Orrstown Financial Services, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Unless otherwise noted, amounts are U.S. dollars; financial statement figures below are in millions.
Business context
Orrstown is a Pennsylvania-based community bank serving markets in Pennsylvania and Maryland. Its activities include commercial and consumer lending, deposit services, fiduciary and investment management, insurance, and brokerage. The filing reports consolidated results for the company and its wholly owned bank subsidiary.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net interest income | $20.6 | $20.8 | $64.4 | $59.9 |
| Provision for loan losses | $0.4 | $2.2 | $(0.01) | $5.0 |
| Noninterest income | $7.7 | $6.9 | $21.9 | $21.1 |
| Noninterest expense | $19.0 | $19.3 | $53.9 | $56.0 |
| Net income | $7.2 | $5.0 | $26.2 | $16.4 |
| Diluted EPS | $0.65 | $0.45 | $2.36 | $1.49 |
| Taxable-equivalent net interest margin | 3.03% | 3.24% | 3.21% | 3.34% |
- Balance sheet at September 30: Assets were $2.87 billion, up from $2.75 billion at December 31, 2020. Shareholders’ equity was $268.6 million, compared with $246.2 million.
- Loans and deposits: Loans totaled $1.94 billion, down $39.9 million from year-end; excluding PPP loans, management reported 7% loan growth in the first nine months. Deposits were $2.50 billion, up $145.2 million.
- Liquidity and cash flow: Cash and cash equivalents were $311.4 million, versus $125.3 million at year-end. Nine-month operating cash flow was $30.2 million, investing cash flow $66.8 million, and financing cash flow $89.2 million.
- Borrowings: Repurchase agreements were $27.6 million, FHLB advances and other borrowings $2.0 million, and subordinated notes $31.9 million. Combined, these balances were about $61.5 million, compared with about $109.4 million at year-end.
- Credit and capital: The allowance for loan losses was $20.0 million, or 1.03% of loans. Nonaccrual loans were $9.1 million (0.47% of loans); total risk assets were $10.3 million. The Bank reported regulatory capital ratios of 14.7% total risk-based capital and 13.5% Tier 1 common equity risk-based capital, and was categorized as well capitalized.
Changes versus comparable periods
- Q3 net income rose 44% year over year, while nine-month net income rose 60%. The nine-month improvement reflected higher net interest income, lower loan-loss provision, and lower noninterest expense.
- Net interest margin declined year over year in both comparisons. Management attributed pressure to elevated cash balances, lower purchase-accounting accretion, and lower investment-security yields. Reduced funding costs partly offset lower interest income.
- Nine-month noninterest income increased modestly, but included $0.6 million in net securities gains; the prior-year period included $2.8 million in gains on portfolio loan sales. Trust and brokerage income grew, while swap fee income fell.
- Loan-loss provision fell sharply from 2020 as the company released COVID-related qualitative reserves; that reserve was reduced to zero by September 30, 2021. Special Mention loans declined $42.0 million from year-end, and classified loans declined to $26.9 million.
- PPP forgiveness reduced outstanding PPP loans by $376.0 million during the first nine months. At quarter-end, $259.9 million of PPP loans remained, with $8.6 million of net deferred fees yet to be recognized, subject to forgiveness timing.
Outlook, risks, contingencies, and unusual items
- The filing provides no quantitative earnings or revenue guidance. Management describes uncertainty from COVID-19, including variants and related responses, and notes possible effects on credit estimates and fair values. It also identifies competition, interest-rate movements, credit quality, economic conditions, cybersecurity, PPP forgiveness and fee timing, and integration of acquisitions among forward-looking risks.
- Management said the company was more asset-sensitive than at year-end and expected to benefit more from rising rates. Its simulation showed estimated 12-month net interest income changes of +3.1% for a 100-basis-point increase and +5.4% for a 200-basis-point increase; a 100-basis-point decrease indicated a 0.9% decline. These are model estimates dependent on assumptions, not forecasts.
- The company terminated a $50 million cash-flow hedge during Q3 after the forecasted hedged transaction was deemed no longer probable. It reclassified $398,000 of realized losses from accumulated other comprehensive income to earnings and recorded a $514,000 termination-related loss in other operating expenses.
- The company repurchased 46,838 shares in Q3 at an average $22.82 per share. The board declared a $0.19-per-share dividend payable November 8, 2021.
- A long-running securities class action remains pending. The Third Circuit affirmed permission to file a third amended complaint in September 2021; motions to dismiss remained pending. The company says it will defend itself and cannot reasonably estimate a possible loss or range.
- The company had not yet adopted the expected-credit-loss standard (ASU 2016-13), with adoption planned for periods beginning after December 15, 2022. Management anticipated the allowance may increase, but said the eventual impact depends on portfolio and economic conditions.
Investor verification priorities
- Check whether PPP forgiveness and recognition of the remaining $8.6 million of deferred fees support future net interest income as PPP balances run off.
- Track deposit composition and retention, excess liquidity, loan growth excluding PPP, and whether net interest margin stabilizes or continues to compress.
- Review credit trends, especially nonaccrual and classified loans, commercial real estate concentrations, charge-offs, and the adequacy of the allowance after COVID-related reserves were fully released.
- Assess the durability of earnings excluding securities gains and other period-specific items, including the hedge termination loss and mortgage servicing-right valuation changes.
- Monitor the SEPTA litigation, adoption planning and allowance impact of ASU 2016-13, and actual results against management’s interest-rate sensitivity assumptions.