Orrstown Financial Services, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Orrstown is a community bank holding company operating primarily in Pennsylvania and Maryland. Unless noted otherwise, financial amounts below are in millions.
Financial performance and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $20.8 | $18.5 | $39.1 | $33.3 |
| Net income | $6.4 | $2.7 | $11.4 | $5.8 |
| Diluted EPS | $0.58 | $0.26 | $1.04 | $0.58 |
| Net interest margin, taxable-equivalent | 3.37% | 3.63% | 3.39% | 3.54% |
| Provision for loan losses | $1.9 | $0.2 | $2.8 | $0.6 |
| Noninterest income | $7.2 | $7.8 | $14.3 | $12.9 |
| Noninterest expense | $18.4 | $23.3 | $36.7 | $39.5 |
At June 30, total assets were $2.77 billion, loans $2.04 billion, deposits $2.25 billion, and shareholders’ equity $225.6 million. Cash and cash equivalents were $52.3 million. Outstanding borrowings included $202.8 million of FHLB advances and other borrowings, $23.7 million of repurchase agreements, and $31.9 million of subordinated notes. The Bank was classified as well capitalized; its total risk-based capital ratio was 13.9% and Tier 1 leverage ratio was 8.4%.
For the first half, operating cash flow was $6.9 million, investing cash flow provided $68.9 million, and financing activities used $79.4 million; cash and cash equivalents declined $3.7 million. The Company reported $843 million of FHLB borrowing capacity, $55.7 million of unencumbered investment securities, and $424.9 million of remaining PPPLF availability.
Material changes and drivers
- Loans increased $397.0 million from year-end, principally reflecting $447.2 million of SBA Paycheck Protection Program loans, net of deferred fees. Total deposits rose $376.2 million, partly from PPP-related balances and customers seeking liquidity amid the pandemic. Management expected associated deposits and borrowings to decline significantly into Q1 2021 as funds were used and loans forgiven.
- Year-over-year earnings benefited from higher net interest income, lower interest expense, and the absence of 2019 merger costs. The 2019 Hamilton acquisition also affects comparability. Q2 2020 had no merger-related expense versus $6.9 million in Q2 2019; first-half amounts were zero versus $7.5 million.
- Noninterest income excluding securities gains rose to $7.2 million in Q2 from $5.7 million, including stronger mortgage banking, swap fees, and $0.9 million of gains on classified-loan sales. First-half noninterest income likewise benefited from $2.8 million in portfolio-loan sale gains. In contrast, 2019 included investment-securities gains of $2.1 million in Q2 and $2.4 million for the first half.
- Net interest margin compressed year over year as market rates and loan yields declined. Q2 loan yield was 4.43%, versus 5.30% a year earlier. Lower funding costs partly offset the decline.
- Provision expense increased to reflect COVID-19-related qualitative reserve adjustments and commercial loan downgrades. The allowance for loan losses was $17.5 million, or 0.86% of loans; excluding SBA-guaranteed loans, the allowance was 1.11% of unguaranteed loans.
Outlook, risks, contingencies, and unusual items
- The filing provides no formal earnings or revenue guidance. Management cautioned that COVID-19 effects, economic conditions, interest rates, credit quality, and financial-asset valuations could materially affect future results and estimates.
- Credit indicators included $7.4 million of nonaccrual loans, 0.36% of gross loans, and $24.9 million of classified loans. Special Mention loans rose $63.8 million from year-end, primarily from commercial downgrades, especially in hospitality. The Bank had processed payment deferrals on $218.1 million of commercial and $21.2 million of consumer loans; these modifications were treated as exempt from TDR status under applicable guidance. Management warned that further loan-loss provisions may be needed.
- COVID-19-related low rates increased mortgage refinancing and mortgage-banking activity, but also drove $820,000 of first-half mortgage-servicing-right impairment charges. Unrealized losses on available-for-sale securities totaled $4.5 million; management reported no cumulative OTTI and said it did not intend, or expect to be required, to sell the affected securities before recovery.
- Wheatland Advisors’ operations were discontinued effective July 31, 2020. The Company recorded a $153,000 impairment of a customer-list intangible related to the pending dissolution.
- A long-running SEPTA securities class action remains active. The court allowed a third amended complaint; defendants’ motions to dismiss were pending, and an interlocutory appeal petition had been filed. The Company disputes the allegations, but said a reasonably possible loss or loss range cannot currently be estimated. A separate Hamilton-merger action settled for $135,000 in mootness fees in April 2020.
- The Company delayed adoption of the expected-credit-loss standard (CECL) to the applicable 2023 effective date for smaller reporting companies. It anticipates the allowance may increase upon adoption, but the impact is not yet determined.
Most important facts for investors to verify
- How PPP forgiveness, fee recognition, and runoff of related deposits and PPPLF funding affect earnings, liquidity, and balance-sheet growth.
- Whether COVID-19 deferrals—particularly in hospitality, restaurants, multifamily, and other exposed categories—convert into delinquencies, downgrades, or credit losses.
- Whether the allowance and its qualitative assumptions remain adequate as economic conditions and borrower performance evolve.
- Underlying earnings and margins excluding temporary PPP fees, loan-sale gains, mortgage refinancing gains, and the prior-year merger-cost comparison.
- Developments in the SEPTA litigation, including any material change in the potential exposure or ability to estimate losses.
- Effects of the Wheatland discontinuation and the eventual CECL adoption on reported results and capital.