ORRSTOWN FINANCIAL SERVICES INC quarterly report, Q3 FY2019

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

MetricQ3 2019Q3 2018Nine months 2019Nine 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 margin3.27%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.