Orrstown Financial Services, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; balance-sheet comparisons are with December 31, 2014. Figures are in millions of dollars unless stated otherwise. The company is a Pennsylvania-based bank holding company operating through Orrstown Bank in south-central Pennsylvania and northern Maryland.
Financial performance and position
| Metric | Q3 / Sep. 30, 2015 | Comparable period / prior year-end |
|---|---|---|
| Net income | $2.461 million; diluted EPS $0.30 | Q3 2014: $5.177 million; $0.64 diluted EPS |
| Nine-month net income | $6.425 million; diluted EPS $0.79 | Nine months 2014: $10.028 million; $1.24 diluted EPS |
| Net interest income | Q3: $8.713 million GAAP; $9.210 million fully tax-equivalent (FTE). Nine months: $25.626 million GAAP; $26.775 million FTE. | Q3 2014: $8.447 million GAAP; nine months 2014: $25.463 million GAAP |
| Net interest margin | Q3: 3.11%; nine months: 3.16% (FTE) | Q3 2014: 3.13%; nine months 2014: 3.20% |
| Total assets | $1,274.340 million | Dec. 31, 2014: $1,190.443 million |
| Loans / allowance for loan losses | Loans $762.858 million; allowance $13.537 million, or 1.77% of loans | Dec. 31, 2014: loans $704.946 million; allowance $14.747 million, or 2.09% |
| Deposits | $1,047.978 million | Dec. 31, 2014: $949.704 million |
| Borrowings | Short-term $54.831 million; long-term debt $24.575 million | Dec. 31, 2014: $86.742 million; $14.812 million, respectively |
| Cash and cash equivalents | $34.272 million | Dec. 31, 2014: $31.409 million |
| Operating cash flow | Nine months: $8.203 million; cash increased $2.863 million | Nine months 2014: operating cash flow $16.014 million |
Q3 net income fell about 52% year over year; nine-month net income fell about 36%. Lower loan-loss provision reversals in 2015 than in 2014 and higher income tax expense were significant comparability factors. Q3 total noninterest income was $4.831 million and noninterest expense $11.224 million. Nine-month totals were $15.082 million and $33.388 million, respectively.
Material changes and operating developments
- Loans grew $57.912 million, or 8.2%, from year-end, with growth across most loan segments. Commercial and industrial loans rose to $69.017 million from $48.995 million; commercial and land development loans rose to $35.483 million from $24.237 million.
- Deposits increased $98.274 million, or 10.3%. Noninterest-bearing deposits rose 20% to $139.565 million. Time deposits reached $315.530 million, driven principally by brokered time deposits; brokered money-market balances declined.
- Nonaccrual loans increased to $16.266 million from $14.432 million at year-end. Total nonperforming assets were $17.288 million, or 1.36% of assets, versus $15.364 million, or 1.29%, at year-end. Total risk assets were $18.287 million, up 11.1% from year-end.
- A $6.692 million commercial-property relationship moved to nonaccrual/impaired status in Q3 as its long-term revenue stream and guarantors’ ability to keep it current weakened. Management said it was adequately secured and no loss was anticipated at the time; no specific reserve or charge-off was recorded.
- The allowance declined $1.210 million from year-end, reflecting $607,000 of net charge-offs and a $603,000 negative provision. The negative provision in 2015 reflected a recovery on a previously charged-off loan.
- Shareholders’ equity increased to $134.728 million from $127.265 million. The Bank was reported as well capitalized; at September 30, its total risk-based capital ratio was 15.9%, CET1 ratio 14.6%, and Tier 1 leverage ratio 9.5%.
- The Federal Reserve terminated its 2012 Written Agreement in April 2015, and the Pennsylvania banking regulator released the Bank from its memorandum of understanding in February 2015. The company resumed quarterly dividends in April 2015 and declared $0.14 per share for the first nine months.
Management commentary, outlook and risks
- Management attributed higher FTE net interest income to loan growth, partly offset by a lower loan yield and higher funding costs. It cited a flattening yield curve and reinvestment of maturing loans and securities at lower rates. The Q3 net interest margin was down 2 basis points year over year; the nine-month margin was down 4 basis points.
- Management said it extended maturities on time deposits and long-term borrowings in Q3 and anticipated higher costs on those funds in future quarters. No specific earnings or growth guidance was provided.
- The filing describes the economic recovery as modest and cites competition, interest-rate movements, credit quality, economic conditions, securities-market volatility, regulation and capital availability as risks. Loan concentrations in commercial real estate and related sectors expose the company to local economic and property-market conditions.
- Interest-rate simulations estimated net interest income would decline 1.8% over the next 12 months under either a 100-basis-point rate decline or a 200-basis-point increase. Net present value was estimated to rise 2.6% under a 100-basis-point decline and fall 1.0% under a 200-basis-point increase. These are model estimates based on assumptions, not forecasts.
- A putative securities class action brought by SEPTA was dismissed without prejudice in June 2015. SEPTA sought leave to file a second amended complaint in July; the court had not yet granted permission. The company disputed the allegations and said potential losses could not be reasonably estimated. The filing also disclosed an ongoing confidential SEC fact-finding inquiry; the company said it was cooperating and noted that the inquiry was not an indication of wrongdoing.
- The company authorized a repurchase program for up to approximately 416,000 shares, or 5% of outstanding shares. It had repurchased 8,813 shares for $147,000, or $16.62 per share, by September 30. The program may be suspended or discontinued.
- The full deferred-tax valuation allowance was recaptured at year-end 2014 after improved profitability, asset quality and capital. As a result, 2015 tax expense was higher than in 2014, when the valuation allowance largely offset federal tax expense. Nine-month 2015 income tax expense was $1.498 million versus $24,000.
Important facts for investors to verify
- Whether the $6.692 million commercial-property credit remains adequately secured and how it affects nonaccrual balances, reserves and future charge-offs.
- Whether loan growth and deposit funding—especially brokered time deposits—remain sustainable and economically attractive as funding costs rise.
- How credit quality and allowance coverage develop: nonaccrual loans rose, while allowance coverage of nonaccrual loans fell to 83.22% from 102.18% at year-end.
- Whether net interest margin stabilizes or contracts further as rates, deposit pricing and asset repricing evolve.
- Developments in the SEPTA litigation and SEC inquiry, including any change in exposure or ability to estimate potential losses.
- Future realization of deferred tax assets and the effect of Basel III capital deductions and the phase-in of the capital conservation buffer.