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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
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OR
|_| TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-11783
ACNB CORPORATION
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2233457
- -------------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16 LINCOLN SQUARE, GETTYSBURG, PENNSYLVANIA 17325-3129
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 334-3161
--------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $2.50 PER SHARE
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(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No |_|
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant at June 30, 2004 was approximately $136,109,000.
The number of shares of Registrant's Common Stock outstanding on March 1, 2005
was 5,436,101.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 2005 definitive Proxy Statement are incorporated by
reference into Part III of this report.
ACNB CORPORATION
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business .................................................... 3
Item 2. Properties .................................................. 10
Item 3. Legal Proceedings ........................................... 10
Item 4. Submission of Matters to a Vote of Stockholders ............. 10
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters and Issuer Purchases of Equity
Securities .................................................. 11
Item 6. Selected Financial Data ..................................... 12
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ............... 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .. 29
Item 8. Financial Statements and Supplementary Data ................. 33
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ...................... 61
Item 9A. Controls and Procedures ..................................... 62
Item 9B. Other Information ........................................... 62
PART III
Item 10. Directors and Executive Officers of the Registrant .......... 63
Item 11. Executive Compensation ...................................... 63
Item 12. Security Ownership of Certain Beneficial Owners and
Management .................................................. 63
Item 13. Certain Relationships and Related Transactions .............. 63
Item 14. Principal Accountant Fees and Services ...................... 63
PART IV
Item 15. Exhibits, Financial Statement Schedules ..................... 64
Signatures .................................................. 65
2
PART I
The management of ACNB Corporation has made forward-looking statements in this
Annual Report on Form 10-K. These forward-looking statements may be subject to
risks and uncertainties. Forward-looking statements include the information
concerning possible or assumed future results of operations of ACNB Corporation
and its wholly-owned subsidiaries, Adams County National Bank and Pennbanks
Insurance Company. When words such as "believes," "expects," "anticipates,"
"may," "could," "should," "estimates," or similar expressions occur in this
annual report, management is making forward-looking statements.
Stockholders should note that many factors, some of which are discussed
elsewhere in this report, could affect the future financial results of ACNB
Corporation and its subsidiaries, both individually and collectively, and could
cause those results to differ materially from those expressed in this report.
These risk factors include the following:
o Operating, legal and regulatory risks;
o Economic, political and competitive forces impacting our various
lines of business;
o The risk that our analysis of these risks and forces could be
incorrect and/or that the strategies developed to address them
could be unsuccessful;
o The possibility that increased demand or prices for ACNB's
financial services and products may not occur;
o Volatility in interest rates; and/or,
o Other risks and uncertainties.
ACNB undertakes no obligation to publicly revise or update these forward-looking
statements to reflect events or circumstances that arise after the date of this
report. Readers should carefully review the risk factors described in other
documents ACNB files periodically with the Securities and Exchange Commission,
including Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
ITEM I - BUSINESS
ACNB CORPORATION
ACNB Corporation is an $924 million financial holding company headquartered in
Gettysburg, Pennsylvania. Through its banking and nonbanking subsidiaries, ACNB
provides a full range of banking and financial services to individuals and
businesses, including commercial and retail banking, trust, accounting and
insurance. ACNB's operations are conducted through its primary operating
subsidiary, Adams County National Bank, with nineteen offices in Adams,
Cumberland and York Counties. The Corporation was organized in 1983 and has had
no acquisitions for the previous five years.
However, on November 19, 2004, ACNB Corporation and ACNB Acquisition Subsidiary
LLC entered into a definitive agreement to purchase Russell Insurance Group,
Inc. Under the terms of the definitive agreement, ACNB Corporation agreed to pay
$4,750,000 in cash to acquire Russell Insurance Group. Additional consideration
of up to $2,882,000 is subject to performance criteria for payment over the next
three years. On January 5, 2005, ACNB Corporation and ACNB Acquisition
Subsidiary, LLC completed the acquisition of Russell Insurance Group, Inc. and
Russell Insurance Group, Inc. will continue to operate as a separate subsidiary
of ACNB Corporation. In addition, ACNB Acquisition Subsidiary LLC has entered
into a three year employment contract with Frank C. Russell, Jr., the President
of Russell Insurance Group, Inc. For more information concerning this
transaction please refer to the ACNB Corporation, ACNB Acquisition Subsidiary
LLC and Russell Insurance Group Stock Purchase Agreement included as Exhibit
10.2 hereto, incorporated in entirety by reference in response to this Item I.
3
ACNB's major source of operating funds is dividends that it receives from its
subsidiary bank. ACNB's expenses consist principally of losses from low-income
housing investments. Dividends that ACNB pays to stockholders consist of
dividends declared and paid to ACNB by the subsidiary bank.
ACNB and its subsidiaries are not dependent upon a single customer or a small
number of customers, the loss of which would have a material adverse effect on
the Corporation. ACNB does not depend on foreign sources of funds, nor does it
make foreign loans.
The common stock of ACNB is listed on the Over The Counter Bulletin Board under
the symbol ACNB.
Commercial lending includes commercial mortgages, real estate development,
accounts receivable financing, and agricultural loans. Consumer lending programs
include home equity loans, automobile and recreational vehicle loans, and
manufactured housing loans. Mortgage lending programs include personal
residential mortgages, residential construction loans, and speculative
construction loans.
Management measures the net interest income of each segment based upon the
earnings and fees for each segment recognized less the charge for the funds
used. The charge for funds used is based on the average cost of funds used by
the respective segment. Other non-interest expense, which includes salaries and
employee benefits, occupancy and equipment expense, and other expenses, is
allocated to each segment and is netted against net interest income after
provision to possible loan losses to arrive at income before income taxes for
each respective segment.
BANKING SUBSIDIARY
ADAMS COUNTY NATIONAL BANK
Adams County National Bank is a full-service commercial bank operating under
charter from the Office of the Comptroller of the Currency. The Bank's principal
market area is Adams County, Pennsylvania, which is located in south central
Pennsylvania. Adams County depends on agriculture, industry and tourism to
provide employment for its residents. No single sector dominates the county's
economy. At December 31, 2004, Adams County National Bank had total assets of
$917 million, total loans of $441 million and total deposits of $647 million.
The main office of the bank is located at 16 Lincoln Square, Gettysburg,
Pennsylvania. In addition to its main office, the bank has thirteen branches in
Adams County, two branches in York County, and three branches in Cumberland
County. Adams County National Bank's service delivery channels for its customers
also include the ATM network, Customer Contact Center, Internet and telephone
banking. The Bank is subject to regulation and periodic examination by the
Office of the Comptroller of the Currency. The Federal Deposit Insurance
Corporation, as provided by law, insures the bank's deposits.
NONBANKING SUBSIDIARY
PENNBANKS INSURANCE CO.
Pennbanks Insurance Co. was organized in 2000 and holds an unrestricted Class
"B" Insurer's License under Cayman Islands Insurance Law. The segregated
portfolio is engaged in the business of reinsuring credit life and credit
accident and disability risks. Total assets of the segregated portfolio as of
December 31, 2004 totaled $452,000.
4
COMPETITION
The financial services industry in ACNB's market area is highly competitive,
including competition from commercial banks, savings banks, credit unions,
finance companies and nonbank providers of financial services. Several of ACNB's
competitors have legal lending limits that exceed those of ACNB's subsidiary, as
well as funding sources on the capital markets that exceed ACNB's availability.
The increased competition has resulted from a changing legal and regulatory
climate, as well as from the economic climate.
In addition, savings banks, savings and loan associations, credit unions, money
market and other mutual funds, mortgage companies, leasing companies, finance
companies, and other financial services companies offer competitive products and
services similar in terms to those offered by ACNB.
Many bank holding companies have elected to become financial holding companies
under the Gramm-Leach-Bliley Act, which gives them a broader range of products
with which the bank must compete. Although the long-range effects of this
development cannot be predicted, most probably it will further narrow the
differences and intensify competition among commercial banks, investment banks,
insurance firms and other financial services companies.
SUPERVISION AND REGULATION
BANK HOLDING COMPANY REGULATION
BANK HOLDING COMPANY ACT OF 1956 - ACNB is a financial holding company and is
subject to the regulations of the Board of Governors of the Federal Reserve
System under the Bank Holding Company Act of 1956. Bank holding companies are
required to file periodic reports with and are subject to examination by the
Federal Reserve. The Federal Reserve has issued regulations under the Bank
Holding Company Act that require a financial holding company to serve as a
source of financial and managerial strength to its subsidiary bank. As a result,
the Federal Reserve may require ACNB to stand ready to use its resources to
provide adequate capital funds to the bank during periods of financial stress or
adversity.
In addition, the Federal Reserve may require a financial holding company to end
a nonbanking business if the nonbanking business constitutes a serious risk to
the financial soundness and stability of any bank subsidiary of the financial
holding company.
The Bank Holding Company Act prohibits ACNB from acquiring direct or indirect
control of more than 5% of the outstanding voting stock of any bank, or
substantially all of the assets of any bank, or merging with another bank
holding company, without the prior approval of the Federal Reserve. The Bank
Holding Company Act allows interstate bank acquisitions and interstate branching
by acquisition and consolidation in those states that had not elected out by the
required deadline. The Pennsylvania Department of Banking also must approve any
similar consolidation. Pennsylvania law permits Pennsylvania financial holding
companies to control an unlimited number of banks.
In addition, the Bank Holding Company Act restricts ACNB's nonbanking activities
to those that are determined by the Federal Reserve Board to be financial in
nature, incidental to such financial activity, or complementary to a financial
activity. The Bank Holding Company Act does not place territorial restrictions
on the activities of nonbank subsidiaries of financial holding companies.
5
GRAMM-LEACH-BLILEY ACT OF 1999 - The Gramm-Leach-Bliley Act of 1999 eliminated
many of the restrictions placed on the activities of bank holding companies that
become financial holding companies. Among other things, the Gramm-Leach-Bliley
Act repealed certain Glass-Steagall Act restrictions on affiliations between
banks and securities firms, and amended the Bank Holding Company Act to permit
bank holding companies that are financial holding companies to engage in
activities, and acquire companies engaged in activities, that are: financial in
nature (including insurance underwriting, insurance company portfolio
investment, financial advisory, securities underwriting, dealing and
market-making, and merchant banking activities); incidental to financial
activities; or complementary to financial activities if the Federal Reserve
determines that they pose no substantial risk to the safety or soundness of
depository institutions or the financial system in general. The
Gramm-Leach-Bliley Act also permits national banks, under certain circumstances,
to engage through special financial subsidiaries in the financial and other
incidental activities authorized for financial holding companies.
REGULATION W - Transactions between a bank and its "affiliates" are
quantitatively and qualitatively restricted under the Federal Reserve Act. The
Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember
banks in the same manner and to the same extent as if they were members of the
Federal Reserve System. The Federal Reserve has also issued Regulation W, which
codifies prior regulations under Sections 23A and 23B of the Federal Reserve
Act, and interpretative guidance with respect to affiliate transactions.
Regulation W incorporates the exemption from the affiliate transaction rules,
but expands the exemption to cover the purchase of any type of loan or extension
of credit from an affiliate. Affiliates of a bank include, among other entities,
the bank's holding company and companies that are under common control with the
bank. ACNB Corporation and Russell Insurance Group, Inc. are considered to be
affiliates of Adams County National Bank.
RECENT LEGISLATION
USA PATRIOT ACT OF 2001 - In October 2001, the USA Patriot Act of 2001 was
enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C., which occurred on September 11, 2001. The Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
abilities to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Patriot Act on financial institutions of all kinds is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and imposes various regulations,
including standards for verifying client identification at account opening, and
rules to promote cooperation among financial institutions, regulators and law
enforcement entities in identifying parties that may be involved in terrorism or
money laundering.
SARBANES-OXLEY ACT OF 2002 - On July 30, 2002, President Bush signed into law
the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies, and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities law.
The SOA is the most far-reaching U.S. securities legislation enacted in some
time. The SOA generally applies to all companies, both U.S. and non-U.S., that
file or are required to file periodic reports with the Securities and Exchange
Commission (the "SEC") under the Securities Exchange Act of 1934, or the
Exchange Act. Given the extensive SEC role in implementing rules relating to
many of the SOA's new requirements, the final scope of these requirements
remains to be determined.
The SOA includes very specific additional disclosure requirements and new
corporate governance rules; requires the SEC and securities exchanges to adopt
extensive additional disclosure, corporate governance and other related rules;
and, mandates further studies of certain issues by the SEC. The SOA represents
significant federal involvement in matters traditionally left to state
regulatory systems, such as the regulation of the accounting profession, and to
state corporate law, such as the relationship between a board of directors and
management and between a board of directors and its committees.
6
The SOA addresses, among other matters:
o Audit committees for all reporting companies;
o Certification of financial statements by the chief executive officer and
the chief financial officer;
o The forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and senior
officers in the twelve-month period following initial publication of any
financial statements that later require restatement;
o A prohibition on insider trading during pension plan black out periods;
o Disclosure of off-balance sheet transactions;
o A prohibition on personal loans to directors and officers;
o Expedited filing requirements for Forms 4s;
o Disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code;
o "Real time" filing of periodic reports;
o Formation of a public accounting oversight board;
o Auditor independence; and,
o Increased criminal penalties for violations of securities laws.
The SOA contains provisions that became effective upon enactment on July 30,
2002 and provisions that will become effective from within 30 days to one year
from enactment. The SEC has been delegated the task of enacting rules to
implement various provisions with respect to, among other matters, disclosure in
periodic filings pursuant to the Exchange Act.
THE AMERICAN JOBS CREATION ACT OF 2004 - In 2004, the American Jobs Creation Act
was enacted as the first major corporate tax act in years. The act addresses a
number of areas of corporate taxation including executive deferred compensation
restrictions. The impact of the act on ACNB is unknown at this time, but
management is monitoring its developments.
DIVIDENDS
ACNB is a legal entity separate and distinct from its subsidiary bank. ACNB's
revenues, on a parent company only basis, result almost entirely from dividends
paid to the corporation by its subsidiary. Federal and state laws regulate the
payment of dividends by ACNB's subsidiary. See "Regulation of Bank" below.
REGULATION OF BANK
The operations of the subsidiary bank are subject to federal and state statutes
applicable to banks chartered under the banking laws of the United States, to
members of the Federal Reserve System, and to banks whose deposits are insured
by the FDIC. The bank's operations are also subject to regulations of the Office
of the Comptroller of the Currency, Federal Reserve and FDIC.
The Office of the Comptroller of the Currency, which has primary supervisory
authority over national banks, regularly examines banks in such areas as
reserves, loans, investments, management practices, and other aspects of
operations. These examinations are designed for the protection of the bank's
depositors rather than ACNB's shareholders. The subsidiary bank must file
quarterly and annual reports to the Federal Financial Institutions Examinations
Council or FFIEC.
7
NATIONAL BANK ACT - The National Bank Act requires the subsidiary national bank
to obtain the prior approval of the Office of the Comptroller of the Currency
for the payment of dividends if the total of all dividends declared by the bank
in one year would exceed the bank's net profits in the current year, as defined
and interpreted by regulation, plus retained earnings for the two preceding
years, less any required transfers to surplus. In addition, the bank may only
pay dividends to the extent that the retained net profits, including the portion
transferred to surplus, exceed statutory bad debts, as defined by regulation.
These restrictions have not had, nor are they expected to have, any impact on
the corporation's dividend policy.
FEDERAL DEPOSIT INSURANCE CORPORATION ACT OF 1991 - Under the Federal Deposit
Insurance Corporation Insurance Act of 1991, any depository institution,
including the bank, is prohibited from paying any dividends, making other
distributions or paying any management fees if, after such payment, it would
fail to satisfy the minimum capital requirement.
FEDERAL RESERVE ACT - A subsidiary bank of a bank holding company is subject to
certain restrictions and reporting requirements imposed by the Federal Reserve
Act, including:
o Extensions of credit to the bank holding company, its subsidiaries or
principal shareholders;
o Investments in the stock or other securities of the bank holding company
o or its subsidiaries; and,
o Taking such stock or securities as collateral for loans.
COMMUNITY REINVESTMENT ACT OF 1977 - Under the Community Reinvestment Act of
1977, the OCC is required to assess the record of all financial institutions
regulated by it to determine if these institutions are meeting the credit needs
of the community, including low and moderate income neighborhoods, which they
serve and to take this record into account in its evaluation of any application
made by any of such institutions for, among other things, approval of a branch
or other deposit facility, office relocation, a merger or an acquisition of bank
shares. The Financial Institutions Reform, Recovery and Enforcement Act of 1989
amended the CRA to require, among other things, that the OCC make publicly
available the evaluation of a bank's record of meeting the credit needs of its
entire community, including low and moderate income neighborhoods. This
evaluation will include a descriptive rating like "outstanding," "satisfactory,"
"needs to improve" or "substantial noncompliance" and a statement describing the
basis for the rating. These ratings are publicly disclosed.
FDICIA - The Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) requires that institutions be classified, based on their risk-based
capital ratios into one of five defined categories, as illustrated below: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized.
UNDER A
TOTAL RISK TIER 1 TIER 1 CAPITAL
BASED RISK BASED LEVERAGE ORDER OR
RATIO RATIO RATIO DIRECTIVE
------------- -------------- ------------- -------------
CAPITAL CATEGORY
Well capitalized >10.0 >6.0 >5.0% NO
Adequately capitalized >8.0 >4.0 >4.0%*
Undercapitalized <8.0 <4.0 <4.0%*
Significantly undercapitalized <6.0 <3.0 <3.0%
Critically undercapitalized <2.0%
* 3.0 for those banks having the highest available regulatory rating.
8
In the event an institution's capital deteriorates to the undercapitalized
category or below, FDICIA prescribes an increasing amount of regulatory
intervention, including: the institution of a capital restoration plan and a
guarantee of the plan by a parent institution; and the placement of a hold on
increases in assets, number of branches or lines of business. If capital has
reached the significantly or critically undercapitalized levels, further
material restrictions can be imposed, including restrictions on interest payable
on accounts, dismissal of management and, in critically undercapitalized
situations, appointment of a receiver. For well capitalized institutions, FDICIA
provides authority for regulatory intervention where the institution is deemed
to be engaging in unsafe or unsound practices or receives a less than
satisfactory examination report rating for asset quality, management, earnings
or liquidity. All but well capitalized institutions are prohibited from
accepting brokered deposits without prior regulatory approval. Under FDICIA,
financial institutions are subject to increased regulatory scrutiny and must
comply with certain operational, managerial and compensation standards to be
developed by Federal Reserve Board regulations. FDICIA also requires the
regulators to issue new rules establishing certain minimum standards to which an
institution must adhere including standards requiring a minimum ratio of
classified assets to capital, minimum earnings necessary to absorb losses and
minimum ratio of market value to book value for publicly held institutions.
Additional regulations are required to be developed relating to internal
controls, loan documentation, credit underwriting, interest rate exposure, asset
growth and excessive compensation, fees and benefits.
ACNB and its subsidiary bank are affected by the monetary and fiscal policies of
government agencies, including the Federal Reserve and FDIC. Through open market
securities transactions and changes in its discount rate and reserve
requirements, the Board of Governors of the Federal Reserve exerts considerable
influence over the cost and availability of funds for lending and investment.
The nature of monetary and fiscal policies on future business and earnings of
ACNB cannot be predicted at this time. 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.
ACCOUNTING POLICY DISCLOSURE
Disclosure of the Corporation's significant accounting policies is included in
Note A to the consolidated financial statements. Some of these policies are
particularly sensitive requiring significant judgments, estimates and
assumptions to be made by management. Additional information is contained in
Management's Discussion and Analysis for the most sensitive of these issues,
including the provision and allowance for loan losses which are located in Note
D to the consolidated financial statements.
Management, in determining the allowance for loan losses, makes significant
estimates. Consideration is given to a variety of factors in establishing this
estimate. In estimating the allowance for loan losses, management considers
current economic conditions, diversification of the loan portfolio, delinquency
statistics, results of internal loan review, financial and managerial strengths
of borrowers, adequacy of collateral, if collateral dependent, or present value
of future cash flows, and other relevant factors.
9
STATISTICAL DISCLOSURES
The following statistical disclosures are included in Management's Discussion
and Analysis, Item 7 hereof, and are incorporated by reference in this Item 1:
o Interest Rate Sensitivity Analysis
o Interest Income and Expense, Volume and Rate Analysis
o Investment Portfolio
o Loan Maturity and Interest Rate Sensitivity
o Loan Portfolio
o Allocation of Allowance for Loan Losses
o Deposits
o Short-Term Borrowings
AVAILABLE INFORMATION
The Corporation's reports, proxy statements and other information are available
for inspection and copying at the Public Reference Room at Judiciary Plaza, 450
Fifth Street, N.W., Washington, DC, 20549, at prescribed rates. The public may
obtain information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330. The Corporation is an electronic filer with the
Commission. The Commission maintains a website that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission. The address of the Commission's website is
http://www.sec.gov.
Upon a stockholder's written request, a copy of the Corporation's Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as
required to be filed with the SEC pursuant to Securities Exchange Act Rule
13a-1, may be obtained, without charge, from John W. Krichten,
Secretary/Treasurer, 16 Lincoln Square, P.O. Box 3129, Gettysburg, PA 17325, or
visit our website at http://www.acnb.com.
EMPLOYEES
As of December 31, 2004, ACNB had 223 full-time equivalent employees. None of
these employees are represented by a collective bargaining agreement, and ACNB
believes it enjoys good relations with its personnel.
ITEM 2 - PROPERTIES
Adams County National Bank, in addition to its main office, had an office
network of nineteen offices at December 31, 2004. All offices are located in
Adams County with the exception of three offices located in Cumberland County
and two offices located in York County. Offices at fifteen locations are owned,
while four are leased. All real estate owned by the subsidiary bank is free and
clear of encumbrances.
ITEM 3 - LEGAL PROCEEDINGS
As of December 31, 2004, there were no material pending legal proceedings, other
than ordinary routine litigation incidental to the business, to which ACNB or
its subsidiaries are a party or by which any of their property is the subject.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
There were no matters submitted to a vote of stockholders during the fourth
quarter of 2004.
10
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ACNB Corporation's common stock trades on the Over The Counter Bulletin Board
under the symbol ACNB. There were 20,000,000 shares of common stock authorized
at December 31, 2004, and 5,436,101 shares outstanding. As of December 1, 2004,
ACNB had approximately 2,900 stockholders of record. There is no other class of
stock authorized or outstanding. ACNB is restricted as to the amount of
dividends that it can pay to stockholders by virtue of the restrictions on the
subsidiary's ability to pay dividends to ACNB. ACNB Corporation has no equity
compensation plans.
There have been no unregistered sales of stock in 2004, 2003, or 2002.
The following table reflects the quarterly high and low prices of ACNB's common
stock for the periods indicated and the cash dividends on the common stock for
the periods indicated.
PRICE RANGE PER SHARE PER SHARE
------------------------- ------------
HIGH LOW DIVIDEND
------ ----- -----------
2004:
First Quarter $27.25 $26.50 $0.21
Second Quarter $26.50 $24.05 $0.21
Third Quarter $25.15 $23.50 $0.21
Fourth Quarter $25.95 $24.90 $0.27
2003:
First Quarter $26.65 $21.00 $0.21
Second Quarter $25.75 $22.80 $0.21
Third Quarter $26.50 $24.05 $0.21
Fourth Quarter $28.50 $25.25 $0.26
11
ITEM 6 - SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA
Interest income $37,752 $ 36,689 $ 37,794 $ 39,161 $ 39,837
Interest expense 13,183 13,945 13,453 16,056 16,929
------------- ------------- ------------- ------------ ------------
Net interest income 24,569 22,744 24,341 23,105 22,908
Provision for loan losses 300 265 370 240 240
------------- ------------- ------------- ------------ ------------
Net interest income after provision for loan
losses 24,269 22,479 23,971 22,865 22,668
Proceeds recognized from life insurance - 2,161 - -
proceeds -
Other income 5,865 7,268 5,028 3,533 2,797
Other expenses 18,571 17,998 16,988 14,327 13,212
------------- ------------- ------------- ------------ ------------
Income before income taxes 11,563 13,910 12,011 12,071 12,253
Applicable income taxes 2,255 3,142 3,107 3,734 4,158
------------- ------------- ------------- ------------ ------------
Net income $ 9,308 $ 10,768 $ 8,904 $ 8,337 $ 8,095
============= ============= ============= ============ ============
BALANCE SHEET DATA (AT YEAR-END)
Assets $924,188 $873,083 $734,644 $630,234 $567,330
Securities 405,943 388,252 309,655 219,841 168,540
Loans, net 436,631 411,051 368,469 357,816 357,159
Deposits 646,872 639,388 582,615 509,235 453,149
Borrowings 196,966 156,676 76,445 51,501 48,957
Stockholders' equity 74,521 72,743 70,460 63,025 60,437
COMMON SHARE DATA
Earnings per share - basic $1.71 $ 1.98 $ 1.64 $ 1.53 $ 1.44
Cash dividends paid 0.90 0.89 1.08 0.88 0.87
Book value per share 13.71 13.38 12.96 11.59 10.75
Weighted average number of common shares 5,436,000 5,436,000 5,436,000 5,436,000 5,623,000
Dividend payout ratio 52.56% 44.93% 65.94% 57.37% 60.23%
PROFITABILITY RATIOS AND CONDITION
Return on average assets 1.04% 1.32% 1.35% 1.45% 1.46%
Return on average equity 12.84% 15.41% 13.45% 13.34% 13.50%
Average stockholders' equity to average assets 8.11% 8.55% 10.04% 11.42% 10.81%
SELECTED ASSET QUALITY RATIOS
Nonperforming loans to total loans 1.86% 1.21% 0.65% 0.51% 0.79%
Net charge-offs to average loans outstanding 0.08% 0.03% 0.07% 0.06% 0.02%
Allowance for loan losses to total loans 0.89% 0.96% 1.02% 1.03% 1.02%
Allowance for loan losses to nonperforming loans 47.94% 79.26% 158.82% 202.34% 129.83%
12
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION AND FORWARD-LOOKING STATEMENTS
INTRODUCTION
The following is management's discussion and analysis of the significant changes
in the results of operations, capital resources and liquidity presented in its
accompanying consolidated financial statements for ACNB Corporation (the
Corporation or ACNB), a financial holding company. Please read this discussion
in conjunction with the consolidated financial statements and disclosures
included herein. Current performance does not guarantee, assure or indicate
similar performance in the future.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this 2004 Annual Report contains
forward-looking statements. Examples of forward-looking statements include, but
are not limited to, (a) projections or statements regarding future earnings,
expenses, net interest income, other income, earnings or loss per share, asset
mix and quality, growth prospects, capital structure and other financial terms,
(b) statements of plans and objectives of management or the board of directors,
and (c) statements of assumptions, such as economic conditions in the
Corporation's market areas. Such forward-looking statements can be identified by
the use of forward-looking terminology such as "believes," "expects," "may,"
"intends," "will," "should," "anticipates," or the negative of any of the
foregoing or other variations thereon or comparable terminology, or by
discussion of strategy. Forward-looking statements are subject to certain risks
and uncertainties. Actual results may differ materially from those projected in
the forward-looking statements. We caution readers not to place undue reliance
on these forward-looking statements. They only reflect management's analysis, as
of this date. The Corporation does not revise or update these forward-looking
statements to reflect events or changed circumstances. Please carefully review
the risk factors described in other documents the Corporation files from
time-to-time with the Securities and Exchange Commission, including the
Quarterly Reports on Form 10-Q, filed by the Corporation in 2004 and any Current
Reports on Form 8-K filed by the Corporation.
CRITICAL ACCOUNTING POLICIES
The accounting policies that the Corporation's management deems to be most
important to the portrayal of its financial condition and results of operations,
and that require management's most difficult, subjective or complex judgment,
often result in the need to make estimates about the effect of such matters
which are inherently uncertain. The following policies are deemed to be critical
accounting policies by management:
The allowance for loan losses represents management's estimate of probable
losses inherent in our loan portfolio. Management makes numerous
assumptions, estimates and adjustments in determining an adequate
allowance. The Corporation assesses the level of potential loss associated
with its loan portfolio and provides for that exposure through an Allowance
for Loan Losses. The allowance is established through a provision for loan
losses charged to earnings. The allowance is an estimate of the losses
inherent in the loan portfolio as of the end of each reporting period. The
Corporation assesses the adequacy of its allowance on a quarterly basis.
The specific methodologies applied on a consistent basis are discussed in
greater detail under the caption, "Allowance for Loan Losses," in a
subsequent section of the following 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 length
of time the fair value has been below cost, the financial condition of the
issuer and the intent and ability of the corporation to hold the securities
until recovery. Declines in fair value that are determined to be other than
temporary are charged against earnings. For additional information see
Footnote C in the Corporation's December 31, 2004 financial statements.
13
EXECUTIVE OVERVIEW
The Corporation's executive management team and board of directors have
identified two performance measurements that they feel are key elements of
enhancing shareholder value. These include: a) increase in earnings per share;
and b) return on realized equity.
The primary source of the Corporation's revenues is net interest income derived
from loans and investments, less their deposit and borrowing funding costs.
Revenues are influenced by general economic factors, including market interest
rates, the economy of the markets served, stock market conditions, as well as
competitive forces within the markets.
Because of a low interest rate environment and overall decline in the financial
services industry's net interest margin, the Corporation was unable to improve
its net interest margin during 2004, but it has stabilized at 2.92% and 2.96% in
2004 and 2003, down from 3.91% in 2002. The stabilization during 2004 was
primarily the result of a stronger emphasis on the securities portfolio as
management leveraged the Corporation's interest earning assets. In addition,
average loans increased 9.1% from 2003 to 2004 as compared to 5.8% from 2002 to
2003. Net interest income increased to $24,569,000 in 2004, compared to
$22,744,000 in 2003, and $24,341,000 in 2002.
Other income was $5,865,000, $9,429,000, and $5,028,000 in 2004, 2003 and 2002.
The significant decrease from 2003 was primarily caused by a gain recognized
from life insurance proceeds of $2,161,000 and an $879,000 decrease in gains on
sale of securities.
Other expense increased to $18,571,000 in 2004, compared to $17,998,000 in 2003
and $16,988,000 in 2002. This increase can be attributed to necessary emphasis
on new technology to serve our customers better and to comply with new
government regulations, and expansion of our market in to new geographic
regions. These efforts have resulted in increases in salaries and employee
benefits, higher occupancy and equipment charges, and other operating expenses.
The Corporation's overall strategy is to enhance growth in existing markets and
complement this with new products and services through the leveraging of
existing resources. This has resulted in net income of $9,308,000, or $1.71 per
share in 2004, compared to $10,768,000, or $1.98 per share in 2003, and
$8,904,000, or $1.64 per share in 2002. Without the unusual occurrence of
$2,161,000 in insurance proceeds, net income during 2003 would have been
$8,607,000 or $1.58.
Returns on average equity were 12.84%, 15.41% and 13.45% in 2004, 2003 and 2002.
A more thorough discussion of Corporation's results of operations is included in
the following pages.
NEW ACCOUNTING STANDARDS
SAB 105
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurements of loan commitments recognized at fair value
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 did not have any impact on our consolidated
financial statements.
14
SOP 03-3
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer." SOP 03-3 addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a
transfer, including business combinations, if those differences are
attributable, at least in part, to credit quality. SOP 03-3 is effective for
loans or debt securities acquired in fiscal years beginning after December 15,
2004. The Corporation adopted the provisions of SOP 03-3 effective January 1,
2005, and the initial implementation did not have any impact on the
Corporation's consolidated financial statements.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The primary source of ACNB's traditional banking revenue is net interest income,
which represents the difference between interest income on earning assets and
interest expense on liabilities used to fund those assets. Earning assets
include loans, securities, and federal funds sold. Interest-bearing funds
include deposits and borrowings.
Net interest income is affected by changes in interest rates, volume of interest
bearing assets and liabilities, and the composition of those assets and
liabilities. The "interest rate spread" and "net interest margin" are two common
statistics related to changes in net interest income. The interest rate spread
represents the difference between the yields earned on interest earning assets
and the rates paid for interest bearing liabilities. The net interest margin is
defined as the percentage of net interest income to average earning assets,
which also considers the Corporation's net noninterest bearing funding sources,
the largest of which are noninterest bearing demand deposits and stockholders'
equity.
15
The following table includes average balances, rates and interest income and
expense, the interest rate spread and the net interest margin:
TABLE 1 - AVERAGE BALANCES, RATES AND INTEREST INCOME AND EXPENSE
2004 2003 2002
------------------------------ ----------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- --------- -------- --------- --------- -------- -------- ---------- ---------
ASSETS DOLLARS IN THOUSANDS
Interest Earning Assets
Loans $424,299 $23,578 5.56% $388,842 $23,670 6.09% $367,494 $24,752 6.74%
Taxable securities 384,563 13,155 3.42% 351,346 12,062 3.43% 247,272 12,727 5.15%
Tax-exempt securities 23,283 917 3.94% 22,236 882 3.97% 5,788 241 4.16%
--------- --------- ------- --------- --------- ------- -------- --------- -------
TOTAL SECURITIES 407,846 14,072 3.45% 373,582 12,944 3.46% 253,060 12,968 5.12%
Other 8,152 102 1.25 5,173 75 1.45 2,336 74 3.17
--------- --------- ------- --------- --------- ------- -------- --------- -------
TOTAL INTEREST EARNING
ASSETS 840,297 37,752 4.49% 767,597 36,689 4.78% 622,890 37,794 6.07%
--------- ------- --------- ------- --------- -------
Cash and due from banks 21,772 20,974 19,050
Premises and equipment 8,296 7,371 6,338
Other assets 27,558 25,628 14,783
Allowance for loan losses (4,067) (3,887) (3,722)
--------- --------- --------
TOTAL ASSETS $893,856 $817,683 $659,339
========= ========= ========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest Bearing Liabilities
Interest bearing demand
deposits $110,293 659 0.60% $100,586 1,088 1.08% $ 83,825 1,134 1.35%
Savings deposits 241,192 2,544 1.05% 225,099 3,415 1.52% 158,804 3,070 1.93%
Time deposits 230,117 6,308 2.74% 225,043 6,721 2.99% 223,308 8,054 3.61%
--------- --------- ------- --------- --------- ------- -------- --------- -------
TOTAL INTEREST BEARING
DEPOSITS 581,602 9,511 1.64% 550,728 11,224 2.04% 465,937 12,258 2.63%
Short-term borrowings 51,437 793 1.54% 45,290 741 1.64% 45,618 961 2.11%
Long-term borrowings 108,507 2,879 2.65% 76,563 1,980 2.59% 5,342 234 4.38%
--------- --------- ------- --------- --------- ------- -------- --------- -------
TOTAL INTEREST BEARING
LIABILITIES 741,546 13,183 1.78% 672,581 13,945 2.07% 516,897 13,453 2.60%
--------- ------- --------- ------- --------- -------
Non-interest bearing
demand deposits 75,472 71,474 72,408
Other liabilities 4,363 3,744 3,829
Stockholders' equity 72,475 69,884 66,205
--------- --------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $893,856 $817,683 $659,339
========= ========= ========
NET INTEREST INCOME $24,569 $22,744 $24,341
========= ========= =========
INTEREST RATE SPREAD 2.71% 2.71% 3.47%
======= ======= =======
NET INTEREST MARGIN 2.92% 2.96% 3.91%
======= ======= =======
For yield calculation purposes, non-accruing loans are included in average loan
balances.
Interest income on loans includes amortized fees and costs on loans totaling
$186,000 in 2004, $637,000 in 2003 and $420,000 in 2002.
Table 1 presents balance sheet items on a daily average basis, net interest
income, interest rate spread, and net interest margin for the years ending
December 31, 2004, 2003 and 2002. Table 2 analyzes the relative impact on net
interest income for changes in the volume of earning assets and interest-bearing
liabilities and changes in rates earned and paid by the Corporation on such
assets and liabilities.
16
Net interest income totaled $24,569,000 in 2004, compared to $22,744,000 in
2003, and $24,341,000 in 2002. The increase in net interest income during 2004
was primarily related to an increase in average earning assets. During 2003, net
interest income declined as a result of a decline in rates, partially offset by
an increase in interest bearing assets.
The net interest margin during 2004 was 2.92% compared to 2.96% during 2003. The
decline in margin was primarily related to a decrease in average net noninterest
bearing sources, primarily non-interest bearing demand deposits and
stockholders' equity, as a percentage of interest bearing assets from 12.38%
during 2003 to 11.75% during 2004. The yield on interest earning assets and cost
of interest bearing liabilities declined by 0.29% during 2004.
The net interest margin during 2003 was 2.96% compared to 3.91% during 2002.
Several factors impacted the net interest margin for 2003. First, ACNB was in an
asset sensitive interest rate risk position in 2003, and interest earning assets
repriced more quickly than interest bearing liabilities. Longer-term funding
sources, including certificates of deposit, have to reach their maturity date to
reprice. The yield on interest earning assets declined by 1.29% while the cost
of interest bearing liabilities declined only 0.53%. Second, ACNB had a less
profitable interest earning asset mix, as deposits and borrowings were used to
fund securities because loan growth remained weak. Finally, the market area
served by ACNB is highly competitive, resulting in financial institutions
pricing quality credits competitively in order to increase volume.
Average earning assets were $840,297,000 in 2004, an increase of 9.5% over the
2003 balance of $767,597,000. Average earning assets for 2002 were $622,890,000.
Securities growth was the primary contributor to the increase in average earning
assets during these periods with loans remaining a secondary source.
A rate/volume analysis detailed in Table 2 shows that the significant increase
in interest income change in 2004 was centered in taxable securities volume
while the largest decrease in interest expense was in savings deposits. Positive
volume changes in net interest income in 2003 were more than offset by negative
rate changes. Management's emphasis on additional loan and security volume in
2004 resulted in increased net interest income and this emphasis will continue
in 2005. Higher interest rates should also have a positive impact on net
interest income.
Average interest bearing liabilities were $741,546,000 in 2004, up from
$672,581,000 in 2003, and $516,897,000 in 2002. Loan and securities growth was
primarily funded by an increase in interest bearing liabilities in 2004 and
2003, with a continued shift in mix from time deposits to borrowed money and
lower-cost demand and savings deposits.
The following table shows changes in net interest income attributed to changes
in rates and changes in average balances of interest-earning assets and
interest-bearing liabilities:
TABLE 2 - RATE/VOLUME ANALYSIS
2004 VERSUS 2003 2003 VERSUS 2002
---------------------------------------- ---------------------------------------
DUE TO CHANGES IN DUE TO CHANGES IN
------------------------- -------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- ------- ------- -------- ------- ---------
IN THOUSANDS
Interest Earning Assets
Loans $2,068 $(2,160) $ (92) $1,389 $(2,471) $(1,082)
Taxable securities 1,126 (33) 1,093 4,372 (5,037) (665)
Tax-exempt securities 42 (7) 35 653 (12) 641
------------ ------------ ------------ ------------ ------------ ------------
TOTAL SECURITIES 1,168 (40) 1,128 5,025 (5,049) (24)
Other 38 (11) 27 56 (55) 1
------------ ------------ ------------ ------------ ------------ ------------
TOTAL 3,274 (2,211) 1,063 6,470 (7,575) (1,105)
------------ ------------ ------------ ------------ ------------ ------------
17
2004 VERSUS 2003 2003 VERSUS 2002
----------------------------------------- ----------------------------------------
DUE TO CHANGES IN DUE TO CHANGES IN
------------------------ ----------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- ------- ------- -------- ------ -------
IN THOUSANDS
Interest Bearing Liabilities
Interest bearing demand deposits $ 96 $ (525) $ (429) $ 203 $ (249) $ (46)
Savings deposits 232 (1,103) (871) 1,092 (747) 345
Time deposits 151 (564) (413) (393) (940) (1,333)
Short-term borrowings 98 (46) 52 (7) (213) (220)
Long-term borrowings 849 50 899 1,880 (134) 1,746
------------ ------------ ------------ ------------ ------------ ------------
TOTAL 1,426 (2,188) (762) 2,775 (2,283) 492
------------ ------------ ------------ ------------ ------------ ------------
CHANGE IN NET INTEREST INCOME $1,848 $ (23) $1,825 $3,695 $(5,292) $(1,597)
============ ============ ============ ============ ============ ============
The net change attributable to the combination of rate and volume has been
allocated to the change is due to volume and rate. For yield calculation
purposes, non-accruing loans are included in average balances.
PROVISION FOR LOAN LOSSES
The provision for loan losses charged against earnings was $300,000 in 2004,
compared to $265,000 in 2003 and $370,000 in 2002. ACNB adjusts the provision
for loan losses periodically as necessary to maintain the allowance at a level
deemed to meet the risk characteristics of the loan portfolio.
See further discussion in the "Asset Quality" discussion of this annual report.
OTHER INCOME
Other income was $5,865,000 for the year ended December 31, 2004, a $3,564,000
decrease from 2003. The decrease was primarily the result of a $2,161,000 gain
realized from insurance proceeds due to the death of an executive officer during
2003 and $1,992,000 of gains on sales of securities during 2003 as compared to
$1,113,000 during 2004. Excluding the gain from insurance proceeds and gains
from sales of securities, other income totaled $5,276,000 during 2003 as
compared to $5,028,000 during 2002.
Income from fiduciary activities, which includes both institutional and personal
trust management services and brokerage service fees, totaled $714,000 for the
year ended December 31, 2004, as compared to $663,000 during 2003 and $683,000
in 2002. At December 31, 2004, ACNB had total assets under administration of
approximately $74,000,000, up 15.6% compared to $64,000,000 at the end of 2003
and $59,000,000 at the end of 2002. The increase in income was the result of an
increase in assets under management.
Other income was $862,000 for the year ended December 31, 2004, a decrease of
$635,000 as compared to income of $1,497,000 during 2003. Other income during
2002 totaled $1,538,000. The major factors in the decline in 2004 as compared to
2003 were a decline in gains on loan sales from $337,000 during 2003 to $113,000
during 2004, which is a result of a major slowdown in mortgage refinancings and
a gain on sale of bank real estate of $173,000 during 2003.
18
OTHER EXPENSE
The largest component of other expense is salaries and employee benefits, which
decreased $18,000, or 0.2%, to $9,884,000 in 2004, after increasing by $448,000,
or 4.7%, in 2003. The decrease in salary and employee benefits was the result of
loan expenses deferred in accordance with Statement of Financial Accounting
Standards No. 91. Excluding the increase in the SFAS No. 91 adjustment, salaries
and benefits would have increased by $423,000 or 4.3%. The change in salaries
and employee benefits during 2004, 2003 and 2002 is attributable to the
following factors:
o Normal merit increases to employees;
o Increases in administrative personnel expense as the bank's
strategic direction continues to focus on greater growth; and,
o Increases in employee benefit costs, particularly health and
welfare benefit plans, consistent with the rising health care cost
trend noted nationwide and increased net periodic pension costs
due to the underperformance of investments in the pension plan.
Net occupancy expense was $952,000 in 2004, $933,000 in 2003, and $829,000 in
2002 and furniture and equipment expense totaled $2,131,000 during 2004 as
compared to $1,960,000 during 2003 and $1,411,000 during 2002. The increases
were the result of additional operational expenses and maintenance associated
with the overall bank growth and more sophisticated delivery channels offered to
the bank's customer base.
Professional services expense totaled $730,000 during 2004, as compared to
$543,000 for 2003 and $648,000 during 2002. During 2004, due diligence fees for
the acquisition of Russell Insurance Group were included in professional
services. During 2002, payments for the rights to and implementation of
Overdraft Privilege were included in professional services expense. The
overdraft privilege service allows checking account overdrafts up to a pre set
dollar amount with a fee for every check paid. The Corporation experienced an
increase in service charges on deposits during 2002 as compared 2001.
Other operating expenses totaled $3,251,000 during 2004, compared to $3,084,000
during 2003 and $3,060,000 in 2002. Significant expense components in this
category include marketing and advertising and Pennsylvania Bank Shares Tax.
INCOME TAX EXPENSE
ACNB recognized income taxes of $2,255,000, or 19.5% of pretax income during
2004 as compared to $3,142,000, or 22.6% of pre-tax income during 2003, and
$3,107,000, or 25.9% of pre-tax income in 2002. The variances from the federal
statutory rate of 35% are generally due to tax-exempt income and investments in
low-income housing partnerships (which qualify for federal tax credits).
The decline in the effective tax rate during 2004 is a result of historical tax
credits of $891,000 associated with a low income housing project. The downward
trend in the effective tax rate from 2002 to 2004 is consistent with the
increase in tax-free investment securities and low income housing credits during
this period.
At December 31, 2004, net deferred tax assets amounted to $2,702,000. Deferred
tax assets are realizable primarily through future reversal of existing taxable
temporary differences. Management currently anticipates future earnings will be
adequate to utilize the net deferred tax assets.
19
FINANCIAL CONDITION
Average earning assets increased in 2004 to $840,297,000 or 9.5% or from
$767,597,000 in 2003, and $622,890,000 in 2002. ACNB's investment portfolio has
increased over the last three years, as a result of planned growth using
borrowed funds. To a lesser degree, growth in commercial and consumer loans
contributed to the increase in average earning assets. Average funding sources,
or interest bearing liabilities, increased in 2004 to $741,546,000 from
$672,581,000 in 2003, and $516,897,000 in 2002.
INVESTMENT SECURITIES
ACNB uses investment securities to generate interest and dividend income, to
manage interest rate risk, and to provide liquidity. The growth in the security
portfolio, in part, reflects the trends in loans, deposits, and borrowed funds
during 2004 and 2003. As deposit and borrowing growth outpaced loan growth
during 2004 and 2003, excess funding was invested in the securities portfolio.
Much of the investment activity focused on U.S. Government agencies, tax-free
municipal, and corporate securities. These securities provide the appropriate
characteristics with respect to yield and maturity relative to the management of
the overall balance sheet.
At December 31, 2004, the securities balance included a net unrealized loss on
available for sale securities of $1,762,000, net of taxes, versus a net
unrealized gain of $442,000, net of taxes at December 31, 2003. The reduction in
interest rates during 2003 led to the appreciation in the fair value of
securities during 2003.
The following tables set forth the composition of the securities portfolio and
the securities maturity schedule, including weighted average yield, as of the
dates indicated:
TABLE 3 - INVESTMENT SECURITIES
2004 2003 2002
--------------- ----------------- ----------------
IN THOUSANDS
AVAILABLE FOR SALE SECURITIES AT FAIR VALUE
U.S. Government and agencies $157,810 $ 39,836 $ 32,428
Mortgage-backed securities 118,000 176,061 184,893
State and municipal 22,928 23,271 -
Corporate bonds 82,071 106,401 65,068
Stock in other banks 574 500 -
---------------- ---------------- ----------------
381,383 346,069 282,389
---------------- ---------------- ----------------
HELD TO MATURITY SECURITIES AT AMORTIZED COST
U.S. Government and agencies 10,000 15,535 25,540
Mortgage-backed securities 14,206 26,201 1,509
State and municipal 354 447 217
---------------- ---------------- ----------------
24,560 42,183 27,266
---------------- ---------------- ----------------
$405,869 $388,252 $309,655
================ ================ ================
20
TABLE 4 - SECURITIES MATURITY SCHEDULE
OVER 10 YEARS
1 YEAR OR LESS OVER 1-5 YEARS OVER 5-10 YEARS OR NO MATURITY TOTAL
---------------- ---------------- ----------------- --------------- ---------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
--------- ----- ------- ------ ------- ------ ------- ------ ------- ------
DOLLARS IN THOUSANDS
U.S. Government and agencies $ - - % $55,000 3.61% $78,912 4.07% $ 35,000 4.02% $168,912 3.91%
Mortgage-backed securities - - 59,450 3.57 39,017 3.72 34,956 4.85 133,423 3.95
State and municipal - - 354 3.33 15,999 3.69 6,917 4.56 23,270 3.94
Corporate bonds 10,178 2.12 72,372 3.44 - - - - 82,550 3.28
Stock in other banks - - - - - - 500 2.50 500 2.50
-------- ----- --------- ----- -------- ------ --------- ----- --------- ------
$10,178 2.12% $187,176 3.65% $133,928 3.92 % $77,373 4.43% $408,655 3.80%
======== ===== ========= ===== ======== ====== ========= ===== ========= ======
Securities are at amortized cost. Mortgage-backed securities are allocated based
upon scheduled maturities.
LOANS
Loans outstanding increased $25,540,000, or 6.1% in 2004, compared to 10.7%
growth experienced in 2003. The growth in loans is consistent with a stable
local economy and lending to support existing customers. The commercial loan
portfolio experienced solid growth during 2003, increasing by approximately
$17,000,000. The commercial loan growth experienced in 2004 is the result of
actively marketing to local businesses. Additionally, ACNB has been able to
participate with other institutions on larger loans.
TABLE 5 - LOAN PORTFOLIO Loans at December 31 were as follows:
2004 2003 2002 2001 2000
----------- ------------ ---------- ----------- ----------
IN THOUSANDS
Commercial, financial and agricultural $ 31,187 $ 18,080 $ 21,128 $ 18,027 $ 18,376
Real estate:
Commercial 99,988 100,536 90,967 83,067 79,629
Construction 20,232 22,298 16,096 15,497 15,786
Residential 278,519 262,893 232,669 232,821 234,620
Installment 10,643 11,222 11,446 12,127 12,443
------------ ------------ ------------ ------------ ------------
TOTAL LOANS $440,569 $415,029 $372,306 $361,539 $360,854
============ ============ ============ ============ ============
The maturity range of the loan portfolio and the amounts of loans with
predetermined and fixed rates are presented in the table below:
TABLE 6 - LOAN MATURITIES AND SENSITIVITIES
LESS THAN 1
YEAR 1-5 YEARS OVER 5 YEARS TOTAL
--------------- ---------------- ---------------- ---------------
IN THOUSANDS
Commercial, financial and agricultural $ 14,615 $ 10,463 $ 6,109 $ 31,187
Real estate:
Commercial 33,721 50,404 15,863 99,988
Construction 13,390 6,306 536 20,232
--------------- ---------------- ---------------- ---------------
TOTAL $ 61,726 $ 67,173 $22,508 $151,407
=============== ================ ================ ===============
Loans with a fixed interest rate 8,331 5,252 7,592 21,175
Loans with a variable interest rate 53,395 61,921 14,916 130,232
--------------- ---------------- ---------------- ---------------
TOTAL $ 61,726 $ 67,173 $22,508 $151,407
=============== ================ ================ ===============
21
Most of the Corporation's activities are with customers located within the south
central Pennsylvania and northern Maryland region of the country. The
Corporation does not have any significant concentrations greater than 10% of
loans to any one industry or customer.
ASSET QUALITY
ACNB loan portfolios are subject to varying degrees of credit risk. Credit risk
is mitigated through prudent underwriting standards, on-going credit review, and
monitoring and reporting asset quality measures. Additionally, loan portfolio
diversification, limiting exposure to a single industry or borrower, and
requiring collateral also reduces ACNB's credit risk.
ACNB's commercial, consumer and residential mortgage loans are principally to
borrowers in south central Pennsylvania and northern Maryland. As the majority
of ACNB's loans are located in this area, a substantial portion of the debtor's
ability to honor their obligations may be affected by the level of economic
activity in the market area.
The unemployment rate in ACNB's market area remained below the national average
during 2004. Additionally, reasonably low interest rates, a stable local economy
and minimal inflation continued to support favorable economic conditions in the
area.
Nonperforming assets include nonaccrual and restructured loans, accruing loans
past due 90 days or more and other foreclosed assets. ACNB's general policy has
been to cease accruing interest on loans when management determines that a
reasonable doubt exists as to the collectibility of additional interest. When
management places a loan on non-accrual status, it reverses unpaid interest
credited to income in the current year. ACNB recognizes income on these loans
only to the extent that it receives cash payments. ACNB occasionally returns
nonaccrual loans to performing status when the borrower brings the loan current
and performs in accordance with contractual terms for a reasonable period of
time. ACNB categorizes a loan as restructured if it changes the terms of the
loan such as interest rate, repayment schedule or both, to terms that it
otherwise would not have granted originally.
The following table sets forth the Corporation's non-performing assets as of the
dates indicated:
TABLE 7 - NON-PERFORMING ASSETS
2004 2003 2002 2001 2000
------------ ------------- ------------ ------------ ------------
DOLLARS IN THOUSANDS
Non-accrual loans $8,054 $4,413 $1,037 $837 $1,318
Accruing loans 90 days past due 160 606 1,379 1,003 1,528
------------ ------------- ------------ ------------ ------------
TOTAL NON-PERFORMING LOANS 8,214 5,019 2,416 1,840 2,846
Foreclosed real estate 213 394 559 1,646 981
------------ ------------- ------------ ------------ ------------
TOTAL NON-PERFORMING ASSETS $8,427 $5,413 $2,975 $3,486 $3,827
============ ============= ============ ============ ============
Ratios:
Non-performing loans to total loans 1.86% 1.21% 0.65% 0.51 0.79%
Non-performing assets to total assets 0.91% 0.62% 0.40% 0.55 0.67%
Allowance for loan losses to non-
performing loans 47.94% 79.26% 158.82% 202.34 129.83%
22
If interest due on all nonaccrual loans had been accrued at original contract
rates, it is estimated that income before income taxes would have been greater
by $384,000 in 2004, $82,000 in 2003, and $55,000 in 2002.
Impaired loans at December 31, 2004 and 2003 totaled $7,539,000 and $200,000,
respectively. The related allowance for loan losses totaled $619,000 and
$20,000, respectively. The increase in nonaccrual and impaired loans during 2004
is related to 3 commercial loan relationships, which are collateralized by real
estate. Even though all 3 relationships' payments were current as of December
31, 2004, they were classified as nonaccrual and impaired during 2004 because
cash flows reported by the related companies are not sufficient to service the
debt.
Potential problem loans are defined as performing loans that have
characteristics that cause management to have doubts as to the ability of the
borrower to perform under present loan repayment terms and which may result in
the reporting of these loans as nonperforming loans in the future. Total
potential problem loans approximated $5.2 million at December 31, 2004. The
majority of these loans are secured by real estate with acceptable loan-to-value
ratios.
ALLOWANCE FOR LOAN LOSSES
ACNB maintains the allowance for loan losses at a level believed adequate by
management to absorb potential losses in the loan portfolio and is established
through a provision for loan losses charged to earnings. On a quarterly basis,
the Corporation utilizes a defined methodology in determining the adequacy of
the allowance for loan losses, which considers specific credit reviews, past
loan loss historical experience, and qualitative factors. This methodology,
which has remained consistent for the past several years, results in an
allowance consisting of two components, "allocated" and "unallocated".
Management assigns internal risk ratings for each significant commercial lending
relationship. Utilizing migration analysis for the previous eight quarters,
management develops a loss factor test, which it then uses to estimate losses
for non-rated and non-classified loans. When management finds loans with
uncertain collectibility of principal and interest, it places those loans on the
"problem list," and evaluates a specific reserve on a quarterly basis in order
to estimate potential losses. Management's analysis considers:
o adverse situations that may affect the borrower's ability to repay;
o estimated value of underlying collateral; and
o prevailing market conditions.
23
If management determines that a specific reserve allocation is not required, it
assigns the general loss factor to determine the reserve. For homogeneous loan
types, such as consumer and residential mortgage loans, management bases
specific allocations on the average loss ratio for the previous three years for
each specific loan pool. Additionally, management adjusts projected loss ratios
for other factors, including the following:
o trends in delinquency levels;
o trends in non-performing and potential problem loans;
o trends in composition, volume and terms of loans;
o effects in changes in lending policies or underwriting procedures;
o experience, ability and depth of management;
o national and local economic conditions;
o concentrations in lending activities; and
o other factors that management may deem appropriate.
Management determines the unallocated portion of the allowance for loan losses
based on the following criteria:
o risk of error in the specific and general reserve allocations;
o other potential exposure in the loan portfolio;
o variances in management's assessment of national and local
economic conditions; and
o other internal or external factors that management believes
appropriate at that time.
Management believes the above methodology accurately reflects losses inherent in
the portfolio. Management charges actual loan losses to the allowance for loan
losses. Management periodically updates the methodology discussed above, which
reduces the difference between actual losses and estimated losses.
Management bases the provision for loan losses, or lack of provision, on the
overall analysis taking into account the methodology discussed above.
24
The following tables set forth information on the analysis of the allowance for
loan losses and the allocation of the allowance for loan losses as of the dates
indicated:
TABLE 8 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
YEARS ENDED DECEMBER 31,
2004 2003 2002 2001 2000
------------ ------------- ------------ ------------ ------------
DOLLARS IN THOUSANDS
Beginning balance $3,978 $3,837 $3,723 $3,695 $3,543
Provision for loan losses 300 265 370 240 240
Loans charged off:
Commercial, financial and
agricultural 316 90 87 39 11
Real estate 31 32 192 131 42
Consumer 43 47 57 139 84
------------ ------------- ------------ ------------ ------------
TOTAL CHARGED-OFF 390 169 336 309 137
------------ ------------- ------------ ------------ ------------
Recoveries:
Commercial, financial and
agricultural 8 6 27 49 5
Real estate - 7 22 3 2
Consumer 42 32 31 45 42
------------ ------------- ------------ ------------ ------------
TOTAL RECOVERIES 50 45 80 97 49
------------ ------------- ------------ ------------ ------------
Net charge-offs 338 124 256 212 88
------------ ------------- ------------ ------------ ------------
Ending balance $3,938 $3,978 $3,837 $3,723 $3,695
============ ============= ============ ============ ============
Ratios:
Net charge-offs to average loans 0.08% 0.03% 0.07% 0.06 0.02%
Allowance for loan losses to total
loans 0.89% 0.96% 1.02% 1.03 1.02%
TABLE 9 - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
2004 2003 2002 2001 2000
------------------ ----------------- --------------------- ------------------ --------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF LOAN OF LOAN OF LOAN OF LOAN OF LOAN
TYPE TO TYPE TO TYPE TO TYPE TO TYPE TO
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
--------- -------- --------- --------- --------- -------- -------- --------- -------- ---------
DOLLARS IN THOUSANDS
Commercial,
financial and
agricultural $ 941 7.1% $ 875 4.4% $ 930 5.6% $ 937 5.0% $ 1,007 5.1%
Real estate:
Commercial 1,288 22.7 1,388 24.2 1,394 24.3 1,543 22.9 1,481 22.1
Construction 248 4.6 308 5.4 258 4.3 275 4.3 307 4.4
Residential 674 63.2 684 63.3 467 62.7 533 64.5 339 65.0
Consumer 420 2.4 504 2.7 375 3.1 360 3.3 132 3.4
Unallocated 367 N/A 219 N/A 413 N/A 75 N/A 429 N/A
--------- -------- --------- --------- --------- -------- -------- --------- -------- ---------
TOTAL $3,938 100.00% $3,978 100.00% $3,837 100.00% $3,723 100.00% $3,695 100.00%
========= ======== ========= ========= ========= ======== ======== ========= ======== =========
25
The allocation of the allowance for loan losses between the various loan
portfolios has changed over the past few years, consistent with the historical
net loss experience in each of the portfolios. The unallocated portion of the
allowance reflects estimated inherent losses within the portfolio that have not
been detected. The unallocated portion of the reserve exists due to risk of
error in the specific and general reserve allocations, other potential exposure
in the loan portfolio, variances in management's assessment of national and
local economic conditions, and other internal and external factors that
management believes appropriate at the time. The unallocated portion of the
reserve has increased due to variances in management's assessment of national
and local economic conditions as may be affected by the current political
environment and other external factors.
While management believes ACNB's allowance for loan losses is adequate based on
information currently available, future adjustments to the reserve may be
necessary due to changes in economic conditions, and management's assumptions as
to future delinquencies or loss rates.
PREMISES AND EQUIPMENT
The increase in premises and equipment from $7,053,000 at December 31, 2003 to
$11,992,000 at December 31, 2004 is primarily related to the Corporation's new
Operations Center, which is scheduled to be completed during 2005. Additionally,
the Corporation anticipates incurring an additional $2.8 million related to the
Operations Center.
DEPOSITS
ACNB continues to rely on deposit growth as the primary source of funds for
lending activities. Average deposits increased 5.6% or $34.9 million during 2004
compared to 15.6% during 2003. The 2003 growth was accomplished primarily
through the marketing of a special money market rate account to compete with
money market mutual funds. Additionally, deposits have grown as consumers have
migrated towards deposit products, which are generally regarded as safer, more
liquid investments as compared to the stock market. ACNB will continue to
explore new products for its customers, to attract and retain other funds
seeking safe havens. However, ACNB's ability to maintain and add to its deposit
base may experience additional competitive pressures from the stock market
and/or other alternative investment products offered by the insurance industry
and others.
TABLE 10 - TIME DEPOSITS
Maturities of time deposits of $100,000 or more outstanding at December 31, 2004
are summarized as follows:
IN THOUSANDS
Three months or less $ 6,724
Over three through six months 4,446
Over six through twelve months 5,872
Over twelve months 18,958
--------
TOTAL $36,000
========
26
BORROWINGS
Short-term borrowings are comprised primarily of securities sold under
agreements to repurchase, and overnight borrowings at the Federal Home Loan Bank
in Pittsburgh (FHLB). As of December 31, 2004, short-term borrowings were
$64,966,000, a decrease of $4,710,000, or 6.8%, from the December 31, 2003
balance of $69,676,000.
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Amounts outstanding at end of year:
FHLB overnight advance $30,706 $29,320 $20,050
Securities sold under repurchase agreements 33,810 39,906 35,945
Treasury tax and loan note 450 450 450
------------ ------------ ------------
$64,966 $69,676 $56,445
============ ============ ============
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Average interest rate at year-end 1.84% 1.37% 1.84%
Maximum amount outstanding at any month-end $79,589 $75,867 $73,064
Average amount outstanding $51,437 $45,290 $45,618
Weighted average interest rate 1.54% 1.64% 2.11%
Long-term debt consists of advances from the Federal Home Loan Bank to fund
ACNB's growth in its securities portfolio. Long-term debt totaled $132,000,000
at December 31, 2004, versus $87,000,000 at December 31, 2003. The increase in
long-term debt was used to fund additional investments in securities and loans.
CAPITAL
The management of capital in a regulated financial services industry must
properly balance return on equity to stockholders while maintaining sufficient
capital levels and related risk-based capital ratios to satisfy regulatory
requirements. Capital management must also consider growth opportunities that
may exist, and the resulting need for additional capital. ACNB's capital
management strategies have been developed to provide attractive rates of returns
to stockholders, while maintaining its "well-capitalized" position.
The primary source of additional capital to ACNB is earnings retention, which
represents net income less dividends declared. During 2004, ACNB retained
$4,416,000, or 47%, of its net income as compared to $5,930,000 or 55% during
2003 and $4,120,000 or 46% during 2002.
ACNB is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on ACNB.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, ACNB must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and reclassifications are also subject to qualitative judgments by the
regulators about components, risk-weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
requires ACNB to maintain minimum amounts and ratios of total and Tier 1 capital
to average assets. Management believes, as of December 31, 2004 and 2003, that
ACNB's banking subsidiary met all minimum capital adequacy requirements to which
they are subject and are categorized as "well-capitalized." There are no
conditions or events since the notification that management believes have
changed the subsidiary bank's category.
27
TABLE 11 - RISKED-BASED CAPITAL
ACNB's capital ratios are as follows:
2004 2003
-------- ---------
Tier 1 leverage ratio (to average assets) 8.34 8.85
Tier 1 risk-based capital ratio (to risk-weighted assets) 13.91 13.93
Total risk-based capital ratio 14.64 14.70
LIQUIDITY
Another source of liquidity is securities sold under repurchase agreement to
customers of ACNB's banking subsidiary totaling $33,810,000 and $39,906,000 at
December 31, 2004 and 2003, respectively.
Effective liquidity management ensures the cash flow requirements of depositors
and borrowers, as well as the operating cash needs of ACNB are met.
ACNB's funds are available from a variety of sources, including assets that are
readily convertible to such as cash and federal funds sold, maturities and
repayments from the securities portfolio, scheduled repayments of loans
receivable, the core deposit base, and the ability to borrow from the FHLB. At
December 31, 2004, ACNB could borrow approximately $450,136,000 from the FHLB of
which $287,430,000 was available.
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 stockholders and corporate expenses. The main source of funding for
the parent company is the dividends it receives from its banking subsidiary.
Federal and state banking regulations place certain restrictions on dividends
paid to the parent company from the subsidiary banks. The total amount of
dividends that may be paid from the subsidiary bank to ACNB were $7,357,000 at
December 31, 2004. For a discussion of ACNB's dividend restrictions, see Item 1
- - "Business."
ACNB manages liquidity by monitoring projected cash inflows and outflows on a
daily basis, and believes it has sufficient funding sources to maintain
sufficient liquidity under varying degrees of business conditions. The
Corporation's operating cash flows totaled $11,034,000 during 2004 as compared
to $12,742,000 during 2003 and $4,862,000 during 2002. The primary sources of
cash flows are payments received for interest and dividends, partially offset by
payments for interest on deposits and borrowings and payments for other
expenses. See the cash flows statement for additional information.
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table represents the Corporation's on and off-balance sheet
aggregate contractual obligations to make future payments as of December 31,
2004:
LESS THAN 1 - 3 4 - 5 OVER 5
1 YEAR YEARS YEARS YEARS TOTAL
------------ ------------ ------------ ------------ ------------
IN THOUSANDS
Time deposits $126,780 $68,101 $28,938 $ - $223,819
Long-term debt 57,000 55,000 - 20,000 132,000
Operating leases 465 523 217 104 1,309
Payments under benifit plans 683 1,512 1,694 9,040 12,929
------------ ------------ ------------ ------------ ------------
TOTAL $184,928 $125,136 $30,849 $29,144 $370,057
============ ============ ============ ============ ============
In addition, the Corporation in the conduct of business operations routinely
enters into contracts for services. These contracts may require payment for
services to be provided in the future and may also contain penalty clauses for
the early termination of the contracts.
28
Management expects to incur approximately $2,775,000 in capital expenditures
during 2005, approximately $2,500,000 for completion of an operations center and
$275,000 for low income housing projects.
Management is not aware of any other commitments or contingent liabilities which
may have a material adverse impact on the liquidity or capital resources of the
Corporation.
OFF-BALANCE SHEET ARRANGEMENTS
The Corporation is party to 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 December 31, 2004, the Corporation
had unfunded outstanding commitments to extend credit of $73 million and
outstanding standby letters of credit of $5,732,000. Because these commitments
generally have fixed expiration dates and many will expire without being drawn
upon, the total commitment level does not necessarily represent future cash
requirements. Refer to footnote N of the consolidated financial statements for a
discussion of the nature, business purpose and importance of the Corporation's
off-balance sheet arrangements.
Financial institutions can be exposed to several market risks that may impact
the value or future earnings capacity of an organization. These risks involve
interest rate risk, foreign currency exchange risk, commodity price risk and
equity market price risk. ACNB'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 borrowings) at various terms and rates. These funds are then
invested into earning assets (loans, leases, investments, etc.) at various terms
and rates. This risk is further discussed below.
ACNB does not have any exposure to foreign currency exchange risk, commodity
price risk or equity market risk.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Interest rate risk is the exposure to fluctuations in the Corporation's future
earnings (earnings at risk) and value (value at risk) resulting from changes in
interest rates. This exposure results from differences between the amounts of
interest earning assets and interest bearing liabilities that reprice within a
specified time period as a result of scheduled maturities and repayment and
contractual interest rate changes.
The primary objective of the Corporation's asset/liability management process is
to maximize current and future net interest income within acceptable levels of
interest rate risk while satisfying liquidity and capital requirements.
Management recognizes that a certain amount of interest rate risk is inherent,
appropriate, and necessary to ensure the Corporation's profitability. Thus the
goal of interest rate risk management is to maintain a balance between risk and
reward such that net interest income is maximized while risk is maintained at a
tolerable level.
Management endeavors to control the exposure to changes in interest rates by
understanding, reviewing and making decisions based on its risk position. The
bank subsidiary asset/liability committee is responsible for these decisions.
The Corporation primarily uses the securities portfolios and FHLB advances to
manage its interest rate risk position. Additionally, pricing, promotion and
product development activities are directed in an effort to emphasize the loan
and deposit term or repricing characteristics that best meet current interest
rate risk objectives. At present, there is no use of hedging instruments.
The committee operates under management policies defining guidelines and limits
on the level of risk. These policies are approved by the Board of Directors.
The Corporation uses simulation analysis to assess earnings at risk and net
present value analysis to assess value at risk. These methods allow management
to regularly monitor both the direction and magnitude of the
29
Corporation's interest rate risk exposure. These modeling techniques involve
assumptions and estimates that inherently cannot be measured with complete
precision. Key assumptions in the analyses include maturity and repricing
characteristics of both assets and liabilities, prepayments on amortizing
assets, non-maturity deposit sensitivity, and loan and deposit pricing. These
assumptions are inherently uncertain due to the timing, magnitude and frequency
of rate changes and changes in market conditions and management strategies,
among other factors. However, the analyses are useful in quantifying risk and
provide a relative gauge of the Corporation's interest rate risk position over
time.
EARNINGS AT RISK
Simulation analysis evaluates the effect of upward and downward changes in
market interest rates on future net interest income. The analysis involves
changing the interest rates used in determining net interest income over the
next twelve months. The resulting percentage change in net interest income in
various rate scenarios is an indication of the Corporation's shorter-term
interest rate risk. The analysis utilizes a "static" balance sheet approach. The
measurement date balance sheet composition (or mix) is maintained over the
simulation time period, with maturing and repayment dollars being rolled back
into like instruments for new terms at current market rates. Additional
assumptions are applied to modify volumes and pricing under the various rate
scenarios. These include prepayment assumptions on mortgage assets, the
sensitivity of non-maturity deposit rates, and other factors deemed significant.
The simulation analysis results are presented in Table 13a. These results as of
December 31, 2004, indicate that the Corporation would expect net interest
income to decrease over the next twelve months by 18.8% assuming an immediate
upward shift in market interest rates of 3.00% and to decrease by 8.5% if rates
shifted downward 1.00%. The results for a downward shift in market rates of
3.00% were not presented as they would not be meaningful in an already low
interest rate environment. This profile reflects a liability sensitive
short-term rate risk position and exceeds guidelines set by policy. However,
included in this simulation were borrowings of $45,000,000 that matured in
January and February of 2005 and were re-termed at 2 and 3 years with an average
rate of 3.76%. The Corporation relies more on cash flow statements and a dynamic
gap report for day to day operations and both indicate an asset sensitive
position.
The model indicates that net interest income would decline in both up and down
directions of interest rates because of a large amount of transaction accounts
positioned to change rates overnight. Since they are theoretically positioned to
change rates immediately they cause a negative change in net interest income
regardless of direction of interest rates. In actual practice, management would
change these rates much more gradually than the model predicts. Since interest
rates are at 50-year lows, an asset sensitive position will enable the
Corporation to capitalize on rising rates. Additionally, management aims to
manage interest rate risk on the asset side or the balance sheet by keeping
security maturities relatively short (average of 7 years to maturity at December
31, 2004) and by trying to attract variable rate loans and commercial loans with
a maximum rate lock period of no more than 5 years.
VALUE AT RISK
The net present value analysis provides information on the risk inherent in the
balance sheet that might not be taken into account in the simulation analysis
due to the shorter time horizon used in that analysis. The net present value of
the balance sheet is defined as the discounted present value of expected asset
cash flows minus the discounted present value of the expected liability cash
flows. The analysis involves changing the interest rates used in determining the
expected cash flows and in discounting the cash flows. The resulting percentage
change in net present value in various rate scenarios is an indication of the
longer term repricing risk and options embedded in the balance sheet.
The net present value analysis results are presented in Table 13b. These
results, as of December 31, 2004, indicate that the net present value would
decrease 18.9% assuming an immediate upward shift in market interest rates of
3.00% and to decrease 2.0% if rates shifted 1.00% in the same manner. The
results for a downward shift in market rates of 3.00% were not presented as they
would not be meaningful in an already low interest rate environment.
30
The Corporation's current strategy is to extend liability maturities and keep
asset maturities relatively short to protect against both greater earnings at
risk and value at risk.
DECEMBER 31, 2004 DECEMBER 31, 2004
- -------------------------------------- ---------------------------------------
TABLE 13A TABLE 13B
NET INTEREST INCOME PROJECTIONS PRESENT VALUE EQUITY
- -------------------------------------- ---------------------------------------
CHANGES IN CHANGES IN
BASIS POINTS % CHANGE BASIS POINTS % CHANGE
- ------------------ ---------------- ------------------ -----------------
(300) N/A % (300) N/A %
(100) (8.54)% (100) (1.98)%
- - % - - %
100 (11.52)% 100 (3.63)%
300 (18.80)% 300 (18.94)%
DECEMBER 31, 2003 DECEMBER 31, 2003
- -------------------------------------- ---------------------------------------
TABLE 13A TABLE 13B
NET INTEREST INCOME PROJECTIONS PRESENT VALUE EQUITY
- -------------------------------------- ---------------------------------------
CHANGES IN CHANGES IN
BASIS POINTS % CHANGE BASIS POINTS % CHANGE
- ------------------ ---------------- ------------------ -----------------
(300) (17.56)% (300) 2.70 %
(100) (9.89)% (100) (1.38)%
- -% - - %
100 (3.38)% 100 2.85%
300 4.39 % 300 3.98%
31
ITEM 8 - FINANCIAL STATEMENTS
(a) The following audited consolidated financial statements and
related documents are set forth in this Annual Report on Form 10-K
on the following pages:
PAGE
Report of Independent Registered Public Accounting Firm ..................... 33
Consolidated Statements of Condition ........................................ 34
Consolidated Statements of Income ........................................... 35
Consolidated Statements of Changes in Stockholders' Equity .................. 36
Consolidated Statements of Cash Flows ....................................... 37
Notes to Consolidated Financial Statements .................................. 38
32
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
To the Board of Directors and Stockholders
ACNB Corporation
Gettysburg, Pennsylvania
We have audited the accompanying consolidated statement of condition of
ACNB Corporation and subsidiaries as of December 31, 2004, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit. The
December 31, 2003 and 2002 consolidated financial statements were audited by
other auditors whose report, dated January 17, 2004, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of ACNB
Corporation and subsidiaries as of December 31, 2004, and the results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Harrisburg, Pennsylvania
March 10, 2005
33
ACNB CORPORATION
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CONDITION
DECEMBER 31,
----------------------------------------
2004 2003
---------------- ----------------
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
ASSETS
Cash and due from banks $ 21,757 $ 32,381
Interest-bearing deposits in banks 938 1,033
---------------- ----------------
Cash and Cash Equivalents 22,695 33,414
Securities available for sale 381,383 346,069
Securities held to maturity, fair value 2004 $25,089; 2003 $43,076 24,560 42,183
Loans held for sale 511 86
Loans, net of allowance for loan losses 2004 $3,938; 2003 $3,978 436,631 411,051
Premises and equipment 11,992 7,053
Restricted investment in bank stocks 10,271 7,047
Investment in bank owned life insurance 19,198 14,683
Investments in low income housing partnerships 6,153 3,371
Other assets 10,794 8,126
---------------- ----------------
TOTAL ASSETS $924,188 $873,083
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing $ 74,667 $ 75,819
Interest bearing 572,205 563,569
---------------- ----------------
Total Deposits 646,872 639,388
Short-term borrowings 64,966 69,676
Long-term borrowings 132,000 87,000
Other liabilities 5,829 4,276
---------------- ----------------
TOTAL LIABILITIES 849,667 800,340
---------------- ----------------
STOCKHOLDERS' EQUITY
Common stock, $2.50 par value; 20,000,000 shares authorized;
5,436,101 shares issued and outstanding 13,590 13,590
Retained earnings 63,127 58,711
Accumulated other comprehensive income (loss) (2,196) 442
---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 74,521 72,743
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $924,188 $873,083
================ ================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
34
ACNB CORPORATION
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
2004 2003 2002
---------------- --------------- ----------------
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
INTEREST INCOME
Loans, including fees $23,578 $23,670 $24,752
Securities:
Taxable 13,002 11,904 12,608
Tax-exempt 917 882 241
Dividends 153 158 119
Other 102 75 74
---------------- --------------- ----------------
TOTAL INTEREST INCOME 37,752 36,689 37,794
---------------- --------------- ----------------
INTEREST EXPENSE
Deposits 9,511 11,224 12,258
Short-term borrowings 793 741 961
Long-term debt 2,879 1,980 234
---------------- --------------- ----------------
TOTAL INTEREST EXPENSE 13,183 13,945 13,453
---------------- --------------- ----------------
NET INTEREST INCOME 24,569 22,744 24,341
PROVISION FOR LOAN LOSSES 300 265 370
---------------- --------------- ----------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 24,269 22,479 23,971
---------------- --------------- ----------------
OTHER INCOME
Service charges on deposit accounts 1,780 1,788 1,755
Income from fiduciary activities 714 663 683
Earnings on investment in bank owned life insurance 683 722 572
Gain recognized from life insurance proceeds - 2,161 -
Gains on sales of securities 1,113 1,992 -
Service charges on ATM and debt card transactions 713 606 480
Other 862 1,497 1,538
---------------- --------------- ----------------
TOTAL OTHER INCOME 5,865 9,429 5,028
---------------- --------------- ----------------
OTHER EXPENSES
Salaries and employee benefits 9,884 9,902 9,454
Net occupancy expense 952 933 829
Equipment expense 2,131 1,960 1,411
Professional services 730 543 648
Other tax expense 990 937 875
Supplies and postage 633 639 711
Other operating 3,251 3,084 3,060
---------------- --------------- ----------------
TOTAL OTHER EXPENSES 18,571 17,998 16,988
---------------- --------------- ----------------
INCOME BEFORE INCOME TAXES 11,563 13,910 12,011
PROVISION FOR INCOME TAXES 2,255 3,142 3,107
---------------- --------------- ----------------
NET INCOME $ 9,308 $10,768 $ 8,904
================ =============== ================
PER SHARE DATA
Basic earnings $ 1.71 $ 1.98 $ 1.64
================ =============== ================
Cash dividends declared $0.90 $ 0.89 $ 1.08
================ =============== ================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
35
ACNB CORPORATION
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
ACCUMULATED
OTHER TOTAL
COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK EARNINGS INCOME (LOSS) EQUITY
---------- ----------- ---------------- ---------------
DOLLARS IN THOUSANDS
BALANCE - DECEMBER 31, 2001 $13,590 $48,661 $ 774 $63,025
-------
Comprehensive income:
Net income - 8,904 - 8,904
Change in net unrealized gains on securities available for
sale, net of reclassification adjustment and taxes - - 3,315 3,315
-------
TOTAL COMPREHENSIVE INCOME 12,219
-------
Cash dividends declared - (4,784) - (4,784)
------- ------- ------- --------
BALANCE - DECEMBER 31, 2002 13,590 52,781 4,089 70,460
-------
Comprehensive income:
Net income - 10,768 - 10,768
Change in net unrealized gains on securities available for
sale, net of reclassification adjustment and taxes - - (3,647) (3,647)
-------
TOTAL COMPREHENSIVE INCOME 7,121
-------
Cash dividends declared - (4,838) - (4,838)
------- ------- ------- --------
BALANCE - DECEMBER 31, 2003 13,590 58,711 442 72,743
--------
Comprehensive income:
Net income - 9,308 - 9,308
Change in net unrealized gains on securities available for
sale, net of reclassification adjustment and taxes - - (2,205) (2,205)
Change in unfunded pension liability, net of taxes - - (433) (433)
-------
TOTAL COMPREHENSIVE INCOME 6,670
-------
Cash dividends declared - (4,892) - (4,892)
------- ------- ------- --------
BALANCE - DECEMBER 31, 2004 $13,590 $63,127 $(2,196) $74,521
======= ======= ======= ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
36
ACNB CORPORATION
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Interest and dividends received $ 40,700 $ 40,467 $ 39,348
Fees and commissions received 2,485 5,066 358
Interest paid (13,064) (14,417) (13,998)
Cash paid to suppliers and employees (16,432) (18,116) (15,675)
Income taxes paid (2,343) (3,053) (3,959)
Loans originated for sale (8,778) (18,735) (22,360)
Proceeds on mortgage loans sold 8,466 21,530 21,148
------------- ------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 11,034 12,742 4,862
------------- ------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities held to maturity 17,491 5,366 16,821
Proceeds from maturities of investment securities available for sale 184,614 148,086 117,852
Proceeds from sales of securities available for sale 200,181 131,253 -
Purchase of investment securities held to maturity - (23,438) -
Purchase of investment securities available for sale (424,870) (344,980) (221,947)
Net purchase of restricted investment in bank stocks (3,224) (3,155) (736)
Net (increase) decrease in loans (25,880) (42,723) (12,271)
Purchase of bank owned life insurance (4,400) - -
Investments in low income housing partnerships (2,944) (1,025) (966)
Capital expenditures (5,784) (675) (2,109)
Proceeds from sale of other real estate owned 181 699 1,140
------------- ------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (64,635) (130,592) (102,216)
------------- ------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, interest-bearing deposits, and savings 6,116 63,507 73,770
accounts
Net increase (decrease) in time certificates of deposit 1,368 (6,734) 1,684
Net increase (decrease) in short-term borrowings (4,710) 13,231 4,944
Dividends paid (4,892) (4,838) (5,871)
Proceeds from long-term borrowings 45,000 67,000 20,000
------------- ------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 42,882 132,166 94,527
------------- ------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (10,719) 14,316 (2,827)
CASH AND CASH EQUIVALENTS - BEGINNING 33,414 19,098 21,925
------------- ------------- --------------
CASH AND CASH EQUIVALENTS - ENDING $ 22,695 $ 33,414 $ 19,098
============= ============= ==============
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES
Net income $ 9,308 $ 10,768 $ 8,904
Adjustments to reconcile net income to net cash provided by operating
activities:
Gains on sales of loans (113) (337) (292)
Earnings on investment in bank owned life insurance (683) (722) (572)
Gains on sales of securities (1,113) (1,992) -
Depreciation and amortization 845 804 631
Provision for loan losses 300 265 370
(Benefit) expense for deferred taxes 350 146 (349)
Amortization of investment securities premiums 2,614 3,240 795
(Increase) decrease in interest receivable 334 538 759
Increase (decrease) in interest payable 119 (472) (545)
(Increase) decrease in mortgage loans held for sale (312) 2,795 (1,212)
(Increase) decrease in other assets (1,406) (1,312) (3,806)
Increase (decrease) in other liabilities 791 (979) 179
------------- ------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $11,034 $12,742 $4,862
============= ============= ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
37
ACNB CORPORATION
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
ACNB Corporation provides banking and financial services to businesses and
consumers through its wholly-owned banking subsidiary, Adams County
National Bank. The Corporation engages in full-service commercial and
consumer banking and trust services through its nineteen locations in
Adams, Cumberland and York counties.
The Corporation, along with seven other banks, entered into a joint venture
to form Pennbanks Insurance Company, an offshore reinsurance company. Each
participating entity owns an insurance cell through which its premiums and
losses from credit life, health and accident insurance are funded. Each
entity is responsible for the activity in its respective cell. The
financial activity for the insurance cell has been reported in the
consolidated financial statements and is not material to the consolidated
financial statements.
The Corporation's primary source of revenue is interest income on loans and
investment securities and fee income on its products and services. Expenses
consist of interest expense on deposits and borrowed funds, provisions for
loan losses, and other operating expenses.
BASIS OF FINANCIAL STATEMENTS
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and include the accounts of the
Corporation and its wholly-owned subsidiaries. All significant
inter-company transactions have been eliminated.
Financial statements prepared in accordance with accounting principles
generally accepted in the United States of America require management to
make estimates and assumptions that affect the reported amounts and
disclosures of contingencies. Actual results could differ from these
estimates. Material estimates that are particularly susceptible to
significant change in the near term relate to the determination of the
allowance for loan losses, fair value disclosures, the valuation of
deferred tax assets, and the evaluation of other than temporary impairment
of securities.
Assets held by the Trust Department in an agency or fiduciary capacity for
its customers are excluded from the financial statements since they do not
constitute assets of the Corporation. Assets held by the Trust Department
amounted to $74,000,000 and $64,000,000 at December 31, 2004 and 2003,
respectively. Income from fiduciary activities is recognized on the cash
method, which approximates the accrual method.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Corporation's activities are with customers located within
south central Pennsylvania and northern Maryland. Note C discusses the
types of securities that the Corporation invests in. Note D discusses the
types of lending that the Corporation engages in. The Corporation does not
have any significant concentrations greater than 10% of loans to any one
industry or customer.
RECLASSIFICATIONS
For comparative purposes, prior years' consolidated financial statements
have been reclassified to conform with the 2004 presentation. Such
reclassifications had no impact on net income.
38
ACNB CORPORATION
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash on hand, balances due from banks, and federal
funds sold, all of which mature within ninety days.
SECURITIES
Debt securities that management has the positive intent and ability to hold
to maturity are classified as "held to maturity" and recorded at amortized
cost. Securities not classified as held to maturity or trading, including
equity securities with readily determinable fair values, are classified as
"available for sale" and recorded at fair value, with unrealized gains and
losses excluded from earnings and reported, net of tax, in other
comprehensive income.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair
value of held to maturity and available for sale securities below their
cost that are deemed to be other than temporary are reflected in earnings
as realized losses. In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the
Corporation to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. Gains and
losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.
RESTRICTED INVESTMENT IN BANK STOCKS
Restricted investment in bank stocks includes Federal Reserve, Atlantic
Central Bankers Bank and Federal Home Loan Bank (FHLB) stocks. Federal law
requires a member institution of the FHLB to hold stock of its district
FHLB according to a predetermined formula. The stock is carried at cost.
LOANS HELD FOR SALE
Loans originated and intended for sale in the secondary market are carried
at the lower of aggregate cost or fair value, as determined by aggregate
outstanding commitments from investors or current investor yield
requirements. Net unrealized losses are recognized through a valuation
allowance by charges to income.
Mortgage loans held for sale are sold with the mortgage servicing rights
released to another financial institution through a correspondent
relationship. The correspondent financial institution absorbs all of the
risk related to rate lock commitments. Gains or losses on sales of mortgage
loans are recognized based on the difference between the selling price and
the carrying value of the related mortgage loans sold.
LOANS
The Corporation grants mortgage, commercial and consumer loans to
customers. A substantial portion of the loan portfolio is represented by
mortgage loans throughout south central Pennsylvania and northern Maryland.
The ability of the Corporation's debtors to honor their contracts is
dependent upon the real estate and general economic conditions in this
area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are reported at
their outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain direct origination costs, are deferred and
recognized as an adjustment of the related loan yield using the interest
method.
39
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS (CONTINUED)
The accrual of interest on mortgage and commercial loans is discontinued at
the time the loan is 90 days past due unless the credit is well-secured and
in process of collection. Personal loans are typically charged off no later
than 120 days past due. Past due status is based on contractual terms of
the loan. In all cases, loans are placed on non-accrual or charged-off at
an earlier date if collection of principal or interest is considered
doubtful.
All interest accrued but not collected for loans that are placed on
non-accrual or charged off is reversed against interest income. The
interest on these loans is accounted for on the cash-basis or cost-recovery
method, until qualifying for return to accrual. Loans are returned to
accrual status when all the principal and interest amounts contractually
due are brought current and future payments are reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower
than the carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience adjusted
for qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses.
The unallocated component of the allowance reflects the margin of
imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management
in determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management determines
the significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances surrounding the
loan and the borrower, including the length of the delay, the reasons for
the delay, the borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans by
either the present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent.
40
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Corporation does not separately
identify individual consumer and residential loans for impairment
disclosures, unless such loans are the subject of a restructuring
agreement.
OFF-BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS
In the ordinary course of business, the Corporation has entered into
commitments to extend credit, including commitments under commercial lines
of credit, and standby letters of credit. Such financial instruments are
recorded when they are funded.
FORECLOSED ASSETS
Assets acquired through, or in lieu of, loan foreclosure are held for sale
and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the
lower of carrying amount or fair value less cost to sell. Revenue and
expenses from operations and changes in the valuation allowance are
included in net expenses from foreclosed assets. Foreclosed real estate
totaled $213,000 and $394,000 at December 31, 2004 and 2003, respectively,
and was included in other assets.
PREMISES AND EQUIPMENT
Land is carried at cost. Bank premises and furniture and equipment are
carried at cost, less accumulated depreciation computed principally by the
straight-line method over the assets' estimated useful lives.
INVESTMENTS IN LOW INCOME HOUSING PARTNERSHIPS
The Corporation's investments in low income housing partnerships are
accounted for using the "cost method" prescribed by Emerging Issues Task
Force (EITF) No. 94-1. In accordance with EITF 94-1, tax credits are
recognized as they become available. Any residual loss is amortized as the
tax credits are received.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when (1) the assets have been isolated from the
Corporation, (2) the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the
transferred assets, and (3) the Corporation does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity.
INCOME TAXES
Deferred income tax assets and liabilities are determined using the
liability method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary
differences between the book and tax bases of the various balance sheet
assets and liabilities and gives current recognition to changes in tax
rates and laws.
RETIREMENT PLAN
The compensation cost of an employee's pension benefit is recognized on the
projected unit credit method over the employee's approximate service
period. The aggregate cost method is utilized for funding purposes.
41
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
The Corporation has a simple capital structure. Basic earnings per share of
common stock is computed based on 5,436,101 weighted average shares of
common stock outstanding for all years presented.
ADVERTISING COSTS
Costs of advertising are expensed when incurred. Advertising expense was
$284,000, $369,000 and $312,000 for the years ended December 31, 2004, 2003
and 2002, respectively.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Changes in certain assets and
liabilities, such as unrealized gains (losses) on securities available for
sale and the minimum pension liability, are reported as a separate
component of the stockholders' equity section of the balance sheet. Such
items, along with net income, are components of comprehensive income.
The components of other comprehensive income (loss) and the related tax
effects are as follows:
YEARS ENDED DECEMBER 31,
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Unrealized holding gains (losses) arising during the period $(2,279) $(3,618) $5,100
Reclassification adjustment for gains realized in net income 1,113 1,992 -
------------ ------------ ------------
Net Unrealized Gains (Losses) (3,392) (5,610) 5,100
Tax effect 1,187 1,963 (1,785)
------------ ------------ ------------
(2,205) (3,647) 3,315
------------ ------------ ------------
Change in minimum pension liability (660) - -
Tax effect 227 - -
------------ ------------ ------------
(433) - -
------------ ------------ ------------
NET OF TAX AMOUNT $(2,638) $(3,647) $3,315
============ ============ ============
The December 31 balances of accumulated other comprehensive income (loss) are as
follows:
MINIMUM
UNREALIZED PENSION ACCUMULATED OTHER
GAINS (LOSSES) LIABILITY COMPREHENSIVE
ON SECURITIES ADJUSTMENT INCOME (LOSS)
---------------- --------------- ---------------
IN THOUSANDS
BALANCE, DECEMBER 31, 2003 $ 442 $ - $ 442
Change during 2004 (2,205) (433) (2,638)
---------------- --------------- ---------------
BALANCE, DECEMBER 31, 2004 $(1,763) $(433) $(2,196)
================ =============== ===============
42
NEW ACCOUNTING STANDARDS
SAB 105
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105
provides guidance about the measurements of loan commitments recognized at
fair value under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SAB 105 also requires companies to
disclose their accounting policy for those loan commitments including
methods and assumptions used to estimate fair value and associated hedging
strategies. SAB 105 is effective for all loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The adoption of SAB
105 did not have any impact on our consolidated financial statements.
SOP 03-3
In December 2003, the Accounting Standards Executive Committee issued
Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or
Debt Securities Acquired in a Transfer." SOP 03-3 addresses accounting for
differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer, including business combinations, if those
differences are attributable, at least in part, to credit quality. SOP 03-3
is effective for loans or debt securities acquired in fiscal years
beginning after December 15, 2004. The Corporation adopted the provisions
of SOP 03-3 effective January 1, 2005, and the initial implementation did
not have any impact on the Corporation's consolidated financial statements.
NOTE B - RESTRICTIONS ON CASH AND DUE FROM BANKS
In return for services obtained through correspondent banks, the Corporation is
required to maintain non-interest bearing cash balances in those correspondent
banks. At December 31, 2004 and 2003, compensating balances approximated
$14,507,000 and $15,797,000, respectively. During 2004, 2003 and 2002, average
required balances approximated $14,300,000, $13,145,000 and $11,613,000,
respectively.
43
NOTE C - SECURITIES
Amortized cost and fair value at December 31, 2004 and 2003 were as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR
AMORTIZED COST GAINS LOSSES VALUE
---------------- --------------- ---------------- ----------------
IN THOUSANDS
SECURITIES AVAILABLE FOR SALE:
DECEMBER 31, 2004:
U.S. Government and agencies $158,912 $ 77 $1,179 $157,810
Mortgage-backed securities 119,217 270 1,487 118,000
State and municipal 22,916 87 75 22,928
Corporate bonds 82,550 18 497 82,071
Stock in other banks 500 74 - 574
---------------- --------------- ---------------- ----------------
$384,095 $526 $3,238 $381,383
=============== ================ ================ ===============
DECEMBER 31, 2003:
U.S. Government and agencies $ 40,000 $ 32 $ 196 $ 39,836
Mortgage-backed securities 176,467 1,180 1,586 176,061
State and municipal 22,922 355 6 23,271
Corporate bonds 105,500 957 56 106,401
Stock in other banks 500 - - 500
--------------- ---------------- ---------------- ---------------
$345,389 $2,524 $1,844 $346,069
=============== ================ ================ ===============
SECURITIES HELD TO MATURITY:
DECEMBER 31, 2004:
U.S. Government and agencies $10,000 $735 $ - $10,735
Mortgage-backed securities 14,206 - 206 14,000
State and municipal 354 - - 354
--------------- ---------------- ---------------- ---------------
$24,560 $735 $206 $25,089
=============== ================ ================ ===============
DECEMBER 31, 2003:
U.S. Government and agencies $15,535 $1,265 $ - $16,800
Mortgage-backed securities 26,201 - 372 25,829
State and municipal 447 - - 447
--------------- ---------------- ---------------- ---------------
$42,183 $1,265 $372 $43,076
=============== ================ ================ ===============
44
NOTE C - SECURITIES (CONTINUED)
The following table shows the Corporation's investments' gross unrealized losses
and fair value, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, at
December 31, 2004:
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
---------------------------- ---------------------------- -----------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------------ ------------ ------------ ------------- ------------- ------------
IN THOUSANDS
SECURITIES AVAILABLE FOR SALE:
U.S. Government and
agencies $78,821 $1,179 $ - $ - $ 78,821 $1,179
Mortgage-backed
securities 55,744 439 39,068 1,048 94,812 1,487
State and municipal 5,921 25 2,572 50 8,493 75
Corporate bonds 68,992 497 - - 68,992 497
------------ ------------ ------------ ------------- ------------- ------------
$209,478 $2,140 $41,640 $1,098 $251,118 $3,238
============ ============ ============ ============= ============= ============
SECURITIES HELD TO MATURITY:
Mortgage-backed securities $ - $ - $14,000 $206 $14,000 $206
============ ============ ============ ============= ============= ============
At December 31, 2004, 11 mortgage-backed and 4 U.S. Government and agency
securities have unrealized losses, and only 3 of the securities have been in a
continuous loss position for 12 months or more. These unrealized losses relate
principally to changes in interest rates subsequent to the acquisition of
specific securities. None of the securities in this category had an unrealized
loss that exceeded 4% of book value and a majority had unrealized losses
totaling less than 1% of book value.
At December 31, 2004, 15 state and municipal securities and 13 corporate bonds
have unrealized losses, and only 2 of the securities have been in a continuous
loss position for 12 months or more. In analyzing the issuer's financial
condition, management considers industry analysts' reports, financial
performance and projected target prices of investment analysts within a one-year
time frame. None of the securities in this category had an unrealized loss that
exceeded 2% of book value and a majority had unrealized losses totaling less
than 1% of book value.
Management routinely sells securities from its available for sale portfolio in
an effort to manage and allocate the portfolio. At December 31, 2004, management
had not identified any securities with an unrealized loss that it intends to
sell. As management has the ability to hold debt securities until maturity, or
for the foreseeable future if classified as available for sale, no declines are
deemed to be other-than-temporary.
45
NOTE C - SECURITIES (CONTINUED)
Amortized cost and fair value at December 31, 2004 by contractual maturity are
shown below. Expected maturities will differ from contractual maturities because
issuers may have the right to call or prepay with or without penalties.
AVAILABLE FOR SALE HELD TO MATURITY
----------------------------------- ------------------------------------
FAIR AMORTIZED COST FAIR
AMORTIZED COST VALUE VALUE
--------------- ---------------- ---------------- ---------------
IN THOUSANDS
1 year or less $ 10,178 $ 10,126 $ - $ -
Over 1 year through 5 years 117,372 116,253 10,354 11,089
Over 5 years through 10 years 94,911 94,956 - -
Over 10 years 41,917 41,474 - -
Mortgage-backed securities 119,217 118,000 14,206 14,000
Equity securities 500 574 - -
--------------- ---------------- ---------------- ---------------
$384,095 $381,383 $24,560 $25,089
=============== ================ ================ ===============
The Corporation realized gross gains of $2,019,000 during 2004 and $2,694,000
during 2003 and gross losses of $906,000 during 2004 and $702,000 during 2003 on
sales of securities available for sale. During 2002, the Corporation did not
realize any gross gains or losses on securities available for sale.
At December 31, 2004 and 2003, securities with a carrying value of $94,122,000
and $130,424,000, respectively, were pledged as collateral as required by law on
public and trust deposits, repurchase agreements and for other purposes.
NOTE D - LOANS
Loans at December 31, 2004 and 2003 were as follows:
2004 2003
--------------- ---------------
IN THOUSANDS
Commercial, financial and agricultural $ 31,187 $ 18,080
Real estate:
Commercial 99,988 100,536
Construction 20,232 22,298
Residential 278,140 262,446
Installment 10,643 11,222
--------------- ---------------
TOTAL LOANS 440,190 414,582
Deferred loan fees and costs, net 379 447
Allowance for loan losses (3,938) (3,978)
--------------- ---------------
NET LOANS $436,631 $411,051
=============== ===============
46
NOTE D - LOANS (CONTINUED)
The Bank grants commercial, residential and consumer loans to customers
primarily within south central Pennsylvania and northern Maryland and the
surrounding area. A large portion of the loan portfolio is secured by real
estate. Although the Bank has a diversified loan portfolio, its debtors' ability
to honor their contracts is influenced by the region's economy.
Changes in the allowance for loan losses were as follows:
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Balance, beginning $3,978 $3,837 $3,723
Provision charged to operations 300 265 370
Recoveries on charged off loans 50 45 80
Loans charged off (390) (169) (336)
------------ ------------ ------------
Balance, ending $3,938 $3,978 $3,837
============ ============ ============
Nonaccrual loans totaled $8,054,000 and $4,413,000 at December 31, 2004 and
2003, respectively. Loans past due 90 days or more and still accruing totaled
$160,000 and $606,000 at December 31, 2004 and 2003, respectively. If interest
on all nonaccrual loans had been accrued at original contract rates, it is
estimated interest income would have been higher by $384,000 in 2004, $82,000 in
2003, and $55,000 in 2002.
The following is a summary of information pertaining to impaired loans:
DECEMBER 31,
-------------------------------------
2004 2003
---------------- ----------------
IN THOUSANDS
Impaired loans with a valuation allowance $7,539 $ 200
=============== ===============
Valuation allowance related to impaired loans $ 619 $ 20
=============== ===============
YEARS ENDED DECEMBER 31,
------------------------------------------------
2004 2003 2002
------------ ------------- ------------
IN THOUSANDS
Average investment in impaired loans $5,085 $200 $ -
============ ============ ============
Interest income recognized using a cash basis method on $ 331 $ - $ -
impaired loans
============ ============ ============
Interest income recognized on impaired loans $ - $ - $ -
============ ============ ============
There were no impaired loans without a related valuation allowance. The increase
in nonaccrual and impaired loans during 2004 is related to 3 commercial loan
relationships. Payments on these loans were current as of December 31, 2004,
however, cash flows reported to the Bank by each of the related companies are
not sufficient to service the debt. As a result, the loans have been classified
as impaired. The loans were also classified as nonaccrual as a result of a
banking regulatory requirement to stop accruing interest on loans for which full
payment of principal and interest is not expected. All three of the loans are
collateralized by real estate.
No additional funds are committed to be advanced in connection with impaired
loans.
47
NOTE E - PREMISES AND EQUIPMENT
Premises and equipment at December 31 were as follows:
2004 2003
--------------- ---------------
IN THOUSANDS
Land $ 1,384 $ 1,343
Buildings and improvements 7,659 7,278
Furniture and equipment 5,735 6,427
Construction in process 5,541 329
--------------- ---------------
20,319 15,377
Accumulated depreciation (8,327) (8,324)
--------------- ---------------
$11,992 $ 7,053
=============== ===============
The increase in construction in process is primarily related to the
Corporation's new operations center, which is scheduled to be completed during
2005. The Corporation anticipates incurring an additional $2.8 million related
to the operations center.
NOTE F - INVESTMENTS IN LOW INCOME HOUSING PARTNERSHIPS
ACNB Corporation is a limited partner in five partnerships, whose purpose is to
develop, manage and operate residential low-income properties. At December 31,
2004 and 2003, the carrying value of these investments was approximately
$6,153,000 and $3,371,000, respectively.
NOTE G - DEPOSITS
Deposits were comprised of the following as of December 31:
2004 2003
--------------- ---------------
IN THOUSANDS
Non-interest bearing demand $ 74,667 $ 75,819
Interest bearing demand 113,259 101,560
Savings 235,127 239,558
Time certificates of deposit less than $100,000 187,819 187,448
Time certificates of deposit greater than $100,000 36,000 35,003
--------------- ---------------
$646,872 $639,388
=============== ===============
48
NOTE G - DEPOSITS (CONTINUED)
Scheduled maturities of time certificates of deposit at December 31, 2004 were
as follows:
IN THOUSANDS
2005 $126,780
2006 38,029
2007 30,072
2008 19,759
2009 9,179
---------------
$223,819
===============
NOTE H - LEASE COMMITMENTS
Certain branch offices and equipment are leased under agreements which expire at
varying dates through 2011. Most leases contain renewal provisions at the
Corporation's option. The total rental expense for all operating leases was
$504,000, $200,000 and $192,000 for the years ended December 31, 2004, 2003 and
2002, respectively.
The following is a schedule by years of future minimum rental payments required
under operating leases that have initial or remaining non-cancelable lease terms
in excess of one year as of December 31:
IN THOUSANDS
2005 $465
2006 322
2007 201
2008 117
2009 100
Later years 104
---------------
$1,309
===============
NOTE I - BORROWINGS
Short-term borrowings and weighted-average interest rates at December 31 are as
follows:
2004 2003
------------------------------- --------------------------------
AMOUNT RATE AMOUNT RATE
--------------- ------------ ---------------- ------------
IN THOUSANDS
Treasury tax and loan note $ 450 2.10% $ 450 0.89%
Federal Home Loan Bank (FHLB)
overnight advance 30,706 2.21 29,320 1.22
Securities sold under repurchase
agreements 33,810 1.51 39,906 1.48
--------------- ------------ ---------------- ------------
$64,966 1.84% $69,676 1.37%
=============== ============ ================ ============
49
NOTE I - BORROWINGS (CONTINUED)
Under an agreement with the FHLB, the Bank has a line of credit available in the
amount of $65,000,000, of which $30,706,000 was outstanding at December 31,
2004. All FHLB advances are collateralized by a security agreement covering
qualifying loans and unpledged treasury, agency and mortgage-backed securities.
In addition, all FHLB advances are secured by the FHLB capital stock owned by
the Corporation having a par value of $9,951,000 at December 31, 2004 and
$6,727,000 at December 31, 2003.
The Corporation offers a short-term investment program for corporate customers
for secured investing. This program consists of overnight and short-term
repurchase agreements that are secured by designated investment securities of
the Corporation. The investment securities are under the control of the
Corporation.
A summary of long-term debt as of December 31 is as follows:
2004 2003
------------------------------- -------------------------------
AMOUNT RATE AMOUNT RATE
--------------- ------------ ---------------- ------------
IN THOUSANDS
FHLB fixed-rate advances maturing:
2005 $ 57,000 1.83% $57,000 1.83%
2006 55,000 2.91 10,000 2.32
2012 10,000 4.41 10,000 4.41
FHLB convertible advance maturing:
2012 10,000 4.27 10,000 4.27
--------------- ------------ ---------------- ------------
$132,000 2.66% $87,000 2.47%
=============== ============ ================ ============
The FHLB advances are collateralized by the security agreement and FHLB capital
stock described previously. The Corporation can borrow a maximum of $450,136,000
from the FHLB, of which $287,430,000 was available at December 31, 2004. The
FHLB has the option to convert the $10,000,000 convertible advance commencing
after August 2004 but not before three-month LIBOR reaches 8%. Upon the FHLB's
conversion, the Bank has the option to repay the respective advance in full.
NOTE J - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS AND ADVANCES
Certain restrictions exist regarding the ability of the bank to transfer funds
to the Corporation in the form of cash dividends, loans or advances. The
approval of the Office of the Comptroller of the Currency is required to pay
dividends in excess of earnings retained in the current year plus retained net
profits for the preceding two years. As of December 31, 2004, $7,355,000 of
undistributed earnings of the bank, included in consolidated retained earnings,
was available for distribution to the Corporation as dividends without prior
regulatory approval. Additionally, dividends paid by the Bank to the Corporation
would be prohibited if the effect thereof would cause the Bank's capital to be
reduced below applicable minimum capital requirements.
Under national banking laws, the Bank is also limited as to the amount it may
loan to its affiliates, including the Corporation, unless such loans are
collateralized by specific obligations. At December 31, 2004, the maximum amount
available for transfer from the Bank to the Corporation in the form of loans was
approximately $7,151,000.
50
NOTE K - INCOME TAXES
The components of income tax expense for the years ended December 31, 2004, 2003
and 2002 are as follows:
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Federal:
Current $1,905 $2,996 $3,456
Deferred 350 146 (349)
------------ ------------ ------------
$2,255 $3,142 $3,107
============ ============ ============
Reconciliations of the statutory federal income tax at a rate of 35% to the
income tax expense reported in the consolidated statements of income for the
years ended December 31, 2004, 2003 and 2002 are as follows:
PERCENTAGE OF INCOME
BEFORE INCOME TAXES
-----------------------------------------------
2004 2003 2002
------------ ------------ ------------
Federal income tax at statutory rate 35.0% 35.0% 35.0%
Tax-exempt income (3.2) (2.2) (1.3)
Earnings on investment in life insurance (2.0) (1.8) (1.7)
Gain on proceeds from life insurance - (5.4) -
Rehabilitation and low-income housing credits (9.9) (2.4) (5.6)
Other (0.4) (0.6) (0.5)
------------ ------------ ------------
19.5% 22.6% 25.9%
============ ============ ============
The provision for federal income taxes includes $390,000 and $697,000 of income
taxes related to net gains on sales of securities in 2004 and 2003,
respectively. There were no sales of securities during 2002. Rehabilitation and
low-income housing Income tax credits were $1,139,000 during 2004, $337,000 for
2003, and $672,000 for 2002. Projected credits are $708,000 in 2005, $608,000 in
2006 to 2009, and $2,111,000 thereafter.
Components of deferred tax assets and liabilities at December 31 were as
follows:
2004 2003
--------------- ---------------
IN THOUSANDS
Deferred tax assets:
Allowance for loan losses $1,351 $1,370
Available for sale securities 949 -
Accrued deferred compensation 346 336
Additional minimum pension liability 227 -
Deferred loan fees 129 154
AMT credit carryforward 215 -
Other 158 147
--------------- ---------------
3,375 2,007
--------------- ---------------
51
NOTE K - INCOME TAXES (CONTINUED)
2004 2003
--------------- ---------------
IN THOUSANDS
Deferred tax liabilities:
Accumulated depreciation $ 141 $ 131
Available for sale securities - 238
Prepaid benefit cost 268 -
Prepaid expenses 264 -
--------------- ---------------
673 369
--------------- ---------------
NET DEFERRED TAX ASSETS $2,702 $1,638
=============== ===============
NOTE L - RETIREMENT PLANS
The Corporation's banking subsidiary has a non-contributory pension plan.
Retirement benefits are a function of both years of service and compensation.
The funding policy is to contribute annually the amount that is sufficient to
meet the minimum funding requirements set forth in the Employee Retirement
Income Security Act.
Information pertaining to the activity in the plan, using a measurement date of
November 1, 2004 is as follows:
2004 2003
--------------- ---------------
IN THOUSANDS
Change in benefit obligation:
Benefit obligation, at beginning of year $13,308 $11,550
Service cost 436 356
Interest cost 783 735
Actuarial loss 1,240 1,150
Benefits paid (471) (483)
--------------- ---------------
Benefit obligation, at end of year 15,296 13,308
--------------- ---------------
Change in plan assets:
Fair value of plan assets at beginning of year 10,649 8,679
Actual return on plan assets 758 1,299
Employer contribution 1,250 1,154
Benefits paid (471) (483)
--------------- ---------------
Fair value of plan assets at end of year 12,186 10,649
--------------- ---------------
FUNDED STATUS (3,110) (2,659)
Unrecognized net actuarial loss 3,373 2,225
Unrecognized transition asset 95 107
Unrecognized prior service costs 429 478
--------------- ---------------
PREPAID BENEFIT COST 787 151
Recognition of additional minimum liability (1,183) (540)
--------------- ---------------
NET ACCRUED PENSION LIABILITY $ (396) $ (389)
=============== ===============
52
NOTE L - RETIREMENT PLANS (CONTINUED)
The accumulated benefit obligation totaled $12,582,000 and $11,038,000 at
December 31, 2004 and 2003, respectively. The intangible pension asset totaled
$523,000 and $540,000 at December 31, 2004 and 2003, respectively.
The components of net periodic benefit cost for the years ended December 31 are
as follows:
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Components of net periodic benefit cost:
Service cost $436 $356 $424
Interest cost 783 735 702
Expected return on assets (740) (656) (689)
Recognized net actuarial loss 74 47 74
Amortization of transition asset 12 12 -
Amortization of prior service costs 49 73 67
------------ ------------ ------------
NET PERIODIC BENEFIT COST $614 $567 $578
============ ============ ============
For the years ended December 31, 2004, 2003 and 2002, the assumptions used to
determine the net periodic benefit cost are as follows:
2004 2003 2002
------------ ------------ ------------
Discount rate 5.50% 6.00% 6.50%
Expected long-term rate of return on plan assets 7.50% 7.25% 7.75%
Annual salary increase 4.69% 4.66% 4.62%
The Corporation's pension plan weighted-average assets' allocations at December
31, 2004 and 2003 are as follows:
2004 2003
------------ ------------
Equity securities 60% 63%
Debt securities 34 32
Real estate 6 5
------------ ------------
100% 100%
============ ============
Equity securities included Corporation common stock in amounts of $939,000, 8%
of total plan assets and $962,000, 9% of total plan assets at December 31, 2004
and 2003, respectively.
The Bank expects to contribute $1,250,000 to its pension plan in 2005.
53
NOTE L - RETIREMENT PLANS (CONTINUED)
Based on current data and assumptions, the following benefit payments, which
reflect expected future service, as appropriate, are expected to be paid over
the next ten fiscal years:
IN THOUSANDS
2005 $ 597
2006 667
2007 673
2008 696
2009 826
2010-2014 5,110
The Corporation's banking subsidiary maintains a 401(k) plan for the benefit of
eligible employees. Employees may contribute up to 100% of their compensation
subject to certain limits based on federal tax laws. The Bank makes matching
contributions up to 100% of the first 4% of an employee's compensation
contributed to the plan. Matching contributions vest to the employee equally
over a 5 year period. Bank contributions to the Plan were $276,000, $251,000 and
$240,000 for 2004, 2003 and 2002, respectively.
The Corporation's banking subsidiary maintains non-qualified compensation plans
for selected senior officers. The estimated present value of future benefits is
accrued over the period from the effective date of the agreements until the
expected retirement dates of the individuals. The balance accrued for these
plans included in other liabilities as of December 31, 2004 and 2003 totaled
$991,000 and $943,000, respectively. The annual expense included in salaries and
benefits expense totaled $143,000, $116,000 and $86,000 during the years ended
December 31, 2004, 2003 and 2002, respectively. To fund the benefits under these
plans, the Bank is the owner of single premium life insurance policies on
participants in the non-qualified retirement plans. At December 31, 2004 and
2003, the cash surrender value of these policies were $3,380,000 and $3,776,000,
respectively.
NOTE M - REGULATORY MATTERS
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet the
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Corporation and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk-weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth below) of Tier 1 capital to average assets and of Tier 1 and total capital
(as defined in the regulations) to risk-weighted assets. Management believes, as
of December 31, 2004, that the Corporation and the Bank meet all capital
adequacy requirements to which they are subject.
54
NOTE M - REGULATORY MATTERS (CONTINUED)
As of December 31, 2004, the most recent notification from the regulators
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Bank's category.
The actual and required capital amounts and ratios were as follows:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
-------------------- ----------------------- ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ------- --------- ------- --------- -------
DOLLARS IN THOUSANDS
CORPORATION:
AS OF DECEMBER 31, 2004:
Tier 1 leverage ratio (to average
assets) $74,521 8.34% $=>35,656 =>4.0 % N/A N/A
Tier 1 risk-based capital ratio (to
risk-0weighted assets) 74,521 13.91 =>21,429 =>4.0 N/A N/A
Total risk-based capital ratio (to
risk-weighted assets) 78,459 14.64 =>42,874 =>8.0 N/A N/A
AS OF DECEMBER 31, 2003:
Tier 1 leverage ratio (to average
assets) 72,391 8.85% $=>32,719 =>4.0 % N/A N/A
Tier 1 risk-based capital ratio (to
risk-weighted assets) 72,391 13.93 =>20,787 =>4.0 N/A N/A
Total risk-based capital ratio (to
risk-weighted assets) 76,369 14.70 =>41,561 =>8.0 N/A N/A
BANK:
AS OF DECEMBER 31, 2004:
Tier 1 leverage ratio (to average
assets) 67,598 7.35% $=>36,788 =>4.0 % $=>45,985 => 5.0%
Tier 1 risk-based capital ratio (to
risk-weighted assets) 67,598 12.77 =>21,174 =>4.0 =>31,736 => 6.0
Total risk-based capital ratio (to
risk-weighted assets) 71,506 13.52 =>42,311 =>8.0 =>52,889 =>10.0
AS OF DECEMBER 31, 2003:
Tier 1 leverage ratio (to average
assets) 66,091 7.70% $=>34,333 =>4.0 % $=>42,916 => 5.0%
Tier 1 risk-based capital ratio (to
risk-weighted assets) 66,091 12.82 =>20,621 =>4.0 =>30,932 => 6.0
Total risk-based capital ratio (to
risk-weighted assets) 70,069 13.60 =>41,217 =>8.0 =>51,521 =>10.0
55
NOTE N - FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK
The Corporation is a 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 consist primarily of commitments to extend credit
(typically mortgages and commercial loans) and, to a lesser extent, standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized on the balance
sheet.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Corporation uses the same credit policies in making commitments
and conditional obligations as it does for on balance sheet instruments. The
Corporation does not anticipate any material losses from these commitments.
Commitments to extend credit, including commitments to grant loans and unfunded
commitments under lines of credit, are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Corporation evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Corporation upon extensions of credit, is based on
management's credit evaluation of the customer. Collateral held varies but may
include accounts receivable, inventory, property and equipment and
income-producing commercial properties. On loans secured by real estate, the
Corporation generally requires loan to value ratios of no greater than 80%.
Standby letters of credit are conditional commitments issued by the Corporation
to guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements and
similar transactions. The terms of the letters of credit vary and may have
renewal features. The credit risk involved in using letters of credit is
essentially the same as that involved in extending loans to customers. The
Corporation holds collateral supporting those commitments for which collateral
is deemed necessary. Management believes that the proceeds obtained through a
liquidation of such collateral would be sufficient to cover the maximum
potential amount of future payments required under the corresponding guarantees.
The current amount of the liability as of December 31, 2004 and 2003 for
guarantees under standby letters of credit issued is not material.
The Corporation has not been required to perform on any financial guarantees,
and has not incurred any losses on its commitments, during the past two years.
A summary of the Corporation's commitments at December 31 were as follows:
2004 2003
--------- --------
IN THOUSANDS
Commitments to extend credit $73,268 $68,654
Standby letters of credit 5,732 5,915
56
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS
Management uses its best judgment in estimating the fair value of the
Corporation's financial instruments; however, there are inherent weaknesses in
any estimation technique. Therefore, for substantially all financial
instruments, the fair value estimates herein are not necessarily indicative of
the amounts the Corporation could have realized in a sales transaction on the
dates indicated. The estimated fair value amounts have been measured as of their
respective year ends and have not been re-evaluated or updated for purposes of
these consolidated financial statements subsequent to those respective dates. As
such, the estimated fair values of these financial instruments subsequent to the
respective reporting dates may be different than the amounts reported at each
year end.
The following information should not be interpreted as an estimate of the fair
value of the entire Corporation since a fair value calculation is only provided
for a limited portion of the Corporation's assets and liabilities. Due to a wide
range of valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between the Corporation's disclosures and those of other
companies may not be meaningful. For the following financial instruments, the
carrying amount is a reasonable estimate of fair value:
Cash and cash equivalents Interest-bearing deposits in banks
Accrued interest receivable
Restricted investment in bank stocks Short-term borrowings
Accrued interest payable
SECURITIES
Fair values for securities are based on quoted market prices, where
available. If quoted market prices are not available, fair value is based
on quoted market prices of comparable securities.
MORTGAGE LOANS HELD FOR SALE
Fair values of mortgage loans held for sale are based on commitments on
hand from investors or prevailing market prices.
LOANS
For variable rate loans that reprice frequently and which entail no
significant changes in credit risk, the carrying amount is a reasonable
estimate of fair value. For fixed rate loans, fair value is estimated using
discounted cash flow analysis, at interest rates currently offered for
loans with similar terms to borrowers of similar credit quality.
DEPOSITS
For demand deposits, the carrying amount is a reasonable estimate of fair
value. For time deposits, fair value is estimated using discounted cash
flow analysis, at interest rates currently offered for time deposits with
similar maturities.
57
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
SHORT-TERM BORROWINGS
The carrying amounts of federal funds purchased, borrowings under
repurchase agreements, and other short-term borrowings maturing within
ninety days approximate their fair values.
LONG-TERM BORROWINGS
The fair values of the Corporation's convertible fixed rate advances are
based on quoted market values. The fair values of the Corporation's other
fixed rate advances are estimated using discounted cash flow analyses based
on the Corporation's current incremental borrowing rates for similar types
of borrowing arrangements.
OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
Off-balance sheet instruments of the Bank consist of letters of credit,
loan commitments and unfunded lines of credit. Fair value is estimated
using fees currently charged for similar agreements, taking into account
the remaining terms of the agreements and the counterparties credit
standings. Any fees charged are immaterial.
Estimated fair values of financial instruments at December 31 were as follows:
2004 2003
---------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ---------- ----------- ----------
IN THOUSANDS
Financial assets:
Cash and due from banks $ 21,757 $ 21,757 $32,381 $32,381
Interest-bearing deposits in banks 938 938 1,033 1,033
Investment securities:
Available for sale 381,383 381,383 346,069 346,069
Held to maturity 24,560 25,089 42,183 43,076
Loans held for sale 511 511 86 86
Loans, less allowance for loan losses 436,631 433,345 411,051 415,195
Accrued interest receivable 4,283 4,283 4,617 4,617
Restricted investment in bank stocks 10,271 10,271 7,047 7,047
Financial liabilities:
Deposits 646,872 647,728 639,388 641,830
Short-term borrowings 64,966 64,966 69,676 69,676
Long-term borrowings 132,000 134,108 87,000 90,648
Accrued interest payable 2,277 2,277 2,158 2,158
Off-balance sheet financial instruments - - - -
58
NOTE P - CONTINGENCIES
The Corporation is subject to claims and lawsuits which arise primarily in the
ordinary course of business. Based on information presently available and advice
received from legal counsel representing the Corporation in connection with any
such claims and lawsuits, it is the opinion of management that the disposition
or ultimate determination of any such claims and lawsuits will not have a
material adverse effect on the consolidated financial position, consolidated
results of operations or liquidity of the Corporation.
NOTE Q - ACNB CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
STATEMENTS OF CONDITION
DECEMBER 31,
2004 2003
------------ ------------
IN THOUSANDS
ASSETS
Cash $ 475 $ 1,523
Investment in subsidiaries 66,252 67,125
Investments in low income housing partnerships 6,153 3,371
Securities and other assets 1,114 947
Receivable from banking subsidiary 935 185
------------ ------------
TOTAL ASSETS $74,929 $73,151
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 408 $ 408
Stockholders' equity 74,521 72,743
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $74,929 $73,151
============ ============
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
Dividends from banking subsidiary $6,592 $ 6,338 $6,871
Other dividends 31 5 -
------------ ------------ ------------
6,623 6,343 6,871
Expenses 384 213 112
------------ ------------ ------------
6,239 6,130 6,759
Income tax benefit 1,256 422 730
------------ ------------ ------------
7,495 6,552 7,489
Equity in undistributed earnings of subsidiaries 1,813 4,216 1,415
------------ ------------ ------------
NET INCOME $9,308 $10,768 $8,904
============ ============ ============
59
NOTE Q - ACNB CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
(CONTINUED)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------------
2004 2003 2002
------------ ------------ ------------
IN THOUSANDS
CASH FLOWS FROM OPERATING ACTIVITIES
Dividends and interest received $7,172 $ 7,996 $ 6,989
Payments to vendors (384) (213) (112)
------------ ------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 6,788 7,783 6,877
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in low income housing partnerships (2,944) (1,025) (966)
Purchase of securities - (500) -
------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (2,944) (1,525) (966)
------------ ------------ ------------
CASH FLOWS USED IN FINANCING ACTIVITIES
Dividends paid (4,892) (4,838) (5,871)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,048) 1,420 50
CASH AND CASH EQUIVALENTS - BEGINNING 1,523 103 53
------------ ------------ ------------
CASH AND CASH EQUIVALENTS - ENDING $ 475 $ 1,523 $ 103
============ ============ ============
RECONCILIATION OF NET INCOME OF NET CASH PROVIDED BY
OPERATING ACTIVITIES
Net income $ 9,308 $10,768 $ 8,904
Equity in undistributed earnings of subsidiaries (1,813) (4,216) (1,415)
(Increase) decrease in receivable from banking subsidiary (750) 1,034 (730)
Decrease in other assets 43 197 118
------------ ------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $6,788 $7,783 $6,877
============ ============ ============
NOTE R -SUBSEQUENT EVENT
On November 19, 2004, the Corporation, through its acquisition subsidiary,
entered into a definitive agreement to purchase Russell Insurance Group Inc.
Under the terms of the definitive agreement, the Corporation agreed to pay
$4,750,000 in cash to acquire Russell Insurance Group Inc. Additional
consideration of up to $2,882,000 is subject to performance criteria for payment
over the next three years. On January 5, 2005, the acquisition was completed. In
addition, the Corporation through its acquisition subsidiary has entered into a
three-year employment contract with Frank Russell, Jr., the President of Russell
Insurance Group Inc. The purchase price allocation has not been finalized.
60
QUARTERLY RESULTS OF OPERATIONS
Selected quarterly information for the years ended December 31, 2004 and 2003 is
as follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ ------------
IN THOUSANDS, EXCEPT PER SHARE DATA
2004
Interest income $8,938 $9,182 $10,004 $9,628
Interest expense 3,069 3,085 3,491 3,538
------------ ------------ ------------ ------------
Net interest income 5,869 6,097 6,513 6,090
Provision for loan losses 75 75 75 75
------------ ------------ ------------ ------------
Net income after provision for loan losses 5,794 6,022 6,438 6,015
Net gains (losses) on sales of securities 817 (46) 243 99
Other income 1,139 1,179 1,234 1,200
Other expenses 5,629 5,337 5,476 4,384
------------ ------------ ------------ ------------
Net income $2,121 $1,818 $2,439 $2,930
============ ============ ============ ============
Basic earnings per share $0.39 $0.33 $0.45 $0.54
============ ============ ============ ============
Dividends per share $0.21 $0.21 $0.21 $0.27
============ ============ ============ ============
2003
Interest income $9,565 $9,012 $8,982 $9,130
Interest expense 3,696 3,728 3,292 3,229
------------ ------------ ------------ ------------
Net interest income 5,869 5,284 5,690 5,901
Provision for loan losses 60 60 60 85
------------ ------------ ------------ ------------
Net income after provision for loan losses 5,809 5,224 5,630 5,816
Net gains on sales of securities 450 545 996 1
Gain recognized from life insurance proceeds - - 646 1,515
Other income 1,489 1,264 1,232 1,291
Other expense 5,281 5,148 5,353 5,358
------------ ------------ ------------ ------------
Net income $2,467 $1,885 $3,151 $3,265
============ ============ ============ ============
Basic earnings per share $0.45 $0.35 $0.58 $0.60
============ ============ ============ ============
Dividends per share $0.21 $0.21 $0.21 $0.26
============ ============ ============ ============
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In connection with the change of accountants for the fiscal year ended 2004,
there were no disagreements with Stambaugh Ness, PC on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements if not resolved to the satisfaction of Stambaugh
Ness, PC would have caused them to make reference thereto in their reports on
the financial statements for such year. In addition, during the fiscal year
ended December 31, 2003, there were no reportable events (as defined in
Regulation S-K Item 304(a)(1)(v)).
61
ITEM 9A - CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer have, within 90 days of
the date of this report, reviewed our process of gathering, analyzing, and
disclosing information that is required to be disclosed in our periodic reports
(and information that, while not required to be disclosed, may bear upon the
decision of management as to what information is required to be disclosed) under
the Securities Exchange Act of 1934, including information pertaining to the
condition of and material developments with respect to our business, operations,
and finances.
The Corporation expects to conclude its testing and evaluation of internal
controls over financial reporting and management's assessment of such controls
prior to filing its amended annual report on Form 10-K/A within the 45-day
period provided by the exemptive order issued by the SEC on November 30, 2004.
The Form 10-K/A will include a management report and auditor report on the
Company's internal control over financial reporting.
As a part of the annual audit of our consolidated financial statements for the
year ended December 31, 2004, control deficiencies have been identified
regarding the preparation of certain financial statement disclosures, the review
of certain types of journal entries, and approval of loans. Adjustments to the
financial statement disclosures were recorded in the accompanying financial
statements. In regards to the journal entry review and loan approvals
deficiencies, management is in the process of testing mitigating procedures and
has not assessed the type of deficiency. These control deficencies may be
considered to be material weakness under the rules specified by the Public
Accounting Oversight Board Auditing Standard No. 2.
Based on our evaluation of the effectiveness of the design and operation of the
disclosure controls and procedures, because of the matters discussed above, our
chief executive officer and chief financial officer concluded that the Company's
disclosure controls and procedures were not effective as of December 31, 2004.
However, the Company believes that the accompanying financial statements fairly
present the financial condition and results of operations for the fiscal years
presented in this report on Form 10-K.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
We continue to review, revise and improve the effectiveness of our internal
controls including strengthening our income tax provision review control
procedure noted above. We have made no significant changes in the Company's
internal controls over financial reporting in connection with our fourth quarter
evaluation that would materially affect, or are reasonably likely to materially
affect our internal controls over financial reporting.
ITEM 9B - OTHER INFORMATION
None.
62
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item, relating to directors, executive
officers, and control persons, is set forth in sections "Principal Beneficial
Owners of the Corporation's Stock," "Information as to Nominees, Directors and
Executive Officers" and "Principal Officers of the Corporation" of the
Registrant's definitive Proxy Statement to be used in connection with the 2005
Annual Meeting of Shareholders, which pages are incorporated herein by
reference.
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Registrant's officers and directors, and persons who own more than 10 percent of
a registered class of the Registrant's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission,
or SEC. Officers, directors and greater than 10 percent shareholders are
required by SEC regulation to furnish the Registrant with copies of all Section
16(a) forms they file.
Based solely on its review of the copies of such forms received by it or written
representations from certain reporting persons that no Forms 5 were required for
those persons, the Registrant believes that during the period of January 1,
2004, through December 31, 2004, its officers and directors were in compliance
with all filing requirements applicable to them.
The Company has adopted a Code of Ethics that applies to directors, officers,
and employees of the Company and the Bank. A copy of the Code of Ethics was
included as an exhibit to the Company's Form 10-K for the year ended December
31, 2003 and filed with the Securities and Exchange Commission. A request for
the Company's Code of Ethics can be made either in writing to Lynda Glass, ACNB
Corporation, 16 Lincoln Square, Gettysburg, Pennsylvania, 17325-0129 or by
telephone to 717-334-3161.
ITEM 11 - EXECUTIVE COMPENSATION
Incorporated by reference in response to this Item 11 is the information under
the headings "Executive Compensation" and "ACNB Corporation" in ACNB
Corporation's 2005 definitive Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference is in response to this Item 12 the information
appearing under the heading "Share Ownership" in ACNB Corporation's 2005
definitive Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in response to this Item 13 is the information
appearing under the heading "Transactions with Directors and Executive Officers"
in ACNB Corporation's 2005 definitive Proxy Statement.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference in response to this Item 14 is the information
appearing under heading "Report of Audit Committee" in ACNB Corporation's
definitive Proxy Statement.
63
PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) 1. FINANCIAL STATEMENTS
The following financial statements are filed as part of this report:
o Report of Independent Registered Public Accounting Firm
o Consolidated Statements of Condition
o Consolidated Statements of Income
o Consolidated Statements of Changes in Stockholders' Equity
o Consolidated Statements of Cash Flows
o Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
Financial statement schedules are omitted because the required information is
either not applicable, not required or is shown in the respective financial
statements or in the notes thereto.
(B) EXHIBITS
3(i) - Articles of Incorporation of ACNB Corporation, as amended.
3(ii) - Bylaws of Registrant; a copy of the Bylaws, as amended, of ACNB
Corporation is incorporated by reference to Exhibit 99 of the Registrant's
Current Report on Form 8-K, filed with the Commission on December 19, 2003.
10.1 - Executive Employment Agreement Dated as of January 1, 2000 between Adams
County National Bank, ACNB Corporation and Thomas A. Ritter. (Incorporated by
reference to Exhibit 99 of the Registrant's Current Report on Form 8-K, filed
with the Commission on March 26, 2001).
10.2 - ACNB Corporation, ACNB Acquisition Subsidiary LLC, Russell Insurance
Group, Inc. Stock Purchase Agreement.
10.3 - Salary Continuation Agreement - applicable to Thomas A. Ritter, Lynda L.
Glass, John W. Krichten, John M. Kiehl, Carl L. Ricker and Ronald L. Hankey.
10.4 - Executive Supplemental Life Insurance Plan - applicable to Gary Bennett,
Lynda L. Glass, Ronald L. Hankey, John M. Kiehl, John W. Krichten, Carl L.
Ricker and Thomas A. Ritter.
10.5 - Director Supplemental Life Insurance Plan - applicable to Philip P.
Asper, Frank Elsner, III, D. Richard Guise, Wayne E. Lau, William B. Lower,
Daniel W. Potts, Marian B. Schultz, Jennifer L. Weaver and Harry L. Wheeler.
10.6 - Director Deferred Fee Agreement - applicable to Frank Elsner, III, D.
Richard Guise, Marian B. Schlutz, Jennifer L. Weaver and Harry L. Wheeler.
10.7 - Adams County National Bank Salary Savings Plan.
10.8 - Group Pension Plan for Employees of Adams County National Bank.
64
14 - Code of Ethics (incorporated by reference to Exhibit 14 of the registrants
annual report on Form 10-K for the year ended December 31, 2003, filed with the
Commission on March 12, 2004)
16.1 - (Incorporated by reference to Exhibit 16.1 of the registrants annual
report on Form 10-K for the year ended December 31, 2003, filed with the
Commission March 12, 2004)
21 - Subsidiaries of the Registrant
23 - Consent of Stambaugh Ness, P.C.
31.1 - Chief Executive Officer certification of annual report on Form 10-K
31.2 - Chief Financial Officer certification of annual report on Form 10-K
32.1 - Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350
as Added by Section 906 of the Sarbanes-Oxley Act of 2002
32.2 - Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350
as Added by Section 906 of the Sarbanes-Oxley Act of 2002
99 - Independent Auditors' Report for the consolidated statement of condition
of ACNB Corporation and subsidiaries as of December 31, 2003 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 2003.
65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ACNB CORPORATION (Registrant) March 3, 2005
-------------
Date
By: /s/ Thomas A. Ritter By: /s/ John W. Krichten
--------------------------------------------- -------------------------------------------
Thomas A. Ritter John W. Krichten
President & CEO Secretary & Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on March 3, 2005, by the following persons in the capacities
indicated.
/s/ Philip P. Asper /s/ Wayne E. Lau
--------------------------------------------- -------------------------------------------
Philip P. Asper Wayne E. Lau
Director Director
/s/ Thomas A. Ritter
--------------------------------------------- -------------------------------------------
Guy F. Donaldson Thomas A. Ritter
Director Director, President & CEO
--------------------------------------------- -------------------------------------------
Frank Elsner, III Marian B. Shultz
Director Director
--------------------------------------------- -------------------------------------------
D. Richard Guise Jennifer L. Weaver
Director & Vice Chairman of the Board Director
/s/ Harry L. Wheeler
--------------------------------------------- -------------------------------------------
Ronald L. Hankey Harry L. Wheeler
Director and Chairman Director
/s/ Daniel W. Potts
--------------------------------------------- -------------------------------------------
Edgar S. Heberlig Daniel W. Potts
Director Director
66