Orrstown Financial Services, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. The company is a Pennsylvania-based community banking holding company operating in south-central Pennsylvania and northern Maryland.
Financial performance and position
Unless otherwise indicated, amounts are in millions of dollars.
| Metric | Q1 2018 / March 31, 2018 | Comparison |
|---|---|---|
| Net income | $3.625; diluted EPS $0.44 | $2.002; diluted EPS $0.24 in Q1 2017 |
| Net interest income | $11.684 | Up 14.1% from $10.237 |
| Taxable-equivalent net interest margin | 3.26% | 3.35% in Q1 2017 |
| Noninterest income | $5.702 | $4.335; includes $0.816 securities gains versus $0.003 |
| Noninterest expense | $13.069 | Up 7.6% from $12.146 |
| Efficiency ratio | 77.1% | Improved from 79.7% |
| Provision for loan losses | $0.200 | $0 in Q1 2017 |
| Total assets | $1,635.906 | $1,558.849 at December 31, 2017 |
| Loans | $1,044.114 | Up $34.102, or 3.4%, since year-end |
| Deposits | $1,299.514 | Up $79.999, or 6.6%, since year-end |
| Cash and cash equivalents | $30.172 | $29.807 at year-end |
| Short-term borrowings / long-term debt | $93.731 / $83.725 | $93.576 / $83.815 at year-end |
| Shareholders’ equity | $142.556 | Down $2.209 since year-end |
Operating cash flow was $4.959 million; investing activities used $83.427 million, principally reflecting securities purchases and loan growth; financing activities provided $78.833 million, mainly from deposit growth and borrowings. Cash and cash equivalents increased $0.365 million during the quarter.
The allowance for loan losses was $13.000 million, or 1.25% of loans, compared with $12.796 million, or 1.27%, at year-end. Nonperforming assets were $10.473 million (0.64% of assets); nonaccrual loans were $9.144 million. Total nonperforming and other risk assets were $11.639 million, down from $11.987 million at year-end but above $8.319 million a year earlier. Net recoveries were $0.004 million in Q1 2018.
The Bank was classified as well capitalized. At March 31, the Bank’s total capital ratio was 13.0%, Tier 1 risk-based ratio 11.8%, CET1 ratio 11.8%, and Tier 1 leverage ratio 8.7%. The company paid $0.12 per share in Q1; a $0.13 per-share dividend was declared in April and paid May 2.
Material changes and management commentary
- Net income rose 81% year over year. Higher loan and securities balances and yields lifted interest income, while interest expense also increased by $0.998 million as deposit and borrowing costs rose.
- Loan growth was broad-based; commercial and industrial loans increased $12.413 million and commercial/land development loans increased $10.752 million from year-end. Management cited growth in legacy and newer markets, while noting strong competition may affect future loan growth.
- Noninterest income before securities gains increased 12.8%, supported by trust, brokerage and mortgage banking activity. The $0.816 million securities gain reflected portfolio repositioning and is an unusual contributor to reported income.
- Expenses increased 7.6%, with salaries and benefits, equipment, data processing, and communications among the increases. Management attributed costs in part to branch and sales-force expansion. It said income growth outpaced expense growth, improving the efficiency ratio.
- Shareholders’ equity fell despite net income, principally because of a $5.083 million after-tax decline in accumulated other comprehensive income, reflecting unrealized losses on available-for-sale securities, and $1.000 million in declared dividends.
Outlook, risks and contingencies
- No specific earnings or balance-sheet guidance was provided. Management described continued efforts to grow loans and fee-based revenue, expand commercial relationships and manage risk assets.
- Interest-rate modeling indicated the company was better positioned for a moderately rising-rate environment than for larger rate increases or falling rates. A 100-basis-point increase was modeled to reduce next-12-month net interest income by 1.8%; a 200-basis-point increase by 5.6%. Results depend on assumptions about repricing, deposit sensitivity and prepayments.
- Credit risks include commercial real estate, construction/development and business lending, as well as geographic concentration in the company’s regional markets. Management cautioned that loan growth could require additional future provisions. The allowance and credit estimates are judgmental and may change with economic conditions and new information.
- Unrealized losses on available-for-sale securities were $5.912 million at March 31, versus $3.894 million at year-end. Management attributed losses primarily to market spreads and interest rates and said it did not intend, and was not more likely than not required, to sell the securities before cost recovery.
- Off-balance-sheet commitments included $334.297 million to fund credit and $13.806 million of standby letters of credit. These amounts are contractual limits, not expected cash outflows; the reserve for unfunded credit exposures was $0.832 million.
- A long-running securities class action brought by SEPTA remains pending. The court had allowed certain Exchange Act claims to proceed against the company, the Bank and named individuals; deadlines were continued pending further court direction. The company said it considers the claims without merit and will defend them, but could not reasonably estimate a loss or range. Separately, the company’s 2016 SEC settlement included a $1 million civil penalty, previously reserved and expensed.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during Q1. It said there were no material changes to the risk factors disclosed in its 2017 Form 10-K.
Important facts for investors to verify
- How sustainable earnings are excluding the $0.816 million securities gain, and whether loan and fee growth offsets higher deposit funding costs and operating expenses.
- Future net interest margin and deposit pricing sensitivity as rates change; assess the assumptions behind the company’s interest-rate simulations.
- Credit performance in commercial real estate, construction/development and commercial and industrial portfolios, including nonperforming assets, criticized loans and allowance adequacy.
- Potential fair-value and capital effects from further securities-market declines, alongside the pace and funding of loan growth.
- Developments in the SEPTA litigation, including revised case deadlines and any potential financial exposure not currently estimable.
- Implementation effects of expected accounting changes, especially the credit-loss standard scheduled for 2020 and lease accounting scheduled for 2019.