Orrstown Financial Services, Inc. — FY 2015 Form 10-K
Business and period: Annual report for the fiscal year ended December 31, 2015, filed March 11, 2016. Orrstown is a Pennsylvania bank holding company whose subsidiary, Orrstown Bank, serves south-central Pennsylvania and Washington County, Maryland. The Bank operates 22 offices and offers commercial, residential and consumer lending, deposits, and trust and investment services.
Financial performance and condition
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Net interest income | $34.3 million | $34.0 million |
| Net interest margin, fully tax-equivalent | 3.14% | 3.20% |
| Noninterest income, including securities gains | $19.2 million | $18.9 million |
| Noninterest expense | $44.6 million | $43.8 million |
| Income before taxes | $9.5 million | $13.0 million |
| Net income | $7.9 million | $29.1 million |
| Diluted earnings per share | $0.97 | $3.59 |
| Operating cash flow | $12.2 million | $17.3 million |
- FY 2015 net income fell 73% year over year. The comparison is significantly affected by a $16.2 million deferred-tax valuation-allowance benefit recorded in 2014; 2015 included $1.6 million of income tax expense. The 2015 effective tax rate was 17.2%.
- Net interest income on a fully tax-equivalent basis rose 1.4%, mainly from higher average loan balances, while net interest margin declined six basis points. The efficiency ratio worsened to 83.5% from 83.0%.
- Total assets were $1.293 billion, up from $1.190 billion; loans grew 10.9% to $781.7 million. Deposits rose 8.7% to $1.032 billion. Shareholders’ equity increased to $133.1 million from $127.3 million.
- The allowance for loan losses was $13.6 million, or 1.74% of loans, down from $14.7 million, or 2.09%. Net charge-offs were $576,000, compared with $2.3 million in 2014; the company recorded a $603,000 negative provision, principally reflecting recovery of a previously charged-off loan.
- Risk assets totaled $18.1 million, up from $16.5 million. Nonperforming assets were $17.3 million, including $16.6 million of nonaccrual loans. A $6.5 million commercial real estate relationship was newly classified as impaired; management said it was well secured and no loss was anticipated.
- Cash and cash equivalents ended at $28.3 million, down $3.1 million. Investing activities used $107.3 million, primarily reflecting loan growth and securities purchases; financing activities provided $92.1 million, including deposit growth and new long-term borrowing.
- Year-end borrowings included $89.2 million of short-term borrowings and $24.5 million of long-term debt. The Bank had approximately $284.2 million of additional FHLB borrowing availability based on qualifying collateral and $30 million in unused unsecured correspondent lines. Available-for-sale securities not pledged totaled $143.7 million.
- The Bank’s year-end regulatory capital ratios were 14.0% total capital to risk-weighted assets, 12.7% Tier 1 and CET1 to risk-weighted assets, and 8.5% Tier 1 leverage; the Bank was categorized as well capitalized.
Material changes and unusual items
- Loan growth was broad-based; commercial and industrial loans increased about $24.6 million, or 50%, to $73.6 million. Noninterest-bearing deposits also increased, while average time deposits declined and brokered time deposits rose to $80.9 million at year-end from $17.1 million.
- The company resumed quarterly dividends in April 2015 after regulatory restrictions were lifted. It declared $0.22 per share for 2015 and repurchased 47,077 shares for $809,000 under a program authorizing repurchases of up to approximately 416,000 shares.
- Legal expense increased to $1.44 million from $705,000, primarily reflecting litigation and an ongoing confidential SEC fact-finding inquiry. The filing says the inquiry is not an indication that the SEC believes a violation occurred.
- Quarterly results show fourth-quarter 2015 net income of $1.45 million and diluted EPS of $0.18, versus $19.11 million and $2.36 in fourth-quarter 2014. The 2014 quarter included the substantial deferred-tax valuation-allowance recapture.
- After year-end, the company sold its GSE commercial CMO portfolio for an unaudited net gain of approximately $1.42 million. The Bank also purchased a regional office building on February 8, 2016, for $4.275 million.
Outlook, commentary and risks
Management described continued moderate growth plans, with anticipated loan growth and efforts to attract core deposits; it also said it may consider acquisitions. No specific earnings or financial guidance was provided. Management cited a flattening yield curve, intense loan competition and pressure on asset yields, and noted that the Federal Reserve raised short-term rates by 25 basis points in December 2015. The company’s modeled next-12-month net interest income declined 1.4% under a 100-basis-point rate decrease and 1.8% under a 200-basis-point increase.
Key risks include commercial real estate and commercial lending concentrations, local economic and collateral-value weakness, interest-rate and funding-cost changes, deposit retention and brokered funding, regulatory capital and liquidity requirements, and the uncertainty of loan-loss estimates. A putative securities class action brought by SEPTA remained at the pleading stage after a second amended complaint was filed in February 2016; discovery was stayed pending motions to dismiss. The company said it would vigorously defend itself and could not estimate reasonably possible losses.
Important facts for investors to verify
- Whether credit quality and the allowance remain adequate as loans grow, especially given the rise in risk assets and the newly impaired $6.5 million relationship.
- Whether the 2015 earnings trend is sustainable without the unusually large 2014 tax benefit and with the reported margin and expense pressures.
- How the company manages brokered deposits, short-term borrowing, near-term time-deposit maturities and pledged collateral while funding loan growth.
- Developments in the SEPTA litigation and confidential SEC inquiry, including any change in estimated exposure or legal costs.
- Whether capital, dividend and repurchase plans remain consistent with Basel III requirements and the company’s growth and liquidity needs.