Acnb Corp: Form 10-Q for the period ended Sep 30, 2023

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 for ACNB Corporation (the Corporation or ACNB), a financial holding company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee, assure or indicate similar performance in the future.

Forward-Looking Statements

In addition to historical information, this Form 10-Q may contain forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure, and other financial terms, (b) statements of plans and objectives of Management or the Board of Directors, and (c) statements of assumptions, such as economic conditions in the Corporation’s market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “intends”, “will”, “should”, “anticipates”, or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties such as national, regional and local market area economic conditions, competitive factors, and regulatory limitations. Actual results may differ materially from those projected in the forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: short-term and long-term effects of inflation and rising costs on the Corporation, customers and economy; banking system instability caused by failures and continuing financial uncertainty of various banks which may adversely impact the Corporation and its securities and loan values, deposit stability, capital adequacy, financial condition, operations, liquidity, and results of operations; effects of governmental and fiscal policies, as well as legislative and regulatory changes; effects of new laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and their application with which the Corporation and its subsidiaries must comply; impacts of the capital and liquidity requirements of the Basel III standards or any future standards; effects of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial 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 of the United States government, including the effects of short-term and long-term federal budget and tax negotiations and a failure to increase the government debt limit or a prolonged shutdown of the federal government; effects of economic conditions particularly with regard to the negative impact of any pandemic, epidemic or health-related crisis and the responses thereto on the operations of the Corporation and current customers, specifically the effect of the economy on loan customers’ ability to repay loans; effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; inflation, securities market and monetary fluctuations; risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest rate protection agreements, as well as interest rate risks; difficulties in acquisitions and integrating and operating acquired business operations, including information technology difficulties; challenges in establishing and maintaining operations in new markets; effects of technology changes; failure of assumptions underlying the establishment of reserves for credit losses and estimations of values of collateral and various financial assets and liabilities; acts of war or terrorism or geopolitical instability; disruption of credit and equity markets; ability to manage current levels of impaired assets; loss of certain key officers; ability to maintain the value and image of the Corporation’s brand and protect the Corporation’s intellectual property rights; continued relationships with major customers; and, potential impacts to the Corporation from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses. We caution readers not to place undue reliance on these forward-looking statements. They only reflect Management’s analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time to time with the Securities and Exchange Commission, including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q. Please also carefully review any Current Reports on Form 8-K filed by the Corporation with the Securities and Exchange Commission.

CRITICAL ACCOUNTING ESTIMATES

The accounting estimates that the Corporation’s management deems to be most important to the portrayal of its financial condition and results of operations, and that require management’s most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following accounting estimates are deemed to be critical by management:

The allowance for credit losses (ACL) represents an amount which, in management’s judgment, is adequate to absorb expected credit losses on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for credit losses, which is recorded as a current period operating expense.

Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness of the ACL is reviewed quarterly by management.

Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed. While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes in the interest rate environment which may directly impact prepayment and curtailment rate assumption, and changes in the financial condition of borrowers.

RESULTS OF OPERATIONS

Quarter ended September 30, 2023, compared to Quarter ended September 30, 2022

Executive Summary

Net income for the three months ended September 30, 2023 was $9.0 million compared to net income of $10.3 million for the comparable quarter of the prior year, a decrease of $1.3 million or 12.4%. Basic and diluted earnings per share for the three months ended September 30, 2023 and 2022 were $1.06 and $1.20, respectively, an 11.7% decrease. The decrease in net income for the third quarter of 2023 was driven primarily by a decrease in net interest income and higher noninterest expenses, partially offset by an increase in noninterest income.

Net Interest Income

Net interest income totaled $21.7 million for the three months ended September 30, 2023 compared to $22.5 million for the comparable quarter of the prior year, a decrease of $775 thousand, or 3.4%. The decrease in net interest income was driven primarily by a decrease in earning assets, an increase in the cost of funds, and a decrease in purchase accounting accretion. Paycheck Protection Program (PPP) fees and purchase accounting accretion totaled $208 thousand for the three months ended September 30, 2023 compared to $853 thousand for the three months ended September 30, 2022. There were no PPP fees for the three months ended September 30, 2023 compared to $24 thousand for the comparable quarter of last year. The fully taxable equivalent (FTE) net interest margin for the three months ended September 30, 2023 was 4.01%, a 41 basis points increase from 3.60% for the comparable quarter of last year.

Average earning assets declined year-over-year driven primarily by a decrease in cash balances and investments, partially offset by loan growth. Interest income increased by $852 thousand for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 driven primarily by higher interest rates and a shift to higher-yielding assets. The average yield on earnings assets was 4.46% for the three months ended September 30, 2023, an increase of 72 basis points from the comparable quarter of the prior year. Interest expense increased by $1.6 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 driven primarily by an increase in cost and amount of short-term and long-term borrowings to fund loan growth and deposit outflows. The average rate paid on interest bearing deposits was 0.26% for the three months ended September 30, 2023, an increase of 12 basis points from the comparable quarter of the prior year. The average rate paid on total borrowings was 3.83% for the three months ended September 30, 2023, an increase of 218 basis points from the comparable quarter last year.

Provision for Credit Losses and Unfunded Commitments

Based on the forward-looking metrics utilized within the CECL model, combined with the current market environment applied to the Bank’s loan portfolio, the provision for credit losses for the three months ended September 30, 2023 was $250 thousand, and the provision for unfunded commitments was a reversal of $171 thousand compared to no provision for the comparable quarter of the prior year. The determination of the provisions was a result of the analysis of the adequacy of the allowances for credit losses and unfunded commitments calculations. Each quarter, the Corporation assesses risks and reserves required compared with the balances in the allowance for credit losses and unfunded commitments.

Other Income

Total other income was $6.3 million for the three months ended September 30, 2023, an increase of $448 thousand, or 7.7%, from the comparable quarter of the prior year. The higher income was driven primarily by an increase of $200 thousand in commissions from insurance sales due to organic growth. In addition, income from fiduciary, investment management and brokerage activities increased $130 thousand, or 15.8%, driven primarily by strong market returns, an increase in estate settlement income and new business generation. Earnings on investment in bank-owned life insurance increased by $111 thousand due to additional purchases of insurance with a cash surrender value of $12.2 million during the second half of 2022. The net loss on equity securities for the three months ended September 30, 2023, improved to a $27 thousand net loss as compared to an $88 thousand net loss during the comparable quarter of the prior year. Other income in the three months ended September 30, 2023, increased $48 thousand, or 13.3%, to $410 thousand primarily driven by increases in third-party fee income and increases in letter of credit income.

Other Expenses

Other expenses for the quarter ended September 30, 2023 were $16.3 million an increase of $1.0 million, or 6.6%, from the comparable quarter of the prior year. Salaries and employee benefits increased by $749 thousand, or 8.0%, from the comparable quarter of the prior year, primarily driven by a general increase in base wages and commissions and an increase to accrued incentive compensation. Other operating increased $193 thousand, or 12.8%, driven primarily by an increase of $111 thousand in holding company related costs and $97 thousand in director-related fees partially offset by various miscellaneous expenses. Marketing and corporate relations expenses were $159 thousand for the third quarter of 2023 compared to $57 thousand for the comparable quarter of last year. The increase was driven by $73 thousand in expenses related to the rebranding of ACNB Bank’s Maryland banking divisions. FDIC and regulatory increased $125 thousand during the quarter ended September 30, 2023 compared to the same quarter of the prior year due to the timing of expense recognition.

Provision for Income Taxes

The Corporation recognized income taxes of $2.6 million during the third quarter of 2023 compared to $2.7 million income, during the comparable quarter in 2022. The provision for income taxes for the third quarter of 2023 reflects an effective combined Federal and state tax rate (ETR) of 22.2% compared to an ETR of 20.9% for the comparable period of 2022. Any variances from the federal statutory rate of 21% are generally due to tax-free income, which includes interest income on tax-free loans and investment securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expense. Low-income housing tax credits were $3 thousand and $70 thousand for the three months ended September 30, 2023 and 2022, respectively.

Nine Months ended September 30, 2023, compared to Nine Months ended September 30, 2022

Executive Summary

Net income for the nine months ended September 30, 2023, was $27.6 million compared to $25.6 million for the comparable period in 2022, an increase of $2.0 million, or 8.0%. Basic and diluted earnings per share for the nine month period in 2023 was $3.24 and $3.23, respectively, and $2.95 for both basic and diluted earnings per share for the comparable period of last year. The higher net income for the nine months ended September 30, 2023 was driven primarily by increases in net interest income and other income partially offset by an increase in total other expenses.

Net Interest Income

Net interest income totaled $66.8 million for the nine months ended September 30, 2023 compared to $59.4 million for the comparable period of last year, an increase of $7.5 million, or 12.5%. The increase in net interest income was primarily a result of growth in higher-yielding interest earning assets coupled with higher interest rates. The FTE net interest margin for the first nine months of 2023 was 4.11%, a 96 basis points increase from 3.15% for the comparable period of last year. Year-to-date, PPP fees and purchase accounting accretion totaled $832 thousand compared to $2.8 million for the comparable period of the prior year. PPP fees were $8 thousand for the nine months ended September 30, 2023 compared to $1.3 million for the comparable period of the prior year.

Average earning assets declined year-over-year driven primarily by cash balances decreasing attributed to anticipated deposit outflows as market rates increased in 2022 and 2023. Given ACNB’s funding level, Management continued to restrain deposit rates despite an increase in market interest rates and an increase in rates by competitors. As a result, average deposits declined year-over-year as customers continued to seek higher yielding alternative deposit and investment products. However, interest income increased by $9.2 million for the nine months ended September 30, 2023 compared to the comparable period of last year driven by higher interest rates and a shift into higher yielding assets. The average yield on earnings assets increased to 4.39% for the nine months ended September 30, 2023 compared to 3.29% for the comparable period of the prior year, an increase of 110 basis points. Interest expense increased by $1.8 million for the nine months ended September 30, 2023 compared to the comparable period of the prior year driven by an increase in short-term and long-term borrowings. The average rate paid on interest-bearing deposits was 0.17% for the nine months ended September 30, 2023, an increase of 2 basis points as compared to 0.15% for the comparable period of last year. The average rate paid on total borrowings was 3.33% for the nine months ended September 30, 2023, an increase of 161 basis points from the comparable period last year.

Provision for Credit Losses and Unfunded Commitments

Based on the forward-looking metrics utilized within the CECL model, combined with the current market environment applied to the Bank’s loan portfolio, the provision for credit losses for the first nine months of 2023 was $74 thousand, and the provision for unfunded commitments was $226 thousand compared to no provision for the comparable period of the prior year. The determination of the provisions was a result of the analysis of the adequacy of the allowances for credit losses and unfunded commitments calculations. Each quarter, the Corporation assesses risks and reserves required compared with the balances in the allowance for credit losses and unfunded commitments.

Other Income

Total other income was $17.5 million for the nine months ended September 30, 2023, an increase of $1.1 million, or 6.7%, from the first nine months of 2022. At the Corporation’s wholly-owned insurance subsidiary, ACNB Insurance Services, Inc., commissions from insurance sales increased $934 thousand, or 14.5%, to $7.4 million during the period primarily due to the acquisition of the business and assets of the Hockley & O’Donnell Agency in the first quarter of 2022 and higher contingent income. Earnings on bank-owned life insurance increased by $347 thousand, or 33.0%, driven primarily by additional purchases of insurance with a cash surrender value of $12.2 million during the second half of 2022. Income from fiduciary, investment management and brokerage activities totaled $2.8 million for the nine months ended September 30, 2023, as compared to $2.4 million for the first nine months of 2022, a $323 thousand, or 13.2%, increase driven primarily by strong market returns and new business generation. A $22 thousand net loss on equity securities was recognized during the first nine months of 2023 compared to a $345 thousand net loss during the first nine months of 2022. A net loss of $739 thousand was recognized on the sales of securities during the first nine months of 2023, compared to no securities sold during the first nine months of 2022. Income from mortgage loans held for sale decreased by $437 thousand, or 93.4%, due to less mortgage activity as a result of an increase in the current rate environment and the strategic decision to retain more mortgage production.

Other Expenses

Other expenses for the nine months ended September 30, 2023 were $48.9 million an increase of $5.3 million, or 12.1%, from the first nine months of 2022. The increase was driven primarily by increases in salaries and employee benefits, other operating, professional services, marketing and corporate relations and equipment expenses. Salaries and employee benefits increased $4.1 million, or 15.8%, when comparing the first nine months of 2023 to the comparable period of the prior year. The increase in salaries and employee benefits expense was driven primarily by a $750 thousand partial reversal of incentive compensation in the first quarter of 2022, higher incentive compensation accrual for 2023 of $277 thousand, a reversal of $484 thousand of net deferred loan expense in the first quarter of 2022 as well as an increase in stock-based compensation expense of $539 thousand, an increase in pension expense of $470 thousand, an increase in the Bank’s salary continuation plan expense of $317 thousand and a general increase in base wages due to merit increases and the acquisition of Hockley & O’Donnell Agency in the first quarter of 2022. Other operating increased $679 thousand, or 15.3%, driven primarily by a loss of $142 thousand as a result of writing off an investment in a title agency, a $131 thousand of increased loan-related and general purpose insurance costs, an increase in costs for the Bank’s internet banking activity costs of $109 thousand, an increase of $118 thousand in director-related fees, and a mark-to-market loss of $66 thousand related to an SBIC fund. Professional services expense totaled $1.6 million during the first nine months of 2023 compared to $1.3 million for the comparable period of the prior year, an increase of $272 thousand or 20.5%. The increase in professional expenses was a result of additional expenses related to the transition of the Corporation’s independent audit firm, higher expenses for third-party consulting services for various projects within the organization, higher expenses for employee recruiting and increased legal fees. Marketing and corporate relations expenses were $472 thousand for the first nine months of 2023 compared to $227 thousand for the comparable period of last year. The increase was driven by $248 thousand expenses related to the rebranding of ACNB Bank’s Maryland banking divisions. Equipment expense increased by $218 thousand, or 4.8%, driven primarily by increases in third-party vendor software costs related to the Bank’s new loan origination system that was implemented in late 2022. FDIC and regulatory costs increased $134 thousand, or 16.8%, due to the timing of expense recognition.

Provision for Income Taxes

The Corporation recognized income taxes of $7.5 million, during the first nine months of 2023, compared to $6.6 million during the comparable period of 2022. The provision for income taxes for the first nine months of 2023 reflects an effective combined ETR of 21.4% compared to an ETR of 20.5% for the comparable period of 2022. Any variances from the federal statutory rate of 21% in the respective periods are generally due to tax-free income, which includes interest income on tax-free loans and investment securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expense. Low-income housing tax credits were $11 thousand and $211 thousand for the nine months ended September 30, 2023 and 2022, respectively.

FINANCIAL CONDITION

Assets totaled $2.4 billion at September 30, 2023 compared to $2.5 billion at December 31, 2022. The decrease from December 31, 2022 was driven primarily by a reduction in cash and cash equivalents to fund loan growth and deposit outflows driven by customers continuing to seek higher yielding alternative deposit and investment products as market interest rates rose during 2022 and 2023 and a reduction in available for sale securities due to general balance sheet and interest rate risk management. Total loans outstanding were $1.6 billion at September 30, 2023 compared to $1.5 billion at December 31, 2022. Loans increased by $77.4 million, or 5.0%, from December 31, 2022 to September 30, 2023, primarily from strong organic loan growth in 2023. Total securities were $501.1 million at September 30, 2023 compared to $620.3 million at December 31, 2022, a decrease of 19.2%. Total deposits were $2.0 billion at September 30, 2023. Deposits decreased by $247.6 million, or 11.3%, since December 31, 2022. Total borrowings were $153.4 million at September 30, 2023. Total borrowings increased by $90.4 million or 143.7%, since December 31, 2022 to fund deposit outflows and loan growth.

Investment Securities

ACNB uses investment securities to generate interest and dividend income, manage interest rate risk, provide collateral for certain funding products, and provide liquidity. The investment portfolio is comprised of U.S. Government and agency, mortgage-backed, state and municipal, and corporate securities. These securities provide the appropriate characteristics with respect to credit quality, yield and maturity relative to the management of the overall balance sheet.

At September 30, 2023, the securities balance included a net unrealized loss on available for sale securities of $59.7 million, net of taxes, on amortized cost of $510.8 million versus a net unrealized loss of $52.7 million, net of taxes, on amortized cost of $617.6 million at December 31, 2022. The change in fair value of available for sale securities was a result of an increase in market interest rates in 2022 and 2023. The changes in value are deemed to be related solely to changes in market interest rates as the credit quality of the portfolio remained strong.

At September 30, 2023, the securities balance included held to maturity securities with an amortized cost of $64.6 million and a fair value of $53.8 million as compared to an amortized cost of $65.0 million and a fair value of $58.1 million at December 31, 2022. These balances include unamortized, unrealized losses of $3.0 million and $3.9 million as of each respective period end which resulted from the transfer of approximately $39.7 million securities from available for sale to held to maturity during the second quarter of 2022.

The Corporation does not own investments consisting of pools of Alt-A or subprime mortgages, private label mortgage-backed securities, or trust preferred investments.

The fair values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather by relying on the security’s relationship to other benchmark quoted prices. The Corporation uses independent service providers to provide matrix pricing. Please refer to Note 7 — “Securities” in the Notes to Consolidated Financial Statements for more information on the security portfolio and Note 9 — “Fair Value Measurements” in the Notes to Consolidated Financial Statements for more information about fair value.

Loans

Loans outstanding increased by $77.4 million, or 5.0%, from December 31, 2022 to September 30, 2023. The increase in loans is largely attributable to growth in the commercial lending portfolio. Total commercial loans increased $51.9 million, or 4.8%, as compared to December 31, 2022. Commercial loans are spread among diverse categories that include municipal governments/school districts, commercial real estate, commercial real estate construction, and commercial and industrial. Residential real estate mortgage lending increased by $22.2 million, or 6.1%, as compared to December 31, 2022.

Most of the Corporation’s lending activities are with customers located within the Bank’s market area of southcentral Pennsylvania and northern Maryland. Non-owner occupied commercial real estate represented 60.4% of the commercial real estate portfolio. These borrowers are geographically dispersed throughout ACNB’s marketplace and are leasing commercial properties to a varied group of tenants including medical offices, retail space, and other commercial purpose facilities. Because of the varied nature of the tenants, in aggregate, management believes that these loans present an acceptable risk when compared to commercial loans in general. ACNB does not originate or hold Alt-A or subprime mortgages in its loan portfolio. For more information please see Note 8 — “Loans and Allowance for Credit Losses” in the Notes to Consolidated Financial Statements.

Allowance for Credit Losses and Asset Quality

The allowance for credit losses at September 30, 2023, was $19.3 million, or 1.19% of total loans as compared to $17.9 million, or 1.16% of loans, at December 31, 2022. As of January 1, 2023, upon adoption of ASU 2016-13, the allowance for credit losses was $19.5 million, or 1.27% of total loans. The increase from year-end was primarily driven by the adoption of CECL as shown in the table below. For more information please see Note 8 — “Loans and Allowance for Credit Losses” in the Notes to Consolidated Financial Statements.

Changes in the allowance for credit losses were as follows:

In thousands

Loans past due 90 days and still accruing were $1.0 million and $1.2 million as of September 30, 2023 and December 31, 2022, respectively. Nonaccrual loans totaled $2.5 million and $2.7 million as of September 30, 2023 and December 31, 2022, respectively.

Information on nonaccrual loans, by collateral type rather than loan class, at September 30, 2023, as compared to December 31, 2022, is as follows:

Dollars in thousands

All nonaccrual loans are to borrowers located within the market area served by the Corporation in southcentral Pennsylvania and northern Maryland. All nonaccrual individually evaluated loans were originated by ACNB’s banking subsidiary.

Premises and Equipment

On January 12, 2022, ACNB Bank announced plans to build a full-service community banking office to serve the Upper Adams area of Adams County, PA. The Upper Adams Office opened in October 2022 and, as a result, three community banking offices were consolidated into the new community banking office. Two of the former community banking offices were subsequently transferred to Assets Held for Sale at fair market value. Also, as part of the Bank’s branch optimization program, in the third quarter of 2022, the Bank announced the planned closure of three additional community banking offices effective December 2022. As a result, two of the former community banking offices were transferred to Assets Held for Sale at fair market value. During the nine months ended September 30, 2023, the Bank sold four community banking offices for a net gain on sale of $337 thousand which was recorded as a gain on assets held for sale.

Foreclosed Assets Held for Resale

The carrying value of real estate acquired through foreclosure was $467 thousand which was comprised of one property at September 30, 2023. This same property was recorded in foreclosed assets held for resale as of December 31, 2022. All acquired properties are actively marketed.

Deposits

ACNB relies on deposits as a primary source of funds for lending activities with total deposits of $2.0 billion as of September 30, 2023. Deposits decreased by $247.6 million, or 11.3%, from December 31, 2022, to September 30, 2023. The decrease in deposits were in both non-interest bearing and interest bearing deposits, as a result of customers seeking higher yielding alternative investment or deposit products as market interest rates rose during 2022 and 2023 and management’s continued strategy of discipline deposit rate structure. Historically, deposits vary between quarters mostly reflecting different levels held by local companies, government units and school districts during different times of the year. Despite the decline in deposits in 2023, the loan-to-deposit ratio was 82.81% at September 30, 2023.

ACNB’s deposit pricing function employs a disciplined pricing approach based upon liquidity needs and alternative funding rates, but also strives to price deposits to be competitive with relevant local competition, including local government investment trusts, credit unions and larger regional banks. Given the Corporation’s funding level, the Corporation continued to restrain deposit rates despite an increase in market interest rates and increases in rates by competitors. Interest bearing deposit costs for the third quarter of 2023 were 0.26% compared to 0.14% for the third quarter of 2022. The ratio of uninsured and non-collateralized deposits to total deposits was approximately 17.4% at September 30, 2023.

Borrowings

Short-term borrowings are comprised primarily of securities sold under agreements to repurchase and short-term borrowings from the FHLB. As of September 30, 2023, short-term Bank borrowings were $33.1 million, as compared to $42.0 million at December 31, 2022. Securities sold under repurchase agreements are within the commercial and local government customer base and have attributes similar to core deposits. Investment securities are pledged in sufficient amounts to collateralize these agreements. Compared to year-end 2022, securities sold under repurchase agreements balances decreased by $8.8 million, or 21.1%, 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 at September 30, 2023 and December 31, 2022. 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, trust preferred subordinated debt and subordinated debt. Long-term borrowings totaled $120.3 million at September 30, 2023, versus $21.0 million at December 31, 2022. During 2023, the bank borrowed $100.0 million from the FHLB at a weighted average fixed rate of 4.63% for a weighted average term of 3.88 years to fund deposit outflows and loan growth. Further borrowings will be used when necessary for a variety of risk management and funding purposes. Please refer to the Liquidity discussion below for more information on the Corporation’s ability to borrow.

Capital

ACNB’s capital management strategies have been developed to provide an appropriate rate of return, in the opinion of management, to shareholders, while maintaining its “well-capitalized” regulatory position in relationship to its risk exposure. Please refer to the Risk-Based Capital section below for more information on the Corporation’s capital ratio.

The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During the first nine months of 2023, ACNB earned $27.6 million and paid dividends of $7.2 million for a dividend payout ratio of 25.94%. Comparatively, during the first nine months of 2022, ACNB earned $25.6 million and paid dividends of $6.7 million for a dividend payout ratio of 26.35%.

On October 24, 2022, the Corporation announced that the Board of Directors approved on October 18, 2022, a new plan to repurchase, in open market and privately negotiated transactions, up to 255,575, or approximately 3%, of the outstanding shares of the Corporation’s common stock. This new common stock repurchase program replaces and supersedes any and all earlier announced repurchase plans. As of September 30, 2023, 47,228 shares of common stock have been repurchased under this new plan.

ACNB Corporation has a Dividend Reinvestment and Stock Purchase Plan that provides registered holders of ACNB Corporation common stock with a convenient way to purchase additional shares of common stock by permitting participants in the plan to automatically reinvest cash dividends on all or a portion of the shares owned and to make quarterly voluntary cash payments under the terms of the plan. Participation in the plan is voluntary, and there are eligibility requirements to participate in the plan. During the nine months ended September 30, 2023, 16,580 shares were issued under this plan with proceeds in the amount of $543 thousand and during the nine months September 30, 2022, 16,226 shares were issued under this plan with proceeds in the amount of $535 thousand.

On March 30, 2021, the Corporation issued $15.0 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 $15.0 million of subordinated debt qualifies as Tier 2 capital at the Holding Company level, but can be transferred to the Bank where it qualifies as Tier 1 Capital. The debt has a 4.00% fixed-to-floating rate and a stated maturity of March 31, 2031. The debt is redeemable by the Corporation at its option, in whole or in part, on or after March 30, 2026, and at any time upon occurrences of certain unlikely events such as receivership, insolvency, or liquidation of ACNB or ACNB Bank.

The Corporation has trust preferred subordinated debt that was assumed by ACNB Corporation through the acquisition of Frederick County Bancorp, Inc. (FCBI). FCBI completed the private placement of an aggregate of $6.0 million of trust preferred securities. The interest rate on the trust preferred subordinated debt is adjusted quarterly to 163 basis points over the three-month Chicago Mercantile Exchange (CME) Term Secured Overnight Financing Rate (SOFR) plus applicable tenor spread adjustment. On September 15, 2023 the most recent interest rate reset date, the interest rate was adjusted to 7.30% for the period ending December 14, 2023. The trust preferred securities mature on December 15, 2036, and may be redeemed at par, at the Corporation’s option, on any interest payment date. The trust preferred subordinated debt qualifies as Tier 1 capital.

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. Management believes, as of September 30, 2023, and December 31, 2022, that ACNB’s banking subsidiary met all minimum capital adequacy requirements to which it is subject and is categorized as “well capitalized” for regulatory purposes. There are no subsequent conditions or events that management believes have changed the banking subsidiary’s category.

Regulatory Capital

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance effective January 1, 2014. The final rules call for the following capital requirements:

• a minimum ratio of common Tier 1 capital to risk-weighted assets of 4.50%;
• a minimum ratio of Tier 1 capital to risk-weighted assets of 6.00%;
• a minimum ratio of total capital to risk-weighted assets of 8.00%; and,
• a minimum leverage ratio of 4.00%.

In addition, the final rules established a common equity Tier 1 capital conservation buffer of 2.50% of risk-weighted assets applicable to all banking organizations.

Risk-Based Capital

In December 2018, the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. The Corporation adopted CECL effective January 1, 2023 and elected to implement the capital transition relief over the permissible three-year period.

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 $10.0 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 9.00% (subsequently reduced to 8.00% as a COVID-19 relief measure). Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework. The CBLR framework was available for banks to use in their March 31, 2020 Call Report. The Corporation has performed changes to capital adequacy and reporting requirements within the quarterly Call Report, and it opted out of the CBLR framework.

The capital ratios are as follows:

Liquidity

Effective liquidity management ensures the cash flow requirements of depositors and borrowers as well as the operating cash needs of ACNB are met. ACNB’s funds are available from a variety of sources, including assets that are readily convertible such as interest bearing deposits with banks, maturities and repayments from the securities portfolio, scheduled repayments of loans receivable, the core deposit base, the ability to raise brokered deposits, and the ability to borrow from, including but not limited to, the FHLB, Federal Reserve Discount Window and other contingent sources.

ACNB manages liquidity by monitoring projected cash inflows and outflows on a daily basis, and believes it has sufficient funding sources to maintain sufficient liquidity under varying degrees of business conditions for liquidity and capital resource requirements for all material short- and long-term cash requirements from known contractual and other obligations.

At September 30, 2023, ACNB’s banking subsidiary could borrow approximately $845.5 million from the FHLB, of which $745.2 million was available. At September 30, 2023, ACNB’s banking subsidiary could borrow approximately $3.6 million from the Discount Window, of which the full amount was available. The underlying collateral at the Discount Window is made up of investment securities held in a joint-custody account under the Bank’s name.

1 Ratios do not include capital conservation buffer.

A new Federal Reserve lending facility, named the Bank Term Funding Program, was enacted in March 2023 that provides banks the ability to borrow on the par value of certain investment securities used to collateralize the account. As of September 30, 2023, ACNB’s banking subsidiary could borrow approximately $169.0 million from the Bank Term Funding Program, of which the full amount was available.

ACNB’s banking subsidiary maintains several unsecured Fed Funds lines with correspondent banks. As of September 30, 2023, Fed Funds line capacity at the banking subsidiary was $132.0 million, of which the full amount was available. In 2018, ACNB Corporation executed a guaranty for a note related to a $1.5 million commercial line of credit from a local bank, with normal terms and conditions for such a line, for ACNB Insurance Services, Inc., the borrower and a wholly-owned subsidiary of ACNB Corporation. The commercial line of credit is for general working capital needs as they arise and did not have any outstanding balance as of September 30, 2023. ACNB Corporation maintains a $5.0 million unsecured line of credit with a correspondent bank. The line of credit remains at full capacity as of September 30, 2023.

Another source of liquidity is securities sold under repurchase agreements to customers of ACNB’s banking subsidiary totaling approximately $33.1 million and $42.0 million at September 30, 2023, and December 31, 2022, 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.

Off-Balance Sheet Arrangements

The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. At September 30, 2023, the Corporation had unfunded outstanding commitments to extend credit of $423.4 million and outstanding standby letters of credit of $22.8 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.

Market Risks

During March and April 2023 three significant bank failures occurred (Silicon Valley Bank, Signature Bank and First Republic Bank). This was and continues to be accompanied by financial instability at certain additional banks. These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including ACNB. These risks include, but are not limited to:

• market risk and loss of confidence in the financial services sector, and/or specific banks;
• deterioration of securities and loan portfolios;
• deposit volatility and/or reductions with higher volumes and occurring over shorter periods of time;
• increased liquidity demand and utilization of sources of liquidity; and,
• interest rate volatility and abrupt, sudden and greater than usual rate changes.

These factors individually, or in any combination, could materially and adversely affect:

• financial condition;
• operations and results thereof; and,
• stock price.

In addition, the previously mentioned bank failures and instabilities may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which may adversely affect the Corporation’s financial condition, operations, results thereof or stock price.

The Corporation cannot predict the impact, timing or duration of such events.

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.

RECENT LEGAL AND REGULATORY DEVELOPMENTS

Management has reviewed the recent development sections that were previously disclosed in the Annual Report on Form 10-K for the fiscal period ended December 31, 2022. There are no material changes in the recent legal and regulatory development section as previously disclosed in the recent developments section on the Form 10-K.

SUPERVISION AND REGULATION

Dividends

ACNB is a legal entity separate and distinct from its subsidiary bank. ACNB’s revenues, on a parent company only basis, result primarily from dividends paid to the Corporation by its subsidiaries. Federal and state laws regulate the payment of dividends by ACNB’s subsidiary bank and state laws effect dividends by ACNB’s insurance subsidiary. For further information, please refer to Regulation of Bank below.

Regulation of Bank

The operations of the subsidiary bank are subject to statutes applicable to banks chartered under the banking laws of Pennsylvania, to state nonmember banks of the Federal Reserve, and to banks whose deposits are insured by the FDIC. The subsidiary bank’s operations are also subject to regulations of the Pennsylvania Department of Banking and Securities, Federal Reserve, and FDIC.

The Pennsylvania Department of Banking and Securities, which has primary supervisory authority over banks chartered in Pennsylvania, 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 the FDIC 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 the Federal Financial Institutions Examination Council, or FFIEC.

Monetary and Fiscal Policy

ACNB and its subsidiary bank are affected by the monetary and fiscal policies of government agencies, including the Federal Reserve and FDIC. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors of the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature and impact of monetary and fiscal policies on future business and earnings of ACNB cannot be predicted at this time. From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of ACNB and the subsidiary bank, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of ACNB.

Management monitors and evaluates changes in market conditions on a regular basis. Based upon the most recent review, management has determined that there have been no material changes in market risks since year-end 2022. For further discussion of year-end information, please refer to the Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Corporation carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in periodic SEC filings.

Disclosure controls and procedures are Corporation controls and other procedures that are designed to ensure that information required to be disclosed by the Corporation in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in the Corporation’s internal control over financial reporting during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

Management has reviewed the risk factors that were previously disclosed in the Annual Report on Form 10-K for the fiscal year ended December 31, 2022. There are no material changes in risk factors as previously disclosed in the Form 10-K except as described below.

CALENDAR YEAR 2023 NEGATIVE DEVELOPMENTS AFFECTING THE BANKING INDUSTRY, INCLUDING BANK FAILURES OR CONCERNS REGARDING LIQUIDITY, HAVE ERODED CUSTOMER CONFIDENCE IN THE BANKING SYSTEM AND MAY HAVE A MATERIAL ADVERSE EFFECT ON THE CORPORATION.

During 2023 events impacting the banking industry, including the high-profile failures or instability of certain banking institutions, have resulted in general uncertainty and eroded confidence in the safety, soundness, and financial strength of the financial services sector. In particular, the bank failures highlighted the potential serious impact of a financial institution unable to meet withdrawal requests by depositors. This has resulted in a growing concern about liquidity in the banking industry, access to and volatile capital markets and reduced stock valuations for certain financial institutions. Similar future events, including additional bank failures or bank instability, could directly or indirectly adversely impact the Corporation’s own liquidity, access to capital markets, stock price, financial condition and results of operations. Further, these recent events may also result in: greater regulatory scrutiny and enforcement; additional and more stringent laws and regulations for the financial services industry; increased FDIC deposit insurance premiums or special FDIC assessments; and higher capital ratio requirements, which as a result could have a material negative impact and adverse effect on the Corporation’s business, financial condition and results of operations.