UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended DECEMBER 31, 2003 --------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------- ------------
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
OR
o
TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-11783
ACNB CORPORATION ----------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) PENNSYLVANIA 23-2233457 - ------------------------------ ----------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 16 LINCOLN SQUARE, GETTYSBURG, PENNSYLVANIA 17325-3129 - ------------------------------------------- ---------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code: (717) 334-3161 -------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $2.50 PER SHARE --------------------------------------- (TITLE OF CLASS)
ACNB CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania
23-2233457
(State or other jurisdiction of
incorporation or organization)(I.R.S. Employer
Identification No.)16 Lincoln Square, Gettysburg, Pennsylvania
17325-3129
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (717) 334-3161
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $2.50 per Share
(Title of class)
Indicate by check mark if
disclosurethe registrant is a well-known seasoned issuer, as defined in Rule 405 ofdelinquent filersthe Securities Act.Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained, to the bestSection 13 or Section 15(d) of theRegistrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_|Act.Yes o No ý
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
|X|ý No|_|oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer o Accelerated filer ý Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in
Exchange ActRule12b-2)12b-2 of the Act). Yes|X|o No|_|ýThe aggregate market value of the voting stock held by nonaffiliates of the Registrant at June 30,
20032005 was approximately$134,849,000.$123,909,000.The number of shares of
Registrant'sRegistrant’s Common Stock outstanding on March 1,20042006 was 5,436,101.DOCUMENTS INCORPORATED BY REFERENCEDocuments Incorporated by Reference
Portions of the
Registrant's 2004 Annual MeetingRegistrant’s 2006 definitive Proxy Statement are incorporated by reference into Part III of this report.ACNB CORPORATION
Table of Contents
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The management of ACNB Corporation has made forward-looking statements in this Annual Report on Form 10-K. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of ACNB Corporation and its wholly-owned subsidiaries, Adams County National Bank,
andPennbanks InsuranceCompany.Company, and Russell Insurance Group, Inc. When words such as"believes", "expects", "anticipates", "may", "could", "should", "estimates",“believes,” “expects,” “anticipates,” “may,” “could,” “should,” “estimates,” or similar expressions occur in this annual report, management is making forward-looking statements.ShareholdersStockholders should note that many factors, some of which are discussed elsewhere in this report, could affect the future financial results of ACNB Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in this report. These risk factors include the following:
o•Operating, legal and regulatory risks;
o•Economic, political and competitive forces impacting our various lines of business;
o•The risk that our analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful;
o•The possibility that increased demand or prices for
ACNB'sACNB’s financial services and products may not occur;o•Volatility in interest rates; and/or,
o•Other risks and uncertainties.
ACNB undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in other documents ACNB files periodically with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
ACNB CORPORATION
ACNB Corporation is
a $872.7an $945 million financial holding company headquartered in Gettysburg, Pennsylvania. Through its banking and nonbanking subsidiaries, ACNB provides a full range of banking and financial services to individuals and businesses, including commercial and retail banking, trust, accounting and insurance.ACNB'sACNB’s operations are conducted through its primary operating subsidiary, Adams County National Bank, withnineteentwenty offices in Adams, Cumberland and York Counties. ThecorporationCorporation was organized in19831983.On November 19, 2004, ACNB Corporation and ACNB Acquisition Subsidiary LLC entered into a definitive agreement to purchase Russell Insurance Group, Inc. Under the terms of the definitive agreement, ACNB Corporation agreed to pay $4,750,000 in cash to acquire Russell Insurance Group. Additional consideration of up to $2,882,000 is subject to performance criteria for payment over the next three years. On January 5, 2005, ACNB Corporation and ACNB Acquisition Subsidiary, LLC completed the acquisition of Russell Insurance Group, Inc. and Russell Insurance Group, Inc. to operate as a separate subsidiary of ACNB Corporation. In addition, ACNB Acquisition Subsidiary LLC has
had no acquisitions forentered into a three year employment contract with Frank C. Russell, Jr., theprevious five years. ACNB'sPresident of Russell Insurance Group, Inc.ACNB’s major source of operating funds is dividends that it receives from its subsidiary bank.
ACNB'sACNB’s expenses consist principally of losses from low-income housinginvestments.investments and interest paid on a term loan used to purchase Russell Insurance Group. Dividends that ACNB pays toshareholdersstockholders consist of dividends declared and paid to ACNB by the subsidiary bank.3
ACNB and its subsidiaries are not dependent upon a single customer or a small number of customers, the loss of which would have a material adverse effect on the Corporation. ACNB does not depend on foreign sources of funds, nor does it make foreign loans.
The common stock of ACNB is listed on the Over The Counter Bulletin Board under the symbol ACNB.
Russell Insurance Group is managed separately from the banking and related financial services that the Corporation offers and is reported as a separate segment.
BANKING SUBSIDIARY
Adams County National Bank
Adams County National Bank is a full-service commercial bank operating under charter from the Office of the Comptroller of the Currency. The
corporation has four operating segmentsBank’s principal market area is Adams County, Pennsylvania, whichinclude commercial, consumer, mortgage lending and investment securities. The corporation's marketplaceis located in south centralPennsylvania which encompassesPennsylvania. Adams County depends on agriculture, industry andareastourism to provide employment for its residents. No single sector dominates the county’s economy. At December 31, 2005, Adams County National Bank had total assets of $931 million, total loans of $493 million and total deposits of $680 million.The main office of the bank is located at 16 Lincoln Square, Gettysburg, Pennsylvania. In addition to its main office, the bank has fourteen branches in
contiguous countiesAdams County, two branches in York County, and three branches in Cumberland County. Adams County National Bank’s service delivery channels for its customers also include the ATM network, Customer Contact Center, Internet and telephone banking. The Bank is subject to regulation and periodic examination by the Office ofYork, Franklin and Cumberland,the Comptroller of the Currency. The Federal Deposit Insurance Corporation, aswell as sections of northern Maryland.provided by law, insures the bank’s deposits.Commercial lending includes commercial mortgages, real estate development, accounts receivable financing, and agricultural loans. Consumer lending programs include home equity loans, automobile and recreational vehicle loans, and manufactured housing loans. Mortgage lending programs include personal residential mortgages, residential construction loans, and speculative construction loans.
Management measures the net interest income of each segment based upon the earnings and fees for each segment recognized less the charge for the funds used. The charge for funds used is based on the average cost of funds used by the respective segment. Other non-interest expense, which includes salaries and employee benefits, occupancy and equipment expense, and other expenses, is allocated to each segment and is netted against net interest income after provision to possible loan losses to arrive at income before income taxes for each respective segment. 3BANKING SUBSIDIARY ADAMS COUNTY NATIONAL BANK Adams County National Bank is a full-service commercial bank operating under charter from the Office of the Comptroller of the Currency. The bank's principal market area is Adams County, Pennsylvania, which is located in south central Pennsylvania. Adams County depends on agriculture, industry and tourism to provide employment for its residents. No single sector dominates the county's economy. At December 31, 2003, Adams County National Bank had total assets of $869 million, total loans of $415 million and total deposits of $639 million. The main office of the bank is located at 16 Lincoln Square, Gettysburg, Pennsylvania. In addition to its main office, the bank has thirteen branches in Adams County, two branches in York County, and three branches in Cumberland County. Adams County National Bank's service delivery channels for its customers also include the ATM network, Customer Contact Center, Internet and telephone banking. The bank is subject to regulation and periodic examination by the Office of the Comptroller of the Currency. The Federal DepositNONBANKING SUBSIDIARIES
Pennbanks Insurance
Corporation, as provided by law, insures the bank's deposits. NONBANKING SUBSIDIARY PENNBANKS INSURANCE CO.Co.Pennbanks Insurance Co. was organized in 2000 and holds an unrestricted Class
"B" Insurer's“B” Insurer’s License under Cayman Islands Insurance Law. The segregated portfolio is engaged in the business of reinsuring credit life and credit accident and disability risks. Total assets of the segregated portfolio as of December 31,2003,2005 totaled$562,000.$388,000.Russell Insurance Group Acquisition
On November 19, 2004, ACNB Corporation entered into a definitive agreement to acquire Russell Insurance Group, Inc., a full-service insurance agency that offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients. This acquisition was finalized on January 5, 2005. Based in Westminster, Maryland, with a satellite office in Timonium, Maryland, Russell Insurance Group has served the needs of its clients since its founding as an independent insurance agency by Frank C. Russell, Jr. in 1978.
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COMPETITION
The financial services industry in
ACNB'sACNB’s market area is highly competitive, including competition from commercial banks, savings banks, credit unions, finance companies and nonbank providers of financial services. Several ofACNB'sACNB’s competitors have legal lending limits that exceed those ofACNB'sACNB’s subsidiary, as well as funding sources on the capital markets that exceedACNB'sACNB’s availability. The increased competition has resulted from a changing legal and regulatory climate, as well as from the economic climate.In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, mortgage companies, leasing companies, finance companies, and other financial services companies offer competitive products and services similar in terms to those offered by ACNB.
Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act, which gives them a broader range of products with which the bank must compete. Although the long-range effects of this development cannot be predicted, most probably it will further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies.
SUPERVISION AND REGULATION
Bank Holding Company Regulation
BANK HOLDING COMPANY
REGULATIONACT OF 1956 - ACNB is a financial holding company and is subject to the regulations of the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. The Federal Reserve has issued regulations under the Bank Holding Company Act that require a financial holding company to serve as a source of financial and managerial strength to its subsidiary bank. As a result, the Federal Reserve may require ACNB to stand ready to use its resources to provide adequate capital funds to the bank during periods of financial stress or adversity.Under the Bank Holding Company Act,In addition, the Federal Reserve may require a financial holding company to end a nonbanking business if the nonbanking business constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the financial holding company.
The Bank Holding Company Act prohibits ACNB from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any bank, or substantially all of the assets of any bank, or
mergemerging with another bank holding company, without the prior approval of the Federal Reserve. The Bank Holding Company Act allows interstate bank acquisitions and interstate branching by acquisition and consolidation in those states that had not elected out by the required deadline. The Pennsylvania Department of Banking also must approve any similar consolidation. Pennsylvania law permits Pennsylvania financial holding companies to control an unlimited number of banks.In addition, the Bank Holding Company Act restricts
ACNB'sACNB’s nonbanking activities to those that are determined by the Federal Reserve Board to be financial in nature, incidental to such financial activity, or complementary to a financial activity. The Bank Holding Company Act does not place territorial restrictions on the activities of nonbank subsidiaries of financial holding companies.45
GRAMM-LEACH-BLILEY ACT OF 1999 - The Gramm-Leach-Bliley Act of 1999 eliminated many of the restrictions placed on the activities of bank holding companies that become financial holding companies. Among other things, the Gramm-Leach-Bliley Act repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the Bank Holding Company Act to permit bank holding companies that are financial holding companies to engage in activities, and acquire companies engaged in activities, that are: financial in nature (including insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities); incidental to financial activities; or complementary to financial activities if the Federal Reserve determines that they pose no substantial risk to the safety or soundness of depository institutions or the financial system in general. The Gramm-Leach-Bliley Act also permits national banks, under certain circumstances, to engage through special financial subsidiaries in the financial and other incidental activities authorized for financial holding companies.
REGULATION W - Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance
Corporation ImprovementActrequiresapplies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve has also issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act, and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules, but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank’s holding companyto guarantee the compliance of any insured depository institution subsidiaryand companies thatmay become "undercapitalized", as defined by regulations,are under common control with thetermsbank. ACNB Corporation and Russell Insurance Group, Inc. are considered to be affiliates ofany capital restoration plan filed by such subsidiary with its appropriate federal banking agency, up to specified limits.Adams County National Bank.RECENT LEGISLATION
USA PATRIOT ACT OF 2001 - In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law
enforcement'senforcement’s and the intelligencecommunities'communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.FINANCIAL SERVICES MODERNIZATION LEGISLATION - In November 1999, the Gramm-Leach-Bliley Act of 1999, or the GLB, was enacted. The GLB repeals provisions of the Glass-Steagall Act which restricted the affiliation of Federal Reserve member banks with firms "engaged principally" in specified securities activities, and which restricted officer, director or employee interlocks between a member bank and any company or person "primarily engaged" in specified securities activities. In addition, the GLB also contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company to engage in a full range of financial activities through a new entity known as a "financial holding company". "Financial activities" is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. The GLB also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company. Financial activities include all activities permitted under new sections of the Bank Holding Company Act or permitted by regulation. To the extent that the GLB permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. The GLB is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, the GLB may have the result of increasing the amount of competition that ACNB faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than ACNB has.SARBANES-OXLEY ACT OF 2002 - On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities law.
The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (the
"SEC"“SEC”) under the Securities Exchange Act of 1934, or the Exchange Act. Given the extensive SEC role in implementing rules relating to many of theSOA'sSOA’s new requirements, the final scope of these requirements remains to be determined.The SOA includes very specific additional disclosure requirements and new corporate governance rules; requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules; and, mandates further studies of certain issues by the SEC. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
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The SOA addresses, among other matters:
o• Audit committees for all reporting companies;
5o• Certification of financial statements by the chief executive officer and the chief financial officer;
o• The forfeiture of bonuses or other incentive-based compensation and profits from the sale of an
issuer'sissuer’s securities by directors and senior officers in the twelve-month period following initial publication of any financial statements that later require restatement;o• A prohibition on insider trading during pension plan black out periods;
o• Disclosure of off-balance sheet transactions;
o• A prohibition on personal loans to directors and officers;
o• Expedited filing requirements for Forms 4s;
o• Disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
o "Real time"• “Real time” filing of periodic reports;
o• Formation of a public accounting oversight board;
o• Auditor independence; and,
o• Increased criminal penalties for violations of securities laws.
The SOA contains provisions that became effective upon enactment on July 30, 2002 and provisions that will become effective from within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.
REGULATION W - Transactions betweenTHE AMERICAN JOBS CREATION ACT OF 2004 — In 2004, the American Jobs Creation Act was enacted as the first major corporate tax act in years. The act addresses a
bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act.number of areas of corporate taxation including executive deferred compensation restrictions. TheFederal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were membersimpact of theFederal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act, and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules,act on ACNB is unknown at this time, butexpands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank's holding company and companies that are under common control with the bank. ACNB Corporationmanagement isconsidered to be an affiliate of Adams County National Bank. In general, subject to certain specified exemptions, a bank ormonitoring itssubsidiaries are limited in their ability to engage in "covered transactions" with affiliates: o To an amount equal to 10% of the bank's capital and surplus, in the case of covered transactions with any one affiliate; and, o To an amount equal to 20% of the bank's capital and surplus, in the case of covered transactions with all affiliates. In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" includes: o Loan or extension of credit to an affiliate; o Purchase of, or an investment in, securities issued by an affiliate; o Purchase of assets from an affiliate, with some exceptions; o Acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and o Issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, under Regulation W: o A bank and its subsidiaries may not purchase a low-quality asset from an affiliate; o Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and, o With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit. 6Regulation W generally excludes all nonbank and nonsavings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation that would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of the bank's capital and surplus.developments.DIVIDENDS
ACNB is a legal entity separate and distinct from its subsidiary bank.
ACNB'sACNB’s revenues, on a parent company only basis, result almost entirely from dividends paid to the corporation by its subsidiary. Federal and state laws regulate the payment of dividends byACNB'sACNB’s subsidiary. See"Regulation“Regulation ofBank"Bank” below.REGULATION OF BANK
The operations of the subsidiary bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. The
bank'sbank’s operations are also subject to regulations of the Office of the Comptroller of the Currency, Federal ReserveFDIC,andPennsylvania Department of Banking.FDIC.The Office of the Comptroller of the Currency, which has primary supervisory authority over national banks, regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. These examinations are designed for the protection of the
bank'sbank’s depositors rather thanACNB'sACNB’s shareholders. The subsidiary bank must file quarterly and annual reports to the Federal Financial Institutions Examinations Council or FFIEC.7
NATIONAL BANK ACT - The National Bank Act requires the subsidiary national bank to obtain the prior approval of the Office of the Comptroller of the Currency for the payment of dividends if the total of all dividends declared by the bank in one year would exceed the
bank'sbank’s net profits in the current year, as defined and interpreted by regulation, plusreturnedretained earnings for the two preceding years, less any required transfers to surplus. In addition, the bank may only pay dividends to the extent that the retained net profits, including the portion transferred to surplus, exceed statutory bad debts, as defined by regulation. These restrictions have not had, nor are they expected to have, any impact on thecorporation'scorporation’s dividend policy.FEDERAL DEPOSIT INSURANCE CORPORATION ACT OF 1991 - Under the Federal Deposit Insurance Corporation Insurance Act of 1991, any depository institution, including the bank, is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy the minimum capital requirement.
FEDERAL RESERVE ACT - A subsidiary bank of a bank holding company is subject to certain restrictions and reporting requirements imposed by the Federal Reserve Act, including:
o• Extensions of credit to the bank holding company, its subsidiaries or
its subsidiaries; oprincipal shareholders;• Investments in the stock or other securities of the bank holding company
• or its subsidiaries; and,
o• Taking such stock or securities as collateral for loans.
COMMUNITY REINVESTMENT ACT OF 1977 - Under the Community Reinvestment Act of 1977, the OCC is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community, including low and moderate income neighborhoods, which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 amended the CRA to require, among other things, that the OCC make publicly available the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation will include a descriptive rating like “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance” and a statement describing the basis for the rating. These ratings are publicly disclosed.
FDICIA - The Federal
ReserveDeposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires that institutions be classified, based on their risk-based capital ratios into one of five defined categories, as illustrated below: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
Total Risk
Based
RatioTier 1
Risk
Based
RatioTier 1
Leverage
RatioUnder a
Capital
Order or
DirectiveCapital Category
Well capitalized
>10.0
>6.0
>5.0
%
NO
Adequately capitalized
> 8.0
>4.0
>4.0
%*
Undercapitalized
< 8.0
<4.0
<4.0
%*
Significantly undercapitalized
< 6.0
<3.0
<3.0
%
Critically undercapitalized
<2.0
%
* 3.0 for those banks having the highest available regulatory rating.
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In the event an institution’s capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including: the institution of a capital restoration plan and a guarantee of the plan by a parent institution; and the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards to be developed by Federal Reserve Board regulations. FDICIA also requires the regulators to issue new rules establishing certain minimum standards to which an institution must adhere including standards requiring a minimum ratio of classified assets to capital, minimum earnings necessary to absorb losses and minimum ratio of market value to book value for publicly held institutions. Additional regulations
also place certain limitationsare required to be developed relating to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth andreporting requirements on extensions of credit by a bank to the principal shareholders of its parent holding company, among others,excessive compensation, fees andto related interests of principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.benefits.ACNB and its subsidiary bank are affected by the monetary and fiscal policies of government agencies, including the Federal Reserve and FDIC. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors of the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature of monetary and fiscal policies on future business and earnings of ACNB cannot be predicted at this time.
OTHERFrom time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of ACNB and the subsidiary bank, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of ACNB.ACCOUNTING POLICY DISCLOSURE
Disclosure of the
corporation'sCorporation’s significant accounting policies is included in Note A to the consolidated financial statements. Some of these policies are7particularly sensitive requiring significant judgments, estimates and assumptions to be made by management. Additional information is contained in Management'sManagement’s Discussion and Analysis for the most sensitive of these issues, including the provision and allowance for loan losses which are located in Note D to the consolidated financial statements.Management, in determining the allowance for loan losses, makes significant estimates. Consideration is given to a variety of factors in establishing this estimate. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan review, financial and managerial strengths of borrowers, adequacy of collateral, if collateral dependent, or present value of future cash flows, and other relevant factors.
89
STATISTICAL DISCLOSURES
The following statistical disclosures are included in
Management'sManagement’s Discussion and Analysis, Item 7 hereof, and are incorporated by reference in this Item 1:o•Interest Rate Sensitivity Analysis
o•Interest Income and Expense, Volume and Rate Analysis
o•Investment Portfolio
o•Loan Maturity and Interest Rate Sensitivity
o•Loan Portfolio
o•Allocation of Allowance for Loan Losses
o•Deposits
o•Short-Term Borrowings
AVAILABLE INFORMATION
The
corporation'sCorporation’s reports, proxy statements and other information are available for inspection and copying at the Public Reference Room at Judiciary Plaza, 450 Fifth Street, N.W., Washington, DC, 20549, at prescribed rates. The public may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. ThecorporationCorporation is an electronic filer with the Commission. The Commission maintains a website that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of theCommission'sCommission’s website isHTTP:http://WWW.SEC.GOV.www.sec.gov.Upon a
shareholder'sstockholder’s written request, a copy of thecorporation'sCorporation’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Securities Exchange Act Rule 13a-1, may be obtained, without charge, fromJohn W. Krichten, Secretary/Lynda L. Glass, Executive Vice President, Secretary and Treasurer, 16 Lincoln Square, P.O. Box 3129, Gettysburg, PA 17325, or visit our website atHTTP:http://WWW.ACNB.COM.www.acnb.com.EMPLOYEES
As of December 31,
2003,2005, ACNB had207203 full-time equivalent employees. None of these employees are represented by a collective bargaining agreement, and ACNB believes it enjoys good relations with its personnel.ACNB IS SUBJECT TO INTEREST RATE RISK
ACNB’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond ACNB’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest ACNB receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) ACNB’s ability to originate loans and obtain deposits, (ii) the fair value of ACNB’s financial assets and liabilities, and (iii) the average duration of ACNB’s mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, ACNB’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
10
Although management believes it has implemented effective asset and liability management strategies, to reduce the potential effects of changes in interest rates on ACNB’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on ACNB’s financial condition and results of operations.
ACNB IS SUBJECT TO CREDIT RISK
As of December 31, 2005, approximately 35% of ACNB’s loan portfolio consisted of commercial and industrial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans. Because ACNB’s loan portfolio contains a significant number of commercial and industrial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on ACNB’s financial condition and results of operations.
ACNB’S ALLOWANCE FOR LOAN LOSSES MAY BE INSUFFICIENT
ACNB maintains an allowance for loan losses, which is a reserve established through a provision for possible loan losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires ACNB to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of ACNB’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review ACNB’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, ACNB will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on ACNB’s financial condition and results of operations.
COMPETITION FROM OTHER FINANCIAL INSTITUTIONS MAY ADVERSELY AFFECT ACNB’S PROFITABILITY.
ACNB’s banking subsidiary faces substantial competition in originating, both commercial and consumer loans. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of its competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce the Corporation’s net income by decreasing the number and size of loans that its banking subsidiary originate and the interest rates they may charge on these loans.
11
In attracting business and consumer deposits, its banking subsidiary faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of ACNB’s competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more convenient branch locations. These competitors may offer higher interest rates than ACNB, which could decrease the deposits that it attracts or require it to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect ACNB’s ability to generate the funds necessary for lending operations. As a result, it may need to seek other sources of funds that may be more expensive to obtain and could increase its cost of funds.
ACNB’s banking subsidiary also competes with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations which may offer more favorable terms. Some of its non-bank competitors are not subject to the same extensive regulations that govern its banking operations. As a result, such non-bank competitors may have advantages over ACNB’s banking subsidiary in providing certain products and services. This competition may reduce or limit its margins on banking services, reduce its market share and adversely affect its earnings and financial condition.
ACNB’S CONTROLS AND PROCEDURES MAY FAIL OR BE CIRCUMVENTED
Management regularly reviews and updates ACNB’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of ACNB’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on ACNB’s business, results of operations and financial condition.
ACNB’S ABILITY TO PAY DIVIDENDS DEPENDS PRIMARILY ON DIVIDENDS FROM ITS BANKING SUBSIDIARY, WHICH IS SUBJECT TO REGULATORY LIMITS.
ACNB is a bank holding company and its operations are conducted by its subsidiaries. Its ability to pay dividends depends on its receipt of dividends from its subsidiaries. Dividend payments from its banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of its subsidiaries to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. There is no assurance that its subsidiaries will be able to pay dividends in the future or that ACNB will generate adequate cash flow to pay dividends in the future. ACNB’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.
ACNB’S PROFITABILITY DEPENDS SIGNIFICANTLY ON ECONOMIC CONDITIONS IN THE COMMONWEALTH OF PENNSYLVANIA AND THE STATE OF MARYLAND.
ACNB’s success depends primarily on the general economic conditions of the Commonwealth of Pennsylvania, the State of Maryland and the specific local markets in which ACNB operates. Unlike larger national or other regional banks that are more geographically diversified, ACNB provides banking and financial services to customers primarily in the south central Pennsylvania and northern Maryland region of the country. The local economic conditions in these areas have a significant impact on the demand for ACNB’s products and services as well as the ability of ACNB’s customers to repay loans, the value of the collateral securing loans and the stability of ACNB’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on ACNB’s financial condition and results of operations.
12
NEW LINES OF BUSINESS OR NEW PRODUCTS AND SERVICES MAY SUBJECT ACNB TO ADDITIONAL RISKS.
From time to time, ACNB may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services ACNB may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of ACNB’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on ACNB’s business, results of operations and financial condition.
ACNB MAY NOT BE ABLE TO ATTRACT AND RETAIN SKILLED PEOPLE
ACNB’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by ACNB can be intense and ACNB may not be able to hire people or to retain them. The unexpected loss of services of one or more of ACNB’s key personnel could have a material adverse impact on ACNB’s business because of their skills, knowledge of ACNB’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. ACNB does not currently have employment agreements or non-competition agreements with any of its senior officers, except its President.
ACNB IS SUBJECT TO CLAIMS AND LITIGATION PERTAINING TO FIDUCIARY RESPONSIBILITY
From time to time, customers make claims and take legal action pertaining to ACNB’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to ACNB’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to ACNB they may result in significant financial liability and/or adversely affect the market perception of ACNB and its products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on ACNB’s business, which, in turn, could have a material adverse effect on ACNB’s financial condition and results of operations.
THE TRADING VOLUME IN ACNB’S COMMON STOCK IS LESS THAN THAT OF OTHER LARGER FINANCIAL SERVICES COMPANIES
ACNB’s common stock trades on the Over The Counter Bulletin Board and the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of ACNB’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which ACNB has no control. Given the lower trading volume of ACNB’s common stock, significant sales of ACNB’s common stock, or the expectation of these sales, could cause ACNB’s stock price to fall.
13
ACNB OPERATES IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY CHANGES IN FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS.
ACNB is subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on ACNB and its operations. Additional legislation and regulations that could significantly affect ACNB’s powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on its financial condition and results of operations. Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority may have a negative impact on ACNB’s results of operations and financial condition.
Like other bank holding companies and financial institutions, ACNB must comply with significant anti-money laundering and anti-terrorism laws. Under these laws, ACNB is required, among other things, to enforce a customer identification program and file currency transaction and suspicious activity reports with the federal government. Government agencies have substantial discretion to impose significant monetary penalties on institutions which fail to comply with these laws or make required reports.
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2 - PROPERTIES
ACNB Corporation owns no real estate.Adams County National Bank, in addition to its main office, had an office network of
eighteennineteen offices at December 31,2003.2005. All offices are located in Adams County with the exception of three offices located in Cumberland County and two offices located in York County. Offices atfourteensixteen locations are owned, while four are leased. All real estate owned by the subsidiary bank is free and clear of encumbrances.As of December 31,
2003,2005, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which ACNB or its subsidiaries are a party or by which any of their property is the subject.ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF
SHAREHOLDERSSTOCKHOLDERSThere were no matters submitted to a vote of
shareholdersstockholders during the fourth quarter of2003. 92005. 14
ITEM 5 - MARKET FOR THE
REGISTRANT'SREGISTRANT’S COMMONSTOCKEQUITY AND RELATEDSHAREHOLDERSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESACNB
Corporation'sCorporation’s common stock trades on the Over The Counter Bulletin Board under the symbol ACNB. There were 20,000,000 shares of common stock authorized at December 31,2003,2005, and 5,436,101 shares outstanding. As ofMarchDecember 1,2004,2005, ACNB had approximately2,9002,792 stockholders of record. There is no other class of stock authorized or outstanding. ACNB is restricted as to the amount of dividends that it can pay toshareholdersstockholders by virtue of the restrictions on thesubsidiary'ssubsidiary’s ability to pay dividends to ACNB. ACNB Corporation has no equity compensation plans.There have been no unregistered sales of stock in
2003, 20022005, 2004, or2001.2003.The following table reflects the quarterly high and low prices of
ACNB'sACNB’s common stock for the periods indicated and the cash dividends on the common stock for the periods indicated.PRICE RANGE PER SHARE PER SHARE 2003 HIGH LOW DIVIDEND ---- ---- --- -------- First Quarter $26.65 $21.00 $ .21 Second Quarter $25.75 $22.80 $ .21 Third Quarter $26.50 $24.05 $ .21 Fourth Quarter $28.50 $25.25 $ .26 PRICE RANGE PER SHARE PER SHARE 2002 HIGH LOW DIVIDEND ---- ---- --- -------- First Quarter $18.50 $17.10 $ .40 Second Quarter $22.40 $17.80 $ .20 Third Quarter $21.50 $19.65 $ .20 Fourth Quarter $21.60 $20.75 $ .28 10
ITEM 6 - SELECTED FINANCIAL DATA YEAR ENDED DECEMBER 31 (Dollars in thousands, except per share data) 2003 2002 2001 2000 1999 ---- ---- ---- ---- ----SUMMARIES OF INCOME Interest income $ 36,689 $ 37,794 $ 39,161 $ 39,837 $ 38,194 Interest expense 13,945 13,453 16,056 16,929 15,966 ---------- ----------- ----------- ----------- ----------- Net interest income 22,744 24,341 23,105 22,908 22,228 Provision for loan losses 265 370 240 240 253 ---------- ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 22,479 23,971 22,865 22,668 21,975 Non-interest income 9,429 5,028 3,533 2,797 2,888 Non-interest expenses 17,998 16,988 14,327 13,212 13,270 ---------- ----------- ----------- ----------- ----------- Income before income taxes 13,910 12,011 12,071 12,253 11,593 Applicable income taxes 3,142 3,107 3,734 4,158 3,770 ---------- ----------- ----------- ----------- ----------- NET INCOME $ 10,768 $ 8,904 $ 8,337 $ 8,095 $ 7,823 ========== =========== =========== =========== =========== FINANCIAL CONDITION AT YEAR END Assets $ 872,731 $ 734,644 $ 630,234 $ 567,330 $ 545,952 Loans, net 411,051 368,469 357,816 357,159 343,811 Deposits 639,388 582,615 509,235 453,149 452,633 Borrowed money 156,676 76,445 51,501 48,957 29,827 Stockholders' equity 72,391 70,100 62,693 60,437 59,863 PER COMMON SHARE DATA Earnings per share - basic $ 1.98 $ 1.64 $ 1.53 $ 1.44 $ 1.35 Earnings per share - diluted 1.98 1.64 1.53 1.44 1.35 Cash dividends paid .89 1.08 0.88 0.87 0.85 Book value 13.32 12.90 11.53 10.75 10.35 Weighted average number of common shares: Basic 5,436,000 5,436,000 5,436,000 5,623,000 5,783,000 Diluted 5,436,000 5,436,000 5,436,000 5,623,000 5,783,000 Dividend payout ratio 45% 66% 58% 60% 63% PROFITABILITY RATIOS ON EARNINGS Return on average assets 1.32% 1.35% 1.45% 1.46% 1.42% Return on average equity 15.41% 13.45% 13.34% 13.50% 12.88% Equity to assets 8.29% 9.54% 9.95% 10.65% 10.96% SELECTED ASSET QUALITY RATIOS Nonperforming loans to total loans 1.21% 0.65% 0.51% 0.79% 1.01% Net charge-offs to average loans outstanding .03% 0.07% 0.06% 0.02% 0.09% Allowance for loan losses to total loans .96% 1.02% 1.03% 1.02% 1.02% Allowance for loan losses to nonperforming loans 79.3% 158.8% 202.3% 129.8% 100.2%11
Price Range Per Share
Per Share
Dividend
High
Low
2005:
First Quarter
$
26.00
$
24.55
$
0.21
Second Quarter
25.00
22.60
$
0.21
Third Quarter
24.00
22.00
$
0.21
Fourth Quarter
22.00
19.20
$
0.28
2004:
First Quarter
$
27.25
$
26.50
$
0.21
Second Quarter
$
26.50
$
24.05
$
0.21
Third Quarter
$
25.15
$
23.50
$
0.21
Fourth Quarter
$
25.95
$
24.90
$
0.27
15
ITEM 6 - SELECTED FINANCIAL DATA
Year Ended December 31,
2005
2004
2003
2002
2001
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA
Interest income
$
42,269
$
37,752
$
36,689
$
37,794
$
39,161
Interest expense
16,991
13,183
13,945
13,453
16,056
Net interest income
25,278
24,569
22,744
24,341
23,105
Provision for loan losses
516
300
265
370
240
Net interest income after provision for loan losses
24,762
24,269
22,479
23,971
22,865
Proceeds recognized from life insurance proceeds
—
—
2,161
—
—
Other income
8,916
5,865
7,268
5,028
3,533
Other expenses
24,892
18,571
17,998
16,988
14,327
Income before income taxes
8,786
11,563
13,910
12,011
12,071
Applicable income taxes
1,410
2,255
3,142
3,107
3,734
Net income
$
7,376
$
9,308
$
10,768
$
8,904
$
8,337
BALANCE SHEET DATA (AT YEAR-END)
Assets
$
945,136
$
924,188
$
873,083
$
734,644
$
630,234
Securities
367,878
405,943
388,252
309,655
219,841
Loans, net
489,008
436,631
411,051
368,469
357,816
Deposits
679,381
646,872
639,388
582,615
509,235
Borrowings
185,085
196,966
156,676
76,445
51,501
Stockholders’ equity
74,010
74,521
72,743
70,460
63,025
COMMON SHARE DATA
Earnings per share - basic
$
1.36
$
1.71
$
1.98
$
1.64
$
1.53
Cash dividends paid
0.91
0.90
0.89
1.08
0.88
Book value per share
13.59
13.71
13.38
12.96
11.59
Weighted average number of common shares
5,436,000
5,436,000
5,436,000
5,436,000
5,436,000
Dividend payout ratio
67.07
%
52.56
%
44.93
%
65.94
%
57.37
%
PROFITABILITY RATIOS AND CONDITION
Return on average assets
0.79
%
1.04
%
1.32
%
1.35
%
1.45
%
Return on average equity
10.03
%
12.84
%
15.41
%
13.45
%
13.34
%
Average stockholders’ equity to average assets
7.92
%
8.11
%
8.55
%
10.04
%
11.42
%
SELECTED ASSET QUALITY RATIOS
Nonperforming loans to total loans
1.40
%
1.86
%
1.21
%
0.65
%
0.51
%
Net charge-offs to average loans outstanding
—
%
0.08
%
0.03
%
0.07
%
0.06
%
Allowance for loan losses to total loans
0.90
%
0.89
%
0.96
%
1.02
%
1.03
%
Allowance for loan losses to nonperforming loans
64.36
%
47.94
%
79.26
%
158.82
%
202.34
%
16
ITEM 7 -
MANAGEMENT'SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSINTRODUCTION AND FORWARD-LOOKING STATEMENTS
INTRODUCTIONIntroduction
The following is
management'smanagement’s discussion and analysis of the significant changes in the results of operations, 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.FORWARD-LOOKING STATEMENTSForward-Looking Statements
In addition to historical information, this
20032005 Annual Report contains forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure and other financial terms, (b) statements of plans and objectives of management or the board of directors, and (c) statements of assumptions, such as economic conditions in the Corporation’s market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “intends,” “will,” “should,” “anticipates,” or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements. We caution readers not to place undue reliance on these forward-looking statements. They only reflectmanagement'smanagement’s analysis, as of this date. ThecorporationCorporation 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 thecorporationCorporation files fromtime to timetime-to-time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q, filed by thecorporationCorporation in20042005 and any Current Reports on Form 8-K filed by thecorporation. CRITICAL ACCOUNTING POLICIESCorporation.Critical Accounting Policies
The accounting policies that the
Corporation'sCorporation’s management deems to be most important to the portrayal of its financial condition and results of operations, and that requiremanagement'smanagement’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 followingpolicy ispolicies are deemed to beacritical accountingpolicypolicies by management:ALLOWANCE FOR LOAN LOSSESThe allowance for loan losses represents
management'smanagement’s estimate of probable losses inherent in our 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“Allowance for LoanLosses"Losses,” in a subsequent section of the followingManagement'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations.RESULTS OF OPERATIONSThe evaluation of securities for other than temporary impairment requires a significant amount of judgment. In estimating other than temporary impairment losses, management considers various factors, including length of time the fair value has been below cost, the financial condition of the issuer and the intent and ability of the corporation to hold the securities until recovery. Declines in fair value that are determined to be other than temporary are charged against earnings. For additional information see Footnote C in the Corporation’s December 31, 2005 financial statements.
17
EXECUTIVE OVERVIEW
ACNB'sThe Corporation’s executive management team and board of directors have identified two performance measurements that they feel are key elements of enhancing shareholder value. These include: a) increase in earnings per share; and b) return on realized equity.
The primary source of the Corporation’s revenues is net interest income derived from loans and investments, less their 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.
Because of a low interest rate environment and overall decline in the financial services industry’s net interest margin, the Corporation was unable to improve its net interest margin during 2005, but it has stabilized at 2.93%, 2.92% and 2.96% in 2005, 2004 and 2003, respectively. The stabilization during 2005 was primarily the result of a stronger emphasis on the loan portfolio as management leveraged the Corporation’s interest earning assets. In addition, average loans increased 9.4% from 2004 to 2005 as compared to 9.1% from 2003 to 2004. Net interest income increased to $25,278,000 in 2005, compared to $24,569,000 in 2004, and $22,744,000 in 2003.
Other income was $8,916,000, $5,865,000, and $9,429,000 in 2005, 2004 and 2003. The increase in 2005 was the result of the purchase of Russell Insurance Group in January 2005, which added $4,121,000 in commissions from insurance sales. This was partially offset by a $1,377,000 decrease in securities gain. The significant decrease from 2003 was primarily caused by a gain recognized from life insurance proceeds of $2,161,000 in 2003 and an $879,000 decrease in gains on sale of securities in 2004.
Other expenses increased to $24,892,000 in 2005, compared to $18,571,000 in 2004 and $17,998,000 in 2003. This increase can be attributed to the Russell Insurance Group, which added $3,013,000 of other expenses and the new operations center. Russell Insurance has added approximately $348,000 to net income
wasafter taking into consideration interest expense on the debt used to finance the purchase. Increases in other expenses were also affected by additional compliance costs, employee medical premium increases, the opening of two new branch offices in New Oxford and the Adams Commerce Center, as well as the opening of the Operations Center to serve the future technology, training, and administrative needs of the Corporation.The Corporation’s overall strategy is to enhance growth in existing markets and complement this with new products and services through the leveraging of existing resources. This has resulted in net income of $7,376,000, or $1.36 per share in 2005, compared to $ 9,308,000, or $1.71 per share in 2004, and $10,768,000, or $1.98 per share
compared to $8,904,000,in 2003. Without the unusual occurrence of $2,161,000 in insurance proceeds, net income during 2003 would have been $8,607,000 or$1.64 per share in 2002, and $8,337,000, or $1.53 per share in 2001.$1.58.Returns on average equity were 10.03%, 12.84%, and 15.41% in 2005, 2004 and 2003.
A more thorough discussion of Corporation’s results of operations is included in the following pages.
18
NEW ACCOUNTING STANDARDS
EITF 03-1
In January 2003,
13.45%the FASB’s Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investors” (EITF 03-1), and in2002,March 2004 the EITF issued an update. EITF 03-1 addresses the meaning of other-than-temporary impairment and13.34%its application to certain debt and equity securities. EITF 03-1 aids in2001. Returnsthe determination of impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff’s recommendations were to nullify the guidance onaverage assets were 1.32%the determination of whether an investment is impaired as set forth in2003, 1.35% in 2002,paragraphs 10-18 of Issue 03-1 and1.45% in 2001. NET INTEREST INCOMEnot to provide additional guidance on the meaning of other-than-temporary impairment. Instead, the staff recommends entities recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115.RESULTS OF OPERATIONS
Net Interest Income
The primary source of
ACNB'sACNB’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 federal funds sold. Interest-bearing funds 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“interest ratespread"spread” and"net“net interestmargin"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 earningassets. Due toassets, which also considers the Corporation’s net noninterest bearing funding sources, the largest of which are noninterest bearing demand deposits andstockholders' equity, the netstockholders’ equity.19
The following table includes average balances, rates and interest
margin exceedsincome and expense, the interest rate spreadas these funding sourcesand the net interest margin:Table 1 - Average Balances, Rates and Interest Income and Expense
2005
2004
2003
Dollars In thousands
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
ASSETS
INTEREST EARNING ASSETS
Loans
$
464,338
$
27,243
5.87
%
$
424,299
$
23,578
5.56
%
$
388,842
$
23,670
6.09
%
Taxable securities
365,204
14,017
3.84
%
384,563
13,155
3.42
%
351,346
12,062
3.43
%
Tax-exempt securities
23,179
916
3.95
%
23,283
917
3.94
%
22,236
882
3.97
%
Total Securities
388,383
14,933
3.84
%
407,846
14,072
3.45
%
373,582
12,944
3.46
%
Other
10,023
93
0.93
%
8,152
102
1.25
%
5,173
75
1.45
%
Total Interest Earning Assets
862,744
42,269
4.90
%
840,297
37,752
4.49
%
767,597
36,689
4.78
%
Cash and due from banks
17,476
21,772
20,974
Premises and equipment
14,017
8,296
7,371
Other assets
38,121
27,558
25,628
Allowance for loan losses
(4,123
)
(4,067
)
(3,887
)
Total Assets
$
928,235
$
893,856
$
817,683
LIABILITIES AND STOCKHOLDERS’ EQUITY
INTEREST BEARING LIABILITIES
Interest bearing demand deposits
$
116,933
$
761
0.65
%
$
110,293
659
0.60
%
$
100,586
1,088
1.08
%
Savings deposits
235,317
3,349
1.42
%
241,192
2,544
1.05
%
225,099
3,415
1.52
%
Time deposits
239,075
7,418
3.10
%
230,117
6,308
2.74
%
225,043
6,721
2.99
%
Total Interest Bearing Deposits
591,325
11,528
1.95
%
581,602
9,511
1.64
%
550,728
11,224
2.04
%
Short-term borrowings
48,976
1,255
2.56
%
51,437
793
1.54
%
45,290
741
1.64
%
Long-term borrowings
130,501
4,208
3.22
%
108,507
2,879
2.65
%
76,563
1,980
2.59
%
Total Interest Bearing Liabilities
770,802
16,991
2.20
%
741,546
13,183
1.78
%
672,581
13,945
2.07
%
Non-interest bearing demand deposits
77,754
75,472
71,474
Other liabilities
6,133
4,363
3,744
Stockholders’ equity
73,546
72,475
69,884
Total Liabilities and Stockholders’ Equity
$
928,235
$
893,856
$
817,683
NET INTEREST INCOME
$
25,278
$
24,569
$
22,744
INTEREST RATE SPREAD
2.70
%
2.71
%
2.71
%
NET INTEREST MARGIN
2.93
%
2.92
%
2.96
%
For yield calculation purposes, non-accruing loans are
non-interest bearing.included in average loan balances. Yields on tax-exempt securities are not tax effected.Interest income on loans includes amortized fees and costs on loans totaling $317,000 in 2005, $186,000 in 2004, and $637,000 in 2003.
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,
2003, 20022005, 2004 and2001.2003. Table 2 analyzes the relative impact on net interest income for changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by the Corporation on such assets and liabilities.20
Net interest income totaled $25,278,000 in 2005, compared to $24,569,000 in 2004, and $22,744,000 in 2003. The increase in net interest income
for the periods broken down by their rateduring 2004 andvolume components. 12Net interest income in 20032005 was$22,744,000, comparedprimarily related to$24,341,000 in 2002 and $23,105,000 in 2001. ACNB was able to increase its net interest income from 2001 to 2002 primarily throughan increase in average earningassets, butassets. During 2003, net interest income declined as a result of a decline in rates,fell too farpartially offset by an increase inlate 2002 and 2003 for the same strategy to work in 2003. Theinterestrate spread andbearing assets.The net interest margin
have compressed overduring 2005 was 2.93% compared to 2.92% during 2004. The margin growth was flat due to a flat yield curve. The Prime rate and fed funds rate increased steadily throughout 2005, but long-term rates moved up very little during thelast three years.same period. The yield on interestrate spread was 2.71% in 2003, down from 3.47% in 2002earning assets and3.60% in 2001.cost of interest bearing liabilities rose by 0.41% and 0.42%, respectively, during 2005.The net
yield on earning assets experienced similar results, totalinginterest margin during 2004 was 2.92% compared to 2.96%in 2003, down from 3.91% in 2002 and 4.27% in 2001.during 2003. Several factors impacted the net interest margin for2003.2004. First, ACNB was in an asset sensitive interest rate risk position in 2003, and interest earning assets repriced more quickly than interest bearing liabilities. Longer-term funding sources, including certificates of deposit, have to reach their maturity date to reprice. The yield on interest earning assets and cost of interest bearing liabilities declined by 0.29%. Second, ACNB had a less profitable interest earning asset mix, as deposits and borrowings were used to fund securities because loan growth remained weak. Finally, the market area served by ACNB is highly competitive, resulting in financial institutions pricing quality credits competitively in order to increase volume.Average earning assets were
$767,597,000$862,744,000 in2003,2005, an increase of23.2%2.7% over the20022004 balance of$622,890,000. Average earning assets for 2001 were $541,117,000. Securities$840,297,000. Loan growth was the primary contributor to the increase in average earning assets duringthese periodsthis period withloans remaining a secondary source. Averagesecurities being reduced.A rate/volume analysis detailed in Table 2 shows that the significant increase in interest income change in 2005 was centered in loan volume while the largest increase in interest expense was in long-term borrowings. Positive volume changes in net interest income in 2004 were
$373,582,000 for the year ended December 31, 2003, compared to $253,060,000 in 2002 and $162,021,000 in 2001. Weak loan growth, coupled with strong growth in transaction accounts, required increasedmore than offset by negative rate changes. Management’s emphasis onthe securities portfolio, which resultedadditional loan volume ingrowth of 47.6%,2005 stabilized net interest income and this emphasis will continue in2003, compared to 56.2% in 2002. Because the bank has traditionally been a mortgage lender and mortgage-backed securities carry higher2006. Higher interest ratesthan other agency securities, most of the securities growth in 2002 was in mortgage-backed securities. Mortgage backed securities grew from $102,419,000 at December 31, 2001, to $184,893,000 at December 31, 2002. In addition, corporate securities increased from $1,957,000 to $65,068,000 or 3,236% during the same time period. During 2003, the trend reversed itself. Because of the Registrant's pronounced exposure to mortgage backed securities and the attendant prepayment risk, securities purchase strategy changed to emphasize corporate securities rather than mortgage backed securities. At December 31, 2003, mortgage backed securities had increased to $202,262,000, while corporate securities had grown 65% to $106,401,000. The significant increase of corporate securities was caused by extremely low U.S. Treasury and agency rates. The rate spread between corporate and government securities indicated the need for a strong preference for corporate securities. The securitiesmay not have arelatively short duration that should provide sufficient liquidity to assist in the funding of loan demand, and opportunities in the bond market should rates rise in 2004. Overall loan income is down due to lower rates, but slow loan growth prevented the increase in volume from making up for the decrease. Average loans were $388,842,000 in 2003, versus $367,494,000 in 2002 and $359,404,000 in 2001. The greater increase in loans, in part, reflects a decision to keep shorter term fixed rate mortgages in the bank's portfolio.positive impact on net interest income.Average interest bearing liabilities were $770,802,000 in 2005, up from $741,546,000 in 2004, and $672,581,000 in
2003, up from $516,897,000 in 2002 and $441,112,000 in 2001. Funding to support loan2003. Loan and securities growthcame fromwas primarily funded by an increase in interest bearing liabilities in20032004 and2002,2003, with a continued shift in mix from time deposits to borrowed money and lower-cost demand and savings deposits.13
TABLE 1 - COMPARATIVE AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS YEAR ENDED DECEMBER 31 2003 2002 -------------------------------- --------------------------------- BALANCE INTEREST RATE BALANCE INTEREST RATE ------- -------- ---- ------- -------- ----ASSETS IN THOUSANDS Loans $ 388,842 $ 23,670 6.09% $367,494 $ 24,752 6.74% Taxable investment securities 351,346 12,062 3.43% 247,272 12,727 5.15% Non-taxable investment securities 22,236 882 3.97% 5,788 241 4.16% Federal funds sold -- -- -- -- -- -- Interest bearing deposits with banks 5,173 75 1.45% 2,336 74 3.17% --------- --------- -------- --------- Total interest earnings assets 767,597 $ 36,689 4.78% 622,890 $ 37,794 6.07% Cash and due from banks 20,974 19,050 Premises and equipment 7,371 6,338 Other assets 25,628 14,783 Allowance for loan losses (3,887) (3,722) --------- -------- TOTAL ASSETS $ 817,683 $659,339 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing demand deposits $ 100,586 $ 1,088 1.08% $ 83,825 $ 1,134 1.35% Savings deposits 225,099 3,415 1.52% 158,804 3,070 1.93% Time deposits (excluding time certificates of deposits of $100,000 or more) 207,599 6,164 2.97% 202,036 6,779 3.36% Time certificates of deposit of $100,000 or more 17,444 557 3.19% 21,272 1,275 5.99% Borrowings 121,853 2,721 2.23% 50,960 1,195 2.34% --------- --------- --------- ---------- Total interest bearing liabilities 672,581 13,945 2.07% 516,897 $ 13,453 2.60% INTEREST RATE SPREAD 2.71% 3.47% Demand deposits 71,474 72,408 Other liabilities 3,744 3,829 Stockholders' equity 69,884 66,205 --------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 817,683 $ 659,339 ========= ========= INTEREST INCOME/ EARNING ASSETS $ 767,597 36,689 4.78% $ 622,890 $ 37,794 6.07% INTEREST EXPENSE/ EARNING ASSETS (767,597) (13,945) 1.82% (622,890) (13,453) (2.16)% ---------- --------- ----- ---------- --------- ------- NET YIELD ON EARNING ASSETS -- $ 22,744 2.96% -- $ 24,341 3.91% ========== ========= ===== =========== ========= =====TABLE 1 - COMPARATIVE AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS YEAR ENDED DECEMBER 31 2001 -------------------------------------- BALANCE INTEREST RATE ------- -------- ---- ASSETS IN THOUSANDS Loans $ 359,404 $ 27,892 7.76% Taxable investment securities 159,722 10,396 6.51% Non-taxable investment securities 2,299 117 5.09% Federal funds sold 3,182 157 4.93% Interest bearing deposits with banks 16,510 599 3.63% ------- --------- Total interest earnings assets 541,117 $ 39,161 7.24% Cash and due from banks 17,642 Premises and equipment 5,081 Other assets 13,836 Allowance for loan losses (3,669) --------- TOTAL ASSETS $ 547,007 ========= LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing demand deposits $ 74,658 $ 1,497 2.01% Savings deposits 117,973 2,554 2.16% Time deposits (excluding time certificates of deposits of $100,000 or more) 191,486 9,699 5.06% Time certificates of deposit of $100,000 or more 20,640 940 4.55% Borrowings 36,355 1,366 3.76% ------ ----------- Total interest bearing liabilities 441,112 $ 16,056 3.64% INTEREST RATE SPREAD 3.60% Demand deposits 66,052 Other liabilities 4,361 Stockholders' equity 62,482 ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 574,007 ========= INTEREST INCOME/ EARNING ASSETS $ 541,117 $ 39,161 7.24% INTEREST EXPENSE/ EARNING ASSETS (541,117) (16,056) (2.97)% ---------- --------- ------- NET YIELD ON EARNING ASSETS -- $ 23,105 4.27% ========= ========= ========The
rate-volume variance analysis set forth in thefollowing tablebelow comparesshows changes in net interest incomeforattributed to changes in rates and changes in average balances of interest-earning assets and interest-bearing liabilities:Table 2 - Rate/Volume Analysis
2005 versus 2004
2004 versus 2003
Due to Changes in
Due to Changes in
In thousands
Volume
Rate
Total
Volume
Rate
Total
INTEREST EARNING ASSETS
Loans
$
2,303
$
1,362
$
3,665
$
2,068
$
(2,160
)
$
(92
)
Taxable securities
(686
)
1,548
862
1,126
(33
)
1,093
Tax-exempt securities
(4
)
3
(1
)
42
(7
)
35
Total Securities
(690
)
1,551
861
1,168
(40
)
1,128
Other
21
(30
)
(9
)
38
(11
)
27
Total
1,634
2,883
4,517
3,274
(2,211
)
1,063
21
2005 versus 2004
2004 versus 2003
Due to Changes in
Due to Changes in
In thousands
Volume
Rate
Total
Volume
Rate
Total
INTEREST BEARING LIABILITIES
Interest bearing demand deposits
$
41
$
61
$
102
$
96
$
(525
)
$
(429
)
Savings deposits
(63
)
868
805
232
(1,103
)
(871
)
Time deposits
253
857
1,110
151
(564
)
(413
)
Short-term borrowings
(40
)
502
462
98
(46
)
52
Long-term borrowings
645
684
1,329
849
50
899
Total
836
2,972
3,808
1,426
(2,188
)
(762
)
Change in Net Interest Income
$
798
$
(89
)
$
709
$
1,848
$
(23
)
$
1,825
The net change attributable to the
periods indicated by theircombination of rate and volumecomponents. Thehas been allocated to the changein interest income/expenseis due tobothvolume andrate has been factoredrate.For yield calculation purposes, non-accruing loans are included in
proportionally. TABLE 2 - ANALYSIS OF CHANGES IN NET INTEREST INCOME
2003 VERSUS 2002 2002 Versus 2001 ----------------------------------------- ----------------------------------------------- DUE TO CHANGES IN Due to Changes in \ IN THOUSANDS VOLUME RATE TOTAL VOLUME RATE TOTAL ------ ---- ----- ------ ---- -----Interest earned on: Loans $ 1,389 $(2,471) $(1,082) $ 613 $(3,753) $(3,140) Taxable investment securities 4,372 (5,037) (665) 4,833 (2,502) 2,331 Non-taxable investment securities 653 (12) 641 149 (25) 124 Federal funds sold -- -- -- (79) (78) (157) Time deposits with banks 56 (55) 1 (457) (68) (525) ---------- -------- -------- --------- ---------- --------- Total Interest Earning Assets 6,470 (7,575) (1,105) 5,059 (6,426) (1,367) -------- -------- -------- -------- -------- -------- Interest paid on: Interest bearing demand deposits 203 (249) (46) 169 (532) (363) Savings deposits 1,092 (747) 345 810 (294) 516 Time deposits (393) (940) (1,333) (2,453) (132) (2,585) Short-term borrowings 1,585 (59) 1,526 444 (615) (171) ------- --------- -------- --------- --------- --------- Total Interest Bearing Liabilities 2,487 (1,995) 492 (1,030) (1,573) (2,603) -------- -------- --------- -------- -------- -------- NET INTEREST EARNINGS $ 3,983 $(5,580) $(1,597) $ 6,089 $(4,853) $ 1,236 ======= ======= ======= ======== ======= =======14PROVISION FOR LOAN LOSSESaverage balances.Provision for Loan Losses
The provision for loan losses charged against earnings was $516,000 in 2005, compared to $300,000 in 2004, and $265,000 in
2003, compared to $370,000 in 2002 and $240,000 in 2001.2003. ACNB adjusts the provision for loan losses periodically as necessary to maintain the allowance at a level deemed to meet the risk characteristics of the loan portfolio.The $130,000, or 54.0%, increase in the provision for loan losses during 2002, compared to 2001, reflects increases in net charge-offs and some growth in the loan portfolio. The 28.4% decrease was indicative of conditions during the major part of 2003, but greater activity at the end of 2003 may cause a larger provision for 2004.See further discussion in the
asset quality“Asset Quality” discussion of this annual report.NON-INTEREST INCOME Non-interestOther Income
Other income was
$9,429,000$8,916,000 for the year ended December 31,2003, an 87.5%2005, a $3,051,000 increaseover 2002. Forfrom 2004. The increase was primarily theyear ended December 31, 2002, non-interest income totaled $5,028,000, an increase of 42.3% over 2001 totals. The 2003 gain in non-interest income is directly attributable to $2,161,000result of insuranceproceedssales due to thedeathacquisition ofan executive officer, $1,992,000Russell Insurance Group in January 2005, which was offset by a decrease of $1,377,000 in securitiesgains realized through sale of securities and $173,000 of gain on the sale ofgain. Excluding insurance revenues, otherreal estate. The insurance proceeds will not recur in 2004, there may be gains on other real estate, but probably notincome totaled $4,795,000 during 2005 assignificant as 2003. If yields can be improved or overall income enhancements achieved, gains will be realized, but with flat or rising interest rates, this may be difficultcompared toaccomplish.$5,865,000 during 2004.Income from fiduciary activities, which includes both institutional and personal trust management services and brokerage service fees,
shrank slightly to $663,000totaled $717,000 for the year ended December 31,2003, down 3% from $683,000 in 2002, which was up 20% from $569,000 in 2001.2005, as compared to $714,000 December 31, 2004, and $663,000 during 2003. At December 31,2003,2005, ACNB had total assets under administration of approximately$64,000,000,$76,000,000, up8%3% compared to$59,000,000$74,000,000 at the end of2002, which was down 14% from $69,000,0002004 and $64,000,000 at the end of2001. The 2001 numbers include assets of approximately $11,000,000 in a non-profit organization bond fund. These funds inflated 2001 totals, but were paid out by the end of 2002. The decrease in income for 2003 came from brokerage fees, while the increase in 2002 resulted from estate management and brokerage fees. Service fees on deposit accounts were $1,788,000 in 2003, a 1.8% increase over 2002's total of $1,755,000. 2002 experienced a larger increase over 2001's results, which were $1,348,000.2003. The increase inboth 2003 and 2002 isincome was the result ofa new service called Overdraft Privilege. The new service allows checking account overdrafts, up to a preset dollar amount, with a fee for every check paid. The largean increasefrom 2001 to 2002 was not repeatedin2003 and probably will not recur in 2004.assets under management.Other
non-interestincome was$1,930,000$1,094,000 for the year ended December 31,2003,2005, an increase of$30,000 or 1.5%, over 2002's amount$232,000 as compared to income of$1,900,000. Earnings on bank-owned life insurance (BOLI) was up $150,000. Non-interest$862,000 during 2004. Other incomefor 2002 was up 59.6%, but various other categories were down. Income was enhancedduring2002 by an2003 totaled $1,497,000. The major factor in the increase inBOLI of $151,000,2005 as compared to 2004 was a$60,000 litigation fee andgain onpublic accounting servicessale of$14,000. BOLI is usedbank real estate of $220,000 during 2005.The decrease in other income from 2003 to
fund various employee benefit plans,2004 was caused by a decline in gains on loan sales from $337,000 during 2003 to $114,000 during 2004 andall employees affected are awarea gain on sale oftheir insured status. NON-INTEREST EXPENSEbank real estate of $173,000 during 2003.22
Other Expenses
The largest component of
non-interest expenseother expenses is salaries and employee benefits, which increased$448,000,$3,000,000, or4.7%30.4%, to$9,902,000$12,884,000 in2003,2005, afterincreasingdecreasing by$1,512,000,$18,000, or19.0%0.2%, in2002. The2004. 70% or $2,108,000 of the increase insalariessalary and employee benefitsduring 2003 is attributablewas the result of the purchase of Russell Insurance Group. The following factors also contributed tothe following factors: ogrowth in 2005, 2004 and 2003.•Purchase of Russell Insurance Group (2005 Factor only);
•Normal merit increases to employees;
o•Increases in administrative personnel expense as the
bank'sbank’s strategic direction continues to focus on greater growth; and,o•Increases in employee benefit costs, particularly health and welfare benefit plans, consistent with the rising health care cost trend noted nationwide and increased net periodic pension costs
dueneeded tothe underperformance of investments inadequately fund the pension plan.Net occupancy expense was
$1,164,000$1,510,000 in 2005, $952,000 in 2004, and $933,000 in 2003,$829,000and furniture and equipment expense totaled $2,395,000 during 2005 as compared to $2,131,000 during 2004, and $1,960,000 during 2003. The majority of the increase in2002, and $701,0002005 was due to the opening of the new operations center. Since the center opened mid-year, there will probably be a similar increase in2001.2006. The40.4% increase experienced in 2003 wasincreases were also the result of additional operational expenses anddepreciationmaintenance associated with the overall bankgrowth. The several branches brought on line in 2001growth and2002 continue to cost more as full year operations are achieved and increase. The 38.9%, or $549,000, increase in furniture and equipment expense during 2003 versus 2002 was the result of increased maintenance costs associated withmore sophisticated delivery channels offered to thebank'sbank’s customer base.Professional
serviceservices expense totaled$339,000$1,147,000 during 2005, as compared to $730,000 during 2004, and $543,000 for 2003. During 2005, Sarbanes-Oxley costs and fees associated with Russell Insurance were the main drivers of growth while fees for theyear ended December 31, 2003, a 25% decrease from 2002 results. The decreaseacquisition of Russell Insurance Group were also included inprofessional services can be attributed2004.Other operating expenses totaled $4,321,000 during 2005, compared to
the following factor: 15o Payments for the rights to$2,967,000 during 2004, andimplementation of Overdraft Privilege, a service the bank has been offering for several years. The payments were completed$2,715,000 in2002. Other non-interest expense totaled $3,696,000 during 2003, versus $3,967,000 in 2002 and $3,220,000 in 2001. Significant expense2003. Expense components in this categoryinclude marketing and advertising, postage, supplies, amortization of core deposit intangibles, and Pennsylvania Shares Tax. The increase in expense noted during 2002 and 2001 wasthat exceed $200,000 are thedirect result of ACNB's overall growth, which requires many of these types of expenses to increase as well. The decrease in 2003 resulted from shifting certain operations to other areasComptroller of thebank. INCOME TAXESCurrency at $202,000 and Russell Insurance Group expenses at $634,000.Income Tax Expense
ACNB recognized income taxes of $1,410,000, or 16.0% of pretax income during 2005, as compared to $2,255,000, or 19.5% during 2004, and $3,142,000, or 22.6% of pre-tax income
induring 2003.Income tax expense was $3,107,000, or 25.9% of pre-tax income, in 2002 and $3,734,000, or 30.9% of pre-tax income, in 2001.The variances from the federal statutory rateof 35%are generally due to tax-exempt income and investments in low-income housing partnerships (which qualify for federal tax credits).The decline in the effective tax rate during
20032005 is a result oflife insurance proceeds upon the death oflower pretax income and anexecutive officer.increase in low income housing credits. The downward trend in the effective tax rate from20012003 to20032005 is consistent with the increase in tax-free investment securities and low income housing credits during this period.At December 31, 2005, net deferred tax assets amounted to $4,428,000. Deferred tax assets are realizable primarily through future reversal of existing taxable temporary differences. Management currently anticipates future earnings will be adequate to utilize the net deferred tax assets.
23
FINANCIAL CONDITION
Average earning assets increased in
20032005 to $862,744,000 or 2.7% or from $840,297,000 in 2004, and $767,597,000or 23% from $622,890,000in2002, and 15% or $541,117,000 in 2001. ACNB's2003. ACNB’s investment portfoliohasincreasedover the last three years,in 2003 and 2004, as a result of planned growth using borrowed funds. To a lesser degree,the slowgrowth in commercial and consumer loans contributed to the increase in average earningassets.assets in 2005. Average funding sources, or interest bearing liabilities, increased in20032005 to $770,802,000 from $741,546,000 in 2004, and $672,581,000from $516,897,000in2002 and $441,112,000 in 2001. INVESTMENT SECURITIES2003.Investment Securities
ACNB uses investment securities to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. The growth in the security portfolio during 2004 and 2003, in part, reflects the trends in loans, deposits, and borrowed
funds during 2003 and 2002.funds. As deposit and borrowing growth outpaced loan growth during2002,2004 and 2003, excess funding was invested in the securities portfolio. Much of the investment activity focused on U.S. Government agencies, tax-free municipal, and corporate securities. These securities provide the appropriate characteristics with respect to yield and maturity relative to the management of the overall balance sheet. In 2005, securities maturities were invested in loans as demand picked up.At December 31,
2003,2005, the securities balance included a net unrealizedgainloss onavailable-for-saleavailable for sale securities of$441,000,$4,725,000, net of taxes, versus a net unrealizedgainloss of$4,089,000,$1,763,000, net of taxes at December 31,2002.2004. Thereductionincrease in interest rates during2002 versus 20012005 led to theappreciationdepreciation in the fair value of securities during2002.2005. The GMAC and Ford Motor Credit bonds discussed below are not considered other-than-temporarily impaired because the temporary impairment is caused by a general increase in interest rates and a rating change. In2003, someaddition, the securitieswere sold;are short term in nature and are profitable as independent entities.The following tables set forth the
corporation realized the gains, increasing income for that year. A total of $1,992,000 in realized gains increased net income by $1,295,000. A major portion of these gains were the by-productcomposition of thesalesecurities portfolio and the securities maturity schedule, including weighted average yield, as ofcertain corporate securities which increased our income and decreased our mortgage backed security prepayments. 16TABLEthe dates indicated:Table 3 -
INVESTMENT SECURITIESInvestment Securities
In thousands
2005
2004
2003
AVAILABLE FOR SALE SECURITIES AT FAIR VALUE
U.S. Government and agencies
$
156,350
$
157,810
$
39,836
Mortgage-backed securities
117,802
118,000
176,061
State and municipal
22,860
22,928
23,271
Corporate bonds
50,978
82,071
106,401
Stock in other banks
723
574
500
348,713
381,383
346,069
HELD TO MATURITY SECURITIES AT AMORTIZED COST
U.S. Government and agencies
10,000
10,000
15,535
Mortgage-backed securities
8,916
14,206
26,201
State and municipal
249
354
447
19,165
24,560
42,183
$
367,878
$
405,943
$
388,252
24
The
amortized cost and estimated fairCorporation owns two securities of non-investment grade. They are 6.125% GMAC notes due on August 28, 2007 with a par value ofinvestment securities$6,000,000 and a current price at December 31,20032005 of 92.5, and2002, were as follows:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value -------------------------------------------------------------------- 2003 IN THOUSANDS HELD-TO-MATURITY SECURITIESU.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 15,535 $ 1,265 $ -- $ 16,800 Mortgage backed securities 26,201 -- 372 25,829 Obligations of states and political subdivisions 447 -- -- 447 ---------- ---------- ----------- ----------- Total debt securities 42,183 1,265 372 43,076 Restricted equity securities 7,547 -- -- 7,547 ---------- ---------- ----------- ----------- Total Held-to-Maturity Securities $ 49,730 $ 1,265 $ 372 $ 50,623 ========== ========== =========== =========== AVAILABLE-FOR-SALE SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 40,000 $ 32 $ 196 $ 39,836 Mortgage backed securities 176,467 1,180 1,586 176,061 Obligations of states and political subdivisions 22,922 355 6 23,271 Corporate debt 105,500 957 56 106,401 ---------- ---------- ----------- ----------- Total Available-for-Sale Securities $ 344,889 $ 2,524 $ 1,844 $ 345,569 ========= ========== ========== ========= 2002 IN THOUSANDS HELD-TO-MATURITY SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 25,540 $ 2,810 $ -- $ 28,350 Obligations of states and political subdivisions 1,509 15 -- 1,524 Corporate debt 217 2 -- 219 ---------- ---------- ----------- ----------- Total debt securities 27,266 2,827 -- 30,093 Restricted equity securities 4,392 -- -- 4,392 ---------- ---------- ----------- ----------- Total Held-to-Maturity Securities $ 31,658 $ 2,827 $ -- $ 34,485 ========== ========== =========== ========== AVAILABLE-FOR-SALE SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies 31,621 807 -- 32,428 Mortgage-backed securities 180,696 4,197 -- 184,893 Corporate debt 63,782 1,286 -- 65,068 ---------- ---------- ----------- ----------- Total Available-for-Sale Securities $ 276,099 $ 6,290 $ -- $ 282,389 ========== ========== =========== ========= 2001 IN THOUSANDS HELD-TO-MATURITY SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 40,744 $ 1,644 $ -- $ 42,388 Obligations of states and political subdivisions 2,123 11 8 2,126 Corporate debt 1,957 17 -- 1,974 ---------- ---------- ----------- ----------- Total debt securities 44,824 1,672 8 46,488 Restricted equity securities 3,656 -- -- 3,656 ---------- ---------- ----------- ----------- Total Held-to-Maturity Securities $ 48,480 $ 1,672 $ 8 $ 50,144 ========== ========== =========== ========== AVAILABLE-FOR-SALE SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies 72,429 775 606 72,598 Mortgage-backed securities 101,416 1,588 585 102,419 ---------- ---------- ----------- ---------- Total Available-for-Sale Securities $ 173,845 $ 2,363 $ 1,191 $ 175,017 ========== ========== =========== ==========17The amortized cost and estimated fairFord Motor Credit 6.5% notes due on January 25, 2007 with a par value ofdebt securities$6,200,000 and a current price at December 31,2003, by contractual2005 of 96.5. The troubles of General Motors and Ford Motor have also caused their captive finance company ratings to be affected and they are now traded in the junk bond sector. As of this writing, GMAC is for sale and success in this endeavor would probably improve their credit rating and their price. Ford Motor Credit is due within eleven months and sells at a price close to par. Management intends to hold these securities to maturityare shown below. Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.
Held-to-Maturity Available-for-Sale --------------------------------- ------------------------------- AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE -------------- ---------- -------------- ----------IN THOUSANDS Within one year $ 93 $ 93 $ 46,831 $ 47,274 After one year through five years 41,555 42,448 192,849 192,680 After five years through ten years 535 535 59,868 59,882 After ten years -- -- 45,341 45,733 ---------- ---------- --------- --------- Total Debt Securities $ 42,183 $ 43,076 $ 344,889 $ 345,569 ========== ========== ========= =========
TABLE 4 - INVESTMENT SECURITIES (YIELDS) U.S. Government StateandFederal and Other Taxable Agency Municipal Securities Total Equivalent Yield ------------------------------------------------------------------------------------------------- DECEMBER 31, 2003 IN THOUSANDSAmortized Cost Within one year $ -- $ 93 $ 46,831 $ 46,924 3.50% After one year through five years 175,381 354 58,669 234,404 3.53% After five years through ten years 51,770 8,633 -- 60,403 4.63% After ten years 31,052 14,289 -- 45,341 5.56% No set maturity -- -- 7,547 7,547 1.60% --------- ---------- --------- --------- Total $ 258,203 $ 23,369 $ 113,047 $ 394,619 ========= =========== ========= ========= Fair Value $ 258,526 $ 23,718 $ 113,948 $ 396,192 ========= =========== ========= ========= Taxable Equivalent Yield 3.75% 6.09% 2.88% DECEMBER 31, 2002 IN THOUSANDS Amortized Cost $ 227,737 $ 11,846 $ 68,174 $ 307,757 ========= =========== ========== ========= DECEMBER 31, 2001 IN THOUSANDS Amortized Cost $ 214,589 $ 2,123 $ 5,613 $ 222,325 ========= ============ ========= =========The weighted average yield of tax-exempt obligations has been calculated on a taxable equivalent basis. The taxable equivalent adjustments are based on an effective tax rate of 35%. The yield informationdoes notgive effectconsider their impairment in value tochanges in fair value that are reflectedbe other-than-temporary as acomponent of stockholders' equity. At December 31, 2003 and 2002, assets with a carrying value of $130,424,000 and $92,123,000, respectively, were pledged as required or permitted by law to secure certain public and trust deposits, repurchase agreements, or for other purposes. LOANSresult.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
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
U.S. Government and agencies
$
—
—
%
$
55,000
3.65
%
$
103,912
4.06
%
$
10,000
4.0
%
$
168,912
3.92
%
Mortgage-backed securities
—
—
70,840
3.64
—
—
58,927
4.71
129,767
4.13
State and municipal
—
—
249
3.68
22,087
3.95
822
4.35
23,158
3.96
Corporate bonds
—
—
52,812
3.73
—
—
—
—
52,812
3.73
Stock in other banks
—
—
—
—
—
—
500
2.5
500
2.5
$
—
—
%
$
178,901
3.66
%
$
125,999
4.04
%
$
70,249
4.59
%
$
375,149
3.96
%
Securities are at amortized cost. Mortgage-backed securities are allocated based upon scheduled maturities.
Loans
Loans outstanding increased
$42,723,000,$52,893,000, or11.5%12.0% in2003,2005, compared to3.0%6.1% growth experienced in2002.2004. The growth in loans is consistent with a stable local economy and lending to support existing customers. The commercial loan portfolio experienced solid growth duringthe period,2005, increasing by approximately$17,000,000.$5,396,000 in commercial loans, $3,513,000 in commercial real estate loans, and $11,675,000 in construction loans. The commercial loan growth experienced in20032005 is the result of actively marketingcommercial loansto local businesses. Additionally, ACNB has been able to participate with other institutions on larger loans.The approximately $15,000,000 increase in real estate mortgage loans is due to a change in pricing policy. Management decided that since 15-year mortgage backed securities were offering yields in the mid 3% range, the bank could afford to hold a certain portion of 10-year to 20-year fixed rate mortgages yielding 5.50% to 6.00% in the portfolio. Currently this portion of mortgages totals approximately $20,000,000. 18TABLETable 5 -
LOAN PORTFOLIOLoan PortfolioLoans at December 31
are summarizedwere as follows:
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSCommercial, financial and agricultural $ 18,080 $ 21,128 $ 18,027 $ 18,376 $ 12,697 Real estate - construction 22,298 16,096 15,497 15,786 13,188 Real estate - mortgage 363,515 326,180 316,928 314,385 308,241 Consumer 11,222 11,446 12,127 12,443 13,661 --------- ---------- ---------- ---------- ---------- Total Loans $415,115 $374,850 $362,579 $360,990 $347,787 ======== ======== ======== ======== ========TABLE 6 - LOAN MATURITY AND INTEREST SENSITIVITY
In thousands
2005
2004
2003
2002
2001
Commercial, financial and agricultural
$
36,583
$
31,187
$
18,080
$
21,128
$
18,027
Real estate:
Commercial
103,501
99,988
100,536
90,967
83,067
Construction
31,907
20,232
22,298
16,096
15,497
Residential
311,865
278,519
262,893
232,669
232,821
Installment
9,608
10,643
11,222
11,446
12,127
Total Loans
$
493,464
$
440,569
$
415,029
$
372,306
$
361,539
25
The
following table outlines the repricing opportunities for all loans outstanding as of December 31, 2003. Loans with immediately adjustable rates, such as loans tied to prime rate, are included in the within one year column. Loans with rates that are adjustable at some time over the lifematurity range of the loan portfolio and the amounts of loans with predetermined and fixed rates areincluded underpresented in thetime heading when they become adjustable. All fixed-ratetable below:Table 6 - Loan Maturities and Sensitivities
In thousands
Less than 1
Year
1-5 Years
Over 5
Years
Total
Commercial, financial and agricultural
$
16,325
$
16,992
$
3,266
$
36,583
Real estate:
Commercial
32,772
58,081
12,648
103,501
Construction
19,773
7,610
4,524
31,907
Total
$
68,870
$
82,683
$
20,438
$
171,991
Loans with a fixed interest rate
$
3,068
$
6,979
$
10,907
$
20,954
Loans with a variable interest rate
65,802
75,704
9,531
151,037
Total
$
68,870
$
82,683
$
20,438
$
171,991
Most of the Corporation’s activities are with customers located within the south central Pennsylvania and northern Maryland region of the country. The Corporation does not have any significant concentrations greater than 10% of loans
are included under the heading in which they mature.to any one industry or customer.
REPRICING PERIOD ------------------------------------------------------- AFTER ONE YEAR WITHIN THROUGH AFTER ONE YEAR FIVE YEARS FIVE YEARS TOTAL -------- ---------- ---------- ----- IN THOUSANDSCommercial, financial and agricultural $ 8,973 $ 5,688 $3,419 $ 18,080 Real estate - construction 13,144 8,882 272 22,298 -------- -------- ------ -------- Total $ 22,117 $ 14,570 $3,691 $ 40,378 ======== ======== ====== ======== Fixed loans with predetermined interest rates $ 5,167 $ 9,457 $3,664 $ 18,288 Loans with variable interest rates 16,950 5,113 27 22,090 -------- -------- ------ -------- Total $ 22,117 $ 14,570 $3,691 $ 40,378 ======== ======== ====== ========ASSET QUALITY
ACNB loan portfolios are subject to varying degrees of credit risk. Credit risk is mitigated through prudent underwriting standards, on-going 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'sACNB’s credit risk.ACNB'sACNB’s commercial, consumer and residential mortgage loans are principally to borrowers in south central Pennsylvania and northern Maryland. As the majority of
ACNB'sACNB’s loans are located in this area, a substantial portion of thedebtor'sdebtor’s ability to honor their obligations may be affected by the level of economic activity in the market area.The unemployment rate in
ACNB'sACNB’s market area remained below the national average during2003.2005. Additionally, reasonably low interest rates, a stable local economy and minimal inflation continued to support favorable economic conditions in the area.Nonperforming assets include nonaccrual and restructured loans, accruing loans past due 90 days or more and other foreclosed assets.
ACNB'sACNB’s general policy has been to cease accruing interest on loans when management determines that a reasonable doubt exists as to the collectibility of additional interest. When management places a loan on non-accrual status, it reverses unpaid interest credited to income in the current year. ACNB recognizes income on these loans only to the extent that it receives cash payments. 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 restructured 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 originally.19TABLE 7 - NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS26
The following table
presents information concerningsets forth theaggregate amount of nonperformingCorporation’s non-performing assets as ofDecember 31:the dates indicated:
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSNonaccrual loans $ 4,413 $ 1,037 $ 837 $ 1,318 $ 1,615 90 days past due still accruing 606 1,379 1,003 1,528 1,920 ------- -------- -------- -------- -------- Nonperforming loans 5,019 2,416 1,840 2,846 3,535 Other real estate 561 559 1,646 981 171 ------- ------- ------- ------- ------- Total Nonperforming Assets $ 5,580 $ 2,975 $ 3,486 $ 3,827 $ 3,706 ======= ======= ======= ======= =======Table 7 - Non-Performing Assets
Dollars in Thousands
2005
2004
2003
2002
2001
Non-accrual loans
$
7,354
$
8,054
$
4,413
$
1,037
$
837
Accruing loans 90 days past due
199
160
606
1,379
1,003
Total Non-Performing Loans
7,553
8,214
5,019
2,416
1,840
Foreclosed real estate
—
213
394
559
1,646
Total Non-Performing Assets
$
7,553
$
8,427
$
5,413
$
2,975
$
3,486
Ratios:
Non-performing loans to total loans
1.40
%
1.86
%
1.21
%
0.65
%
0.51
%
Non-performing assets to total assets
0.73
%
0.91
%
0.62
%
0.40
%
0.55
%
Allowance for loan losses to non- performing loans
64.36
%
47.94
%
79.26
%
158.82
%
202.34
%
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 $501,000 in 2005, $384,000 in 2004, and $82,000 in
2003, $55,000 in 2002, and $99,000 in 2001. The corporation does not accrue interest on any loan when principal or interest is in default for 90 days or more, unless the loan is well secured and in the process of collection. Consumer2003.Impaired loans
and residential real estate loans secured by 1-to-4 family dwellings shall ordinarily not be subject to these guidelines. When a loan is placed in a nonaccrual status, all previously accrued, but uncollected, interest is charged against the interest income account.
YEAR ENDED DECEMBER 31 ---------------------------------------------------------------------------------------------------- 2003 2002 2001 --------------------------------- ----------------------------- ---------------------------- NONPERFORMING NET NONPERFORMING NET NONPERFORMING NET LOANS CHARGE-OFFS LOANS CHARGE-OFFS LOANS CHARGE-OFFS IN THOUSANDSReal estate loans (1-to-4 family dwellings) $ 512 $ 25 $ 987 $ -- $ 1,341 $ 31 Real estate loans (other) 4,505 -- 1,370 170 462 97 Commercial and industrial -- 84 37 60 11 (10) Consumer 2 15 22 26 26 94 ------- ------- ------- ------- ------- ------- TOTAL $ 5,019 $ 124 $ 2,416 $ 256 $ 1,840 $ 212 ======= ======= ======= ======= ======= =======As ofat December 31,2003, nonperforming loans2005 and 2004 totaled$5,019,000, an increase of $2,603,000 or 107.7% from December 31, 2002.$3,419,000 and $7,539,000, respectively. Theincrease in nonperforming loans is primarily the result of a large credit that was moved into nonaccrual status during 2003. Therelated allowance for loanis fully secured by real estatelosses totaled $698,000 andpaying erratically. Although nonperforming loans increased, these levels are within acceptable limits and are generally secured by real estate which facilitates collection activity and keeps ultimate losses within reasonable totals.$619,000, respectively.Potential problem loans are defined as performing loans that have characteristics that cause management to have
seriousdoubts 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 nonperforming loans in the future. Total potential problem loans approximated$4.0$29 million at December 31,2003.2005. $17,567,000 were classified as other assets especially mentioned and $11,562,000 were classified substandard. The majority of these loans are secured by real estate with acceptable loan-to-value ratios.ALLOWANCE FOR LOAN LOSSESAllowance for Loan Losses
ACNB maintains the allowance for loan losses at a level believed adequate by management to absorb potential losses in the loan portfolio and is established through a provision for loan losses charged to earnings.
Quarterly,On a quarterly basis, thecorporationCorporation utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan loss historical experience, and qualitative factors. This methodology, which has remained consistent for the past several years, results in an allowance consisting of two components,"allocated"“allocated” and"unallocated"“unallocated”.Management assigns internal risk ratings for each significant commercial lending relationship. Utilizing migration analysis for the previous eight quarters, management develops a loss factor test, which it then uses to estimate losses for non-rated and non-classified loans. When management finds loans with uncertain collectibility of principal and interest, it places those loans on the
"problem list",“problem list,” and evaluates a specific reserve on a quarterly basis in order to estimate potential losses.Management'sManagement’s analysis considers:o•adverse situations that may affect the
borrower'sborrower’s ability to repay;o•estimated value of underlying collateral; and
o•prevailing market conditions.
2027
If management determines that a specific reserve allocation is not required, it 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:
o•trends in delinquency levels;
o•trends in non-performing and potential problem loans;
o•trends in composition, volume and terms of loans;
o•effects in changes in lending policies or underwriting procedures;
o•experience, ability and depth of management;
o•national and local economic conditions;
o•concentrations in lending activities; and
o•other factors that management may deem appropriate.
Management determines the unallocated portion of the allowance for loan losses based on the following criteria:
o•risk of error in the specific and general reserve allocations;
o•other potential exposure in the loan portfolio;
o•variances in
management'smanagement’s assessment of national and local economic conditions; ando•other internal or external factors that management believes appropriate at that time.
Management believes the above methodology accurately reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology discussed above, which reduces the difference between actual losses and estimated losses.
Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the methodology discussed above.
21
TABLE 8 - SUMMARY OF LOAN LOSS EXPERIENCE 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSBalance of allowance for loan losses at beginning of period $ 3,837 $ 3,723 $ 3,695 $ 3,543 $ 3,594 Loans charged-off: Commercial, financial and agricultural 90 87 39 11 58 Real estate - construction -- -- -- -- -- Real estate - mortgage 32 192 131 42 128 Consumer 47 57 139 84 204 --------- --------- --------- --------- --------- Total loans charged-off 169 336 309 137 390 Recovery of charged-off loans: Commercial, financial and agricultural 6 27 49 5 5 Real estate - construction -- -- -- -- -- Real estate - mortgage 7 22 3 2 35 Consumer 32 31 45 42 46 --------- --------- --------- --------- --------- Total recoveries 45 80 97 49 86 Net loans charged-off 124 256 212 88 304 Provision for possible loan losses 265 370 240 240 253 --------- --------- --------- --------- --------- Balance at end of period $ 3,978 $ 3,837 $ 3,723 $ 3,695 $ 3,543 ========= ========= ========= ========= ========= TOTAL LOAN BALANCES IN THOUSANDS - ------------------------------------------------------------------------------------------------------------------------------ Average total loans $ 388,842 $ 367,494 $ 359,404 $ 352,666 $ 344,323 Total loans at year-end 415,115 374,850 362,579 360,990 347,787 RATIOS - ------------------------------------------------------------------------------------------------------------------------------ Net charge-offs to: Average total loans 0.03% 0.07% 0.06% 0.02% 0.09% Total loans at year-end 0.03% 0.07% 0.06% 0.02% 0.09% Allowance for loan losses 3.14% 6.67% 5.69% 2.38% 8.58% Allowance for loan losses to: Average total loans 1.02% 1.04% 1.04% 1.05% 1.03% Total loans at year-end .96% 1.02% 1.03% 1.02% 1.02%28
The following tables set forth information on the analysis of the allowance for loan losses
increased $141,000 from $3,837,000 at December 31, 2002, to $3,978,000 at December 31, 2003. Theand the allocation of the allowancerepresents .96% of loans outstanding at December 31, 2003, versus 1.02%for loan losses as of theprior year-end. Net charge-offs were $124,000dates indicated:Table 8 - Analysis of Allowance for Loan Losses
Years Ended December 31,
Dollars in thousands
2005
2004
2003
2002
2001
Beginning balance
$
3,938
$
3,978
$
3,837
$
3,723
$
3,695
Provision for loan losses
516
300
265
370
240
Loans charged off:
Commercial, financial and agricultural
41
316
90
87
39
Real estate
4
31
32
192
131
Consumer
42
43
47
57
139
Total Charged-off
87
390
169
336
309
Recoveries:
Commercial, financial and agricultural
22
8
6
27
49
Real estate
54
—
7
22
3
Consumer
13
42
32
31
45
Total Recoveries
89
50
45
80
97
Net charge-offs (revenues)
(2
)
340
124
256
212
Ending balance
$
4,456
$
3,938
$
3,978
$
3,837
$
3,723
Ratios:
Net charge-offs to average loans
—
%
0.08
%
0.03
%
0.07
%
0.06
%
Allowance for loan losses to total loans
0.9
%
0.89
%
0.96
%
1.02
%
1.03
%
Table 9 - Allocation of the
year ended December 31, 2003, versus $256,000 in 2002, a decrease of 51.6%. Charge-offsAllowance for2004 will most likely total between $200,000 and $300,000. 22Loan Losses
TABLE 9 - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES 2003 2002 2001 2000 1999 ------------------ ----------------- ------------------ ------------------ --------------- % OF % OF % OF % OF % OF GROSS GROSS GROSS GROSS GROSS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS ------ ------ ------- ------ ------ ------ ------ ------ ------ ------IN THOUSANDS Commercial, financial and $ 2,571 0.62% $ 2,582 0.68% $ 2,633 0.73% $ 2,590 0.72% $ 1,042 0.30% Agricultural Real estate - construction 105 0.03% 65 0.02% 122 0.03% 205 0.05% 246 0.07% Real estate - mortgage 579 0.14% 402 0.11% 533 0.15% 495 0.13% 1,474 0.43% Consumer 504 0.12% 375 0.10% 360 0.10% 132 0.04% 251 0.07% Unallocated 219 0.05% 413 0.11% 75 0.02% 273 0.08% 530 0.15% ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Total $ 3,978 0.96% $ 3,837 1.02% $ 3,723 1.03% $ 3,695 1.02% $ 3,543 1.02% ======= ===== ======= ===== ======= ===== ======= ===== ======= =====
2005
2004
2003
2002
2001
Dollars in thousands
Amount
Percent
of Loan Type to Total Loans
Amount
Percent
of Loan Type to Total Loans
Amount
Percent
of Loan Type to Total Loans
Amount
Percent
of Loan Type to Total Loans
Amount
Percent
of Loan Type to Total Loans
Commercial, financial and agricultural
$
539
7.4
%
$
941
7.1
%
$
875
4.4
%
$
930
5.6
%
$
937
5.0
%
Real estate:
Commercial
1,760
21.0
1,288
22.7
1,388
24.2
1,394
24.3
1,543
22.9
Construction
735
6.5
248
4.6
308
5.4
258
4.3
275
4.3
Residential
592
63.2
674
63.2
684
63.3
467
62.7
533
64.5
Consumer
369
1.9
420
2.4
504
2.7
375
3.1
360
3.3
Unallocated
461
N/A
367
N/A
219
N/A
413
N/A
75
N/A
Total
$
4,456
100.00
%
$
3,938
100.00
%
$
3,978
100.00
%
$
3,837
100.00
%
$
3,723
100.00
%
29
The allocation of the allowance for loan losses between the various loan portfolios has changed over the past few years, consistent with the historical net loss experience in each of the portfolios.
The largest reserve allocation is to the commercial, financial and agricultural loan portfolio, which represents approximately 65% of the reserve balance. This is because of specific allocations to the reserve for troubled credits and continued loan growth in that category. Nonperforming loans have increased during the year, this was primarily the result of one large credit. Absent this credit, the overall credit rating of the commercial portfolio would have been approximately the same as 2002. This nonhomogeneous loan portfolio continues to represent the greatest risk exposure to ACNB, as the credits generally are significantly larger than the remainder of the portfolio and the related collateral is not as marketable. Over the past several years, the allowance for loan losses as a percent of outstanding loan balance has remained steady at approximately 1.00%.The unallocated portion of the allowance reflects estimated inherent losses within the portfolio that have not been detected. The unallocated portion of the reserve exists due to risk of error in the specific and general reserve allocations, other potential exposure in the loan portfolio, variances inmanagement'smanagement’s assessment of national and local economic conditions, and other internal and external factors that management believes appropriate at the time. The unallocated portion of the reserve hasdecreasedincreased due to variances inmanagement'smanagement’s assessment of national and local economic conditions as may be affected by the current political environment and other external factors.While management believes
ACNB'sACNB’s allowance for loan losses is adequate based on information currently available, future adjustments to the reserve may be necessary due to changes in economic conditions, andmanagement'smanagement’s assumptions as to future delinquencies or loss rates.DEPOSITSPremises and Equipment
The increase in premises and equipment from $11,992,000 at December 31, 2004 to $14,696,000 at December 31, 2005 is primarily related to the Corporation’s new Operations Center, which was occupied in May 2005. The total cost of the operations center was $7,887,000 of which $5,316,000 was in construction in process at December 31, 2004.
Deposits
ACNB continues to rely on deposit growth as the primary source of funds for lending activities. Average deposits increased
18.2%1.8% or$85$12.0 millionin 2003. This increase is greater than the 15.1%during 2005 compared to 5.6% during 2004. The 2005 growthachieved in 2002. This growth has beenwas accomplished primarily through the marketing of a special money market rate account to compete with money market mutual funds. Additionally,due to consumers' confidence slipping in the stock and mutual fund markets,deposits have grown astheseconsumersmigratehave migrated towards deposit products, which are generally regarded as safer, more liquidinvestments.investments as compared to the stock market. ACNB will continue to explore new products for its customers, to attract and retain other funds seeking safe havens.As the stock market recovers in the months ahead, ACNB'sHowever, ACNB’s ability to maintain and add to its deposit basewill probably come undermay experience additional competitivepressures. 23TABLEpressures from the stock market and/or other alternative investment products offered by the insurance industry and others.Table 10 -
TIME DEPOSITSTimedeposits in denominations of $100,000 or more at December 31, 2003, 2002 and 2001, are summarized in the following table. The interest expense related to time certificates of deposit in denominations of $100,000 or more totaled $1,153,000 in 2003, $1,275,000 in 2002, and $1,583,000 in 2001. IN THOUSANDS 2003 2002 2001 ---- ---- ---- Time certificates of deposit $ 35,003 $ 33,657 $ 33,746 Other time deposits 1,000 1,000 1,000DepositsMaturities of time deposits of $100,000 or more outstanding at December 31,
2003, 2002 and 2001,2005 are summarized as follows:IN THOUSANDS 2003 2002 2001 ---- ---- ---- Three months or less $ 7,420 $ 7,432 $ 12,049 Over three through six months 3,245 6,560 9,898 Over six through twelve months 4,928 5,007 5,974 Over twelve months 20,410 15,658 6,825 -------- -------- -------- Total $ 36,003 $ 34,657 $ 34,746 ======== ======== ======== BORROWINGS
In thousands
Three months or less
$
8,588
Over three through six months
5,082
Over six through twelve months
8,011
Over twelve months
24,347
Total
$
46,028
30
Borrowings
Short-term borrowings are comprised primarily of securities sold under agreements to repurchase, and overnight borrowings at the Federal Home Loan Bank in
Pittsburgh.Pittsburgh (FHLB). As of December 31,2003,2005, short-term borrowings were$69,676,000, an increase$59,307,000, a decrease of$13,231,000,$5,659,000, or23.4%8.7%, from the December 31,20022004 balance of$56,445,000.$64,966,000.
In thousands
2005
2004
2003
Amounts outstanding at end of year:
FHLB overnight advance
$
34,965
$
30,706
$
29,320
Securities sold under repurchase agreements
23,892
33,810
39,906
Treasury tax and loan note
450
450
450
$
59,307
$
64,966
$
69,676
In thousands
2005
2004
2003
Average interest rate at year-end
3.52
%
1.84
%
1.37
%
Maximum amount outstanding at any month-end
$
70,793
$
79,589
$
75,867
Average amount outstanding
48,976
$
51,437
$
45,290
Weighted average interest rate
2.56
%
1.54
%
1.64
%
Long-term debt consists of advances from the Federal Home Loan Bank to fund
ACNB'sACNB’s growth in itssecurities portfolio.earning asset portfolio and a loan from a commercial bank to fund the purchase of Russell Insurance Group. Long-term debt totaled$87,000,000$125,778,000 at December 31,2003,2005, versus$20,000,000 outstanding$132,000,000 at December 31,2002. ACNB increased its reliance on long-term debt during 2002 to match maturities with long-term tax-free securities at positive spreads. The increase of $67,000,000 in long-term debt during 2003 was a direct result of management's intention to capitalize on the 30 year lows in interest rates. CAPITAL2004.Capital
The management of capital in a regulated financial services industry must properly balance return on equity to stockholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Capital management must also consider growth opportunities that may exist, and the resulting need for additional capital.
ACNB'sACNB’s capital management strategies have been developed to provide attractive rates of returns to stockholders, while maintaining its"well-capitalized"“well-capitalized” position.The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During
2003,2005, ACNB retained$5,930,000,$2,429,000 or55%,33% of its netincome.income as compared to $4,416,000, or 47% in 2004, and $5,930,000 or 55% during 2003.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 their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components,
risk weightings,risk-weightings, and other factors.Quantitative measures established by regulation to ensure capital adequacy requires ACNB to maintain minimum amounts and ratios of total and Tier 1 capital to average assets. Management believes, as of December 31,
20032005 and2002,2004, thatACNBACNB’s banking subsidiary met all minimum capital adequacy requirements to which they are subject and are categorized as"well-capitalized".“well-capitalized.” There are no conditions or events since the notification that management believes have changed the subsidiarybank'sbank’s category.24TABLE31
Table 11 -
RISKED-BASED CAPITAL ACNB'sRisked-Based CapitalACNB’s capital ratios are as follows:
2003 2002 ---- ---- Common stockholders' equity to assets 8.29% 9.54% Tier 1 leverage ratio 8.81% 9.00% Tier 1 risk-based capital ratio 13.86% 15.13% Total risk-based capital ratio 14.63% 16.03% LIQUIDITY
2005
2004
Tier 1 leverage ratio (to average assets)
7.81
8.34
Tier 1 risk-based capital ratio (to risk-weighted assets)
13.14
13.91
Total risk-based capital ratio
13.94
14.64
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'sACNB’s funds are available from a variety of sources, including assets that are readily convertible to such as cash
(federaland federal funds sold,short-term investments),maturities and repayments from the securities portfolio, scheduled repayments of loans receivable, the core deposit base, and the ability to borrow from the FHLB. At December 31,2003,2005, ACNB could borrow approximately$365,000,000$442,272,000 from theFHLB; $116,320,000FHLB of which $287,307,000 wasoutstanding.available.Another source of liquidity is securities sold under repurchase agreement to customers of ACNB’s banking subsidiary totaling $23,892,000 and $33,810,000 at December 31, 2005 and 2004, respectively.
The liquidity of the parent company also represents an important aspect of liquidity management. The parent
company'scompany’s cash outflows consist principally of dividends toshareholdersstockholders and corporate expenses. The main source of funding for the parent company is the dividends it receives from its banking subsidiary. Federal and state banking regulations place certain restrictions on dividends paid to the parent company from the subsidiary banks. The total amount of dividends that may be paid from the subsidiary bank to ACNB were$8,568,000$7,538,000 at December 31,2003.2005. For a discussion ofACNB'sACNB’s dividend restrictions, see Item 1 -- "Business" above.“Business.”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. The Corporation’s operating cash flows totaled $11,392,000 during 2005 as compared to $11,034,000 during 2004, and $12,742,000 during 2003. The primary sources of cash flows are payments received for interest and dividends, partially offset by payments for interest on deposits and borrowings and payments for other expenses. See the cash flows statement for additional information.
Aggregate Contractual Obligations
The following table represents the Corporation’s on and off-balance sheet aggregate contractual obligations to make future payments as of December 31, 2005:
In thousands
Less than
1 Year
1 - 3
Years
4 - 5
Years
Over 5
Years
Total
Time deposits
$
134,265
$
79,375
$
31,241
$
—
$
244,881
Long-term debt
55,258
45,569
649
24,302
125,778
Operating leases
412
543
401
693
2,049
Payments under benefit plans
756
1,552
1,872
9,244
13,424
Total
$
190,691
$
127,039
$
34,163
$
34,239
$
386,132
In addition, the Corporation in the conduct of business operations routinely enters into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contracts.
32
Management
expectsis not aware of any other commitments or contingent liabilities which may have a material adverse impact on the liquidity or capital resources of the Corporation.Off-Balance Sheet Arrangements
The Corporation is party to
incur approximately $10,000,000financial instruments with off-balance sheet risk incapital expenditures during 2004-2005, approximately $7,000,000the 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, 2005, the Corporation had unfunded outstanding commitments to extend credit of $117 million and outstanding standby letters of credit of $5,961,000. 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. Refer to footnote N of the consolidated financial statements for aproposed operations centerdiscussion of the nature, business purpose and$3,000,000 for low income housing projects. See footnote N for other off balanceimportance of the Corporation’s off-balance sheetcommitments. The following tables illustrate contractual obligations for years 2003, 2002 and 2001.
PAYMENT DUE BY PERIOD (12/31/2003) ---------------------------------------------------------------------------- LESS THAN 1-3 3-5 MORE THAN TOTAL 1 YEAR YEARS YEARS 5 YEARS ----- --------- ----- ----- ---------IN THOUSANDS Contractual Obligations Long-Term Debt Obligations $ 87,000 $ -- $ 67,000 $ -- $ 20,000 Operating Lease Obligations 1,600 437 709 276 178 Total $ 88,600 $ 437 $ 67,709 $ 276 $ 20,178 PAYMENT DUE BY PERIOD (12/31/2002) ---------------------------------------------------------------------------- LESS THAN 1-3 3-5 MORE THAN TOTAL 1 YEAR YEARS YEARS 5 YEARS ----- --------- ----- ----- --------- IN THOUSANDS Contractual Obligations Long-Term Debt Obligations $ 20,000 $ -- $ -- $ -- $ 20,000 Operating Lease Obligations 993 184 321 175 313 Total $ 20,993 $ 184 $ 321 $ 175 $ 20,313 PAYMENT DUE BY PERIOD (12/31/2001) ---------------------------------------------------------------------------- LESS THAN 1-3 3-5 MORE THAN TOTAL 1 YEAR YEARS YEARS 5 YEARS ----- --------- ----- ----- --------- IN THOUSANDS Contractual Obligations Long-Term Debt Obligations $ -- $ -- $ -- $ -- $ -- Operating Lease Obligations 857 134 217 193 313 Total $ 857 $ 134 $ 217 $ 193 $ 31325TABLE 12 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKarrangements.
Principal Amount Maturing In FAIR VALUE ---------------------------------------------------------------------- DECEMBER 31, RATE SENSITIVE ASSETS IN THOUSANDS 2004 2005 2006 2007 2008 Thereafter TOTAL 2003 - ---------------------------------------------------------------------------------------------------------------------------Fixed interest rate loans $ 35,478 $ 37,535 $30,704 $13,621 $ 3,643 $ 1,107 $ 122,088 $ 122,091 Average interest rate 6.35% 6.20% 6.10% 6.08% 6.09% 5.69% 6.15% Variable interest rate loans $215,990 $ 55,043 $ 9,566 $10,396 $ 1,794 $ 152 $ 292,941 $ 293,190 Average interest rate 4.95% 5.83% 6.52% 5.99% 6.09% 7.13% 5.21% Fixed interest rate securities $178,410 $107,275 $42,484 $10,447 $ -- $55,556 $ 394,172 $ 395,745 Average interest rate 3.82% 3.43% 2.29% 6.03% 3.61% 3.58% Variable interest rate securities $ 93 $ 105 $ 118 $ 131 $ -- $ -- $ 447 $ 447 Average interest rate 2.98% 2.98% 2.98% 2.98% 0.00% 0.00% 2.98% Other interest bearing assets $ 1,033 $ -- $ -- $ -- $ -- $ -- $ 1,033 $ 1,033 Average interest rate 1.00% 0.00% 0.00% 0.00% 0.00% 0.00% 1.00% RATE SENSITIVE LIABILITIES - --------------------------------------------------------------------------------------------------------------------------- Non-interest bearing checking $ -- $ -- $ -- $ -- $ -- $75,819 $ 75,819 $ 73,259 Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Savings and interest bearing checking $ 85,360 $ -- $ -- $ -- $ -- $256,080 $ 341,440 $ 318,904 Average interest rate 1.02% 0.00% 0.00% 0.00% 0.00% 1.02% 1.02% Time deposits $118,644 $ 42,980 $25,675 $22,859 $11,971 $ -- $ 222,129 $ 223,459 Average interest rate 1.97% 3.51% 3.83% 3.96% 3.60% 0.00% 2.78% Fixed interest rate borrowings $ -- $ 57,000 $10,000 $ -- $ -- $20,000 $ 87,000 $ 90,648 Average interest rate 0.00% 1.83% 2.32% 0.00% 0.00% 4.34% 2.46% Variable interest rate borrowings $ 39,747 $ -- $ -- $ -- $ -- $29,929 $ 69,676 $ 67,745 Average interest rate 1.27% 0.00% 0.00% 0.00% 0.00% 1.48% 1.36%Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of an organization. These risks involve interest rate risk, foreign currency exchange risk, commodity price risk and equity market price risk.
ACNB'sACNB’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"“purchasing” funds (customer deposits and borrowings) at various terms and rates. These funds are then invested into earning assets (loans, leases, investments, etc.) at various terms and rates. This risk is further discussed below.ACNB does not have any exposure to foreign currency exchange risk, commodity price risk or equity market risk.
INTEREST RATEITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Interest rate risk is the exposure to fluctuations in the
corporation'sCorporation’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest earning assets and interest bearing liabilities that reprice within a specified time period as a result of scheduled maturities and repayment and contractual interest rate changes.The primary objective of the
corporation'sCorporation’s asset/liability management process is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate, and necessary to ensure thecorporation'sCorporation’s profitability. Thus the goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at a tolerable level.Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The bank subsidiary asset/liability committee is responsible for these decisions. The
corporationCorporation primarily uses the securities portfolios and FHLB advances to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives. At present, there is no use ofoff-balance sheethedging instruments.The committee operates under management policies defining guidelines and limits on the level of risk. These policies are approved by the Board of Directors.
33
The
corporationCorporation uses simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of thecorporation'sCorporation’s interest rate risk exposure. These modeling techniques involve assumptions and estimates that inherently cannot be measured with complete precision. Key26assumptions in the analyses include maturity and repricing characteristics of both assets and liabilities, prepayments on amortizing assets, non-maturity deposit sensitivity, and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of the corporation'sCorporation’s interest rate risk position over time.EARNINGS AT RISKEarnings at Risk
Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of the
corporation'sCorporation’s shorter-term interest rate risk. The analysis utilizes a"static"“static” balance sheet approach. The measurement date balance sheet composition (or mix) is maintained over the simulation time period, with maturing and repayment dollars being rolled back into like instruments for new terms at current market rates. Additional assumptions are applied to modify volumes and pricing under the various rate scenarios. These include prepayment assumptions on mortgage assets, the sensitivity of non-maturity deposit rates, and other factors deemed significant.The simulation analysis results are presented in Table 13a. These results as of December 31,
2003,2005, indicate that thecorporationCorporation would expect net interest income toincreasedecrease over the next twelve months by4.4%15.1% assuming an immediate upward shift in market interest rates of 3.00% and todecreaseincrease by17.6%1.9% if rates shifted downwardin the same manner.3.00%. This profile reflectsan asseta liability sensitive short-term rate risk position and exceeds guidelines set by policy.With interest rates already so low, liability rates could not fall 3.00%, so the accuracyHowever, included in this simulation were borrowings ofthe results is not as good as could be expected during$55,000,000 that mature in February, June and July of 2006. The Corporation relies more on cash flow statements and amore normal rate environment. Netdynamic gap report for day to day operations and both indicate an asset sensitive position.The model indicates that net interest income
declines with bothwould decline in an upand down directionsdirection of interest rates because of a large amount of transaction accounts positioned to change rates overnight. Since they are theoretically positioned to change rates immediately they cause a negative change in net interestincome regardless of direction of interest rates.income. In actual practice, management would change these rates much more gradually than the model predicts.Since interest rates areValue at
50-year lows, an asset sensitive position will enable the corporation to capitalize on rising rates. VALUE AT RISKRiskThe net present value analysis provides information on the risk inherent in the balance sheet that might not be taken into account in the simulation analysis due to the shorter time horizon used in that analysis. The net present value of the balance sheet is defined as the discounted present value of expected asset cash flows minus the discounted present value of the expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet.
The net present value analysis results are presented in Table 13b. These results, as of December 31,
2003,2005, indicate that the net present value would decrease4.0%28.0% assuming an immediate upward shift in market interest rates of 3.00% andto increase 1.4%decrease 11.4% if rates shifteddownward1.00% in the same manner.34
The
risk position of ACNB is within the guidelines set by policy. Again, with rates so low, these results are not as accurate as they would normally be. The corporation'sCorporation’s current strategy is to extend liability maturities and keep asset maturities relatively short to protect against both greater earnings at risk and value at risk.DECEMBER 31, 2003 DECEMBER 31,2003 - ------------------------------------------------------------------------- TABLE 13A TABLE 13B NET INTEREST INCOME PROJECTIONS PRESENT VALUE EQUITY - ------------------------------------------------------------------------- Changes in Changes in Basis Points % Change Basis Points % Change - ------------------------------------------------------------------------- (300) (17.56)% (300) 2.70% (100) (9.89)% (100) (1.38)% -- 0.0% -- 0.0% 100 (3.38)% 100 2.85% 300 4.39% 300 3.98% DECEMBER 31, 2002 DECEMBER 31,2002 - ------------------------------------------------------------------------- TABLE 13A TABLE 13B NET INTEREST INCOME PROJECTIONS PRESENT VALUE EQUITY - ------------------------------------------------------------------------- Changes in % Change Changes in % Change Basis Points Basis Points - ------------------------------------------------------------------------- (300) (8.9)% (300) 2.0% (100) (2.1)% (100) 1.0% -- 0.0% -- 0.0% 100 (0.7)% 100 (1.3)% 300 (0.4)% 300 (4.6)% 27Item
December 31, 2005
December 31, 2005
Table 13a
Net Interest Income Projections
Table 13b
Present Value Equity
Changes in
Basis Points
% Change
Changes in
Basis Points
% Change
(300
)
1.87
%
(300
)
6.18
%
(100
)
1.14
%
(100
)
4.44
%
—
—
%
—
—
%
100
(6.11
)%
100
(11.41
)%
300
(15.07
)%
300
(27.96
)%
December 31, 2004
December 31, 2004
Table 13a
Net Interest Income Projections
Table 13b
Present Value Equity
Changes in
Basis Points
% Change
Changes in
Basis Points
% Change
(300
)
N/A
%
(300
)
N/A
%
(100
)
(8.54
)%
(100
)
(1.98
)%
—
—
%
—
—
%
100
(11.52
)%
100
(3.63
)%
300
(18.80
)%
300
(18.94
)%
35
ITEM 8 -
Financial StatementsFINANCIAL STATEMENTS(a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:
PAGE ---- Independent Auditor's Report ...........................................29 Consolidated Statements of Condition ...................................30 Consolidated Statements of Income ......................................31 Consolidated Statements of Changes in Stockholders' Equity .............32 Consolidated Statements of Cash Flows ..................................33 Notes to Consolidated Financial Statements .............................34 28
36
REPORT OF INDEPENDENT
AUDITOR'S REPORTREGISTERED PUBLIC ACCOUNTING FIRMTo
The Stockholders andthe Board of Directors and StockholdersACNB Corporation
Gettysburg, Pennsylvania
We have audited the accompanying consolidated statements of condition of ACNB Corporation and subsidiaries as of December 31,
20032005 and2002,2004, and the related consolidated statements of income, changes instockholders'stockholders’ equity and cash flows foreach ofthethreeyearsin the period ended December 31, 2003.then ended. These consolidated financial statements are the responsibility of thecorporation'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements baseduponon our audits. The December 31, 2003 consolidated financial statements were audited by other auditors whose report, dated January 17, 2004, expressed an unqualified opinion on those statements.We conducted our audits in accordance with
auditingthe standardsgenerally accepted inof theUnited States of America.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the 2005 and 2004 consolidated financial statements referred to above present fairly, in all material respects, the financial position of ACNB Corporation and subsidiaries as of December 31,
20032005 and2002,2004, and the results of their operations and their cash flows foreach ofthethreeyearsin the periodthen ended,December 31, 2003,in conformity with accounting principles generally accepted in the United States of America.[SIG OMITTED] Stambaugh Ness, PC York, Pennsylvania January 17,We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of ACNB Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2006 expressed an unqualified opinion on management’s assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting.
/s/ BEARD MILLER COMPANY LLP
Beard Miller Company LLP
Harrisburg, Pennsylvania
February 24, 2006
37
ACNB CORPORATION
CONSOLIDATED STATEMENTS OF CONDITION
December 31,
Dollars in thousands, except per share data
2005
2004
ASSETS
Cash and due from banks
$
18,382
$
21,757
Interest-bearing deposits in banks
892
938
Cash and Cash Equivalents
19,274
22,695
Securities available for sale
348,713
381,383
Securities held to maturity, fair value 2005 $19,192; 2004 $25,089
19,165
24,560
Loans held for sale
60
511
Loans, net of allowance for loan losses 2005 $4,456; 2004 $3,938
489,008
436,631
Premises and equipment
14,696
11,992
Restricted investment in bank stocks
9,053
10,271
Investment in bank owned life insurance
21,116
19,198
Investments in low income housing partnerships
5,665
6,153
Other assets
18,386
10,794
Total Assets
$
945,136
$
924,188
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits:
Non-interest bearing
$
79,428
$
74,667
Interest bearing
599,953
572,205
Total Deposits
679,381
646,872
Short-term borrowings
59,307
64,966
Long-term borrowings
125,778
132,000
Other liabilities
6,660
5,829
Total Liabilities
871,126
849,667
STOCKHOLDERS’ EQUITY
Common stock, $2.50 par value; 20,000,000 shares authorized; 5,436,101 shares issued and outstanding
13,590
13,590
Retained earnings
65,556
63,127
Accumulated other comprehensive loss
(5,136
)
(2,196
)
Total Stockholders’ Equity
74,010
74,521
Total Liabilities and Stockholders’ Equity
$
945,136
$
924,188
The accompanying notes are an integral part of the consolidated financial statements.
38
ACNB CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
Dollars in thousands, except per share data
2005
2004
2003
INTEREST INCOME
Loans, including fees
$
27,243
$
23,578
$
23,670
Securities:
Taxable
13,729
13,002
11,904
Tax-exempt
916
917
882
Dividends
288
153
158
Other
93
102
75
Total Interest Income
42,269
37,752
36,689
INTEREST EXPENSE
Deposits
11,528
9,511
11,224
Short-term borrowings
1,255
793
741
Long-term borrowings
4,208
2,879
1,980
Total Interest Expense
16,991
13,183
13,945
Net Interest Income
25,278
24,569
22,744
PROVISION FOR LOAN LOSSES
516
300
265
Net Interest Income after Provision for Loan Losses
24,762
24,269
22,479
OTHER INCOME
Service charges on deposit accounts
1,742
1,780
1,788
Income from fiduciary activities
717
714
663
Earnings on investment in bank owned life insurance
768
683
722
Gain recognized from life insurance proceeds
—
—
2,161
Gains (losses) on sales of securities
(264
)
1,113
1,992
Service charges on ATM and debit card transactions
738
713
606
Commissions from insurance sales
4,121
—
—
Other
1,094
862
1,497
Total Other Income
8,916
5,865
9,429
OTHER EXPENSES
Salaries and employee benefits
12,884
9,884
9,902
Net occupancy expense
1,510
952
933
Equipment expense
2,395
2,131
1,960
Professional services
1,147
730
543
Other tax expense
1,044
990
937
Supplies and postage
761
633
639
Advertising expense
830
284
369
Other operating
4,321
2,967
2,715
Total Other Expenses
24,892
18,571
17,998
Income before Income Taxes
8,786
11,563
13,910
PROVISION FOR INCOME TAXES
1,410
2,255
3,142
Net Income
$
7,376
$
9,308
$
10,768
PER SHARE DATA
Basic earnings
$
1.36
$
1.71
$
1.98
Cash dividends declared
$
0.91
$
0.90
$
0.89
The accompanying notes are an integral part of the consolidated financial statements.
39
ACNB CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2005, 2004
29THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOFTHE CONSOLIDATED FINANCIAL STATEMENTS. 30
CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED DECEMBER 31 ------------------------------- 2003 2002 2001 ---- ---- ---- INTEREST INCOME IN THOUSANDS, EXCEPT PER SHARE DATALoans (including fees) $ 23,670 $ 24,752 $ 27,892 Time deposits with banks 75 74 599 Federal funds sold -- -- 157 Taxable securities 12,062 12,727 10,396 Non-taxable securities 882 241 117 -------- -------- -------- TOTAL INTEREST INCOME 36,689 37,794 39,161 INTEREST EXPENSE Interest bearing deposits 11,224 12,258 14,690 Short term borrowings 741 961 1,366 Long term borrowings 1,980 234 -- -------- -------- -------- TOTAL INTEREST EXPENSE 13,945 13,453 16,056 NET INTEREST INCOME 22,744 24,341 23,105 Provision for possible loan losses 265 370 240 -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 22,479 23,971 22,865 NON-INTEREST INCOME Trust income 663 683 569 Service fees on deposit accounts 1,788 1,755 1,348 Gain on other real estate 173 118 5 Bank owned life insurance 722 572 421 Gain from officer's life insurance 2,161 -- -- Securities gains 1,992 -- -- Other income 1,930 1,900 1,190 -------- -------- -------- TOTAL NON-INTEREST INCOME 9,429 5,028 3,533 NON-INTEREST EXPENSE Salaries and employee benefits 9,902 9,454 7,942 Net occupancy expense 1,164 829 701 Equipment expense 1,960 1,411 1,088 Other taxes 937 875 836 Professional services 339 452 540 Other expense 3,696 3,967 3,220 -------- -------- -------- TOTAL NON-INTEREST EXPENSE 17,998 16,988 14,327 INCOME BEFORE INCOME TAXES 13,910 12,011 12,071 Applicable income taxes 3,142 3,107 3,734 -------- -------- -------- NET INCOME $ 10,768 $ 8,904 $ 8,337 ======== ======= ======= PER COMMON SHARE DATA * Basic earnings $1.98 $ 1.64 $1.53 Cash dividends paid $ .89 $ 1.08 $ .88*BASED ON A WEIGHTED AVERAGE OF 5,436,101 SHARES IN 2003, 5,436,101 SHARES IN 2002, AND 5,436,117 SHARES IN 2001. THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 31
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Accumulated Other Common Additional Retained Comprehensive Stock Paid-In Capital Earnings Income Total --------- --------------- --------------- -------------- -------------- IN THOUSANDSBALANCE AT JANUARY 1, 2001 $13,602 -- $46,258 $577 $60,437 Comprehensive income: Net income -- -- 8,337 -- 8,337 Change in unrealized gains on securities, net of tax -- -- -- 197 197 Change in unfunded pension liability, net of tax -- -- -- (332) (332) --------- Total comprehensive income 8,202 ---------- Cash dividends paid and declared -- -- (5,870) -- (5,870) Retirement of 4,725 shares (12) -- (64) -- (76) --- ------------ ----------- ------------ ----------- BALANCE AT DECEMBER 31, 2001 $13,590 -- $48,661 $442 $62,693 Comprehensive income: Net income -- -- 8,904 -- 8,904 Change in unrealized gains on securities, net of tax -- -- -- 3,315 3,315 Change in unfunded pension liability, net of tax (28) (28) ------------- Total comprehensive income 12,191 --------- Cash dividends paid -- -- (4,784) -- (4,784) -- ------------ ---------- ------------ ---------- BALANCE AT DECEMBER 31, 2002 $ 13,590 $ -- $ 52,781 $ 3,729 $ 70,100 Comprehensive income: Net income -- -- 10,768 -- 10,768 Change in unrealized gains on securities, net of tax -- -- -- (3,647) (3,647) Change in unfunded pension liability, net of tax 8 8 ------------ Total comprehensive income 7,129 --------- Cash dividends paid -- -- (4,838) -- (4,838) --------- --------- BALANCE AT DECEMBER 31, 2003 $ 13,590 $ -- $ 58,711 $ 90 $ 72,391 ======== ============ ======== ========= ========THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 32
CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31 ----------------------------------------- 2003 2002 2001 ---- ---- ---- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS IN THOUSANDS CASH FLOWS FROM OPERATING ACTIVITIESInterest and dividends received $ 39,469 $ 38,754 $ 37,634 Fees and commissions received 10,173 5,458 3,949 Interest paid (14,417) (13,998) (16,167) Cash paid to suppliers and employees (20,921) (20,855) (26,933) Income taxes paid (3,053) (3,959) (3,970) Loans originated for sale (18,735) (22,360) (15,962) Proceeds of mortgage loans sold 21,193 20,856 15,058 --------- ----------- ---------- NET CASH PROVIDED (USED IN) BY OPERATING ACTIVITIES 13,709 3,896 (6,391) CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities held-to-maturity 5,366 16,821 21,872 Proceeds from maturities of investment securities available-for-sale 277,347 117,852 42,759 Purchase of investment securities held-to-maturity (23,438) -- (5,000) Purchase of investment securities available-for-sale (348,135) (222,683) (105,774) Net decrease (increase) in loans (42,723) (12,271) (1,618) Capital expenditures (675) (2,109) (1,470) Proceeds from sale of other real estate owned 699 1,140 60 --------- ---------- -- NET CASH (USED IN) INVESTING ACTIVITIES (131,559) (101,250) (49,171) CASH FLOW FROM FINANCING ACTIVITIES Net Increase (decrease) in demand deposits, NOW accounts, and savings accounts 63,507 73,770 34,965 Net increase (decrease) in certificates of deposit (6,734) 1,684 20,644 Net increase in securities sold under agreement to repurchase 3,961 2,706 1,509 Dividends paid (4,838) (5,871) (4,783) Net increase (decrease) in borrowed funds 76,270 22,238 1,512 Retirement of common stock -- -- (76) --------- ---------- --- NET CASH PROVIDED BY FINANCING ACTIVITIES 132,166 94,527 53,771 --------- ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,316 (2,827) (1,791) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 19,098 21,925 23,716 --------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 33,414 $ 19,098 $ 21,925 ========= ========= ========= RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Net income $ 10,768 $ 8,904 $ 8,337 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Depreciation and amortization 804 631 454 Provision for possible loan losses 265 370 240 Benefit (expense) for deferred taxes 146 (794) (475) Amortization (Accretion) of investment securities premiums (discounts) 3,240 795 (138) Increase (Decrease) in taxes payable 493 (58) (151) Decrease (Increase) in interest receivable 538 759 (293) Increase (Decrease) in interest payable (472) (545) (111) Increase (Decrease) in accrued expenses (668) 400 (340) Decrease (Increase) in mortgage loans held for sale 2,458 (1,504) (904) Decrease (Increase) in other assets (3,059) (4,899) (12,720) Increase (Decrease) in other liabilities (804) (163) (290) ---- ---- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES $ 13,709 $ 3,896 $ (6,391) ========= ========== ==========THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 33CASH FLOWS
Years Ended December 31,
In thousands
2005
2004
2003
CASH FLOWS FROM OPERATING ACTIVITIES
Interest and dividends received
$
43,740
$
40,700
$
40,467
Fees and commissions received
8,413
2,485
5,066
Interest paid
(16,448
)
(13,064
)
(14,417
)
Cash paid to suppliers and employees
(21,562
)
(16,432
)
(18,116
)
Income taxes paid
(3,202
)
(2,343
)
(3,053
)
Loans originated for sale
(15,103
)
(8,778
)
(18,735
)
Proceeds from sales of mortgage loans
15,554
8,466
21,530
Net Cash Provided by Operating Activities
11,392
11,034
12,742
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of securities held to maturity
5,188
17,491
5,366
Proceeds from maturities of securities available for sale
38,550
184,614
148,086
Proceeds from sales of securities available for sale
22,761
200,181
131,253
Purchase of securities held to maturity
—
—
(23,438
)
Purchase of securities available for sale
(34,813
)
(424,870
)
(344,980
)
Net sale (purchase) of restricted investment in bank stocks
1,218
(3,224
)
(3,155
)
Net increase in loans
(52,893
)
(25,880
)
(42,723
)
Purchase of bank owned life insurance
(1,200
)
(4,400
)
—
Cash paid for insurance agency acquisitions, net of cash acquired
(5,810
)
—
—
Investments in low income housing partnerships
(95
)
(2,944
)
(1,025
)
Capital expenditures
(4,092
)
(5,784
)
(675
)
Proceeds from sale of property and foreclosed real estate
692
181
699
Net Cash Used in Investing Activities
(30,494
)
(64,635
)
(130,592
)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, interest-bearing deposits, and savings accounts
11,447
6,116
63,507
Net increase (decrease) in time certificates of deposit
21,062
1,368
(6,734
)
Net increase (decrease) in short-term borrowings
(5,659
)
(4,710
)
13,231
Dividends paid
(4,947
)
(4,892
)
(4,838
)
Proceeds from long-term borrowings
51,000
45,000
67,000
Repayments on long-term borrowings
(57,222
)
—
—
Net Cash Provided by Financing Activities
15,681
42,882
132,166
Net Increase (Decrease) in Cash and Cash Equivalents
(3,421
)
(10,719
)
14,316
CASH AND CASH EQUIVALENTS - BEGINNING
22,695
33,414
19,098
CASH AND CASH EQUIVALENTS - ENDING
$
19,274
$
22,695
$
33,414
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income
$
7,376
$
9,308
$
10,768
Adjustments to reconcile net income to net cash provided by operating activities:
Gains on sales of loans, property and foreclosed real estate
(311
)
(113
)
(337
)
Earnings on investment in bank owned life insurance
(768
)
(683
)
(722
)
(Gains) losses on sales of securities
264
(1,113
)
(1,992
)
Depreciation and amortization
1,605
845
804
Provision for loan losses
516
300
265
(Benefit) expense for deferred taxes
(140
)
350
146
Net amortization of investment securities premiums
1,555
2,614
3,240
(Increase) decrease in interest receivable
(84
)
334
538
Increase (decrease) in interest payable
543
119
(472
)
(Increase) decrease in mortgage loans held for sale
451
(312
)
2,795
Increase in other assets
(102
)
(1,406
)
(1,312
)
Increase (decrease) in other liabilities
487
791
(979
)
Net Cash Provided by Operating Activities
$
11,392
$
11,034
$
12,742
The accompanying notes are an integral part of the consolidated financial statements.
41
ACNB CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A
SUMMARY OF- SIGNIFICANT ACCOUNTING POLICIESBUSINESSNature of Operations
ACNB Corporation provides banking, insurance, and financial services to businesses and consumers through its wholly-owned
banking subsidiary ofsubsidiaries, Adams County NationalBank.Bank and Russell Insurance Group, Inc. ThecorporationBank engages in full-service commercial and consumer banking and trust services through itsseventeentwenty locations in Adams, Cumberland and York counties.During 2000,On November 19, 2004, the
corporation,Corporation entered into a definitive agreement to acquire Russell Insurance Group, Inc., a full-service insurance agency, based in Westminster, Maryland, with a satellite office in Timonium, Maryland. The agency offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients. This acquisition was finalized on January 5, 2005.The Corporation, along with seven other banks, entered into a joint venture to form Pennbanks Insurance Company, an offshore reinsurance company. Each participating entity owns an insurance cell through which its premiums and losses from credit life, health and accident insurance are funded. Each entity is responsible for the activity in its respective cell. The financial activity for the insurance cell has been reported in the consolidated financial statements and is not material to the consolidated financial statements.
The
corporation'sCorporation’s primary source of revenue is interest income on loans and investment securities and fee income on its products and services. Expenses consist of interest expense on deposits and borrowed funds, provisions for loan losses, and other operating expenses.BASIS OF FINANCIAL STATEMENTSBasis of Financial Statements
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the
corporationCorporation and itswholly ownedwholly-owned subsidiaries. All significantinter-companyintercompany transactions have been eliminated.Financial statements prepared in accordance with accounting principles generally accepted
accounting principlesin the United States of America require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures ofcontingencies.contingencies at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, fair value disclosures, the valuation of deferred tax assets, and the evaluation of other than temporary impairment of securities.Assets held by the Trust Department in an agency or fiduciary capacity for its customers are excluded from the financial statements since they do not constitute assets of the Corporation. Assets held by the Trust Department amounted to $76,000,000 and $74,000,000 at December 31, 2005 and 2004, respectively. Income
and expenses are recorded on the accrual basis of accounting, except for trust department income and certain other fees which are recorded primarilyfrom fiduciary activities is recognized on the cashbasis. Recognitionmethod, which approximates the accrual method.42
Significant Group Concentrations of
such income on an accrual basis is impracticalCredit RiskMost of the Corporation’s activities are with customers located within south central Pennsylvania and
wouldnorthern Maryland. Note C discusses the types of securities that the Corporation invests in. Note D discusses the types of lending that the Corporation engages in. The Corporation does notmaterially affect net income.have any significant concentrations greater than 10% of loans to any one industry or customer.Reclassifications
For comparative purposes, prior
years'years’ consolidated financial statements have been reclassified to conform withreport classificationsthe 2005 presentation. Such reclassifications had no impact on net income.Cash and Cash Equivalents
For purposes of
the current year. CASH EQUIVALENTS For the purpose of presentation inthe consolidated statements of cash flows, cash and cash equivalents include cash on hand,amountsbalances due from banks, and federal fundssold. Generally, federal funds are purchased andsold,for one-day periods. INVESTMENT SECURITIES Under Statementall ofFinancial Accounting Standards No. 115,which mature within ninety days.Securities
Debt securities
are required to be classified into one of three categories: held-to-maturity, available-for-sale, or trading. Investments in securities which the corporationthat management has the positive intent and ability to hold to maturity are classified asheld-to-maturity. These securities are accounted for“held to maturity” and recorded at amortized cost.OtherSecurities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified asavailable-for-sale“available for sale” andaccounted forrecorded at fairmarket value. The difference between amortized costvalue, with unrealized gains and losses excluded from earnings and reported, net of tax, in other comprehensive income.Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value
is an unrealized holding gain or loss included, netoftaxes,held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings asaccumulated other comprehensive income in stockholders' equity. Management will reassessrealized losses. In estimating other-than-temporary impairment losses, management considers (1) theappropriatenesslength of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of theclassifications each quarter. Amortizationissuer, and (3) the intent and ability ofpremium and accretionthe Corporation to retain its investment in the issuer for a period ofdiscounttime sufficient to allow forinvestment securities is computed by the straight-line method to the maturity date. There is not a material difference between the straight-line method and the interest method.any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.IncomeRestricted Investment in Bank Stocks
Restricted investment in bank stocks includes Federal Reserve, Atlantic Central Bankers Bank and Federal Home Loan Bank (FHLB) stocks. Federal law requires a member institution of the FHLB to hold stock of its district FHLB according to a predetermined formula. The stock is
accrued the month it is earned. LOANS AND REVENUE RECOGNITIONcarried at cost.Loans
are stated at their principal amount outstanding, exceptHeld formortgages heldSaleLoans originated and intended for sale
whichin the secondary market are carried at the lower of aggregate cost ormarket value.fair value, as determined by aggregate outstanding commitments from investors or current investor yield requirements. Net unrealized losses are recognized through a valuation allowance by charges to income.Mortgage loans held for sale are sold with the mortgage servicing rights released to another financial institution through a correspondent relationship. The correspondent financial institution absorbs all of the risk related to rate lock commitments. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.
43
Loans
The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout south central Pennsylvania and northern Maryland. The ability of the Corporation’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income
on loansis accruedas earned. LOAN ORIGINATION FEES AND COSTSon the unpaid principal balance. Loan origination fees,and the relatednet of certain direct origination costs, areoffset, and the net amount isdeferred andamortized over the life of the loanrecognized as an adjustmenttoof the related loan yield using the interest method.The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Personal loans 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 non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income.
34ALLOWANCE FOR POSSIBLE LOAN LOSSESThe interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for
possibleloan losses charged toincomeearnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.The allowance for loan losses is evaluated on a regular basis by management and is based upon
management'smanagement’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.The allowance consists of
outstandingspecific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historicalloanloss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate ofthe subsidiary, and the adequacyprobable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies forpossibleestimating specific and general losses in the portfolio.44
A loan
losses. A significant change in this estimate could result in a material change to net income. Loans are deemedis considered impaired when, based on current information and events, it is probable that thecorporationCorporation will be unable to collectall amountsthe scheduled payments of principal or interest when duein accordance withaccording to the contractual terms of the loan agreement.The corporation evaluates collectivelyFactors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons forimpairment largethe delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.Large groups of smaller balance homogeneous
loans. Atloans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under commercial lines of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Foreclosed real estate totaled $-0- and $213,000 at December 31,
20032005 and2002, all of the corporation's impaired loans were on non-accrual status for all reported periods. PREMISES AND EQUIPMENT2004, respectively, and is included in other assets.Premises and Equipment
Land is carried at cost. Bank premises and furniture and equipment are carried at cost, less accumulated depreciation computed principally by the straight-line
method. Depreciation is recorded based onmethod over theassets'assets’ estimated useful lives.NONPERFORMING ASSETS NonperformingInvestments in Low Income Housing Partnerships
The Corporation’s investments in low income housing partnerships are accounted for using the “cost method” prescribed by Emerging Issues Task Force (EITF) No. 94-1. In accordance with EITF 94-1, tax credits are recognized as they become available. Any residual loss is amortized as the tax credits are received.
45
Bank Owned Life Insurance
The Corporation’s banking subsidiary maintains non-qualified compensation plans for selected senior officers. To fund the benefits under these plans, the Bank is the owner of single premium life insurance policies on participants in the non-qualified retirement plans. Investment in bank owned life insurance policies was used to finance the non-qualified compensation plans and provide tax-exempt return to the Corporation.
Transfers of Financial Assets
Transfers of financial assets are
comprised of loansaccounted forwhichas sales when control over theaccrual of interestassets has beendiscontinued duesurrendered. Control over transferred assets is deemed toa serious weakeningbe surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange theborrower's financial condition. Loans are generally placed on a nonaccrual basis when principal or interest is past due 90 days or moretransferred assets, andwhen, in(3) theopinion of management, full collection of principal or interest is unlikely. AtCorporation does not maintain effective control over thetime a loan is placed on nonaccrual status, the accrual of interest is discontinued.transferred assets through an agreement to repurchase them before their maturity.Income
on such loans is then recognized only to the extent of cash received. The basis in foreclosed real estate is carried at the lower of fair market value, less costs to sell, or the carrying value of the related loan at the time of acquisition. INCOME TAXESTaxesDeferred income tax assets and liabilities are
reflected at currently enacted income tax rates applicable todetermined using theperiod in whichliability method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assetsorand liabilitiesare expectedand gives current recognition tobe realized or settled. Aschanges in taxlaws orratesare enacted, deferred tax assetsandliabilities are adjusted throughlaws.Retirement Plan
The compensation cost of an employee’s pension benefit is recognized on the
provisionprojected unit credit method over the employee’s approximate service period. The aggregate cost method is utilized forincome taxes. NET INCOME PER SHAREfunding purposes.Net Income per Share
The Corporation has a simple capital structure. Basic earnings per share of common stock is computed based on
the basis of the5,436,101 weighted averagenumber ofshares of common stockoutstanding. The corporation does not have diluted earnings per share. ADVERTISING COSTSoutstanding for all years presented.Advertising Costs
Costs of advertising are expensed when incurred.
Cost of advertising was $369,000, $312,000 and $260,000, for the years ending December 31, 2003, 2002 and 2001, respectively. COMPREHENSIVE INCOME The corporation has elected to reflect the statement of comprehensive income within the consolidated statements of changes in stockholders' equity.Comprehensive
income reflects the impact of the change in unrealizedIncomeAccounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Changes in certain assets and liabilities, such as unrealized gains (losses) on
available-for-sale investments, net of tax,securities available for sale and theunfundedminimum pension liability, are reported as a separate component of the stockholders’ equity section of the balance sheet. Such items, along with net income, are components oftax.comprehensive income.46
The components of other comprehensive income (loss) and the related tax effects are as follows:
Years Ended December 31,
In thousands
2005
2004
2003
Unrealized holding losses arising during the period
$
(4,824
)
$
(2,279
)
$
(3,618
)
Reclassification adjustment for gains (losses) realized in net income
(264
)
1,113
1,992
Net Unrealized Losses
(4,560
)
(3,392
)
(5,610
)
Tax effect
1,598
1,187
1,963
(2,962
)
(2,205
)
(3,647
)
Change in minimum pension liability
34
(660
)
—
Tax effect
12
227
—
22
(433
)
—
Net of Tax Amount
$
(2,940
)
$
(2,638
)
$
(3,647
)
The December 31 balances of accumulated other comprehensive loss are as follows:
In thousands
Unrealized
Losses on
Securities
Minimum
Pension
Liability
Adjustment
Accumulated
Other
Comprehensive
Loss
BALANCE, DECEMBER 31, 2004
$
(1,763
)
$
(433
)
$
(2,196
)
Change during 2005
(2,962
)
22
(2,940
)
BALANCE, DECEMBER 31, 2005
$
(4,725
)
$
(411
)
$
(5,136
)
Segment Reporting
The Bank acts as an independent community financial services provider, which offers traditional banking and related financial services to individual business and government customers. Through its branch and automated teller machine networks, the Bank offers a full array of commercial and retail financial services, including the taking of time, savings, and demand deposits; the making of commercial, consumer, and mortgage loans; and the providing of other financial services. Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail and mortgage banking operations of the Bank. As such, discrete financial information is not available and segment reporting would not be meaningful. See Note S for a discussion of insurance operations.
47
New Accounting Standards
EITF 03-1
In January 2003, the FASB’s Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investors” (EITF 03-1), and in March 2004 the EITF issued an update. EITF 03-1 addresses the meaning of other-than-temporary impairment and its application to certain debt and equity securities. EITF 03-1 aids in the determination of impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff’s recommendations were to nullify the guidance on the determination of whether an investment is impaired as set forth in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the meaning of other-than-temporary impairment. Instead, the staff recommends entities recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115.
NOTE B - RESTRICTIONS ON CASH AND DUE FROM
BANK ACCOUNTS The bankBANKSIn return for services obtained through correspondent banks, the Corporation is required to maintain
average reservenon-interest bearing cash balanceswith the Federal Reserve Bank. The average amount of these reserve balances for the years endedin those correspondent banks. At December 31,20032005 and2002, were approximately $13,145,0002004, compensating balances approximated $3,217,000 and$11,613,000,$14,507,000, respectively.35NOTE C
INVESTMENT- SECURITIESTheAmortized cost and fair value at December 31, 2005 and 2004 were as follows:
In thousands
Amortized
Cost
Gross
Unrealized Gains
Gross
Unrealized Losses
Fair
Value
SECURITIES AVAILABLE FOR SALE:
December 31, 2005:
U.S. Government and agencies
$
158,912
$
—
$
2,562
$
156,350
Mortgage-backed securities
120,851
—
3,049
117,802
State and municipal
22,909
30
79
22,860
Corporate bonds
52,812
—
1,834
50,978
Stock in other banks
500
223
—
723
$
355,984
$
253
$
7,524
$
348,713
December 31, 2004:
U.S. Government and agencies
$
158,912
$
77
$
1,179
$
157,810
Mortgage-backed securities
119,217
270
1,487
118,000
State and municipal
22,916
87
75
22,928
Corporate bonds
82,550
18
497
82,071
Stock in other banks
500
74
—
574
$
384,095
$
526
$
3,238
$
381,383
48
In thousands
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
SECURITIES HELD TO MATURITY:
December 31, 2005:
U.S. Government and agencies
$
10,000
$
259
$
—
$
10,259
Mortgage-backed securities
8,916
—
232
8,684
State and municipal
249
—
—
249
$
19,165
$
259
$
232
$
19,192
December 31, 2004:
U.S. Government and agencies
$
10,000
$
735
$
—
$
10,735
Mortgage-backed securities
14,206
—
206
14,000
State and municipal
354
—
—
354
$
24,560
$
735
$
206
$
25,089
At December 31, 2005, 17 mortgage-backed and 9 U.S. Government and agency securities have unrealized losses, and 15 of the securities have been in a continuous loss position for 12 months or more. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of specific securities. None of the securities in this category had an unrealized loss that exceeded 6% of amortized cost and
estimateda majority had unrealized losses totaling less than 2% of amortized cost.At December 31, 2005, 15 state and municipal securities and 9 corporate bonds have unrealized losses, and 11 of the securities have been in a continuous loss position for 12 months or more. In analyzing the issuer’s financial condition, management considers industry analysts’ reports, financial performance and projected target prices of investment analysts within a one-year time frame. None of the securities in this category had an unrealized loss that exceeded 10% of amortized cost and a majority had unrealized losses totaling less than 2% of amortized cost.
Currently the Corporation holds two securities with a total fair value of $11,560,000 (Ford Motor Credit 6.5% due January 25, 2007 and GMAC 6.125% due August 28, 2007) that are not of investment grade, but are not considered other than temporarily impaired as management has the intent and ability to hold them to maturity.
Management routinely sells securities from its available for sale portfolio in an effort to manage and allocate the portfolio. At December 31, 2005, management had not identified any securities with an unrealized loss that it intends to sell. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.
49
The following table shows the Corporation’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31,
20032005 and2002, were as follows:2004:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ----------------------------------------------------------------------- 2003 IN THOUSANDS HELD-TO-MATURITY SECURITIESU.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 15,535 $ 1,265 $ -- $ 16,800 Mortgage backed securities 26,201 -- 372 25,829 Obligations of states and political subdivisions 447 -- -- 447 --- ------------ ------------ ------------- Total debt securities 42,183 1,265 372 43,076 Restricted equity securities 7,547 -- -- 7,547 ----- ------------ ------------ ------------ Total Held-to-Maturity Securities $ 49,730 $ 1,265 $ 372 $ 50,623 ========== ========== =========== ========== AVAILABLE-FOR-SALE SECURITIES U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 40,000 $ 32 $ 196 $ 39,836 Mortgage backed securities 176,467 1,180 1,586 176,061 Obligations of states and political subdivisions 22,922 355 6 23,271 Corporate debt 105,500 957 56 106,401 --------- ----------- ------------- ---------- Total Available-for-Sale Securities $ 344,889 $ 2,524 $ 1,844 $ 345,569 ========= ========= ========== ========= 2002 IN THOUSANDS HELD-TO-MATURITY SECURITIES U.S. Treasury securities and obligations of _U.S. Government corporations and agencies $ 25,540 $ 2,810 $ -- $ 28,350 Obligations of states and political subdivisions 1,509 15 -- 1,524 Corporate debt 217 2 -- 219 ---- -------------- ------------ ------------- Total debt securities 27,266 2,827 -- 30,093 Restricted equity securities 4,392 -- -- 4,392 --------- ----------- ------------- ---------- Total Held-to-Maturity Securities $ 31,658 $ 2,827 $ -- $ 34,485 ========== ========== =========== ========== AVAILABLE-FOR-SALE SECURITIES U.S. Treasury securities and obligations of $ U.S. Government corporations and agencies 31,621 $ 807 -- $ 32,428 Mortgage-backed securities 180,696 4,197 -- 184,893 Corporate debt 63,782 1,286 -- 65,068 --------- ----------- ------------- ---------- Total Available-for-Sale Securities $ 276,099 $ 6,290 $ -- $ 282,389 ========== ========== =========== =========
Less than 12 Months
12 Months or More
Total
In thousands
Fair
Value
Unrealized Losses
Fair
Value
Unrealized Losses
Fair
Value
Unrealized Losses
SECURITIES AVAILABLE FOR SALE:
DECEMBER 31, 2005:
U.S. Government and agencies
$
77,977
$
935
$
78,373
$
1,627
$
156,350
$
2,562
Mortgage-backed securities
50,107
822
67,695
2,227
117,802
3,049
State and municipal
5,680
49
2,130
30
7,810
79
Corporate bonds
12,739
268
38,239
1,566
50,978
1,834
$
146,503
$
2,074
$
186,437
$
5,450
$
332,940
$
7,524
SECURITIES HELD TO MATURITY:
Mortgage-backed securities
$
—
$
—
$
8,684
$
232
$
8,684
$
232
SECURITIES AVAILABLE FOR SALE:
DECEMBER 31, 2004:
U.S. Government and agencies
$
78,821
$
1,179
$
—
$
—
$
78,821
$
1,179
Mortgage-backed securities
55,744
439
39,068
1,048
94,812
1,487
State and municipal
5,921
25
2,572
50
8,493
75
Corporate bonds
68,992
497
—
—
68,992
497
$
209,478
$
2,140
$
41,640
$
1,098
$
251,118
$
3,238
SECURITIES HELD TO MATURITY:
Mortgage-backed securities
$
—
$
—
$
14,000
$
206
$
14,000
$
206
50
Amortized cost and fair value at December 31, 2005 by contractual maturity are shown below. Expected maturities
maywill differ from contractual maturities becausesomeissuers may have the right to call or prepayobligationswith or withoutcall or prepaymentpenalties.
Available for Sale
Held to Maturity
In thousands
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
1 year or less
$
—
$
—
$
—
$
—
Over 1 year through 5 years
97,812
94,769
10,249
10,508
Over 5 years through 10 years
125,999
124,719
—
—
Over 10 years
10,822
10,700
—
—
Mortgage-backed securities
120,851
117,802
8,916
8,684
Equity securities
500
723
—
—
$
355,984
$
348,713
$
19,165
$
19,192
The
amortized costCorporation realized gross gains of $-0- during 2005, $2,019,000 during 2004, andestimated fair value$2,694,000 during 2003 and gross losses ofdebt$264,000 during 2005, $906,000 during 2004, and $702,000 during 2003 on sales of securitiesat December 31, 2003, by contractual maturity are shown below.
Held-to-Maturity Available-for-Sale ---------------------------------- ------------------------------ Amortized Fair Amortized Fair COST VALUE COST VALUE IN THOUSANDSWithin one year $ 93 $ 93 $ 46,831 $ 47,274 After one year through five years 41,555 42,448 192,849 192,680 After five years through ten years 535 535 59,868 59,882 After ten years -- -- 45,341 45,733 ---------- ---------- --------- -------- 9 Total Debt Securities $ 42,183 $ 43,076 $ 344,88 $345,569 ========== ========== ======== =========36
U.S. Government Other Taxable and Federal State and Equivalent Agency Municipal Securities Total Yield --------------- ----------------- ----------------- ---------------- ------------ DECEMBER 31, 2003 IN THOUSANDS Amortized CostWithin one year $ -- $ 93 $ 46,831 $ 46,924 3.50% After one year through five years 175,381 354 58,669 234,404 3.53% After five years through ten years 51,770 8,633 -- 60,403 4.63% After ten years 31,052 14,289 -- 45,341 5.56% No set maturity -- -- 7,547 7,547 1.60% ------------- -------------- ------------ ------------ Total $ 258,203 $ 23,369 $ 113,047 $ 394,619 ========= =========== ========= ========= Fair Value $ 258,526 $ 23,718 $ 113,948 $ 396,192 ========= =========== ========= ========= Taxable Equivalent Yield 3.75% 6.09% 2.88% December 31, 2002 IN THOUSANDS Amortized Cost $ 227,737 $ 11,846 $ 68,174 $ 307,757 ========= =========== ========== ========= December 31, 2001 IN THOUSANDS Amortized Cost $ 214,589 $ 2,123 $ 5,613 $ 222,325 ========= ============ =========== =========The weighted average yield of tax-exempt obligations has been calculated on a taxable equivalent basis. The taxable equivalent adjustments are based on an effective tax rate of 35%. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity.available for sale.At December 31,
20032005 and2002, assets2004, securities with a carrying value of$130,424,000$95,760,000 and$92,123,000,$94,122,000, respectively, were pledged as collateral as requiredor permittedby lawto secure certainon public and trust deposits, repurchase agreementsorand for other purposes.NOTE D - LOANS
AND ALLOWANCE FOR LOAN LOSSESLoans at December 31,
are summarized2005 and 2004 were as follows:
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSCommercial, financial and agricultural $ 18,080 $ 21,128 $ 18,027 $ 18,376 $ 12,697 Real estate - construction 22,298 16,096 15,497 15,786 13,188 Real estate - mortgage 363,515 326,180 316,928 314,385 308,241 Consumer 11,222 11,446 12,127 12,443 13,661 --------- -------- -------- --------- -------- $ 415,115 $374,850 $362,579 $ 360,990 $347,787 ========= ======== ======== ========= ========
In thousands
2005
2004
Commercial, financial and agricultural
$
36,583
$
31,187
Real estate:
Commercial
103,501
99,988
Construction
31,907
20,232
Residential
311,241
278,140
Consumer
9,529
10,643
Total Loans
492,761
440,190
Deferred loan fees and costs, net
703
379
Allowance for loan losses
(4,456
)
(3,938
)
Net Loans
$
489,008
$
436,631
51
The
following table outlinesBank grants commercial, residential and consumer loans to customers primarily within south central Pennsylvania and northern Maryland and therepricing opportunities for all loans outstanding as of December 31, 2003. Loans with immediately adjustable rates, such as loans tied to prime rate, are included in the within one year column. Loans with rates that are adjustable at some time over the lifesurrounding area. A large portion of the loanare included underportfolio is secured by real estate. Although thetime heading when they become adjustable. All fixed-rate loans are included underBank has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by theheadingregion’s economy.Changes in
which they mature.
Repricing Period ---------------------------------------------------------------- After One Within Year Through After One Year Five Years Five Years Total IN THOUSANDSCommercial, financial and agricultural $ 8,973 $ 5,688 $ 3,419 $18,080 Real estate - construction 13,144 8,882 272 22,298 -------- ------- ------- ------- Total $ 22,117 $14,570 $ 3,691 $40,378 ======== ======= ======= ======= Fixed loans with predetermined interest rates $ 5,167 $ 9,457 $ 3,664 $18,288 Loans with variable interest rates 16,950 5,113 27 22,090 -------- ------- ------- ------- Total $ 22,117 $14,570 $ 3,691 $40,378 ======== ======= ======= =======37Transactions in the valuation portion ofthe allowance for loan lossesfor the past five yearswere as follows:
In thousands
2005
2004
2003
Balance, beginning
$
3,938
$
3,978
$
3,837
Provision charged to operations
516
300
265
Recoveries on charged off loans
89
50
45
Loans charged off
(87
)
(390
)
(169
)
Balance, ending
$
4,456
$
3,938
$
3,978
Nonaccrual loans totaled $7,354,000 and $8,054,000 at December 31,
are shown below:
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSBalance of allowance for loan losses at beginning of period $ 3,837 $ 3,723 $ 3,695 $ 3,543 $ 3,594 LOANS CHARGED-OFF: Commercial, financial and agricultural 90 87 39 11 58 Real estate - construction -- -- -- -- -- Real estate - mortgage 32 192 131 42 128 Consumer 47 57 139 84 204 ----------- ----------- ----------- ------------ ----------- Total loans charged-off 169 336 309 137 390 RECOVERY OF CHARGED-OFF LOANS: Commercial, financial and agricultural 6 27 49 5 5 Real estate - construction -- -- -- -- -- Real estate - mortgage 7 22 3 2 35 Consumer 32 31 45 42 46 ----------- ----------- ----------- ------------ ----------- Total recoveries 45 80 97 49 86 Net loans charged-off 124 256 212 88 304 Provision for possible loan losses 265 370 240 240 253 ----------- ----------- ----------- ------------ ----------- Balance at end of period $ 3,978 $ 3,837 $ 3,723 $ 3,695 $ 3,543 =========== =========== =========== =========== =========== TOTAL LOAN BALANCES IN THOUSANDS - ------------------------------------------------------------------------------------------------------------------------------------ Average total loans $ 388,842 $ 367,494 $ 359,404 $ 352,666 $ 344,323 Total loans at year-end $ 415,115 $ 374,850 $ 362,579 $ 360,990 $ 347,787 RATIOS - ------------------------------------------------------------------------------------------------------------------------------------ NET CHARGE-OFFS TO: Average total loans 0.03% 0.07% 0.06% 0.02% 0.09% Total loans at year-end 0.03% 0.07% 0.06% 0.02% 0.09% Allowance for loan losses 3.14% 6.67% 5.69% 2.38% 8.58% ALLOWANCE FOR LOAN LOSSES TO: Average total loans 1.02% 1.04% 1.04% 1.05% 1.03% Total loans at year-end 0.96% 1.02% 1.03% 1.02% 1.02%The amounts of additional provision to the allowance were based on management's judgment after considering an analysis of larger loans, all loans known to management to have unusual risk characteristics, nonperforming2005 and 2004, respectively. Loans past due 90 days orproblem loans, historical patterns of charge-offsmore andrecoveries,still accruing totaled $199,000 andactual net charge-offs. Further consideration was given to current economic and employment conditions both nationally and in the corporation's local service area. Loans secured by real estate comprised of 93% of the corporation's total loan portfolio$160,000 at December 31, 2005 and 2004, respectively. If interest on all nonaccrual loans had been accrued at original contract rates, it is estimated interest income would have been higher by $501,000 in 2005, $384,000 in 2004, and $82,000 in 2003.The
majorityfollowing is a summary ofloansinformation pertaining to impaired loans:
December 31,
In thousands
2005
2004
Impaired loans with a valuation allowance
$
3,419
$
7,539
Valuation allowance related to impaired loans
$
698
$
619
Years Ended December 31,
In thousands
2005
2004
2003
Average investment in impaired loans
$
5,479
$
5,085
$
200
Interest income recognized on impaired loans
$
14
$
331
$
—
No additional funds are committed to be advanced in
both the commercial, financial and agricultural category and the consumer category are also secured by personal property, negotiable assets, or business assets. This conservative policy explains the low ratio of losses to loans experienced by the corporation over the last five years. This policy did not change during the year ending 2003. Management anticipates that charge-off amounts will approximate $200,000 to $300,000 in 2004. s 38ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSESconnection with impaired loans.
2003 2002 2001 2000 1999 ---------------- ---------------- ----------------- ---------------- ---------------- % OF % of % of % of % of GROSS Gross Gross Gross Gross AMOUNT LOANS Amount Loans Amount Loans Amount Loans Amount Loans -------- ------- -------- ------- -------- -------- -------- ------- -------- ------- IN THOUSANDSCommercial, financial and agricultural $ 2,571 0.62% $2,582 0.68% $2,633 0.73% $2,590 0.72% $1,042 0.30% Real estate - construction 105 0.03% 65 0.02% 122 0.03% 205 0.05% 246 0.07% Real estate - mortgage 579 0.14% 402 0.11% 533 0.15% 495 0.13% 1,474 0.43% Consumer 504 0.12% 375 0.10% 360 0.10% 132 0.04% 251 0.07% Unallocated 219 0.05% 413 0.11% 75 0.02% 273 0.08% 530 0.15% --- ----- ---- ----- -- ----- --- ----- --- ----- Total $3,978 0.96% $3,837 1.02% $3,723 1.03% $3,695 1.02% $3,543 1.02% ====== ====== ====== ===== ====== ===== ====== ===== ====== =====52
NOTE E - PREMISES AND EQUIPMENT
The composition of corporation premisesPremises and equipment at December 31
waswere as follows:2003 2002 ---- ---- IN THOUSANDS Land $ 1,343 $ 1,378 Bank premises 7,607 7,422 Furniture
In thousands
2005
2004
Land
$
1,314
$
1,384
Buildings and improvements
14,782
7,659
Furniture and equipment
7,668
5,735
Construction in process
122
5,541
23,886
20,319
Accumulated depreciation
(9,190
)
(8,327
)
$
14,696
$
11,992
The decrease in construction in process in 2005 was primarily related to the Corporation’s new operations center, which was completed and
equipment 6,427 7,112 Less: Accumulated depreciation and amortization 8,324 8,730 --------- -------- Total $ 7,053 $ 7,182 ======== ======= A summary of depreciation and amortization expenses is as follows: 2003 2002 2001 ---- ---- ---- IN THOUSANDS Bank premises $ 211 $ 203 $ 172 Furniture and equipment 592 428 282 ------- ------- ------ Total $ 803 $ 631 $ 454 ====== ====== =====placed into service during 2005.NOTE F
INVESTMENT- INVESTMENTS INREAL ESTATELOW INCOME HOUSING PARTNERSHIPSACNB Corporation is a limited partner in five partnerships, whose purpose is to develop, manage and operate
Residentialresidential low-income properties.These investments are accounted for under the equity method of accounting.At December 31,20032005 and2002,2004, the carrying value of these investments was approximately$3,371,000$5,665,000 and$2,558,000,$6,153,000, respectively.NOTE G
NONPERFORMING ASSETS The- DEPOSITSDeposits were comprised of the following
table presents information concerning the aggregate amount of nonperforming assetsas of December 31:
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- IN THOUSANDSNonaccrual loans $ 4,413 $ 1,037 $ 837 $ 1,318 $ 1,615 90 days past due still accruing 606 1,379 1,003 1,528 1,920 Restructured loans -- -- -- -- -- Other real estate owned 561 559 1,646 981 171 --------- --------- -------- --------- --------- Total Nonperforming Assets $ 5,580 $ 2,975 $ 3,486 $ 3,827 $ 3,706 ======= ======= ======= ======= =======39If interest due on all nonaccrual loans had been accrued at original contract rates, it is estimated that income before taxes would have been greater than$82,000 in 2003, $55,000 in 2002, and $99,000 in 2001. The corporation does not accrue interest on any loan when principal or interest are in default for 90 days or more, unless the loan is well secured and in the process
In thousands
2005
2004
Non-interest bearing demand
$
79,428
$
74,667
Interest bearing demand
122,269
111,664
Savings
232,803
236,722
Time certificates of deposit less than $100,000
198,853
187,819
Time certificates of deposit greater than $100,000
46,028
36,000
$
679,381
$
646,872
53
Scheduled maturities of
collection. Consumer loans and residential real estate loans secured by 1-to-4 family dwellings shall ordinarily not be subject to these guidelines. When a loan is placed in a nonaccrual status, all previously accrued, but uncollected, interest is charged against the interest income account. Previously accrued interest is not charged-off if principal and interest are protected by sound collateral values. NOTE H TIME DEPOSITS Time deposits in denominations of $100,000 or more at December 31, 2003 and 2002, are summarized in the following table. The interest expense related totime certificates of depositin denominations of $100,000 or more totaled $,1,153,000 in 2003, $1,275,000 in 2002, and $1,583,000 in 2001. 2003 2002 ---- ---- IN THOUSANDS Time certificates of deposit $ 35,003 $ 33,657 Other time deposits 1,000 1,000 Maturities of time deposits of $100,000 or more outstandingat December 31,2003 and 2002, are summarized2005 were as follows:2003 2002 ---- ---- IN THOUSANDS Three months or less $ 7,420 $ 7,432 Over three through six months 3,245 6,560 Over six through twelve months 4,928 5,007 Over twelve months 20,410 15,658 --------- --------- Total 36,003 $ 34,657 ======== ========
In thousands
2006
$
134,265
2007
50,775
2008
28,600
2009
15,467
2010
15,774
$
244,881
NOTE
IH - LEASE COMMITMENTSCertain branch offices and equipment are leased under agreements which expire at varying dates through
2011.2016. Most leases contain renewal provisions at thecorporation'sCorporation’s option. The total rental expense for all operating leases was$200,000, $192,000,$528,000, $504,000, and$151,000$200,000 for the years ended December 31, 2005, 2004 and 2003,2002 and 2001,respectively.The following is a schedule by years of future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31:
IN THOUSANDS 2004.............................................................. $ 437 2005.............................................................. 416 2006.............................................................. 293 2007.............................................................. 170 2008.............................................................. 106 Later years....................................................... 178 -------- Total Minimum Payments............................................ $1,600 ====== 40
In thousands
2006
$
412
2007
316
2008
227
2009
211
2010
190
Later years
693
$
2,049
NOTE
JI - BORROWINGSFederal funds purchased, securities sold under agreements to repurchase,Short-term borrowings and
other short-term borrowings generally mature within one to 90 days from the date originated. The following is a summary of aggregate short-term borrowings for the years December 31, 2003, 2002 and 2001, respectively. 2003 2002 2001 ---- ---- ---- IN THOUSANDS Amount outstanding at year-end $ 69,676 $ 56,445 $ 51,501 Averageweighted-average interestrate at year-end 1.20% 1.84% 2.13% Maximum amount outstanding at any month-end $ 75,867 $ 73,064 $ 57,965 Average amount outstanding $ 47,472 $ 46,295 $ 36,355 Weighted average interest rate 1.64% 2.16% 3.76% LONG TERM BORROWINGS DECEMBER 31 -------------------------- IN THOUSANDS 2003 2002 ---- ---- FHLB nonredeemable advance, 4.27% due 2012 $ 10,000 $ 10,000 FHLB nonredeemable advance, 4.41% due 2012 $ 10,000 $ 10,000 FHLB nonredeemable advance, 1.95% due 2005 $ 25,000 $ -- FHLB nonredeemable advance, 1.82% due 2005 $ 20,000 $ -- FHLB nonredeemable advance, 1.62% due 2005 $ 12,000 $ -- FHLB nonredeemable advance, 2.32% due 2006 $ 10,000 $ -- -------- --------- Total $ 87,000 $ 20,000 ======== ========= At December 31, 2003, the bank had an overnight advance from the Federal Home Loan Bank of Pittsburgh of $29,320,000 at an interest rate of 1.03% and a similar borrowing of $20,050,000rates at December 312002. The Corporation's capacity to borrow fromare as follows:
2005
2004
In thousands
Amount
Rate
Amount
Rate
Treasury tax and loan note
$
450
4.23
%
$
450
2.10
%
Federal Home Loan Bank (FHLB) overnight advance
34,965
4.23
30,706
2.21
Securities sold under repurchase agreements
23,892
2.11
33,810
1.51
$
59,307
3.38
%
$
64,966
1.84
%
54
Under an agreement with the FHLB,
totaled approximately $365,000,000the Bank has a line of credit available in the amount of $85,000,000, of which $34,965,000 was outstanding at December 31,2003, with $116,320,000 outstanding2005. All FHLB advances are collateralized by a security agreement covering qualifying loans and unpledged U.S. Treasury, agency and mortgage-backed securities. In addition, all FHLB advances are secured by the FHLB capital stock owned by the Corporation having a par value of $8,734,000 at December 31, 2005 and $9,951,000 at December 31, 2004.The Corporation offers a short-term investment program for corporate customers for secured investing. This program consists of overnight and short-term repurchase agreements that are secured by designated investment securities of the Corporation. The investment securities are under the control of the Corporation.
A summary of long-term debt as of
that date.December 31 is as follows:
2005
2004
In thousands
Amount
Rate
Amount
Rate
FHLB fixed-rate advances maturing:
2005
$
—
—
%
$
57,000
1.83
%
2006
55,000
2.91
55,000
2.91
2007
25,000
3.60
—
—
2008
20,000
3.96
—
—
2012
10,000
4.41
10,000
4.41
FHLB convertible advance maturing:
2012
10,000
4.27
10,000
4.27
Loan payable to local bank
5,778
6.50
—
—
$
125,778
3.61
%
$
132,000
2.66
%
The FHLB advances are collateralized by the security agreement and FHLB capital stock described previously. The Corporation can borrow a maximum of $442,272,000 from the FHLB, of which $287,307,000 was available at December 31, 2005. The FHLB has the option to convert the $10,000,000 convertible advance but not before three-month LIBOR reaches 8%. Upon the FHLB’s conversion, the Bank has the option to repay the respective advance in full.
The loan payable to a local bank is payable in monthly installments of $52,569 and matures in January 2020. The loan is unsecured.
55
NOTE
KJ - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS AND ADVANCESCertain restrictions exist regarding the ability of the bank to transfer funds to the
corporationCorporation in the form of cash dividends, loans or advances. The approval of the Office of the Comptroller of the Currency is required to pay dividends in excess of earnings retained in the current year plus retained net profits for the preceding two years. As of December 31,2003, $8,568,0002005, $7,538,000 of undistributed earnings of the bank, included in consolidated retained earnings, was available for distribution to thecorporationCorporation as dividends without prior regulatory approval. Additionally, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.Under national banking laws, the
bankBank is also limited as to the amount it may loan to its affiliates, including thecorporation,Corporation, unless such loans are collateralized by specific obligations. At December 31,2003,2005, the maximum amount available for transfer from thebankBank to thecorporationCorporation in the form of loans was approximately$7,054,000.$7,352,000.NOTE
LK - INCOME TAXESThe
compositioncomponents ofapplicableincometaxes (benefits)tax expense for the years ended December 31,was allocated2005, 2004 and 2004 are as follows:
2003 2002 2001 ---- ---- ---- IN THOUSANDSIncome from continuing operations $ 3,142 $ 3,107 $ 3,734 Stockholders' equity for other comprehensive
In thousand
2005
2004
2003
Federal:
Current
$
1,483
$
1,905
$
2,996
Deferred
(140
)
350
146
1,343
2,255
3,142
State:
Current
67
—
—
$
1,410
$
2,255
$
3,142
Reconciliations of the statutory federal income tax at a rate to the income
(1,959) 1,789 (90) ------ ---------- --- Total $ 1,183 $ 4,896 $ 3,644 ========= ========= =========41Incometax expenseattributable to other comprehensivereported in the consolidated statements of incomeconsists of the following at December 31: 2003 2002 2001 ---- ---- ---- IN THOUSANDS Unrealized gains (losses) on securities arising during the period $ (1,963) $ 1,803 $ 89 Unfunded pension liability 4 (14) (179) --------- ------- ------- Income Tax (Benefit) Expense Related to Other Comprehensive Income $ (1,959) $ 1,789 (90) ========= ======= === Income tax expense attributable to income from continuing operations consists of the following at December 31: 2003 2002 2001 ---- ---- ---- IN THOUSANDS Currently payable $ 2,996 $ 3,456 $ 4,124 Deferred tax benefit 146 (349) (390) --------- ------- ------- Applicable Income Tax $ 3,142 $ 3,107 $ 3,734 ========= ========= ========= Forfor the years ended December 31,the applicable income tax expense attributable to income from continuing operations differs from the tax expense computed by applying the federal statutory rate to pretax earnings. The components of the differences2005, 2004 and 2003 are as follows:
Percentage of Income
before Income Taxes
2005
2004
2003
Federal income tax at statutory rate
34.0
%
35.0
%
35.0
%
Tax-exempt income
(4.7
)
(3.2
)
(2.2
)
Earnings on investment in life insurance
(2.8
)
(2.0
)
(1.8
)
Gain on proceeds from life insurance
—
—
(5.4
)
Rehabilitation and low-income housing credits
(9.0
)
(9.9
)
(2.4
)
Other
(1.5
)
(0.4
)
(0.6
)
16.0
%
19.5
%
22.6
%
56
The provision for federal income taxes includes $(90,000), $390,000 and $697,000 of income taxes (benefit) related to net gains (losses) on sales of securities in 2005, 2004 and 2003,
2002 2001 ---- ---- ---- IN THOUSANDS Income taxes at statutory rate $ 4,869 $ 4,204 $ 4,225 Increase (Decrease) resulting from: Tax-exempt income (1,320) (353) (266)respectively. Rehabilitation and low-income housing income tax credits(336) (670) (186) Other (71) (74) (39) --------- ------- ------- Applicable Income Taxes $ 3,142 $ 3,107 $ 3,734 ========= ======== ======== The significant componentswere $789,000 during 2005, $1,139,000 during 2004, and $337,000 for 2003. Projected credits are $677,000 in 2006 to 2009, $544,000 in 2010 and $1,527,000 thereafter.Components of deferred tax assets and
deferred taxliabilities at December 312003 and 2002, arewere as follows:IN THOUSANDS 2003 2002 ---- ---- Deferred tax assets: Allowance for loan losses $ 1,370 $ 1,322 Deferred compensation 440 450 Unfunded pension liability 189 193 Other 196 380 ---------- --------- Total gross deferred tax assets 2,195 2,345 --------- --------- Deferred tax liabilities: Depreciation 131 153 Net unrealized gains on available-for-sale securities 238 2,201 ---------- --------- Total gross deferred tax liabilities 369 2,354 ---------- --------- Net Deferred Tax (Liability) Asset $ 1,826 $ (9) ======== ======== Since the corporation has historically had strong earnings, management believes the deferred tax assets are realizable. Income taxes paid during 2003, 2002 and 2001, were $2,856,000, $4,004,000 and $4,090,000, respectively. 42
In thousands
2005
2004
Deferred tax assets:
Allowance for loan losses
$
1,529
$
1,351
Available for sale securities
2,547
949
Accrued deferred compensation
356
346
Additional minimum pension liability
215
227
Deferred loan fees
106
129
AMT credit carryforward
131
215
Other
409
158
5,293
3,375
Deferred tax liabilities:
Accumulated depreciation
125
141
Prepaid benefit cost
460
268
Prepaid expenses
280
264
865
673
Net Deferred Tax Assets
$
4,428
$
2,702
57
NOTE
ML - RETIREMENT PLANSThe
corporation'sCorporation’s banking subsidiary has a non-contributory pension plan. Retirement benefits are a function of both years of service and compensation. The funding policy is to contribute annually the amount that is sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act.Information pertaining to the activity in the plan, using a measurement date of November 1, 2005 is as follows:
In thousands
2005
2004
Change in benefit obligation:
Benefit obligation, at beginning of year
$
15,296
$
13,308
Service cost
538
436
Interest cost
825
783
Actuarial (gain) loss
(314
)
1,240
Benefits paid
(514
)
(471
)
Benefit obligation, at end of year
15,831
15,296
Change in plan assets:
Fair value of plan assets at beginning of year
12,186
10,649
Actual return on plan assets
721
758
Employer contribution
1,250
1,250
Benefits paid
(514
)
(471
)
Fair value of plan assets at end of year
13,643
12,186
Funded Status
(2,188
)
(3,110
)
Unrecognized net actuarial loss
3,062
3,373
Unrecognized transition asset
83
95
Unrecognized prior service costs
389
429
Prepaid Benefit Cost
1,346
787
Recognition of additional minimum liability
(1,098
)
(1,183
)
Net Prepaid (Accrued) Pension Cost
$
248
$
(396
)
The
totalaccumulated benefit obligation totaled $13,395,000 and $12,582,000 at December 31, 2005 and 2004, respectively. The intangible pensionexpenseasset totaled $472,000 and $523,000 at December 31, 2005 and 2004, respectively.58
The components of net periodic benefit cost for the years ended December 31
2003, 2002, 2001 was $567,000, $578,000 and $406,000, respectively. The following tables provide a reconciliation ofare as follows:
In thousands
2005
2004
2003
Components of net periodic benefit cost:
Service cost
$
538
$
436
$
356
Interest cost
825
783
735
Expected return on assets
(876
)
(740
)
(656
)
Recognized net actuarial loss
152
74
47
Amortization of transition asset
12
12
12
Amortization of prior service costs
40
49
73
Net Periodic Benefit Cost
$
691
$
614
$
567
For the
changes in the plan benefit obligations and fair value of plan assets for the two planyears ended December 31, 2005, 2004 and 2003,and 2002, and a statement ofthefunded statusassumptions used to determine the net periodic benefit cost are asof December 31, 2003 and 2002. 2003 2002 IN THOUSANDS RECONCILIATION OF BENEFIT OBLIGATIONS: Benefit obligations - beginning of year $ 11,550 $ 11,426 Service costs 358 424 Interest costs 735 702 Actuarial (gains) losses 1,150 (849) Benefit payments (483) (295) Plan changes -- 142 ------- -------- Benefit Obligations - End of Year 13,308 11,550 ------- -------- RECONCILIATION OF FAIR VALUE OF PLAN ASSETS: Fair value offollows:
2005
2004
2003
Discount rate
5.50
%
5.50
%
6.00
%
Expected long-term rate of return on plan assets
7.50
%
7.50
%
7.25
%
Annual salary increase
4.69
%
4.69
%
4.66
%
The Corporation’s pension plan
assets - beginning of year 8,679 8,680 Actual return on plan assets 1,299 6 Employer contributions 1,154 288 Benefits paid (483) (295) ------- -------- Fair Value of Plan Assets - End of Year 8,679 10,649 ------- -------- RECONCILIATION OF FUNDED ASSETS: Funded statusweighted-average assets’ allocations at December 31,(under funded) over (2,659) (2,871) funded Unrecognized net actuarial loss 2,225 1,776 Unrecognized transition asset (obligation) 107 119 Unrecognized prior service costs 478 550 ------- -------- Prepaid (accrued) benefit cost 151 (426) Recognition of additional minimum liability (540) (560) ------- -------- Net Accrued Pension $ (389) $ (986) ------- -------- The accumulated benefit obligation was $11,038,0002005 and$9,665,000 at December 31, 2003 and 2002, respectively. During 2002, the frozen defined benefit plan of the bank acquired in 1999 was merged into the existing plan. The following table provides the components of net periodic benefit costs for the years ending December 31: 2003 2002 2001 ---- ---- ---- IN THOUSANDS COMPONENTS OF NET PERIODIC BENEFIT COSTS: Service costs $ 344 $ 424 $ 343 Interest costs 735 702 665 Expected return on assets (644) (689) (662) Recognized net actuarial loss 47 74 -- Amortization of transition asset 12 -- (2) Amortization of prior service costs 73 67 62 ------- ------- ------- Net Periodic Benefit Costs $ 567 $ 578 $ 406 ===== ===== ===== The assumptions used in the measurement of the benefit obligations are shown in the following table: Weighted average assumptions as of December 31: 2003 2002 2001 ---- ---- ---- Discount rate 6.00% 6.50% 6.25% Expected return on plan assets 7.25% 7.75% 8.25% Rate of compensation increase 4.66% 4.62% 4.69% The corporation's pension plan weighted-average assets allocation at December 31, 2003 and 2002, by asset category2004 are as follows:Plan Assets at December 31 --------------------------- Asset Category 2003 2002 - ------------------------- ------------ ------------ Equity Securities 30% 19% Debt Securities 7% 5% Real Estate 63% 75% Other 0% 1% ------------ ------------ 100% 100% ============ ============ 43
2005
2004
Equity securities
56
%
59
%
Debt securities
38
34
Real estate
6
7
100
%
100
%
Equity securities included
corporationCorporation common stock in amounts of$962,000, 10%$759,000, 6% of total plan assets and$791,000, 9%$939,000, 8% of total plan assets at December 31,20032005 and2002,2004, respectively.The
corporationBank expects to contribute$1,154,650$1,250,000 to its pension plan in2004.2006.59
Based on current data and assumptions, the following benefit payments, which reflect expected future service, as appropriate, are expected to be paid over the next
10ten fiscalyears. ----------------------------- ---------------------------- YEAR BENEFIT PAYMENT ----------------------------- ---------------------------- 2004 $550,000 ----------------------------- ---------------------------- 2005 $590,000 ----------------------------- ---------------------------- 2006 $660,000 ----------------------------- ---------------------------- 2007 $670,000 ----------------------------- ---------------------------- 2008 $690,000 ----------------------------- ---------------------------- 2009-2013 $5,750,000 ----------------------------- ----------------------------years:
In thousands
2006
$
670
2007
680
2008
700
2009
820
2010
880
2011-2015
5,400
The
corporation'sCorporation’s banking subsidiaryhasmaintains a 401(k)Salary Deferralplan for the benefit of eligible employees. Employees may contribute up to 100% of their compensation subject to certain limits based on federal tax laws. The Bank makes matching contributions up to 100% of the first 4% of an employee’s compensation contributed to the plan. Matching contributions vest to the employee equally over a 5 year period. Bank contributions to the Planwhich covers all eligible employees.were $289,000, $276,000, and $251,000 for 2005, 2004 and 2003, respectively.The Corporation’s banking subsidiary maintains non-qualified compensation plans for selected senior officers. The estimated present value of future benefits is accrued over the period from the effective date of the agreements until the expected retirement dates of the individuals. The balance accrued for these plans included in other liabilities as of December 31, 2005 and 2004 totaled $1,039,000 and $991,000, respectively. The annual expense included in salaries and benefits
amounted to $251,000, $240,000expense totaled $142,000, $143,000, and$204,000 for$116,000 during the years ended December 31, 2005, 2004 and 2003,2002 and 2001,respectively.The corporation has non-qualified salary agreements with certain senior management. The future commitmentsTo fund the benefits under thesearrangements have been funded through corporate-owned variable rateplans, the Bank is the owner of single premium life insurancepolicies.policies on participants in the non-qualified retirement plans. At December 31,20032005 and2002,2004, thepresentcash surrender value of these policies were $3,501,000 and $3,380,000, respectively.NOTE M - REGULATORY MATTERS
The Corporation and the
future obligations was $943,000Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and$913,000, respectively.possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Theinsurance policies includedcapital amounts and classification 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 the Corporation and the Bank to maintain minimum amounts and ratios (set forth below) of Tier 1 capital to average assets and of Tier 1 and total capital (as defined in
other assets had a total cash valuethe regulations) to risk-weighted assets. Management believes, as of$3,776,000 and $3,614,000, respectively, atDecember 31,20032005, that the Corporation and2002.the Bank meet all capital adequacy requirements to which they are subject.60
As of December 31, 2005, the most recent notification from the regulators categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The actual and required capital amounts and ratios were as follows:
Actual
For Capital Adequacy
Purposes
To be Well Capitalized
under Prompt
Corrective Action
Provisions
Dollars in thousands
Amount
Ratio
Amount
Ratio
Amount
Ratio
CORPORATION:
As of December 31, 2005:
Tier 1 leverage ratio (to average assets)
$
73,214
7.81
%
$
³37,495
³4.0
%
N/A
N/A
Tier 1 risk-based capital ratio (to risk-weighted assets)
73,214
13.14
³22,286
³4.0
N/A
N/A
Total risk-based capital ratio (to risk-weighted assets)
77,670
13.94
³44,572
³8.0
N/A
N/A
As of December 31, 2004:
Tier 1 leverage ratio (to average assets)
$
74,521
8.34
%
$
>35,656
>4.0
%
N/A
N/A
Tier 1 risk-based capital ratio (to risk-weighted assets)
74,521
13.91
³21,429
³4.0
N/A
N/A
Total risk-based capital ratio (to risk-weighted assets)
78,459
14.64
³42,874
³8.0
N/A
N/A
BANK:
As of December 31, 2005:
Tier 1 leverage ratio (to average assets)
$
69,065
7.44
%
$
³37,145
³4.0
%
$
³46,431
³5.0
%
Tier 1 risk-based capital ratio (to risk-weighted assets)
69,065
12.69
³21,773
³4.0
³32,655
³6.0
Total risk-based capital ratio (to risk-weighted assets)
73,521
13.51
³43,547
³8.0
³54,419
³10.0
As of December 31, 2004:
Tier 1 leverage ratio (to average assets)
$
67,598
7.35
%
$
>36,788
>4.0
%
$
>45,985
>5.0
%
Tier 1 risk-based capital ratio (to risk-weighted assets)
67,598
12.77
³21,174
³4.0
³31,736
³ 6.0
Total risk-based capital ratio (to risk-weighted assets)
71,506
13.52
³42,311
³8.0
³52,889
³10.0
61
NOTE N
COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT- FINANCIAL INSTRUMENTS WITHOFF-BALANCEOFF BALANCE SHEET RISKThe
corporationCorporation is a party to financial instruments withoff-balanceoff balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instrumentsincludeconsist primarily of commitments to extend credit (typically mortgages and commercial loans) and, to a lesser extent, standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet.The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit
and financial guarantees which involve, to varying degrees, elementsis represented by the contractual amount ofcredit risk in excess of the amount recognized in the consolidated statements of condition.those instruments. ThecorporationCorporation uses the same credit policies in making commitments and conditional obligations as it does foron-balanceon balance sheet instruments.A summary of significant commitments and contingent liabilities at December 31, 2003 and 2002, is presented below. 2003 2002 ---- ---- IN THOUSANDSThe Corporation does not anticipate any material losses from these commitments.Commitments to extend credit,
$ 68,654 $ 54,495 Standby lettersincluding commitments to grant loans and unfunded commitments under lines ofcredit 5,915 5,775 Commitments to extendcredit, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. ThecorporationCorporation evaluates eachcustomer'scustomer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by thecorporationCorporation uponextensionextensions of credit, is based onmanagement'smanagement’s credit evaluation of thecreditor. The typecustomer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties. On loans secured by real estate, the Corporation generally requires loan to value ratios ofcollateral may vary; however, a significant portion of these financial instruments is secured through real estate.no greater than 80%.Standby letters of credit
and financial guarantees writtenare conditional commitments issued by thecorporationCorporation to guarantee the performance of a customer to a third party.TheseThose guarantees are primarily issued to support public and private borrowingarrangements.arrangements and similar transactions. The terms of the letters of credit vary and may have renewal features. The credit risk involved inissuingusing letters of credit is essentially the same as that involved in extending loans to customers.CONCENTRATIONS OF CREDIT RISKThecorporation has a diversified loan portfolio and grants agribusiness, commercial and residential loans to customers, substantially all of whom are local residents in the corporation's primary marketplace. 44CONTINGENT LIABILITIES The corporationCorporation holds collateral supporting those commitments for which collateral isparty to litigation and claims arising in the normal course of business.deemed necessary. Managementafter consultation with legal counsel,believes that theliabilities, if any, arising fromproceeds obtained through a liquidation of suchlitigation and claims will notcollateral would bematerialsufficient to cover theconsolidated financial position. NOTE O RELATED PARTY TRANSACTIONSmaximum potential amount of future payments required under the corresponding guarantees. Theaggregate balancecurrent amount ofloans (in excess of $60,000) made to directors and executive officers inthenormal course of businessliability as of December 31,20032005 and2002, was $1,377,0002004 for guarantees under standby letters of credit issued is not material.The Corporation has not been required to perform on any financial guarantees, and
$1,568,000, respectively. The termshas not incurred any losses on its commitments, during the past two years.A summary of
these loansthe Corporation’s commitments at December 31 weresubstantially the sameasthose for unrelated parties.
Balance at Balance at Number January 1, Amounts December 31, of 2003 Additions Collected 2003 Debtorsfollows:
In thousands
2005
2004
Commitments to extend credit
$
116,893
$
73,268
Standby letters of credit
5,961
5,732
62
NOTE O -
-----------------------------------------------------------------------------------------$1,568,000 $694,000 $885,000 $1,377,000 9NOTE P DISCLOSURES ABOUTFAIR VALUE OF FINANCIAL INSTRUMENTSStatement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", requires all entities to disclose the estimated fair value ofManagement uses its
financial instrument assets and liabilities. For 2003 and 2002, approximately 96% of the corporation's assets and 90% of its liabilities are considered financial instruments as definedbest judgment inStatement of Financial Accounting Standards No. 107. Many of the corporation's financial instruments, however, lack an available trading market as characterized by a willing buyer and a willing seller engaging in an exchange transaction. Therefore, significant estimations and present value calculations were used by the corporation for the purposes of this disclosure. The following methods and assumptions were used to estimateestimating the fair value ofeach class ofthe Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments,for which it is practicable to estimatethevalue. Financial instruments actively tradedfair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in asecondary marketsales transaction on the dates indicated. The estimated fair value amounts have beenvalued using quoted available market prices.measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.
DECEMBER 31, 2003 December 31, 2002 -------------------------- -------------------------- ESTIMATED CARRYING Estimated Carrying FAIR VALUE AMOUNT Fair Value Amount ---------- -------- ---------- -------- IN THOUSANDSCash and due from banks $ 32,381 $ 32,381 $ 18,089 $ 18,089 Interest bearing deposits with banks 1,033 1,033 1,009 1,009 Investment securities 396,192 395,299 316,874 314,047 Interest receivable 2,470 2,470 4,300 4,300The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. For the following financial instruments, the carrying amount is a reasonable estimate of fair value:
Cash and cash equivalents
Interest-bearing deposits in banks
Accrued interest receivable
Restricted investment in bank stocks
Short-term borrowings
Accrued interest payable
Securities
Fair values for
netsecurities are based on quoted market prices, where available. If quoted market prices are not available, fair value is based on quoted market prices of comparable securities.Mortgage Loans Held for Sale
Fair values of mortgage loans held for sale are
estimated for portfolios with similar financial characteristics.based on existing commitments from investors or prevailing market prices.Loans
are segregated into commercial, residential real estate,For variable rate loans that reprice frequently and
consumer. The loan categories are further segmented into fixed and adjustable types. Fair value for adjustable-rate commercial loans is considered to be the same aswhich entail no significant changes in credit risk, the carrying amount is a reasonable estimate of fair value. For fixed rate loans, fair valuebecause these loans were made based on the corporation's prime lending rate, whichisthe same rate these loans would be written as of the date of this financial statement. Fixed-rate commercial loans have been revalued at a rate the corporation would use if the loans were written as of December 31, 2003 and 2002. Mortgages and consumer loans have been revaluedestimated using discounted cashflows. The mortgages were estimated using market ratesflow analysis, atDecember 31, 2003 and 2002, and consumer loans were revalued using rates being charged by the corporation at year-end 2003 and 2002. Fair value for nonperforming loans is based on current valuations of underlying collateral.
DECEMBER 31, 2003 December 31, 2002 -------------------------- ------------------------------ ESTIMATED CARRYING Estimated Carrying FAIR VALUE AMOUNT Fair Value Amount ---------- -------- ---------- -------- IN THOUSANDSNet loans $ 415,195 $ 411,051 $ 370,973 $ 368,469 Mortgage loans held for sale 86 86 2,544 2,544Under Statement of Financial Accounting Standards No. 107, for December 31, 2003 and 2002, the asset and liability price tables published by the Office of Thrift Supervisor were used to value deposits with no stated maturities. The fair value 45of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using theinterest rates currently offered fordepositsloans with similar terms to borrowers of similarremainingcredit quality.Deposits
For demand deposits, the carrying amount is a reasonable estimate of fair value. For time deposits, fair value is estimated using discounted cash flow analysis, at interest rates currently offered for time deposits with similar maturities.
Long-Term Borrowings
The fair
value estimates do not includevalues of thebenefit that results fromCorporation’s long-term borrowings are estimated using discounted cash flow analyses based on thelow-cost funding providing by the deposit liabilities, compared to the costCorporation’s current incremental borrowing rates for similar types of borrowingfunds inarrangements.63
Off-Balance Sheet Credit-Related Instruments
Off-balance sheet instruments of the
market.
DECEMBER 31, 2003 December 31, 2002 -------------------------- -------------------------- ESTIMATED CARRYING Estimated Carrying FAIR VALUE AMOUNTBank consist of letters of credit, loan commitments and unfunded lines of credit. FairValue Amount ---------- -------- ---------- -------- IN THOUSANDSDeposits with no stated maturities $ 392,163 $ 417,259 $ 330,498 $ 353,253 Deposits with stated maturities 223,459 222,129 232,920 229,362 Repurchase agreements 37,975 39,906 34,101 35,945 Federal funds purchased and demand notes 450 450 450 450 Federal Home Loan Bank borrowings 119,968 116,320 40,792 40,050 Interest payable 2,158 2,158 2,451 2,451The fairvalueof commitments to extend creditis estimated using fees currently charged for similar agreements, taking into account the remaining terms of the agreements and thecreditworthinesscounterparties credit standings. Any fees charged are immaterial.Estimated fair values of
the counterparties. For loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements, or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The contract amount and the estimated fair value for commitments to extend credit and standby credits are charted.
DECEMBER 31, 2003 December 31, 2002 -------------------------- -------------------------- ESTIMATED CARRYING Estimated Carrying FAIR VALUE AMOUNT Fair Value Amount ---------- -------- ---------- -------- IN THOUSANDSCommitments to extend credit $ 68,654 $ 68,654 $ 54,495 $ 54,495 Standby letters of credit 5,915 5,915 5,775 5,775Fair value estimates are based on existing on- and off-balance sheetfinancial instrumentswithout attemptingat December 31 were as follows:
2005
2004
In thousands
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
Financial assets:
Cash and due from banks
$
18,382
$
18,382
$
21,757
$
21,757
Interest-bearing deposits in banks
892
892
938
938
Investment securities:
Available for sale
348,713
348,713
381,383
381,383
Held to maturity
19,165
19,192
24,560
25,089
Loans held for sale
60
60
511
511
Loans, less allowance for loan losses
489,008
475,868
436,631
433,345
Accrued interest receivable
4,367
4,367
4,283
4,283
Restricted investment in bank stocks
9,053
9,053
10,271
10,271
Financial liabilities:
Deposits
679,381
678,968
646,872
647,728
Short-term borrowings
59,307
59,307
64,966
64,966
Long-term borrowings
125,778
125,358
132,000
134,108
Accrued interest payable
2,820
2,820
2,277
2,277
Off-balance sheet financial instruments
—
—
—
—
NOTE P - CONTINGENCIES
The Corporation is subject to
estimateclaims and lawsuits which arise primarily in thevalueordinary course offuture businessbusiness. Based on information presently available and advice received from legal counsel representing thevalueCorporation in connection with any such claims and lawsuits, it is the opinion ofassetsmanagement that the disposition or ultimate determination of any such claims andliabilities that arelawsuits will notconsidered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets and liabilities and property and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses canhave asignificantmaterial adverse effect on thefair value estimates.consolidated financial position, consolidated results of operations or liquidity of the Corporation.64
NOTE Q - ACNB CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
STATEMENTS OF CONDITION
DECEMBER 31 -------------------------------- IN THOUSANDS 2003 2002 ---- ---- ASSETSCash $ 1,523 $ 103 Securities and other assets 4,498 3,199 Investment in common stock of subsidiary 66,424 62,164 Receivable from subsidiary 185 1,219 --------- --------- TOTAL ASSETS $ 72,630 $ 66,685 ========= ========= LIABILITIES Accrued expenses $ 408 $ 392 --------- --------- STOCKHOLDERS' EQUITY Common stock (par value $2.50; 20,000,000 shares authorized; 5,436,101 and 5,436,101 issued and outstanding shares on 12/31/03 and 12/31/02, respectively) 13,590 13,590 Retained earnings 68.632 52,703 -------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 72,630 $ 66,685 ======== =========46
December 31,
In thousands
2005
2004
ASSETS
Cash
$
548
$
475
Investment in banking subsidiary
64,321
65,956
Investment in other subsidiaries
6,642
296
Investments in low income housing partnerships
5,665
6,153
Securities and other assets
1,202
1,114
Receivable from banking subsidiary
1,679
935
Total Assets
$
80,057
$
74,929
LIABILITIES AND STOCKHOLDERS’ EQUITY
Long-term debt
$
5,778
$
—
Other liabilities
269
408
Stockholders’ equity
74,010
74,521
Total Liabilities and Stockholders’ Equity
$
80,057
$
74,929
STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 ------------------------------------ IN THOUSANDS 2003 2002 2001 ---- ---- ---- INCOMEDividend from subsidiary $ 6,338 $ 6,871 $ 5,284 Interest income 5 -- 3 EXPENSE 213 112 132 ---------- --- ----------- INCOME BEFORE TAXES AND EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARY 6,130 6,759 5,155 Applicable tax benefit (422) (730) (231) ---- INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARY 6,552 7,489 5,386 Equity in undistributed net income of subsidiary 4,216 1,415 2,951 ---------- ---------- ---------- NET INCOME $ 10,768 $ 8,904 $ 8,337 ======== ========= =========
Years Ended December 31,
In thousands
2005
2004
2003
Dividends from banking subsidiary
$
4,947
$
6,592
$
6,338
Other dividends
32
31
5
4,979
6,623
6,343
Expenses
924
384
213
4,055
6,239
6,130
Income tax benefit
1,092
1,256
422
5,147
7,495
6,552
Equity in undistributed earnings of subsidiaries
2,229
1,813
4,216
Net Income
$
7,376
$
9,308
$
10,768
65
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 --------------------------------- IN THOUSANDS 2003 2002 2001 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIESDividends and interest received $ 6,343 $ 6,871 $ 5,287 --------- --------- --------- Net Cash Provided by Operating Activities 6,871 6,343 5,287 CASH FLOWS FROM INVESTING ACTIVITIES Investment in equity investments (77) (950) (714) Investments in other assets (8) -- (52) --------- --------- --------- Net Cash Used in Investing Activities (85) (950) (766) CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (4,838) (5,871) (4,783) Retirement of common stock -- -- (76) --------- --------- --------- Net Cash Used in Financing Activities (4,838) (5,871) (4,859) --------- --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,420 50 (338) --------- --------- --------- CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 103 53 391 --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,523 $ 103 $ 53 ========= ========== ========= RECONCILIATION OF NET INCOME OF NET CASH PROVIDED BY OPERATING ACTIVITIES Net income $ 10,768 $ 8,904 $ 8,337 Increase in investment in common stock of subsidiary (4,216) (1,415) (2,951) Decrease (Increase) in receivable from subsidiary 1,034 (730) (231) Loss (Gain) on equity investment (1,243) 112 132 --------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 6,343 $ 6,871 $ 5,287 ========= ========= =========
Years Ended December 31,
In thousands
2005
2004
2003
CASH FLOWS FROM OPERATING ACTIVITIES
Dividends and interest received
$
4,979
$
7,172
$
7,996
Reimbursements from subsidiaries
347
—
—
Payments to vendors
(438
)
(384
)
(213
)
Other
14
—
—
Net Cash Provided by Operating Activities
4,902
6,788
7,783
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in low income housing partnerships
(95
)
(2,944
)
(1,025
)
Purchase of insurance agency
(5,565
)
—
—
Purchase of securities
—
—
(500
)
Net Cash Used in Investing Activities
(5,660
)
(2,944
)
(1,525
)
CASH FLOWS USED IN FINANCING ACTIVITIES
Proceeds from long-term debt
6,000
—
—
Repayments on long-term debt
(222
)
—
—
Dividends paid
(4,947
)
(4,892
)
(4,838
)
Net Cash Provided by (Used in) Financing Activities
831
(4,892
)
(4,838
)
Net Increase (Decrease) in Cash and Cash Equivalents
73
(1,048
)
1,420
CASH AND CASH EQUIVALENTS - BEGINNING
475
1,523
103
CASH AND CASH EQUIVALENTS - ENDING
$
548
$
475
$
1,523
RECONCILIATION OF NET INCOME OF NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income
$
7,376
$
9,308
$
10,768
Equity in undistributed earnings of subsidiaries
(2,229
)
(1,813
)
(4,216
)
(Increase) decrease in receivable from banking subsidiary
(744
)
(750
)
1,034
Other
499
43
197
Net Cash Provided by Operating Activities
$
4,902
$
6,788
$
7,783
66
NOTE R
FINANCIAL INFORMATION RELATING TO OPERATING SEGMENTS (UNAUDITED) Management- ACQUISITIONOn January 5, 2005, the Corporation acquired 100 percent of Russell Insurance Group, Inc. (RIG), a Westminister, Maryland-based full service insurance agency, as a subsidiary of the
corporation monitorsCorporation. The results of RIG’s operations have been included in the consolidated financial statements since that date. RIG offers a broad range of property andevaluates four segments of its operations, which includecasualty, life and health insurance to both commercialconsumer, mortgage lendingandinvestment securities. The corporation's marketplace isindividual clients in northern Maryland and south centralPennsylvania which encompasses Adams CountyPennsylvania.The carrying amounts of the tangible assets acquired and
areas in contiguous countiesthe liabilities assumed on January 5, 2005, approximated their fair value. The excess ofYork, Franklin and Cumberland, as well as sectionsthe acquisition cost over the fair value ofnorthern Maryland. Commercial lending includes commercial mortgages, real estate development, accounts receivable financing, and agricultural loans. Consumer lending programs include home equity loans, automobile and recreational vehicle loans, and manufactured housing loans. Mortgage lending programs include personal residential mortgages, residential construction loans, and speculative construction loans. Management measuresthe netinterest income of each segment based uponassets acquired has been recorded as goodwill. The aggregate purchase price was $5,663,000, including certain capitalized costs. In accordance with theearnings and fees for each segment recognized less the charge for the funds 47used. The charge for funds used is based on the average cost of funds used by the respective segment. Other non-interest expense, which includes salaries and employee benefits, occupancy and equipment expense, and other expenses, is allocated to each segment and is netted against net interest income after provision to possible loan losses to arrive at income before income taxes for each respective segment. The following tables are for the years ending December 31, 2003 and 2002, by the four operating segments:
Commercial Consumer Mortgage Investment 2003 IN THOUSANDS Lending Lending Lending Securities Other Total - ------------------------------------------------------------------------------------------------------------------------------------Total interest income $ 10,075 $ 5,385 $ 8,211 $ 13,018 $ -- $ 36,689 Charge for funds used (6,173) (2,763) (4,514) (11,969) 11,474 (13,945) ------------ ----------- ------------ ----------- ----------- ----------- Net Interest Income 3,902 2,622 3,697 1,049 11,474 22,744 Provision for possible loan losses 103 90 72 -- -- 265 ------------- ------------- -------------- -------------- ------------- ------------- Net Interest Income After Provision _for Possible Loan Losses 3,799 2,532 3,625 1,049 11,474 22,479 Non-interest income 47 13 147 1,992 7,230 9,429 Non-interest expense (1,515) (946) (1,574) (53) (13,910) (17,998) ------------ ------------ ------------ -------------- ---------- ----------- Income Before Income Taxes $ 2,331 $ 1,599 $ 2,198 $ 2,988 $ 4,794 $ 13,910 =========== ========== =========== =========== ========== ========== Average Funds Used $ 178,471 $ 79,882 $ 130,509 $ 346,079 $ 77,387 $ 812,328 ========= ========= ========= ========= ========= =========
Commercial Consumer Mortgage Investment 2002 IN THOUSANDS Lending Lending Lending Securities Other Total - ------------------------------------------------------------------------------------------------------------------------------------Total interest income $ 9,707 $ 5,390 $ 9,656 $ 13,041 $ -- $ 37,794 Charge for funds used (6,526) (2,894) (5,658) (9,175) 10,800 (13,453) ------------ ------------ ------------ ------------- ------------ ---------- Net Interest Income 3,181 2,496 3,998 3,866 10,800 24,341 Provision for possible loan losses (144) (126) (100) -- -- 370 ------------- ------------- ------------- -------------- -------------- ----------- Net Interest Income After Provision for Possible Loan Losses 3,037 2,370 3,898 3,866 10,800 23,971 Non-interest income 10 59 118 -- 4,841 5,028 Non-interest expense (1,333) (850) (1,293) (104) (13,408) (16,988) ------------ ------------- ------------ ---------- ----------- ---------- Income Before Income Taxes $ 1,714 $ 1,579 $ 2,723 $ 3,762 $ 2,233 $ 12,011 =========== =========== =========== ============ =========== =========== Average Funds Used $ 159,088 $ 70,535 $ 137,929 $ 223,644 $ 68,143 $ 659,339 ========= ========== ========= ========== ========== ==========
Commercial Consumer Mortgage Investment 2001 IN THOUSANDS Lending Lending Lending Securities Other Total - ------------------------------------------------------------------------------------------------------------------------------------Total interest income $ 11,500 $ 4,123 $ 12,268 $ 11,270 $ -- $ 39,161 Charge for funds used (7,861) (2,369) (7,806) (6,858) 8,838 (16,056) ----------- ----------- ------------ ------------ ----------- ----------- Net Interest Income 3,639 1,754 4,462 4,412 8,838 23,105 ----------- ----------- ------------ ------------ ----------- ----------- Provision for possible loan losses (94) (82) (64) -- -- 240 ------------- ------------- -------------- ------------ ------------ ------------- Net Interest Income After Provision for Possible Loan Losses 3,545 1,672 4,398 4,412 8,838 22,865 Non-interest income 39 70 91 -- 3,333 3,533 Non-interest expense (1,279) (532) (1,141) (11,335) (14,327) ----------- ------------ ------------ ----------- ---------- ----------- (40) Income Before Income Taxes $ 2,305 $ 1,210 $ 3,348 $ 4,372 $ 836 $ 12,071 =========== ========== =========== =========== =========== ========== Average Funds Used $ 153,221 $ 46,180 $ 152,142 $ 162,021 $ 60,443 $574,007 ========= ========= ========= ========= ========= =========NOTE S EFFECT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets" in July 2001. SFAS No. 141 requires that all business combinations initiated after June 30, 2001, shall be accounted for using the purchase method of accounting. The pooling method of accounting is prohibited. SFAS No. 142 prescribes accounting for all purchased goodwill and intangible assets. The statement requires that acquired goodwill is not amortized, but is tested for impairment at least annually or whenever an impairment event arises. The Corporation does not have goodwill recorded on its books; accordingly these provisions have no impact on the Corporation's financial condition or results of operations. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets" was effective for 2002. This statement requires an entity to recognize an 48impairment loss if the carrying value amount of a long-lived asset or asset group is not recoverable and exceeds fair value. These authoritative guidelines had no effect on the corporation's financial condition or results of operations. SFAS No. 147, "Acquisitions of Certain Financial Institutions - an amendment of SFAS No. 72 and 144 and Interpretation No. 9 issued in October 2002, provided guidance on the applicationterms of thepurchase methodacquisition, there is contingent consideration associated with this transaction ofaccountingup toacquisitions of financial institutions.$2,882,000, subject to performance criteria for payment over three years subsequent to the acquisition. In addition, theStatement amends SFAS No. 144 to include in its scope, long-term customer-relationship intangible assets of financial institutions. Those assets are subject to the same recoverability and impairment recognition and measurement provisions provided for SFAS No. 144 effective as of October 2002. The corporationCorporation has$417,000 and $673,000 of core deposit intangibles at December 31, 2002 and 2001, respectively related to the acquisition of deposits from another institution in 2001. In addition, during 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment to SFAS No. 123 issued in December 2002; SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" issued in June 2002 and SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64." Based upon the corporation's current activities, these standards do not impact its accounting and reporting requirements. SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" issued April 2003, improved the reporting in Statement 133 by requiring that contracts with comparable characteristics be accounted for similarly as either derivatives or hybrid instruments. This Statement is generally effective for contractsentered intoor modified after June 30, 2003a three-year employment contract witha few exceptions. This statement requires loan commitments that relate toFrank Russell, Jr., theoriginationPresident ofmortgage loans thatRIG.The purchase price of $5,663,000, which includes closing costs of $220,000, was allocated as follows (in thousands):
Cash
$
628
Intangible asset
3,230
Goodwill
2,334
Other assets
1,049
Other liabilities
(1,578
)
$
5,663
The intangible asset, representing the customer base, will be
heldamortized over 10 years. Goodwill will not be amortized but will be analyzed annually forsaleimpairment. Amortization of goodwill and the intangible asset will be deductible for tax purposes.In 2005, RIG acquired two additional books of business with an aggregate purchase price of $368,000. This amount is being amortized over 10 years.
NOTE S - SEGMENT AND RELATED INFORMATION
Russell Insurance Group is managed separately from the banking and related financial services that the Corporation offers. Russell Insurance Group offers a broad range of property and casualty, life and health insurance to
be accountedboth commercial and individual clients.Segment information for 2005 is as
derivative instruments by the issuer of the loan commitment. Under this statement loan origination fees need to be adjusted to fair value at the balance sheet date. This authoritative guidance had no effect on the corporation's financial condition or results of operations as the loan origination fees on mortgage loans held for sale by the corporation approximates fair value. 49follows (in thousands):
Commissions from insurance sales
$
4,121
Income before income taxes
1,108
Total assets
7,729
67
QUARTERLY RESULTS OF OPERATIONS
Selected quarterly information for the years ended December 31,
20032005 and2002,2004 is as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ---------------- --------------- --------------- 2003 IN THOUSANDS, EXCEPT PER SHARE DATAInterest income $ 9,565 $ 9,012 $ 8,982 $ 9,130 Interest expense 3,696 3,728 3,292 3,229 ---------- ---------- ---------- ---------- Net interest income 5,869 5,284 5,690 5,901 ---------- ---------- ---------- ---------- Provision for possible loan losses 60 60 60 85 ---------- ---------- ---------- ---------- Net income $ 2,467 $ 1,885 $ 3,151 $ 3,265 ========= ========= ========= ========= Basic earnings per share 0.45 0.35 0.58 0.60 Return on average assets 1.30% 0.93% 1.51% 1.52% 2002 Interest income $ 9,409 $ 9,350 $ 9,491 $ 9,544 Interest expense 3,313 3,207 3,324 3,609 ---------- ---------- ---------- ---------- Net interest income 6,096 6,143 6,167 5,935 ---------- ---------- ---------- ---------- Provision for possible loan losses 60 60 60 190 ---------- ---------- ---------- ---------- Net income $ 2,274 $ 2,220 $ 2,294 $ 2,116 ========= ========= ========= ========= Basic earnings per share 0.42 0.41 0.42 0.39 Return on average assets 1.47% 1.41% 1.37% 1.28%
In thousands, except per share data
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
2005
Interest income
$
10,096
$
10,357
$
10,702
$
11,114
Interest expense
3,746
4,001
4,448
4,796
Net interest income
6,350
6,356
6,254
6,318
Provision for loan losses
90
90
168
168
Net interest income after provision for loan losses
6,260
6,266
6,086
6,150
Net gains (losses) on sales of securities
—
(272
)
8
—
Other income
2,293
2,283
2,359
2,245
Other expenses
6,471
6,548
6,669
6,614
Net income
$
2,082
$
1,729
$
1,784
$
1,781
Basic earnings per share
0.38
0.32
0.33
0.33
Dividends per share
0.21
0.21
0.21
0.28
2004
Interest income
$
8,938
$
9,182
$
10,004
$
9,628
Interest expense
3,069
3,085
3,491
3,538
Net interest income
5,869
6,097
6,513
6,090
Provision for loan losses
75
75
75
75
Net interest income after provision for loan losses
5,794
6,022
6,438
6,015
Net gains (losses) on sales of securities
817
(46
)
243
99
Other income
1,139
1,179
1,234
1,200
Other expenses
5,629
5,337
5,476
4,384
Net income
$
2,121
$
1,818
$
2,439
$
2,930
Basic earnings per share
$
0.39
$
0.33
$
0.45
$
0.54
Dividends per share
$
0.21
$
0.21
$
0.21
$
0.27
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
LETTER REGARDING CHANGE IN CERTIFYING ACCOUNTANT On October 8, 2003, Stambaugh Ness, PC, the Registrant's principal accountants, notified the Registrant that it will decline to stand for appointment after completion of the current audit for calendar year 2003. Services to be provided by Stambaugh Ness, PC, through the end of the calendar year 2003 included the interim review for the third quarter ended September 30, 2003. Stambaugh Ness, PC, has chosen not to continue to provide independent auditing services to companies who report to the Securities and Exchange Commission. Stambaugh Ness, PC, will provide a letter of final resignation in 2004. On December 11, 2003, the Audit Committee of the Registrant's Board of Directors voted to engage Beard Miller Company, LLP, as principal accountants to replace Stambaugh Ness, PC. The change will become effective for the 2004 year end audit including interim reviews commencing with the first quarter ending March 31, 2004.In connection with
auditsthe change of accountants for thetwofiscalyearsyear endedDecember 31, 2002, and subsequent interim periods through October 8, 2003,2004, there were no disagreements with Stambaugh Ness, PC on any matter of accounting principles or practices, financial statement disclosure, or auditing scope orprocedures,procedure, which disagreements if not resolved to the satisfaction of StambaughNess' satisfaction,Ness, PC would have caused them to make referenceto the subject matter of the disagreementthereto inconnection with its report. The audittheir reportsof Stambaugh Ness, PC,on the financial statementsof ACNB Corporation as of andfor such year. In addition, during theyearsfiscal year ended December 31,2002 and 2001, did not contain any adverse opinion or disclaimer of opinion, nor2003, there werethey qualified or modified asno reportable events (as defined in Regulation S-K Item 304(a)(1)(v)).68
ITEM 9A - CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Within 90 days prior to
uncertainty, audit scope, or accounting principles. We have provided Stambaugh Ness, PC, with a copy of the foregoing disclosures. Attached as Exhibit 16.1 is a copy of Stambaugh Ness' letter dated December 18, 2003, stating that it has found no basis for disagreement with such statements. During the years ended December 31, 2002 and 2001 and the subsequent interim periods throughthe date of this Form8-K, neither10-K, theregistrant nor anyone onCorporation carried out an evaluation, under the supervision and with the participation of itsbehalf consulted Beard Miller Company LLP on any matters or reportable events listed in Item 304 (a)(2)(i) and (ii). 50ACNB did not consult with Beard Miller Company LLP prior to its engagement regarding the application of accounting principles to a specified transaction, either completed or proposed, the type of audit opinion that might be rendered on the financial statements of ACNB or any matter that was either the subject of a disagreement or a reportable event within the meaning of Item 304(a)(1) of Regulation S-K. ITEM 9A - CONTROLS AND PROCECURES Ourmanagement, includingour principal executivethe Chief Executive Officer andprincipal financial officer, has evaluatedPrincipal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and proceduresas of December 31, 2003. Our disclosure controlspursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer andprocedures are designed to provide reasonable assurancePrincipal Financial Officer concluded that, theinformation required to be disclosed in this Form 10-K annual report has been appropriately recorded, processed, summarized and reported. Based on that evaluation, our principal executive and principal financial officer has concluded that ourCorporation’s disclosure controls and procedures are effectiveatin timely alerting them to material information relating to thereasonable assurance level. Our management, includingCorporation (including its consolidated subsidiaries) required to be included in ourprincipal executiveperiodic SEC filings.Based on our evaluation of the effectiveness of the design and
principaloperation of the disclosure controls and procedures, our Chief Executive Officer and Principal Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of December 31, 2005. The Corporation believes that the accompanying financialofficer, has evaluated anystatements fairly present the financial condition and results of operations for the fiscal years presented in this report on Form 10-K.CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
We have made no significant changes in
ourthe Corporation’s internalcontrolcontrols over financial reportingthat occurred during thein connection with our fourth quarterof 2003, and has concludedevaluation thatthere was no change during the fourth quarter of 2003 that haswould materiallyaffected,affect, orisare reasonably likely to materially affect our internal controls over financial reporting.69
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
ACNB Corporation (“ACNB”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles, and as such, include some amounts that are based on management’s best estimates and judgments.
ACNB’s management is responsible for establishing and maintaining effective internal control over financial reporting. The system of internal control over financial reporting, as it relates to the financial statements, is evaluated for effectiveness by management and tested for reliability through a program of internal audits and management testing and review. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
The Board of Directors of ACNB, through its Audit Committee, meets regularly with management, internal auditors, and the independent registered public accounting firm. The Audit Committee provides oversight to ACNB by reviewing audit plans and results, and evaluates management’s actions for internal control, accounting and financial reporting matters. The internal auditors and independent registered public accounting firm have direct and confidential access to the Audit Committee to discuss the results of their examinations.
Management assessed the effectiveness of ACNB’s internal control over financial reporting as of December 31, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our assessment, management concluded that as of December 31, 2005, ACNB’s internal control over financial reporting is effective and meets the criteria of the Internal Control - Integrated Framework.
ACNB’s independent registered public accounting firm, Beard Miller Company LLP, has issued an attestation report on management’s assessment of ACNB’s internal control over financial reporting. This report appears on pages 71 and 72.
/s/ Thomas A. Ritter
/s/ David W. Cathell
Thomas A. Ritter
David W. Cathell
President and Chief Executive Officer
Principal Financial Officer
70
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of ACNB CorporationWe have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that ACNB Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
71
In our opinion, management’s assessment that ACNB Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, ACNB Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the December 31, 2005 and 2004 consolidated statements of condition and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended of ACNB Corporation, and our report dated February 24, 2006 expressed an unqualified opinion.
/s/ BEARD MILLER COMPANY LLP
Beard Miller Company LLP
Harrisburg, Pennsylvania
February 24, 2006
None.
72
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item, relating to directors, executive officers, and control persons, is set forth in sections
"Principal“Principal Beneficial Owners of theCorporation's Stock", "InformationCorporation’s Stock,” “Information as to Nominees, Directors and ExecutiveOfficers"Officers” and"Principal“Principal Officers of theCorporation"Corporation” of theRegistrant'sRegistrant’s definitive Proxy Statement to be used in connection with the20042006 Annual Meeting of Shareholders, which pages are incorporated herein by reference.SECTION 16(A) BENEFICIAL OWNERSHIP COMPLIANCE.Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Registrant'sRegistrant’s officers and directors, and persons who own more than 10 percent of a registered class of theRegistrant'sRegistrant’s equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission, or SEC. Officers, directors and greater than 10 percent shareholders are required by SEC regulation to furnish the Registrant with copies of all Section 16(a) forms they file.Based solely on its review of the copies of such forms received by it or written representations from certain reporting persons that no Forms 5 were required for those persons, the Registrant believes that during the period of January 1,
2003,2005, through December 31,2003,2005, its officers and directors were in compliance with all filing requirements applicable tothem; except, however,them.The Corporation has adopted a Code of Ethics that applies to directors, officers, and employees of the Corporation and the Bank. A copy of the Code of Ethics was included as an exhibit to the Corporation’s Form 10-K for the year ended December 31, 2003 and filed with the Securities and Exchange Commission. A request for the Corporation’s Code of Ethics can be made either in writing to Lynda
L.Glass,inadvertently filed one report, reporting one transaction, late.ACNB Corporation, 16 Lincoln Square, Gettysburg, Pennsylvania, 17325-0129 or by telephone to 717-334-3161.ITEM 11 - EXECUTIVE COMPENSATION
Incorporated by reference in response to this Item 11 is the information under the headings
"Executive Compensation"“Executive Compensation” and"ACNB Corporation"“ACNB Corporation” inthe 2004 Annual MeetingACNB Corporation’s 2006 definitive Proxy Statement.ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference in response to this Item 12 is the information appearing under the
headings "Share Ownership"heading “Share Ownership” inthe 2004 Annual MeetingACNB Corporation’s 2006 definitive Proxy Statement.ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in response to this Item 13 is the information appearing under the heading
"Transactions“Transactions with Directors and ExecutiveOfficers"Officers” inthe 2004 Annual MeetingACNB Corporation’s 2006 definitive ProxyStatement and under "Notes to Consolidated Financial Statements - Note O - Related Party Transactions" located elsewhere in this Form 10-K.Statement.ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required hereunder is incorporatedIncorporated by reference
fromin response to this Item 14 is thecorporation's 2004 Annual Meetinginformation appearing under heading “Report of Audit Committee” in ACNB Corporation’s definitive ProxyStatement under the section "Report of the Audit Committee." 51Statement. 73
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K. (A)(a) 1. FINANCIAL STATEMENTS
The following financial statements are filed as part of this report:
o•Report of Independent Registered Public Accounting Firm
•Consolidated Statements of Condition
o•Consolidated Statements of Income
o•Consolidated Statements of Changes in
Shareholders'Stockholders’ Equityo•Consolidated Statements of Cash Flows
o•Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
Financial statement schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto.
(B).(b) EXHIBITS
3(i) - Articles of Incorporation of ACNB Corporation, as
amended (incorporated by reference to registrant's annual report on Form 10-K for the year ended December 31, 2001, filed with the Commission on March 20, 2002).amended.3(ii) - Bylaws of Registrant; a copy of the Bylaws, as amended, of ACNB Corporation is incorporated by reference to Exhibit 99 of the
Registrant'sRegistrant’s Current Report on Form 8-K, filed with the Commission on December 19, 2003.10.1 - Executive Employment Agreement Dated as of January 1, 2000 between Adams County National Bank, ACNB Corporation and Thomas A. Ritter. (Incorporated by reference to Exhibit 99 of the
Registrant'sRegistrant’s Current Report on Form 8-K, filed with the Commission on March 26, 2001).1110.2 -
Statement RegardingACNB Corporation, ACNB Acquisition Subsidiary LLC, Russell Insurance Group, Inc. Stock Purchase Agreement. (Incorporated by reference to Exhibit 10.2 of theComputationRegistrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)10.3 - Salary Continuation Agreement - applicable to Thomas A. Ritter, Lynda L. Glass, John W. Krichten, John M. Kiehl, Carl L. Ricker and Ronald L. Hankey. (Incorporated by reference to Exhibit 10.3 of
Earnings Per Share 12the Registrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)10.4 -
Statements re: ComputationExecutive Supplemental Life Insurance Plan - applicable to Gary Bennett, Lynda L. Glass, Ronald L. Hankey, John M. Kiehl, John W. Krichten, Carl L. Ricker and Thomas A. Ritter. (Incorporated by reference to Exhibit 10.4 ofRatios (Included hereinthe Registrants Form 10K for the year ended December 31, 2004 filed with the Commission onpages 11March 15, 2005.)10.5 - Director Supplemental Life Insurance Plan - applicable to Philip P. Asper, Frank Elsner, III, D. Richard Guise, Wayne E. Lau, William B. Lower, Daniel W. Potts, Marian B. Schultz, Jennifer L. Weaver and
25)Harry L. Wheeler. (Incorporated by reference to Exhibit 10.5 of the Registrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)10.6 - Director Deferred Fee Agreement - applicable to Frank Elsner, III, D. Richard Guise, Marian B. Schlutz, Jennifer L. Weaver and Harry L. Wheeler. (Incorporated by reference to Exhibit 10.6 of the Registrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)
74
10.7 - Adams County National Bank Salary Savings Plan. (Incorporated by reference to Exhibit 10.2 of the Registrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)
10.8 - Group Pension Plan for Employees of Adams County National Bank. (Incorporated by reference to Exhibit 10.2 of the Registrants Form 10K for the year ended December 31, 2004 filed with the Commission on March 15, 2005.)
14 - Code of Ethics (incorporated by reference to Exhibit 14 of the registrants annual report on Form 10-K for the year ended December 31, 2003, filed with the Commission on March 12, 2004)
16.1 - (Incorporated by reference to Exhibit 16.1 of the registrants annual report on Form 10-K for the year ended December 31, 2003, filed with the Commission March 12, 2004)
21 - Subsidiaries of the Registrant
23 -
ConsentsConsent of Stambaugh Ness, P.C.31.1 - Chief Executive Officer certification of annual report on Form 10-K
31.2 -
ChiefPrincipal Financial Officer certification of annual report on Form 10-K32.1 - Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002
32.2 -
ChiefPrincipal Financial Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002(C). REPORTS ON FORM 8-K Form 8-K filed October 10, 200399 -
ChangesIndependent Auditor Report on the consolidated statements of income, changes inRegistrant's Certifying Accountant Form 8-K/A filed October 17, 2003 - Changes in Registrant's Certifying Accountant Form 8-K filed October 24, 2003 - Press Release announcing Registrant's Third Quarter Earnings Form 8-K filedstockholders’ equity, and cash flows of ACNB Corporation and subsidiaries for the year ended December18, 2003 - Changes in Registrant's Certifying Accountant Form 8-K filed December 19, 2003 - Bylaws of the Registrant 5231, 2003. 75
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ACNB CORPORATION (Registrant) MARCH 16, 2004 -------------- DATE
ACNB CORPORATION (Registrant)
March 14, 2006
Date
By:
/S/ THOMAS A. RITTER By: /S/ JOHN W. KRICHTEN -------------------------------------------- -------------------------------------------------/s/ Thomas A. Ritter
JohnBy:
/s/ David W.
KrichtenCathellThomas A. Ritter
David W. Cathell
President & CEO
Secretary & TreasurerPrincipal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March
16, 2004,14, 2006, by the following persons in the capacities indicated.
/S/ PHILIP P. ASPER /S/ WAYNE E. LAU --------------------------------------------- ----------------------------------------------------/s/ Philip P. Asper
Wayne E. Lau/s/ Daniel W. Potts
Philip P. Asper
Daniel W. Potts
Director
Director
/S/ GUY F. DONALDSON /S/ THOMAS A. RITTER --------------------------------------------- ---------------------------------------------------- Guy F. Donaldson/s/ Frank Elsner, III
/s/ Thomas A. Ritter
Frank Elsner, III
Thomas A. Ritter
Director
Director, President & CEO
/S/ FRANK ELSNER, III /S/ MARIAN B. SCHULTZ --------------------------------------------- ---------------------------------------------------- Frank Elsner, III/s/ D. Richard Guise
/s/ Marian B. Schultz
Director Director /S/ D. RICHARD GUISE /S/ JENNIFER L. WEAVER --------------------------------------------- ----------------------------------------------------D. Richard Guise
Jennifer L. WeaverMarian B. Schultz
Director & Vice Chairman of the Board
Director
Board /S/ RONALD L. HANKEY /S/ HARRY L. WHEELER --------------------------------------------- ----------------------------------------------------/s/ Ronald L. Hankey
/s/ Alan J. Stock
Ronald L. Hankey
Alan J. Stock
Director and Chairman of the Board
Director
/s/ Edgar S. Heberlig
/s/ Jennifer L. Weaver
Edgar S. Heberlig
Jennifer L. Weaver
Director
Director
/s/ Wayne E. Lau
/s/ Harry L. Wheeler
Wayne E. Lau
Harry L. Wheeler
Director
and ChairmanDirector
/S/ EDGAR S. HEBERLIG --------------------------------------------- Edgar S. Heberlig Director53EXHIBIT INDEX
PAGEEXHIBIT 3(i) Articles of Incorporation of ACNB Corporation, as amended (incorporated by reference to registrant's annual report on Form 10-K for the year ended December 31, 2001, filed with the Commission on March 20, 2002.) EXHIBIT 3(ii) Bylaws of Registrant A copy of the Bylaws, as amended, of ACNB Corporation is incorporated by reference to Exhibit 3(ii) of the Registrant's Current Report on Form 8-K, filed with the Commission on December 19, 2003. EXHIBIT 10.1 Executive Employment Agreement Dated as of January 1, 2000 between Adams County National Bank, ACNB Corporation and Thomas A. Ritter. (Incorporated by reference to Exhibit 99 of the Registrant's Current Report on Form 8-K, filed with the Commission on March 26, 2001). EXHIBIT 11 Statement Regarding the Computation of Earnings Per Share................................................55 EXHIBIT 12 Statements re: Computation of Ratios (Included herein on pages 11 and 25) EXHIBIT 14 Code of Ethics............................................................................................56 EXHIBIT 21 Subsidiaries of the Registrant............................................................................60 EXHIBIT 23 Consent of Stambaugh Ness, P.C............................................................................61 EXHIBIT 31.1 Chief Executive Officer certification of annual report on Form 10-K.......................................62 EXHIBIT 31.2 Chief Financial Officer certification of annual report on Form 10-K.......................................63 EXHIBIT 32.1 Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002 ...........................................64 EXHIBIT 32.2 Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002 ...........................................655476