Orrstown Financial Services, Inc. — FY 2019 Form 10-K
Reporting period: Year ended December 31, 2019; filed March 16, 2020. Unless stated otherwise, financial amounts below are in U.S. dollars and millions. Fourth-quarter figures are unaudited. Orrstown is a community banking and financial services company operating in south-central Pennsylvania and Maryland, with commercial banking, lending, deposits, trust and investment services.
Financial performance and position
- Revenue and earnings: Net interest income was $69.3 million, up 32.9% from $52.2 million in 2018. Total noninterest income, including securities gains, was $28.5 million, versus $21.0 million. Net income rose to $16.9 million from $12.8 million; diluted EPS increased to $1.61 from $1.50.
- Margins and returns: Taxable-equivalent net interest margin was 3.43%, compared with 3.36% in 2018; excluding purchase-accounting accretion, it was 3.22% versus 3.33%. Return on average assets was 0.76% (0.75% in 2018) and return on average equity was 8.21% (8.56%).
- Expenses and unusual items: Noninterest expense increased 33.4% to $77.3 million, including $9.0 million of merger and branch-consolidation expense and a $615,000 write-off of an insurance claim receivable. Investment securities gains were $4.7 million, up from $1.0 million. Effective tax rate was 13.8%, versus 11.4%.
- Fourth quarter: Net income was $4.2 million and diluted EPS was $0.38, compared with $1.2 million and $0.12 in fourth-quarter 2018. Fourth-quarter 2019 included $988,000 of branch-consolidation costs; provision for loan losses was zero.
- Balance sheet: Total assets were $2.38 billion, up from $1.93 billion. Loans were $1.64 billion (up 31.8%); deposits were $1.88 billion (up 20.3%); and shareholders’ equity was $223.2 million (up 28.7%). Hamilton, acquired in May 2019, accounted for most of the loan growth; organic deposit growth was also reported.
- Credit quality: The allowance for loan losses was $14.7 million, or 0.89% of loans, compared with $14.0 million and 1.12% a year earlier. Nonperforming assets increased to $10.9 million from $5.3 million; nonperforming loans were 0.65% of loans versus 0.41%. Management attributed much of the increase to one commercial loan downgraded to nonaccrual in the fourth quarter. Net charge-offs were $259,000.
- Cash flow and liquidity: Operating cash flow was $9.1 million, down from $22.5 million. Cash and cash equivalents ended the year at $56.5 million, versus $88.8 million. Available-for-sale securities, net of pledges, provided $331.7 million of additional liquidity; reported additional FHLB borrowing availability was $540.7 million. Outstanding loan commitments were $477.2 million.
- Funding and capital: Year-end short-term borrowings were $154.9 million, long-term debt $63.1 million and subordinated notes $31.8 million. The $32.5 million subordinated notes bear fixed interest at 6.0% through December 2023, then float at three-month LIBOR plus 3.16%. The Bank’s total risk-based capital ratio was 13.4%, CET1 ratio 12.5% and leverage ratio 9.4%; it was categorized as well capitalized and exceeded the 2.5% capital conservation buffer.
Material changes versus prior year
- Hamilton Bancorp’s May 2019 acquisition expanded Orrstown into the greater Baltimore market. Orrstown issued 1.77 million shares and paid $14.2 million cash; acquired deposits were $388.2 million and loans $347.4 million. The acquisition increased the share count and affected year-over-year comparability.
- Interest income growth from larger loan and securities balances was partly offset by higher funding costs. The Federal Reserve cut rates three times in 2019; competitive deposit pricing and deposit mix limited the decline in deposit costs.
- Five Pennsylvania branches were consolidated in January 2020. The Company also planned to sell/lease back an operations-center facility, with completion anticipated in the second quarter of 2020.
- Cash dividends per share increased to $0.60 for 2019 from $0.51 for 2018. A $0.17 per-share dividend declared in January 2020 was paid in February.
Outlook, risks and contingencies
- No specific numerical earnings or growth guidance is provided. Management described continued growth in targeted markets and loan demand as objectives, while noting that competition, a flatter yield curve and deposit pricing could pressure margins and operating leverage.
- Management reported that the coronavirus outbreak had created substantial economic uncertainty in early 2020. The Federal Reserve had made an emergency 50-basis-point rate cut; the filing stated that the outlook remained uncertain.
- Key risks include credit deterioration, commercial real estate and commercial lending exposures, interest-rate and securities valuation changes, acquisition integration and goodwill, deposit competition, cybersecurity, regulatory requirements and the planned LIBOR transition. Orrstown had not adopted the expected-credit-loss standard (CECL); it elected the extended deadline, no later than January 1, 2023, and anticipated the allowance could increase upon adoption.
- The long-running SEPTA securities litigation had advanced to a third amended complaint following a February 2020 court order. Orrstown disputed the allegations and intended to defend itself; it could not reasonably estimate a possible loss or range. A separate putative shareholder suit related to the Hamilton merger was also disclosed, with the Company stating it intended to defend the claims.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management’s internal-control assessment excluded Hamilton’s operations from its scope.
Important facts for investors to verify
- How much of earnings growth was recurring versus driven by acquisition accounting, securities gains and other nonrecurring items; compare reported and purchase-accounting-adjusted margin.
- Whether the increase in nonaccrual loans and past-due balances continues, especially the commercial relationship identified as the main fourth-quarter deterioration, and whether the allowance remains adequate.
- Hamilton integration progress, remaining fair-value adjustments, cost savings and the acquired franchise’s contribution to earnings and deposits.
- Deposit retention and repricing, near-term time-deposit maturities, borrowing needs and liquidity available after collateral pledges and loan commitments.
- Developments in the SEPTA and Hamilton merger litigation, the financial effect of branch consolidation and facility disposition, and the eventual CECL allowance and capital impact.