Orrstown Financial Services, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The company is a Pennsylvania-based bank holding company operating Orrstown Bank, with 25 offices in Pennsylvania and Maryland. Amounts below are in millions of dollars unless otherwise noted.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $9.23 | $8.71 | $26.84 | $25.63 |
| Provision for (recovery of) loan losses | $0.25 | $(0.60) | $0.25 | $(0.60) |
| Noninterest income | $4.57 | $4.83 | $14.77 | $15.08 |
| Noninterest expense | $11.99 | $11.22 | $35.66 | $33.39 |
| Net income | $1.44 | $2.46 | $4.70 | $6.43 |
| Diluted EPS | $0.18 | $0.30 | $0.58 | $0.79 |
- Q3 net interest income rose 6.0% year over year; fully tax-equivalent net interest margin was 3.14%, up 3 basis points. For the nine-month period, fully tax-equivalent net interest income rose 5.5% and margin fell 4 basis points to 3.12%.
- Q3’s decline in earnings reflected a $250,000 loan-loss provision versus a $603,000 provision recovery a year earlier, higher operating expenses and lower noninterest income. Nine-month earnings also included a $1.0 million SEC civil penalty, expensed in Q2.
- Q3 efficiency ratio worsened to 83.2% from 79.6%; the nine-month ratio improved to 82.7% from 83.3%. Dividends were $0.09 per share in Q3 and $0.26 per share for nine months.
Financial position, cash flow and capital
- At September 30, total assets were $1.354 billion, up $61.3 million from year-end 2015. Loans were $847.1 million, up $65.3 million (8.4%), with commercial real estate the largest source of growth. Available-for-sale securities were $374.9 million, down $19.2 million.
- Deposits grew $101.2 million (9.8%) to $1.133 billion. Short-term borrowings declined $46.3 million to $42.9 million; long-term debt was $24.2 million. Cash and cash equivalents were $37.6 million, up $9.3 million from year-end.
- For the first nine months, operating cash flow was $10.3 million, investing cash outflow was $53.0 million and financing cash inflow was $51.9 million. Loan growth and purchases of premises and equipment were major investing uses; deposit growth funded much of the activity.
- Shareholders’ equity was $139.8 million. The Bank remained classified as well capitalized: total risk-based capital was 13.4%, CET1 was 12.1%, and Tier 1 leverage was 8.5%. Management reported the company and Bank met applicable capital requirements.
- Unrealized gains on available-for-sale securities increased accumulated other comprehensive income to $5.1 million from $1.2 million at year-end; Q3 other comprehensive loss was $2.3 million, reflecting a securities valuation decline during the quarter.
Credit quality, changes and unusual items
- Nonperforming assets were $14.3 million, or 1.05% of assets, versus $17.3 million and 1.34% at year-end 2015. Nonaccrual loans were $13.6 million; the allowance for loan losses was $13.85 million, or 1.64% of loans and 102.2% of nonaccrual loans.
- Classified loans were $24.5 million, about 2.9% of loans, compared with $25.3 million, or 3.2%, at year-end. One non-owner-occupied commercial real estate relationship of $6.1 million moved into impaired status; a $650,000 specific reserve was recorded. The company cautioned that loan growth could require additional provisions.
- The company sold its GSE commercial mortgage obligation portfolio in Q1, recording $1.42 million in securities gains, and used proceeds to support lending and reduce short-term borrowings. In Q3 it purchased $63.2 million of securities, primarily GSE CMOs.
- The SEC investigation into accounting and related matters for 2010–2011 was settled September 27, 2016. The company and certain current and former executives agreed to cease and desist and pay civil penalties; the company’s $1.0 million penalty had already been accrued and was paid in Q3. The settlement was without admitting or denying the SEC’s findings.
- A putative securities class action brought by SEPTA remains pending at the pleading stage after a second amended complaint and defendants’ motions to dismiss. The company disputes the claims; possible losses cannot currently be reasonably estimated.
Outlook, commentary and risks
- No numerical earnings or growth guidance is provided. Management described loan growth opportunities from market activity and expanded relationship-management capacity, while identifying plans to grow balance-sheet and fee-based business, reduce risk assets and mitigate losses as forward-looking objectives, not assurances.
- Management cited a slow and uncertain economic recovery, market volatility, a flattening yield curve, competitive pressure on loan pricing and potential changes in interest rates. The company’s interest-rate simulations estimated next-12-month net interest income would decline 1.9% with a 100-basis-point rate decrease and 0.8% with a 200-basis-point increase. Estimated balance-sheet value would fall 1.3% with a 100-basis-point decrease and rise 6.0% with a 200-basis-point increase.
- Other material exposures include commercial real estate and construction lending concentrations, credit quality and collateral valuation, deposit and funding costs, securities-market values, litigation, and regulatory requirements. Management said disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether loan growth and commercial real estate exposure remain manageable, particularly the $6.1 million impaired relationship and the adequacy of the allowance.
- Whether deposit growth, funding costs and loan pricing sustain net interest income and margin as rates and competition change.
- The continuing status and potential financial impact of the SEPTA litigation; the filing does not provide a reasonably estimable loss range.
- How recurring earnings develop excluding the $1.0 million SEC penalty, securities gains and the prior-year loan-loss recovery.
- Whether securities valuations, capital ratios and liquidity remain resilient under changing interest-rate and economic conditions.