Orrstown Financial Services Inc 2026 Q3 Earnings Call

Thank you, Holly, and good morning, everyone. I would like to thank everyone for participating in Orrstown's third quarter 2026 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, orrstown.com. Once there, you can 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 earnings release and investor presentation also include non-GAAP financial measures. The appropriate reconciliations to GAAP are included in those documents. Joining me today on the call is Neil Kalani, Orrstown's Chief Financial Officer.

Also participating in the discussion are Zach Khuri, Chief Revenue Officer, Bob Karate, Chief Risk Officer, and David Chajkowski, Chief Credit Officer. Orrstown delivered another strong quarter with solid execution across the franchise. Net income was $22.8 million, or $1.17 per diluted share. Return on average equity and return on average assets both increased quarter-to-quarter and continued to exceed peer multiples. Net interest income rose $4.5 million to $53.3 million. Net interest margin improved to 4.12%, an increase of 25 basis points on an absolute basis and 12 basis points after adjusting the prior quarter for a one-time charge. Total loans increased by $95.3 million, or 9% annualized, with growth across the commercial, consumer, and residential mortgage portfolios. Significant loan growth combined with net deposit outflows, some of which were seasonal, required increased reliance on borrowings. Available alternative funding sources remained strong at $1.7 billion.

Our efficiency ratio declined to 56% from adjusted 58.6% the prior quarter, reflecting improved operating leverage. Credit quality remained sound. Classified loans and non-accrual loans both decreased quarter-to-quarter. We remain prudent in our lending decisions, but we believe that the credit environment remains stable and without significant signs of stress, even in a rising rate environment. Neil Kalani, our CFO, will now discuss our quarterly results in more detail.

Neil? Thanks, Adam, and good morning, everyone.

We had an outstanding quarter with return on average assets of 1.60%, and return on average equity was 14.62%. As noted on slide four of the earnings deck, our net interest margin expanded this quarter to 4.12%. This is 12 basis points higher than the prior quarter margin, adjusted for the one-time $1.6 million charge from the subordinated debt redemption. During the third quarter, our asset yields increased by eight basis points, and our cost of interest-bearing liabilities decreased to 2.40%. We continue to maintain a disciplined loan pricing philosophy and also had the benefit of lower funding costs after redeeming our subordinated debt. Since we remain asset sensitive, our asset yields will benefit from the rate increase in September, as well as any subsequent hikes. Through the end of 2027, I'm projecting net interest margin in the range of 4.05%-4.15%.

We will reevaluate this range next quarter as we get a better sense of the market dynamics. Since the Codorus Valley merger in 2024, we have been focused on replacing the loan accretion as it winds down. We have been addressing this with strong loan growth and prudent pricing. While we have been achieving that goal, it has not been clearly evident given some of the purchase accounting noise. This quarter, we can clearly demonstrate that accomplishment. Our interest income on loans, excluding purchase accounting accretion, was $62.6 million for the third quarter of 2026, compared to $59.0 million in the second quarter. We believe our loan production capability, along with pricing and overall balance sheet management approach, will lead to continued net interest income growth going forward. On slide five, fee income decreased to $13.4 million in the quarter from $13.8 million in the second quarter.

Wealth management income increased to $6.0 million from $5.9 million in the second quarter. This is the second consecutive quarter in which Orrstown Financial Advisors recorded record revenues. Swap fees declined slightly due to the impact of timing, and mortgage income also declined, mainly due to mark-to-market adjustments on the held-for-sale portfolio and pipeline. In the third quarter, non-interest income was 20% of total revenue. While this is down from the second quarter, it was driven by the growth in net interest income noted earlier. Fee income remains a meaningful contributor to earnings, supported by continued strength across multiple fee categories. Annualized guidance for fee income into 2027 is in the range of $54 million to $56 million. Moving to slide six, non-interest expenses decreased by $400,000 to $37.3 million in the third quarter of 2026.

We maintain a focus on managing expenses and have continued to reduce reliance on outside professional services. The efficiency ratio came down to 56% in the third quarter, and on an annualized basis, I am projecting the expense run rate to be between $153 million and $157 million. In addition to normal inflationary increases, this assumes some investments in our sales force and technology to ultimately drive higher revenues. Our credit quality is discussed on slide seven. Provision expense was $1.1 million for the third quarter of 2026. This is inclusive of $1.0 million of net charge-offs. There were several moving parts to the provision this quarter, with the impact of the strong loan production and qualitative factor adjustments being offset by the impact of improving economic data on the quantitative inputs.

Our allowance coverage ratio was 1.11% at September 30th, 2026, which we believe is adequately aligned with the risk profile of our loan portfolio. Classified loans declined by another $4 million in the third quarter, and non-accrual loans also declined by $900,000 from the second quarter. We continue to see solid credit metrics in our portfolio. The earnings and performance metrics are on slide eight. Our earnings metrics increased meaningfully in the third quarter. We believe we have the opportunity and ability to continue our growth trajectory. We did experience a decline in the tangible common equity ratio to 9.1% at September 30th, 2026, from 9.5% at June 30th, as well as a decline in tangible book value per share. These decreases were directly the result of a $41.6 million increase in unrealized losses on the investment portfolio, which was driven by the increase in market rates and spreads.

The loan portfolio is covered on slide 9. Loans grew by 9% on an annualized basis in the quarter, with loan yields increasing. We had $166 million of commercial loan production during the third quarter, and consumer loan growth remained a strength. Orrstown Bank has reached its full year 5% loan growth goal at September 30, 2026. Our loan growth goal remains in the mid-single digits going forward. Depending on how rates move and how it impacts client demand, we can see that growth potentially being on the lower end of the mid-single digit range. We remain confident in our team's ability to continue to replicate their success from 2026. Moving over to slide 10, deposits remain up $53 million year to date, despite some seasonal pressure during the quarter.

The cost of total deposits declined to 1.83% for the third quarter from 1.88% in the second quarter, reflecting our focus on overall mix. The loan-to-deposit ratio increased to 92% at September 30, 2026, as we utilized borrowings to fund the loan growth. The team will maintain its attention on the deposit mix and driving growth of low-cost deposits. The investment portfolio is covered on slide 11. The yield in the portfolio is very strong at 4.54%. The higher unrealized losses I referenced earlier were driven by a rapid increase in treasury rates and widening of credit spreads. While it's had a substantial impact on the fair value of the investment portfolio, we are comfortable with the positions that we hold. Slide 12 highlights our capital position. There was a modest increase in the ratios during the third quarter of 2026.

The deferred tax asset associated with the increased investment losses partially offset the increase in the capital ratios. We remain confident in further capital generation being driven by strong earnings. Overall, the third quarter of 2026 highlighted our ability to achieve substantial loan growth and also effectively manage our balance sheet. Fee income continues to be a significant source of earnings, and our declining efficiency ratio demonstrates our enhanced operating leverage. Looking forward, we plan to prudently invest in technology and people while continuing our growth story at the same time. Thank you for your time this morning, and I'll turn the call back to Adam Metz for his closing remarks.

Adam? Thank you, Neil. We are proud of our third quarter performance, which reflected continued expansion in net interest margin, robust loan growth across several segments, successful management of funding costs, and disciplined expense control.

Although the economic interest rate and competitive environments remain dynamic, we enter the remainder of the year from a position of strength and remain confident in our ability to execute across a range of economic conditions. As we approach 2027, we believe the company is operating from a position of strength. Our core banking and wealth management business are all contributing to growth, while credit quality, capital levels, and expense discipline remain favorable. As always, I'd like to thank our employees for their dedication and our shareholders for the trust they place in us. We appreciate your continued support and look forward to updating you on our achievements next quarter.