ACNB Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. ACNB provides banking, wealth-management and insurance services in south-central Pennsylvania and northern Maryland. Comparisons are affected by the July 1, 2017 acquisition of New Windsor Bancorp; its results are included in 2018 but not the comparable 2017 periods.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $14.091 million | $9.831 million | $27.653 million | $19.297 million |
| Provision for loan losses | $0.320 million | $0 | $0.570 million | $0 |
| Other income | $4.317 million | $3.528 million | $8.029 million | $6.610 million |
| Other expenses | $11.251 million | $9.634 million | $22.237 million | $18.634 million |
| Net income | $5.507 million | $2.722 million | $10.420 million | $5.359 million |
| Basic earnings per share | $0.78 | $0.45 | $1.48 | $0.88 |
| Cash dividends declared per share | $0.23 | $0.20 | $0.43 | $0.40 |
- Q2 net income increased 102.3%; first-half net income increased 94.4%. Management attributed growth to the New Windsor acquisition, organic revenue growth and a lower effective tax rate following the Tax Cuts and Jobs Act.
- Net interest margin was 3.82% in Q2 versus 3.39%; first-half margin was 3.81% versus 3.38%. Net interest spread was 3.69% in Q2 versus 3.30%.
- At June 30, total assets were $1.623 billion, net loans $1.234 billion, deposits $1.334 billion and stockholders’ equity $160.3 million. Year-over-year asset growth largely reflects the acquisition.
- Cash and cash equivalents were $63.1 million, up $28.6 million since year-end. First-half operating cash flow was $14.6 million; investing cash outflow was $3.4 million and financing cash inflow was $17.5 million.
- Short-term borrowings were $26.4 million and long-term borrowings $89.8 million. Long-term debt included $80.2 million of FHLB advances, a $4.6 million local-bank loan and $5.0 million trust-preferred subordinated debt.
- The allowance for loan losses was $13.1 million, or 1.05% of loans, compared with $14.0 million, or 1.12%, at year-end 2017. First-half net charge-offs were $1.403 million.
- Bank subsidiary regulatory capital ratios at June 30 included a 9.13% leverage ratio, 12.71% common Tier 1 and Tier 1 risk-based ratios, and a 13.86% total risk-based ratio; the bank was categorized as well capitalized.
Material changes and management commentary
- Compared with Q2 2017, net interest income rose 43.3%, reflecting higher average earning assets, acquisition-related balances and purchase-accounting accretion. Interest expense also rose 56.8% in Q2, primarily from acquired deposits, higher deposit rates and higher-cost funding.
- Other income rose 22.4% in Q2, with growth in deposit and debit-card fees and insurance commissions. Other expenses rose 16.8%, including higher salary and benefits, occupancy, equipment and acquired-intangible amortization. No merger-related expenses were reported in Q2 2018, versus $208,000 in Q2 2017.
- The effective income-tax rate was 19.5% in Q2 and 19.1% for the first half, versus 26.9% and 26.3%, respectively, in 2017. Management cited the reduction in the federal corporate rate and tax-exempt income and credits.
- Loans were up 28.6% year over year, mainly from New Windsor; they rose only 0.2% from December 2017. Management cited seasonality, competition and early payoffs as constraints on year-to-date growth.
- Nonaccrual loans declined to $3.411 million from $6.355 million at year-end; loans more than 90 days past due and still accruing were $2.753 million. Management described credit quality as stable, charge-offs as low and past-due loans as manageable, while noting commercial-real-estate exposure and uncertainty in collateral values.
Outlook, risks and contingencies
- The filing gives no quantified earnings or revenue guidance. Management expects continued pressure on funding costs as rates rise and competing banks seek deposits; it intends to pursue loan growth and rebalance earning assets to support yield and interest income.
- Management cited intense lending competition, a compressing yield curve, slower local economic activity and potential loan payoffs as headwinds. Deposit retention may also be affected by customer rate sensitivity and competition.
- Available FHLB borrowing capacity was approximately $669.1 million, with $566.6 million reported available and $399 million considered practicable additional capacity. Management stated liquidity sources were sufficient for operating needs.
- Off-balance-sheet commitments included $282.4 million of unfunded credit commitments and $5.0 million of standby letters of credit; management noted many commitments may expire undrawn. The related guarantee liability was not material.
- Unrealized losses on available-for-sale securities increased from year-end, which management primarily attributed to interest-rate and spread changes; management reported no intent or expected requirement to sell loss-position securities before recovery and did not consider them other-than-temporarily impaired.
- ACNB was evaluating the expected-credit-loss standard (CECL), which management said could increase the allowance and accelerate loss recognition. It expected the forthcoming lease standard to result in right-of-use assets and liabilities, with no material effect on operations or capital adequacy expected.
- Other identified risks include CRE collateral and local economic conditions, rising deposit costs, insurance-carrier commission pressure and nonrenewal of large accounts, debit-card fraud and cybersecurity, regulatory/compliance costs, pension assumptions, and goodwill impairment. New Windsor goodwill was not tested during the first half; management planned testing during 2018.
- No material pending legal proceedings or material changes to previously disclosed risk factors were reported. Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported earnings and margin improvement reflects recurring business performance versus acquisition effects and purchase-accounting accretion.
- Whether deposit costs continue to rise faster than earning-asset yields, and the resulting effect on net interest margin.
- Credit trends, particularly commercial real estate, delinquency, charge-offs and the adequacy of the allowance as the portfolio grows.
- The outcome of New Windsor goodwill impairment testing and the expected effect of CECL adoption on reserves and capital.
- Liquidity and funding sensitivity, including the use and availability of FHLB capacity and the sizable unfunded lending commitments.
- Further movement in securities’ unrealized losses and any change in management’s ability or intent to hold affected securities until recovery.