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 contains forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure, and other financial terms, (b) statements of plans and objectives of management or the Board of Directors, and (c) statements of assumptions, such as economic conditions in the Corporation's market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "intends", "will", "should", "anticipates", or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties 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: the effects of governmental and fiscal policies, as well as legislative and regulatory changes; the effects of new laws and regulations, specifically the impact of the Coronavirus Response and Relief Supplemental Appropriations Act, the Coronavirus Aid, Relief, and Economic Security Act, the Tax Cuts and Jobs Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act; impacts of the capital and liquidity requirements of the Basel III standards; the 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; the 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 responses thereto on the operations of the Corporation and current customers, specifically the effect of the economy on loan customers' ability to repay loans; the effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; the 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; the effects of technology changes; volatilities in the securities markets; the effect of general economic conditions and more specifically in the Corporation's market areas; the 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; disruption of credit and equity markets; the ability to manage current levels of impaired assets; the loss of certain key officers; the 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, and any Current Reports on Form 8-K.
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
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in the need to make estimates on the effects of these questions which are inherently uncertain. The following policies are considered 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 on RIG's outstanding goodwill from its most recent testing, which was performed as ofOctober 1, 2020 . 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, 2021 . 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
summary
Net income for the three months endedMarch 31, 2021 , was$7,471,000 , compared to a net loss of$1,223,000 for the same quarter in 2020, an increase of$8,694,000 or 710.9%. Basic earnings (loss) per share for the three month period was$0.86 in 2021 and$(0.14) in 2020, or a 714.3% increase. The higher net income for the first quarter of 2021 was primarily a result of higher fee income, less loan loss provision compared to the first quarter of 2020 which had a loan charge-off of$2,000,000 , and one-time merger expenses. Net interest income for the quarter endedMarch 31, 2021 decreased$130,000 , or 0.7%, as decreases in total interest income were greater than decreases in total interest expense. Provision for loan losses was$50,000 for the quarter endedMarch 31, 2021 , compared to$4,000,000 for the same quarter in 2020, based on the adequacy analysis including estimation of 2020 COVID-19 losses (that even though not realized were believed to be embedded in the loan portfolio in the first quarter of 2020), resulting in an allowance to total loans of 1.26% (1.66% of non-acquired loans) atMarch 31, 2021 . Other income increased$1,747,000 , or 41.9%, due in part to increases in bank fees from selling mortgages into the secondary market and change in equity securities fair value. Other expenses decreased$5,670,000 , or 29.1%, due in part to merger-related expenses in 2020 in connection with the acquisition ofFrederick County Bancorp, Inc. in theFrederick County, Maryland market (FCBI) inJanuary 2020 . During the first quarter of 2021 there were$0 in merger/system conversion related expenses for the acquisition of FCBI that was effective onJanuary 11, 2020 . Although profitable, ACNB was profoundly impacted by the COVID-19 events, as were most community banks. 41 --------------------------------------------------------------------------------
Net interest income
Net interest income totaled$17,325,000 for the three months endedMarch 31, 2021 , compared to$17,455,000 for the same period in 2020, a decrease of$130,000 , or 0.7%. Net interest income decreased due to an decrease in interest income to a greater extent than a decrease in interest expense. Interest income decreased$1,539,000 , or 7.4%, due to the change in mix of average earning assets, in addition to decreased rates due to market events. The decrease in interest expense resulted from deposit rate decreases in addition to a favorable change in deposit mix (as discussed below). Loans outstanding was a result of active participation in the SBA Payroll Protection Program (PPP), the acquisition of FCBI offsetting loan paydowns and payoffs despite concerted effort by management to offset the recent year trend of the market area's heightened competition and the COVID-19 related slow economic conditions. Loan yields were negatively impacted by declines in theU.S. Treasury yields and other market driver interest rates. The first quarter saw continued lower market yields and the difference between longer term rates and shorter term rates was generally modest. These driver rates 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, 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 were FCBI purchase accounting adjustments that increased yield. Interest income decreased on investment securities due to new purchases 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 2021; and there exists ample ability to borrow for liquidity needs. The ability to increase lending is contingent on the 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, as economic conditions in the Corporation's marketplace 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, after COVID-19Federal 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$1,409,000 , or 40.8%, 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%. The effects of these rate actions and a host of other responses cannot be predicted currently. 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 2021 was 2.81% compared to 3.30% during the same period in 2020. Also comparing the first quarter of 2021 to 2020, the yield on interest earning assets decreased by 0.97% and the cost of interest bearing liabilities decreased by 0.47%. The net interest margin was 2.94% for the first quarter of 2021 and 3.55% for the first quarter of 2020. The net interest margin decrease was net of lower purchase accounting adjustments which decreased 28 basis points, but was more impacted by sharp market rate decreases (including PPP loans) and less loans as a percentage in the earning asset mix and more lower yielding investments and liquidity assets. Average earning assets were$2,387,000,000 during the first quarter of 2021, an increase of$411,000,000 from the average for the first quarter of 2020. Average interest bearing liabilities were$1,721,000,000 in the first quarter of 2021, an increase of$266,000,000 from the same period in 2020. Non-interest demand deposits increased$210,000,000 on average. 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.
Allowance for loan losses
The provision for loan losses was$50,000 in the first quarter of 2021 and$4,000,000 in the first quarter of 2020. 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 the FCBI acquisition or theNew Windsor Bancorp, Inc. acquisition completed in 2017 (New Windsor), which were recorded at fair value as the acquisition dates. Total impaired loans atMarch 31, 2021 were 5.8% higher when compared toDecember 31, 2020 . Nonaccrual loans increased by 9.2%, or$651,000 , sinceDecember 31, 2020 ; all substandard loans increased by 7.6% 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. The first quarter 2021 provision was calculated to be much lower due to the intervening provisioning for the impact of the COVID-19 pandemic and the continued reduction in modifications made in prior periods because of COVID-19. This customer base includes businesses in the hospitality/tourism industry, restaurants and related businesses and lessors of commercial real estate properties. The estimated increase in this 2021 qualitative factor for this event was approximately$0 for a total of$50,000 in provision expense. The remainder of the provision was due to limited loss incurred in 2021 charge-offs. Otherwise Management concluded that the loan portfolio exhibited continued general stability in quantitative and qualitative 42 -------------------------------------------------------------------------------- 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 ongoing COVID-19 event 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 2021 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 2021, the Corporation had net charge-offs of$39,000 , as compared to net charge-offs of$1,983,000 for the first quarter of 2020. Other Income Total other income was$5,913,000 for the three months endedMarch 31, 2021 , up$1,747,000 , or 41.9%, from the first quarter of 2020. Fees from deposit accounts decreased by$216,000 , or 21.8%, due to COVID-19-related decrease in economic activity that reduced 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 increased by$140,000 or 21.9%, to$778,000 due to variations in volume and mix, including 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. A another challenge to this revenue source is the general COVID-19 event and related impact caused decrease in retail activity and the retail system-wide security breaches in the merchant base that 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$703,000 for the three months endedMarch 31, 2021 , as compared to$668,000 for the first quarter of 2020, a 5.2% 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$9,000 , or 2.6%, as a net result of more insurance in place, varying crediting rates and administrate cost. At the Corporation's wholly-owned insurance subsidiary,Russell Insurance Group, Inc. (RIG), revenue was down by$57,000 , or 4.0%, to$1,383,000 during the period due to variations in commission volume, net of volume on new books of business purchased in the interim period. A continuing risk to RIG revenue is nonrenewal of large commercial accounts and actions by insurance carriers to reduce commissions paid to agencies such as RIG. Contingent or extra commission payments from insurance carriers are received in the second quarter of each year. Contingent commissions accruals were lower than prior years, due to specific claims at RIG 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 not practicable atMarch 31, 2021 , however they are expected to exceed the prior year. Income for sold mortgages included in other income, increased by$965,000 or 303.5% due to demand for refinancing in the low 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 2021 and 2020. A$365,000 net fair value gain was recognized on local bank and CRA-related equity securities during the first quarter of 2021 due to less concern on COVID-19 related negative market value effect on publicly-traded local bank stocks, compared to a$475,000 net fair value loss during the first quarter of 2020 when such concerns were high. No equity securities were sold in either period. Other income in the three months endedMarch 31, 2021 , was up by$49,000 , or 20.4%, to$289,000 due to a variety other fee income variances, mostly volume related.
Other expenses
Other expenses for the quarter endedMarch 31, 2021 were$13,787,000 , a decrease of$5,670,000 or 29.1%, most of which was the result of the first quarter of 2020 merger expenses of$5,965,000 . The largest component of other expenses is salaries and employee benefits, which increased by$167,000 , or 2.0%, when comparing the first quarter of 2021 to the same period a year ago. Overall, the increase in salaries and employee benefits was the result of increases as follows:
• the replacement and maintenance of personnel in contact with customers during the COVID-19 event due to a competitive labor market;
• variations in the personnel in contact with customers retained to serve the FCBI market;
• increased organic growth initiatives at RIG;
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• an increase in staff in support functions and a more skilled mix of employees made necessary by regulation and growth;
• normal employee merit increases and related payroll taxes;
• the variation and timing of performance-based commissions, restricted stock awards and incentives;
• market developments in actively managing the costs of employee benefit plans, including health insurance;
• the variable cost of benefits from the 401 (k) plan and the non-qualifying pension plan; and,
•defined benefit pension expense, which was up by$126,000 , or 210.0%, when comparing the three months endedMarch 31, 2021 , to the three months endedMarch 31, 2020 , 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 increased by$186,000 , or 19.0% during the period, mostly due to more winter season expense. Equipment expense increased by$7,000 , or 0.5%, due to tech equipment expenditures which vary due to specific projects. Equipment expense is subject to ever-increasing technology demands and the need for system upgrades for security and reliability purposes.ACNB Bank is in the midst of a core system conversion that will change various expense components (which cannot be fully estimated) when complete as part of its Digital Transformation strategy. Technology investments and training allowing staff to work from home continues to prove invaluable in keeping the Bank operational during the pandemic. Professional services expense totaled$224,000 during the first quarter of 2021, as compared to$402,000 for the same period in 2020, a decrease of$178,000 , or 44.3%. 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 are not on a regular recurring basis. Marketing and corporate relations expenses were$77,000 for the first quarter of 2021, or 58.2% lower, as compared to the same period of 2020. Marketing expense varies with the timing and amount of planned advertising production and media expenditures, typically related to the promotion of certain in-market banking and trust products. Foreclosed assets held for resale consist of the fair value of real estate acquired through foreclosure on real estate loan collateral or the acceptance of ownership of real estate in lieu of the foreclosure process. Fair values are based on appraisals that consider the sales prices of similar properties in the proximate vicinity less estimated selling costs. Foreclosed real estate (income) expense recovery (from prior year losses) was$(1,000) and$75,000 for the three months endedMarch 31, 2021 and 2020, respectively. The expense varies based upon the number and mix of commercial and residential real estate properties, unpaid property taxes, and deferred maintenance required upon acquisition. In addition, some properties suffer decreases in value after acquisition, requiring write-downs to fair value during the prolonged marketing cycles for these distressed properties. The higher expense in 2020 was related to expense until final liquidation. Foreclosed assets held for resale expenses or recoveries will vary in the remainder of 2021 depending on the unknown expenses related to new properties acquired. Foreclosure actions could be delayed in the COVID-19 environment. Other tax expense increased by$66,000 , or 20.2%, comparing the three months endedMarch 31, 2021 and 2020, 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 with retained earnings equity and acquisitions. Supplies and postage expense decreased by 22.0% due to variation in timing of sporadic refills.FDIC and regulatory expense increased 465.9% due to prior periods use of credits that did not repeat in the current periods. Intangible amortization decreased 6.0% on bank acquisition calculations and RIG books of business purchases. Other operating expenses increased by$104,000 , or 8.9%, in the first quarter of 2021, as compared to the first quarter of 2020. Increases included electronic banking and corporate governance related costs. In addition, other expenses include the expense 44 -------------------------------------------------------------------------------- of reimbursing checking and debit card customers for unauthorized transactions to their accounts and other third-party fraudulent use, added approximately$77,000 to other expenses in the first quarter of 2021 compared to$34,000 in the first quarter of 2020. Third-party breaches also cause additional card inventory and processing costs to the Corporation, none of which is expected to be recovered from the third-party merchants or other parties where the breaches occur. The debit card electronic delivery channel is valued by customers and provides significant revenue to the Corporation. The expense related to reimbursements is unpredictable and varying, but ACNB has policies and procedures to limit exposure.
Provision for income taxes
The Corporation recognized income taxes of$1,930,000 , or 20.5% of pretax income, during the first quarter of 2021, as compared to$(613,000) , or 33.4% of pretax loss, during the same period in 2020. 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$62,000 for the three months endedMarch 31, 2021 and 2020, respectively.
FINANCIAL CONDITION
Assets totaled$2,654,617,000 atMarch 31, 2021 , compared to$2,555,362,000 atDecember 31, 2020 , and$2,180,065,000 atMarch 31, 2020 . Average earning assets during the three months endedMarch 31, 2021 , increased to$2,387,000,000 from$2,130,625,000 during the same period in 2020. Average interest bearing liabilities increased in 2021 to$1,721,000,000 from$1,544,540,000 in 2020.
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, 2021 , the securities balance included a net unrealized loss on available for sale securities of$1,434,000 , net of taxes, on amortized cost of$356,852,000 versus a net unrealized gain of$4,645,000 , net of taxes, on amortized cost of$331,745,000 atDecember 31, 2020 , and a net unrealized gain of$4,463,000 , net of taxes, on amortized cost of$247,310,000 atMarch 31, 2020 . The change in fair value of available for sale securities during 2021 was a result of the higher amount of investments in the available for sale portfolio and by a decrease in fair value from an increase in theU.S. Treasury yield curve rates and the spread from this yield curve required by investors on the types of investment securities that ACNB owns. TheFederal Reserve 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. 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 as ofMarch 31, 2021 , leading to fair value deceases.. However, 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, 2021 , the securities balance included held to maturity securities with an amortized cost of$9,155,000 and a fair value of$9,451,000 , as compared to an amortized cost of$10,294,000 and a fair value of$10,768,000 atDecember 31, 2020 , and an amortized cost of$18,090,000 and a fair value of$18,565,000 atMarch 31, 2020 . The held to maturity securities areU.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. Due to changes in accounting rules, no held to maturity securities were added in the past several years. No held to maturity securities were acquired from FCBI. 45 --------------------------------------------------------------------------------
The Company does not hold investments comprised of Alt-A or subprime mortgage pools, private label mortgage-backed securities or preferred trust 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 8 - "Securities" in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note 10 - "Fair Value Measurements" in the Notes to Consolidated Financial Statements for more information about fair value.
Loans
Loans outstanding increased by$4,679,000 , or 0.3%, atMarch 31, 2021 fromMarch 31, 2020 , and decreased by$27,066,000 , or 1.7%, fromDecember 31, 2020 , toMarch 31, 2021 . The decrease in loans year to date is largely attributable to the sale of most new residential mortgages and the early payoff of loans in the residential mortgage, consumer, and government lending portfolios. Year over year, organic loan growth is primarily a result of active participation in the Paycheck Protection Program (PPP). 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 normal course of business, more payoffs were anticipated in the remainder of 2021 from either customers' cash reserves or refinancing at competing banks and markets, and currently lending actions are continuing while dealing with modifications and the ongoing work involved with thePPP Small Business Administration (SBA) guaranteed loans. During the first three months of 2021, total commercial purpose loans increased and local market portfolio residential mortgages decreased, largely from the acquisition of FCBI and active participation in the PPP program. Total commercial purpose segments increased$6,494,000 , or 0.6%, as compared toDecember 31, 2020 .$142,036,000 of this increase was PPP loans written in 2020 and 2021 to existing ACNB commercial customer base. 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$78,945,000 atMarch 31, 2021 , an increase of 14.8% from$68,772,000 held at the end of 2020; these loans are especially subject to refinancing in a declining rate environment. Residential real estate mortgage lending, which includes smaller commercial purpose loans secured by the owner's home, decreased by$32,751,000 , or 6.5%, as compared toDecember 31, 2020 . These loans are to local borrowers who preferred loan types that would not be sold into the secondary mortgage market. Of the$473,199,000 total in residential mortgage loans atMarch 31, 2021 ,$124,767,000 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, 2021 , the Corporation had an outstanding balance of$142,036,347 under the PPP program, net of repayments and forgiveness to date. Gross fees collected totaled$8,650,000 . Of this amount, fee income recognized was approximately$2,875,000 , before costs in 2020.$953,000 was recognized as adjustment to interest income yield through the first quarter of 2021, and the balance 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$371,449,000 , or 23.1% of total loans, atMarch 31, 2021 . 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 46 --------------------------------------------------------------------------------
risk compared to commercial loans in general. ACNB does not issue 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:
• unfavorable situations that could affect the borrower’s repayment capacity;
• the current estimated fair value of the underlying collateral; and,
• prevailing market conditions.
If management determines a loan is not impaired, a specific reserve allocation is not required. Management then places the loan 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:
• loan policies and procedures, including underwriting standards and collection, write-off and collection practices;
• national, regional and local economic and business conditions, as well as the state of various market segments, including the impact on the value of the underlying collateral for collateral-dependent loans;
• the nature and size of the portfolio and the loan conditions;
• experience, skill and depth of loan and staff management;
• the volume and severity of delinquent, classified and non-accounting loans, as well as other loan modifications; and,
• existence and effect of any concentration of credit and change in the level of such concentrations.
•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 allocation of specific and general reserves;
• the perceived level of consumer and small business loans with proven weaknesses for which it is not possible to develop specific allocations;
• other potential exposure in the loan portfolio;
• deviations in management’s assessment of national, regional and local economic conditions; and,
• other internal or external factors that management deems appropriate at the time, such as COVID-19.
47 -------------------------------------------------------------------------------- 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 2021 and the resulting allowance atMarch 31, 2021 , 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 2020 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, 2021 . The amount of the unallocated portion of the allowance was$1,048,000 atMarch 31, 2021 . Before the COVID-19 event, management concluded that the loan portfolio exhibited continued general improvement in quantitative and qualitative measurements. Management believes the above methodology materially reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology and the assumptions discussed above. Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the methodology discussed above, which is consistent with recent quarters' improvement in the credit quality in the loan portfolio, but with increased risk from the impact of the COVID-19 crisis . The provision for year-to-dateMarch 31, 2021 and 2020, was$50,000 and$4,000,000 , respectively. More specifically, as total loans decreased from year-end 2020 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. InJune 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. InOctober 2019 , FASB voted to delay implementation of the CECL standard for certain companies, including those companies that qualify as a smaller reporting company underSEC rules untilJanuary 1, 2023 . As a result ACNB will likely be able to defer implementation of the CECL standard for a period of time. The allowance for loan losses atMarch 31, 2021 , was$20,237,000 , or 1.26% of total loans (1.66% of non-acquired loans), as compared to$15,852,000 , or 0.99% of loans, atMarch 31, 2020 , and$20,226,000 , or 1.23% of loans, atDecember 31, 2020 . The increase from year-end resulted from charge-offs of$39,000 net of recoveries and$50,000 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 9 - "Loans" in the Notes to Consolidated Financial Statements. 48 --------------------------------------------------------------------------------
The changes in the allowance for loan losses are as follows:
Three Months Ended Year Ended Three Months Ended
In thousands March 31, 2021 December 31, 2020 March 31, 2020
Beginning balance - January 1 $ 20,226 $ 13,835 $ 13,835
Provisions charged to operations 50 9,140 4,000
Recoveries on charged-off loans 16 238 85
Loans charged-off (55) (2,987) (2,068)
Ending balance $ 20,237 $ 20,226 $ 15,852
Loans past due 90 days and still accruing were $675,000 and nonaccrual loans
were $7,692,000 as of March 31, 2021 . $111,000 of the nonaccrual balance at
March 31, 2021 , were 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 $3,037,000 at March 31, 2020 , while nonaccruals
were $4,826,000 . $175,000 of the nonaccrual balance at March 31, 2020 , was in
troubled debt restructured loans. $3,758,000 of the impaired loans were accruing
troubled debt restructured loans. Loans past due 90 days and still accruing were
$855,000 at December 31, 2020 , while nonaccruals were $7,041,000 . $127,000 of
the nonaccrual balance at December 31, 2020 , were in troubled debt restructured
loans. $3,680,000 of the impaired loans were accruing troubled debt restructured
loans. Total additional loans classified as substandard (potential problem
loans) at March 31, 2021 , March 31, 2020 , and December 31, 2020 , were
approximately $2,470,000 , $2,887,000 and $2,607,000 , respectively.
Because of the manageable level of nonaccrual loans and with substandard loans
in the first quarter of 2021, a $50,000 provision addition to the allowance was
necessary due to charge-offs of $39,000 .
In the first two quarters of 2020, the Corporation had received significant
numbers of requests to modify loan terms and/or defer principal and/or interest
payments, and had agreed to appropriate deferrals or are in the process of doing
so. Under Section 4013 of the CARES Act, loans less than 30 days past due as of
December 31, 2019 , will be considered current for COVID-19 related
modifications. A financial institution can then use FASB agreed upon temporary
changes to GAAP for loan modifications related to COVID-19 that would otherwise
be categorized as a troubled debt restructuring (TDR), and suspend any
determination of a loan modified as a result of COVID-19 being a TDR, including
the requirement to determine impairment for accounting purposes. Similarly, FASB
has confirmed that short-term modifications made on a good-faith basis in
response to COVID-19 to loan customers who were current prior to any relief are
not TDRs.
Beginning the week of March 16, 2020 , the Corporation began receiving requests
for temporary modifications to the repayment structure for borrower loans. The
modifications are grouped into deferred payments of no more than six months,
interest only, lines of credit only and other. As of March 31, 2021 , the
Corporation had 30 temporary modifications with principal balances totaling
$23,720,360 .
The details regarding the actual loan modifications are as follows:
Type of Loans Number of Loans Deferral Period Balance Percentage of Capital Commercial Purpose 28 Up to 6 months$ 23,562,751 9.15 % Consumer Purpose 2 Up to 6 months 157,609 0.06 30$ 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. 49 --------------------------------------------------------------------------------
Information on non-criminal loans, by collateral type rather than loan category, at
Number of Current
Credit Specific Loss Year
Dollars in thousands Relationships Balance Allocations Charge-Offs Location Originated
March 31, 2021
Owner occupied commercial real
estate 9 $ 4,544 $ 151 $ - In market 2008 - 2019
Investment/rental residential real
estate 3 410 - - In market 2009 - 2016
Commercial and industrial 3 2,738 1,955 - In market 2008 - 2019
Total 15 $ 7,692 $ 2,106 $ -
December 31, 2020
Owner occupied commercial real
estate 9 $ 4,601 $ 124 $ - In market 2008 - 2019
Investment/rental residential real
estate 3 410 34 - In market 2009 - 2016
Commercial and industrial 2 2,030 1,224 - In market 2008 - 2019
Total 14 $ 7,041 $ 1,382 $ -
Management has deemed it appropriate to provide this type of information in more detail by type of guarantee in order to provide additional details 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 Company had no impaired and non-incremental loans included in the construction of commercial buildings at
Owner occupied commercial real estate atMarch 31, 2021 , includes nine unrelated loan relationships. A$1,009,000 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. An$802,000 merger-acquired loan relationship for a light manufacturing enterprise which was performing when acquired is pursuing a possible sale. An unrelated$392,000 credit was added to this category in the second quarter of 2020 when ACNB was notified that property was scheduled for tax sale which has been suspended. The other loans in this category have balances of less than$240,000 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 2014 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
Investment/rental residential real estate atMarch 31, 2021 , includes three unrelated loan relationships totaling$410,000 for which the real estate is collateral and the purpose of which is for speculation, rental, or other non-owner occupied uses. One loan in this category atApril 2015 , was stayed from further foreclosure action by a bankruptcy filing. A second loan added in the third quarter of 2019 appears to be adequately collateralized in an upcoming sheriff's sale. An unrelated loan relationship in this category was a business affected by COVID-19 but has made payments. A$1,795,000 commercial and industrial loan was added in the fourth quarter of 2020 after ceasing operations. Liquidation are underway with a specific allocation of$1,1190,000 . A related$441,000 owner occupied real estate loan is also in nonaccrual. An unrelated commercial and industrial loan atMarch 31, 2021 with a balance of$34,000 and a specific allocation of$11,000 ; this loan is currently making payments. A third unrelated loan relationship was added in the first quarter 2021 with an outstanding balance of$909,000 and a specific allocation$754,000 due to concerns on collateralization. 50 -------------------------------------------------------------------------------- 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 2021 and 2020 was a result of the measurement of the adequacy of the allowance for loan losses at each period. Premises and Equipment During the quarter endedJune 30, 2016 , a building was sold and the Corporation is leasing back a portion of that building. In connection with these transactions, a gain of$1,147,000 was realized, of which$447,000 was recognized in the quarter endedJune 30, 2016 and the remaining$700,000 deferred for future recognition over the lease back term. A reduction of lease expense of$18,000 was recognized in the first three months of 2021 and 2020, respectively. 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 .
Assets seized 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. The carrying value of real estate acquired through foreclosure totaled$0 for no properties atMarch 31, 2021 , compared to$0 for no properties and borrowers atDecember 31, 2020 . The decrease in the carrying value was due to all properties sold in 2020. All properties after acquisition are actively marketed. The Corporation expects to obtain and market additional foreclosed assets through the remainder of 2021; however, the total amount and timing is currently not certain. Deposits ACNB relies on deposits as a primary source of funds for lending activities with total deposits of$2,278,622,000 as ofMarch 31, 2021 . Deposits increased by$467,265,000 , or 25.8%, fromMarch 31, 2020 , toMarch 31, 2021 , and increased by$93,097,000 , or 4.3%, fromDecember 31, 2020 , toMarch 31, 2021 . Deposits increased in the first quarter of 2021 from PPP proceeds deposited to customer's accounts and from increased balances in a broad base of accounts from lack of economic activity due to the COVID-19 event. Even with this increase in volume, deposit interest expense decreased 43.4% 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 trust, credit unions and larger regional banks. During the recession and subsequent slow recovery, 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 will 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. If rates rise rapidly, or when the equity markets are high, funds could leave the Corporation or be priced higher to maintain deposits.
Loans
51 -------------------------------------------------------------------------------- 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 2020, repurchase agreement balances were down$7,182,000 , or 18.7%, due to changes in the cash flow position of ACNB's commercial and local government customer base and competition from non-bank sources. There were no short-term FHLB borrowings atMarch 31, 2021 and 2020, orDecember 31, 2020 . 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. Long-term borrowings totaled$65,616,000 atMarch 31, 2021 , versus$53,745,000 atDecember 31, 2020 , and$71,723,000 atMarch 31, 2020 . Long-term borrowings decreased 8.5% fromMarch 31, 2020 .$20.0 million was the net decrease to FHLB term Bank borrowings to balance loan demand and deposit growth. FHLB fixed-rate term Bank advances that matured after the first quarter of 2019 were not renewed due to adequate deposit funding sources. A second quarter of 2017$4.6 million Corporation loan was paid down to$1.2 million outstanding balance on a borrowing from a local bank that had been made to fund the cash payment to shareholders of the New Windsor acquisition. RIG borrowed$1.0 million from a local bank at the end of the third quarter of 2018 to fund a book of business purchase. The balance of this loan was paid down to$0 atMarch 31, 2021 . In addition,$5 million and$8.7 million was Corporation debt acquired from New Windsor and FCBI, respectively. 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, repurchase issued and outstanding shares of the Corporation, support general corporate purposes, underwrite growth opportunities, create an interest reserve for the notes issued, and downstream 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 city
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$257,612,000 atMarch 31, 2021 , compared to$257,972,000 atDecember 31, 2020 , and$246,994,000 atMarch 31, 2020 . Shareholders' equity decreased in the first three months of 2021 by$360,000 primarily due to the increase in accumulated other comprehensive loss from change in investment market value, net of$5,294,000 in retained earnings from 2021 earnings net of dividends paid to date. 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 . A$5,835,000 increase in accumulated other comprehensive loss was a result of a net decrease in the fair value of the investment portfolio from the increase in market rates and 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. The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During the first three months of 2021, ACNB earned$7,471,000 and paid dividends of$2,177,000 for a dividend payout ratio of 29.1%. During the first three months of 2020, ACNB earned$(1,223,000) and paid dividends of$2,167,000 for a dividend payout ratio of (177.2)%.ACNB Corporation has a Dividend Reinvestment and Stock Purchase Plan that provides registered holders ofACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. Year-to-dateMarch 31, 2021 , 5,627 shares were issued under this plan with proceeds in the amount of$(181,000) . Year-to-dateMarch 31, 2020 , shares were provided to participants by open market purchases. Proceeds were used for general corporate purposes.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, 2021 , 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 on 52 --------------------------------------------------------------------------------
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, 2021 , 35,587 shares were issued under this plan and 538,468 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 no shares repurchased under the plan during the quarter endedMarch 31, 2021 . 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, 2021 , andDecember 31, 2020 , 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.
Changes in regulatory capital
InJuly 2013 , the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations beganJanuary 1, 2015 , while larger institutions (generally those with assets of$250 billion or more) began compliance effectiveJanuary 1, 2014 . The final rules call for the following capital requirements:
• a minimum ratio of common Tier 1 capital to risk-weighted assets of 4.5%;
• a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%;
• a minimum ratio of total capital to risk-weighted assets of 8.0%; and,
• a minimum leverage ratio of 4.0%.
In addition, the final rules 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 onJanuary 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 FRY-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 beforeMay 19, 2010 , for inclusion in the Tier 1 capital of banking organizations with total consolidated assets of less than$15 billion as ofDecember 31, 2009 , and banking organizations that were mutual holding companies as ofMay 19, 2010 . 53 -------------------------------------------------------------------------------- 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 ofMarch 31, 2021 , 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, 2021 .
The capital ratios of the banking subsidiary are as follows:
To Be Well Capitalized
Under Prompt
Corrective Action
March 31, 2021 December 31, 2020 Regulations
Tier 1 leverage ratio (to average assets) 9.21 % 9.01 % 5.00 %
Common Tier 1 capital ratio (to risk-weighted
assets) 14.33 % 13.86 % 6.50 %
Tier 1 risk-based capital ratio (to risk-weighted
assets) 14.33 % 13.86 % 8.00 %
Total risk-based capital ratio 15.58 % 15.10 % 10.00 %
Liquidity
Effective liquidity management ensures that the cash needs of depositors and borrowers, as well as ACNB’s operating cash requirements, 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, 2021 , ACNB's banking subsidiary had a borrowing capacity of approximately$825,196,000 from the FHLB, of which$775,330,000 was available. Because of various restrictions and requirements on utilizing the available balance, ACNB considers$566,000,000 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 54 -------------------------------------------------------------------------------- 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$31,282,000 and$38,464,000 atMarch 31, 2021 , andDecember 31, 2020 , 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 expected cash inflows and outflows on a daily basis and believes that it has sufficient sources of funding to maintain sufficient liquidity under varying degrees of commercial terms.
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, 2021 , the Corporation had unfunded outstanding commitments to extend credit of approximately$358,944,000 and outstanding standby letters of credit of approximately$8,094,000 . Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.
Market risks
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.
The 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. 55 -------------------------------------------------------------------------------- With the combination of the two organizations,ACNB Corporation , on a consolidated basis, has approximately$2.7 billion in assets,$2.3 billion in deposits, and$1.6 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 , as ofApril 1, 2021 . 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 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:
Capital requirements of the holding company
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 56 -------------------------------------------------------------------------------- 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 of Charter-based conversions of institutions in difficulty
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.
Connection from one state to another
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
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.
Interchange Fee Limits
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 57 --------------------------------------------------------------------------------
compliance with 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.
MONITORING AND REGULATION
The 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.
Banking regulations
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 58
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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.
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