Orrstown Financial Services(ORRF) - 2024 Q1 - Quarterly Report

PART I – FINANCIAL INFORMATION Glossary of Defined Terms This section defines key financial and regulatory terms to ensure consistent understanding of the report - The glossary defines terms such as ACL (Allowance for credit losses), AFS (Available-for-sale), AOCI (Accumulated other comprehensive income (loss)), CECL (Current expected credit losses), and various regulatory bodies (FASB, FDIC, FRB, SEC) to aid in understanding the financial report[9] - The terms 'Orrstown,' 'we,' 'us,' 'our,' and 'Company' refer to Orrstown Financial Services, Inc. and its subsidiaries, unless the context indicates otherwise[9] Item 1. Financial Statements This section presents the unaudited condensed consolidated financial statements and accompanying notes Condensed Consolidated Balance Sheets (Unaudited) Condensed Consolidated Balance Sheet Highlights (Unaudited) | Metric (in thousands) | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Total assets | $3,183,331 | $3,064,240 | | Total liabilities | $2,911,649 | $2,799,184 | | Total shareholders' equity | $271,682 | $265,056 | | Cash and cash equivalents | $182,722 | $65,161 | | Total deposits | $2,695,951 | $2,558,814 | | Net loans | $2,273,908 | $2,269,611 | - Total assets increased by $119.09 million from December 31, 2023, to March 31, 2024, primarily driven by a significant increase in cash and cash equivalents and interest-bearing deposits with banks[10] - Total deposits increased by $137.14 million, with interest-bearing deposits growing by $149.58 million, while noninterest-bearing deposits decreased by $12.45 million[10] Condensed Consolidated Statements of Income (Unaudited) Condensed Consolidated Statements of Income Highlights (Unaudited) | Metric (in thousands) | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Total interest income | $42,650 | $34,277 | | Total interest expense | $15,769 | $7,983 | | Net interest income | $26,881 | $26,294 | | Provision for credit losses | $298 | $729 | | Total noninterest income | $6,630 | $6,078 | | Total noninterest expenses | $22,469 | $20,255 | | Net income | $8,531 | $9,156 | | Basic earnings per share | $0.82 | $0.88 | | Diluted earnings per share | $0.81 | $0.87 | - Net income decreased by $625 thousand (6.8%) year-over-year, from $9.156 million in Q1 2023 to $8.531 million in Q1 2024, primarily due to higher noninterest expenses, including merger-related costs[11][13] - Net interest income increased by $587 thousand (2.2%) year-over-year, driven by a substantial increase in interest income from loans ($7.49 million increase) and short-term investments ($658 thousand increase), partially offset by a significant rise in interest expense on deposits ($7.31 million increase)[11] Condensed Consolidated Statements of Comprehensive Income (Unaudited) Condensed Consolidated Statements of Comprehensive Income Highlights (Unaudited) | Metric (in thousands) | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Net income | $8,531 | $9,156 | | Total other comprehensive (loss) income, net of tax and reclassification adjustments | $(192) | $7,088 | | Total comprehensive income | $8,339 | $16,244 | - Total comprehensive income significantly decreased from $16.244 million in Q1 2023 to $8.339 million in Q1 2024, primarily due to a shift from net unrealized gains on securities available for sale ($8.774 million in Q1 2023) to net unrealized losses ($1.676 million in Q1 2024)[15] Condensed Consolidated Statements of Changes in Shareholders' Equity (Unaudited) Condensed Consolidated Statements of Changes in Shareholders' Equity Highlights (Unaudited) | Metric (in thousands) | Balance, January 1, 2024 | Net Income | Total Other Comprehensive Loss, net of taxes | Cash Dividends | Share-based Compensation Plans | Balance, March 31, 2024 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Total Shareholders' Equity | $265,056 | $8,531 | $(192) | $(2,123) | $410 | $271,682 | - Total shareholders' equity increased by $6.626 million from January 1, 2024, to March 31, 2024, primarily driven by net income of $8.531 million, partially offset by cash dividends of $2.123 million and total other comprehensive loss of $192 thousand[17] Condensed Consolidated Statements of Cash Flows (Unaudited) Condensed Consolidated Statements of Cash Flows Highlights (Unaudited) | Metric (in thousands) | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Net cash provided by operating activities | $12,670 | $5,414 | | Net cash used in investing activities | $(9,380) | $(56,603) | | Net cash provided by financing activities | $114,271 | $88,689 | | Net increase in cash and cash equivalents | $117,561 | $37,500 | | Cash and cash equivalents at end of period | $182,722 | $98,323 | - Net cash provided by operating activities increased significantly to $12.670 million in Q1 2024 from $5.414 million in Q1 2023, primarily due to changes in accrued interest payable and other liabilities[19] - Net cash used in investing activities decreased substantially from $(56.603) million in Q1 2023 to $(9.380) million in Q1 2024, mainly driven by a lower net increase in loans and higher maturities/repayments of AFS securities[19] - Net cash provided by financing activities increased to $114.271 million in Q1 2024 from $88.689 million in Q1 2023, primarily due to a significant net increase in deposits ($137.137 million)[19] Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines the Company's operations, basis of presentation, and significant accounting policies - Orrstown Financial Services, Inc. operates as a financial holding company through Orrstown Bank, providing banking and financial advisory services across several counties in Pennsylvania and Maryland, and extending lending to adjacent counties in Virginia and West Virginia[23] - The Company adopted ASU 2016-13 (CECL) on January 1, 2023, replacing the incurred loss model with a lifetime expected loss model for financial assets measured at amortized cost, including loans and held-to-maturity securities, and off-balance sheet credit exposures[27] - The ACL for loans is determined using a quantitative assessment (DCF methodology for most loan segments, remaining life for consumer loans) and a qualitative component, considering factors like lending policies, loan volume, credit concentrations, collateral valuation, and economic conditions[28][31][33][36] - For AFS securities, an impairment evaluation is conducted to determine if credit losses exist, based on factors like issuer creditworthiness and collateral performance, with ACL recorded for credit-related losses and non-credit losses in AOCI[41][42] - Recent accounting pronouncements, ASU 2023-07 (Segment Reporting) and ASU 2023-09 (Income Taxes), are being evaluated, with no significant impact anticipated on consolidated financial statements[44][45] NOTE 2. PENDING MERGER This note details the pending merger agreement with Codorus Valley Bancorp, Inc - On December 12, 2023, Orrstown Financial Services, Inc. entered into an Agreement and Plan of Merger with Codorus Valley Bancorp, Inc., with Orrstown as the surviving corporation[46] - Upon completion, each share of Codorus Valley common stock will be converted into the right to receive 0.875 shares of Orrstown Common Stock[47] - Codorus Valley had total assets of $2.2 billion, total loans of $1.7 billion, and total deposits of $1.9 billion as of March 31, 2024, operating 22 full-service and eight limited-purpose branches[48] - The transaction is subject to regulatory and shareholder approvals and is expected to close in the third quarter of 2024[48] NOTE 3. INVESTMENT SECURITIES This note summarizes the Company's Available-for-Sale (AFS) investment securities portfolio Investment Securities Available-for-Sale (AFS) Summary (in thousands) | Metric | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Amortized Cost | $552,155 | $549,089 | | Fair Value | $514,909 | $513,519 | | Gross Unrealized Gains | $1,197 | $1,317 | | Gross Unrealized Losses | $38,443 | $36,887 | - The Company did not record an Allowance for Credit Losses (ACL) on AFS securities, as unrealized losses are attributed to market conditions (primarily interest rates) and not credit deterioration[52][58] - Unrealized losses were higher at March 31, 2024, compared to prior periods, due to market uncertainty from inflation and higher interest rates[52] Investment Securities by Contractual Maturity (March 31, 2024, in thousands) | Maturity Category | Amortized Cost | Fair Value | | :--- | :--- | :--- | | Due after one year through five years | $31,400 | $28,140 | | Due after five years through ten years | $56,101 | $50,898 | | Due after ten years | $157,515 | $143,478 | | CMOs and MBSs | $201,923 | $188,494 | | Asset-backed | $105,216 | $103,899 | | Totals | $552,155 | $514,909 | - The Company recorded investment security losses of $5 thousand in Q1 2024 (vs. $8 thousand in Q1 2023) from mark-to-market losses on an equity security, with no sales of investment securities during these periods[61] NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES This note details the Company's loan portfolio, credit risks, and Allowance for Credit Losses (ACL) - The loan portfolio is diversified across commercial real estate (owner-occupied, non-owner occupied, multi-family, non-owner occupied residential), acquisition and development (1-4 family residential construction, commercial and land development), commercial and industrial, municipal, and residential mortgage (first lien, home equity) segments[62][73] Loan Portfolio by Segment and Class (in thousands) | Loan Class | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Commercial real estate: Owner occupied | $364,280 | $373,757 | | Commercial real estate: Non-owner occupied | $707,871 | $694,638 | | Commercial real estate: Multi-family | $147,773 | $150,675 | | Acquisition and development: Commercial and land development | $118,010 | $115,249 | | Commercial and industrial | $365,524 | $367,085 | | Residential mortgage: First lien | $270,748 | $266,239 | | Total loans | $2,303,073 | $2,298,313 | - The Company uses an internal grading system ('Pass,' 'Special Mention,' 'Substandard,' 'Doubtful,' 'Loss') to monitor loan risk, with 'Special Mention' indicating potential weaknesses and 'Substandard' indicating well-defined weaknesses jeopardizing debt liquidation[73] Nonaccrual Loans by Class (in thousands) | Loan Class | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Owner-occupied commercial real estate | $3,925 | $15,786 | | Non-owner occupied commercial real estate | $228 | $240 | | Multi-family commercial real estate | $1,233 | $1,233 | | Non-owner occupied residential | $2,016 | $2,572 | | Commercial and land development | $1,306 | $1,361 | | Commercial and industrial | $1 | $672 | | First lien residential mortgage | $2,621 | $2,309 | | Total nonaccrual loans | $12,886 | $25,527 | Allowance for Credit Losses (ACL) Activity (in thousands) | Metric | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Balance, beginning of period | $28,702 | $25,178 | | Provision for credit losses | $421 | $729 | | Charge-offs | $(99) | $(142) | | Recoveries | $141 | $176 | | Balance, end of period | $29,165 | $28,364 | - The ACL increased to $29.165 million at March 31, 2024, from $28.702 million at December 31, 2023, with a provision for credit losses of $421 thousand for Q1 2024[110] NOTE 5. LEASES This note outlines the Company's operating lease arrangements for branches and office space - The Company primarily uses operating leases for branches and office space, with lease terms ranging from 4 to 29 years, including renewal options[111] Operating Lease Summary (in thousands) | Metric | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Operating lease ROU assets | $10,593 | $10,824 | | Operating lease ROU liabilities | $11,403 | $11,614 | | Weighted-average remaining lease term (years) | 15.0 | 15.1 | | Weighted-average discount rate | 4.4% | 4.4% | - Cash paid for operating lease liabilities was $335 thousand for Q1 2024, with operating lease expense at $356 thousand[112] NOTE 6. GOODWILL AND OTHER INTANGIBLE ASSETS This note details the Company's goodwill and other intangible assets, including amortization - Goodwill remained at $18.7 million at both March 31, 2024, and December 31, 2023, with no impairment charges recorded in Q1 2024 or Q1 2023[114] - Other intangible assets, primarily core deposit intangibles and other customer relationship intangibles, decreased from $2.414 million at the beginning of Q1 2024 to $2.189 million at period-end due to $225 thousand in amortization expense[116][117] Estimated Future Amortization Expense for Other Intangible Assets (March 31, 2024, in thousands) | Year | Amortization Expense | | :--- | :--- | | 2024 | $611 | | 2025 | $656 | | 2026 | $476 | | 2027 | $297 | | 2028 | $120 | | Thereafter | $29 | | Total | $2,189 | NOTE 7. SHARE-BASED COMPENSATION PLANS This note describes the Company's share-based compensation plans and related expenses - The Company's 2011 Plan provides various share-based awards to officers, employees, and directors, with 283,033 shares available for issuance at March 31, 2024[120][121] Restricted Share Compensation Expense (in thousands) | Metric | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Restricted share award expense | $945 | $616 | | Restricted share award tax benefit | $198 | $129 | | Fair value of shares vested | $2,888 | $2,037 | - Unrecognized compensation expense related to share awards totaled $6.1 million at March 31, 2024, expected to be recognized over a weighted-average period of 2.2 years[121] - The employee stock purchase plan allows eligible employees to buy common stock at a discount, with 3,850 shares purchased in Q1 2024 at a weighted average price of $20.67[122][123] NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS This note details the Company's use of derivative financial instruments for risk management - The Company uses derivative financial instruments (interest rate swaps and caps) to manage interest rate risk, not for trading or speculative purposes[124][125] - At March 31, 2024, the Company had two interest rate swaps designated as cash flow hedges with a total notional value of $125.0 million (hedging FHLB advances and AFS securities)[127] - Three pay-fixed interest rate swaps on commercial loans, with a total notional value of $100.0 million, were designated as fair value hedges to mitigate interest rate risk on long-term fixed-rate loans[129] - The Company had 35 customer and 35 corresponding third-party broker interest rate derivatives not designated as hedging instruments, with an aggregate notional amount of $504.3 million at March 31, 2024, and recognized $199 thousand in swap fee income in Q1 2024[131] Fair Value of Derivative Instruments (in thousands) | Derivative Type | Notional Amount (Mar 31, 2024) | Fair Value (Mar 31, 2024) | Notional Amount (Dec 31, 2023) | Fair Value (Dec 31, 2023) | | :--- | :--- | :--- | :--- | :--- | | Total derivatives designated as hedging instruments | N/A | $1,148 | N/A | $(2,009) | | Total derivatives not designated as hedging instruments | N/A | $51 | N/A | $(76) | NOTE 9. SHORT-TERM BORROWINGS This note summarizes the Company's short-term borrowing activities, primarily from the FHLB Short-Term Borrowings Summary (in thousands) | Metric | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Balance at period-end | $75,000 | $97,500 | | Weighted average interest rate during the period | 5.67% | 5.68% | | Average balance during the period | $97,505 | $87,370 | | Average interest rate during the period | 5.77% | 5.46% | - The Company had $75.0 million in available FHLB lines for short-term borrowings at March 31, 2024, an increase from $52.5 million at December 31, 2023[140] NOTE 10. LONG-TERM DEBT This note details the Company's long-term debt, primarily FHLB fixed-rate advances Long-Term Debt Components (in thousands) | Maturity Year | March 31, 2024 Amount | December 31, 2023 Amount | March 31, 2024 Weighted Average Rate | December 31, 2023 Weighted Average Rate | | :--- | :--- | :--- | :--- | :--- | | 2025 | $15,000 | $15,000 | 4.57% | 4.57% | | 2028 | $25,000 | $25,000 | 3.98% | 3.98% | | Total FHLB Advances | $40,000 | $40,000 | 4.20% | 4.20% | - The Bank had additional availability of $996.0 million at the FHLB at March 31, 2024, based on qualifying collateral[141] - The Bank has $20.0 million in available unsecured lines of credit with two correspondent banks, with no borrowings outstanding at March 31, 2024, or December 31, 2023[142] NOTE 11. SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL This note details shareholders' equity and compliance with regulatory capital requirements - The Company and the Bank met all capital adequacy requirements at March 31, 2024, and December 31, 2023, with the Bank categorized as 'well capitalized' under prompt corrective action regulations[145][146] Capital Ratios (March 31, 2024) | Capital Ratio (Orrstown Financial Services, Inc.) | Actual Ratio | For Capital Adequacy Purposes (includes buffer) | | :--- | :--- | :--- | | Total risk-based capital | 13.4% | 10.5% | | Tier 1 risk-based capital | 11.2% | 8.5% | | Tier 1 common equity risk-based capital | 11.2% | 7.0% | | Tier 1 leverage capital | 9.0% | 4.0% | - The adoption of CECL on January 1, 2023, resulted in a $2.4 million reduction to opening retained earnings and a $100 thousand increase to the allowance for off-balance sheet exposures, with the Company electing a three-year phase-in option for regulatory capital impact[144] - The Board of Directors declared a cash dividend of $0.20 per common share on April 23, 2024, payable on May 14, 2024[149] NOTE 12. EARNINGS PER SHARE This note presents the basic and diluted earnings per share calculations for the Company Earnings Per Share (in thousands, except per share amounts) | Metric | Three Months Ended March 31, 2024 | Three Months Ended March 31, 2023 | | :--- | :--- | :--- | | Net income | $8,531 | $9,156 | | Weighted average shares outstanding - basic | 10,349 | 10,385 | | Basic earnings per share | $0.82 | $0.88 | | Diluted earnings per share | $0.81 | $0.87 | - Diluted earnings per share decreased from $0.87 in Q1 2023 to $0.81 in Q1 2024, reflecting the decrease in net income[150] NOTE 13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK This note describes the Company's financial instruments with off-balance sheet risk - The Company uses off-balance sheet financial instruments, such as commitments to extend credit and standby letters of credit, to meet client financing needs, which involve credit and interest rate risk[151] Contractual/Notional Amounts of Off-Balance Sheet Instruments (in thousands) | Instrument Type | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Home equity lines of credit | $339,871 | $337,460 | | 1-4 family residential construction loans | $52,218 | $40,330 | | Commercial real estate, construction and land development loans | $134,924 | $132,607 | | Commercial, industrial and other loans | $358,353 | $357,099 | | Standby letters of credit | $28,218 | $24,529 | - The reserve for off-balance sheet credit exposures totaled $1.6 million at March 31, 2024 (vs. $1.7 million at December 31, 2023), with a reversal to the provision for credit losses of $123 thousand in Q1 2024[155] NOTE 14. FAIR VALUE This note provides disclosures on fair value measurements for financial instruments - Fair value measurements are categorized into Level 1 (quoted prices in active markets), Level 2 (significant other observable inputs), and Level 3 (significant unobservable inputs)[157][158] Financial Assets Measured at Fair Value on a Recurring Basis (March 31, 2024, in thousands) | Asset Type | Level 1 | Level 2 | Level 3 | Total Fair Value | | :--- | :--- | :--- | :--- | :--- | | Investment securities | $17,789 | $479,386 | $17,734 | $514,909 | | Loans held for sale | — | $535 | — | $535 | | Derivatives | — | $13,197 | $56 | $13,253 | | Total Financial Assets | $17,789 | $493,118 | $17,790 | $528,697 | - The fair values of interest rate swaps, caps, and risk participation derivatives are determined using models incorporating observable market data (Level 2), adjusted for nonperformance risk[161] - Individually evaluated loans with an ACL allocation are measured at fair value on a nonrecurring basis, primarily based on collateral value (Level 2 or Level 3 if management adjusts appraisal or for construction properties)[169][170] - The fair value of interest rate lock commitments on residential mortgages is a Level 3 valuation input due to the use of a 'pull through percentage' (92% at March 31, 2024) as a significant unobservable input[165] NOTE 15. CONTINGENCIES This note discloses legal proceedings and contingencies that may impact the Company - The Company is involved in litigation arising from the ordinary course of business, with no material effect on operations, liquidity, or financial position expected at this time, except as described[177] - A putative class action complaint was filed against Orrstown Bank on March 25, 2022, alleging breach of account agreements by charging certain overdraft fees, seeking refunds, damages, and an injunction[178] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's analysis of the company's financial condition and operational results Overview This overview summarizes Orrstown's financial position and performance for the quarter - At March 31, 2024, the Company reported total assets of $3.2 billion, total liabilities of $2.9 billion, and total shareholders' equity of $271.7 million[181] - Net income for the three months ended March 31, 2024, was $8.5 million, with diluted earnings per share of $0.81, compared to $9.2 million and $0.87, respectively, for the same period in 2023[182] - The Company incurred $672 thousand in merger-related expenses in Q1 2024 due to the pending merger with Codorus Valley, which, if excluded, would result in adjusted net income of $9.2 million and diluted EPS of $0.88[182][190] Cautionary Note About Forward-Looking Statements This section outlines the inherent uncertainties and risks of forward-looking statements in the report - The report contains forward-looking statements reflecting management's current views on future events and financial performance, identified by words like 'may,' 'should,' 'expect,' and 'anticipate'[183] - These statements are subject to risks and uncertainties, including general economic conditions, interest rate changes, merger-related delays, competition, regulatory changes, credit quality, and operational risks, which could cause actual results to differ materially[183] Economic Climate, Inflation and Interest Rates This section discusses prevailing economic conditions and their potential impact on the Company - Preliminary real GDP increased by 1.6% annualized in Q1 2024, a decline from 3.4% in Q4 2023, reflecting reduced consumer spending and exports[185] - The PCE price index increased by 3.4% in Q1 2024 (3.7% excluding food and energy), up from 1.8% in Q4 2023, indicating persistent inflationary pressures[185] - The national unemployment rate slightly increased to 3.8% in March 2024, while state-wide rates in Pennsylvania and Maryland decreased[186] - The 10-year Treasury bond yield rose to 4.62% at March 31, 2024, and the FOMC maintained the Fed Funds rate, signaling no reductions until inflation trends towards the 2.0% target[187] Critical Accounting Estimates This section highlights the Company's critical accounting estimates, judgments, and assumptions - The Company's financial position and results are significantly influenced by management's accounting policies, estimates, and assumptions, especially for credit losses and valuation methodologies[189] - Different assumptions could lead to material changes in reported financial position and results, with estimates potentially impacted by economic conditions, including inflation and geopolitical tensions[188][189] RESULTS OF OPERATIONS This section provides a detailed analysis of the Company's financial performance for Q1 2024 Summary Q1 2024 vs. Q1 2023 Financial Summary (in thousands, except per share) | Metric | Q1 2024 | Q1 2023 | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net income | $8,531 | $9,156 | $(625) | (6.8%) | | Diluted earnings per share | $0.81 | $0.87 | $(0.06) | (6.9%) | | Net interest income | $26,881 | $26,294 | $587 | 2.2% | | Provision for credit losses | $298 | $729 | $(431) | (59.1%) | | Noninterest income | $6,630 | $6,078 | $552 | 9.1% | | Noninterest expenses | $22,469 | $20,255 | $2,214 | 10.9% | | Income tax expense | $2,213 | $2,232 | $(19) | (0.9%) | - Excluding $672 thousand in merger-related expenses, adjusted net income for Q1 2024 would be $9.2 million, and diluted EPS would be $0.88[190] Net Interest Income - Net interest income increased by $587 thousand (2.2%) to $26.9 million in Q1 2024, primarily due to a $1.6 million interest recovery from a commercial real estate loan payoff, partially offset by increased cost of funds[191][195] Net Interest Income, Spread, and Margin (Taxable-Equivalent Basis) | Metric | Q1 2024 | Q1 2023 | Change (bps) | | :--- | :--- | :--- | :--- | | Taxable-equivalent net interest income | $27,263 | $26,624 | $639 | | Net interest spread | 3.26% | 3.62% | (36) | | Net interest margin | 3.77% | 3.94% | (17) | | Yield on interest-earning assets | 5.96% | 5.12% | 84 | | Cost of interest-bearing liabilities | 2.70% | 1.50% | 120 | - The yield on loans increased by 98 basis points to 6.34% in Q1 2024, contributing $7.5 million more interest income, driven by higher rates and increased average loan balances[204] - Interest expense on interest-bearing liabilities increased by $7.8 million, with the cost of interest-bearing liabilities rising by 120 basis points to 2.70% due to higher market rates and competitive deposit pricing[210] Provision for Credit Losses - The provision for credit losses decreased to $298 thousand in Q1 2024 from $729 thousand in Q1 2023, including a $123 thousand reversal for off-balance sheet credit exposures[213] - The decrease was primarily due to an improvement in GDP forecast and a decrease in the Collateral Valuation Trends qualitative factor for residential mortgage and installment loans, partially offset by a reduction in prepayment speed assumptions[213] - Nonaccrual loans decreased by $8.4 million to $12.9 million at March 31, 2024, from $21.3 million at March 31, 2023, mainly due to $18.0 million in repayments, including a $15.2 million commercial real estate loan payoff[214] Noninterest Income Noninterest Income (in thousands) | Metric | Q1 2024 | Q1 2023 | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total noninterest income | $6,630 | $6,078 | $552 | 9.1% | | Swap fee income | $199 | $0 | $199 | 100.0% | | Trust and investment management income | $2,024 | $1,888 | $136 | 7.2% | | Brokerage income | $1,078 | $859 | $219 | 25.5% | - Noninterest income increased by $552 thousand (9.1%) to $6.6 million in Q1 2024, driven by a $199 thousand increase in swap fee income and a $355 thousand increase in wealth management income (trust, investment management, and brokerage)[216] Noninterest Expenses Noninterest Expenses (in thousands) | Metric | Q1 2024 | Q1 2023 | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total noninterest expenses | $22,469 | $20,255 | $2,214 | 10.9% | | Salaries and employee benefits | $13,752 | $12,196 | $1,556 | 12.8% | | Merger-related expenses | $672 | $0 | $672 | 100.0% | | Furniture and equipment | $1,438 | $1,227 | $211 | 17.2% | | Other operating expenses | $1,350 | $1,614 | $(264) | (16.4%) | - Noninterest expenses increased by $2.2 million (10.9%) to $22.5 million in Q1 2024, primarily due to a $1.6 million increase in salaries and employee benefits and $672 thousand in merger-related expenses[217] - Other notable changes include a $211 thousand increase in furniture and equipment expense and a $264 thousand decrease in other operating expenses, mainly from reduced credit valuation adjustments on derivatives[217] Income Tax Expense Income Tax Expense and Effective Tax Rate | Metric | Q1 2024 | Q1 2023 | | :--- | :--- | :--- | | Income tax expense | $2,213 | $2,232 | | Effective tax rate | 20.6% | 19.6% | - The effective tax rate increased to 20.6% in Q1 2024 from 19.6% in Q1 2023, primarily due to increased disallowed interest expense, higher state income taxes, and non-deductible merger-related expenses[218] FINANCIAL CONDITION This section analyzes the Company's financial condition and key balance sheet components Investment Securities - AFS securities increased by $1.4 million to $514.9 million at March 31, 2024, from $513.5 million at December 31, 2023, driven by $21.8 million in purchases (agency MBS/CMO and non-agency CMOs) partially offset by a $10.0 million non-agency CMO call and $8.1 million in paydowns[223] - Net unrealized losses on investment securities increased by $1.7 million to $37.2 million at March 31, 2024, from $35.6 million at December 31, 2023, primarily due to higher treasury rates and wider credit spreads[223] - The Company does not intend to sell securities with unrealized losses and has the ability to hold them until recovery of amortized cost, concluding that losses are not credit-related[222] - The overall duration of the investment securities portfolio was 4.4 years at March 31, 2024[223] Loan Portfolio Loan Portfolio by Segment and Class (in thousands) | Loan Class | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Commercial real estate: Owner occupied | $364,280 | $373,757 | | Commercial real estate: Non-owner occupied | $707,871 | $694,638 | | Commercial and industrial | $365,524 | $367,085 | | Residential mortgage: First lien | $270,748 | $266,239 | | Total loans | $2,303,073 | $2,298,313 | - Total loans increased by $4.8 million from December 31, 2023, to March 31, 2024, driven by a $7.9 million increase in the residential mortgage segment, partially offset by a $2.3 million decrease in commercial loans[227] - The increase in residential mortgage loans was primarily due to portfolio originations, while commercial loan decreases were influenced by payoffs of a nonaccrual commercial real estate loan ($13.4 million) and a special mention commercial loan ($7.2 million)[227] Asset Quality - Credit risk is managed through underwriting standards, ongoing credit reviews, loan portfolio diversification, and collateral requirements, with a concentration in south central Pennsylvania and the greater Baltimore, Maryland region[228][229] Risk Elements and Asset Quality Ratios | Metric | March 31, 2024 | December 31, 2023 | | :--- | :--- | :--- | | Nonaccrual loans | $12,886 | $25,527 | | Total nonperforming assets | $12,886 | $25,527 | | Total risk assets | $12,985 | $25,602 | | Total nonperforming loans to total loans | 0.56% | 1.11% | | ACL to total loans | 1.27% | 1.25% | | ACL to nonperforming loans | 226.33% | 112.44% | - Total risk assets decreased by $12.6 million to $13.0 million at March 31, 2024, primarily due to the payoff of a $13.4 million owner-occupied commercial real estate loan[233][236] - Special Mention loans decreased by $8.2 million to $16.0 million at March 31, 2024, due to repayments, including $7.2 million from one commercial client[250] Credit Risk Management - The Allowance for Credit Losses (ACL) is maintained at a level adequate for expected credit losses, calculated quarterly with adjustments recorded to the provision for credit losses[241] Allowance for Credit Losses Activity (in thousands) | Metric | Q1 2024 | Q1 2023 | | :--- | :--- | :--- | | Balance, beginning of period | $28,702 | $25,178 | | Provision for credit losses | $421 | $729 | | Charge-offs | $(99) | $(142) | | Recoveries | $141 | $176 | | Balance, end of period | $29,165 | $28,364 | - The ACL increased by $463 thousand to $29.2 million at March 31, 2024, with the ACL as a percentage of total loans at 1.27%[254] - Management believes the ACL is adequate based on current information, but future adjustments may be necessary due to changes in economic conditions, regulatory guidance, or management's assumptions[257] Deposits - Total deposits increased by $137.1 million to $2.7 billion at March 31, 2024, from $2.6 billion at December 31, 2023[258] - The increase was driven by interest-bearing demand deposits ($56.9 million), time deposits ($50.4 million), and money market deposits ($48.7 million), partially offset by decreases in non-interest bearing deposits ($12.4 million) and savings deposits ($6.5 million)[258] - Uninsured and uncollateralized deposits totaled $413.5 million (15% of total deposits) at March 31, 2024, down from $442.7 million (17%) at December 31, 2023[259] Borrowings - FHLB advances and other borrowings decreased by $22.5 million to $115.0 million at March 31, 2024, from $137.5 million at December 31, 2023, as the Bank repaid overnight borrowings using available liquidity[262] - The Company's $32.5 million unsecured subordinated notes, maturing December 30, 2028, converted to a variable interest rate (90-day average fallback SOFR plus 3.16%) on December 30, 2023, resulting in an interest rate of 8.77% at March 31, 2024[263] Shareholders' Equity, Capital Adequacy and Regulatory Matters - Shareholders' equity increased by $6.6 million to $271.7 million at March 31, 2024, driven by net income of $8.5 million, partially offset by $2.1 million in dividends and $192 thousand in other comprehensive losses[266] - Total comprehensive income decreased by $7.9 million to $8.3 million in Q1 2024, primarily due to an $8.1 million increase in after-tax net unrealized losses on investment securities[266] - Book value per common share increased to $25.38 at March 31, 2024, from $24.98 at December 31, 2023, and tangible book value per share increased to $23.47 from $23.03[267] - The Bank maintained a 'well-capitalized' position under regulatory guidelines, with a capital conservation buffer of 5.1% at March 31, 2024, exceeding the 2.5% requirement[267][269] Liquidity - Cash and cash equivalents totaled $182.7 million at March 31, 2024, up from $65.2 million at December 31, 2023, reflecting increased deposits and net income, partially offset by decreased borrowings[272] - Unencumbered investment securities were $66.1 million at March 31, 2024. The Company had a maximum FHLB borrowing capacity of $1.1 billion, with $140.2 million outstanding, and $20.0 million in available unsecured lines of credit with other banks[272] Supplemental Reporting of Non-GAAP Measures This section provides supplemental non-GAAP financial information to offer additional performance insights - Non-GAAP measures are provided to help investors understand the impact of non-recurring charges, such as merger-related expenses, on financial results[274] Tangible Book Value per Common Share (in thousands, except per share) | Metric | March 31, 2024 | | :--- | :--- | | Shareholders' equity (GAAP) | $271,682 | | Less: Goodwill | $18,724 | | Less: Other intangible assets | $2,189 | | Plus: Related tax effect | $460 | | Tangible common equity (non-GAAP) | $251,229 | | Common shares outstanding | 10,705 | | Book value per share (GAAP) | $25.38 | | Tangible book value per share (non-GAAP) | $23.47 | Adjusted Net Income and Diluted Earnings Per Share (in thousands, except per share) | Metric | Q1 2024 | Q1 2023 | | :--- | :--- | :--- | | Net income (GAAP) | $8,531 | $9,156 | | Plus: Merger-related expenses | $672 | — | | Less: Related tax effect | $(1) | — | | Adjusted net income (non-GAAP) | $9,202 | $9,156 | | Diluted earnings per share (GAAP) | $0.81 | $0.87 | | Diluted earnings per share, adjusted (non-GAAP) | $0.88 | $0.87 | Item 3. Quantitative and Qualitative Disclosures About Market Risk This section provides disclosures about the Company's exposure to market risk, primarily interest rate risk Interest Rate Risk - Interest rate risk is the exposure to fluctuations in the Bank's future earnings and value due to changes in interest rates, resulting from mismatches in repricing of interest-earning assets and interest-bearing liabilities[282] - Management uses its securities portfolio, FHLB advances, interest rate swaps, and brokered deposits to manage interest rate risk, aiming to keep fluctuations in net interest income within policy limits[284] - Simulation analysis (earnings at risk) and net present value analysis (value at risk) are used to monitor the direction and magnitude of interest rate risk exposure, with assumptions based on management's best estimates[285] Net Interest Income Sensitivity - Simulation analysis projects the effect of upward and downward changes in market interest rates on net interest income over the next twelve months[287] - At March 31, 2024, a 200 basis point decrease in rates is projected to decrease net interest income by 8.2%, while a 200 basis point increase is projected to increase net interest income by 1.7%[291] - The projected decrease in falling rate scenarios is partly due to long-term fixed-rate funding added in 2023 and the expectation that funding pressure will not abate, with interest-bearing liabilities repricing faster than interest-earning assets (excluding cash)[288] Economic Value - Net present value analysis assesses longer-term repricing risk and embedded options by discounting expected asset and liability cash flows under various interest rate scenarios[289] - At March 31, 2024, a 200 basis point decrease in rates is projected to decrease economic value by 14.2%, while a 200 basis point increase is projected to increase economic value by 0.5%[291] - The model's results are influenced by funding cost, repricing speed, and client behavior, and do not reflect potential management actions[290] Item 4. Controls and Procedures This section confirms the effectiveness of the Company's disclosure controls and procedures - The Company's management, including the CEO and CFO, concluded that disclosure controls and procedures were effective as of March 31, 2024[292] - No significant changes to the Company's internal control over financial reporting occurred during the three months ended March 31, 2024, that materially affected or are reasonably likely to affect it[293] PART II – OTHER INFORMATION Item 1. Legal Proceedings This section refers to Note 15 for information on legal proceedings - Information regarding legal proceedings is incorporated by reference from Note 15, Contingencies, to the Consolidated Financial Statements[295] Item 1A. Risk Factors This section states no material changes to previously disclosed risk factors have occurred - There have been no material changes to the risk factors as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2023[296] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section reports on the Company's share repurchase program activity Share Repurchase Program Activity (Q1 2024) | Period | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced plans or programs | Maximum number of shares that may yet be purchased under the plans or programs | | :--- | :--- | :--- | :--- | :--- | | January 1, 2024 to March 31, 2024 | — | $— | — | 28,467 | - The Company repurchased zero shares of its common stock during the three months ended March 31, 2024[297] - As of March 31, 2024, 28,467 shares (0.3% of outstanding common stock) remained available for future repurchase under the authorized program[297] Item 3. Defaults upon Senior Securities This section states there are no applicable defaults upon senior securities - This item is not applicable, indicating no defaults upon senior securities[298] Item 4. Mine Safety Disclosures This section states there are no applicable mine safety disclosures - This item is not applicable, indicating no mine safety disclosures[299] Item 5. Other Information This section confirms no new Rule 10b5-1 trading arrangements were adopted by executives - During Q1 2024, none of the Company's directors or executive officers adopted or terminated any Rule 10b5-1(c) trading arrangements or 'non-Rule 10b5-1 trading arrangements'[300] Item 6. Exhibits This section lists the exhibits filed as part of the Form 10-Q - Exhibits include the Agreement and Plan of Merger with Codorus Valley Bancorp, Inc., Articles of Incorporation, By-laws, Specimen Common Stock Certificate, Rule 13a-14(a)/15d-14(a) Certifications (Principal Executive Officer and Principal Financial Officer), Section 1350 Certifications, and various XBRL Taxonomy Extension files[305] SIGNATURES This section contains the required signatures of the registrant's authorized officers - The report is duly signed on behalf of Orrstown Financial Services, Inc. by Thomas R. Quinn, Jr., President and Chief Executive Officer, and Neelesh Kalani, Executive Vice President and Chief Financial Officer, on May 9, 2024[307][308]