Business context and reporting period
Orrstown Financial Services, Inc. is a Pennsylvania-based bank holding company operating Orrstown Bank and wealth-advisory subsidiary Wheatland. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods. Results reflect the October 2018 Mercersburg acquisition and Hamilton Bancorp, acquired May 1, 2019; Hamilton’s results are included from the acquisition date.
Financial performance and condition
| Metric | Q2 2019 | Six months 2019 |
|---|---|---|
| Net interest income | $18.4 million, up 49% year over year | $33.1 million, up $9.1 million year over year |
| Net interest margin, taxable-equivalent | 3.61%, versus 3.32%; 3.31% excluding purchase-accounting impact | 3.52%, versus 3.29%; 3.33% excluding purchase-accounting impact |
| Net income | $2.7 million, versus $4.0 million | $5.8 million, versus $7.6 million |
| Diluted EPS | $0.26, versus $0.48 | $0.58, versus $0.92 |
| Noninterest income | $7.9 million, including $2.1 million securities gains | $13.1 million, including $2.4 million securities gains |
| Noninterest expense | $23.3 million, including $6.9 million merger costs | $39.5 million, including $7.5 million merger costs and a $0.6 million insurance-claim write-off |
| Operating cash flow | $5.8 million for the first half, versus $13.9 million in 2018 |
At June 30, 2019, total assets were $2.40 billion, loans $1.60 billion, deposits $2.02 billion, and shareholders’ equity $219.9 million. Cash and cash equivalents were $116.9 million. Short-term borrowings were $9.4 million, long-term debt $83.3 million, and subordinated notes $31.8 million. The allowance for loan losses was $14.5 million, or 0.90% of loans.
First-half investing cash flow was positive $63.1 million, including $29.4 million of net cash received from acquisitions and substantial securities-sale proceeds. Financing cash flow was negative $40.8 million, including debt repayments. The Bank was reported well capitalized: total risk-based capital was 13.0%, CET1 was 12.1%, and Tier 1 leverage was 8.6%.
Material changes versus comparable periods
- First-half net interest income increased, supported by acquired and organically grown loans, higher asset yields, and purchase-accounting accretion. Deposit costs and other interest expense also rose; interest expense was $10.8 million versus $5.6 million.
- Reported earnings fell despite higher net interest income and securities gains, principally amid merger-related and expanded operating costs. First-half net income also included the $615,000 write-off of an insurance receivable after an insurer denied a claim related to a 2018 cybersecurity incident.
- Loans grew $354.0 million and deposits $456.8 million from year-end, substantially reflecting acquisitions. Hamilton added approximately $335 million of loans and contributed most of the reported deposit growth.
- Shareholders’ equity rose $46.4 million, including $36.6 million of stock issued for Hamilton and $6.4 million of after-tax improvement in accumulated other comprehensive income.
- Nonperforming loans were 0.27% of loans versus 0.41% at year-end. Total nonperforming and other risk assets rose to $7.9 million from $6.5 million, principally because of acquired loans 90 days past due and still accruing.
Outlook, risks, contingencies, and unusual items
The filing provides no numerical earnings or growth guidance. Management said competition was strong and organic loan growth had slowed relative to prior years. It expects continued integration and acquisition-related execution to affect results; achieving anticipated merger savings and synergies, and their timing, are uncertain. Management identified interest-rate movements, credit quality, economic conditions, securities-market volatility, competition, and litigation as risks. Rate-sensitivity analysis indicated better positioning in moderately rising rates than in substantially rising or falling rates; modeled net interest income changed by negative 2.1% for a 100-basis-point decline and positive 1.1% for a 100-basis-point increase.
Hamilton acquisition fair values remain preliminary and subject to refinement. The company is implementing the expected-credit-loss standard and cannot yet reasonably estimate its adoption impact; the FASB had proposed a possible delay for smaller reporting companies, which the company was evaluating. A long-running securities class action remains pending: SEPTA sought leave to file a third amended complaint, and deposition discovery was stayed pending a decision. The company disputes the allegations and said potential losses cannot presently be reasonably estimated.
After quarter-end, the company reported selling approximately $18 million of securities at a net gain of approximately $2.3 million. The board declared a $0.15-per-share dividend payable August 12, 2019.
Important facts for investors to verify
- Whether the Hamilton integration delivers expected cost savings and revenue or funding benefits, and how merger costs trend after this quarter.
- How much earnings and net interest margin depend on purchase-accounting accretion and securities gains, versus recurring operations.
- Loan quality and reserve adequacy as acquired and organic lending expand, particularly acquired past-due loans and concentrations in commercial real estate and business lending.
- Deposit pricing, funding costs, liquidity, and capital ratios as the combined balance sheet grows.
- Developments in the SEPTA litigation, the cybersecurity-related insurance matter, and implementation of the credit-loss accounting standard.