Orrstown Financial Services, Inc. — 2022 Q2 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Unaudited consolidated results cover the company and its wholly owned bank subsidiary, Orrstown Bank, a community bank operating in Pennsylvania and Maryland.
Financial performance
| Metric | Q2 2022 | Q2 2021 | First half 2022 | First half 2021 |
|---|---|---|---|---|
| Net interest income | $24.1 million | $21.9 million | $46.7 million | $43.8 million |
| Provision for loan losses | $1.8 million | $0.6 million | $2.1 million | $(0.4) million |
| Noninterest income | $7.2 million | $6.7 million | $14.7 million | $14.2 million |
| Noninterest expense | $18.8 million | $17.0 million | $38.2 million | $34.8 million |
| Net income | $8.9 million | $8.8 million | $17.2 million | $19.0 million |
| Diluted EPS | $0.83 | $0.79 | $1.59 | $1.71 |
| Tax-equivalent net interest margin | 3.68% | 3.24% | 3.59% | 3.31% |
Q2 earnings were slightly higher year over year, while first-half net income and diluted EPS declined. Higher net interest income and swap fees supported results; higher loan-loss provision, compensation and other operating costs, and weaker mortgage banking income were offsets.
Balance sheet, cash flow and capital
- At June 30, total assets were $2.824 billion, versus $2.835 billion at year-end 2021. Loans were $2.018 billion, up $37.6 million; excluding SBA Paycheck Protection Program loans, management reported 11.0% loan growth in the first half.
- Deposits totaled $2.479 billion, up $13.7 million from December 31. Cash and cash equivalents were $111.9 million, down from $208.7 million; first-half investing cash outflow was $118.1 million, mainly reflecting $121.5 million of securities purchases and loan growth.
- First-half operating cash flow was $25.3 million. Financing cash outflow was $4.0 million, including $14.1 million of treasury-stock acquisitions, partly offset by deposit growth. Dividends paid were $4.2 million.
- Debt and funding included $24.3 million of repurchase agreements, $1.7 million of FHLB advances and other borrowings, and $32.0 million of subordinated notes. Total deposits were the principal funding source.
- Shareholders’ equity was $237.5 million, down $34.1 million from year-end, largely due to a $33.8 million after-tax other comprehensive loss on available-for-sale securities, dividends and share repurchases. The securities portfolio had $37.2 million of net unrealized losses at June 30, compared with $5.6 million of net unrealized gains at year-end; management attributed the change mainly to rising rates and reported no second-quarter OTTI.
- The Bank was classified as well capitalized. At June 30, its total risk-based capital ratio was 13.3% and Tier 1 leverage ratio was 9.5%; its capital conservation buffer was 5.3%, above the 2.5% requirement. The company’s total risk-based capital ratio was 13.5%.
Material changes and management commentary
- Net interest margin improved as cash was deployed into commercial loans and securities, asset yields rose, and funding costs fell. Management described the company as asset-sensitive and expected rising rates to benefit net interest income, while noting that liability costs could accelerate as rates rise further.
- Swap fee income increased to $785,000 in Q2 and $1.7 million in the first half, reflecting customer demand to lock in commercial-loan rates. Mortgage banking income fell 57% in Q2 and 64% in the first half as rising rates and low housing inventory reduced production and loan sales.
- Noninterest expense increased 10% in Q2 and 10% in the first half. Compensation was the largest driver; Q2 advertising and promotions also included a $500,000 Pennsylvania EITC contribution, associated with $450,000 of eligible tax credits.
- Credit quality measures improved from year-end: nonperforming assets were $5.4 million, or 0.19% of assets, versus $6.4 million, or 0.23%; the allowance for loan losses was $23.3 million, or 1.15% of loans, versus $21.2 million, or 1.07%. Management said loan growth drove the higher allowance and cautioned that economic conditions could require further provisions.
- Management cited inflation, supply-chain and labor constraints, geopolitical tensions, and two consecutive quarters of declining U.S. GDP as economic uncertainties. It provided no specific earnings or balance-sheet guidance in the supplied filing text.
Risks, contingencies and unusual items
- The company expects to adopt the current expected credit losses standard (CECL) on January 1, 2023 and anticipates a one-time increase to the allowance, though the amount is not provided. It was still evaluating the impact.
- Two lawsuits remain unresolved: the long-running SEPTA securities class action and a 2022 customer class action alleging improper overdraft fees. Management disputes the claims; potential losses or ranges could not be reasonably estimated, and no liability was recorded for the overdraft action.
- Available-for-sale securities’ fair value and accumulated other comprehensive income are exposed to interest-rate movements. The filing’s simulation estimates a 1.9% increase in next-12-month net interest income for a 100-basis-point rate increase and a 7.3% decrease for a 100-basis-point decrease, subject to modeling assumptions.
- Off-balance-sheet commitments to fund and standby letters of credit totaled approximately $813.8 million. The filing notes that commitments may expire undrawn and are not equivalent to expected cash outflows.
- The company repurchased 407,824 shares in Q2 at an average $24.25 per share; approximately 154,371 authorized shares remained available for repurchase at quarter-end. The board declared a $0.19-per-share dividend payable in August.
Important facts for investors to verify
- Whether loan and deposit growth, rising asset yields and net interest margin gains persist as deposit pricing responds to further rate changes.
- Future mortgage banking and swap-fee trends, and whether expense growth moderates.
- Credit performance and allowance adequacy as commercial lending expands and economic conditions evolve.
- The scale of unrealized securities losses, related capital effects, and any changes in management’s ability or need to sell securities before recovery.
- CECL’s final estimated adoption impact and developments or potential exposure in the SEPTA and overdraft-fee litigation.
- Liquidity and capital after share repurchases, alongside the company’s use of available borrowing capacity and pledged securities.