2 analyzes the relative impact on net interest income for changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by the Corporation on such assets and liabilities.
Net interest income totaled $83,425,000 for the year ended December 31, 2022, compared to $71,244,000 for the same period in 2021, an increase of $12,181,000, or 17.1%. Net interest income increased due to a higher net interest margin that benefited from higher interest rates, deployment of excess liquidity into securities, lower funding costs and growth in higher-yielding assets. Interest income increased $8,890,000, or 11.4%, driven by higher interest rates and a shift from cash and cash equivalents into securities. Interest expense decreased $3,291,000, or 47.6%, in 2022 from 2021. The decrease in interest expense was driven by a reduction in long-term borrowings and a reduction in deposits costs. Paycheck Protection Program (PPP) fees and purchase accounting accretion for the year ended December 31, 2022 totaled $3,768,000, compared to $8,781,000 for the year ended December 31, 2021.
Average earning assets were $2,503,428,000 in 2022, a decrease of $23,881,000, or 0.9%, from the average balance of $2,527,309,000 in 2021. Average cash and cash equivalents decreased while average total securities increased in 2022 as compared to 2021. Average interest bearing liabilities were $1,788,165,000 in 2022, down from $1,819,682,000 in 2021.
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Average deposits (including non-interest bearing) were up 0.3%, while average borrowings decreased by 28.7% due to principal paybacks. Average lower-cost transaction and savings deposits increased in 2022. The decrease in average time deposits was in part from existing customers moving to better liquidity available from transaction and savings deposits.
The following table shows changes in net interest income attributed to changes in rates and changes in average balances of interest earning assets and interest bearing liabilities:
Table 2 — Rate/Volume Analysis
| 2022 versus 2021 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Due to Changes in | |||||||||||
| In thousands | Volume | Rate | Total | ||||||||
| INTEREST EARNING ASSETS | |||||||||||
| Loans | $ | (2,119) | $ | 1,179 | $ | (940) | |||||
| Taxable securities | 2,775 | 1,601 | 4,376 | ||||||||
| Tax-exempt securities | 246 | 355 | 601 | ||||||||
| Total Securities | 3,021 | 1,956 | 4,977 | ||||||||
| Other | (328) | 5,181 | 4,853 | ||||||||
| Total | $ | 574 | $ | 8,316 | $ | 8,890 | |||||
| INTEREST BEARING LIABILITIES | |||||||||||
| Interest bearing demand deposits | $ | 81 | $ | 99 | $ | 180 | |||||
| Savings deposits | 69 | (566) | (497) | ||||||||
| Time deposits | (716) | (1,418) | (2,134) | ||||||||
| Short-term borrowings | 1 | 37 | 38 | ||||||||
| Long-term borrowings | (991) | 113 | (878) | ||||||||
| Total | (1,556) | (1,735) | (3,291) | ||||||||
| Change in Net Interest Income | $ | 2,130 | $ | 10,051 | $ | 12,181 |
The net change attributable to the combination of rate and volume has been allocated on a consistent basis between volume and rate based on the absolute value of each. For yield calculation purposes, nonaccruing loans are included in average balances.
Provision for Loan Losses
As a result of stable loan metrics, combined with low credit losses in the portfolio, the provision for loan losses charged against earnings was $0 in 2022 compared to $50,000 in 2021. The determination of the provision was a result of the analysis of the adequacy of the allowance for loan losses calculation. The allowance for loan losses generally does not include the loans acquired through acquisition, which were recorded at fair value as of the acquisition date. Each quarter, the Corporation assesses risk in the loan portfolio and reserve required compared with the balance in the allowance for loan losses and the current evaluation factors. For additional discussion of the provision and the loans associated therewith, please refer to the Asset Quality section of this Management’s Discussion and Analysis. ACNB charges confirmed loan losses to the allowance and credits the allowance for recoveries of previous loan charge-offs.
Other Income
Other income was $21,807,000 and $22,776,000 in 2022 and 2021, respectively. The decrease was primarily a result of lower income from mortgage loans held for sale, as interest rates continued to increase in 2022, and losses from the changes in fair value of equity securities. Income from mortgage loans held for sale was $487,000 for the year ended December 31, 2022 compared to $3,393,000 for the year ended December 31, 2021. A $298,000 net fair value loss was recognized on local bank and CRA-related equity securities in 2022 due to normal variations in market value compared to a $439,000 net fair value gain in 2021. A net loss of $234,000 was recognized on the sale of securities in 2022, and no securities were sold in 2021. The largest source of other income is commissions from insurance sales attributable to ACNB Insurance Services, Inc. Commissions from insurance sales increased by 35.1% in 2022 to $8,307,000, driven primarily by the acquisition of the business and assets of the Hockley & O’Donnell Agency in the first quarter of 2022. Service charges on deposit accounts increased 15.8% to $4,066,000 for 2022 driven by improved customer activity. During the third quarter of 2022, additional bank-owned life
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insurance was purchased with a cash surrender value of $12,200,000 driving the increase in 2022 as compared to 2021.
Other Expenses
Other expenses increased 2.3% to $60,281,000 for the year ended December 31, 2022. The largest component of other expenses is salaries and employee benefits, which decreased 2.3% in 2022 to $35,979,000 compared to $36,816,000 in 2021. The decrease was a result of lower incentive compensation and pension expenses. Equipment expense was $6,612,000 for the year ended December 31, 2022 compared to $6,175,000 for the prior year of 2021. The increase in equipment expense was attributable to the additional ongoing expenses related to the banking subsidiary’s core systems conversion in late 2021 and the implementation of a new loan origination system in late 2022. Professional services expense was $2,086,000 for the year ended December 31, 2022 compared to $1,304,000 for the prior year of 2021. The increase in professional services expense was a result of additional costs related to the change in the Corporation’s independent audit firm, consultants for Current Expected Credit Loss (CECL) standard readiness and purchase accounting work, loan workout costs for a large commercial loan, legal expenses, and executive recruiters to fill key roles within the organization. FDIC and regulatory and intangible assets amortization expenses were $1,128,000 and $1,492,000, respectively, for the year ended December 31, 2022 compared to $960,000 and $1,164,000 for the prior year of 2021. The increase in intangible assets amortization expense was due to the acquisition of the business and assets of the Hockley & O’Donnell Insurance Agency. Other operating expense was $6,154,000 for the year ended December 31, 2022 compared to $5,841,000 for the prior year of 2021. The increase in other operating expense was driven primarily by waived consumer loan fees, internet banking expense, and operational and customer fraud losses.
Provision for Income Taxes
ACNB recognized income taxes of $9,199,000, or 20.5% of pretax income, during 2022 as compared to $7,185,000, or 20.5%, during 2021. 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. Note K — “Income Taxes”, to the Consolidated Financial Statements under Part II, Item 8, “Financial Statements and Supplementary Data,” includes a reconciliation of our federal statutory tax rate to the Corporation’s effective tax rate, which is a comparison between years and measures income tax expense as a percentage of pretax income.
FINANCIAL CONDITION
Total assets were $2,525,507,000 at December 31, 2022 compared to $2,786,987,000 at December 31, 2021, a decrease of 9.4%. The decrease was driven by a reduction in cash and cash equivalents of $541,970,000 as a result of investing excess cash into securities, funding loan growth and deposit outflows. Total loans outstanding were $1,538,610,000 at December 31, 2022 compared to $1,468,427,000 at December 31, 2021, an increase of 4.8%. Year-over-year, the increase was driven mainly by growth in the commercial real estate and construction loan portfolios. Excluding payoffs for PPP loans, loans grew by 6.0% from December 31, 2021 to December 31, 2022. Total securities were $620,250,000 at December 31, 2022 compared to $446,161,000 at December 31, 2021, an increase of 39.0%. Total deposits were $2,198,975,000 at December 31, 2022. Deposits decreased by $227,414,000, or 9.4%, since December 31, 2021. The decrease in deposits was a result of customers seeking higher yielding alternative investment or deposit products as market interest rates rose during 2022.
Investment Securities
ACNB uses investment securities to generate interest and dividend income, manage interest rate risk, provide collateral for certain funding products, and provide liquidity. The decision to change the securities portfolio in 2022 was to provide better yields on excess deposits. The investment portfolio is comprised of U.S. Government agency, municipal, and corporate securities. These securities provide the appropriate characteristics with respect to credit quality, yield and maturity relative to the management of the overall balance sheet.
At December 31, 2022, the securities balance included a net unrealized loss on available for sale securities of $52,734,000, net of taxes, on amortized cost of $617,641,000 versus a net unrealized loss of $3,474,000, net of taxes, on amortized cost of $441,565,000 at December 31, 2021. The change in fair value of available for sale securities during 2022 was driven by more investments in the available for sale portfolio and an increase in market interest rates during 2022. 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.
At December 31, 2022, the securities balance included held to maturity securities with an amortized cost of $64,977,000 and a fair value of $58,078,000, as compared to an amortized cost of $6,454,000 and a fair value of $6,652,000 at December 31, 2021. 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
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include U.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 higher yields to enhance the net interest margin and net interest income in future quarters. Purchases were primarily in government sponsored entities (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 C — “Securities” in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note L — “Fair Value Measurements” in the Notes to Consolidated Financial Statements for more information about fair value which is incorporated herein by reference.
The following tables set forth the composition of the securities portfolio and the securities maturity schedule, including weighted average yield, as of the end of the years indicated:
Table 3 — Investment Securities
| In thousands | 2022 | 2021 | |||||
|---|---|---|---|---|---|---|---|
| AVAILABLE FOR SALE SECURITIES AT FAIR VALUE | |||||||
| U.S. Government and agencies | $ | 210,999 | $ | 245,041 | |||
| Mortgage-backed securities | 295,718 | 133,496 | |||||
| State and municipal | 15,235 | 44,611 | |||||
| Corporate bonds | 31,602 | 13,950 | |||||
| $ | 553,554 | $ | 437,098 | ||||
| HELD TO MATURITY SECURITIES AT AMORTIZED COST | |||||||
| Mortgage-backed securities | 3,279 | 6,454 | |||||
| State and municipal | 61,698 | — | |||||
| $ | 64,977 | $ | 6,454 | ||||
| EQUITY SECURITIES WITH READILY DETERMINABLE FAIR VALUES | |||||||
| CRA Mutual Fund | $ | 915 | $ | 1,036 | |||
| Canapi Ventures SBIC Fund | 206 | — | |||||
| Stock in other Banks | 598 | 1,573 | |||||
| $ | 1,719 | $ | 2,609 |
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Table 4 discloses investment securities at the scheduled maturity date at December 31, 2022. Many securities have call features that make their redemption possible before the stated maturity date.
Table 4 — Securities Maturity Schedule
| 1 Year or Less | Over 1 - 5 Years | Over 5 - 10 Years | Over 10 Years or No Maturity | Total | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Dollars in thousands | Amount | Rate | Amount | Rate | Amount | Rate | Amount | Rate | Amount | Rate | ||||||||||||||||||||||||
| U.S. Government and agencies | $ | 11,012 | 2.43 | % | $ | 148,541 | 1.68 | % | $ | 78,847 | 2.30 | % | $ | 3,067 | 4.30 | % | $ | 241,467 | 1.95 | % | ||||||||||||||
| Mortgage-backed securities | — | — | 10,936 | 0.59 | 15,037 | 2.30 | 304,841 | 2.36 | 330,814 | 2.30 | ||||||||||||||||||||||||
| State and municipal | 285 | 2.00 | 377 | 1.34 | 16,437 | 2.67 | 59,834 | 3.52 | 76,933 | 3.32 | ||||||||||||||||||||||||
| Corporate bonds | — | — | 17,296 | 4.88 | 14,108 | 4.54 | 2,000 | 5.25 | 33,404 | 4.76 | ||||||||||||||||||||||||
| $ | 11,297 | 2.42 | % | $ | 177,150 | 1.92 | % | $ | 124,429 | 2.60 | % | $ | 369,742 | 2.58 | % | $ | 682,618 | 2.41 | % |
Securities are at amortized cost. Mortgage-backed securities are allocated based upon scheduled maturities.
The Corporation continues to analyze increasing investments to increase interest income, despite the possible subsequent decrease in market value if rates increase further.
Fair value of equity securities with readily determinable fair values are as follows at December 31, 2022:
| 1 Year or Less | Over 1 - 5 Years | Over 5 - 10 Years | No Maturity | Total | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Dollars in thousands | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | ||||||||||||||||||||||||
| CRA Mutual Fund | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 915 | — | % | $ | 915 | — | % | ||||||||||||||
| Canapi Ventures SBIC Fund | — | — | — | — | — | — | 206 | — | 206 | — | ||||||||||||||||||||||||
| Stock in other Banks | — | — | — | — | — | — | 598 | — | 598 | — | ||||||||||||||||||||||||
| $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 1,719 | — | % | $ | 1,719 | — | % |
Loans
Year over year, loans outstanding increased by $70,183,000, or 4.8%, in 2022 as compared to 2021. Year-over-year, the increase was driven mainly by growth in the commercial real estate and construction loan portfolios. Excluding payoffs for PPP loans, loans grew by 6.0% from December 31, 2021 to December 31, 2022. Commercial real estate loans increased $35,550,000, or 4.5%, in 2022 while real estate construction loans increased $30,470,000, or 60.9% in 2022. Growth in both portfolios was spread throughout the footprint and across various property types. Despite the intense competition in the Corporation’s market areas, management continues to focus on asset quality and disciplined underwriting standards in the loan origination process.
Residential real estate mortgages, which includes home equity loan and lines of credit secured by the owner’s home, increased by $4,352,000, or 1.0%. Growth was driven by an increase in home equity loans. Included in the mortgages were $114,751,000 in residential mortgage loans secured by junior liens or home equity loans, which are also in many cases junior liens. Junior liens inherently have more credit risk by virtue of the fact that another financial institution may have a senior security position in the case of foreclosure liquidation of collateral to extinguish the debt. Generally, foreclosure actions could become more prevalent if the real estate market weakens, property values deteriorate, or rates increase sharply.
Included in the commercial, financial and agricultural category are loans to Pennsylvania school districts, municipalities (including townships) and essential purpose authorities. In most cases, these loans are backed by the general obligation of the local municipal body. In many cases, these loans are obtained through a bid process that includes other local and regional banks. These loans are predominantly bank qualified for mostly tax-free interest income treatment for federal income taxes. These loans totaled $72,945,000 in 2022, an increase of 16.1% from $62,823,000 held at the end of 2021; these loans are especially subject to refinancing in certain rate environments.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020 provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the SBA to temporarily guarantee loans under a new 7(a) loan program called the PPP. As a qualified SBA lender, the Corporation was
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automatically authorized to originate PPP loans. As of December 31, 2022, the Corporation did not have any outstanding balances under the PPP program. As of December 31, 2022, the Corporation had originated an aggregate total of 2,217 loans in the amount of $223,036,703 under the PPP. Deferred fee income was approximately $9.5 million, before costs. The Corporation recognized $986,000 and $5,627,000 of PPP fees in 2022 and 2021, respectively.
Table 5 — Loan Portfolio
Loans at December 31 were as follows:
| In thousands | 2022 | 2021 | ||||
|---|---|---|---|---|---|---|
| Commercial, financial and agricultural | $ | 178,762 | $ | 179,567 | ||
| Real estate: | ||||||
| Commercial | 821,805 | 786,255 | ||||
| Construction | 80,470 | 50,000 | ||||
| Residential | 446,239 | 441,887 | ||||
| Consumer | 11,334 | 10,718 | ||||
| Total Loans | $ | 1,538,610 | $ | 1,468,427 |
The repricing range of the loan portfolio at December 31, 2022, and the amounts of loans with predetermined and fixed rates are presented in the tables below:
Table 6 — Loan Sensitivities
LOANS MATURING
| In thousands | Less than 1 Year | 1-5 Years | Over 5 Years | Total | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Commercial, financial and agricultural | $ | 41,813 | $ | 59,583 | $ | 77,366 | $ | 178,762 | ||||||
| Real estate: | ||||||||||||||
| Commercial | 33,306 | 86,125 | 702,374 | 821,805 | ||||||||||
| Construction | 24,670 | 17,091 | 38,709 | 80,470 | ||||||||||
| Residential | 32,454 | 30,231 | 383,554 | 446,239 | ||||||||||
| Total | $ | 132,243 | $ | 193,030 | $ | 1,202,003 | $ | 1,527,276 |
LOANS BY REPRICING OPPORTUNITY
| In thousands | Less than 1 Year | 1-5 Years | Over 5 Years | Total | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Commercial, financial and agricultural | $ | 62,131 | $ | 64,136 | $ | 52,495 | $ | 178,762 | ||||||
| Real estate: | ||||||||||||||
| Commercial | 161,986 | 480,382 | 179,437 | 821,805 | ||||||||||
| Construction | 41,748 | 24,025 | 14,697 | 80,470 | ||||||||||
| Residential | 126,952 | 122,671 | 196,616 | 446,239 | ||||||||||
| Total | $ | 392,817 | $ | 691,214 | $ | 443,245 | $ | 1,527,276 | ||||||
| Loans with a fixed interest rate | $ | 95,530 | $ | 691,031 | $ | 439,840 | $ | 1,226,401 | ||||||
| Loans with a variable interest rate | 297,287 | 183 | 3,405 | 300,875 | ||||||||||
| Total | $ | 392,817 | $ | 691,214 | $ | 443,245 | $ | 1,527,276 |
Most of the Corporation’s lending activities are with customers located within the Bank’s market area of southcentral Pennsylvania and northern Maryland area. Unemployment rates in the subsidiary bank’s market recently, and historically, have been better than those for Pennsylvania and Maryland as a whole, and similar to the United States. Included in commercial real estate loans are loans made to lessors of non-residential properties that total $434,057,000, or 28.2% of total loans, at December 31, 2022. 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
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risk when compared to commercial loans in general. ACNB does not originate or hold Alt-A or subprime mortgages in its loan portfolio.
Asset Quality
The ACNB loan portfolio is subject to varying degrees of credit risk. Credit risk is mitigated through prudent and disciplined underwriting standards, ongoing credit review, and monitoring and reporting asset quality measures. Additionally, loan portfolio diversification, limiting exposure to a single industry or borrower, and requiring collateral also reduces ACNB’s credit risk. ACNB’s commercial, consumer and residential mortgage loans are principally to borrowers in ACNB’s market area of southcentral Pennsylvania and northern Maryland. As the majority of ACNB’s loans are located in this area, a substantial portion of the debtor’s ability to honor the obligation may be affected by the level of economic activity in the market area.
As a result of stable loan risk metrics, combined with low credit losses in the portfolio, the provision for loan losses for 2022 was $0 despite solid loan growth. Non-performing loans were $3,857,000, or 0.25% of total loans, at December 31, 2022, compared to $6,219,000, or 0.42% of total loans, at December 31, 2021. Non-performing assets were $4,331,000, or 0.17% of total assets, at December 31, 2022, compared to $6,219,000, or 0.22% of total assets, at December 31, 2021. Net charge-offs for the year ended December 31, 2022 were 0.08% of total average loans, compared to 0.08% for the year ended December 31, 2021. Net charge-offs for the year were due to a few isolated credits of unrelated borrowers and were not indicative of a general weakness in the overall loan portfolio.
Non-performing assets include nonaccrual loans and restructured loans (troubled debt restructures or TDRs), accruing loans past due 90 days or more, and other foreclosed assets. The accrual of interest on residential mortgage and commercial loans (consisting of commercial and industrial, commercial real estate, and commercial real estate construction loan categories) is discontinued at the time the loan is 90 days past due unless the credit is well secured and in the process of collection. Consumer loans (consisting of home equity lines of credit and consumer loan categories) are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. ACNB occasionally returns nonaccrual loans to performing status when the borrower brings the loan current and performs in accordance with contractual terms for a reasonable period of time. ACNB categorizes a loan as a TDR if it changes the terms of the loan, such as interest rate, repayment schedule or both, to terms that it otherwise would not have granted to a borrower, for economic or legal reasons related to the borrower’s financial difficulties.
The following table sets forth the Corporation’s non-performing assets as of the end of the years indicated:
Table 7 — Non-Performing Assets
| Dollars in thousands | 2022 | 2021 | |||||
|---|---|---|---|---|---|---|---|
| Nonaccrual loans, including TDRs | $ | 2,654 | $ | 5,489 | |||
| Accruing loans 90 days past due | 1,203 | 730 | |||||
| Total Non-Performing Loans | 3,857 | 6,219 | |||||
| Foreclosed assets | 474 | — | |||||
| Total Non-Performing Assets | $ | 4,331 | $ | 6,219 | |||
| Total Accruing Troubled Debt Restructurings | $ | 3,461 | $ | 3,574 | |||
| Ratios: | |||||||
| Non-performing loans to total loans | 0.25 | % | 0.42 | % | |||
| Non-performing assets to total assets | 0.17 | % | 0.22 | % | |||
| Allowance for loan losses to non-performing loans | 463.08 | % | 306.05 | % |
If interest due on all nonaccrual loans had been accrued at original contract rates, it is estimated that income before income taxes would have been greater by $410,000 in 2022 and $462,000 in 2021. The decrease in nonaccrual loans from 2021 to 2022 is discussed further below.
Impaired loans at December 31, 2022 and 2021, totaled $6,115,000 and $9,063,000, respectively. At December 31, 2022 and 2021, the Corporation had nonaccruing and accruing troubled debt restructurings of $3,461,000 and $3,637,000, respectively. $0 and $63,000, respectively, of the impaired loans were troubled debt restructured loans, which were also classified as nonaccrual. $3,461,000 and $3,574,000 of the impaired loans were accruing troubled debt restructured loans at December 31, 2022 and 2021, respectively. Loans whose terms are modified are classified as troubled debt restructurings if the borrowers have been granted concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve interest rates being granted below current market
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rates for the credit risk of the loan or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired. The related allowance for loan losses on all impaired loans totaled $820,000 and $1,455,000 at December 31, 2022 and 2021, respectively. The decrease in accruing troubled debt restructurings was a result of payment made in accordance with loan terms. The decrease in nonaccrual loans was a result of additional loans added to this category net of paydowns and payoffs made by the customers on these loans. Potential problem loans are defined as performing loans that have characteristics that cause management to have doubts as to the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as non-performing loans in the future. Total additional potential problem loans approximated $605,000 at December 31, 2022, compared to $1,725,000 at December 31, 2021.
Foreclosed assets held for resale consist of the fair value of real estate acquired through foreclosure on real estate loan collateral or the acceptance of ownership of real estate in lieu of the foreclosure process. Fair values are based on appraisals that consider the sales prices of similar properties in the proximate vicinity less estimated selling costs. Foreclosed assets held for resale totaled $474,000, consisting of one property, at December 31, 2022 compared to $0 at December 31, 2021.
Allowance for Loan Losses
ACNB maintains the allowance for loan losses at a level believed to be adequate by management to absorb probable losses in the loan portfolio, and it is funded through a provision for loan losses charged to earnings. On a quarterly basis, ACNB utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan losses, historical experience, and qualitative factors. This methodology results in an allowance that is considered appropriate in light of the high degree of judgment required and that is prudent and conservative, but not excessive.
Management assigns internal risk ratings for each commercial lending relationship. Utilizing historical loss experience, adjusted for changes in trends, conditions and other relevant factors, management derives estimated losses for non-rated and non-classified loans. When management identifies impaired loans with uncertain collectability of principal and interest, it evaluates a specific reserve on a quarterly basis in order to estimate potential losses. Management’s analysis considers:
•adverse situations that may affect the borrower’s ability to repay;
•the current estimated fair value of underlying collateral; and,
•prevailing market conditions.
Loans not tested for impairment do not require a specific reserve allocation. Management places these loans in a pool of loans with similar risk factors and assigns the general loss factor to determine the reserve. For homogeneous loan types, such as consumer and residential mortgage loans, management bases specific allocations on the average loss ratio for the previous three years for each specific loan pool. Additionally, management adjusts projected loss ratios for other factors, including the following:
•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;
•nature and volume of the portfolio and terms of loans;
•experience, ability and depth of lending management and staff;
•volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications; and,
•existence and effect of any concentrations of credit and changes in the level of such concentrations.
Management determines the unallocated portion of the allowance for loan losses, which represents the difference between the reported allowance for loan losses and the calculated allowance for loan losses, based on the following criteria:
•the risk of imprecision in the specific and general reserve allocations;
•the perceived level of consumer and small business loans with demonstrated weaknesses for which it is not practicable to develop specific allocations;
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•other potential exposure in the loan portfolio;
•variances in management’s assessment of national, regional, and local economic conditions; and,
•other internal or external factors that management believes appropriate at that time, such as COVID-19.
The unallocated portion of the allowance is deemed to be appropriate as it reflects an uncertainty that remains in the loan portfolio; specifically reserves where the Corporation believes that tertiary losses are probable above the loss amount derived using appraisal-based loss estimation, where such additional loss estimates are in accordance with regulatory and GAAP guidance. Appraisal-based loss derivation does not fully develop the loss present in certain unique, ultimately bank-owned collateral. The Corporation has determined that the amount of provision in 2022 and the resulting allowance at December 31, 2022, are appropriate given management’s current analysis of the continuing level of risk in the loan portfolio. Management also believes the unallocated allowance is appropriate. The amount of the unallocated portion of the allowance decreased at December 31, 2022, as management deemed this to be reasonable. Otherwise, the assessment concluded that credit quality was stable and past due loans manageable.
Management believes the above methodology materially reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology and the assumptions discussed above.
Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the methodology discussed above, which is consistent with recent years’ improvement in the credit quality in the loan portfolio, and with lessened risk from the impact of the COVID-19 crisis. The provision for 2022 was $0, compared to $50,000 for 2021. The decrease in the allowance for loan losses as a percentage of total loans of 1.30% at December 31, 2021 to 1.16% at December 31, 2022 was driven by stable to improving credit metrics in the loan portfolio.
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.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The new model referred to as current expected credit losses (CECL) model, will apply to: (a) financial assets subject to credit losses and measured at amortized cost; and (b) certain off-balance sheet credit exposures. This includes loans, held to maturity debt securities, loan commitments, financial guarantees and net investments in leases as well as reinsurance and trade receivables. The estimate of expected credit losses should consider historical information, current information, and supportable forecasts, including estimates of prepayments. ASU 2016-13 was originally effective for SEC filers for annual periods beginning after December 15, 2019, and interim periods within those annual periods. In November 2019, the FASB approved a delay of the required implementation date of ASU 2016-13 for smaller reporting companies, as defined by the Securities and Exchange Commission, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.
Management has formed a focus group consisting of multiple members from areas, including credit, finance, loan servicing, and information systems. The Corporation is completing its data and model validation analyses, with parallel processing of our existing allowance for loan losses model. The Corporation is continuing to conduct model comparisons and finalized policy and control framework over the adoption process. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on the financial condition or results of operations.
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The following tables set forth information on the analysis of the allowance for loan losses and the allocation of the allowance for loan losses as of the dates indicated:
Table 8 — Analysis of Allowance for Loan Losses
| Years Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| Dollars in thousands | 2022 | 2021 | |||||
| Beginning balance | $ | 19,033 | $ | 20,226 | |||
| Provision for loan losses | — | 50 | |||||
| Loans charged-off: | |||||||
| Commercial, financial and agricultural | 238 | 1,176 | |||||
| Commercial real estate and construction | 831 | — | |||||
| Residential mortgage | 36 | 22 | |||||
| Consumer | 181 | 120 | |||||
| Total Loans Charged-Off | 1,286 | 1,318 | |||||
| Recoveries: | |||||||
| Commercial, financial and agricultural | 58 | 43 | |||||
| Commercial real estate and construction | — | — | |||||
| Residential mortgage | 27 | — | |||||
| Consumer | 29 | 32 | |||||
| Total Recoveries | 114 | 75 | |||||
| Net charge-offs | 1,172 | 1,243 | |||||
| Ending balance | $ | 17,861 | $ | 19,033 | |||
| Ratios: | |||||||
| Net charge-offs to average loans | 0.08 | % | 0.08 | % | |||
| Allowance for loan losses to total loans | 1.16 | % | 1.30 | % |
Table 9 — Allocation of the Allowance for Loan Losses
| 2022 | 2021 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Dollars in thousands | Amount | Percent of Loan Type to Total Loans | Amount | Percent of Loan Type to Total Loans | ||||||||||
| Commercial, financial and agricultural | $ | 2,848 | 11.6 | % | $ | 3,176 | 12.2 | % | ||||||
| Real estate: | ||||||||||||||
| Commercial | 10,016 | 53.5 | 10,716 | 53.6 | ||||||||||
| Construction | 1,000 | 5.2 | 616 | 3.4 | ||||||||||
| Residential | 3,376 | 29.0 | 3,736 | 30.1 | ||||||||||
| Consumer | 376 | 0.7 | 408 | 0.7 | ||||||||||
| Unallocated | 245 | N/A | 381 | N/A | ||||||||||
| Total | $ | 17,861 | 100.0 | % | $ | 19,033 | 100.0 | % |
The allowance for loan losses at December 31, 2022, was $17,861,000, or 1.16% of loans, as compared to $19,033,000, or 1.30% of loans, at December 31, 2021. The ratio of non-performing loans plus foreclosed assets to total assets was 0.17% at December 31, 2022, as compared to 0.22% at December 31, 2021.
Loans past due 90 days and still accruing were $1,203,000 and nonaccrual loans were $2,654,000 as of December 31, 2022. Loans past due 90 days and still accruing were $730,000 at December 31, 2021, while nonaccruals were $5,489,000.
As to nonaccrual and substandard loans, management believes that adequate collateralization generally exists for these loans in accordance with GAAP. Each quarter, the Corporation assesses risk in the loan portfolio compared with the balance in the allowance for loan losses and the current evaluation factors.
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Additional information on nonaccrual loans at December 31, 2022 and 2021, is as follows:
| Dollars in thousands | Number of Credit Relationships | Balance | Current Specific Loss Allocations | Current Year Charge-Offs | Location | Originated | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 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 | $ | — | |||||||||||
| December 31, 2021 | ||||||||||||||||||
| Owner occupied commercial real estate | 7 | $ | 3,890 | $ | 599 | $ | — | In market | 2008-2019 | |||||||||
| Investment/rental residential real estate | 1 | 112 | — | — | In market | 2016 | ||||||||||||
| Commercial and industrial | 3 | 1,487 | 856 | 970 | In market | 2008-2019 | ||||||||||||
| Total | 11 | $ | 5,489 | $ | 1,455 | $ | 970 |
Management deemed it appropriate to provide this type of more detailed information by collateral type in order to provide additional detail on the loans.
All nonaccrual impaired loans are to borrowers located within the market area served by the Corporation in southcentral Pennsylvania and northern Maryland. All nonaccrual impaired loans were originated by ACNB’s banking subsidiary, except for one participation loans discussed below, for purposes listed in the classifications in the table above. The Corporation had no impaired and nonaccrual loans included in commercial real estate construction at December 31, 2022.
Owner occupied commercial real estate includes five unrelated loan relationships. The merger-acquired loan relationship for a light manufacturing enterprise was paid off during the third quarter of 2022. An $859,000 relationship in food service that was performing when acquired in 2017 was added in the first quarter of 2020 after becoming 90 days past due early in the year, subsequent payments have been received. A $255,000 commercial mortgage loan was added to this category in the third quarter of 2022. A $350,000 commercial mortgage was added to this category in the fourth quarter of 2022. The other unrelated loans in this category have balances of less than $189,000 each, for which the real estate is collateral and is used in connection with a business enterprise that is suffering economic stress or is out of business. The loans in this category were originated between 2012 and 2019 and are business loans impacted by specific borrower credit situations. Collateral valuation resulted in an $191,690 specific allocation on one of the five loan relationships. Most loans in this category are making principal payments. Collection efforts will continue unless it is deemed in the best interest of the Corporation to initiate foreclosure procedures.
The acquired commercial real estate participation loan previously included in this category was transferred to foreclosed assets held for resale. The Corporation previously recognized an $831,000 specific reserve on this loan and the $831,000 was charged-off during the third quarter of 2022.
Investment/rental residential real estate includes one loan relationship (which is deemed to be adequately collateralized) totaling $104,000 for which the real estate is collateral and the purpose of which is for speculation, rental, or other non-owner occupied uses; this relationship is making principal reductions.
A $1,795,000 commercial and industrial loan was added in the fourth quarter of 2020 after ceasing operations, with a current balance of $162,000. Liquidation is mostly complete with a specific allocation of $9,000 after a $970,000 third quarter of 2021 charge-off. A related $371,000 owner occupied real estate loan was also in nonaccrual but settled in the first quarter of 2022. A third unrelated loan relationship was added in the first quarter of 2021 with a current outstanding balance of $619,000 and a specific allocation of $619,000 due to concerns on collateralization and liens.
The Corporation utilizes a systematic review of its loan portfolio on a quarterly basis in order to determine the adequacy of the allowance for loan losses. In addition, ACNB engages the services of an outside independent loan review function and sets the timing and coverage of loan reviews during the year. The results of this independent loan review are included in the systematic review of the loan portfolio. The allowance for loan losses consists of a component for individual loan impairment, primarily based on the loan’s collateral fair value and expected cash flow. A watch list of loans is identified for evaluation based on internal and external loan grading and reviews. Loans other than those determined to be impaired are grouped into pools of loans with similar credit risk characteristics. These loans are evaluated as groups with allocations made to the allowance based on historical loss experience adjusted for current trends in delinquencies, trends in underwriting and oversight, concentrations of credit, and general economic conditions within the Corporation’s trading area. The provision expense was based on the loans discussed above, as well as current trends in the watch list and the local economy as a whole. The charge-
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offs discussed elsewhere in this Management’s Discussion and Analysis create the recent loss history experience and result in the qualitative adjustment which, in turn, affects the calculation of losses inherent in the portfolio. The provision for loan losses of $0 for 2022 and the provision for loan losses of $50,000 for 2021, was a result of an analysis and the measurement of the adequacy of the allowance for loan losses at each period. More specifically, with the manageable level of nonaccrual loans and substandard loans in 2022, the $0 provision addition to the allowance was necessary in proportion to loan portfolio growth, net charge-offs and estimated loss from nonaccrual and substandard loans in accordance with management’s belief that adequate collateralization generally exists for these loans in accordance with GAAP. Each quarter, the Corporation assesses risk in the loan portfolio compared with the balance in the allowance for loan losses and the current evaluation factors.
Premises and Equipment
On January 12, 2022, ACNB Bank announced plans to build a full-service community banking office to serve the Upper Adams area of Adams County, PA. The Upper Adams Office opened in October 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 effective December 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 at December 31, 2022.
Foreclosed Assets Held for Resale
The carrying value of real estate acquired through foreclosure was $474,000 with one property at December 31, 2022, compared to $0 with no properties at December 31, 2021. All acquired properties are actively marketed.
Other Assets
Other assets increased $19,136,000, or 69.0%, in 2022 compared to 2021, due primarily to an increase in deferred tax assets and pension related assets, as well as normal variations in a number of non-earning asset accounts.
Deposits
ACNB relies on deposits as a primary source of funds for lending activities. Total deposits were $2,198,975,000 at December 31, 2022. Deposits decreased by $227,414,000, or 9.4%, since December 31, 2021. 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. 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 2022, the loan-to-deposit ratio was 69.97% at December 31, 2022.
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 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 despite an increase in market interest rates and an increase in rates by competitors. Interest bearing deposit costs for 2022 was 0.15% compared to 0.29% for 2021.
Table 10 — Time Deposits
Maturities of time deposits exceeding $250,000 outstanding at December 31, 2022, are summarized as follows:
| In thousands | ||
|---|---|---|
| Three months or less | $ | 22,004 |
| Over three through six months | 19,617 | |
| Over six through twelve months | 8,167 | |
| Over twelve months | 1,780 | |
| Total | $ | 51,568 |
Borrowings
Short-term borrowings are comprised primarily of securities sold under agreements to repurchase and short-term borrowings from the FHLB. As of December 31, 2022, short-term borrowings were $41,954,000, an increase of $6,752,000, or 19.2%, from the December 31, 2021, balance of $35,202,000. 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 2021, repurchase agreement balances were up due to normal
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changes in the cash flow position of ACNB’s commercial and local government customer base. There were no short-term FHLB borrowings, at December 31, 2022 and 2021. This account is used or not used due to daily fluctuation in deposits and loans. 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 $21,000,000 at December 31, 2022, versus $34,700,000 at December 31, 2021. The Corporation decreased long-term borrowings 39.5% from December 31, 2021 as excess liquidity was used to pay down higher cost funding. 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.
The following tables set forth information about the Corporation’s short-term borrowings as of the dates indicated:
| In thousands | 2022 | 2021 | |||||
|---|---|---|---|---|---|---|---|
| Short-term borrowings outstanding at end of year: | |||||||
| FHLB overnight advance | $ | — | $ | — | |||
| Securities sold under repurchase agreements | 41,954 | 35,202 | |||||
| Total | $ | 41,954 | $ | 35,202 |
| Dollars in thousands | 2022 | 2021 | |||||
|---|---|---|---|---|---|---|---|
| Average interest rate at year-end | 0.12 | % | 0.12 | % | |||
| Maximum amount outstanding at any month-end | $ | 41,954 | $ | 45,681 | |||
| Average amount outstanding | $ | 35,882 | $ | 35,153 | |||
| Weighted average interest rate | 0.12 | % | 0.11 | % |
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 $245,042,000 at December 31, 2022, compared to $272,114,000 at December 31, 2021. The decline in shareholders’ equity was primarily attributable to the change in accumulated other comprehensive income due to unrealized losses in the securities portfolio resulting from the increase in market interest rates during the year.
The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During 2022, ACNB retained $26,635,000, or 74.5%, of its net income, as compared to $18,866,000, or 67.8%, in 2021.
Quarterly cash dividends paid to ACNB Corporation shareholders in 2022 totaled $9,117,000, or $1.06 per common share. Compared to prior year, ACNB Corporation paid $1.03 in total dividends per common share in 2021, which included a special dividend of $0.02 per common share paid on June 15, 2021.
ACNB Corporation has a Dividend Reinvestment and Stock Purchase Plan that provides registered holders of ACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. Cumulative to December 31, 2022, 235,403 shares were issued under this plan. Proceeds are used for general corporate purposes.
On October 24, 2022, the Corporation announced that the Board of Directors approved on October 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 of December 31, 2022, no common stock has 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
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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 of December 31, 2022 and 2021, 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
In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance effective January 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 of December 31, 2022, 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.
Table 11 — Risk-Based Capital
ACNB Corporation considers the capital ratios of the banking subsidiary to be the relevant measurement of capital adequacy.
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 the FDIC’s Prompt Corrective Action framework. The CBLR framework was available for banks to use in their March 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.
The banking subsidiary’s capital ratios are as follows:
| 2022 | 2021 | To be Well Capitalized under Prompt Corrective Action Regulations | ||||||
|---|---|---|---|---|---|---|---|---|
| Tier 1 leverage ratio (to average assets) | 9.50 | % | 8.81 | % | 5.00 | % | ||
| Common Tier 1 capital (to risk-weighted assets) | 14.68 | % | 16.32 | % | 6.50 | % | ||
| Tier 1 risk-based capital ratio (to risk-weighted assets) | 14.68 | % | 16.32 | % | 8.00 | % | ||
| Total risk-based capital ratio | 15.76 | % | 17.57 | % | 10.00 | % |
For further information on the actual and required capital amounts and ratios, please refer to Note N — “Stockholders’ Equity and Regulatory Matters” in the Notes to Consolidated Financial Statements.
Liquidity
Effective liquidity management ensures the cash flow requirements of depositors and borrowers, as well as the operating
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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 December 31, 2022, ACNB’s banking subsidiary could borrow approximately $821,375,000 from the FHLB of which $808,275,000 was available. At December 31, 2022, ACNB’s banking subsidiary could borrow approximately $5,619,000 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.
ACNB’s banking subsidiary maintains several unsecured Fed Funds lines with correspondent banks. As of December 31, 2022, 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 by the borrower. A subsequent draw taken was reduced to $0 in 2020 on this commercial line of credit since its inception. The liability is recorded for the net drawn amount of this line, no further liability is recorded for the remaining line as to the guarantor’s obligation as the guarantor would have full recourse from all assets of its wholly-owned subsidiary. The Corporation maintains a $5,000,000 unsecured line of credit with a correspondent bank. The line of credit remains at full capacity at year-end.
Another source of liquidity is securities sold under repurchase agreements to customers of ACNB’s banking subsidiary totaling $41,954,000 and $35,202,000 at December 31, 2022 and 2021, 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. For a discussion of ACNB’s dividend restrictions, please refer to Item 1 — “Business” and Note J — “Regulatory Restrictions on Dividends” in the Notes to Consolidated Financial Statements.
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.
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. At December 31, 2022, the Corporation had unfunded outstanding commitments to extend credit of $401,786,000 and outstanding standby letters of credit of $11,429,000. 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. Please refer to Note O — “Financial Instruments with Off-balance Sheet Risk” in the Notes to Consolidated Financial Statements for a discussion of the nature, business purpose, and importance of the Corporation’s off-balance sheet arrangements.
New Accounting Pronouncements
See Note A — “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for a summary of these new accounting pronouncements not yet adopted.