Edgar Filing: ACNB CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

Commission file number 0-11783

ACNB CORPORATION

(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
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (717) 334-3161

Title of each class		Name of each exchange on which registered
Common Stock, $2.50 par value per share		The NASDAQ Stock Market, LLC

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 o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer x

Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares of the Registrant’s Common Stock outstanding on October 28, 2011, was 5,941,382.

PART I - FINANCIAL INFORMATION

ACNB CORPORATION

ITEM 1 - FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)

Dollars in thousands, except per share data	September 30, 2011			September 30, 2010			December 31, 2010

ASSETS
Cash and due from banks	$	13,270		$	15,317		$	14,091
Interest bearing deposits with banks	41,725			17,547			10,082

Total Cash and Cash Equivalents	54,995			32,864			24,173

Securities available for sale	209,335			205,534			190,730
Securities held to maturity, fair value $10,758; $10,844; $10,671	10,035			10,048			10,044
Loans held for sale	80			3,761			3,068
Loans, net of allowance for loan losses $15,412; $15,278; $15,252	666,597			654,542			650,039
Premises and equipment	14,625			14,344			14,119
Restricted investment in bank stocks	7,507			9,170			8,420
Investment in bank-owned life insurance	28,175			27,200			27,443
Investments in low-income housing partnerships	3,866			4,189			4,124
Goodwill	5,972			5,972			5,972
Intangible assets	3,209			3,848			3,688
Foreclosed assets held for resale	4,076			7,934			7,859
Other assets	16,146			13,790			18,988

Total Assets	$	1,024,618		$	993,196		$	968,667

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES
Deposits:
Non-interest bearing	$	121,068		$	106,087		$	103,464
Interest bearing	680,105			658,776			643,062
Total Deposits	801,173			764,863			746,526

Short-term borrowings	44,195			41,785			39,086
Long-term borrowings	71,248			81,611			81,499
Other liabilities	8,533			11,113			7,802

Total Liabilities	925,149			899,372			874,913

STOCKHOLDERS’ EQUITY

Common stock, $2.50 par value; 20,000,000 shares authorized; 6,003,982, 5,990,943 and 5,990,943 shares issued; 5,941,382, 5,928,343 and 5,928,343 shares outstanding	15,010			14,977			14,977
Treasury stock, at cost (62,600 shares)	(728		)	(728		)	(728		)
Additional paid-in capital	8,951			8,787			8,787
Retained earnings	72,900			69,035			69,536
Accumulated other comprehensive income	3,336			1,753			1,182

Total Stockholders’ Equity	99,469			93,824			93,754

Total Liabilities and Stockholders’ Equity	$	1,024,618		$	993,196		$	968,667

The accompanying notes are an integral part of the consolidated financial statements.

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

	Three Months Ended September 30,				Nine Months Ended September 30,
Dollars in thousands, except per share data	2011		2010		2011		2010
INTEREST INCOME
Loans, including fees	$	8,575	$	8,976	$	25,803	$	27,247
Securities:
Taxable	1,508		1,779		4,589		5,576
Tax-exempt	306		314		914		1,004
Dividends	3		7		9		22
Other	29		24		74		66

Total Interest Income	10,421		11,100		31,389		33,915
INTEREST EXPENSE
Deposits	1,133		1,553		3,380		4,828
Short-term borrowings	24		25		72		98
Long-term borrowings	706		810		2,221		2,499

Total Interest Expense	1,863		2,388		5,673		7,425

Net Interest Income	8,558		8,712		25,716		26,490

PROVISION FOR LOAN LOSSES	1,200		1,400		3,610		4,610

Net Interest Income after Provision for Loan Losses	7,358		7,312		22,106		21,880
OTHER INCOME
Service charges on deposit accounts	621		618		1,787		1,768
Income from fiduciary activities	323		350		1,025		953
Earnings on investment in bank-owned life insurance	244		252		732		759
Gain on life insurance proceeds	—		—		—		78
Net gains on sales of securities	1		47		1		72
Service charges on ATM and debit card transactions	319		287		917		831
Commissions from insurance sales	1,186		1,137		3,699		3,740
Other	188		225		685		743

Total Other Income	2,882		2,916		8,846		8,944

OTHER EXPENSES
Salaries and employee benefits	4,233		4,216		12,698		12,711
Net occupancy	505		520		1,561		1,658
Equipment	651		603		1,995		1,834
Other tax	210		182		593		588
Professional services	267		247		737		728
Supplies and postage	163		160		483		505
Marketing	123		72		375		281
FDIC and regulatory	225		355		965		1,061
Intangible assets amortization	160		161		481		482
Other operating	961		782		2,482		2,412

Total Other Expenses	7,498		7,298		22,370		22,260

Income before Income Taxes	2,742		2,930		8,582		8,564

PROVISION FOR INCOME TAXES	562		626		1,836		1,773

Net Income	$	2,180	$	2,304	$	6,746	$	6,791

PER SHARE DATA
Basic earnings	$	0.37	$	0.39	$	1.14	$	1.15
Cash dividends declared	$	0.19	$	0.19	$	0.57	$	0.57

The accompanying notes are an integral part of the consolidated financial statements.

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

Nine Months Ended September 30, 2011 and 2010

Dollars in thousands	Common Stock		Treasury Stock			Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity

BALANCE — JANUARY 1, 2010	$	14,977	$	(728	)	$	8,787	$	65,623		$	(356	)	$	88,303

Comprehensive income:
Net income	—		—			—		6,791			—			6,791
Other comprehensive income, net of taxes	—		—			—		—			2,109			2,109

Total Comprehensive Income														8,900

Cash dividends declared	—		—			—		(3,379		)	—			(3,379		)

BALANCE — SEPTEMBER 30, 2010	$	14,977	$	(728	)	$	8,787	$	69,035		$	1,753		$	93,824

BALANCE — JANUARY 1, 2011	$	14,977	$	(728	)	$	8,787	$	69,536		$	1,182		$	93,754

Comprehensive income:
Net income	—		—			—		6,746			—			6,746
Other comprehensive income, net of taxes	—		—			—		—			2,154			2,154

Total Comprehensive Income														8,900

Common stock shares issued (13,039 shares)	33		—			164		—			—			197

Cash dividends declared	—		—			—		(3,382		)	—			(3,382		)

BALANCE — SEPTEMBER 30, 2011	$	15,010	$	(728	)	$	8,951	$	72,900		$	3,336		$	99,469

The accompanying notes are an integral part of the consolidated financial statements.

ACNB CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Nine Months Ended September 30,
Dollars in thousands	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	6,746		$	6,791
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of loans and foreclosed real estate, net of writedowns on foreclosed real estate	(296		)	(68		)
Earnings on investment in bank-owned life insurance	(732		)	(759		)
Gain on life insurance proceeds	—			(78		)
Gain on sales of securities	(1		)	(72		)
Depreciation and amortization	1,675			1,773
Provision for loan losses	3,610			4,610
Net amortization of investment securities premiums	445			73
Increase in interest receivable	(173		)	(296		)
Increase (decrease) in interest payable	10			(129		)
Mortgage loans originated for sale	(13,636		)	(23,385		)
Proceeds from loans sold to others	16,868			19,992
(Increase) decrease in other assets	2,165			(496		)
Increase in other liabilities	860			140

Net Cash Provided by Operating Activities	17,541			8,096

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities available for sale	45,857			43,996
Proceeds from sales of investment securities available for sale	—			6,561
Purchase of investment securities available for sale	(61,776		)	(41,381		)
Net increase in loans	(22,512		)	(29,115		)
Redemption of restricted investments in bank stocks	913			—
Purchase of bank-owned life insurance	—			(250		)
Capital expenditures	(1,700		)	(903		)
Proceeds from life insurance death benefits	—			294
Proceeds from sale of foreclosed real estate	6,179			656

Net Cash Used in Investing Activities	(33,039		)	(20,142		)

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits	17,604			12,258
Net increase in time certificates of deposits and interest bearing deposits	37,043			24,082
Net increase (decrease) in short-term borrowings	5,109			(13,506		)
Dividends paid	(3,382		)	(3,379		)
Common stock issued	197			—
Proceeds from long-term borrowings	—			22,000
Repayments on long-term borrowings	(10,251		)	(20,683		)

Net Cash Provided by Financing Activities	46,320			20,772

Net Increase in Cash and Cash Equivalents	30,822			8,726

CASH AND CASH EQUIVALENTS — BEGINNING	24,173			24,138

CASH AND CASH EQUIVALENTS — ENDING	$	54,995		$	32,864

Interest paid	$	5,663		$	7,554
Incomes taxes paid	$	1,100		$	2,300
Loans transferred to foreclosed assets held for resale	$	2,344		$	2,669

The accompanying notes are an integral part of the consolidated financial statements.

ACNB CORPORATION

ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

ACNB Corporation, headquartered in Gettysburg, Pennsylvania, provides banking, insurance, and financial services to businesses and consumers through its wholly-owned subsidiaries, ACNB Bank and Russell Insurance Group, Inc. (RIG). The Bank engages in full-service commercial and consumer banking and trust services through its nineteen retail banking locations in Adams, Cumberland and York Counties, Pennsylvania. There are also two loan production offices situated in York and Franklin Counties, Pennsylvania.

RIG is a full-service insurance agency, based in Westminster, Maryland. The agency offers a broad range of property and casualty, life, and health insurance to both commercial and individual clients. In 2008, due to an agency acquisition, a second location of RIG was established in Germantown, Maryland.

The Corporation, along with seven other banks, entered into a joint venture to form BankersRe Insurance Group, SPC (formerly Pennbanks Insurance Co., SPC), 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.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly ACNB Corporation’s financial position as of September 30, 2011 and 2010, and the results of operations, changes in stockholders’ equity, and cash flows for the three and nine months ended September 30, 2011 and 2010. All such adjustments are of a normal recurring nature.

The accounting policies followed by the Corporation are set forth in Note A to the Corporation’s consolidated financial statements in the 2010 ACNB Corporation Annual Report on Form 10-K, filed with the SEC on March 11, 2011. It is suggested that the consolidated financial statements contained herein be read in conjunction with the consolidated financial statements and notes included in the Corporation’s Annual Report on Form 10-K. The results of operations for the three and nine month periods ended September 30, 2011, are not necessarily indicative of the results to be expected for the full year.

The Corporation has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2011, for items that should potentially be recognized or disclosed in the consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

2. Earnings Per Share

The Corporation has a simple capital structure. Basic earnings per share of common stock is computed based on 5,933,741 and 5,928,343 weighted average shares of common stock outstanding for the nine months ended September 30, 2011 and 2010, respectively, and 5,937,915 and 5,928,343 for the three months ended September 30, 2011 and 2010, respectively. The Corporation does not have dilutive securities outstanding.

3. Retirement Benefits

The components of net periodic benefit costs (income) related to the non-contributory, defined benefit pension plan for the three month and nine month periods ended September 30 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
In thousands	2011			2010			2011			2010
Service cost	$	143		$	115		$	429		$	345
Interest cost	240			268			720			804
Expected return on plan assets	(457		)	(304		)	(1,371		)	(912		)
Recognized net actuarial loss	35			109			105			327
Other, net	13			13			39			39

Net Periodic Benefit Cost (Income)	$	(26	)	$	201		$	(78	)	$	603

The Corporation previously disclosed in its consolidated financial statements for the year ended December 31, 2010, that it had not yet been determined the amount the Bank plans on contributing to the Plan in 2011. As of September 30, 2011, this contribution has still not been determined. The Corporation reduced the benefit formula for the defined benefit pension plan effective January 1, 2010, in order to manage total benefit costs. The new formula is the earned benefit as of December 31, 2009, plus 0.75% of a participant’s average monthly pay multiplied by years of benefit service earned on and after January 1, 2010, but not more than 25 years. The benefit percentage factor and maximum years of service eligible were both reduced.

4. Guarantees

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $6,176,000 in standby letters of credit as of September 30, 2011. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The current amount of the liability, as of September 30, 2011, for guarantees under standby letters of credit issued is not material.

5. Other Comprehensive Income (Loss)

The Corporation’s other comprehensive income (loss) items are unrealized gains on securities available for sale and unfunded pension liability. The components of other comprehensive income (loss) for the three month and nine month periods ended September 30 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
In thousands	2011			2010			2011			2010
Unrealized holding gains (losses) on available for sale securities arising during the period	$	1,502		$	(98	)	$	3,121		$	2,901
Reclassification of gains realized in net income	(1		)	(47		)	(1		)	(72		)

Net Unrealized Gains (Losses)	1,501			(145		)	3,120			2,829

Tax effect	508			(50		)	1,058			961

	993			(95		)	2,062			1,868

Change in pension liability	45			122			141			366

Tax effect	15			41			49			125

	30			81			92			241

Other Comprehensive Income (Loss)	$	1,023		$	(14	)	$	2,154		$	2,109

The components of the accumulated other comprehensive income, net of taxes, are as follows:

In thousands	Unrealized Gains on Securities		Pension Liability			Accumulated Other Comprehensive Income
BALANCE, SEPTEMBER 30, 2011	$	5,985	$	(2,649	)	$	3,336

BALANCE, DECEMBER 31, 2010	$	3,923	$	(2,741	)	$	1,182

BALANCE, SEPTEMBER 30, 2010	$	6,074	$	(4,321	)	$	1,753

6. Segment Reporting

Russell Insurance Group, Inc. (RIG) is managed separately from the banking segment, which includes the Bank and related financial services that the Corporation offers. RIG offers a broad range of property and casualty, life and health insurance to both commercial and individual clients.

Segment information for the nine month periods ended September 30, 2011 and 2010, is as follows:

In thousands	Banking		Insurance		Intercompany Eliminations			Total
2011
Net interest income and other income from external customers	$	31,072	$	3,490	$	—		$	34,562
Income before income taxes	7,879		703		—			8,582
Total assets	1,014,216		12,638		(2,236		)	1,024,618
Capital expenditures	1,698		2		—			1,700

2010
Net interest income and other income from external customers	$	31,947	$	3,487	$	—		$	35,434
Income before income taxes	8,092		472		—			8,564
Total assets	982,840		11,939		(1,583		)	993,196
Capital expenditures	887		16		—			903

Segment information for the three month periods ended September 30, 2011 and 2010, is as follows:

In thousands	Banking		Insurance		Intercompany Eliminations			Total
2011
Net interest income and other income from external customers	$	10,453	$	987	$	—		$	11,440
Income before income taxes	2,570		172		—			2,742
Total assets	1,014,216		12,638		(2,236		)	1,024,618
Capital expenditures	587		—		—			587

2010
Net interest income and other income from external customers	$	10,730	$	898	$	—		$	11,628
Income before income taxes	2,841		89		—			2,930
Total assets	982,840		11,939		(1,583		)	993,196
Capital expenditures	240		—		—			240

Intangible assets, representing customer lists, are amortized over 10 years on a straight line basis. Goodwill is not amortized, but rather is analyzed annually for impairment. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested for impairment when such events occur. Amortization of goodwill and the intangible assets is deductible for tax purposes.

7. 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 (loss).

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 on debt securities, management considers (1) whether management intends to sell the security, or (2) if it is more likely than not that management will be required to sell the security before recovery, or (3) management does not expect to recover the entire amortized cost basis. In assessing potential other-than-temporary impairment for equity securities, consideration is given to management’s intention and ability to hold the securities until recovery of unrealized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Amortized cost and fair value at September 30, 2011, and December 31, 2010, were as follows:

In thousands	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
SECURITIES AVAILABLE FOR SALE
SEPTEMBER 30, 2011
U.S. Government and agencies	$	38,298	$	891	$	18	$	39,171
Mortgage-backed securities	110,089		6,024		16		116,097
State and municipal	37,060		1,895		26		38,929
Corporate bonds	13,154		310		39		13,425
CRA mutual fund	1,044		36		—		1,080
Stock in other banks	626		26		19		633

	$	200,271	$	9,182	$	118	$	209,335

DECEMBER 31, 2010
U.S. Government and agencies	$	28,225	$	297	$	262	$	28,260
Mortgage-backed securities	109,386		5,292		319		114,359
State and municipal	34,214		643		181		34,676
Corporate bonds	11,303		367		11		11,659
CRA mutual fund	1,032		—		2		1,030
Stock in other banks	627		119		—		746

	$	184,787	$	6,718	$	775	$	190,730

SECURITIES HELD TO MATURITY
SEPTEMBER 30, 2011
U.S. Government and agencies	$	10,035	$	723	$	—	$	10,758

DECEMBER 31, 2010
U.S. Government and agencies	$	10,044	$	627	$	—	$	10,671

All mortgage-backed security investments are government sponsored enterprise (GSE) pass through instruments issued by the Federal National Mortgage Association (FNMA), Government National Mortgage Association (GNMA) or Federal Home Loan Mortgage Corporation (FHLMC), which guarantee the timely payment of principal on these investments.

At September 30, 2011, three U.S. Government and agency securities had unrealized losses that individually did not exceed 1% of amortized cost. These securities have not 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.

At September 30, 2011, one mortgage-backed security had an unrealized loss that individually did not exceed 1% of amortized cost. This security has not been in a continuous loss position for 12 months or more. This unrealized loss relates principally to changes in interest rates subsequent to the acquisition of the specific security.

At September 30, 2011, four state and municipal bonds had unrealized losses that individually did not exceed 3% of amortized cost. These securities have not 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.

At September 30, 2011, two corporate bonds had unrealized losses, of which one has been in a continuous loss position for 12 months or more. The securities in this category had unrealized losses that individually did not exceed 4% of amortized cost. These unrealized losses relate principally to changes in interest rates subsequent to the acquisition of specific securities.

At September 30, 2011, one stock in other banks had an unrealized loss that individually did not exceed 15% of amortized cost. This security has not been in a continuous loss position for 12 months or more. This unrealized loss relates principally to volatility in all financial stocks.

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. Based on the above information, management has determined that none of these investments are other-than-temporarily impaired.

The fair values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or by matrix pricing (Level 2) which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather by relying on the security’s relationship to other benchmark quoted prices. The Corporation uses an independent service provider to provide matrix pricing and uses the valuation of another provider to compare for reasonableness.

Management routinely sells securities from its available for sale portfolio in an effort to manage and allocate the portfolio. At September 30, 2011, management had not identified any securities with an unrealized loss that it intends or will be required to sell.

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 September 30, 2011, and December 31, 2010:

	Less than 12 Months				12 Months or More				Total
In thousands	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
SECURITIES AVAILABLE FOR SALE
SEPTEMBER 30, 2011
U.S. Government and agencies	$	4,963	$	18	$	—	$	—	$	4,963	$	18
Mortgage-backed securities	2,060		16		—		—		2,060		16
State and municipal	1,969		26		—		—		1,969		26
Corporate bonds	1,990		7		968		32		2,958		39
Stock in other banks	109		19		—		—		109		19
	$	11,091	$	86	$	968	$	32	$	12,059	$	118

DECEMBER 31, 2010
U.S. Government and agencies	$	10,585	$	262	$	—	$	—	$	10,585	$	262
Mortgage-backed securities	21,071		319		—		—		21,071		319
State and municipal	11,680		181		—		—		11,680		181
Corporate bonds	989		11		—		—		989		11
CRA mutual fund	1,030		2		—		—		1,030		2
	$	45,355	$	775	$	—	$	—	$	45,355	$	775

Amortized cost and fair value at September 30, 2011, by contractual maturity, where applicable, 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

In thousands

Amortized
Cost

Fair
Value

Amortized
Cost

Fair
Value

1 year or less

6,628

6,756

—

Over 1 year through 5 years

33,408

34,470

10,035

10,758

Over 5 years through 10 years

38,867

40,413

—

Over 10 years

9,609

9,886

—

Mortgage-backed securities

110,089

116,097

—

CRA mutual fund

1,044

1,080

Stock in other banks

626

633

—

200,271

209,335

10,035

10,758

The Corporation realized gross gains of $1,000 during the third quarter of 2011 and $54,000 during the third quarter of 2010, as well as $0 of gross losses during the third quarter of 2011 and $7,000 during the third quarter of 2010, on sales of securities available for sale. State and municipal securities were sold at a loss in 2010 in order to adjust the Corporation’s interest rate sensitivity, reduce exposure to geographical locations, balance the mix with other investment types, and reduce risks related to insurance coverage. For the nine month period ended September 30, 2011, the Corporation realized $1,000 in gross gains and did not realize any losses on sales of securities available for sale. For the nine month period ended September 30, 2010, the Corporation realized $128,000 of gross gains and $56,000 of gross losses on sales of securities available for sale.

At September 30, 2011, and December 31, 2010, securities with a carrying value of $118,360,000 and $99,197,000, respectively, were pledged as collateral as required by law on public and trust deposits, repurchase agreements, and for other purposes.

8. Loans

The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout southcentral 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 payoff 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.

The loans receivable portfolio is segmented into commercial, residential mortgage, home equity lines of credit, and consumer loans. Commercial loans consist of the following classes: commercial and industrial, commercial real estate, and commercial real estate construction.

The accrual of interest on residential 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. Consumer loans (consisting of home equity lines of credit and consumer loan classes) are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual 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 nonaccrual 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 Credit Losses

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses is established as losses are estimated to occur 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 reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated statement of condition. The amount of the unfunded lending commitments is not material to the consolidated statements.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of 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, the 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 pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity, and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative risk factors. These qualitative risk factors include:

· lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices;

· national, regional and local economic and business conditions, as well as the condition of various market segments, including the impact on the value of underlying collateral for collateral dependent loans;

· the nature and volume of the portfolio and terms of loans;

· the experience, ability and depth of lending management and staff;

· the volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications; and,

· the existence and effect of any concentrations of credit and changes in the level of such concentrations.

Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

The unallocated component of the allowance 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 commercial 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.

A specific allocation within the allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Corporation’s impaired loans are measured based on the estimated fair value of the loan’s collateral.

For commercial loans secured by real estate, estimated fair values of collateral are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal, and the condition of the property. Appraised values are discounted based on the age of the appraisal, special use nature of the property, or condition of the property to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value.

For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging reports, equipment appraisals, or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

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.

Loans whose terms are modified are classified as troubled debt restructured loans if the Corporation grants such borrowers concessions that it would not otherwise consider and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate, continuance of a below market interest rate, or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings may be restored to accrual status if principal and interest payments, under the modified terms, are current for a sustained period of time and, based on a well-documented credit evaluation of the borrower’s financial condition, there is reasonable assurance of repayment. Loans classified as troubled debt restructurings are generally designated as impaired.

The allowance calculation methodology includes further segregation of loan classes into credit quality rating categories. The borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are generally evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments.

Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects.

Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.

In addition, federal and state regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

Commercial and Industrial Lending - The Corporation originates commercial and industrial loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes which include short-term loans and lines of credit to finance machinery and equipment purchases, inventory, and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and may be renewed annually.

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum values have been established by the Corporation and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, collateral appraisals, etc.

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower’s character and capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Corporation’s analysis.

Commercial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions.

Commercial Real Estate Lending - The Corporation engages in commercial real estate lending in its primary market area and surrounding areas. The Corporation’s commercial real estate portfolio is secured primarily by commercial retail space, office buildings, and hotels. Generally, commercial real estate loans have terms that do not exceed 20 years, have loan-to-value ratios of up to 80% of the appraised value of the property, and are typically secured by personal guarantees of the borrowers.

In underwriting these loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. Appraisals on properties securing commercial real estate loans originated by the Corporation are performed by independent appraisers.

Commercial real estate loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions and the complexities involved in valuing the underlying collateral.

Commercial Real Estate Construction Lending - The Corporation engages in commercial real estate construction lending in its primary market area and surrounding areas. The Corporation’s commercial real estate construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans.

The Corporation’s commercial real estate construction loans are generally secured with the subject property. Terms of construction loans depend on the specifics of the project, such as estimated absorption rates, estimated time to complete, etc.

In underwriting commercial real estate construction loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the projected cash flow generated by the project using feasibility studies, market data, and other pertinent information. Appraisals on properties securing commercial real estate construction loans originated by the Corporation are performed by independent appraisers.

Commercial real estate construction loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions and the uncertainties surrounding total construction costs.

Residential Mortgage Lending - One-to-four family residential mortgage loan originations are generated by the Corporation’s marketing efforts, its present customers, walk-in customers, and referrals. These loans originate primarily within the Corporation’s market area or with customers primarily from the market area.

The Corporation offers fixed-rate and adjustable-rate mortgage loans with terms up to a maximum of 30 years for both permanent structures and those under construction. The Corporation’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The majority of the Corporation’s residential mortgage loans originate with a loan-to-value of 80% or less. Loans in excess of 80% are required to have private mortgage insurance.

In underwriting one-to-four family residential real estate loans, the Corporation evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan. Properties securing real estate loans made by the Corporation are appraised by independent appraisers. The Corporation generally requires borrowers to obtain an attorney’s title opinion or title insurance, as well as fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. The Corporation has not engaged in subprime residential mortgage originations.

Residential mortgage loans present a moderate level of risk due primarily to general economic conditions, as well as a weakened housing market.

Home Equity Lines of Credit Lending - The Corporation originates home equity lines of credit primarily within the Corporation’s market area or with customers primarily from the market area. Home equity lines of credit are generated by the Corporation’s marketing efforts, its present customers, walk-in customers, and referrals.

Home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of 90% and a maximum term of 20 years. In underwriting home equity lines of credit, a thorough analysis of the borrower’s financial ability to repay the loan as agreed is performed. The ability to repay is determined by the borrower’s employment history, current financial condition, and credit background.

Home equity lines of credit generally present a moderate level of risk due primarily to general economic conditions, as well as a weakened housing market.

Consumer Lending - The Corporation offers a variety of unsecured and secured consumer loans, including those for vehicles and mobile homes and those secured by savings deposits. These loans originate primarily within the Corporation’s market area or with customers primarily from the market area.

Consumer loan terms vary according to the type and value of collateral and the creditworthiness of the borrower. In underwriting consumer loans, a thorough analysis of the borrower’s financial ability to repay the loan as agreed is performed. The ability to repay is determined by the borrower’s employment history, current financial condition, and credit background.

Consumer loans may entail greater credit risk than residential mortgage loans or home equity lines of credit, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Corporation’s internal risk rating system as of September 30, 2011, and December 31, 2010:

In thousands	Pass		Special Mention		Substandard		Doubtful		Total
SEPTEMBER 30, 2011
Commercial and industrial	$	55,357	$	4,152	$	4,477	$	—	$	63,986
Commercial real estate	198,842		15,838		15,388		—		230,068
Commercial real estate construction	5,789		12,475		2,903		—		21,167
Residential mortgage	291,337		4,052		3,441		—		298,830
Home equity lines of credit	50,358		1,654		555		—		52,567
Consumer	15,391		—		—		—		15,391
	$	617,074	$	38,171	$	26,764	$	—	$	682,009

DECEMBER 30, 2010
Commercial and industrial	$	43,448	$	5,041	$	4,187	$	—	$	52,676
Commercial real estate	193,731		14,530		17,689		—		225,950
Commercial real estate construction	11,009		10,963		4,663		—		26,635
Residential mortgage	289,833		2,882		4,282		—		296,997
Home equity lines of credit	46,383		2,081		393		—		48,857
Consumer	14,176		—		—		—		14,176
	$	598,580	$	35,497	$	31,214	$	—	$	665,291

The following table summarizes information relative to impaired loans by loan portfolio class as of September 30, 2011, and December 31, 2010:

Impaired Loans with Allowance

Impaired Loans with
No Allowance

In thousands

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

Recorded
Investment

Unpaid
Principal
Balance

SEPTEMBER 30, 2011

Commercial and industrial

3,126

1,135

264

1,379

Commercial real estate

142

6,521

7,318

Commercial real estate construction

—

2,903

7,481

Residential mortgage

573

1,487

2,005

3,841

1,253

11,175

18,183

	Impaired loans with Allowance						Impaired Loans with No Allowance
In thousands	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance
DECEMBER 31, 2010
Commercial and industrial	$	869	$	1,869	$	547	$	68	$	68
Commercial real estate	4,326		4,326		726		3,955		4,184
Commercial real estate construction	4,216		7,716		729		172		232
Residential mortgage	97		97		57		954		1,312
	$	9,508	$	14,008	$	2,059	$	5,149	$	5,796

The following table summarizes information relative to average impaired loans and related interest income by loan portfolio class for the three and nine months ended September 30, 2011:

	Three Months Ended September 30, 2011				Nine Months Ended September 30, 2011
In thousands	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
Commercial and industrial	$	1,863	$	—	$	1,154	$	—
Commercial real estate	6,534		—		7,435		44
Commercial real estate construction	3,214		—		3,676		—
Residential mortgage	1,908		—		1,473		—
	$	13,519	$	—	$	13,738	$	44

The following table presents nonaccrual loans by loan portfolio class as of September 30, 2011, and December 31, 2010:

In thousands	September 30, 2011		December 31, 2010
Commercial and industrial	$	3,390	$	937
Commercial real estate	6,663		8,281
Commercial real estate construction	2,903		4,388
Residential mortgage	2,060		1,051
	$	15,016	$	14,657

The following table summarizes information relative to troubled debt restructurings by loan portfolio class:

In thousands	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
SEPTEMBER 30, 2011
Commercial and industrial	$	490	$	245
Commercial real estate	$	371	$	146
Commercial real estate construction	$	1,548	$	862

DECEMBER 31, 2010
Commercial and industrial	$	490	$	439
Commercial real estate	$	371	$	168