Orrstown Financial Services Q2 2025 Earnings Call Transcript

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July 23, 2025

Key Takeaways

  • Positive Sentiment: Excluding merger charges, ROA rose to 1.51% and ROE climbed to 15.12%, while NIM improved to 4.07%, reflecting prudent loan pricing and effective funding cost management.
  • Positive Sentiment: Fee income increased by $1.3 million quarter-over-quarter to 21% of operating revenue, driven by wealth management fees with $3 billion in assets under management and room for further expansion.
  • Positive Sentiment: The efficiency ratio improved to 58.7% from 60.5% despite residual merger expenses, and noninterest costs are expected to decline to $35–36 million per quarter, enhancing overall profitability.
  • Positive Sentiment: Total loans grew 6% annualized (commercial up 2%), the loan pipeline is at its strongest since the merger, and credit quality remains sound with nominal net charge-offs and nonaccruals down to 0.57% of loans.
  • Positive Sentiment: Capital ratios strengthened, the board authorized a share repurchase program of up to 500,000 shares (2,134 shares repurchased this quarter), and the quarterly dividend was raised from $0.26 to $0.27 per share.
AI Generated. May Contain Errors.
Earnings Conference Call
Orrstown Financial Services Q2 2025
00:00 / 00:00

There are 6 speakers on the call.

Speaker 4

Good morning. My name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the Orrstown Financial Services, Inc. Second Quarter 2025 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during the Q&A session, simply press star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the call over to Tom Quinn, President and Chief Executive Officer of Orrstown Financial Services, Inc. and Orrstown Bank, who will begin the conference. Mr. Quinn, please go ahead.

Operator

Thank you, Kate, and good morning. I'd like to thank everyone for participating in Orrstown Financial Services' Second Quarter 2025 Earnings Conference Call, both by telephone and through the webcast. If you have not read the earnings release we issued yesterday afternoon, you may access it along with the financial tables and schedules by going to our website, www.orrstown.com. Once there, you may click on the Investor Relations link and then on the Events and Presentations link. Also, before we start, I would like to mention that today's presentation may contain forward-looking information. Cautionary statements about this information are included in the earnings release, the investor presentation, and our SEC filings. The presentation also includes non-GAAP financial measures as identified in the earnings release and investor presentation. The appropriate reconciliations to GAAP are included in the appendices.

Operator

Joining me on the call this morning are Orrstown Bank Senior Executive Vice President and Chief Operating Officer Adam Metz, as well as our Executive Vice President and Chief Financial Officer Neelesh Kalani. Our Chief Risk Officer Bob Coradi and our Chief Credit Officer David Chajkowski will also participate on the call. Our financial highlights for the quarter are summarized on slide 3 of the deck. Despite some lingering merger-related expenses, GAAP earnings were strong and core earnings continued to increase. Excluding certain merger-related charges, return on average assets was 1.51% and return on average equity was 15.12% for the second quarter of 2025, compared to 1.45% and 14.97% respectively for the first quarter of 2025. We expect stronger net income going forward as loan growth accelerates. Net interest margin also increased.

Operator

NIM was 4.07% in the second quarter of 2025, compared to 4.0% in the first quarter of 2025, with the possibility of further upside. We believe that we are pricing loans prudently and managing funding costs well, which is evidenced by the improving margin. Fee income remained a core strength of the organization during the second quarter. Fee income as a percentage of operating revenue was 21% during the quarter, an improvement from prior periods. Non-interest income increased $1.3 million quarter to quarter. The team has been doing an excellent job of generating fee income from various sources, led by our wealth management fees remaining the largest component of our fee income. Now at $3 billion in assets under management, there is significant opportunity to build this business. While expenses remain slightly more elevated than we would like, they are coming down.

Operator

Over time, our core operating expenses are in line with expectations. The team remains focused on establishing a foundation to support future growth. Excluding the impact of merger-related expenses, the efficiency ratio is 58.7% for the second quarter compared to 60.5% for the first quarter of 2025. We do not anticipate any meaningful merger-related expenses going forward. We do expect expenses to continue to decline throughout the year, which will further boost our already strong earnings stream. We believe that we consistently have demonstrated the ability to maintain strong profitability in any environment. I would now like to turn it over to Adam Metz for a discussion on our balance sheet. Adam.

Speaker 1

Thank you, Tom, and good morning, everybody. Loan growth was relatively modest this quarter, but we believe that the loan pipeline is strong. Total loan growth was 6% for the quarter on an annualized basis. Annualized commercial loan growth was 2%. During the quarter, we saw a good mix of CNI and CRE, and also a good mix between floating and fixed. We believe our overall loan pipeline is strong. Currently, it's the highest it's been since the merger of the two companies. This reflects the strength and resilience of our regional economy, the deep engagement of our team with our clients, and the impact of new talent we've attracted, including individuals with middle-market experience. As I've said before, talent matters, and we feel confident in the team we have in place and continue to build upon. It does remain a competitive lending environment.

Speaker 1

We remain confident in our ability to grow loans the right way. Credit quality remains sound. We believe that the work we have done since the merger to protect credit quality has been very beneficial. Net charge-offs were again nominal in the second quarter. Classified loans and non-accrual loans decreased quarter to quarter. Non-accrual loans to total loans decreased to 0.57% for the second quarter compared to 0.59% for the first quarter. We continue to build capital, which will create flexibility for us in the future. Capital ratios increased across the board quarter to quarter. We remain well capitalized by all measures. We continue to prioritize shareholder value. Late in the second quarter, the board of directors authorized a share repurchase program of up to 500,000 shares of common stock. The company repurchased 2,134 common shares during the quarter.

Speaker 1

We plan to utilize this authorization judiciously to support our currency, as well as we believe we remain undervalued. The board voted to increase our quarterly dividend by $0.01 per share from $0.26 to $0.27 per share. This is the third dividend increase in the past year, and our dividend has increased 35% since the merger. Neelesh Kalani, our CFO, will now discuss our second quarter results in more detail. Neelesh?

Speaker 5

Thanks, Adam. Good morning, everyone. We had a very strong second quarter, both from a GAAP basis and adjusted for some of the residual merger-related noise. We've achieved normalized ROA over 1.5% and expect improvement from there. Tom already walked through the numbers at a high level, so I'll just jump into the details starting on slide 4. The margin remained very strong and improved to 4.07% in the second quarter. Cost of deposits declined by 12 basis points. This was partially offset by loan yields declining by 7 basis points due to the lower purchase loan accretion than prior quarter. Absent the impact of the loan accretion, loan yields remain relatively flat compared to the previous quarter. This highlights our continued discipline on both loan and deposit pricing. The environment remains very competitive on both fronts, so the potential for margin pressure is real.

Speaker 5

I do see further upside in the margin into the third quarter with the expectation that it stabilizes after that point, assuming rates remain unchanged and we do remain asset-sensitive. As noted on slide 5, fee income was $12.9 million for the second quarter, up by $1.3 million from the prior quarter. For the second quarter, fee income was almost at 21% of total revenues, but our goal remains to be to continue to exceed 20%. The team had an excellent quarter from a swap fee generation standpoint, with just short of $700,000 in swap fees. Service charges increased by $200,000 as our treasury management team continues to successfully grow its base, and the broad fee waivers that we discussed previously that we temporarily implemented are no longer in place.

Speaker 5

Wealth management had another very strong quarter and remains a significant focus for Orrstown to boost our non-interest income going forward. Obviously, there was a rough start to the stock market in the beginning of the quarter that did have some impact quarter over quarter, but we're very happy with the income generated from that business and the opportunities that lie ahead. The quarter also included some solar tax credit income and other items that are not necessarily consistent from quarter to quarter. I don't expect the current fee income run rate to continue in the near term. It is a longer-term expectation for us, but several components do remain dependent on timing. A quarterly run rate around $12 million is likely reasonable there, but certainly within the range of $11.5 million to $12.5 million. Non-interest expenses covered on slide 6.

Speaker 5

While we had a little more noise than we expected during the second quarter, the picture of our efforts on expenses is becoming more evident. Non-interest expense declined by approximately $600,000 in the quarter, and that includes merger-related expenses of almost $1 million and severance costs of approximately $600,000. The efficiency ratio continues to come down, as Tom noted, and I've been messaging a go-forward run rate around $35 million each quarter. If you back out the items I just talked about and about $1 million of consulting fees, kind of in excess of normal in the quarter associated with the continued process improvement work that we have going, it gets you to that $35 million number. Merger-related expenses this quarter were associated with the final components of our core system conversion, and we don't anticipate any associated costs of significance going forward associated with the merger.

Speaker 5

The excess consulting costs are expected to decline over the next couple of quarters, so I expect the quarterly expense run rate in the $35 million to $36 million range for the next few quarters and early next year approaching a 55% efficiency ratio inclusive of amortization costs. However, I will continue to reiterate that the primary reason for our success over the years has been our ability to attract strong talent to set us up for growth, so that approach will continue and could potentially impact the expense run rate. We would obviously expect that those decisions, if they do happen, would impact the revenue side of the equation over time as well. Credit quality is covered on slide 7. We recorded a small provision this quarter primarily from a negligible amount of charge-offs on a net basis. Classified loans decreased by 14%. Non-accruals were down slightly as well.

Speaker 5

Our allowance coverage ratio was 1.22%, which we continue to believe adequately addresses the risks in the loan portfolio. Slide 8 highlights our key performance metrics as adjusted for merger-related expenses. In the second quarter, normalized EPS reached $1.04, adjusted ROA was 1.51%, and adjusted ROE was 15.1%. With both the expected impact of our loan pipeline on interest income and the momentum we have on expenses, we do see some upside in those numbers, which puts us near the top of our peer group. In addition, now that we're a year out from the merger, we built TCE back over 8%. Moving to the balance sheet slide on slide 9, total loans grew to $3.93 billion.

Speaker 5

While commercial loans, as Adam mentioned, grew only by 2% annualized, we do have a strong pipeline heading into the third quarter, and we remain prudent in our lending decisions and continue to focus on risk and long-term relationships. The average yield on loans was 6.5%. As mentioned earlier, the yield was impacted by the lower purchase accounting accretion, which will vary each quarter based on timing of prepayments of acquired loans. On slide 10, deposits did decline by $117 million as we continue to shift away from promotional time deposits and money markets. Cost of deposits declined from 2.14% to 2.01% in the quarter due to the impact of pricing decisions in the first quarter and new funding at lower cost. The 87% loan-to-deposit ratio provides us with sufficient liquidity to fund our loan pipeline without placing a heavy reliance on alternative funding sources.

Speaker 5

As I've indicated in the past, we're fairly comfortable in the low 90% range, so we feel good about where we are from that standpoint. As communicated previously and shown on slide 11, we use some of our liquidity to enhance the securities portfolio and generate additional interest income as loan production ramps up. We purchased $50 million of securities in the quarter, and the portfolio is now up to $885 million. We'll continue to look for opportunities as the market creates them to strengthen our balance sheet and create strong yields. The duration remains relatively short at 4 and a half years, and unrealized losses are still around 3% of the book balance at June 30. On slide 12, you can see that our regulatory capital ratios are now at or above pre-merger levels.

Speaker 5

As we've said previously, the capital levels and expected growth in the ratios as we move forward present us with many options to continue our growth trajectory. I'd like to now turn the call back over to Adam Metz for some closing remarks. Adam.

Speaker 1

Thank you, Neelesh. We believe that the work we have done since the merger to protect credit quality, enhance liquidity, and build capital has presented us with significant strategic flexibility going forward. Capacity to accelerate commercial lending for strong relationships, considering buybacks as we believe our stock is undervalued, contemplating redemption of sub debt, and ability to take advantage of other strategic opportunities. We remain optimistic about the future, both in the short and long term. We would now like to open the call to questions. Before we get started, the operator will briefly review the instructions with you.

Speaker 4

At this time, I would like to remind everyone in order to ask a question, press STAR and then the number 1 on your telephone keypad. We request that your questions be limited to one question and one follow-up. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Gregory Zingone with Piper Sandler. Your line is open.

Speaker 4

Hey, good morning, guys. How are you?

Speaker 4

Morning, morning. Morning.

Speaker 4

You guys had a pretty clean quarter on credit. I was wondering, though, are there still other credits in the Codorus Valley deal that you were still looking to move off of or sell?

Speaker 4

Are there other credits in the Codorus Valley deal that we want to address?

Speaker 4

In the past, we have engaged in some loan sales. We haven't in the past two quarters because, as you've seen, we've been relatively successful working them out with very little in the way of any charge-offs. There might be a couple of loans that we may see as an opportunity in the next couple of quarters, but I wouldn't look for anything real substantial in terms of major loan sales.

Speaker 4

Thank you. As a follow-up, is there a capital level that you guys have in mind that you would like to reach before seriously considering another acquisition? Thank you.

Speaker 4

I'm sorry, you asked, was there a capital level we want to achieve?

Speaker 4

Before another acquisition.

Speaker 4

Like we've kind of said before, I think we're there. We need to continue to, we're at pre-merger levels now. We'll continue to build to a good spot over the next couple of quarters. I think we're at the point where we don't have to get any outside capital to do something. Obviously, it depends on the type of deal and the size and all that, but we feel we're in a good spot now, and particularly over the next quarter, can build it up even more in the next several quarters.

Speaker 4

Thank you.

Speaker 4

Your next question comes from the line of Tim Switzer with KBW. Your line is open.

Speaker 4

Hey, good morning. Thank you for taking my question.

Speaker 4

Morning, Tim.

Speaker 4

I wanted to follow up on your comments about the potential for NIM expansion in Q3 and then maybe some stabilization. It sounds like that assumes rates stay unchanged. Can you provide some commentary on how two to three rate cuts in the back half of the year could impact that, particularly going into 2026, maybe where the exit NIM would be?

Speaker 4

I'm sorry, what was the end of your question? Where the what would be?

Speaker 4

Where would the exit NIM be at the end of this year, say we get, you know, two to three Fed rate cuts?

Speaker 4

We are, like I said, asset-sensitive, so there would be negative impact to overall net interest income going forward with the floating rate loans resetting, but we would certainly have the opportunity to continue to bring the deposit costs down. A couple of rate cuts would negatively impact us, but we would need to keep pushing on the loan side to offset some of that impact. That's really kind of where we're at from a margin projection standpoint. Deposit costs are probably still very competitive. I think we've seen the reduction that we're going to experience probably stay relatively flat from here without rate reductions. As I've always said, it is a difficult question to answer to a certain extent going forward if rates get cut, how hard can we push on deposit costs and how competitive it is.

Speaker 4

Certainly, there's some downside as risks come down, as rates come down.

Operator

I will add to that something Adam Metz mentioned, that our pipelines have not been bigger since the two companies came together. Properly pricing those loans will be critical as we see rate cuts.

Operator

Great. Okay. I'd love to follow up on some of your commentary about the wealth management business. Obviously, it had a pretty good quarter, but it sounds like it's an area where you guys see a lot of opportunity for growth. I'm sure there's maybe some synergies you can achieve with Codorus Valley Bancorp, Inc., but I'd love to get some more details on what initiatives you have there, where the growth is coming from, and your outlook for that business.

Operator

I think it's encouraging to the bank right now when you see in the RIA space that Zike snapped up CW Advisor's $13.5 billion acquisition of assets under management for $950 million. You're sitting on $3 billion in AUM, and you realize that you grow the franchise there, the value of your franchise should only improve. I think Adam's got a real strong strategic mindset towards bringing in more advisors. I'll let you talk about it, Adam, and to share with them kind of some of the things we're doing, not only in Maryland, but in Lancaster as well.

Operator

Yeah, I do think we have an opportunity in front of us. A lot of that will be through talent acquisition, and I think we're pretty close on some fronts there. We also have, as I said before, a lot of opportunity in what I say are growth markets. We are just sort of scratching the surface as it relates to our Maryland market, and there's a lot of opportunity there, but also in Lancaster and Harrisburg as well.

Operator

Great. Thank you, guys.

Speaker 4

Your next question comes from the line of David Long with Raymond James. Your line is open.

Speaker 4

Good morning, everyone, and thanks for taking my questions. In your prepared remarks, you talked about the strength of the economic backdrop within your footprint. I just, on top of that, wanted to get some color from you guys as far as what are you hearing from your business customers? You know, when we talked in April, I think sentiment was pretty poor. You said the market was much lower than where we are today. Coming off of Liberation Day, how has the sentiment of your commercial clients adjusted or changed over the last few months?

Speaker 1

I would just answer that question by saying our pipeline is the largest it's been since the merger of the two companies. We're having daily conversations with our clients, but I would tell you we've seen the pipeline not only grow, but fund here in July, and we expect it to continue. Yes, there is some noise on the headlines on any given day, but right now they're moving forward, and we feel good about where we are.

Speaker 1

Got it. Thanks for that. As a follow-up, can you maybe elaborate a little bit more on your appetite to add middle-market bankers? Are these bankers, what do you have in your model today for ads? With growing the team, is it coming from bankers from larger institutions, smaller institutions? Where are you finding the best opportunities? Thank you.

Operator

Yeah, this is Tom. I'll turn it over to Adam in a second. In recent weeks, we hired the number one lender from a $40 billion regional bank. That individual was the number one person in that company in the middle-market space. I think Adam can elaborate on some of the other areas that he wants to focus on. Adam.

Speaker 1

Yeah, I think we do have some upside there to sort of balance out the team. We were very pleased to hire this individual. Brings a lot of experience in a variety of industries. We've also been successful in hiring an individual for our Lancaster, York market, another one for our York market. Talent matters, and we've been very, you know, we allow them the ability to service their clients in a way that's meaningful for them. We also, as we always, lead with risk. We feel like we've been telling a pretty compelling story, and we've been successful in attracting talent. We're always on the lookout for great talent. I think that will continue.

Speaker 1

Great. Thanks a lot for the color. I appreciate it.

Speaker 4

Your next question comes from the line of Dan Cardenas with Janney Montgomery Scott. Your line is open.

Speaker 4

Hey, good morning, everybody. Just a quick couple of follow-up questions on the lending side. Maybe can you give us some color on what the line utilization rate is on your commercial portfolio? How does that compare to historical levels?

Speaker 4

Yeah, we've not seen a material change in line utilization in the quarter. I think it's remained fairly stable. Utilization rates are fairly modest right now in the commercial portfolio.

Speaker 4

All right. As you look at growth in the back half of the year, is that going to be primarily CRE driven? I mean, where do you see the most opportunity within your footprint?

Speaker 1

Yeah, I would tell you the first half of this last quarter, the loan growth came mostly from CNI. The second half of the last quarter, we had some good CRE deals. We are now at 293% of risk-based capital in our CRE bucket. We do have, as we've talked about earlier, a number of measures to reduce that. We now feel like we have capacity to go out and do the right CRE deals with the right relationships. I feel like right now we're pretty well mixed as we look forward in our pipeline, but we do have room for additional CRE.

Speaker 1

Are the wins on those deals primarily pricing driven, or what's kind of the secret sauce that will allow you to get the transactions that you want?

Speaker 1

I'm sorry. I didn't necessarily hear your question there.

Speaker 1

I was just wondering if, you know, to win the loans, I know it's competitive out there, but are those wins primarily driven by pricing, or are there some other factors that come into play that allow you to win a customer over?

Speaker 1

I would speak to our relationship model there. It's not just, you know, certainly we have to be competitive on the loan pricing, but I think we constantly speak about earning an extra, you know, we earn what we price our loans at. We have to speak to our relationship-driven model. It's not just the commercial lender, it's the treasury management, it's the retail franchise, it's the wealth management as well.

Operator

Yeah, I would add to that that if you go back to 2020 when our lending team embraced clients to help them with PPP when they couldn't get them at the banks they were at, when you go back to the SIVV failure and we contacted all our clients to help them as they were nervous about, you know, liquidity challenges they might have or might not have. When you look at the consultative nature of how we approach, we're looking for bankers, not just people that can lend money. Sometimes you're saying no to the client in winning a relationship because the client truly appreciates what you're doing in long term.

Operator

I think Adam has spoken at length to our lending team about the importance of managing the relationship, being there for a relationship, and fostering kind of an attitude that, you know, we're there to help them and their businesses. That approach seems to work, right? It's paid long-term dividends.

Operator

Excellent. My last question, it's been a year since the Codorus Valley deal has been consummated. Are you guys ready to do another transaction? What's kind of the parameters that you're looking for in potential targets in terms of size and geographic location?

Operator

Yeah, I think it's a question we don't typically answer publicly. What I would tell you is that the bank has done a really fantastic job of integrating the People's Bank merger in the sense that by the end of 2024, we had pushed 18% cost saves out. That was a target we had for this past June 30. We exceeded that. We continued to move on integrating. Clearly, there are some loans we wanted to move out of the bank. We did that pretty judiciously as well. I think we're now looking at best idea, best practice wins long term for the clients. We've got a few other things we're rounding out.

Operator

As we look to the future, we would want something that added tremendous value to the franchise, a product or service we don't currently have in a geography that was close to where we are or within a state or two we've always focused on. I think that's something that we've done three acquisitions of banks in 106 years. It's something we take and discuss at length with our board and move through that. I don't think we, it's not ego-driven. It's what's right for the shareholders, and we live by that every day.

Operator

Great. Thank you for taking our questions.

Speaker 4

Your next question comes from the line of Tim Switzer with KBW. Your line is open.

Speaker 4

Hey, thanks for letting me back on. I just had one follow-up. I appreciate you guys have gone through, I think, most of the work de-risking the loan book from Codorus has resulted in some good credit turns, but I'd love to hear the details on what kind of loan review you guys have done to gauge the risk of tariffs and what the outcome of that has been.

Speaker 4

Yeah, sure. We took a couple of different approaches on how we tried to assess the risk relative to tariffs. One thing we did was we just did a full stress of the entire CNI book. We stressed their NOI at 10% and 20%. The outcome of that was that under that 20% stress scenario, our classified total risk-based capital ratio would still be below our 25% threshold that we've set internally. We feel pretty good about the resiliency of the portfolio as it relates to any risk around tariffs.

Speaker 4

Great. That's all I had. Thank you, guys.

Speaker 4

That concludes the Q&A portion of the presentation. Mr. Quinn, I turn the call back over to you for concluding remarks.

Operator

Thank you again, Kate, and thank you all for participating today. As always, if we can clarify any of the items discussed on this call or in the earnings release, please feel free to give us a call. Wishing you all a wonderful day. Thank you very much.

Speaker 4

This concludes the Orrstown Financial Services, Inc. Second Quarter 2025 Earnings Conference Call. You may disconnect your line at this time.

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