Business context and reporting period
Orrstown Financial Services, Inc. is a Pennsylvania-based bank holding company operating Orrstown Bank, serving communities in Pennsylvania and Maryland. This unaudited Form 10-Q covers the three months ended March 31, 2021; comparisons are with Q1 2020 unless stated otherwise. Dollar amounts below are in millions except per-share data.
Financial performance and position
| Metric | Q1 2021 / March 31, 2021 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $21.9 | $18.3 in Q1 2020 |
| Net interest margin, taxable-equivalent | 3.38% | 3.41% in Q1 2020 |
| Noninterest income | $7.5 | $7.1 in Q1 2020 |
| Noninterest expense | $17.8 | $18.3 in Q1 2020 |
| Net income / diluted EPS | $10.2 / $0.92 | $5.1 / $0.46 in Q1 2020 |
| Total assets | $2,963.5 | $2,750.6 at Dec. 31, 2020 |
| Total loans / allowance for loan losses | $2,045.0 / $19.0 | $1,979.7 / $20.2 at Dec. 31, 2020 |
| Total deposits | $2,547.1 | $2,356.9 at Dec. 31, 2020 |
| Shareholders’ equity | $254.4 | $246.2 at Dec. 31, 2020 |
- Q1 net interest income after provision was $22.9 million; the provision was a $1.0 million benefit, versus $0.9 million expense in Q1 2020. Net recoveries were $0.2 million.
- Operating cash flow was $16.6 million, investing cash flow was a $6.6 million use, and financing cash flow was $191.0 million provided. Cash and cash equivalents rose $201.0 million during the quarter to $326.2 million.
- Interest-bearing liabilities totaled $2,026.4 million on an average-balance basis. At quarter-end, borrowings comprised $22.8 million in repurchase agreements, $57.9 million in FHLB advances and other borrowings, and $31.9 million in subordinated notes.
- Liquidity included $94.3 million of unencumbered securities, $820.8 million of maximum FHLB borrowing capacity, and $516.9 million of remaining PPP Liquidity Facility availability; no PPP Liquidity Facility borrowings were outstanding.
- The Bank was classified as well capitalized. Its total risk-based capital ratio was 15.3%, Tier 1 risk-based ratio 14.1%, and Tier 1 leverage ratio 8.6%.
Material changes versus the prior comparable period
- Net income roughly doubled, supported by a $3.6 million increase in net interest income and a $1.0 million credit-reserve release. Total interest expense fell $3.6 million as funding costs declined, despite higher average interest-bearing deposits.
- Average loan balances increased substantially, primarily from PPP lending; average PPP loans were $463.0 million in Q1 2021 versus none in Q1 2020. Quarter-end PPP loans, net of deferred fees and costs, were $504.3 million.
- Noninterest income rose 7%. Mortgage banking income increased $1.9 million to $2.2 million, while the prior-year period included $1.9 million of gains from portfolio loan sales. Q1 2021 also included $0.6 million of mortgage servicing-rights valuation reserve reversal.
- Noninterest expenses fell 2.8%, partly due to lower salaries and advertising; prior-year comparisons also included a $0.5 million insurance recovery and different timing of tax-credit-related contributions.
- Loans increased $65.3 million and deposits increased $190.2 million from year-end, largely related to PPP funding. Securities declined $58.8 million, including $75.7 million of sales proceeds from securities sold during the quarter.
- Nonperforming loans improved to 0.48% of loans from 0.52% at year-end. The allowance-to-loans ratio declined to 0.93% from 1.02%.
Guidance, outlook, commentary and risks
- The filing provides no formal earnings or revenue guidance. Management said PPP-related deposits are expected to decline significantly into the second half of 2021 as borrowers use funds and loans are forgiven. Management also described plans to grow relationship lending and use investment repayments to help fund loan growth.
- Management attributed the allowance release to improved credit performance, returning deferred loans to regular payment, and reduced balances of non-guaranteed loans. It cautioned that COVID-19 effects and economic conditions could require additional loan-loss provisions.
- COVID-19-related loan deferrals totaled $7.5 million at March 31, down from $18.2 million at year-end. Special Mention loans declined $9.6 million during the quarter. PPP loans are SBA-guaranteed, but the filing identifies possible risk if the SBA does not honor its guarantees.
- Interest-rate sensitivity modeling showed estimated 12-month net interest income increasing 4.6% under a 100-basis-point rise and decreasing 1.1% under a 100-basis-point decline. These are model estimates dependent on assumptions, not forecasts.
- A shareholder securities lawsuit remains pending, with the Third Circuit’s decision on an interlocutory appeal pending as of the filing. The company says it intends to defend the claims; it cannot reasonably estimate a possible loss or range.
- The company had not adopted the expected-credit-loss standard (CECL); it expected adoption in fiscal 2023 and anticipated the allowance could increase, with the ultimate effect dependent on portfolio composition and economic conditions. It was also preparing for LIBOR transition, planning to use SOFR for loan agreements.
- After quarter-end, the Board authorized repurchases of up to 562,000 additional shares and declared a $0.18-per-share dividend payable May 10, 2021.
Important facts for investors to verify
- How much reported earnings and loan growth depend on PPP fee recognition and the timing of SBA forgiveness; $12.6 million of PPP net deferred fees remained unrecognized at quarter-end.
- Whether the credit-quality improvement and COVID-related reserve release persist, particularly as deferrals end and economic conditions evolve.
- The sustainability of mortgage banking revenue and servicing-rights valuations, given refinance activity and changing interest rates.
- The pace and impact of PPP-related deposit runoff, and continuing liquidity and capital levels as the balance sheet changes.
- Developments in the pending securities litigation and any subsequent estimate or disclosure of potential exposure.