ACNB CORPORATION INTRODUCTION AND FORWARD-LOOKING STATEMENTS
Introduction
The following is management's discussion and analysis of the significant changes in the financial condition, results of operations, comprehensive income, capital resources, and liquidity presented in its accompanying consolidated financial statements forACNB Corporation (the Corporation or ACNB), a financial holding company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee, assure or indicate similar performance in the future.
Forward-Looking Statements
In addition to historical information, this Form 10-Q may contain forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure, and other financial terms, (b) statements of plans and objectives of Management or the Board of Directors, and (c) statements of assumptions, such as economic conditions in the Corporation's market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "intends", "will", "should", "anticipates", or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties such as local economic conditions, competitive factors, and regulatory limitations. Actual results may differ materially from those projected in the forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: short- and long-term effects of inflation and rising costs on the Corporation, customers and economy; effects of governmental and fiscal policies, as well as legislative and regulatory changes; effects of new laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and their application with which the Corporation and its subsidiaries must comply; impacts of the capital and liquidity requirements of the Basel III standards; effects of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as theFinancial Accounting Standards Board and other accounting standard setters; ineffectiveness of the business strategy due to changes in current or future market conditions; future actions or inactions ofthe United States government, including the effects of short- and long-term federal budget and tax negotiations and a failure to increase the government debt limit or a prolonged shutdown of the federal government; effects of economic conditions particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by the spread of Coronavirus Disease 2019 (COVID-19) and any other pandemic, epidemic or health-related crisis and the responses thereto on the operations of the Corporation and current customers, specifically the effect of the economy on loan customers' ability to repay loans; effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; inflation, securities market and monetary fluctuations; risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest rate protection agreements, as well as interest rate risks; difficulties in acquisitions and integrating and operating acquired business operations, including information technology difficulties; challenges in establishing and maintaining operations in new markets; effects of technology changes; effect of general economic conditions and more specifically in the Corporation's market areas; failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities; acts of war or terrorism or geopolitical instability; disruption of credit and equity markets; ability to manage current levels of impaired assets; loss of certain key officers; ability to maintain the value and image of the Corporation's brand and protect the Corporation's intellectual property rights; continued relationships with major customers; and, potential impacts to the Corporation from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses. We caution readers not to place undue reliance on these forward-looking statements. They only reflect Management's analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time to time with theSecurities and Exchange Commission , including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q. Please also carefully review any Current Reports on Form 8-K filed by the Corporation with theSecurities and Exchange Commission . 36 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The accounting policies that the Corporation's management deems to be most important to the portrayal of its financial condition and results of operations, and that require management's most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management: The allowance for loan losses represents management's estimate of probable losses inherent in the loan portfolio. Management makes numerous assumptions, estimates and adjustments in determining an adequate allowance. The Corporation assesses the level of potential loss associated with its loan portfolio and provides for that exposure through an allowance for loan losses. The allowance is established through a provision for loan losses charged to earnings. The allowance is an estimate of the losses inherent in the loan portfolio as of the end of each reporting period. The Corporation assesses the adequacy of its allowance on a quarterly basis. The specific methodologies applied on a consistent basis are discussed in greater detail under the caption, Allowance for Loan Losses, in a subsequent section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. 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 the length of time the fair value has been below cost, the financial condition of the issuer, and the Corporation's intent to sell, or requirement to sell, the security before recovery of its value. Declines in fair value that are determined to be other than temporary are charged against earnings. Accounting Standard Codification (ASC) Topic 350, Intangibles -Goodwill and Other, requires that goodwill is not amortized to expense, but rather that it be assessed or tested for impairment at least annually. Impairment write-downs are charged to results of operations in the period in which the impairment is determined. The Corporation did not identify any impairment onACNB Insurance Services, Inc.'s outstanding goodwill from its most recent testing, which was performed as ofOctober 1, 2021 . A qualitative assessment on the Bank's outstanding goodwill, resulting from the 2017 New Windsor acquisition, was performed on the anniversary date of the merger which showed no impairment. Subsequent to that evaluation, ACNB concluded that it would be preferable to evaluate goodwill in the fourth quarter at year-end. This date was preferable from the anniversary date measurement as events happening nearer to year-end could be factored in if necessary. The second evaluation again revealed no impairment and it was agreed to continue to evaluate goodwill for the Bank at or near year-end. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested for impairment when such events occur. The Corporation has not identified any such events and, accordingly, has not tested goodwill resulting from the acquisition ofNew Windsor Bancorp, Inc. (New Windsor) for impairment during the three months endedMarch 31, 2022 . Other acquired intangible assets that have finite lives, such as core deposit intangibles, customer relationship intangibles and renewal lists, are amortized over their estimated useful lives and subject to periodic impairment testing. Core deposit intangibles are primarily amortized over ten years using accelerated methods. Customer renewal lists are amortized using the straight line method over their estimated useful lives which range from eight to fifteen years. RESULTS OF OPERATIONS
Quarter ended
Executive Summary
Net income for the three months endedMarch 31, 2022 , was$6,599,000 , compared to a net income of$7,471,000 for the first quarter in 2021, a decrease of$872,000 or 11.7%. Basic earnings per share for the three month periodMarch 31, 2022 and 2021 was$0.76 and$0.86 , respectively, an 11.6% decrease. The lower net income for the first quarter of 2022 was primarily a result of lessor fee income, as compared to the first quarter of 2021 in which there was a significantly higher volume of residential mortgage loans sold to the secondary market as consumers refinances and purchased homes in the low interest rate environment. Net interest income for the quarter endedMarch 31, 2022 decreased$272,000 , or 1.6%, as decreases in total interest income were more than decreases in total interest expense. Provision for loan losses was$0 for the quarter endedMarch 31, 2022 , compared to$50,000 for the same quarter in 2021, based on the adequacy analysis, resulting in an allowance to total loans of 1.28% (1.61% of non-acquired loans) atMarch 31, 2022 . Other income decreased$1,454,000 , or 24.6%, due to decreased fees from selling mortgages into the secondary market while fees from fiduciary activities and deposits increased. Other expenses decreased$505,000 , or 3.7%, due in part to adjustment of year end personnel incentive accrual due to issuance of restricted stock instead of cash and higher expense structure of the new core system. While continuing to be profitable, 37 -------------------------------------------------------------------------------- ACNB was materially impacted by Pandemic events that carried over lower than desired loans outstanding and resulting excess liquidity, affecting interest income. Net Interest Income Net interest income totaled$17,053,000 for the three months endedMarch 31, 2022 , compared to$17,325,000 for the same period in 2021, a decrease of$272,000 , or 1.6%. Net interest income decreased due to a decrease in interest income in a greater amount than the decrease in interest expenses. Interest income decreased$1,293,000 , or 6.7%, due to the change in mix of average earning assets, in addition to decreased rates outstanding due to market events in 2020 and 2021. The decrease in interest expense resulted from deposit rate decreases in addition to a favorable change in deposit mix (as discussed below). Loans outstanding on average decreased year over year due to 2021 loan paydowns and payoffs (including PPP loans) despite concerted effort by management to counteract the recent year trend of the market area's heightened competition and the COVID-19 related slow economic conditions. Active participation in the SBA Payroll Protection Program (PPP) were largely paid off by the first quarter of 2022. Earning asset yields in 2020 and 2021 were negatively impacted by declines in theU.S. Treasury yields and other market driver interest rates which carried over to the first quarter as continued low yields on the existing balance sheet even as market rates experience a massive increase in terms relevant to lending and investing during the quarter. The difference between longer term rates and shorter term rates was flat to inverted by the end of the quarter. These current driver rates will affect new loan originations and are indexed to a portion of the loan portfolio in that a change in the driver rates changes the yield on new loans and on existing loans at subsequent interest rate reset dates. From these changes in prior quarters, interest income yield was negatively affected as new loans replace paydowns on existing loans and variable rate loans reset to new current rates in these years. Partially offsetting lower yields in the first quarter were purchase accounting adjustments ($590,000 ) and PPP fees ($468,000 ) recognized that increased yield. Both fees were lower than the amounts in the first quarter of 2021(purchase accounting$885,000 and PPP fees$949,000 ), are finite in amount and nonrecurring in nature, especially the PPP fees, that will not repeat in this magnitude in upcoming periods. Interest income decreased on investment securities due to increased new purchases during 2021 at rates lower than rates on maturing investments. An elevated amount of earning assets remained in short-term, low-rate money market type accounts during the first quarter of 2022; and there exists ample ability to borrow for liquidity needs. The ability to increase lending is contingent on the lingering effects of COVID-19 on current and potential customers even with intense competition that has reduced new loans and may result in the payoff of existing loans, allowing economic conditions in the Corporation's marketplace to eventually return to its previous stable state. As to funding costs, interest rates on alternative funding sources, such as the FHLB, and other market driver rates are factors in rates the Corporation and the local market pay for deposits. However,Federal Open Market Committee (FOMC) actions, rates on transaction, savings and time deposits were sharply reduced in order to match sharply reduced market earning asset yields. Interest expense decreased$1,021,000 , or 49.9%, due to lower rates offsetting higher volume on transaction deposits, certificate of deposit rate decreases and lower volume, and by less use of higher cost borrowings. The medical need to stop the spread of COVID-19 caused government officials to close or restrict operations of many businesses and their workers. One of the responses was for theFederal Reserve to decrease rates to 0% to 0.25% and the massive injection of liquidity into markets. The resulting inflation was cause for a reversal of course with rates increased and the expectation for further increases that were anticipated and built into terms of two years through five years and longer terms to a lesser extent. The effects of these rate actions and a host of other responses currently cannot be predicted. Over the longer term, the Corporation continues its strategic direction to increase asset yield and interest income by means of loan growth and rebalancing the composition of earning assets to commercial loans. The net interest spread for the first quarter of 2022 was 2.61% compared to 2.81% during the same period in 2021. Also comparing the first quarter of 2022 to 2021, the yield on interest earning assets decreased by 0.46% and the cost of interest bearing liabilities decreased by 0.26%. The net interest margin was 2.67% for the first quarter of 2022 and 2.94% for the first quarter of 2021. The net interest margin decrease included lower purchase accounting adjustments which decreased 9 basis points, but was more impacted by sharp market rate decreases (including PPP loans fees) and less loans as a percentage in the earning asset mix and more lower yielding investments assets. The Corporation's ALCO processes continually measure and assess possibleFOMC rate actions and prepare appropriate response strategies. Average earning assets were$2,593,000,000 during the first quarter of 2022, an increase of$206,000,000 from the average for the first quarter of 2021. Average interest bearing liabilities were$1,870,000,000 in the first quarter of 2022, an increase of$149,000,000 from the same period in 2021. Non-interest demand deposits increased$65,000,000 on average over the same period in 2021. All increases were a result of COVID-19 related slow economic activity that tend to concentrate increased liquidity into the banking system, including PPP loan proceeds. Unrealized losses on available for sale investment securities were$21.4 million net of taxes atMarch 31, 2022 an increase from$3.5 million loss net of taxes atDecember 31, 2021 . The credit quality of the portfolio was high for all periods and the interest rate risk position was appropriate for a community bank and within investment policy guidelines; the increase in the other 38 -------------------------------------------------------------------------------- comprehensive loss was due to changes in interest rates relevant to the terms of the individual investments, such market rates averaged a 150 basis point increase, the highest quarterly increase in decades. This other comprehensive loss increase had no impact on regulatory capital ratios, which remain well capitalized. Nor did the increase have an effect on net income as the investments were not impaired and the losses were unrealized. Liquidity remains high and the Corporation has not traditionally sold investments for liquidity nor does it currently envision a need to do so. Since the onset of COVID-19, deposit growth has outpaced loan growth resulting in an excess liquidity position at the Corporation. Late in the quarter endedMarch 31, 2022 , the Corporation deployed excess liquidity by moving approximately$185,000,000 from cash into higher-yielding securities with a tax equivalent yield of approximately 2.80%. These new purchases were consistent with the current investment portfolio, but with higher yields to enhance the net interest margin and net interest income in future quarters.
Provision for Loan Losses
The provision for loan losses was$0 in the first quarter of 2022 and$50,000 in the first quarter of 2021. The determination of the provision was a result of the analysis of the adequacy of the allowance for loan losses calculation. The allowance for loan and lease losses generally does not include the loans acquired from theFrederick County Bancorp, Inc. acquisition completed in 2020 (FCBI) or theNew Windsor Bancorp, Inc. acquisition completed in 2017 (New Windsor), which were recorded at fair value as of the acquisition dates. Total impaired loans atMarch 31, 2022 were 10.8% lower when compared toDecember 31, 2021 . Nonaccrual loans decreased by 17.2%, or$946,000 , sinceDecember 31, 2021 ; all substandard loans increased by 0.5% in that period. Each quarter, the Corporation assesses risk in the loan portfolio compared with the balance in the allowance for loan losses and the current evaluation factors. As a result of stable loan risk metrics, combined with low credit losses in the portfolio, the provision for loan losses for the first quarter of 2022 was$0 . This customer base includes businesses in the hospitality/tourism industry, restaurants and related businesses and lessors of commercial real estate properties. The qualitative factor for this event and a related factor on commercial and industrial loan collateral was decreased. The lack of the provision in the first quarter of 2022, was despite loss incurred in year to date 2022 charge-offs as allowance for the losses were calculated in prior periods. Otherwise, Management concluded that the loan portfolio exhibited continued general stability in quantitative and qualitative measurements as shown in the tables and narrative in this Management's Discussion and Analysis and the Notes to the Consolidated Financial Statements. The long term effect of the various Pandemic and geopolitical events cannot be currently estimated other than the calculation that resulted in the above mentioned special qualitative factors. This same analysis concluded that the unallocated allowance should be in the same range in 2022 compared with the previous quarter. For more information, please refer to Allowance for Loan Losses in the following Financial Condition section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. ACNB charges confirmed loan losses to the allowance and credits the allowance for recoveries of previous loan charge-offs. For the first quarter of 2022, the Corporation had net charge-offs of$70,000 , as compared to net charge-offs of$39,000 for the first quarter of 2021.
Other Income
Total other income was$4,459,000 for the three months endedMarch 31, 2022 , down$1,454,000 , or 24.6%, from the first quarter of 2021. Fees from deposit accounts increased by$184,000 , or 23.8%, due to partial resumption of economic activity that produces fee generating activity. Fee volume varies with balance levels, account transaction activity, and customer-driven events such as overdrawing account balances. Various specific government regulations effectively limit fee assessments related to deposit accounts, making future revenue levels uncertain. Revenue from ATM and debit card transactions decreased by$25,000 or 3.2%, to$753,000 due to variations in volume and mix, including prior period COVID-19 related higher online volume. The longer term trend had been increases resulting from consumer desire to use more electronic delivery channels (Internet and mobile applications); however, regulations or legal challenges for large financial institutions may impact industry pricing for such transactions and fees in connection therewith in future periods, the effects of which cannot be currently quantified. The retail system-wide security breaches in the merchant base are negatively affecting consumer confidence in the debit card channel. Income from fiduciary, investment management and brokerage activities, which includes fees from both institutional and personal trust, investment management services, estate settlement and brokerage services, totaled$810,000 for the three months endedMarch 31, 2022 , as compared to$703,000 for the first quarter of 2021, a 15.2% net increase as a net result of higher fee volume from increased assets under management, higher sporadic estate fee income and varying fees on brokerage relationship transactions. Earnings on bank-owned life insurance decreased by$11,000 , or 3.3%, as a net result of varying crediting rates and administrate cost. At the Corporation's wholly-owned insurance subsidiary,ACNB Insurance Services, Inc. , revenue was down by$183,000 , or 13.2%, to$1,200,000 during the three month period due to decreases in commission on recurring books of business due to economic activity factors or loss of commission through nonrenewal. A continuing risk toACNB Insurance Service, Inc.'s revenue is nonrenewal of large commercial accounts and actions by insurance carriers to reduce commissions paid to agencies such asACNB Insurance Services, Inc. Contingent or extra commission payments from insurance carriers are received in the second quarter of each year. Contingent commissions vary 39 -------------------------------------------------------------------------------- from prior periods, due to specific claims atACNB Insurance Services, Inc. and trends in the entire insurance marketplace in general. Heightened pressure on commissions is expected to continue in this business line from insurance company actions. Estimation of upcoming contingent commissions is estimated atMarch 31, 2022 to be materially higher than 2021. See Note 12 for discussion of the insurance book of business purchase onFebruary 28,2022 . Income for sold mortgages included in other income, decreased by$1,002,000 or 78.1% due to less demand for refinancing in the current much higher rate environment; such demand is rate dependent and therefore volatile. There were no gains or losses on sales of securities during the first quarter of 2022 and 2021. A$109,000 net fair value loss was recognized on local bank and CRA-related equity securities during the first quarter of 2022 due to normal variations in market value on publicly-traded local bank stocks, compared to a$365,000 net fair value gain during the first quarter of 2021 when these stocks recovered from Pandemic lows. No equity securities were sold in either period. Other income in the three months endedMarch 31, 2022 , was down by$50,000 , or 17.3%, to$239,000 due to a variety of other fee income variances, mostly volume related.
Other Expenses
Other expenses for the quarter endedMarch 31, 2022 were$13,282,000 , a decrease of$505,000 or 3.7%, most of which was the result of changes in salaries and benefits. The largest component of other expenses is salaries and employee benefits, which decreased by$1,109,000 , or 12.8%, when comparing the first quarter of 2022 to the same period a year ago. Overall, the decrease in salaries and employee benefits was the result of factors as follows:
•challenges and cost in replacing and maintaining customer-facing staff due to a competitive labor market;
•partial reversal of prior year end 2021 incentive compensation accrual as
•costs in back-office staff due to the marketplace high demand for employees;
•increased organic and inorganic growth initiatives at
•maintaining staff in support functions and higher skilled mix of employees necessitated by regulations and growth;
•normal merit increases to employees and associated payroll taxes;
•varying and timing on other performance-based commissions and incentives;
•market changes in actively managing employee benefit plan costs, including health insurance;
•varying cost of 401(k) plan and non-qualified retirement plan benefits; and,
•defined benefit pension expense, which was down by$291,000 , or 440.9%, when comparing the three months endedMarch 31, 2022 , to the three months endedMarch 31, 2021 , resulting from the change in discount rates which increases or decreases the future pension obligations (creating volatility in the expense), return on assets at the latest annual evaluation date due to market conditions and changes in actuarial assumptions reflecting increased longevity. The Corporation's overall pension plan investment strategy is to achieve a mix of investments to meet the long-term rate of return assumption and near-term pension obligations with a diversification of asset types, fund strategies, and fund managers. The mix of investments is adjusted periodically by retaining an advisory firm to recommend appropriate allocations after reviewing the Corporation's risk tolerance on contribution levels, funded status, plan expense, as well as any applicable regulatory requirements. However, the determination of future benefit expense is also dependent on the fair value of assets and the discount rate on the year-end measurement date, which in recent years has experienced fair value volatility and low discount rates. The expense could also be higher in future years due to volatility in the discount rates at the latest measurement date, lower plan returns, and change in mortality tables utilized. Net occupancy expense decreased by$8,000 , or 0.7% during the period, mostly due to lower winter season expense. Equipment expense increased by$227,000 , or 17.6%, due to aSeptember 2021 upgrade to a new core application system that was a major step in the corporation's Digital Transformation Strategy. Equipment expense is subject to ever-increasing technology demands and the need for system upgrades for security and reliability purposes. This conversion will change various expense components (the future expense cannot be fully estimated) when complete. Technology investments and training allowing staff 40 --------------------------------------------------------------------------------
to work from home continues to prove invaluable in the pandemic, but also in attracting a broader talent pool.
Professional services expense totaled$309,000 during the first quarter of 2022, as compared to$224,000 for the same period in 2021, an increase of$85,000 , or 37.9%. This category includes expenses related to legal corporate governance, risk, compliance management and audit engagements, and legal counsel matters in connection with loans. It varies with specific engagements that occur at different times of each year, such as loan and compliance reviews. Marketing and corporate relations expenses were$103,000 for the first quarter of 2022, or 33.8% higher, as compared to the same period of 2021. Marketing expense varies with the timing and amount of planned advertising production and media expenditures, typically related to the promotion of certain in-market banking and trust products. Other tax expense increased by$23,000 , or 5.9%, comparing the three months endedMarch 31, 2022 and 2021, including higher PennsylvaniaBank Shares Tax . The PennsylvaniaBank Shares Tax is a shareholders' equity-based tax and is subject to increases based on state government parameters and the level of the stockholders' equity base that increased due to retained earnings equity. Supplies and postage expense increased by 11.0% due to variation in the timing of necessary replenishments.FDIC and regulatory expense increased 16.8% due to increase in the net asset base and credits that do not repeat regularly. Intangible amortization increased 4.4% on bank acquisition calculations whileACNB Insurance Services, Inc. increased on the books of business purchase. Other operating expenses increased by$180,000 , or 14.1%, in the first quarter of 2022, as compared to the first quarter of 2021. Increases included corporate governance, electronic banking and consulting related costs. In addition, other expenses include the expense of reimbursing checking and debit card customers for unauthorized transactions to their accounts and other third-party fraudulent use, which added approximately$30,000 to other expenses in the first quarter of 2022 compared to$77,000 in the first quarter of 2021. The expense related to reimbursements is unpredictable and varying, but ACNB has policies and procedures to limit exposure recognizing the value of electronic and other banking channels to customers and the significant revenue generated especially in the debit card arena. Provision for Income Taxes The Corporation recognized income taxes of$1,631,000 , or 19.8% of pretax income, during the first quarter of 2022, as compared to$1,930,000 , or 20.5% of pretax income, during the same period in 2021. The variances from the federal statutory rate of 21% in the respective periods are generally due to tax-exempt income from investments in and loans to state and local units of government at below-market rates (an indirect form of taxation), investment in bank-owned life insurance, and investments in low-income housing partnerships (which qualify for federal tax credits). In addition, both years includeMaryland corporation income taxes. Low-income housing tax credits were$70,000 and$70,000 for the three months endedMarch 31, 2022 and 2021, respectively.
FINANCIAL CONDITION
Assets totaled$2,746,156,000 atMarch 31, 2022 , compared to$2,786,987,000 atDecember 31, 2021 , and$2,654,617,000 atMarch 31, 2021 . Average earning assets during the three months endedMarch 31, 2022 , increased to$2,593,000,000 from$2,387,000,000 during the same period in 2021. Average interest bearing liabilities increased in 2022 to$1,870,000,000 from$1,721,000,000 in 2021.
ACNB uses investment securities to generate interest and dividend income, manage interest rate risk, provide collateral for certain funding products, and provide liquidity. The changes in the securities portfolio were the net result of purchases and matured securities to provide proper collateral for public deposits. Investing into investment security portfolio assets over the past several years was made more challenging due to theFederal Reserve Bank's program commonly called Quantitative Easing in which, by theFederal Reserve's open market purchases, the yields were maintained at a lower level than would otherwise be the case. The investment portfolio is comprised ofU.S. Government agency, municipal, and corporate securities. These securities provide the appropriate characteristics with respect to credit quality, yield and maturity relative to the management of the overall balance sheet. AtMarch 31, 2022 , the securities balance included a net unrealized loss on available for sale securities of$24,912,000 , net of taxes, on amortized cost of$608,393,000 versus a net unrealized loss of$3,474,000 , net of taxes, on amortized cost of$441,565,000 atDecember 31, 2021 , and a net unrealized loss of$1,434,000 , net of taxes, on amortized cost of$356,852,000 atMarch 31, 2021 . The change in fair value of available for sale securities during 2022 was a result of the higher amount of investments in the available for sale portfolio and by an decrease in fair value from an unprecedented (in recent decades) first quarter increase in theU.S. Treasury yield curve rates (which varies daily with volatility) and the spread from this yield curve 41 -------------------------------------------------------------------------------- required by investors on the types of investment securities that ACNB owns. TheFederal Reserve had reinstituted their rate-decreasing Quantitative Easing program in the COVID-19 crisis; and after increasing the fed funds rate inmid-December 2015 throughDecember 2018 theFederal Reserve decreased the target rate to 0% to 0.25% in the ongoing COVID-19 crisis; both actions causing theU.S. Treasury yield curve to decrease in 2020 through most of 2021 when banks includingACNB Bank increased investment holding due to the lack of loan demand from massive government stimulus.. However, the bond market sensed that government stimulus would lead to inflation and the yield curve increased in terms relevant to the investment securities in the Corporation's portfolio which occurred as predicted as of the quarter endedMarch 31, 2022 , leading to fair value decreases. Fair values were volatile on any given day in all periods presented and such volatility will continue. The changes in value are deemed to be related solely to changes in interest rates as the credit quality of the portfolio is high. AtMarch 31, 2022 , the securities balance included held to maturity securities with an amortized cost of$28,019,000 and a fair value of$27,679,000 , as compared to an amortized cost of$6,454,000 and a fair value of$6,652,000 atDecember 31, 2021 , and an amortized cost of$9,155,000 and a fair value of$9,451,000 atMarch 31, 2021 . The held to maturity securities wereU.S. government pass-through mortgage-backed securities in which the full payment of principal and interest is guaranteed; however, they were not classified as available for sale because these securities are generally used as required collateral for certain eligible government accounts or repurchase agreements.They are also held for possible pledging to access additional liquidity for banking subsidiary needs in the form of FHLB borrowings.. No held to maturity securities were acquired from FCBI. In addition,$22.1 million in newly purchased municipal securities were added to held to maturity in the first quarter of 2022 as a part of a liquidity utilization purchase.
The Corporation does not own investments consisting of pools of Alt-A or subprime mortgages, private label mortgage-backed securities, or trust preferred investments.
The fair values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather by relying on the security's relationship to other benchmark quoted prices. The Corporation uses independent service providers to provide matrix pricing. Please refer to Note 7 - "Securities" in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note 9 - "Fair Value Measurements" in the Notes to Consolidated Financial Statements for more information about fair value. Unrealized losses on available for sale investment securities were$24.9 million net of taxes atMarch 31, 2022 an increase from$3.5 million loss net of taxes atDecember 31, 2021 . The credit quality of the portfolio was high for all periods and the interest rate risk position was appropriate for a community bank and within investment policy guidelines; the increase in the other comprehensive loss was due to changes in interest rates relevant to the terms of the individual investments, such market rates averaged a 150 basis point increase, the highest quarterly increase in decades. This other comprehensive loss increase had no impact on regulatory capital ratios, which remain well capitalized. Nor did the increase have an effect on net income as the investments were not impaired and the losses were unrealized. Liquidity remains high and the Corporation has not traditionally sold investments for liquidity nor does it currently envision a need to do so. Since the onset of COVID-19, deposit growth has outpaced loan growth resulting in an excess liquidity position at the Corporation. Late in the quarter endedMarch 31, 2022 , the Corporation deployed excess liquidity by moving approximately$185,000,000 from cash into higher-yielding securities with a tax equivalent yield of approximately 2.80%. These new purchases were consistent with the current investment portfolio, but with higher yields to enhance the net interest margin and net interest income in future quarters. Purchases were primarily in government sponsored enterprise (GSE) pass-through instruments issued by the Federal National Mortgage Association (FNMA),Government National Mortgage Association (GNMA) orFederal Home Loam Mortgage Corporation (FHLMC), which guarantee the timely payment of principal on these investments.
Loans
Loans outstanding decreased by$126,392,000 , or 7.8%, atMarch 31, 2022 fromMarch 31, 2021 , and increased by$15,899,000 , or 1.1%, fromDecember 31, 2021 , toMarch 31, 2022 . The increase in loans year to date is largely attributable to the reduced sales of residential mortgages, PPP loan payoffs slowing, and the origination of loans in the commercial, consumer, and government lending portfolios. Year over year, organic loan declines was primarily a result of active participation and subsequent payoffs in the Paycheck Protection Program (PPP) as well as the sale of refinanced residential mortgages. Despite the intense competition in the Corporation's market areas, there is a continued focus internally on asset quality and disciplined underwriting standards in the loan origination process. In all periods, residential real estate lending and refinance activity was sold to the secondary market and commercial loans were subject to refinancing to competition for different rates or terms. In the 42 -------------------------------------------------------------------------------- normal course of business, more payoffs were anticipated in the remainder of 2022 from either customers' cash reserves or refinancing at competing banks and markets, and currently lending actions are continuing while wrapping up thePPP Small Business Administration (SBA) guaranteed loans. During the first three months of 2022, total commercial purpose loans increased while local market portfolio residential mortgages decreased, largely from concerted origination efforts and lower PPP payoffs. Total commercial purpose segments increased$26,953,000 , or 2.7%, as compared toDecember 31, 2021 . The first quarter 2022 growth was net of$8,697,000 of PPP loans paid off in 2022. Otherwise these loans are spread among diverse categories that include municipal governments/school districts, commercial real estate, commercial real estate construction, and commercial and industrial. Included in the commercial, financial and agricultural category are loans toPennsylvania school districts, municipalities (including townships) and essential purpose authorities. In most cases, these loans are backed by the general obligation of the local government body. In many cases, these loans are obtained through a bid process with other local and regional banks. The loans are predominantly bank qualified for mostly tax-free interest income treatment for federal income taxes. These loans totaled$78,767,000 atMarch 31, 2022 , a increase of 25.0% from$62,823,000 held at the end of 2021; these loans are especially subject to refinancing in certain rate environments. Residential real estate mortgage lending, which includes smaller commercial purpose loans secured by the owner's home, decreased by$12,001,000 , or 2.7%, as compared toDecember 31, 2021 . These loans are to local borrowers who preferred loan types that would not be sold into the secondary mortgage market. Of the$429,886,000 total in residential mortgage loans atMarch 31, 2022 ,$112,312,000 were secured by junior liens or home equity loans, which are also in many cases junior liens. Junior liens inherently have more credit risk by virtue of the fact that another financial institution may have a senior security position in the case of foreclosure liquidation of collateral to extinguish the debt. Generally, foreclosure actions could become more prevalent if the real estate market weakens, property values deteriorate, or rates increase sharply. Non-real estate secured consumer loans comprise 0.8% of the portfolio, with automobile-secured loans representing less than 0.1% of the portfolio. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law onMarch 27, 2020 , and provided over$2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the SBA to temporarily guarantee loans under a new 7(a) loan program called the PPP. As a qualified SBA lender, the Corporation was automatically authorized to originate PPP loans. As ofMarch 31, 2022 , the Corporation had an outstanding balance of$9,844,452 under the PPP program, net of repayments and forgiveness to date. As ofMarch 31, 2022 , the Corporation had originated an aggregate total of 2,217 loans in the amount of$223,036,703 under the PPP. Deferred fee income was approximately$9.5 million , before costs. The Corporation recognized$2,875,000 of PPP fee income during 2020,$5,627,000 during 2021, and$468,000 during the three months endedMarch 31, 2022 . The remaining amount will be recognized in future quarters as an adjustment of interest income yield. Most of the Corporation's lending activities are with customers located within southcentralPennsylvania and in the northernMaryland area. This region currently and historically has lower unemployment rates than theU.S. as a whole. Included in commercial real estate loans are loans made to lessors of non-residential properties that total$412,942,000 , or 27.8% of total loans, atMarch 31, 2022 . These borrowers are geographically dispersed throughout ACNB's marketplace and are leasing commercial properties to a varied group of tenants including medical offices, retail space, and other commercial purpose facilities. Because of the varied nature of the tenants, in aggregate, management believes that these loans present an acceptable risk when compared to commercial loans in general. ACNB does not originate or hold Alt-A or subprime mortgages in its loan portfolio.
Allowance for Loan Losses
ACNB maintains the allowance for loan losses at a level believed to be adequate by management to absorb probable losses in the loan portfolio, and it is funded through a provision for loan losses charged to earnings. On a quarterly basis, ACNB utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan losses, historical experience, and qualitative factors. This methodology results in an allowance that is considered appropriate in light of the high degree of judgment required and that is prudent and conservative, but not excessive. Management assigns internal risk ratings for each commercial lending relationship. Utilizing historical loss experience, adjusted for changes in trends, conditions, and other relevant factors, management derives estimated losses for non-rated and non-classified loans. When management identifies impaired loans with uncertain collectibility of principal and interest, it evaluates a specific reserve on a quarterly basis in order to estimate potential losses. Management's analysis considers:
•adverse situations that may affect the borrower's ability to repay;
•the current estimated fair value of underlying collateral; and,
•prevailing market conditions.
43
--------------------------------------------------------------------------------
Loans not tested for impairment do not require a specific reserve
allocation. Management places these loans in a pool of loans with similar risk
factors and assigns the general loss factor to determine the reserve. For
homogeneous loan types, such as consumer and residential mortgage loans,
management bases specific allocations on the average loss ratio for the previous
twelve quarters for each specific loan pool. Additionally, management adjusts
projected loss ratios for other factors, including the following:
•lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices;
•national, regional and local economic and business conditions, as well as the condition of various market segments, including the impact on the value of underlying collateral for collateral dependent loans;
•nature and volume of the portfolio and terms of loans;
•experience, ability and depth of lending management and staff;
•volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications;
•existence and effect of any concentrations of credit and changes in the level of such concentrations; and,
•For 2020 a special allowance was developed to quantify a current expected incurred loss as a result of the COVID-19 crisis. The factor considered the loan mix effects of businesses likely to be harder hit by quarantine closure orders, the relative amount of COVID-19 related modifications requested to date, the estimated regional infection stage and geopolitical factors. A large unknown in this factor is the expected duration of the quarantine period. Management determines the unallocated portion of the allowance for loan losses, which represents the difference between the reported allowance for loan losses and the calculated allowance for loan losses, based on the following criteria:
•the risk of imprecision in the specific and general reserve allocations;
•the perceived level of consumer and small business loans with demonstrated weaknesses for which it is not practicable to develop specific allocations;
•other potential exposure in the loan portfolio;
•variances in management's assessment of national, regional and local economic conditions; and,
•other internal or external factors that management believes appropriate at that time, such as COVID-19.
The unallocated portion of the allowance is deemed to be appropriate as it reflects an uncertainty that remains in the loan portfolio; specifically reserves where the Corporation believes that tertiary losses are probable above the loss amount derived using appraisal-based loss estimation, where such additional loss estimates are in accordance with regulatory and GAAP guidance. Appraisal-based loss derivation does not fully develop the loss present in certain unique, ultimately bank-owned collateral. The Corporation has determined that the amount of provision in 2022 and the resulting allowance atMarch 31, 2022 , are appropriate given the continuing level of risk in the loan portfolio. Further, management believes the unallocated allowance is appropriate, because even though the impaired loans added since 2021 demonstrate generally low risk due to adequate real estate collateral, the value of such collateral can decrease; plus, the growth in the loan portfolio is centered around commercial real estate which continues to have little increase in value and low liquidity. In addition, there are certain loans that, although they did not meet the criteria for impairment, management believes there was a strong possibility that these loans represented potential losses atMarch 31, 2022 . The amount of the unallocated portion of the allowance was$499,000 atMarch 31, 2022 , as management concluded that the loan portfolio was better reflected in metrics used in the allocated evaluation. Otherwise, the assessment concluded that credit quality was stable, COVID-19 related charge-offs were relatively low and past due loans manageable. Management believes the above methodology materially reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology and the assumptions discussed above.
Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the
44
--------------------------------------------------------------------------------
methodology discussed above, which is consistent with recent quarters'
improvement in the credit quality in the loan portfolio, and with lessened risk
from the impact of the COVID-19 crisis. The acquisition of FCBI and New Windsor
loans at fair value did not require a provision expense. The provision for
year-to-date March 31, 2022 and 2021, was $0 and $50,000 , respectively. The
increase in the allowance for loan losses as a percentage of total loans of
1.26% at March 31, 2021 to 1.28% at March 31, 2022 was primarily related to the
decrease in non-acquired loans, such reduction did not necessarily reduce the
risk in the portfolio in direct proportion. More specifically, as total loans
decreased from year-end 2021 and the provision expense decreased year over year,
the allowance for loan losses was derived with data that most existing impaired
credits were, in the opinion of management, adequately collateralized.
Federal and state regulatory agencies, as an integral part of their examination
process, periodically review the Corporation's allowance for loan losses and may
require the Corporation to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination,
which may not be currently available to management. Based on management's
comprehensive analysis of the loan portfolio and economic conditions, management
believes the current level of the allowance for loan losses is adequate.
In June 2016 , the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses
(Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13
requires credit losses on most financial assets measured at amortized cost and
certain other instruments to be measured using an expected credit loss model
(referred to as the current expected credit loss (CECL) model). Under this
model, entities will estimate credit losses over the entire contractual term of
the instrument (considering estimated prepayments, but not expected extensions
or modifications unless reasonable expectation of a troubled debt restructuring
exists) from the date of initial recognition of that instrument. Upon adoption,
the change in this accounting guidance could result in an increase in the
Corporation's allowance for loan losses and require the Corporation to record
loan losses more rapidly. In October 2019 , FASB voted to delay implementation of
the CECL standard for certain companies, including those companies that qualify
as a smaller reporting company under SEC rules until January 1, 2023 . As a
result ACNB used the deferral period to develop the proper procedure, data
sources and testing for implementation..
The allowance for loan losses at March 31, 2022 , was $18,963,000 , or 1.28% of
total loans (1.61% of non-acquired loans), as compared to $20,237,000 , or 1.26%
of loans, at March 31, 2021 , and $19,033,000 , or 1.30% of loans, at December 31,
2021 . The decrease from year-end resulted from charge-offs of $70,000 net of
recoveries and $0 in provisions, as shown in the table below. In the following
discussion, acquired loans from FCBI and New Windsor were recorded at fair value
at the acquisition date and are not included in the tables and information
below, see more information in Note 8 - "Loans" in the Notes to Consolidated
Financial Statements.
Changes in the allowance for loan losses were as follows:
Three Months Ended Year Ended Three Months Ended
In thousands March 31, 2022 December 31, 2021 March 31, 2021
Beginning balance - January 1 $ 19,033 $ 20,226 $ 20,226
Provisions charged to operations - 50 50
Recoveries on charged-off loans 12 75 16
Loans charged-off (82) (1,318) (55)
Ending balance $ 18,963 $ 19,033 $ 20,237
Loans past due 90 days and still accruing were $964,000 and nonaccrual loans
were $4,543,000 as of March 31, 2022 . $47,000 of the nonaccrual balance at
March 31, 2022 , were in troubled debt restructured loans. $3,545,000 of the
impaired loans were accruing troubled debt restructured loans. Loans past due 90
days and still accruing were $675,000 at March 31, 2021 , while nonaccruals were
$7,692,000 . $111,000 of the nonaccrual balance at March 31, 2021 , was in
troubled debt restructured loans. $3,653,000 of the impaired loans were accruing
troubled debt restructured loans. Loans past due 90 days and still accruing were
$730,000 at December 31, 2021 , while nonaccruals were $5,489,000 . $63,000 of the
nonaccrual balance at December 31, 2021 , were in troubled debt restructured
loans. $3,574,000 of the impaired loans were accruing troubled debt restructured
loans. Total additional loans classified as substandard (potential problem
loans) at March 31, 2022 , March 31, 2021 , and December 31, 2021 , were
approximately $1,120,000 , $2,470,000 and $1,725,000 , respectively.
Because of the manageable level of nonaccrual loans and with substandard loans
in the first quarter of 2022, a
45
--------------------------------------------------------------------------------
The Corporation implemented numerous initiatives to support and protect
employees and customers during the COVID-19 pandemic. These efforts continue
with current information and guidelines related to ongoing COVID-19 initiatives.
As of September 30, 2021 , the Corporation no longer had any temporary loan
modifications or deferrals for either commercial or consumer customers,
furthering the positive trend of improvement in 2021. In comparison, as of March
31, 2021 , the Corporation had 30 temporary modifications with principal balances
totaling $23,720,360 .
As to nonaccrual and substandard loans, management believes that adequate
collateralization generally exists for these loans in accordance with GAAP. Each
quarter, the Corporation assesses risk in the loan portfolio compared with the
balance in the allowance for loan losses and the current evaluation factors.
Information on nonaccrual loans, by collateral type rather than loan class, at
Number of Current
Credit Specific Loss Year
Dollars in thousands Relationships Balance Allocations Charge-Offs Location Originated
March 31, 2022
Owner occupied commercial real
estate 6 $ 3,469 $ 836 $ - In market 2008 - 2017
Investment/rental residential real
estate 1 110 - - In market 2016
Commercial and industrial 3 964 802 - In market 2008 - 2019
Total 10 $ 4,543 $ 1,638 $ -
December 31, 2021
Owner occupied commercial real
estate 7 $ 3,890 $ 599 $ - In market 2008 - 2019
Investment/rental residential real
estate 1 112 - - In market 2016
Commercial and industrial 3 1,487 856 970 In market 2008 - 2019
Total 11 $ 5,489 $ 1,455 $ 970 Management deemed it appropriate to provide this type of more detailed information by collateral type in order to provide additional detail on the loans.
All nonaccrual impaired loans are to borrowers located within the market area served by the Corporation in southcentralPennsylvania and nearby market areas ofMaryland . All nonaccrual impaired loans were originated by ACNB's banking subsidiary, except for one participation loan discussed below, for purposes listed in the classifications in the table above.
The Corporation had no impaired and nonaccrual loans included in commercial real
estate construction at
Owner occupied commercial real estate atMarch 31, 2022 , includes seven unrelated loan relationships. A$913,000 relationship in food service that was performing when acquired was added in the first quarter of 2020 after becoming 90 days past due early in the year, subsequent payments have been received. Collateral valuation resulted in no specific allocations. Another$807,000 merger-acquired loan relationship for a light manufacturing enterprise which was performing when acquired is working through bankruptcy and has no specific allocation. The other unrelated loans in this category have balances of less than$197,000 each, for which the real estate is collateral and is used in connection with a business enterprise that is suffering economic stress or is out of business. The loans in this category were originated between 2008 and 2019 and are business loans impacted by specific borrower credit situations. Most loans in this category are making principal payments. Collection efforts will continue unless it is deemed in the best interest of the Corporation to initiate foreclosure procedures. A$1,311,000 (after partial payoff in the third quarter of 2020) 2017-acquired commercial real estate participation loan was added in the fourth quarter of 2019 and has been currently assigned a$836,000 specific allocation atMarch 31, 2022 . Investment/rental residential real estate atMarch 31, 2022 , includes one loan relationship (which is deemed to be adequately collateralized) totaling$110,000 for which the real estate is collateral and the purpose of which is for speculation, rental, or other non-owner occupied uses; this relationship is making principal reductions. 46 -------------------------------------------------------------------------------- A$1,795,000 commercial and industrial loan was added in the fourth quarter of 2020 after ceasing operations, with a current balance of$170,000 . Liquidation is mostly complete with a specific allocation of$19,000 after a$970,000 third quarter of 2021 charge-off. A related$441,000 owner occupied real estate loan was also in nonaccrual but settled in the first quarter. An unrelated commercial and industrial loan atMarch 31, 2022 with a balance of$11,000 (after numerous principal payments) is currently continuing making payments. A third unrelated loan relationship was added in the first quarter 2021 with an outstanding balance of$783,000 and a specific allocation$783,000 due to concerns on collateralization and liens. The Corporation utilizes a systematic review of its loan portfolio on a quarterly basis in order to determine the adequacy of the allowance for loan losses. In addition, ACNB engages the services of an outside independent loan review function and sets the timing and coverage of loan reviews during the year. The results of this independent loan review are included in the systematic review of the loan portfolio. The allowance for loan losses consists of a component for individual loan impairment, primarily based on the loan's collateral fair value and expected cash flow. A watch list of loans is identified for evaluation based on internal and external loan grading and reviews. Loans other than those determined to be impaired are grouped into pools of loans with similar credit risk characteristics. These loans are evaluated as groups with allocations made to the allowance based on historical loss experience adjusted for current trends in delinquencies, trends in underwriting and oversight, concentrations of credit, and general economic conditions within the Corporation's trading area. The provision expense was based on the loans discussed above, as well as current trends in the watch list and the local economy as a whole. The charge-offs discussed elsewhere in this Management's Discussion and Analysis create the recent loss history experience and result in the qualitative adjustment which, in turn, affects the calculation of losses inherent in the portfolio. The provision for loan losses for 2022 and 2021 was a result of the measurement of the adequacy of the allowance for loan losses at each period. Premises and Equipment ACNB valued six buildings acquired from New Windsor at$8,624,000 atJuly 1, 2017 and five properties acquired from FCBI at$7,514,000 atJanuary 11, 2020 . As a part of an ongoing delivery system optimization strategy, two community offices closed in the second quarter of 2021 resulted in a small net gain in 2021. OnJanuary 12, 2022 ,ACNB Bank announced plans to build a full-service community banking office to serve the Upper Adams area ofAdams County, PA. Upon completion of construction of the Upper Adams Office in Fall 2022, the plan is to consolidate operations of the three currentACNB Bank offices in the UpperAdams geography as part of the Bank's branch optimization strategy and continued endeavors to enhance operational efficiencies.
Foreclosed Assets Held for Resale
Foreclosed assets held for resale consists of the fair value of real estate acquired through foreclosure on real estate loan collateral or the acceptance of ownership of real estate in lieu of the foreclosure process. These fair values, less estimated costs to sell, become the Corporation's new cost basis. Fair values are based on appraisals that consider the sales prices of similar properties in the proximate vicinity less estimated selling costs.
Deposits
ACNB relies on deposits as a primary source of funds for lending activities with total deposits of$2,410,761,000 as ofMarch 31, 2022 . Deposits increased by$132,139,000 , or 5.8%, fromMarch 31, 2021 , toMarch 31, 2022 , and decreased by$15,628,000 , or 0.6%, fromDecember 31, 2021 , toMarch 31, 2022 . Deposits increased in the first quarter of 2022 from same quarter prior year due to increased balances in a broad base of accounts from lack of economic activity continuing from the COVID-19 event and effects. Even with this increase in volume, deposit interest expense decreased 55.4% due to lower rates. Otherwise, deposits vary between quarters mostly reflecting different levels held by local government and school districts during different times of the year. ACNB's deposit pricing function employs a disciplined pricing approach based upon alternative funding rates, but also strives to price deposits to be competitive with relevant local competition, including a local government investment trusts, credit unions and larger regional banks. During the multiple periods of low rates, deposit growth mix experienced a shift to transaction accounts as customers put more value in liquidity andFDIC insurance. Products, such as money market accounts and interest-bearing transaction accounts that had suffered declines in past years, continued with recovered balances; however, it is expected that a return to more normal, lower balances could occur when the economy improves. With heightened competition, ACNB's ability to maintain and add to its deposit base may be impacted by the reluctance of consumers to accept community banks' lower rates (as compared to Internet-based competition) and by larger competition willing to pay above market rates to attract market share. Continued periods where rates rise rapidly, or when the equity markets are high, funds could leave the Corporation or be priced higher to maintain deposits. 47 --------------------------------------------------------------------------------
Borrowings
Short-term Bank borrowings are comprised primarily of securities sold under agreements to repurchase and short-term borrowings from the FHLB. As ofMarch 31, 2022 , short-term Bank borrowings were$30,028,000 , as compared to$35,202,000 atDecember 31, 2021 , and$31,282,000 atMarch 31, 2021 . Agreements to repurchase accounts are within the commercial and local government customer base and have attributes similar to core deposits. Investment securities are pledged in sufficient amounts to collateralize these agreements. In comparison to year-end 2021, repurchase agreement balances were down$5,174,000 , or 14.7%, due to changes in the cash flow position of ACNB's commercial and local government customer base and lack of competition from non-bank sources. There were no short-term FHLB borrowings atMarch 31, 2022 and 2021, orDecember 31, 2021 . Short-term FHLB borrowings are used to even out Bank funding from seasonal and daily fluctuations in the deposit base. Long-term borrowings consist of longer-term advances from the FHLB that provides term funding of loan assets, and Corporate borrowings that were acquired or originated in regards to the acquisitions and to refund or extend such Corporation borrowings. Long-term borrowings totaled$30,200,000 atMarch 31, 2022 , versus$34,700,000 atDecember 31, 2021 , and$65,616,000 atMarch 31, 2021 . Long-term borrowings decreased 54.0% fromMarch 31, 2021 .$30.7 million was the net decrease to FHLB term Bank borrowings made to balance loan demand and deposit growth. FHLB fixed-rate term Bank advances that matured after the first quarter of 2019 were not renewed and another$5.0 million was prepaid in 2021 to utilize liquidity from earning assets and deposit changes. A second quarter of 2017$4.6 million Corporation loan was paid off during the second quarter of 2021.ACNB Insurance Services, Inc. borrowed$1.5 million from a local bank in the first quarter of 2022 to fund a book of business purchase. In addition,$5 million and$8.7 million was Corporation debt acquired from New Windsor and FCBI, respectively. The$5 million New Windsor acquired debt was paid off with proceeds from the subordinated debt proceeds inJune 2021 . OnMarch 30, 2021 ,ACNB Corporation issued$15,000,000 in Fixed-to-Floating Rate subordinated debt dueMarch 31, 2031 . The terms are five year 4% fixed rate and thereafter callable at 100% or a floating rate. The potential use of the net proceeds include retiring outstanding debt of the Corporation, repurchasing issued and outstanding shares of the Corporation, supporting general corporate purposes, underwriting growth opportunities, creating an interest reserve for the notes issued, and downstreaming proceeds toACNB Bank to continue to meet regulatory capital requirements, increase the regulatory lending ability of the Bank, and support the Bank's organic growth initiatives. Please refer to the Liquidity discussion below for more information on the Corporation's ability to borrow.
Capital
ACNB's capital management strategies have been developed to provide an appropriate rate of return, in the opinion of management, to shareholders, while maintaining its "well-capitalized" regulatory position in relationship to its risk exposure. Total shareholders' equity was$256,009,000 atMarch 31, 2022 , compared to$272,114,000 atDecember 31, 2021 , and$257,612,000 atMarch 31, 2021 . Shareholders' equity decreased in the first three months of 2022 by$16,105,000 primarily due to$4,342,000 in retained earnings from 2022 earnings net of dividends paid to date, net of the increase in accumulated other comprehensive loss from change in investment market value. There were no first quarter share repurchases. The acquisition of New Windsor resulted in 938,360 new ACNB shares of common stock issued to the New Windsor shareholders valued at$28,620,000 in 2017. The acquisition of FCBI resulted in 1,590,547 new ACNB shares of common stock issued to the FCBI shareholders valued at$57,721,000 . Since year end 2021 a$21,359,000 increase in accumulated other comprehensive loss was primarily a result of a net decrease in the fair value of the investment portfolio from the first quarter increase in market rates and to a much lesser extent changes in the net funded position of the defined benefit pension plan. Other comprehensive income or loss is mainly caused by fixed-rate investment securities gaining or losing value in different interest rate environments and changes in the net funded position of the defined benefit pension plan. There was no cash losses taken and changes in market value do not affect regulatory capital or net income. The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During the first three months of 2022, ACNB earned$6,599,000 and paid dividends of$2,257,000 for a dividend payout ratio of 34.2%. During the first three months of 2021, ACNB earned$7,471,000 and paid dividends of$2,177,000 for a dividend payout ratio of 29.1%.ACNB Corporation has a Dividend Reinvestment and Stock Purchase Plan that provides registered holders ofACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. Year-to-dateMarch 31, 2022 , 5,587 shares were issued under this plan with proceeds in the amount of$183,000 . 48 --------------------------------------------------------------------------------
Year-to-date
ACNB Corporation has a Restricted Stock plan available to selected officers and employees of the Bank, to advance the best interest ofACNB Corporation and its shareholders. The plan provides those persons who have responsibility for its growth with additional incentive by allowing them to acquire an ownership inACNB Corporation and thereby encouraging them to contribute to the success of the Corporation. As ofMarch 31, 2022 , there were 25,945 shares of common stock granted as restricted stock awards to employees of the subsidiary bank. The restricted stock plan expired by its own terms after 10 years onFebruary 24, 2019 , and no further shares may be issued under the plan. Proceeds are used for general corporate purposes. OnMay 1, 2018 , stockholders approved and ratified theACNB Corporation 2018 Omnibus Stock Incentive Plan, effective as ofMarch 20, 2018 , in which awards shall not exceed, in the aggregate, 400,000 shares of common stock, plus any shares that are authorized, but not issued, under the 2009 Restricted Stock Plan. As ofMarch 31, 2022 , 57,822 shares were issued under this plan and 516,233 shares were available for grant. Proceeds are used for general corporate purposes. OnFebruary 25, 2021 , the Corporation announced that the Board of Directors approved onFebruary 23, 2021 , a plan to repurchase, in open market and privately negotiated transactions, up to 261,000, or approximately 3%, of the outstanding shares of the Corporation's common stock. This new stock repurchase program replaces and supersedes any and all earlier announced repurchase plans. There were 54,071 shares purchased under this plan as ofDecember 31, 2021 . There were no shares purchased under the plan during the quarter endedMarch 31, 2022 . OnSeptember 30, 2021 , the Corporation entered into an issuer stock repurchase agreement with an independent third-party broker under which the broker is authorized to repurchase the Corporation's common stock on behalf of the Corporation during the period from the close of business onSeptember 30, 2021 throughMarch 31, 2022 , subject to certain price, market and volume constraints specified in the agreement. The agreement was established in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (Exchange Act). The shares will be purchased pursuant to the Corporation's previously announced stock repurchase program and in a manner consistent with applicable laws and regulations, including the provisions of the safe harbor contained in Rule 10b-18 under the Exchange Act. ACNB is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on ACNB. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, ACNB must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require ACNB to maintain minimum amounts and ratios of total and Tier 1 capital to average assets. Management believes, as ofMarch 31, 2022 , andDecember 31, 2021 , that ACNB's banking subsidiary met all minimum capital adequacy requirements to which it is subject and is categorized as "well capitalized" for regulatory purposes. There are no subsequent conditions or events that management believes have changed the banking subsidiary's category.
Regulatory Capital Changes
InJuly 2013 , the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations beganJanuary 1, 2015 , while larger institutions (generally those with assets of$250 billion or more) began compliance effectiveJanuary 1, 2014 . The final rules call for the following capital requirements:
•a minimum ratio of common Tier 1 capital to risk-weighted assets of 4.5%;
•a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%;
•a minimum ratio of total capital to risk-weighted assets of 8.0%; and,
•a minimum leverage ratio of 4.0%.
49
--------------------------------------------------------------------------------
In addition, the final rules establish a common equity Tier 1 capital
conservation buffer of 2.5% of risk-weighted assets applicable to all banking
organizations. If a banking organization fails to hold capital above the minimum
capital ratios and the capital conservation buffer, it will be subject to
certain restrictions on capital distributions and discretionary bonus payments.
The phase-in period for the capital conservation and countercyclical capital
buffers for all banking organizations began on January 1, 2016 .
Under the initially proposed rules, accumulated other comprehensive income
(AOCI) would have been included in a banking organization's common equity Tier 1
capital. The final rules allow community banks to make a one-time election not
to include these additional components of AOCI in regulatory capital and instead
use the existing treatment under the general risk-based capital rules that
excludes most AOCI components from regulatory capital. The opt-out election must
be made in the first call report or FR Y-9 series report that is filed after the
financial institution becomes subject to the final rule. The Corporation elected
to opt-out.
The rules permanently grandfather non-qualifying capital instruments (such as
trust preferred securities and cumulative perpetual preferred stock) issued
before May 19, 2010 , for inclusion in the Tier 1 capital of banking
organizations with total consolidated assets of less than $15 billion as of
December 31, 2009 , and banking organizations that were mutual holding companies
as of May 19, 2010 .
The proposed rules would have modified the risk-weight framework applicable to
residential mortgage exposures to require banking organizations to divide
residential mortgage exposures into two categories in order to determine the
applicable risk weight. In response to commenter concerns about the burden of
calculating the risk weights and the potential negative effect on credit
availability, the final rules do not adopt the proposed risk weights, but retain
the current risk weights for mortgage exposures under the general risk-based
capital rules.
Consistent with the Dodd-Frank Act, the new rules replace the ratings-based
approach to securitization exposures, which is based on external credit ratings,
with the simplified supervisory formula approach in order to determine the
appropriate risk weights for these exposures. Alternatively, banking
organizations may use the existing gross-up approach to assign securitization
exposures to a risk weight category or choose to assign such exposures a 1,250
percent risk weight.
Under the new rules, mortgage servicing assets and certain deferred tax assets
are subject to stricter limitations than those applicable under the current
general risk-based capital rule. The new rules also increase the risk weights
for past due loans, certain commercial real estate loans, and some equity
exposures, and makes selected other changes in risk weights and credit
conversion factors.
The Corporation calculated regulatory ratios as of March 31, 2022 , and confirmed
no material impact on the capital, operations, liquidity, and earnings of the
Corporation and the banking subsidiary from the changes in the regulations.
In 2019, the federal banking agencies issued a final rule to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, including the community bank leverage ratio (CBLR) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than$10 billion , and limited amounts of off-balance sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9% (subsequently reduced to 8% as a COVID-19 relief measure). Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of theFDIC's Prompt Corrective Action framework. The CBLR framework was available for banks to use in theirMarch 31, 2020 Call Report. The Corporation has performed changes to capital adequacy and reporting requirements within the quarterly Call Report, and it opted out of the CBLR framework onMarch 31, 2022 . 50 --------------------------------------------------------------------------------
The banking subsidiary's capital ratios are as follows:
To Be Well Capitalized
Under Prompt
Corrective Action
March 31, 2022 December 31, 2021 Regulations
Tier 1 leverage ratio (to average assets) 9.20 % 8.81 % 5.00 %
Common Tier 1 capital ratio (to risk-weighted
assets) 15.98 % 16.32 % 6.50 %
Tier 1 risk-based capital ratio (to risk-weighted
assets) 15.98 % 16.32 % 8.00 %
Total risk-based capital ratio 17.20 % 17.57 % 10.00 %
Liquidity
Effective liquidity management ensures the cash flow requirements of depositors and borrowers, as well as the operating cash needs of ACNB, are met.
ACNB's funds are available from a variety of sources, including assets that are readily convertible such as interest bearing deposits with banks, maturities and repayments from the securities portfolio, scheduled repayments of loans receivable, the core deposit base, and the ability to borrow from the FHLB. AtMarch 31, 2022 , ACNB's banking subsidiary had a borrowing capacity of approximately$799,000,000 from the FHLB, of which$776,000,000 was available. Because of various restrictions and requirements on utilizing the available balance, ACNB considers$576,000,000 to be the practicable additional borrowing capacity, which is considered to be sufficient for operational needs. The FHLB system is self-capitalizing, member-owned, and its member banks' stock is not publicly traded. ACNB creates its borrowing capacity with the FHLB by granting a security interest in certain loan assets with requisite credit quality. ACNB has reviewed information on the FHLB system and the FHLB ofPittsburgh , and has concluded that they have the capacity and intent to continue to provide both operational and contingency liquidity. The FHLB ofPittsburgh instituted a requirement that a member's investment securities must be moved into a safekeeping account under FHLB control to be considered in the calculation of maximum borrowing capacity. The Corporation currently has securities in safekeeping at the FHLB ofPittsburgh ; however, the safekeeping account is under the Corporation's control. As better contingent liquidity is maintained by keeping the securities under the Corporation's control, the Corporation has not moved the securities which, in effect, lowered the Corporation's maximum borrowing capacity. However, there is no practical reduction in borrowing capacity as the securities can be moved into the FHLB-controlled account promptly if they are needed for borrowing purposes. Another source of liquidity is securities sold under repurchase agreements to customers of ACNB's banking subsidiary totaling approximately$30,028,000 and$35,202,000 atMarch 31, 2022 , andDecember 31, 2021 , respectively. These agreements vary in balance according to the cash flow needs of customers and competing accounts at other financial organizations. The liquidity of the parent company also represents an important aspect of liquidity management. The parent company's cash outflows consist principally of dividends to shareholders and corporate expenses. The main source of funding for the parent company is the dividends it receives from its subsidiaries. Federal and state banking regulations place certain legal restrictions and other practicable safety and soundness restrictions on dividends paid to the parent company from the subsidiary bank. ACNB manages liquidity by monitoring projected cash inflows and outflows on a daily basis, and believes it has sufficient funding sources to maintain sufficient liquidity under varying degrees of business conditions for liquidity and capital resource requirements for all material short- and long-term cash requirements from known contractual and other obligations. OnMarch 30, 2021 , the Corporation issued$15 million of subordinated debt in order to pay off existing higher rate debt, to potentially repurchase ACNB common stock and to use for inorganic growth opportunities. Otherwise, the$15 million of subordinated debt qualifies as Tier 2 capital at the Holding Company level, but can be transferred to the Bank where it qualifies as Tier 1 Capital. The debt has a 4.00% fixed-to-floating rate and a stated maturity ofMarch 31, 2031 . The debt is redeemable by the Corporation at its option, in whole or in part, on or afterMarch 30, 2026 , and at any time upon occurrences of certain unlikely events such as receivership insolvency or liquidation of ACNB orACNB Bank .
Off-Balance Sheet Arrangements
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. AtMarch 31, 2022 , the Corporation had unfunded outstanding commitments to extend credit of 51 --------------------------------------------------------------------------------
approximately
Market Risks
Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of the organization. These risks involve interest rate risk, foreign currency exchange risk, commodity price risk, and equity market price risk. ACNB's primary market risk is interest rate risk. Interest rate risk is inherent because, as a financial institution, ACNB derives a significant amount of its operating revenue from "purchasing" funds (customer deposits and wholesale borrowings) at various terms and rates. These funds are then invested into earning assets (primarily loans and investments) at various terms and rates.
Acquisition of
ACNB Corporation , the parent financial holding company ofACNB Bank , aPennsylvania state-chartered,FDIC -insured community bank, headquartered inGettysburg, Pennsylvania , completed the acquisition ofFrederick County Bancorp, Inc. (FCBI) and its wholly-owned subsidiary,Frederick County Bank , headquartered inFrederick, Maryland , effectiveJanuary 11, 2020 . FCBI was merged with and into a wholly-owned subsidiary ofACNB Corporation immediately followed by the merger ofFrederick County Bank with and intoACNB Bank .ACNB Bank operates in theFrederick County, Maryland , market as "FCB Bank , A Division ofACNB Bank ". Under the terms of the Reorganization Agreement, FCBI stockholders received 0.9900 share ofACNB Corporation common stock for each share of FCBI common stock that they owned as of the closing date. As a result,ACNB Corporation issued 1,590,547 shares of its common stock and cash in exchange for fractional shares based upon$36.43 , the determined market share price ofACNB Corporation common stock in accordance with the Reorganization Agreement. With the combination of the two organizations,ACNB Corporation , on a consolidated basis, has approximately$2.7 billion in assets,$2.4 billion in deposits, and$1.5 billion in loans with 31 community banking offices and three loan offices located in the counties ofAdams ,Cumberland ,Franklin ,Lancaster andYork inPennsylvania and the counties ofBaltimore ,Carroll andFrederick inMaryland . Further discussion of the risk factors involved with the merger of FCBI into the Corporation can be found in Part II, Item 1A - Risk Factors.
RECENT DEVELOPMENTS
BANK SECRECY ACT (BSA) - The Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), imposes obligations onU.S. financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism. Financial institutions also are required to respond to requests for information from federal banking agencies and law enforcement agencies. Information sharing among financial institutions for the above purposes is encouraged by an exemption granted to complying financial institutions from the privacy provisions of the Gramm-Leach-Bliley Act and other privacy laws. Financial institutions that hold correspondent accounts for foreign banks or provide banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited from dealing with foreign "shell banks" and persons from jurisdictions of particular concern. The primary federal banking agencies and the Secretary of theTreasury have adopted regulations to implement several of these provisions. EffectiveMay 11, 2018 , the Bank began compliance with the new Customer Due Diligence Rule, which clarified and strengthened the existing obligations for identifying new and existing customers and includes risk-based procedures for conducting ongoing customer due diligence. All financial institutions are also required to establish internal anti-money laundering programs. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act. The Corporation's banking subsidiary has a BSA andUSA PATRIOT Act compliance program commensurate with its risk profile and appetite. TAX CUTS AND JOBS ACT - OnDecember 22, 2017 , the Tax Cuts and Jobs Act was signed into law. Among other changes, the Tax Cuts and Jobs Act reduced the federal corporate tax rate from 35% to 21% effectiveJanuary 1, 2018 . ACNB anticipates that this tax rate change should reduce its federal income tax liability in future years, as it did in 2018. However, the Corporation did recognize certain effects of the tax law changes in 2017.U.S. generally accepted accounting principles require companies to revalue their deferred tax assets and liabilities as of the date of enactment, with resulting tax effects accounted for 52 -------------------------------------------------------------------------------- in the reporting period of enactment. Since the enactment took place inDecember 2017 , the Corporation revalued its net deferred tax assets in the fourth quarter of 2017, resulting in an approximately$1.7 million reduction to earnings in 2017. DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT (DODD-FRANK) - In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. Dodd-Frank was intended to effect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank created theFinancial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally created a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank has had and will continue to have a significant impact on ACNB's business operations as its provisions take effect. It is expected that, as various implementing rules and regulations are released, they will increase ACNB's operating and compliance costs and could increase the banking subsidiary's interest expense. Among the provisions that are likely to affect ACNB are the following:
Holding Company Capital Requirements
Dodd-Frank requires theFederal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior toMay 19, 2010 , by a bank holding company with less than$15 billion in assets as ofDecember 31, 2009 . Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion, consistent with safety and soundness.
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to$250,000 per depositor. Dodd-Frank also broadened the base forFDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. Dodd-Frank requires theFDIC to increase the reserve ratio of theDeposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that theFDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Dodd-Frank also eliminated the federal statutory prohibition against the payment of interest on business checking accounts.
Corporate Governance
Dodd-Frank requires publicly-traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on "golden parachute" payments in connection with approvals of mergers and acquisitions unless previously voted on by the stockholders. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of$1.0 billion , regardless of whether the company is publicly traded. Dodd-Frank also gives theSEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.
Prohibition Against Charter Conversions of Troubled Institutions
Dodd-Frank prohibits a depository institution from converting from a state to a federal charter, or vice versa, while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator, which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks are able to enter new markets more freely.
Limits on Interstate Acquisitions and Mergers
53
--------------------------------------------------------------------------------
Dodd-Frank precludes a bank holding company from engaging in an interstate
acquisition - the acquisition of a bank outside its home state - unless the bank
holding company is both well capitalized and well managed. Furthermore, a bank
may not engage in an interstate merger with another bank headquartered in
another state unless the surviving institution will be well capitalized and well
managed. The previous standard in both cases was adequately capitalized and
adequately managed.
Limits on Interchange Fees
Dodd-Frank amended the Electronic Fund Transfer Act to, among other things, give theFederal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over$10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
Dodd-Frank created the independent federal agency called theConsumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. TheCFPB has examination and primary enforcement authority with respect to depository institutions with$10 billion or more in assets. Smaller institutions are subject to rules promulgated by theCFPB , but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. TheCFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes theCFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, Dodd-Frank allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a "qualified mortgage" as defined by theCFPB . Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. ABILITY-TO-REPAY AND QUALIFIED MORTGAGE RULE - Pursuant to Dodd-Frank as highlighted above, theCFPB issued a final rule onJanuary 10, 2013 (effective onJanuary 10, 2014 ), amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine the consumer's ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and, (8) credit history. Alternatively, the mortgage lender can originate "qualified mortgages", which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a "qualified mortgage" is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Loans which meet these criteria will be considered qualified mortgages and, as a result, generally protect lenders from fines or litigation in the event of foreclosure. Qualified mortgages that are "higher-priced" (e.g., subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not "higher-priced" (e.g., prime loans) are given a safe harbor of compliance. The impact of the final rule, and the subsequent amendments thereto, on the Corporation's lending activities and the Corporation's statements of income or condition has had little or no impact; however, management will continue to monitor the implementation of the rule for any potential effects on the Corporation's business. DEPARTMENT OF DEFENSE MILITARY LENDING RULE - In 2015, theU.S. Department of Defense issued a final rule which restricts pricing and terms of certain credit extended to active duty military personnel and their families. This rule, which was implemented effectiveOctober 3, 2016 , caps the interest rate on certain credit extensions to an annual percentage rate of 36% and restricts other fees. The rule requires financial institutions to verify whether customers are military personnel subject to the rule. The impact of this final rule, and any subsequent amendments thereto, on the Corporation's lending activities and the Corporation's statements of income or condition has had little or no impact; however, management will continue to monitor the implementation of the rule for any potential effects on the Corporation's business. 54 --------------------------------------------------------------------------------
SUPERVISION AND REGULATION
Dividends
ACNB is a legal entity separate and distinct from its subsidiary bank. ACNB's revenues, on a parent company only basis, result primarily from dividends paid to the Corporation by its subsidiaries. Federal and state laws regulate the payment of dividends by ACNB's subsidiary bank. For further information, please refer to Regulation of Bank below.
Regulation of Bank
The operations of the subsidiary bank are subject to statutes applicable to banks chartered under the banking laws ofPennsylvania , to state nonmember banks of theFederal Reserve , and to banks whose deposits are insured by theFDIC . The subsidiary bank's operations are also subject to regulations of thePennsylvania Department of Banking and Securities ,Federal Reserve , andFDIC .The Pennsylvania Department of Banking and Securities , which has primary supervisory authority over banks chartered inPennsylvania , regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. The subsidiary bank is also subject to examination by theFDIC for safety and soundness, as well as consumer compliance. These examinations are designed for the protection of the subsidiary bank's depositors rather than ACNB's shareholders. The subsidiary bank must file quarterly and annual reports to theFederal Financial Institutions Examination Council , orFFIEC . Monetary and Fiscal Policy ACNB and its subsidiary bank are affected by the monetary and fiscal policies of government agencies, including theFederal Reserve andFDIC . Through open market securities transactions and changes in its discount rate and reserve requirements, theBoard of Governors of theFederal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature and impact of monetary and fiscal policies on future business and earnings of ACNB cannot be predicted at this time. From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of ACNB and the subsidiary bank, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of ACNB.
© Edgar Online, source
