Acquisition of Frederick County Bancorp, Inc.

On January 11, 2020, ACNB completed its previously announced acquisition of Frederick County Bancorp, Inc. (FCBI) of Frederick, Maryland. FCBI was a locally owned and managed institution with five locations in Frederick County Maryland. The acquisition positioned ACNB Corporation for strong and profitable growth in a desirable market that is adjacent to the Corporation’s current footprint in southcentral Pennsylvania and central Maryland. ACNB transacted the merger to complement the Corporation’s existing operations, while consistent with the Corporation’s strategic plan of enhancing long-term shareholder value. The fair value of total assets acquired as a result of the merger totaled $444.4 million, loans totaled $329.9 million and deposits totaled $374.1 million.

Goodwill recorded in the merger was $22.1 million. In accordance with the terms of the Reorganization Agreement, each share of FCBI common stock was converted into the right to receive 0.9900 share of ACNB common stock. As a result of the merger, ACNB issued 1,590,547 shares of its common stock and cash in exchange for fractional shares based upon $36.43, the determined market price of ACNB common stock in accordance with the Reorganization Agreement. The results of the combined entity’s operations are included in the Corporation’s Consolidated Financial Statements from the date of acquisition.

The acquisition of FCBI is being accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition.

The following table summarizes the consideration paid for FCBI and the fair value of assets acquired and liabilities assumed as of the acquisition date:

Purchase Price Consideration in Common Stock



FCBI shares outstanding	1,601,764
Shares paid in cash for fractional shares	150.88
Cash consideration (per FCBI share)	$	36.43
Cash portion of purchase price (cash payout of stock options and cash in lieu of fractional shares)	$	100,798
FCBI shares outstanding	1,601,764
Shares paid stock consideration	1,601,613
Exchange ratio	0.9900
Total ACNB shares issued	1,585,597
ACNB’s share price for purposes of calculation	$	36.34
Equity portion of purchase price	$	57,620,595
Cost of shares owned by buyer	$	187,200
Total consideration paid	$	57,908,593



Allocation of Purchase Price	In thousands
Total Purchase Price		$	57,909

Fair Value of Assets Acquired
Cash and cash equivalents	35,262
Investment securities	22,167
Loans held for sale	4,050
Loans	329,917
Restricted stock	1,141
Premises and equipment	11,682
Core deposit intangible asset	3,572
Other assets	14,330
Total assets	422,121

Fair Value of Liabilities Assumed
Non-interest bearing deposits	103,492
Interest bearing deposits	270,566
Subordinated debt	6,000
Long term borrowings	3,450
Other liabilities	2,824
Total liabilities	386,332

Net Assets Acquired		35,789
Goodwill Recorded in Acquisition		$	22,120

Pursuant to the accounting requirements, the Corporation assigned a fair value to the assets acquired and liabilities assumed of FCBI. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

The assets acquired and liabilities assumed in the acquisition of FCBI were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition and are subject to adjustment for up to one year after the closing date of the acquisition. While the fair values are not expected to be materially different from the estimates, any material adjustments to the estimates will be reflected, retroactively, as of the date of the acquisition. The items most susceptible to adjustment are the fair value adjustments on loans, core deposit intangible and the deferred income tax assets resulting from the acquisition.

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

Investment securities available-for-sale

The estimated fair values of the investment securities available for sale, primarily comprised of U.S. Government agency mortgage-backed securities, U.S. government agencies and municipal bonds, were determined using Level 2 inputs in the fair value hierarchy. The fair values were determined using independent pricing services. The Corporation’s independent pricing service utilized matrix pricing, 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 relying on the security’s relationship to other benchmark quoted prices. Management reviewed the data and assumptions used in pricing the securities. A fair value premium of $163,000 was recorded and will be amortized over the estimated life of the investments using the interest rate method.

Loans

Acquired loans (impaired and non-impaired) are initially recorded at their acquisition-date fair values using Level 3 inputs. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected life time losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Corporation has prepared three separate loan fair value adjustments that it believed a market participant might employ in estimating the entire fair value adjustment necessary under ASC 820-10 for the acquired loan portfolio. The three-separate fair valuation methodology employed are: 1) an interest rate loan fair value adjustment, 2) a general credit fair value adjustment, and 3) a specific credit fair value adjustment for purchased credit impaired loans subject to ASC 310-30 procedures. The acquired loans were recorded at fair value at the acquisition date without carryover of FCBI’s previously established allowance for loan losses. The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $339,577,000. The table below illustrates the fair value adjustments made to the amortized cost basis in order to present a fair value of the loans acquired. The credit adjustment on purchased credit impaired loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that has been deemed uncollectible based on the Corporation’s expectations of future cash flows for each respective loan.



In thousands
Gross amortized cost basis at January 11, 2020	$	339,577
Interest rate fair value adjustment on pools of homogeneous loans	(2,632		)
Credit fair value adjustment on pools of homogeneous loans	(5,326		)
Credit fair value adjustment on purchased credit impaired loans	(1,702		)
Fair value of acquired loans at January 11, 2020	$	329,917

For loans acquired without evidence of credit quality deterioration, ACNB prepared the interest rate loan fair value and credit fair value adjustments. Loans were grouped into homogeneous pools by characteristics such as loan type, term, collateral and rate. Market rates for similar loans were obtained from various internal and external data sources and reviewed by management for reasonableness. The average of these rates was used as the fair value interest rate a market participant would utilize. A present value approach was utilized to calculate the interest rate fair value discount of $2.6 million.

Additionally for loans acquired without credit deterioration, a credit fair value adjustment was calculated using a two-part credit fair value analysis: 1) expected lifetime credit migration losses; and 2) estimated fair value adjustment for certain qualitative factors. The expected lifetime losses were calculated using historical losses observed at the Bank, FCBI and peer banks. ACNB also estimated an environmental factor to apply to each loan type. The environmental factor represents potential discount which may arise due to general credit and economic factors. A credit fair value discount of $5.3 million was determined. Both the interest rate and credit fair value adjustments relate to loans acquired with evidence of credit quality deterioration will be substantially recognized as interest income on a level yield amortization method over the expected life of the loans.

The following table presents the acquired purchased credit impaired loans receivable at the Acquisition Date:



In thousands
Contractual principal and interest at acquisition	$	4,289
Nonaccretable difference	(2,361		)
Expected cash flows at acquisition	1,928
Accretable yield	(354		)
Fair value of purchased impaired loans	$	1,574

The Corporation acquired five branches of FCBI. The fair value of FCBI’s premises, including land, buildings, and improvements, was determined based upon independent third-party appraisals performed by licensed appraisers in the market in which the premises are located. The Corporation prepared an internal analysis to compare the lease contract obligations to comparable market rental rates. The Corporation believed that the leased contract rates were in a reasonable range of market rental rates and concluded that no fair market value adjustment related to leasehold interest was necessary.

Core Deposit Intangible

The fair value of the core deposit intangible was determined based on a discounted cash flow analysis using a discount rate commensurate with market participants. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through national brokered CD offering rates. The projected cash flows were developed using projected deposit attrition rates. The core deposit intangible will be amortized over ten years using the sum-of-years digits method.

Time Deposits

The fair value adjustment for time deposits represents a discount from the value of the contractual repayments of fixed- maturity deposits using prevailing market interest rates for similar-term time deposits. The time deposit premium of approximately $255,000 is being amortized into income on a level yield amortization method over the contractual life of the deposits.

Long-term Borrowings

The Corporation assumed a trust preferred subordinated debt in connection with the merger. The fair value of the trust preferred subordinated debt was determined using a discounted cash flow method using a market participant discount rate for similar instruments. The trust preferred capital note was valued at discount of $854,000, which is being amortized into income on a level yield amortization method based upon the assumed market rate, and the term of the trust preferred subordinated debt instrument.

The following table presents certain pro forma information as if FCBI had been acquired on September 30, 2019. These results combine the historical results of the Corporation in the Corporation’s Consolidated Statements of Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on September 30, 2019. In particular, no adjustments have been made to eliminate the amount of FCBI’s provision for loan losses that would not have been necessary had the acquired loans been recorded at fair value as of September 30, 2019. The Corporation expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below:



In thousands	For the Nine Months Ended September 30, 2019
Total revenues (net interest income plus noninterest income)	$	72,281
Net Income	22,138

Acquisition-related expenses associated with the acquisition of FCBI were $6.0 million for the three months ended March 31, 2020. Such costs include legal and accounting fees, lease and contract termination expenses, system conversion, operations integration, and employee severances, which have been expensed as incurred.