Orrstown Financial Services, Inc. Announces Quarterly Operating Results

SHIPPENSBURG, Pa., Oct. 26, 2011 /PRNewswire/ --

• Quarterly earnings were $4.3 million for the third quarter ended September 30, 2011 versus $4.9 million for the same period in 2010. YTD earnings decreased from $12.2 million in 2010 to a loss of $2.5 million in 2011.
• Quarterly and year-to-date operating results include provisions for loan losses of $7.9 million and $32.3 million for the periods.  YTD provision for loan losses represents 1.43x net charge-offs for the period.  
• Net interest income for 2011 increased 9.9% and 13.6% on a quarter and year-to-date basis over 2010 results.
• Net interest margin increased from 3.62% in the third quarter of 2010 to 3.66% in the third quarter of 2011.
• Efficiency ratio improved on a linked-quarter basis to 52.4% for the third quarter of 2011 compared to 52.6% in the second quarter of 2011 and 54.8% in the third quarter of 2010.
• Quarterly dividend discontinued per regulatory guidance.

Orrstown Financial Services, Inc. (NASDAQ: ORRF) announced today net income for the quarter ended September 30, 2011 of $4.3 million, compared to net income in the third quarter of 2010 of $4.9 million, and a net loss for the nine months ended September 30, 2011 of $2.5 million, compared to net income of $12.2 million for the same period in 2010.  Diluted earnings per share amounted to $0.54 for the quarter ended September 30, 2011, as compared to $0.61 during the third quarter 2010.  On a year-to-date basis, diluted earnings (loss) per share totaled ($0.31) as of September 30, 2011, compared to $1.62 for the same period in 2010.  

"The Company's quarterly results returned to profitable levels, following the net loss we posted in the second quarter of 2011," said Thomas R. Quinn, Jr., President and Chief Executive Officer. "Despite returning to profitability, the Company's operating results have been heavily influenced by the lingering effects of the sluggish economy, and in particular, a depressed local real estate market.  The provision for loan losses totaled $7.9 million for the quarter, and reflects the level needed to replenish the allowance for loan losses after charge-offs incurred during the period, and the increased nonaccrual loans the Company is currently working through.  Noninterest expense has also been impacted by asset quality issues, as we incur additional expenses associated with external loan review, legal advice on loan workouts and other regulatory matters, and costs associated with collections and real estate owned," Quinn added.

"Management has been working vigorously on loan quality issues to minimize the Company's risk of loss," Quinn continued.  "As we address these issues, we are refining existing policies and procedures, and have re-engineered our Credit Administration functions and Special Assets Group to enable us to effectively reduce our level of nonperforming assets.  We believe these enhanced processes will better position us well into the future. Fundamental performance metrics remain solid. The largest component of our revenue, net interest income, improved by 13.6% year-to-date when compared to the same period in 2010, and our net interest margin has shown only slight compression, from 3.71% in the second quarter of 2011 to 3.66% in the third quarter," Quinn stated.

Based on direction from the Company's primary Federal regulator, Orrstown Financial Services, Inc.  will not declare a cash dividend this quarter.  The Company's primary regulator advised that it will not approve the payment of a cash dividend at this time. The Company is acutely aware that many of its shareholders rely on the dividend to supplement their income and meet expenses.  However, the Company must follow the guidance given to it by its regulators. To do otherwise, subjects the Company to increased risk of adverse regulatory actions.   Quinn stated, "We are very disappointed to join the ranks of the many other community banking organizations, both locally and across the nation, that have cut or suspended their dividends. But the Board of Directors had no other realistic choice in this matter."  There can be no assurances as to whether, or in what amounts, cash dividends will be declared in the future or, if declared, whether they will continue, be suspended or discontinued, according to the Company.

QUARTERLY OPERATING RESULTS

Net income for the quarter ended September 30, 2011 was $4.3 million, compared to net income of $4.9 million for the same quarter in 2010, resulting in diluted earnings per share of $0.54 and $0.61 for the periods, respectively.  As a result of the lower net income level in 2011, the Company's return on assets and return on tangible equity ratios declined from 1.36% and 14.03%, respectively, for the quarter ended September 30, 2010 to 1.11% and 12.54%, respectively, for the same period in 2011.  

Net Interest Income

Net interest income totaled $12.8 million for the three months ended September 30, 2011, a $1.2 million, or 9.9%, increase over 2010.   The growth in net interest income came principally through an increase in interest earning assets, which averaged $1.46 billion for the quarter ended September 30, 2011, compared to $1.33 billion in for the same period in 2010.  Complementing the growth in interest earning assets was a 4 basis point increase in net interest margin.  Despite the low interest rate environment, the Company has been able to manage its blend of interest earnings assets and liabilities so that net interest margin increased slightly from 3.62% for the three months ended September 30, 2010 to 3.66% for the same quarter in 2011.  The Company has been able to lower its overall cost of funds to 0.72% for the period, an improvement over the prior year's cost of funds of 0.92% and the linked quarter's cost of 0.76%.    

Provision for Loan Losses

The provision for loan losses for the three months ended September 30, 2011 totaled $7.9 million, an increase over the third quarter 2010 provision of $1.1 million.  The increase in the provision for loan losses over the prior period was attributable to replenishing the allowance for loan losses from $9.4 million of charge-offs experienced during the quarter, combined with decreases in asset quality ratios, including elevated levels of nonaccrual loans, restructured loans and delinquencies as noted in "Nonperforming Assets/Risk Elements" below.  

Noninterest Income

Noninterest income, excluding securities gains, totaled $6.6 million for the three months ended September 30, 2011, compared to $4.9 million for the same period in 2010.  Included in 2011's income was the gain on sale of the Company's merchant service business totaling $995,000 and a gain on the sale of an interest rate swap in the amount of $673,000. Excluding these items, noninterest income remained consistent between the two periods, with some shift to mortgage banking income, offset by less loan related fees received on prepayment penalties, letters of credit fees and other loan services. Trust and brokerage income increased 7.3%, the result of additional trust and brokerage assets under management.  

Securities gains totaled $2.4 million for the three months ended September 30, 2011, compared to $1.1 million for the same period in 2010.  The difference in gains taken between the two periods was the result of interest rate and market conditions, and the Company's asset liability management strategies.

Noninterest expenses

Noninterest expenses amounted to $10.8 million for the three months ended September 30, 2011, as compared to $9.5 million for the corresponding prior year period.  The increase in expenses can primarily be attributed to increased professional services, which increased from $122,000 for the third quarter 2010 to $1.1 million for the same period in the current year.  Professional services include expenses associated with loan review assistance, and legal and accounting costs associated with the increased complexity of the Company and regulatory issues.  In addition, collection and real estate expenses increased 160.5% from $228,000 for the third quarter of 2010 to $594,000 in 2011. FDIC insurance costs continue to elevate in light of increased deposits and higher assessments recorded in 2011 compared to 2010, and resulted in $690,000 of expense for the three months ended September 30, 2011 compared to $305,000 in 2010, an increase of 126.2%.  Despite the increase in noninterest expenses, the Company's efficiency ratio for the third quarter of 2011 was favorable at 52.4%, compared to 54.8% in the same period in 2010, and slightly better than the ratio in the second quarter of 2011, which was 52.6%.  The efficiency ratio expresses noninterest expense as a percentage of tax equivalent net interest income and noninterest income, excluding securities gains.

YEAR-TO-DATE OPERATING RESULTS

On a year-to-date basis, the Company incurred a net loss of $2.5 million, compared to net income of $12.2 million for the first nine months of 2010, resulting in diluted earnings (loss) per share of ($0.31) and $1.62 for the year-to-date periods.  As a result of the net loss for the period, the Company's return on assets and return on tangible equity ratios were negative for the year, compared to 1.23% and 13.57% respectively for the same period in 2010.  

Net Interest Income

Net interest income totaled $38.0 million for the nine months ended September 30, 2011, a $4.6 million, or 13.6% increase over the same period in 2010.   The growth in net interest income came principally through growth in volume as interest earning assets averaged $1.44 billion for the nine months ended September 30, 2011, compared to $1.24 billion for the same period in 2010.  Slightly offsetting the growth in interest earning assets was a 3 basis point decline in net interest margin.  Despite the low interest rate environment, the Company has been able to manage its blend of interest earnings assets and liabilities so that the net interest margin has only declined marginally, from 3.72% for the nine months ended September 30, 2010 to 3.69% in 2011, which includes the lowering of its overall cost of funds to 0.77% for the nine month period.      

Provision for Loan Losses

The provision for loan losses for the nine months ended September 30, 2011 totaled $32.3 million, a significant increase over the prior year's amount of $7.6 million for the same period.  The factors attributable to the increase in the provision for loan losses, included the following:  

• An additional charge-off of $5.6 million on a previously reported commercial credit in which the borrower is currently in bankruptcy. As a result of the Bank's recent termination of its involvement with the borrower's Plan of Reorganization exit financing, it was determined prudent to charge-off the entire loan balance, as the Bank is presently listed as an unsecured non-priority claimant in the pre-petition indebtedness.

• Prolonged softening real estate conditions, particularly in the bank's southern market, have resulted in additional loan loss provisions, as the allowance for loan losses was increased by $9.2 million after charge-offs that related to borrowings that were collateral dependent.  Upon receiving updated appraisals in 2011, it was noted that the appraised values were significantly less than previous appraisals, or even listed sales prices. Real estate values are depressed due to lack of growth in the market and abundance of properties available.  

• The Bank's recognition of continuing softness in overall economic conditions and deterioration of underlying collateral securing lending relationships resulted in an ongoing credit review process during the second and third quarters that covered nearly 100% of the commercial loan portfolio as measured in dollars.  This process led to downgraded internal risk ratings on many existing credits, and subsequently raised required reserve levels.   Loans classified as 'substandard' or 'doubtful' have increased to $146.3 million as of September 30, 2011, compared to $67.8 at December 31, 2010.  Classified loans have declined 2.5% from June 30, 2011, principally the result of charge-offs, or partial charge-off of loans.    

• The continued economic pressures on customers and valuations on underlying collateral resulted in management increasing its qualitative reserve allocations on its loan portfolios to reflect these conditions. In addition, the $22.7 million in net charge-offs experienced in 2011 resulted in increased quantitative reserve allocations to specific loan portfolios.

Noninterest Income

Noninterest income, excluding securities gains, totaled $16.0 million for the nine months ended September 30, 2011, compared to $14.6 million for the same period in 2010.  Revenue increases were generated in most business lines, with trust and brokerage income and mortgage banking activities posting 16.7% and 30.5% increases, respectively.  Results for 2010 were impacted by $239,000 recognized in life insurance death benefits upon the death of a former director, whereas 2011's income was enhanced due to a gain on the sale of its merchant services business of $995,000. Additionally, gains on the sale of an interest rate swap totaling $778,000 were recognized in 2010, which is consistent with the $791,000 earned in 2011.  A decline in loan related fees has been experienced in 2011, which include prepayment penalties, letters of credit fees and other loan related services.  

Securities gains totaled $3.2 million for the nine months ended September 30, 2011, compared to $3.3 million for the same period in 2010.  The Company continues to take securities gains due to interest rate and market conditions, and the Company's asset liability management strategies.

Noninterest expenses

Noninterest expenses amounted to $30.0 million for the nine months ended September 30, 2011, as compared to $26.7 million for the corresponding prior year period.  The increase in expenses can be attributed to increased professional services, including loan review assistance and legal costs associated with loan workouts and foreclosures, plus a $250,000 provision for unfunded loan commitments included in other expenses.  FDIC insurance costs continue to increase due to the increased level of deposits and higher assessments recorded in 2011 compared to 2010. Offsetting these increases in noninterest expenses was a reduction in employee benefits, as certain performance based compensation plans have been lowered or eliminated in light of the Company's 2011 performance.  The Company's efficiency ratio for the nine months ended September 30, 2011 was 52.6%, an improvement on 2010's ratio of 53.6% for the same period.    

FINANCIAL CONDITION

Assets grew $5.6 million to $1.52 billion at September 30, 2011 from $1.51 billion at December 31, 2010.  The Company was able to increase gross loans outstanding by $29.5 million from $966.9 million at year-end to $996.5 million at September 30, 2011.  This loan growth was funded principally through cash flow from the sale of available for sale securities, which decreased $77.7 million for the first nine months of 2011, with the excess proceeds remaining in interest bearing deposits with banks, which grew $64.5 million. Deposits increased by 8.3% to $1.3 billion at September 30, 2011, from $1.2 billion at December 31, 2010.  A portion of the growth in deposits was attributable to certain customers, whose accounts migrated from repurchase agreements, and were previously included as short-term borrowings in the balance sheet.

Stockholders' Equity

Stockholders' equity decreased $1.3 million for the first nine months of 2011, and totaled $159.2 million at September 30, 2011.  This decrease was primarily the result of the net loss posted for the period and dividends declared; slightly offset by an increase in accumulated other comprehensive income.  Despite the decline in shareholders' equity, the Company's regulatory capital ratios remain strong and exceed all regulatory minimums to be considered well capitalized, including tier-1 leverage ratio of 8.7%, tier-1 risk-based capital ratio of 13.4% and total risk-based capital ratio of 14.7%.  

Asset Quality

The Company continues to monitor its classified loans in light of the continued softness in economic conditions and collateral values.  As a result of this monitoring, additional nonperforming assets and other risk elements were identified.  Total risk elements, which include nonaccrual loans, other real estate owned, restructured loans still accruing and loans past due 90 days or more still accruing, increased to $74.6 million at September 30, 2011, from $54.5 million and $18.4 million at June 30, 2011 and December 31, 2010, respectively.

The largest increase in risk elements was restructured loans, which totaled $37.7 million at September 30, 2011, compared to approximately $34.5 million at June 30, 2011 and $1.2 million at December 31, 2010.  As noted above, the Company designated certain relationships in which management worked with the borrower and modified terms and conditions, principally extension of loan maturities, as restructured loans.  Despite the Company's ability to increase the rate on many of these loans to a floor rate of interest and strengthening of loan quality with additional collateral in certain instances, the loans were designated as restructured as the borrowers were experiencing financial difficulties, and the new rates were below a market rate of interest for similar risk characteristics.   The Company proactively took actions with these borrowers to enable them to repay their loans under revised terms and conditions, which were felt to mitigate loss potential to the bank while allowing the borrowers to work through these softened economic times.  

Nonaccrual loans increased from $13.9 million at December 31, 2010 to $31.2 million at September 30, 2011, an increase of 124.3%, or $17.3 million.  The net increase in nonaccrual loans is primarily the result of $869,000 of pay downs, $22.2 million of loans being charged-off, $2.2 million of loans foreclosed on and transferred to other real estate owned, and loans totaling $42.5 million being moved to nonaccrual status during the nine-month period.   Since June 30, 2011, nonaccrual loans increased by $16.4 million, a result of $27.5 million of loans moved to non-accrual status, offset by $9.2 million in loans charged-off and $1.8 million foreclosed on and transferred to real estate owned.  

During 2011, the Company increased the number of personnel in its loan workout and credit review departments and outsourced certain credit review responsibilities in order to mitigate the Company's risk of loss, and to eventually reduce its level of nonaccrual and classified loans.  During the quarter ended September 30, 2011, new appraisals were received on many criticized assets and updated financial statements were received on these borrowers. Based upon an evaluation of the credit condition of the borrowers as well as continued softness noted in real estate market conditions, reclassifying certain loans to nonaccrual status was determined to be an appropriate course of action.  

Summary of Financial Highlights:

(1) Supplemental Reporting of Non-GAAP-based Financial Measures

Return on average tangible assets and return on average tangible equity are non-GAAP-based financial measures calculated using non-GAAP-based amounts.  The most directly comparable GAAP-based measures are return on average assets and return on average equity, which are calculated using GAAP-based amounts.  The Company calculates the return on average tangible assets and equity by excluding the balance of intangible assets and their related amortization expense, net of tax, from the calculation of return on average assets and equity.  Management uses the return on average tangible assets and equity to assess the Company's core operating results and believes that this is a better measure of our operating performance, as it is based on the Company's tangible assets and capital.  Further, we believe that by excluding the impact of purchase accounting adjustments it allows for a more meaningful comparison with the Company's peers, particularly those that may not have acquired other companies.  Lastly, the exclusion of goodwill and intangible assets is consistent with the treatment by bank regulatory agencies, which exclude these amounts from the calculation of risk-based capital ratios. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures.  A reconciliation of return on average assets and equity to the return on average tangible assets and equity, respectively, is set forth below.

Tangible equity is a non-GAAP financial measure calculated using non-GAAP based amounts.  The most directly comparable GAAP based measure is shareholders' equity.  In order to calculate tangible equity, Company management subtracts intangible assets from shareholders' equity.  A reconciliation of tangible equity to shareholders' equity is set forth below.

This release references tax-equivalent net interest income which is a non-GAAP financial measure.  Tax-equivalent net interest income is derived from GAAP interest income and net interest income using an assumed tax rate of 35%.  We believe the presentation of net interest income on a tax–equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.

The following reconciles net interest income to net interest income on a fully taxable equivalent basis:

About the Company:

With over $1.5 billion in assets, Orrstown Financial Services, Inc. and its wholly-owned subsidiary, Orrstown Bank, provide a full range of consumer and business financial services through twenty-one banking offices and two remote service facilities located in Cumberland, Franklin and Perry Counties, Pennsylvania and Washington County, Maryland.  Orrstown Financial Services, Inc.'s stock is traded on the NASDAQ Capital Market under the symbol ORRF.

Safe Harbor Statement:  

This news release may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.  Actual results and trends could differ materially from those set forth in such statements due to various risks, uncertainties and other factors.  Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: ineffectiveness of the Company's business strategy due to changes in current or future market conditions; the effects of competition, including industry consolidation and development of competing financial products and services; changes in laws and regulations, including the recent Dodd-Frank Wall Street Reform and Consumer Protection Act; interest rate movements; changes in credit quality; volatilities in the securities markets; and deteriorating economic conditions, and other risks and uncertainties, including those detailed in Orrstown Financial Services, Inc.'s filings with the Securities and Exchange Commission. The statements are valid only as of the date hereof and Orrstown Financial Services, Inc. disclaims any obligation to update this information.

SOURCE Orrstown Financial Services, Inc.