UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
x | QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2009
Or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File Number 001-34292
ORRSTOWN FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Commonwealth of Pennsylvania | 23-2530374 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
77 East King Street, P.O. Box 250, Shippensburg, Pennsylvania | 17257 | |
(Address of principal executive offices) | (Zip Code) |
(717) 532-6114
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b 2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b 2 of the Exchange Act). YES ¨ NO x
As of June 30, 2009, 6,403,102 shares of common stock, no par value, of the registrant were outstanding.
ORRSTOWN FINANCIAL SERVICES, INC.
INDEX
2
PART I - FINANCIAL INFORMATION
Item 1. | Financial Statements |
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands) |
(Unaudited) June 30, 2009 |
(Audited) * December 31, 2008 |
||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 13,125 | $ | 12,871 | ||||
Federal funds sold |
5,270 | 13,933 | ||||||
Cash and cash equivalents |
18,395 | 26,804 | ||||||
Interest bearing deposits with banks |
677 | 409 | ||||||
Member stock, at cost which approximates market value |
7,886 | 7,713 | ||||||
Securities available for sale |
164,864 | 120,640 | ||||||
Loans |
845,473 | 820,468 | ||||||
Allowance for loan losses |
(7,413 | ) | (7,140 | ) | ||||
Net Loans |
838,060 | 813,328 | ||||||
Premises and equipment, net |
30,150 | 31,050 | ||||||
Goodwill and intangible assets |
21,064 | 21,186 | ||||||
Cash surrender value of life insurance |
16,915 | 16,552 | ||||||
Accrued interest receivable |
3,768 | 3,983 | ||||||
Other assets |
11,210 | 10,118 | ||||||
Total assets |
$ | 1,112,989 | $ | 1,051,783 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Deposits: |
||||||||
Non-interest bearing |
$ | 93,935 | $ | 84,261 | ||||
Interest bearing |
715,187 | 673,107 | ||||||
Total deposits |
809,122 | 757,368 | ||||||
Short term borrowings |
84,399 | 64,007 | ||||||
Long term debt |
105,067 | 118,287 | ||||||
Accrued interest payable |
1,322 | 1,165 | ||||||
Other liabilities |
6,654 | 7,609 | ||||||
Total liabilities |
1,006,564 | 948,436 | ||||||
Common stock, no par value - $ .05205 stated value per share; 50,000,000 shares authorized; 6,469,517 and 6,455,123 shares issued |
337 | 336 | ||||||
Additional paid - in capital |
82,777 | 82,555 | ||||||
Retained earnings |
24,788 | 21,120 | ||||||
Accumulated other comprehensive income |
453 | 1,369 | ||||||
Treasury stock, 66,415 and 69,457 shares, at cost |
(1,930 | ) | (2,033 | ) | ||||
Total shareholders equity |
106,425 | 103,347 | ||||||
Total liabilities and shareholders equity |
$ | 1,112,989 | $ | 1,051,783 | ||||
* | Condensed from audited financial statements |
The accompanying notes are an integral part of these condensed financial statements.
3
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended | |||||||
(Dollars in Thousands) |
June 2009 |
June 2008 |
|||||
INTEREST INCOME |
|||||||
Interest and fees on loans |
$ | 11,787 | $ | 11,726 | |||
Interest and dividends on investment securities |
1,342 | 905 | |||||
Interest on short term investments |
13 | 54 | |||||
Total interest income |
13,142 | 12,685 | |||||
INTEREST EXPENSE |
|||||||
Interest on deposits |
3,265 | 3,299 | |||||
Interest on short-term borrowings |
96 | 239 | |||||
Interest on long-term debt |
969 | 983 | |||||
Total interest expense |
4,330 | 4,521 | |||||
Net interest income |
8,812 | 8,164 | |||||
Provision for loan losses |
300 | 257 | |||||
Net interest income after provision for loan losses |
8,512 | 7,907 | |||||
OTHER INCOME |
|||||||
Service charges on deposits |
1,750 | 1,718 | |||||
Other service charges |
1,130 | 1,119 | |||||
Trust department income |
637 | 713 | |||||
Brokerage income |
350 | 377 | |||||
Other income |
190 | 218 | |||||
Securities gains / (losses) |
293 | (1 | ) | ||||
Total other income |
4,350 | 4,144 | |||||
OTHER EXPENSES |
|||||||
Salaries and employee benefits |
4,268 | 3,811 | |||||
Occupancy and equipment |
1,176 | 1,072 | |||||
Data processing |
283 | 247 | |||||
Advertising |
113 | 145 | |||||
Other operating expense |
2,504 | 1,610 | |||||
Total other expense |
8,344 | 6,885 | |||||
Income before income taxes |
4,518 | 5,166 | |||||
Income tax expense |
1,064 | 1,563 | |||||
Net income |
$ | 3,454 | $ | 3,603 | |||
PER SHARE DATA |
|||||||
Basic earnings per share |
$ | 0.54 | $ | 0.56 | |||
Diluted earnings per share |
$ | 0.51 | $ | 0.54 | |||
Dividends per share |
$ | 0.22 | $ | 0.22 |
The accompanying notes are an integral part of these condensed financial statements.
4
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Six Months Ended | ||||||
(Dollars in Thousands) |
June 2009 |
June 2008 | ||||
INTEREST INCOME |
||||||
Interest and fees on loans |
$ | 23,202 | $ | 23,971 | ||
Interest and dividends on investment securities |
2,484 | 1,923 | ||||
Interest on short term investments |
33 | 179 | ||||
Total interest income |
25,719 | 26,073 | ||||
INTEREST EXPENSE |
||||||
Interest on deposits |
6,656 | 7,384 | ||||
Interest on short-term borrowings |
181 | 650 | ||||
Interest on long-term debt |
2,048 | 1,958 | ||||
Total interest expense |
8,885 | 9,992 | ||||
Net interest income |
16,834 | 16,081 | ||||
Provision for loan losses |
515 | 415 | ||||
Net interest income after provision for loan losses |
16,319 | 15,666 | ||||
OTHER INCOME |
||||||
Service charges on deposits |
3,261 | 3,253 | ||||
Other service charges |
2,177 | 1,827 | ||||
Trust department income |
1,286 | 1,423 | ||||
Brokerage income |
635 | 756 | ||||
Other income |
502 | 448 | ||||
Securities gains / (losses) |
458 | 48 | ||||
Total other income |
8,319 | 7,755 | ||||
OTHER EXPENSES |
||||||
Salaries and employee benefits |
8,539 | 7,828 | ||||
Occupancy and equipment |
2,390 | 2,029 | ||||
Data processing |
530 | 478 | ||||
Advertising |
226 | 243 | ||||
Security impairment expense |
36 | 0 | ||||
Other operating expense |
4,300 | 3,007 | ||||
Total other expense |
16,021 | 13,585 | ||||
Income before income taxes |
8,617 | 9,836 | ||||
Income tax expense |
2,138 | 2,983 | ||||
Net income |
$ | 6,479 | $ | 6,853 | ||
PER SHARE DATA |
||||||
Basic earnings per share |
$ | 1.01 | $ | 1.07 | ||
Diluted earnings per share |
$ | 0.96 | $ | 1.02 | ||
Dividends per share |
$ | 0.44 | $ | 0.43 |
The accompanying notes are an integral part of these condensed financial statements.
5
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (UNAUDITED)
Six Months Ended June 30, 2009 and 2008 | |||||||||||||||||||||||
(Dollars in thousands) |
Common Stock |
Additional Paid-In Capital |
Retained Earnings |
Accumulated Other Comprehensive Income |
Treasury Stock |
Total Shareholders Equity |
|||||||||||||||||
Beginning Balance, January 1, 2008 |
$ | 336 | $ | 82,488 | $ | 13,868 | $ | 567 | ($ | 1,135 | ) | $ | 96,124 | ||||||||||
Comprehensive income |
|||||||||||||||||||||||
Net income |
0 | 0 | 6,853 | 0 | 0 | 6,853 | |||||||||||||||||
Change in unrealized loss on investment securities available for sale, net of tax |
0 | 0 | 0 | (421 | ) | (421 | ) | ||||||||||||||||
Comprehensive income |
6,432 | ||||||||||||||||||||||
Cash dividends ($.43 per share) |
0 | 0 | (2,760 | ) | 0 | 0 | (2,760 | ) | |||||||||||||||
Split dollar post retirement plan |
0 | 0 | (263 | ) | 0 | 0 | (263 | ) | |||||||||||||||
Stock-based compensation plans: |
|||||||||||||||||||||||
Compensation expense |
0 | (8 | ) | 0 | 0 | 0 | (8 | ) | |||||||||||||||
Purchase of treasury stock (3,962 shares) |
0 | 0 | 0 | 0 | (123 | ) | (123 | ) | |||||||||||||||
Issuance of treasury stock (9,460 shares) |
0 | (61 | ) | 0 | 0 | 350 | 289 | ||||||||||||||||
Balance, June 30, 2008 |
$ | 336 | $ | 82,419 | $ | 17,698 | $ | 146 | ($ | 908 | ) | $ | 99,691 | ||||||||||
Beginning Balance, January 1, 2009 |
$ | 336 | $ | 82,555 | $ | 21,120 | $ | 1,369 | ($ | 2,033 | ) | $ | 103,347 | ||||||||||
Comprehensive income |
|||||||||||||||||||||||
Net income |
0 | 0 | 6,479 | 0 | 0 | 6,479 | |||||||||||||||||
Change in unrealized gain on investment securities available for sale, net of tax |
0 | 0 | 0 | 170 | 0 | 170 | |||||||||||||||||
Net unrealized losses on derivatives |
0 | 0 | 0 | (1,086 | ) | 0 | (1,086 | ) | |||||||||||||||
Comprehensive income |
5,563 | ||||||||||||||||||||||
Cash dividends ($.44 per share) |
0 | 0 | (2,811 | ) | 0 | 0 | (2,811 | ) | |||||||||||||||
Stock-based compensation plans: |
|||||||||||||||||||||||
Compensation expense |
0 | 24 | 0 | 0 | 0 | 24 | |||||||||||||||||
Issuance of stock |
1 | 240 | 0 | 0 | 0 | 241 | |||||||||||||||||
Issuance of treasury stock (3,042 shares) |
0 | (42 | ) | 0 | 0 | 103 | 61 | ||||||||||||||||
Balance, June 30, 2009 |
$ | 337 | $ | 82,777 | $ | 24,788 | $ | 453 | ($ | 1,930 | ) | $ | 106,425 | ||||||||||
The accompanying notes are an integral part of these condensed financial statements.
6
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended | ||||||||
(Dollars in Thousands) |
June 2009 |
June 2008 |
||||||
COMPREHENSIVE INCOME |
||||||||
Net Income |
$ | 3,454 | $ | 3,603 | ||||
Other comprehensive income, net of tax |
||||||||
Unrealized gain (loss) on investment securities available for sale |
7 | (788 | ) | |||||
Unrealized (loss) on rate swaps |
(1,059 | ) | 0 | |||||
Comprehensive Income |
$ | 2,402 | $ | 2,815 | ||||
Six Months Ended | ||||||||
(Dollars in Thousands) |
June 2009 |
June 2008 |
||||||
COMPREHENSIVE INCOME |
||||||||
Net Income |
$ | 6,479 | $ | 6,853 | ||||
Other comprehensive income, net of tax |
||||||||
Unrealized gain (loss) on investment securities available for sale |
170 | (421 | ) | |||||
Unrealized (loss) on rate swaps |
(1,086 | ) | 0 | |||||
Comprehensive Income |
$ | 5,563 | $ | 6,432 | ||||
The accompanying notes are an integral part of these condensed financial statements.
7
ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended | ||||||||
(Dollars in Thousands) |
June 2009 |
June 2008 |
||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net income |
$ | 6,479 | $ | 6,853 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
1,714 | 1,028 | ||||||
Provision for loan losses |
515 | 415 | ||||||
Net loss on disposal of other real estate owned |
9 | 0 | ||||||
Investment securities (gains) |
(458 | ) | (48 | ) | ||||
Securities impairment loss |
36 | 0 | ||||||
Other, net |
(2,000 | ) | (553 | ) | ||||
Net cash provided by operating activities |
6,295 | 7,695 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Net (increase) in interest bearing deposits with banks |
(268 | ) | (55 | ) | ||||
Purchases of available for sale securities |
(98,703 | ) | (25,791 | ) | ||||
Sales and maturities of available for sale securities |
54,844 | 33,631 | ||||||
Proceeds from disposal of other real estate owned |
417 | 0 | ||||||
Purchase of intangible assets |
0 | 18 | ||||||
Net (increase) in loans |
(26,011 | ) | (50,860 | ) | ||||
Purchases of bank premises and equipment |
(201 | ) | (4,680 | ) | ||||
Other, net |
(1,199 | ) | (986 | ) | ||||
Net cash (used) by investing activities |
(71,121 | ) | (48,723 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net increase in deposits |
51,754 | 30,780 | ||||||
Dividends paid |
(2,811 | ) | (2,760 | ) | ||||
Net proceeds from issuance of common stock |
241 | 0 | ||||||
Purchase of treasury stock |
0 | (123 | ) | |||||
Net proceeds from issuance of treasury stock |
61 | 288 | ||||||
Net change in short-term borrowings |
20,392 | 7,197 | ||||||
Proceeds from long-term borrowings |
0 | 13,000 | ||||||
Repayment of long-term borrowings |
(13,220 | ) | (865 | ) | ||||
Net cash provided by financing activities |
56,417 | 47,517 | ||||||
Net increase in cash and cash equivalents |
(8,409 | ) | 6,489 | |||||
Cash and cash equivalents at beginning of period |
26,804 | 18,433 | ||||||
Cash and cash equivalents at end of period |
$ | 18,395 | $ | 24,922 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid during the period for: |
||||||||
Interest |
$ | 8,728 | $ | 10,138 | ||||
Income Taxes |
1,575 | 3,025 | ||||||
Supplemental schedule of noncash investing and financing activities: |
||||||||
Unrealized gain (loss) on investments available for sale (net of deferred taxes of $92 and ($222) at June 30, 2009 and 2008, respectively) |
170 | (421 | ) | |||||
Unrealized (loss) on rate swaps (net of deferred taxes of $585 and $0 at June 30, 2009 and 2008, respectively) |
(1,086 | ) | | |||||
Other real estate acquired in settlement of loans |
764 | 135 |
The accompanying notes are an integral part of these condensed financial statements.
8
ORRSTOWN FINANCIAL SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2009
Note 1: Summary of Significant Accounting Policies
Basis of Presentation
The unaudited financial statements of Orrstown Financial Services, Inc. (the Company) and its subsidiary are presented at and for the three and six months ended June 30, 2009 and 2008 and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. Information presented at December 31, 2008 is condensed from audited year-end financial statements. For further information, refer to the audited consolidated financial statements and footnotes thereto, included in the annual report on Form 10-K for the year ended December 31, 2008.
Operating
Orrstown Financial Services, Inc. is a financial holding company including its wholly-owned subsidiary, Orrstown Bank. All significant intercompany transactions and accounts have been eliminated. Operating results for the three and six months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.
Cash Flows
For purposes of the Statements of Cash Flows, cash and cash equivalents include Cash and due from banks and Federal funds sold. As permitted by Statement of Financial Accounting Standards No. 104, the Company has elected to present the net increase or decrease in deposits with banks, loans and deposits in the Statement of Cash Flows.
Federal Income Taxes
For financial reporting purposes, the provision for loan losses charged to operating expense is based on managements judgment, whereas for federal income tax purposes the amount allowable under present tax law is deducted. Additionally, deferred compensation is charged to operating expense in the period the liability is incurred for financial reporting purposes, whereas for federal income tax purposes these expenses are deducted when paid. As a result of the aforementioned timing differences plus the timing differences associated with depreciation expense, deferred income taxes are provided in the financial statements. Income tax expense is less than the amount calculated using the statutory tax rate primarily as a result of tax exempt income earned from state and political subdivision obligations and tax free loans.
Investment Securities
Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold securities until maturity, they are classified as securities held to maturity and carried at amortized historical cost. Securities to be held for indefinite periods of time, and not intended to be held to maturity, are classified as available for sale and carried at fair value. Securities held for indefinite periods of time include securities that management intends to use as part of its asset and liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk, and other factors related to interest rate and resultant prepayment risk changes.
Realized gains and losses on dispositions are based on the net proceeds and the adjusted book value of the securities sold, using the specific identification method. Unrealized gains and losses on investment securities available for sale are based on the difference between book value and fair value of each security. These gains and losses are credited or charged to other comprehensive income, whereas realized gains and losses flow through the Companys results of operations.
The Company has classified all investment securities as available for sale. At December 31, 2008, fair value exceeded amortized cost by $816,000 and at June 30, 2009 fair value exceeded amortized cost by $1,089,000. In shareholders equity, the balance of accumulated other comprehensive income increased to $708,000 at June 30, 2009 from $538,000 at December 31, 2008.
9
Stock-Based Compensation
The Company maintains two stock-based compensation plans. These plans provide for the granting of stock options to the Companys directors and the Banks employees. FAS Statement No 123R, Share-Based Payment requires financial statement recognition of compensation cost for stock options and other stock-based awards. Both of the Companys stock-based compensation plans are fully vested when granted and, therefore, are expensed on the date of grant using the Black-Scholes option-pricing model.
Earnings per Share of Common Stock
Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect the addition of an incremental number of shares added as a result of converting common stock equivalents. A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows.
Earnings per share for the three and six months ended June 30, have been computed as follows:
Three Months Ended | Six Months Ended | |||||||||||
(In Thousands, except per share data) |
June 2009 |
June 2008 |
June 2009 |
June 2008 | ||||||||
Net Income |
$ | 3,454 | $ | 3,603 | $ | 6,479 | $ | 6,853 | ||||
Weighted average shares outstanding (basic) |
6,392 | 6,422 | 6,389 | 6,421 | ||||||||
Impact of common stock equivalents |
338 | 318 | 337 | 321 | ||||||||
Weighted average shares outstanding (diluted) |
6,730 | 6,740 | 6,726 | 6,742 | ||||||||
Per share information: |
||||||||||||
Basic earnings per share |
$ | 0.54 | $ | 0.56 | $ | 1.01 | $ | 1.07 | ||||
Diluted earnings per share |
$ | 0.51 | $ | 0.54 | $ | 0.96 | $ | 1.02 |
Derivative Instruments and Hedging Activities
The Company follows Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Financial Instruments and Hedging Activities, as amended, to account for derivative and hedging activities. In accordance with this statement, all derivatives are recognized in the Consolidated Financial Statements at their fair values. On the dates that derivative contracts are entered into, the Company designates derivatives as (a) hedges of fair values of recognized assets or liabilities or of unrecognized firm commitments (fair-value hedges); (b) hedges of forecasted transactions or variable cash flows to be received or paid in conjunction with recognized assets or liabilities (cash-flow hedges) or (c) instruments that are held for trading or non-hedging purposes (trading or economic-hedging instruments). For a derivative treated as a fair-value hedge, the effective portion of a change in fair value is recorded as an adjustment to the hedged item. The ineffective portion of the fair-value hedge is recognized in current period earnings. Upon termination of a fair-value hedge of a debt instrument, the resulting gain or loss is amortized to earnings through the maturity date of the debt instrument. For a derivative treated as a cash flow hedge, the ineffective portion of changes in fair value is reported in current period earnings. The effective portion of the cash flow hedge is recorded as an adjustment to the hedged item through other comprehensive income. For a derivative treated as a trading or economic hedging instrument, changes in fair value are reported in current period earnings. Fair values are determined based upon quoted market prices and mathematical models using current and historical data.
The Company formally assesses, both at the hedges inception, and on an on-going basis, whether derivatives used in hedging transactions have been highly effective in offsetting changes in fair values or cash flows of hedged items and whether those derivatives are expected to remain highly effective in subsequent periods. The Company discontinues hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in fair value or cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all cases in which hedge accounting is discontinued and a derivative remains outstanding, the Company will carry the derivative at fair value in the Consolidated Financial Statements, recognizing changes in fair value in current period other comprehensive income in the statement of changes in shareholders equity.
10
The Company follows Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 includes the disclosure requirements for derivative instruments and hedging activities to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows.
The Bank has entered into three (3) rate swap agreementstwo on November 24, 2008, and one on May 22, 2009 related to fixed rate loans. The Bank uses interest rate swaps to reduce interest rate risks and to manage interest income. By entering into these agreements, the Bank converts floating rate assets into fixed rate assets, or alternatively, converts fixed rate assets into floating rate assets. Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income. These interest rate swap agreements are considered cash flow hedge derivative instruments that qualify for hedge accounting. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. In the event of default by a counter party, the risk in these transactions is the cost of replacing the agreements at current market rates.
The effect of derivative instruments on the Financial Statements for the quarter ended June 30, 2009, are as follows:
Asset Derivatives at June 30, 2009
(Dollars in thousands) |
||||||||||||||
Derivatives designated as hedging instruments under Statement 133 |
Notional/Contract Amount |
Fair Value Balance Sheet Location |
Estimated Net Fair Value |
Expiration Date |
Fixed Rate |
|||||||||
Interest rate swap - 4 year cash flow |
$ | 30,000 | Other assets | $ | (11 | ) | 11/26/12 | 4.97 | % | |||||
Interest rate swap - 5 year cash flow |
20,000 | Other assets | (120 | ) | 11/26/13 | 5.28 | % | |||||||
Interest rate swap - 4 year cash flow |
10,000 | Other assets | (261 | ) | 05/27/13 | 4.54 | % | |||||||
$ | 60,000 | $ | (392 | ) | 5.00 | % | ||||||||
For the quarters ended June 30, 2009 and June 30, 2008
(Dollars in thousands) |
||||||||||||||
Derivatives in Statement 133 cash flow hedging relationships |
Amount of Gain (Loss) Recognized in OCI on Derivatives (Effective Portion) |
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion) |
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion) | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||
Interest rate swap - 4 year cash flow |
$ | (675 | ) | 0 | Other income | $ | (18 | ) | 0 | |||||
Interest rate swap - 5 year cash flow |
(693 | ) | 0 | Other income | (10 | ) | 0 | |||||||
Interest rate swap - 4 year cash flow |
(261 | ) | 0 | Other income | 0 | 0 | ||||||||
$ | (1,629 | ) | 0 | $ | (28 | ) | 0 | |||||||
Under the terms of the agreement, the Bank pays interest monthly at the rate equivalent to Wall Street Journal prime and receives interest income monthly at the fixed rate shown above.
Recent Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies. FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company/Bank does not expect the adoption of FSP FAS 141(R)-1 to have a material impact on its (consolidated) financial statements.
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying
11
circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. The Company/Bank does not expect the adoption of FSP FAS 157-4 to have a material impact on its (consolidated) financial statements.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009. The Company/Bank does not expect the adoption of FSP FAS 107-1 and APB 28-1 to have a material impact on its (consolidated) financial statements.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. FSP FAS 115-2 and FAS 124-2 amends other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009. The Company/Bank does not expect the adoption of FSP FAS 115-2 and FAS 124-2 to have a material impact on its (consolidated) financial statements.
In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities. SAB 111 maintains the SEC Staffs previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. The Company/Bank does not expect the implementation of SAB 111 to have a material impact on its (consolidated) financial statements.
In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events. SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. The Company/Bank does not expect the adoption of SFAS 165 to have a material impact on its (consolidated) financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140. SFAS 166 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferors continuing involvement, if any, in transferred financial assets. SFAS 166 must be applied as of the beginning of the first annual reporting period that begins after November 15, 2009 and for interim periods within that first annual reporting period. Earlier application is prohibited. The Company/Bank does not expect the adoption of SFAS 166 to have a material impact on its (consolidated) financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R). SFAS 167 improves financial reporting by enterprises involved with variable interest entities. SFAS 167 will be effective as of the beginning of the first annual reporting period that begins after November 15, 2009 and for interim periods within that first annual reporting period. Earlier application is prohibited. The Company/Bank does not expect the adoption of SFAS 167 to have a material impact on its (consolidated) financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles a replacement of FASB Statement No. 162. SFAS 168 establishes the FASB Accounting Standards Codification, which will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company/Bank does not expect the adoption of SFAS 168 to have a material impact on its (consolidated) financial statements.
In June 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 112 (SAB 112). SAB 112 revises or rescinds portions of the interpretative guidance included in the codification of SABs in order to make the interpretive guidance consistent with current U.S. GAAP. The Company/Bank does not expect the adoption of SAB 112 to have a material impact on its (consolidated) financial statements.
12
Note 2: Other Commitments
In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are not reflected in the accompanying financial statements. These commitments include various guarantees and commitments to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Companys subsidiary bank evaluates each customers credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on managements credit evaluation of the customer. Standby letters of credit and financial guarantees written are conditional commitments to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral supporting those commitments when deemed necessary by management. As of June 30, 2009, $27,924,000 of performance standby letters of credit have been issued. The Company does not anticipate any losses as a result of these transactions.
Note 3: Fair Value Measurements
SFAS 157, Fair Value Measurements, (SFAS 157) defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, establishes a three-level valuation hierarchy for disclosure of fair value measurement and expands disclosures requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The definition of fair value is clarified by SFAS No. 157 to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
The three levels are defined as follows: Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market for the asset or liability, for substantially the full term of the financial instrument. Level 3 the valuation methodology is derived from model-based techniques in which at least one significant input is unobservable to the fair value measurement and based on the Companys own assumptions about market participants assumptions.
Following is a description of the valuation methodologies used for instruments measured on a recurring basis at estimated fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:
Securities
Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. All of the Companys securities are classified as available for sale.
Interest Rate Swaps
Cash flow interest rate swaps are classified within level 2 with fair values determined by quoted market prices and mathematical models using current and historical data.
Loans Held for Sale
Loans held for sale are required to be measured at the lower of cost or fair value. Under SFAS No 157, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At June 30, 2009, loans held for sale, which were included in total loans on the balance sheet and were recorded at cost, amounted to $3,146,000.
Impaired Loans
SFAS No. 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), or at the fair value of the loans collateral (if the loan is collateral dependent). Fair value of the loans collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. Impaired loans are substantially recorded at cost at June 30, 2009.
13
Other Real Estate Owned
Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. The majority of OREO is carried at cost.
The Company had no estimated fair value liabilities at June 30, 2009. A summary of assets at June 30, 2009 measured at estimated fair value on a recurring basis were as follows:
(Dollars in Thousands) |
Level 1 | Level 2 | Level 3 | Total Fair Value Measurements |
||||||||||
Securities available for sale |
$ | 1,139 | $ | 163,725 | $ | | $ | 164,864 | ||||||
Interest rate swaps |
0 | (392 | ) | 0 | (392 | ) | ||||||||
Total assets |
$ | 1,139 | $ | 163,333 | $ | | $ | 164,472 | ||||||
Fair values of financial instruments
The Company implemented FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:
Cash, Due from Banks, Short-Term Investments, and Federal Funds Sold
The carrying amounts of cash, due from banks, short-term investments, and federal funds sold approximate their fair value.
Securities Available for Sale
Fair values for investment securities are based on quoted market prices.
Interest Rate Swaps
Fair values for cash flow interest rate swaps are determined by quoted market prices and mathematical models using current and historical data.
Loans Receivable
For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Restricted Bank Stock
These investments are carried at cost. The Company is required to maintain minimum investment balances in these stocks, which are not actively traded and therefore have no readily determinable market value.
Deposit Liabilities
The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposits and IRAs are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected maturities on time deposits.
Short-Term Borrowings
The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Companys current incremental borrowing rates for similar types of borrowing arrangements.
14
Long-Term Borrowings
The fair value of the Companys fixed rate long-term borrowings is estimated using a discounted cash flow analysis based on the Corporations current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts of variable-rate long-term borrowings approximate their fair values at the reporting date.
Accrued Interest
The carrying amounts of accrued interest approximate their fair values.
Off-Balance-Sheet Instruments
The Company generally does not charge commitment fees. Fees for standby letters of credit and other off-balance-sheet instruments are not significant.
The estimated fair values of the Companys financial statements were as follows at June 30, 2009:
June 30, 2009 | ||||||||
(Dollars in thousands) |
Carrying Amount |
Fair Value | ||||||
Financial Assets |
||||||||
Cash, due from banks, and short-term investments |
$ | 13,802 | $ | 13,802 | ||||
Federal funds sold |
5,270 | 5,270 | ||||||
Securities available for sale |
164,864 | 164,864 | ||||||
Restricted bank stocks |
7,886 | 7,886 | ||||||
Interest rate swaps |
(392 | ) | (392 | ) | ||||
Loans |
845,473 | |||||||
Allowance for loan losses |
(7,413 | ) | ||||||
Net loans |
838,060 | 833,004 | ||||||
Accrued interest receivable |
3,768 | 3,768 | ||||||
Total financial assets |
$ | 1,033,258 | $ | 1,028,202 | ||||
Financial Liabilities |
||||||||
Deposits |
$ | 809,122 | $ | 812,372 | ||||
Short-term borrowed funds |
84,399 | 84,399 | ||||||
Long-term borrowed funds |
105,067 | 107,739 | ||||||
Accrued interest payable |
1,322 | 1,322 | ||||||
Total financial liabilities |
$ | 999,910 | $ | 1,005,832 | ||||
Subsequent Events
The Company adopted the Statement of Financial Accounting Standards (SFAS) No. 165, Subsequent Events. SFAS No. 165 establishes general standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. SFAS No. 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition in the financial statements, identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that should be made about events or transactions that occur after the balance sheet date. In preparing these financial statements, the Company evaluated the events and transactions that occurred between June 30, 2009 through August 7, 2009, the date these financial statements were issued.
15
PART I - FINANCIAL INFORMATION
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
OVERVIEW
Orrstown Financial Services, Inc. (the Company) is a financial holding company with a wholly-owned bank subsidiary, Orrstown Bank. The following is a discussion of our consolidated financial condition at June 30, 2009 and results of operations for the three and six months ended June 30, 2009 and three and six months ended June 30, 2008. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated.
Some statements and information may contain forward-looking statements. Factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to: general political and economic conditions, unforeseen changes in the general interest rate environment, developments concerning credit quality in various corporate lending industry sectors, legislative or regulatory developments, legal proceedings, and pending or proposed changes in accounting rules, policies, practices, and procedures. Each of these factors could affect estimates and assumptions used to produce forward looking statements causing actual results to differ materially from those anticipated. Future results could also differ materially from historical performance.
Critical Accounting Policies
The Bank policy related to the allowance for loan losses is considered to be a critical accounting policy because the allowance for loan losses represents a particularly sensitive accounting estimate. The amount of the allowance is based on managements evaluation of the collectibility of the loan portfolio, including the nature of the loan portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, grouping of like loans, grading of individual loan quality, review of specific problem loans, the examination of underlying collateral and current economic conditions that may affect the borrowers ability to pay.
SUMMARY OF FINANCIAL RESULTS
Orrstown Financial Services, Inc. recorded net income of $3,454,000 for the second quarter of 2009 compared to $3,603,000 for the same period in 2008, representing a decrease of $149,000 or 4.1%. Basic earnings per share (EPS) decreased $0.02 to $0.54 in the recent quarter from the $0.56 earned during the second quarter of 2008. Diluted earnings per share for the second quarter were $0.51 versus $0.54 last year.
Sequentially earnings improved significantly as the second quarter 2009 earnings of $3,454,000 were up $429,000, or 14.2% from the $3,025,000 earned during first quarter 2009. In addition, when comparing second quarter 2009 results to first quarter 2009 results, basic earnings per share grew to $0.54 from $0.47, diluted earnings per share grew to $0.51 from $0.45, net interest margin grew to 3.57% from 3.40% and return on assets grew to 1.26% from 1.15%. The sequential gains were achieved primarily due to continual growth, lowered cost of funds, an increased flow of tax credit projects and despite a $517,000 special assessment for FDIC insurance.
Net income for the first six months of 2009 was $6,479,000 compared to $6,853,000 for the same period in 2008, representing a decrease of $374,000 or 5.5%. Basic earnings per share for the first half of 2009 decreased by $0.06 to $1.01 from the $1.07 earned for the same period in 2008. Diluted earnings per share for the first six months were $0.96 versus $1.02 last year.
Included below are ratios for the return on average tangible assets (ROTA) and return on average tangible equity (ROTE) which exclude intangibles from the balance sheet and related amortization and tax expense from net income due to the associated goodwill and intangibles from the acquisition of companies and purchased deposits.
16
The following statistics compare the second quarter and year-to-date performance of 2009 to that of 2008:
Three Months Ended | Six Months Ended | |||||||||||
June 2009 |
June 2008 |
June 2009 |
June 2008 |
|||||||||
Return on average assets |
1.26 | % | 1.57 | % | 1.20 | % | 1.51 | % | ||||
Return on average tangible assets |
1.30 | % | 1.63 | % | 1.24 | % | 1.57 | % | ||||
Return on average equity |
13.14 | % | 14.69 | % | 12.50 | % | 14.11 | % | ||||
Return on average tangible equity |
16.61 | % | 18.94 | % | 15.86 | % | 18.27 | % | ||||
Average equity / Average assets |
9.58 | % | 10.71 | % | 9.63 | % | 10.72 | % |
RESULTS OF OPERATIONS
Quarter ended June 30, 2009 compared to Quarter ended June 30, 2008
Net interest income for the second quarter of 2009 was $8,812,000 representing a growth of $648,000, or 7.9% over the $8,164,000 realized during the second quarter last year. On a fully taxable equivalent basis (FTE), net interest income for the second quarter of 2009 and 2008 was $9,123,000 and $8,394,000, respectively.
The table that follows states rates on a fully taxable equivalent basis (FTE):
Three Months Ended | ||||||||||||||||||
June 2009 | June 2008 | |||||||||||||||||
(Dollars in thousands) |
Average Balance |
Tax Equivalent Interest |
Tax Equivalent Rate |
Average Balance |
Tax Equivalent Interest |
Tax Equivalent Rate |
||||||||||||
Interest Earning Assets: |
||||||||||||||||||
Federal funds sold & interest bearing bank balances |
$ | 19,111 | $ | 13 | 0.27 | % | $ | 9,875 | $ | 54 | 2.20 | % | ||||||
Investment securities |
155,757 | 1,494 | 3.84 | % | 87,746 | 1,052 | 4.82 | % | ||||||||||
Total loans |
836,667 | 11,946 | 5.65 | % | 740,164 | 11,809 | 6.34 | % | ||||||||||
Total interest-earning assets |
1,011,535 | 13,453 | 5.29 | % | 837,785 | 12,915 | 6.12 | % | ||||||||||
Interest Bearing Liabilities: |
||||||||||||||||||
Interest bearing demand deposits |
$ | 299,518 | $ | 829 | 1.11 | % | $ | 248,181 | $ | 910 | 1.47 | % | ||||||
Savings deposits |
61,378 | 48 | 0.31 | % | 62,553 | 156 | 1.00 | % | ||||||||||
Time deposits |
350,509 | 2,388 | 2.73 | % | 268,666 | 2,233 | 3.34 | % | ||||||||||
Short term borrowings |
79,116 | 96 | 0.49 | % | 56,966 | 239 | 1.69 | % | ||||||||||
Long term borrowings |
106,996 | 969 | 3.58 | % | 88,260 | 983 | 4.41 | % | ||||||||||
Total interest bearing liabilities |
897,517 | 4,330 | 1.93 | % | 724,626 | 4,521 | 2.51 | % | ||||||||||
Net interest income / net interest spread |
$ | 9,123 | 3.36 | % | $ | 8,394 | 3.61 | % | ||||||||||
Net interest margin |
3.57 | % | 3.96 | % |
Net Interest Income
FTE net interest income totaled $9,123,000 for the second quarter of 2009 versus $8,394,000 for the same period last year, an increase of $729,000, or 8.7%. This increase was achieved solely by volume factors as our net interest margin has declined by 39 basis points verses second quarter 2008. While our cost of funds has declined we have seen a more rapid drop in earning asset yields over those time frames. The lower rate environment, versus a year earlier, has limited investment opportunities and loans indexed to prime or libor have declined in yield since June 2008. This has resulted in a decline of 83 basis points in earning asset yield versus second quarter 2008. The use of interest rate swaps, loan rate floors and a continually declining cost of funds enabled us to hold our net interest margin at 3.57% during second quarter 2009, which represents a 17 basis point increase from the 3.40% net interest margin generated during first quarter 2009. The generally low rate environment has made it difficult to increase earning asset yields, which remained at 5.29% for the quarter, the same yield as first quarter 2009, but our balance sheet is poised to prosper in a rising rate environment. We have used $25 million of TAF borrowings at 25 basis points to help average down our cost of funds.
17
Noninterest Income
Total noninterest income increased $206,000, or 5.0%, from $4,144,000 to $4,350,000. Net security gains the second quarter 2009 were $293,000 compared to the $1,000 of net losses taken in the second quarter of 2008. Revenue produced by our secondary mortgage market program grew $306,000 as refinancing activity has been brisk. The aforementioned increases offset declines of $91,000 in overdraft protection fees, $76,000 in trust income and $27,000 in brokerage fees.
Noninterest Expense
Other expenses rose from $6,885,000 during the second quarter of 2008 to $8,344,000 during the same period of 2009, an increase of $1,459,000, or 21.2%. Salary expense increased by $294,000, or 11.0%, over the prior year. Benefit expense grew overall by $163,000. Employee insurance plan expenses have increased by $111,000, and employment tax expense increased by $22,000. These increases were attributable to growth of staff and annual reviews.
Occupancy and equipment expense rose $104,000, or 9.7%. Depreciation expense contributed $125,000 of the increase along with an increase of $17,000 in equipment maintenance and repairs and decrease of $9,000 in building maintenance and $33,000 decrease in minor furniture/equipment. The opening of our operations center and a second Hagerstown, MD, branch during 2008 contributed to these increases.
The costs of printing and supplies decreased $45,000. Mortgage servicing expense increased by $69,000 due to the increased loan demand for secondary market mortgage loans. FDIC insurance expense increased by $563,000, which included the special assessment of $517,000 that was recorded on June 30, 2009. Other than the FDIC insurance assessment, increases were brought about by continued company growth.
Six months ended June 30, 2009 compared to Six months ended June 30, 2008
Net interest income for the first six months of 2009 was $16,834,000 representing a growth of $753,000, or 4.7% over the $16,081,000 realized during the same period last year. On a fully taxable equivalent basis (FTE), net interest income for the first six months of 2009 and 2008 was $17,449,000 and $16,547,000, respectively.
The table that follows states rates on a fully taxable equivalent basis (FTE):
Six Months Ended | ||||||||||||||||||
June 2009 | June 2008 | |||||||||||||||||
(Dollars in thousands) |
Average Balance |
Tax Equivalent Interest |
Tax Equivalent Rate |
Average Balance |
Tax Equivalent Interest |
Tax Equivalent Rate |
||||||||||||
Interest Earning Assets: |
||||||||||||||||||
Federal funds sold & interest bearing bank balances |
$ | 26,498 | $ | 33 | 0.25 | % | $ | 13,593 | $ | 179 | 2.65 | % | ||||||
Investment securities |
139,483 | 2,788 | 4.01 | % | 88,712 | 2,222 | 5.05 | % | ||||||||||
Total loans |
828,833 | 23,513 | 5.66 | % | 727,065 | 24,138 | 6.60 | % | ||||||||||
Total interest-earning assets |
994,814 | 26,334 | 5.28 | % | 829,370 | 26,539 | 6.36 | % | ||||||||||
Interest Bearing Liabilities: |
||||||||||||||||||
Interest bearing demand deposits |
$ | 291,289 | $ | 1,662 | 1.15 | % | $ | 240,448 | $ | 2,013 | 1.68 | % | ||||||
Savings deposits |
60,947 | 112 | 0.37 | % | 62,759 | 370 | 1.19 | % | ||||||||||
Time deposits |
350,567 | 4,882 | 2.81 | % | 271,302 | 5,001 | 3.71 | % | ||||||||||
Short term borrowings |
70,342 | 181 | 0.51 | % | 56,531 | 650 | 2.27 | % | ||||||||||
Long term borrowings |
112,399 | 2,048 | 3.62 | % | 87,391 | 1,958 | 4.43 | % | ||||||||||
Total interest bearing liabilities |
885,544 | 8,885 | 2.02 | % | 718,431 | 9,992 | 2.80 | % | ||||||||||
Net interest income / net interest spread |
$ | 17,449 | 3.26 | % | $ | 16,547 | 3.57 | % | ||||||||||
Net interest margin |
3.48 | % | 3.94 | % |
Net Interest Income
FTE net interest income totaled $17,449,000 during the first six months of 2009 versus $16,547,000 during the first half of 2008, an increase of $902,000 or 5.5%.
The increase was generated entirely by volume as our net interest margin declined from 3.94% to 3.48% for the same reasons detailed in the quarterly comparative section. The net interest margin has slowly strengthened as we have moved through 2009, but had depressed sharply during the fourth quarter 2008 where there were repeated decreases in the federal funds target rate and the prime lending rate. The declines in prime pushed our earning asset yield down but the use of prime for fixed interest rate swaps, prime indexed advances, floors on floating rate loans and a gradual decline in cost of funds has enabled us to widen our net interest margin as we have advanced through 2009.
18
Noninterest Income
Other income increased $564,000, or 7.3%, from $7,755,000 during the first half of 2008 to $8,319,000 during the first six months of 2009. A large component of the increase was a $410,000 increase in securities gains as we moved to protect some gains as rates slowly moved up. We also saw revenue produced by our secondary mortgage market program increase by $562,000, or 60.7%, as refinancing opportunities continued to present themselves. In addition, debit card revenue grew $102,000, or 15.4%.
The aforementioned increases helped to offset declines in loan fees and overdraft protection fees that were somewhat attributable to the slowing economy.
Noninterest Expense
Other expenses rose from $13,585,000 during the first six months of 2008 to $16,021,000 during the same period of 2009, an increase of $2,436,000, or 17.9%. Salary expense increased by $461,000, or 8.6%, versus the prior year. Benefit expenses rose $250,000. These increases are reasonable given the growth of the Company.
Occupancy and equipment expense rose $361,000, or 17.8%. General growth of the Company plus the build out of an operations center and a second Hagerstown, MD, branch were contributors to this increase.
Other operating expenses rose $1,293,000, with FDIC insurance increases representing $653,000 of that total.
The overhead efficiency ratio for Orrstown Financial Services, Inc, is 62.6% for the first six months of 2009. This compares to peer averages of approximately 67% for publicly traded banks of peer size ($1-5 billion), 71% for Mid Atlantic banks and 72% for all banks, per SNL Financial.
INCOME TAX EXPENSE
Income tax expense decreased $499,000, or 31.9%, during the second quarter of 2009 versus the second quarter of 2008. For the first six months of 2009 the income tax expense decreased $845,000, or 28.0% over the same period 2008. The marginal federal income tax bracket is 35% for 2009 and 38% for 2008, but the use of tax free investments and an increase in low income housing credit investments and the completion of a historic tax credit project has helped lower the effective income tax rate.
Effective income tax rates were as follows:
Three Months Ended | Six Months Ended | |||||||||||
June 2009 |
June 2008 |
June 2009 |
June 2008 |
|||||||||
Effective income tax rate |
23.6 | % | 30.3 | % | 24.8 | % | 30.3 | % |
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration factors such as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers ability to pay. Through this review and evaluation process, an amount deemed adequate to meet current growth and future loss expectations is charged to operations. The unallocated portion of the reserve ensures that any additional unforeseen losses that are not otherwise identifiable will be able to be absorbed. It is intended to provide for imprecise estimates in assessing projected losses, uncertainties in economic conditions and allocating pool reserves. Management deems the total of the allocated and unallocated portions of the allowance for loan losses to be adequate to absorb any losses at this time.
The provision for loan losses amounted to $300,000 and $257,000 for the second quarter of 2009 and 2008, respectively. The reserve to loan ratio for the Company was 0.88% at June 30, 2009 compared to 0.85% on June 30, 2008. These provisions compared to net charge-offs of $61,000 during the second quarter 2009 and $15,000 during the same period last year.
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For the first six months of 2009 the provision for loan losses was $515,000 compared to $415,000 taken in the first half of 2008. The year to date net charge-offs for 2009 were $242,000 compared to $127,000 of net charge-offs for the same period 2008. The increased provision during 2009 is due primarily to general economic conditions, including a perceived slowing in certain industries. The provision also increased due to the increase in nonperforming assets from $6,054,000 in second quarter 2008 to $9,168,000 in second quarter 2009. Overall loan quality, however, remains strong.
The provision for loan losses and the other changes in the allowance for loan losses are shown below:
Three Months Ended | Six Months Ended | |||||||||||||||
(Dollars in Thousands) |
June 2009 |
June 2008 |
June 2009 |
June 2008 |
||||||||||||
Balance at beginning of period |
$ | 7,174 | $ | 6,187 | $ | 7,140 | $ | 6,141 | ||||||||
Provision for loan losses |
300 | 257 | 515 | 415 | ||||||||||||
Recoveries |
8 | 20 | 12 | 26 | ||||||||||||
Loan charge-offs |
(69 | ) | (35 | ) | (254 | ) | (153 | ) | ||||||||
Balance at end of period |
$ | 7,413 | $ | 6,429 | $ | 7,413 | $ | 6,429 | ||||||||
NONPERFORMING ASSETS / RISK ELEMENTS
Nonperforming assets at June 30, are as follows:
(Dollars in Thousands) |
2009 | 2008 | ||||||
Loans on nonaccrual (cash) basis |
$ | 1,905 | $ | 166 | ||||
Loans whose terms have been renegotiated |
0 | 0 | ||||||
OREO |
939 | 227 | ||||||
Total nonperforming loans and OREO |
2,844 | 393 | ||||||
Loans past due 90 or more days and still accruing |
6,324 | 5,661 | ||||||
Total nonperforming and other risk assets |
$ | 9,168 | $ | 6,054 | ||||
Ratio of total risk assets to total loans and OREO |
1.08 | % | 0.80 | % | ||||
Ratio of total risk assets to total assets |
0.82 | % | 0.64 | % |
Any loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed under Item III of Industry Guide 3 do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources.
At June 30, 2009, the total recorded investment in impaired loans was $9,192,000, of which $3,136,000 had allowances determined in accordance with SFAS No. 114 and $6,056,000 did not have allowances determined in accordance with SFAS 114. The allowance for loan losses on these impaired loans amounted to $1,550,000 at June 30, 2009. At March 31, 2009, the total recorded investment in impaired loans was $2,373,000, of which $24,000 had allowances determined in accordance with SFAS No. 114 and $2,349,000 did not have allowances determined in accordance with SFAS 114. The allowance for loan losses on these impaired loans amounted to $15,000 at March 31, 2009. Despite the increase in impaired loans between March 31, 2009, and June 30, 2009, we remain adequately reserved with $610,000 or 8.2% of the loan loss reserve unallocated at June 30, 2009.
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CAPITAL
Orrstown Financial Services, Inc. is a financial holding company and, as such, must maintain a well capitalized status in its bank subsidiary. Management foresees no problem in maintaining capital ratios well in excess of regulatory minimums. A comparison of Orrstown Financial Services, Inc.s capital ratios to regulatory minimum requirements at June 30, 2009 are as follows:
Orrstown Financial Services, Inc. |
Regulatory Minimum |
Regulatory Well Capitalized Minimum |
|||||||
Leverage Ratio |
7.7 | % | 4 | % | 5 | % | |||
Risk Based Capital Ratios: |
|||||||||
Tier I Capital Ratio |
10.1 | % | 4 | % | 6 | % | |||
Total (Tier I & II) Capital Ratio (core capital plus allowance for loan losses) |
11.0 | % | 8 | % | 10 | % |
All growth experienced during 2009 has been supported by capital growth in the form of retained earnings. Equity represented 9.6% of assets at June 30, 2009 and 9.8% at December 31, 2008.
Management is not aware of any current recommendations by regulatory authorities which, if implemented, would have a material effect on the Companys liquidity, capital resources or operations.
LIQUIDITY
The primary function of asset/liability management is to assure adequate liquidity while minimizing interest rate risk. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Sources of liquidity include investment securities, loan and lease income and payments, and increases in customers deposit accounts. Additionally, Orrstown Bank is a Federal Home Loan Bank (FHLB) member, and standard credit arrangements available to FHLB members provide increased liquidity. Recognizing the need for varied funding sources we have established modest relationships using other nontraditional sources, as provided for in our contingency funding plan. We have tested those facilities and are comfortable with our relationships. Liquidity was primarily provided by operating activities and the sale and maturities of available for sale securities.
PART I - FINANCIAL INFORMATION
Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
Market risk is defined as the exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. For domestic banks, the majority of market risk is related to interest rate risk.
Interest rate sensitivity management requires the maintenance of an appropriate balance between interest sensitive assets and liabilities. Interest bearing assets and liabilities that are maturing or repricing should be adequately balanced to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The Company has consistently followed a strategy of pricing assets and liabilities according to prevailing market rates while largely matching maturities, within the guidelines of sound marketing and competitive practices. Rate sensitivity is measured by monthly gap analysis, quarterly rate shocks, and periodic simulation. The cumulative gap position at 12 months is slightly negative at $72.5 million at June 30, 2009 and the RSA/ RSL cumulative ratio was 0.86%, which was approximately the same as the 0.89% reported at December 31, 2008. The cumulative RSA/RSL at June 30, 2009 is 0.89% at three months. The Company enjoys a closely balanced position that does not place it at undue risk under any interest rate scenario. Many of the deposit dollars in transaction accounts are discretionarily priced so management maintains significant pricing flexibility.
Item 4. | Controls and Procedures |
(a) Evaluation of disclosure controls and procedures:
The Companys Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934, as amended) as of June 30, 2009. Based on such evaluation, such officers have concluded that, as of June 30, 2009, the Companys disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiary) required to be included in the Companys periodic filings under the Exchange Act.
(b) Changes in internal controls:
The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There have not been any significant changes in the Companys internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, such controls during the quarter ended June 30, 2009.
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The nature of Orrstown Financial Services, Inc.s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. In the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.
In addition to the risk factors disclosed in the Annual Report on Form 10-K for the year ended December 31, 2008, the Company also has exposure to the following risk:
Asset Valuation Risk The Company maintains an investment portfolio that includes investments, the market value of which may be affected by factors other than the underlying performance of the issuer, such as ratings downgrades, adverse changes in business climate, and lack of liquidity for resales. The Company periodically, but not less than quarterly, evaluates such investments and other assets for impairment indicators. The Company may be required to record additional impairment charges if investments suffer a decline in value that is considered other-than-temporary. If it is determined that a significant impairment has occurred, the Company would be required to take a OTTI charge against earnings, which could have a material adverse effect on results of operations for the period in which the charge occurs.
Except as herein disclosed, there have been no material changes from the risk factors as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2008.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
On April 27, 2006, Orrstown Financial Services, Inc. announced a Stock Repurchase Plan approving the purchase of up to 150,000 shares as conditions allow. The plan may be suspended at any time without prior notice and has no prescribed time limit in which to fill the authorized repurchase amount. There were no repurchases of common equity securities during the quarter ended June 30, 2009. As of June 30, 2009, 92,007 shares have been purchased under the program.
The Company did not sell any unregistered securities.
Item 3 - Defaults upon Senior Securities
Not applicable
Item 4 - Submission of Matters to a Vote of Security Holders
The 2009 Annual Meeting of Shareholders of Orrstown Financial Services, Inc. was held on May 5, 2009. The only matter submitted to a vote of shareholders was the election of three directors to Class C for three year terms expiring in 2012. There was no solicitation in opposition to the nominees of the Board of Directors for election to the Board. All nominees of the Board of Directors were elected. The number of votes cast FOR, as well as the number of votes WITHHELD for each of the nominees was as follows:
Nominee: |
Votes FOR | Votes WITHHELD | ||
Anthony F. Ceddia |
3,961,236 | 223,477 | ||
Andrea Pugh |
3,959,683 | 225,030 | ||
Kenneth R. Shoemaker |
3,897,722 | 286,991 |
The following Directors continued their term of office after the meeting:
Gregory A. Rosenberry, Glenn W. Snoke, Jeffrey W. Coy, John S. Ward, and Joel R. Zullinger.
As previously disclosed, in Current Reports on Form 8-K filed May 7, 2009, the resignations of the following Directors were accepted at the annual reorganization meeting of the Board of Directors, held immediately following the Annual Meeting of Shareholders:
Denver L. Tuckey and Peter C. Zimmerman.
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As previously disclosed, in Current Reports on Form 8-K filed May 7, 2009, the following new Directors were appointed to office at the annual reorganization meeting of the Board of Directors, held immediately following the Annual Meeting of Shareholders:
Thomas R. Quinn, Jr. and Mark Keller.
None
3.1 | Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of the Registrants Registration Statement on Form S-4, Registration No. 333-131176. | |||
3.2 | By-laws. Incorporated by reference to Exhibit 3.2 of the Registrants Registration Statement on Form S-4, Registration No. 33-18888. | |||
4 | Instruments defining the rights of security holders including indentures. The rights of the holders of Registrants common stock are contained in: | |||
(i) | Articles of Incorporation of Orrstown Financial Services, Inc., incorporated by reference to Exhibit 3.1 of the Registrants Registration Statement on Form S-4, Registration No.333-131176. | |||
(ii) | By-laws of Orrstown Financial Services, Inc., incorporated by reference to Exhibit 3.2 to the Registrants Registration Statement on Form S-4, Registration No. 33-18888. | |||
31.1 | Rule 13a - 14(a)/15d-14(a) Certification (Chief Executive Officer) filed herewith | |||
31.2 | Rule 13a - 14(a)/15d-14(a) Certifications (Chief Financial Officer) filed herewith | |||
32.1 | Section 1350 Certifications (Chief Executive Officer) filed herewith | |||
32.2 | Section 1350 Certifications (Chief Financial Officer) filed herewith |
23
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Thomas R. Quinn, Jr. |
(Thomas R. Quinn, Jr., President & CEO) |
(Duly Authorized Officer) |
/s/ Bradley S. Everly |
(Bradley S. Everly, Senior Vice President & CFO) |
(Principal Financial Officer) |
Date: August 7, 2009 |
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ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARIES
EXHIBIT INDEX
3.1 | Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of the Registrants Registration Statement on Form S-4, Registration No.333-131176. | |||
3.2 | By-laws. Incorporated by reference to Exhibit 3.2 to the Registrants Registration Statement on Form S-4, Registration No. 33-18888. | |||
4 | Instruments defining the rights of security holders including indentures. The rights of the holders of Registrants common stock are contained in: | |||
i. | Articles of Incorporation of Orrstown Financial Services, Inc., incorporated by reference to Exhibit 3.1 of the Registrants Registration Statement on Form S-4, Registration No.333-131176. | |||
ii. | By-laws of Orrstown Financial Services, Inc., incorporated by reference to Exhibit 3.2 to the Registrants Registration Statement on Form S-4, Registration No. 33-18888. | |||
31.1 | Rule 13a - 14(a)/15d-14(a) Certification (Chief Executive Officer) filed herewith | |||
31.2 | Rule 13a - 14(a)/15d-14(a) Certifications (Chief Financial Officer) filed herewith | |||
32.1 | Section 1350 Certifications (Chief Executive Officer) filed herewith | |||
32.2 | Section 1350 Certifications (Chief Financial Officer) filed herewith |
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