Orrstown Financial Services, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This annual filing also reports fourth-quarter results. The Company is a Pennsylvania-based bank holding company operating Orrstown Bank and, following its December 2016 acquisition, Wheatland Advisors.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net interest income | $36.5 million | $34.3 million |
| Total noninterest income | $19.7 million | $19.2 million |
| Net income | $6.6 million | $7.9 million |
| Diluted earnings per share | $0.81 | $0.97 |
| Net interest margin | 3.14% | 3.14% |
| Return on average assets / equity | 0.50% / 4.80% | 0.64% / 5.99% |
| Net cash from operating activities | $15.6 million | $12.2 million |
- Year-end assets were $1.415 billion, up from $1.293 billion; loans increased 13.0% to $883.4 million and deposits rose 11.7% to $1.152 billion.
- Year-end shareholders’ equity was $134.9 million. Total short- and long-term borrowings were $112.0 million. Cash and cash equivalents were $30.3 million; available-for-sale securities totaled $400.2 million, of which $82.9 million was unpledged and available as a liquidity source.
- Operating cash flow was $15.6 million; investing cash flow was negative $128.9 million, largely reflecting loan growth and securities activity; financing cash flow was positive $115.2 million, principally from deposit growth.
- Regulatory capital ratios remained above applicable well-capitalized thresholds. The Bank’s total risk-based capital ratio was 13.2%, CET1 ratio 12.0%, and leverage ratio 8.4%.
Material changes and fourth-quarter results
- Net income fell 15.8% year over year. Increased net interest income and noninterest income were more than offset by higher operating expenses and the return to a loan-loss provision after releases in 2015.
- Noninterest expense increased 7.9% to $48.1 million. Salaries and benefits rose 9.6%, and data processing expense rose 17.4%, reflecting hiring, expansion, and technology investment. Expenses included a $1.0 million SEC settlement penalty.
- Credit measures improved: nonperforming and other risk assets declined 54% to $8.3 million; nonperforming assets were 0.52% of assets versus 1.34% in 2015. The allowance was $12.8 million, or 1.45% of loans, down from $13.6 million, or 1.74%.
- Fourth-quarter net income was $1.9 million, or $0.24 per diluted share, versus $1.4 million, or $0.18 per diluted share, in fourth-quarter 2015. Quarterly net interest income was $9.7 million versus $8.7 million.
- The Company sold a classified loan with a $5.9 million carrying balance for $5.1 million, recording an $846,000 charge-off. Net charge-offs for the year were $1.0 million, compared with $576,000 in 2015.
Outlook, risks, and unusual items
- Management anticipated further loan growth in 2017, with securities repayments expected to help fund lending. It also noted that competition could temper future loan growth. No quantitative earnings or revenue guidance was provided.
- Management cited a flat yield curve, competitive loan pricing, and higher deposit funding costs as pressures on profitability. Its interest-rate analysis estimated next-12-month net interest income declines of 3.3% under a 100-basis-point rate decrease and 2.5% under a 200-basis-point increase.
- Credit exposure is concentrated in commercial real estate and the Company’s South Central Pennsylvania and Washington County, Maryland markets. Commercial real estate was approximately 62% of the loan portfolio; deterioration in local conditions or major borrower relationships could raise credit losses.
- On September 27, 2016, the Company settled an SEC investigation concerning accounting and related matters for 2010–2011, agreeing to a $1.0 million penalty and a cease-and-desist order, without admitting or denying the SEC’s findings. The penalty was expensed in 2016.
- A separate SEPTA securities class action remains pending. Some claims against the Company and certain individuals survived dismissal; trial was scheduled for October 2018. The Company said it could not reasonably estimate potential losses and intends to defend the claims.
- Wheatland Advisors was acquired in December 2016; its contribution to 2016 results was modest, and purchase-price allocation was still estimated at year-end.
Important facts for investors to verify
- Whether loan growth can be sustained without weakening underwriting or increasing commercial real estate concentration and credit costs.
- Whether the allowance remains adequate as loans grow, given the decline in reserve coverage and the increase in 2016 net charge-offs.
- How deposit pricing, brokered funding, and upcoming time-deposit maturities affect funding costs and liquidity.
- The financial and legal implications of the pending SEPTA litigation, beyond the settled SEC penalty.
- Wheatland’s finalized purchase accounting, ongoing contribution, and integration costs; and the Company’s ability to manage elevated operating expenses.