Orrstown Financial Services, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Orrstown is a Pennsylvania-based financial holding company operating a community bank and investment-advisory businesses, including Wheatland Advisors, acquired in December 2016. Amounts below are in U.S. dollars; “$ million” figures are rounded.
Financial performance and position
- Q3 earnings: Net income was $2.77 million, versus $1.44 million a year earlier; diluted EPS was $0.34 versus $0.18. Nine-month net income was $8.08 million versus $4.70 million, and diluted EPS was $0.98 versus $0.58.
- Revenue and margin: Q3 net interest income rose 20% to $11.08 million; nine-month net interest income increased 19.4% to $32.04 million. Taxable-equivalent net interest margin was 3.31% in Q3 (3.14% in Q3 2016) and 3.34% for nine months (3.12% in 2016). Noninterest income was $5.26 million in Q3 and $15.21 million year to date, including securities gains of $0.53 million and $1.19 million, respectively.
- Expenses and profitability: Noninterest expense increased 9.2% to $13.09 million in Q3 and 5.6% to $37.65 million for nine months. The efficiency ratio improved to 79.4% from 83.2% in Q3 and to 78.4% from 82.7% year to date. Effective tax rates were 11.9% for Q3 and 14.0% for nine months.
- Balance sheet at September 30: Total assets were $1.534 billion, up from $1.415 billion at year-end 2016. Loans were $981.2 million, up 11.1%; deposits were $1.217 billion, up 5.6%. Shareholders’ equity was $144.4 million, compared with $134.9 million at year-end.
- Funding and liquidity: Cash and cash equivalents were $22.5 million, down from $30.3 million at year-end. Short-term borrowings were $91.6 million versus $87.9 million, and long-term debt was $63.9 million versus $24.2 million. Nine-month operating cash flow was $9.3 million; investing used $122.5 million and financing provided $105.4 million. Deposit growth and $60 million of long-term debt proceeds helped fund loan and investment growth.
- Credit and capital: Allowance for loan losses was $12.8 million, or 1.30% of loans. Nonaccrual loans were $5.25 million; nonperforming assets were $6.51 million, or 0.42% of assets. Classified loans totaled $21.3 million, 2.2% of loans. The Bank was reported well capitalized; its CET1 ratio was 11.9% and total capital ratio 13.1%.
Material changes versus comparable periods
- Loan and securities balances and yields supported higher net interest income; management cited loan growth and a rising-rate environment. The average cost of interest-bearing liabilities also rose, to 0.68% in Q3 from 0.56%.
- Trust and investment-management income increased, with Wheatland contributing to growth. Mortgage banking income declined as refinancing slowed, margins compressed, and some production was retained in the loan portfolio.
- Q3 securities gains included a portfolio repositioning intended to improve responsiveness to short-term rate increases. Nine-month 2017 securities gains were lower than in 2016; the prior-year period included a $1.0 million SEC settlement expense, absent in 2017.
- Higher staffing, benefit, facilities, and legal costs contributed to expense growth. Nonaccrual loans and total risk assets were lower than a year earlier, although OREO increased to $1.26 million from $0.35 million at year-end 2016.
Outlook, commentary, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management describes plans to grow commercial lending and fee-based businesses, expand in core and new markets, and diversify the loan portfolio. It cautions that actual results may differ and that loan growth could require additional loan-loss provisions.
- Interest-rate exposure is material. Modeling indicated net interest income would decline 7.3% under a 100-basis-point rate decrease and 1.4% under a 100-basis-point increase; management said the company was better positioned for rising than falling rates. These estimates depend on assumptions about repricing, prepayments, and deposit behavior.
- Credit, geographic, and concentration risks include commercial real estate, construction and development, and commercial lending in south-central Pennsylvania and northern Maryland. The allowance is based on estimates that may change with economic conditions and borrower performance.
- The SEPTA securities class action remains pending. The company intends to defend the claims, but says reasonably possible losses cannot currently be estimated. It recorded $553,000 of related indemnification costs in the first nine months of 2017 ($508,000 in Q3); additional costs may arise. A separate SEC settlement in 2016 included a $1.0 million penalty already expensed.
- The Board declared a $0.12-per-share dividend payable November 15, 2017. The company reported effective disclosure controls and no material third-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth, especially in commercial real estate and commercial and industrial lending, is accompanied by stable credit quality and adequate allowance coverage.
- Whether deposit costs rise faster than asset yields, and how rate changes affect net interest margin and modeled interest-rate sensitivity.
- How recurring earnings develop excluding securities gains, and whether higher staffing, expansion, and litigation expenses persist.
- Progress and potential indemnification or other costs in the SEPTA litigation, for which the company has not estimated a loss range.
- Funding and liquidity needs as loans grow, including the use of borrowings and the company’s ability to maintain regulatory capital buffers.