Orrstown Financial Services, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Amounts are in millions of dollars except per-share data and ratios. Results include Mercersburg from October 2018 and Hamilton from May 1, 2019, limiting comparability with 2018.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $17.920 | $12.704 | $51.041 | $36.741 |
| Provision for loan losses | $0.300 | $0.200 | $0.900 | $0.600 |
| Noninterest income | $8.782 | $5.492 | $21.888 | $16.699 |
| Noninterest expense | $18.161 | $13.336 | $57.657 | $39.677 |
| Net income | $6.901 | $4.016 | $12.690 | $11.653 |
| Diluted EPS | $0.62 | $0.49 | $1.23 | $1.41 |
| Taxable-equivalent net interest margin | 3.27% | 3.28% | 3.43% | 3.29% |
Q3 net income rose about 72%; nine-month net income increased about 9%, while diluted EPS fell as the share count rose, including shares issued for Hamilton. Noninterest income included securities gains of $2.328 million in Q3 and $4.731 million year to date. Excluding securities gains, noninterest income was $6.454 million in Q3 and $17.157 million for nine months.
Balance sheet, cash flow, and capital
- At September 30, total assets were $2.314 billion, up from $1.934 billion at December 31, 2018. Loans were $1.593 billion, up $345.4 million; deposits were $1.923 billion, up $364.7 million. Hamilton was a major contributor to both increases.
- Cash and cash equivalents were $50.9 million, down from $88.8 million at year-end. For the first nine months, operating cash flow was $3.5 million versus $15.1 million in 2018; investing activities provided $87.5 million, while financing activities used $128.9 million.
- Short-term borrowings were $36.6 million, long-term debt $63.2 million, and subordinated notes $31.8 million, totaling $131.6 million versus $179.4 million at year-end. The company issued $32.5 million of 6.0% subordinated notes in December 2018.
- Shareholders’ equity was $223.5 million. The Bank was reported well capitalized; its total risk-based capital ratio was 13.6% and Tier 1 leverage ratio 8.9%.
Material changes, commentary, and risks
- Loan growth and acquisitions increased interest income, but deposit costs and other funding expenses also rose. Q3 margin was essentially flat year over year; excess cash of about $70 million during the quarter reduced margin by an estimated 11 basis points. Management cited a flattened yield curve and 2019 rate cuts as offsets to prior rate increases.
- Q3 noninterest expenses included $0.471 million of merger costs. Nine-month expenses included $7.976 million of merger costs and a $0.615 million write-off of an insurance claim receivable related to a 2018 cybersecurity incident. Management attributed higher operating costs largely to acquired and expanded operations.
- Asset-quality indicators weakened from year-end: nonperforming loans were 0.44% of loans versus 0.41%; total nonperforming and other risk assets rose to $11.6 million from $6.5 million. Management said much of the increase in loans 90 days or more past due but still accruing related to acquired Mercersburg and Hamilton loans. The allowance was $14.8 million, or 0.93% of loans, and the nine-month provision was $0.9 million.
- Management said loan growth may require additional future provisions. The company anticipated that adoption of the expected-credit-loss standard would increase the allowance, but the amount was not clear; it was evaluating the delayed implementation timeline for smaller reporting companies.
- In October 2019, the Board approved consolidation of five Pennsylvania branches and sale of an operations center, subject to regulatory approval. The company estimated one-time charges of $0.8–$1.2 million and annual savings of $1.5–$2.0 million beginning in Q2 2020; completion was anticipated in Q1 2020. These are estimates, not reported results.
- A long-running securities class action remained pending. A motion to file a further amended complaint was unresolved, and deposition discovery was stayed. The company disputed the allegations and said a reasonably possible loss or range could not be estimated.
- No specific earnings guidance was provided. Management identified acquisition integration, competition and loan growth, interest-rate movements, credit quality, economic conditions, securities-market volatility, and litigation costs as risks.
Important facts for investors to verify
- How much reported earnings growth is sustainable after excluding securities gains, acquisition-related purchase-accounting accretion, tax benefits, and merger or other unusual costs.
- Whether Hamilton integration, loan origination, deposit funding costs, and the elevated acquired-loan delinquencies develop as management expects.
- Future credit-loss provisions and the eventual allowance impact and implementation timing of the expected-credit-loss accounting standard.
- Regulatory approval, final charges, timing, and realized savings from the announced branch consolidations and operations-center sale.
- Developments in the pending litigation and any change in the company’s ability to estimate potential exposure.