ACNB CORPORATION
ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly ACNB Corporation’s financial position as of June 30, 2006 and 2005, and the results of its operations, changes in stockholders’ equity and cash flows for the three and six months ended June 30, 2006 and 2005. All such adjustments are of a normal recurring nature.
The accounting policies followed by the Corporation are set forth in Note A to the Corporation’s financial statements in the 2005 ACNB Corporation Annual Report on Form 10-K, filed with the SEC on March 15, 2006. The results of operations for the six month period ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year. For comparative purposes, the June 30, 2005 balances have been reclassified to conform with the 2006 presentation. Such reclassifications had no impact on net income.
2. Earnings Per Share
Earnings per share are based on the weighted average number of shares of stock outstanding during each period. Weighted average shares outstanding for the three month and six month periods ended June 30, 2006 and 2005 were 5,436,101. The Corporation does not have dilutive securities outstanding.
3. Components of Net Periodic Benefit Cost
The components of net periodic benefit costs for the three month and six month periods ended June 30 were as follows:
| | Three Months Ended June 30, | | Six Months Ended June 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Service cost | | $ | 142 | | $ | 134 | | $ | 283 | | $ | 268 | |
Interest cost | | 213 | | 206 | | 426 | | 412 | |
Expected return on plan assets | | (254 | ) | (219 | ) | (508 | ) | (438 | ) |
Recognized net actuarial loss | | 31 | | 38 | | 63 | | 76 | |
Other, net | | 13 | | 13 | | 26 | | 26 | |
Net Periodic Benefit Cost | | $ | 145 | | $ | 172 | | $ | 290 | | $ | 344 | |
The Corporation previously disclosed in its financial statements for the year ended December 31, 2005 that it expected to contribute $1,250,000 to its pension plan in 2006. As of June 30, 2006, $0 of contributions have been made.
4. Guarantees
The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation, generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $4,473,000 in standby letters of credit, as of June 30, 2006. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees should be sufficient to cover the potential amount of future payment required under the corresponding guarantees. The current amount of the liability, as of June 30, 2006 for guarantees under standby letters of credit issued is not material.
6
ACNB CORPORATION
ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Comprehensive Income
The Corporation’s other comprehensive income items are unrealized gains (losses) on securities available for sale and unfunded pension liability. There was no change in the unfunded pension liability during the three month and six month periods ended June 30, 2006 and 2005. The components of other comprehensive income (loss) for the three month and six month periods ended June 30 were as follows:
| | Three Months Ended June 30, | | Six Months Ended June 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Unrealized holding gains (losses) on available for sale securities arising during the period | | $ | (1,662 | ) | $ | 4,166 | | $ | (3,170 | ) | $ | (3,017 | ) |
Reclassification of (gains) losses realized in net income | | (204 | ) | 272 | | (204 | ) | 272 | |
Net Unrealized Gains (Losses) | | (1,866 | ) | 4,438 | | (3,374 | ) | (2,745 | ) |
Tax effect | | 651 | | (1,554 | ) | 1,179 | | 961 | |
Other Comprehensive Income (Loss) | | $ | (1,215 | ) | $ | 2,884 | | $ | (2,195 | ) | $ | (1,784 | ) |
6. Acquisition of Russell Insurance Group, Inc.
On January 5, 2005, the Corporation acquired 100 percent of Russell Insurance Group, Inc.(RIG), a Westminster, Maryland-based full service insurance agency, as a subsidiary of the Corporation. The results of RIG’s operations have been included in the consolidated financial statements since that date.
The carrying amounts of the tangible assets acquired and the liabilities assumed on January 5, 2005, approximated their fair value. The excess of the acquisition cost over the fair value of the net assets acquired has been recorded as goodwill. The aggregate purchase price was $5,663,000, including certain capitalized costs. In accordance with the terms of the acquisition, there is contingent consideration associated with this transaction of up to $2,882,000, subject to performance criteria for payment over three years subsequent to the acquisition. In addition, the corporation has entered into a three-year employment contract with Frank Russell, Jr., the President of RIG.
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, is being amortized over 10 years. Goodwill is not amortized but is analyzed annually for impairment. Amortization on goodwill and the intangible asset are deductible for tax purposes.
7
7. Segment 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 both commercial and individual clients.
Segment information for the three and six month periods ended June 30, 2006 and 2005 are as follows (in thousands):
| | Three Months Ended
June 30, | | Six Months Ended
June 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Commissions from insurance sales | | $ | 1,062 | | $ | 1,001 | | $ | 2,337 | | $ | 2,039 | |
Income before income taxes | | $ | 302 | | $ | 297 | | $ | 828 | | $ | 584 | |
Total assets | | | | | | $ | 8,323 | | $ | 7,651 | |
8
ACNB CORPORATION
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION AND FORWARD-LOOKING STATEMENTS
INTRODUCTION
The following is management’s discu ssion 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. The consolidated financial statements include its wholly-owned subsidiaries, Adams County National Bank, Russell Insurance Group, Inc. and Pennbanks Insurance Company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee or assure and is not necessarily indicative of similar performance in the future.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Form 10-Q 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 reflect management’s analysis, as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time-to-time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q, filed by the Corporation and any Current Reports on Form 8-K filed by the Corporation.
CRITICAL ACCOUNTING POLICIES
The accounting policies that the Corporation’s management deems to be most important to the portrayal of its financial condition and results of operations, and that require management’s most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management:
The allowance for loan losses represents management’s estimate of probable losses inherent in 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 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.
The evaluation of goodwill and intangibles for impairment requires a significant amount of judgment, and includes consideration of various factors, including estimates of future income from the customer base. Impairment would be recognized through a charge to earnings.
9
NEW ACCOUNTING PRONOUNCEMENTS
FAS 155
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Corporation is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have a material impact on the Corporation’s financial position and results of operations.
FAS 156
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets — An Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Corporation will be as of the beginning of fiscal 2007. The Corporation does not believe that the adoption of SFAS 156 will have a significant effect on its financial statements.
FIN 48
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Corporation is currently evaluating the impact of adopting FIN 48 on its financial statements.
RESULTS OF OPERATIONS
Net income for the three months ended June 30, 2006 was $1,931,000 compared to $1,729,000 for the same quarter in 2005, an increase of $202,000 or 12%. Earnings per share increased from $.32 in 2005 to $.36 in 2006. Net interest income increased $52,000 or 1%, provision for loan losses increased $135,000 or 150%, other income increased $606,000 or 30% and other expenses increased $26,000, or 3%.
Net income for the six months ended June 30, 2006 was $3,657,000 compared to $3,811,000 for the same six month period in 2005, a decrease of $154,000 or 4%. Earnings per share decreased from $.70 in 2005 to $.67 in 2006. Net int erest income decreased $22,000, or less than 1%, provision for loan losses increased $270,000 or 150%, other income increased $807,000 or 19% and other expenses increased $332,000 or 3%.
Quarter ended June 30, 2006 compared to quarter ended June 30, 2005
Net Interest Income
Net interest income totaled $6,310,000 during the quarter ended June 30, 2006 compared to $6,258,000 for the same period in 2005, an increase of $52,000 or 1%. Net interest income was restrained by an increase in interest expense on funding sources that are sensitive to changes in short-term rates; interest expense increased $1,534,000 or 37%. Rate sensitive funding sources include money market deposit accounts, overnight borrowings and maturities of term borrowings and certificates of deposits. The Federal Reserve increased targeted fed funds rates 200 basis points (2%) during the intervening year. The increase in funding costs mostly offset improvements to interest income which increased $1,586,000 or 15%. Improvement in interest income was a result of more volume, a better mix of higher-earning loans and rate increases. The Corporation has a strategic plan to increase asset yield and interest income by growth and rebalancing the composition of earning assets.
10
The net interest spread for the second quarter of 2006 was 2.60% compared to 2.76% during the same period in 2005. Also comparing the second quarter of 2005 to 2006, the yield on interest earning assets increased by 0.50% and the cost of interest bearing liabilities increased by 0.66%. The net interest margin was 2.87% for the second quarter of 2006 and 2.98% for the second quarter of 2005.
Average earning assets were $882,303,000 during the second quarter of 2006, an increase of $39,902,000 over the average for the second quarter of 2005. Average interest bearing liabilities were $798,631,000 in the second quarter of 2006, an increase of $41,540,000 from the same quarter in 2005.
Provision for Loan Losses
The provision for loan losses charged against earnings was $225,000 in the second quarter of 2006 compared to $90,000 in the second quarter of 2005, an increase of $135,000 or 150%. The increase was primarily a result of loan growth in the intervening period. 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. For the second quarter of 2006, the Corporation had net charge-offs of $27,000 compared with net recoveries of $7,000 for the second quarter of 2005.
Other Income
Total o ther income was $2,617,000 for the three months ended June 30, 2006, a $606,000 or 30% increase from the second quarter of 2005. A gain on investment securities in 2006, combined with a loss in the second quarter of 2005, was a primary reason for the increase between the two periods. In addition, insurance sales commissions by the Corporation’s subsidiary, Russell Insurance Group, Inc. rose by $61,000 or 6%.
Fees from deposit accounts and ATM/debit card revenue increased by $86,000 or 14% due to revised fee schedules and higher volume. Income from fiduciary activities, which includes both institutional and personal trust management services, totaled $153,000 for the three months ended June 30, 2006, as compared to $205,000 during the second quarter of 2005, a 25% decrease. Of the total decrease, brokerage services income decreased $19,000 due to the termination of an outsourced arrangement and reduced estate settlement income accounted for most of the remainder. Earnings on bank owned life insurance increased by $22,000 or 11% as a result of additional insurance coverage.
Other Expenses
The largest component of other expenses is salaries and employee benefits, which decreased by $12,000 during the second quarter of 2006 as compared to the same period a year ago. During the second quarter of 2006 the Corporation expensed the severance costs related to the June 13, 2006, settlement with the former Secretary and Treasurer of the Corporation in the amount of approximately $133,000. Overall, the decrease in salaries and employee benefits was the result of:
· Lower full-time equivalent employees offsetting normal merit increases to employees and
· Stable benefit costs after several years of rising health insurance costs.
Net occupancy expense increased by $146,000 or 36% due to the completion of the Corporation’s Operations Center in the second quarter of 2005 and the addition of two retail banking offices. Equipment expense increased $61,000 or 11% as a result of additional technology investments and relat ed maintenance expenses and depreciation associated with the overall organizational growth.
Professional services expense totaled $298,000 during second quarter of 2006, as compared to $341,000 for the same period in 2005. A technology consulting engagement accounted for the higher cost in 2005. Amounts in both years were materially higher than previous years due to expenses relating to Sarbanes-Oxley §404 compliance.
Postage increased due to an expanded customer base and additional direct mail promotions as well as a postage rate increase. Supplies also increased as a result of additional offices in the retail banking network and other operating needs.
Other operatin g expenses totaled $1,159,000 during the quarter ended June 30, 2006, compared to $1,187,000 during the second quarter of 2005. Lower expenses in 2006 included marketing expenses that in both periods included costs to further the growth and brand image of the Corporation with variances due to different promotions in each period.
11
Six months ended June 30, 2006 compared to six months ended June 30, 2005
Net Interest Income
Net interest income totaled $12,497,000 during the six months ended June 30, 2006 compared to $12,519,000 for the same period in 2005, a decrease of $22,000 or less than 1%. Net interest income was restrained by an increase in interest expense on funding sources that are sensitive to changes in short-term rates; interest expense increased $3,102,000 or 39%. Rate sensitive funding sources include money market deposit accounts , overnight borrowings and maturities of term borrowings and certificates of deposits. The Federal Reserve increased targeted fed funds rates eight times during the intervening year. The increase in funding costs offset improvements to interest income which increased $3,080,000 or 15%. Improvement in interest income was a result of more volume, a better mix of higher-earning loans and rate increases. The Corporation has a strategic plan to increase asset yield and interest income by growth and rebalancing the composition of earning assets.
The net interest spread for the first six months of 2006 was 2.60% compared to 2.78% during the same period in 2005. The yield on interest earning assets increased by 0.51% and the cost of interest bearing liabilities increased by 0.69% when comparing the first six months of each year. The net interest margin was 2.86% for the fir st six months of 2006 and 2.98% for the first six months of 2005. As the Corporation remains liability sensitive with more liabilities repricing than earning assets repricing in the next 12 months, the Corporation expects further pressure on its net interest margin, although the magnitude of the decrease and its effect on net interest income cannot be measured currently due to uncertainties in the direction and magnitude of interest rate movements and growth and mix of balance sheet components.
Average earning assets were $882,546,000 during the first six months of 2006, an increase of $35,739,000 over the average for the first six months of 2005. Average interest bearing liabilities were $800,431,000 in the first six months of 2006, an increase of $33,124,000 over the same six month period in 2005.
Provision for Loan Losses
The provision for loan losses charged against earnings was $450,000 in the first six months of 2006 compared to $180,000 in the first six months of 2005, an increase of $270,000 or 150%. The increase was primarily a result of loan growth in the intervening period. 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. For the first six months of 2006, the Corporation had net recoveries of $9,000 compared with net charge-offs of $32,000 for the first six months of 2005.
Other Income
Total other income was $5,111,000 for the six months ended June 30, 2006, an $807,000 or 19% increase from the first six months of 2005. Gains on investment securities in 2006 of $204,000, combined with losses in the first six months of 2005 of $272,000, were a primary reason for the increase between the two periods. In addition, insurance sales commissions by the Corporation’s subsidiary, Russell Insurance Group, Inc. rose by $298,000 or 15%.
Fees from deposit accounts and ATM/debit card revenue increased by $138,000 or 12% due to revised fee schedules and higher volume. Income from fiduciary activities, which includes both institutional and personal trust management services, totaled $305,000 for the six months ended June 30, 2006, as compared to $361,000 during the first six months of 2005, a 16% decrease. Brokerage services income and estate settlement incom e decreased. Earnings on bank owned life insurance increased $43,000 or 12% as a result of additional insurance coverage.
Other Expenses
The largest component of other expenses is salaries and employee benefits, which increased by $52,000, or 1%, during the first six months of 2006 as compared to the same period a year ago. During the second quarter of 2006 the Corporation expensed the severance costs related to the June 13, 2006, settlement with the former Secretary and Treasurer of the Corporation in the amount of approximately $133,000. Overall, salaries and employee benefits decreased as the result of:
· Lower full-time equivalent employees offsetting normal merit increases to employees and
· Stable benefit costs after several years of rising health insurance costs.
12
Net occupancy expense increased by $350,000 or 45% due to the completion of the Corporation’s Operations Center in 2005 and the addition of two retail banking offices. Equipment expense increased $119,000 or 10% as a result of additional technology investments and related maintenance expenses and depreciation associated with the overall organizational growth.
Professional services expense totaled $603,000 during the first six months of 2006, as compared to $666,000 for the same period in 2005. A technology consulting engagement accounted for the higher cost in 2005. Amounts in both years were materially higher than previous years due to expenses relating to Sarbane s-Oxley §404 compliance
Postage increased due to an expanded customer base and additional direct mail promotions as well as a postage rate increase. Supplies also increased as a result of additional offices in the retail banking network and other operating needs.
Other operating expenses totaled $2,200,000 during the six months ended June 30, 2006, compared to $2,263,000 during the first six months of 2005. Decreased expenses in 2006 include communications and loan collection expenses. Marketing expenses decreased by $19,000 in 2006 with variances due to the timing and scope of various promotional and advertising activities.
Income Tax Expense
The Corporation recognized income taxes of $487,000, or 20.1% of pretax income during the second quarter of 2006 as compared to $325,000, or 15.8% of pre-tax income during the same period in 2005. The Corporation recognized income taxes of $916,000, or 20.0% of pretax income during the first six months of 2006 as compared to $712,000, or 15.7% of pre-tax income during the same period in 2005. The variances from the federal statutory rate of 34% in all periods are generally due to tax-exempt income and investments in low-income housing partnerships (which qualify for federal tax credits). The higher effective tax rate in 2006 was a result of less federal tax credits. The income tax provision during the second quarter ended June 30, 2006 and 2005 included historical and low-income housing tax credits of $173,000 and $160,000, respectively. The income tax provision during the six months ended June 30, 2006 and 2005 included historical and low income housing tax credits of $346,000 and $432,000, respectively.
FINANCIAL CONDITION
Assets totaled $956,965,000 at June 30, 2006 compared to $945,136,000 at December 31, 2005 and $916,710,000 at June 30, 2005. Average earning assets during the six months ended June 30, 2006 increased to $882,546,000 from $846,807,000 during the same period in 2005. Average interest bearing liabilities increased in 2006 to $800,431,000 from $767,307,000 in 2005.
Investment Securities
ACNB uses invest ment securities to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. The investment portfolio is comprised of 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.
At June 30, 2006, the securities balance included a net unrealized loss of $6,920,000, net of taxes, on available for sale securities versus a net unrealized loss of $4,725,000, net of taxes, at December 31, 2005. The increase in interest rates during 2005 and 2006 led to the depreciation in the fair value of securities during 2006. Although rising rates decreased the value of all securities, investments in U.S. Government agencies and mortgage-backed securities purchased during periods of low interest rates sustained the large st decreases. Management has determined that the declines in fair value are not other than temporary.
Loans
Loans outstanding increased by $53,598,000 or 12% from June 30, 2005 to June 30, 2006 and $25,347,000 or 5% from December 31, 2005 to June 30, 2006. The growth in loans is consistent with the Corporation’s strategic direction to increase loans, a stable local economy and lending to support existing customers. Compared to June 30, 2005, commercial loans grew by $40 million or 22%. Commercial loan growth is the result of the strategic plan to actively lend to businesses in the market area. Additionally, ACNB has been able to participate with other local institutions on commercial lending credits. Residential real estate and home equity lending increased $13 million or 5%, as a result of a stable local housing market.
13
Most of the Corporation’s lending activities are with customers located within the south central Pennsylvania and northern Maryland region of the country. This region currently and historically has lower unemployment than the U.S. as a whole. The Corporation does not have any concentrations greater than 10% of loans to any one industry or customer.
Allowance for Loan Losses
The allowance for loan losses at June 30, 2006 was $4,915,000 or 0.95% of loans, as compared to $4,086,000 or 0.88% of loans at June 30, 2005 and $4,456,000 or 0.90% of loans at December 31, 2005. The ratio of non-performing assets plus foreclosed assets to total assets was 0.47% at June 30, 2006 as compared to 0.82% at June 30, 2005 and 0.73% at December 31, 2005.
Loans past due 90 days and still accruing were $120,000 and nonaccrual loans were $4,287,000 as of June 30, 2006, substantially all of which are secured by real estate. Loans past due 90 days and still accruing were $199,000 at December 31, 2005, while nonaccruals were $6,725,000. Nonaccrual loans decreased due to the restoration of a commercial loan to accruing status during the first six months of 2006 as it demonstrated repaying ability and sufficient collateral position.
The Corporation utilizes a systematic review of its loan portfolio on a quarterly basis in order to determine the adequacy of the allowance for loan losses. The allowance for loan losses consists of a component for individual loan impairment primarily based on the loan’s collateral fair value and other observable data. A watch list of loans is identified for evaluation based on regulatory examinations as well as internal and external loan grading and reviews. Loans other than those determined to be impaired are grouped into pools of loans with similar credit risk characteristics. These loans are evaluated as groups with allocations made to the allowance based on historical loss experience adjusted for current trends in delinquencies, trends in underwriting and oversight, concentrations of credit and general economic conditions within the Corporation’s trading area. The increase in the provision for loan losses expense for the first six months of 2006 compared to the first six months of 2005 was a result of the measurement of the adequacy of the allowance for loan losses at each period. The 2006 measurement was higher based on an increase in the loan portfolio volume that increased the allocation to pools of loans.
No additional funds are committed to be advanced in connection with impaired loans.
Premises and Equipment
Premises and equipment increased from $14,652,000 at June 30, 2005 to $14,696,000 at December 31, 2005 and to $15,111,000 at June 30, 2006. The increases from period to period were primarily related to technology investments and the upgrading of facilities.
Deposits
ACNB continues to rely on deposit growth as a primary source of funds for lending activities. Deposits increased by $2,625,000, or less than 1% from June 30, 2005 to June 30, 2006. Deposits decreased by $738,000, or less than 1% from December 31, 2005 to June 30, 2006 as customer funds held in transaction accounts were used for cash flow needs or redeployed in investments outside of the Bank. Deposit growth has centered in money market accounts and promotional certificates of deposit, both of which attract funds from the Bank’s other deposit categories as well as providing new funding sources. Deposits costs increased during the first six months of 2006, particularly in money market accounts due to movements in short-term rates.
Borrowings
Short-term borrowings are comprised primarily of securities sold under a greements to repurchase and overnight borrowings at the Federal Home Loan Bank of Pittsburgh (FHLB). As of June 30, 2006, short-term borrowings were $61,745,000, as compared to $59,307,000 at December 31, 2005 and $32,731,000 at June 30, 2005. The Corporation increased short-term borrowings by 4% from year-end 2005 to partially fund asset growth.
Long-term debt consists primarily of advances from the FHLB to fund ACNB’s asset growth. Long-term debt totaled $135,650,000 at June 30, 2006, versus $125,778,000 at December 31, 2005 and $125,900,000 at June 30, 2005. The Corporation increased long-term debt by 8% from year-end 2005 to partially fund asset growth. In the first six months of 2006, rates on FHLB advances were somewhat higher than rates required to raise new certificate of deposit funding; however, FHLB borrowing does not cause disintermediation of other deposit funds.
14
Capital
ACNB’s capital management strategies have been developed to provide attractive rates of returns to stockholders, while maintaining its “well-capitalized” position. Total Stockholders’ Equity was $73,189,000 at June 30, 2006 compared to $74,010,000 at December 31, 2005 and $74,265,000 at June 30, 2005. Stockholders’ Equity decreased in the first six months of 2006 as the accumulated other comprehensive loss exceeded earnings retained in capital. Other comprehensive loss is mainly caused by fixed-rate investment securities temporarily losing value in a rising interest rate environment.
The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During the first six months of 2006, ACNB earned $3,657,000 and paid dividends of $2,283,000 for a net retainage of $1,374,000 or 38%. During the first six months of 2005, ACNB earned $3,811,000 and paid dividends of $2,283,000 for a net retainage of $1,5282,000 or 40%.
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 invo lve quantitative measures of its assets and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications 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 requires ACNB and its banking subsidiary to maintain minimum amounts and ratios of total and Tier 1 capital to average and risk-weighted assets. Management believes, as of June 30, 2006, that ACNB and its banking subsidiary met all minimum capital adequacy requirements to which they are subject and are categorized as “well-capitalized”. There are no conditions or events since the notification that management believes have changed ACNB or the subsidiary bank’s category.
Risk-Based Capital
ACNB’s capital ratios are as follows:
| | June 30, | | December 31, | |
| | 2006 | | 2005 | |
Tier 1 leverage ratio (to average assets) | | 7.81 | % | 7.81 | % |
Tier 1 risk-based capital ratio (to risk-weighted assets) | | 12.83 | | 13.14 | |
Total risk-based capital ratio | | 13.68 | | 13.94 | |
Liquidity
Effective liquidity management ensures the cash flow requirements of depositors and borrowers, as well as the operating cash needs of ACNB, are met.
ACNB’s funds are available from a variety of sources, including assets that are readily convertible to cash, 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 June 30, 2006, ACNB had a borrowing capacity of approximately $435,000,000 from the FHLB of which $267,000,000 was available.
Another source of liquidity is securities sold under repurchase agreements to customers of ACNB’s banking subsidiary totaling $23,361,000 and $23,892,000 at June 30, 2006 and December 31, 2005, respectively.
The liquidity of the parent company (ACNB Corporation) also represents an important aspect of liquidity management. The parent company’s cash outflows consist principally of dividends to stockholders 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 subsidiary banks. The total amount of dividends that may be paid from the subsidiary bank to ACNB was $4,050,000 at June 30, 2006.
15
Off-Balance Sheet Arrangements
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. At June 30, 2006, the Corporation had unfunded outstanding commitments to extend credit of $115 million and outstanding standby letters of credit of $4 million. 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.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management monitors and evaluates changes in market conditions on a regular basis. Based upon the most recent review management has determined that there have been no material changes in market risks since year end. For further discussion of year end information, refer to the Annual Report on Form 10-K.
16
ITEM 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (“ Exchange Act”) Rule 13a-15e. Based upon that evaluation, the Corporation’s Chief Executive Officer along with the Corporation’s Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective.
Disclosure controls and procedures are corporation controls and other procedures that are designed to ensure that information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.
There were no changes in our internal control over financial reporting during our fiscal quarter ended June 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
17
PART II
ACNB CORPORATION
OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position or results of operations of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and its subsidiaries by government authorities.
ITEM 1A - RISK FACTORS
Management has reviewed the risk factors that were previously disclosed in the Form 10-K for the fiscal year ended December 31, 2005. It was determined that there are no material changes from the risk factors as previously disclosed in the Form 10-K.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS - NOTHING TO REPORT.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES - NOTHING TO REPORT.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
a. An annual meeting of shareholders was held at 1:00 p.m. on May 9, 2006 at ACNB Corporation Operations Center, 100 V-Twin Drive, Gettysburg, PA 17325.
b. Seven matters were voted upon, as follows:
Proposal to fix the number of Directors of ACNB Corporation at thirteen (13):
Votes Cast
“FOR” | | Votes Cast
“AGAINST” | | Votes
ABSTAINED |
3,926,741 | | 34,863 | | 52,222 |
Proposal to fix the number of Class 1 Directors at five (5):
Votes Cast
“FOR” | | Votes Cast
AGAINST” | | Votes
ABSTAINED |
3,920,668 | | 33,418 | | 59,740 |
Proposal to fix the number of Class 2 Directors at four (4):
Votes Cast
“FOR” | | Votes Cast
“AGAINST” | | Votes
ABSTAINED |
3,928,024 | | 26,062 | | 59,740 |
Proposal to fix the number of Class 3 Directors at four (4):
18
Votes Cast
“FOR” | | Votes Cast
“AGAINST” | | Votes
ABSTAINED |
3,925,797 | | 28,586 | | 59,443 |
Election of one (1) Class 1 Director to serve for a one-year term:
Director | | Term Expires | | Votes Cast
“FOR” | | Votes
“WITHHELD” |
Frank C. Russell, Jr. | | 2007 | | 3,900,968 | | 112,858 |
Election of four (4) Class 2 Directors to serve for a three-year term:
Director | | Term Expires | | Votes Cast
“FOR” | | Votes
“WITHHELD” |
| | | | | | |
Wayne E. Lau | | 2009 | | 3,910,009 | | 103,817 |
Alan J. Stock | | 2009 | | 3,937,871 | | 75,955 |
Jennifer L. Weaver | | 2009 | | 3,897,747 | | 116,079 |
Harry L. Wheeler | | 2009 | | 3,911,110 | | 102,716 |
To ratify the selection of bmc (Beard Miller Company LLP) as ACNB Corporation’s independent auditors for the year ending December 31, 2006.
Votes Cast
“FOR” | | Votes Cast
“AGAINST” | | Votes
“ABSTAINED” |
3,980,324 | | 12,397 | | 21,105 |
Names of Directors whose terms continue after the meeting.
Director | | | Term Expires | |
D. Richard Guise | | 2007 | |
Ronald L. Hankey | | 2007 | |
Edgar S. Heberlig | | 2007 | |
Marian B. Schultz | | 2007 | |
Philip P. Asper | | 2008 | |
Frank Elsner, III | | 2008 | |
Daniel W. Potts | | 2008 | |
Thomas A. Ritter | | 2008 | |
ITEM 5 - OTHER INFORMATION - NOTHING TO REPORT.
19
