Orrstown Financial Services (ORRF), the bank-holding company for Orrstown Bank, operates 32 locations throughout Pennsylvania and Maryland with total assets of approximately $1.9 Billion. Founded in 1919, the Bank has operated continuously since it was established by a group of community leaders in Orrstown, PA. Today, Orrstown Bank is headquartered in Shippensburg, Pennsylvania and continues to provide a full range of consumer, business, and wealth management services.
Contrary to most of the banks profiled here at Golden Belt, Orrstown had a rough couple years coming out of the financial crisis. Over a two year period in 2011-2012, Orrstown posted nearly $70 million of net losses, necessitating formal enforcement actions in March 2012 that were ultimately lifted in April 2015. Prior and during the crisis and subsequent enforcement period, key personnel was put in place (Tom Quinn took CEO helm in 2009; new Chief Financial Officer and new Chief Risk Officer in 2012) and the management team laid the foundation for a long-term growth plan. Significant investments in enterprise risk, credit administration, and technology were put in place and serve as pillars for today’s growth. Management is actively looking to expand the Bank’s footprint in its key markets, with a focus on driving shareholder value.
Orrstown management’s forward-looking work earlier in the decade is starting to bear fruit. Orrstown was busy in October 2018: they closed the acquisition of Mercerburg Financial and announced an agreement to acquire Hamilton Bancorp ($500 million asset size, based Towson, MD) in a cash and stock deal; the cash component is subject to reduction based on potential credit losses/write-downs and stock component is (deal terms are linked here). Orrstown stated in its press release:
Including the impact of merger-related benefits and charges, the transaction is projected to result in earnings per share accretion of approximately 8% in 2020, with an internal rate of return of approximately 18.6% and a tangible book value earn back period of approximately 1.3 years
Hamilton was an underperforming bank franchise and Orrstown is purchasing at an attractive level. The tough truth of bank acquisitions is you have to trust your management team to execute on the deal conversion; they have to hit their targets for cost saves, deposit retention, and credit marks (ORRF disclosed they reviewed ~65% of commercial loan portfolio, the 50 largest commercial loan relationships, and 25% of the residential/consumer loans during due diligence process).
I’ll ride with Orrstown on this one, Hamilton was not a well-operated franchise but Orrstown is buying at an attractive price that should allow them to integrate and grow the bank in some of Baltimore’s better markets.
Away from M&A news: buoyed by the tax and regulatory benefits of the past year, Orrstown’s bottom line has recovered from the nasty 2012-2015 experience. Orrstown’s profitability has room to improve, and I think there are some ‘green shoots’ hinting that ORRF will be an attractive growth franchise over the coming years. 2018 full year ROA printed 0.75% and ROE printed 8.9% – figures are below my typical core holding, but there are nonrecurring expenses impacting, and hiding, what the normal profitability potential is at Orrstown.
On to share valuation, two items hit ORRF shares recently – shares sold off on the news of the Hamilton acquisition and another hit came during broad market selloff in December. Shares are down ~30% since its 2018 high, and I think the current valuation is underestimating the attractiveness (both price and market expansion) of the Hamilton acquisition and Orrstown’s potential going forward; this could be a nice window to grab shares in a growing regional player primed for long-term growth.
Primary drivers setting up ORRF shareholders for continued investment performance over the longer-term:
- (Normalized) Compounding Earnings: Under the current regulatory environment and once the deal expenses subside, ROE should print a 10%+ rate and provide attractive growth and investment returns to shareholders.
- Dividend Income: ORRF pays a ~3.10% dividend yield (33% payout ratio).
- M&A Upside (likely down the road): ORRF could place itself in a nice position to market itself as a target in a couple year’s time (likely next cycle).
- Deposit Funding franchise is valuable:
- 78% of ORRF’s deposits are either noninterest-bearing (13%) or lower-cost money-market accounts (65%)
- The total cost of funds on ORFF’s ~$1.6 Billion deposit book is 0.88%
- Asset Quality: credit book is in good shape; low 0.33% NPA/Assets metric along with a reserve balance 2.2x the NPAs. On its face, nothing alarming about loan concentrations.
- Deposit Funding franchise is valuable:
Some concerns that could pressure earnings/profitability/growth to keep an eye on:
- Economic Cycle – Hard to forecast how close we are to a turn in the credit cycle, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in local and national economies.
- Acquisition Execution – Acquiring, integrating, and growing an acquired franchise (especially in new market geography) is challenging; costs can overrun budgeted levels, credit issues in the loan book can surprise, and deposit/loan relationships can walk out the door.
- Index Inclusion – ORRF is a Russell 2000 member. Russell ETF flows and rebalances can drive near-term price dislocations in smaller, less-liquid bank names.
Bank Description & Geography
Orrstown Bank has been operating nearly 100 years, and pro forma bank will operate 38 locations in Pennsylvania and Baltimore.
- Orrstown (Trust Clients) – 6.25%
- BlackRock – 5.7%
- Vanguard – 3.9%
- Elizabeth Park – 3.0%
- EJF Capital – 1.1% (added to ORRF in Q3 2018)
- Basswood Capital – 0.9%
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