Orrstown's Margin Slips on Sub-Debt Charge as Deposit Costs Ease
Orrstown Financial Services (ORRF) reported net interest margin compressed to 3.87% in the second quarter, though the decline was driven largely by a $1.6 million accelerated charge tied to redeeming high-cost subordinated debt.
Orrstown Financial Services (ORRF), the Pennsylvania-based community bank, reported net interest margin fell 3 basis points to 3.87% in the second quarter, extending a slide from 4.11% in the third quarter of 2023 through 4.00% and 3.90% in the two quarters since. The headline number masks a steadier underlying trend: core margin excluding a $1.6 million accelerated fair-value-mark amortization tied to the June 30 redemption of $31.0 million in 7.72%-yielding subordinated notes came in at 4.00%. Net interest income slipped to $48.8 million from $49.0 million, continuing a downtrend from $51.0 million in each of the prior two quarters, even as it grew from $49.5 million a year earlier.
The deposit-cost backdrop improved for a second straight quarter, with the cost of interest-bearing deposits falling 8 basis points, offsetting some of the pressure from the sub-debt charge. Loan growth accelerated to $51.7 million quarter-over-quarter, roughly 5% annualized, led by residential mortgages, which rose $32.8 million (about 16% annualized) including $17.1 million in home equity, alongside a $18.9 million increase in commercial loans. Deposits were essentially flat, down $7.4 million to $4.6 billion, as declines in time, interest-bearing demand and savings balances were mostly offset by growth in noninterest-bearing demand (+$38.2 million) and money market accounts (+$9.3 million), a mix shift that lowered funding costs even as the loan-to-deposit ratio ticked up to 89% from 88%.
Credit quality improved on nearly every measure. Classified loans fell $8.4 million to $49.2 million, nonaccrual loans dropped $6.2 million to $23.8 million, and the nonaccrual ratio fell to 0.58% from 0.74%. The allowance for credit losses as a share of total loans declined to 1.13% from 1.17%, a qualitative-factor-driven reserve release, even as net charge-offs rose to $1.2 million from $0.9 million. Provisioning has nonetheless normalized higher over the past two quarters, with the $0.34 million provision for credit losses well above the $0.1 million and $0.11 million booked in the fourth quarter of 2023 and second quarter of 2023, respectively, despite the improving asset-quality trend.
Noninterest income fell $1.8 million to $13.8 million, though the decline traced almost entirely to the absence of a $2.4 million one-time BOLI death benefit recorded in the first quarter and a $0.6 million drop in swap fee income. Wealth management income hit a record $5.9 million, up from $5.6 million and above the $5.3 million-to-$5.7 million range of the prior four quarters, underscoring a fee franchise that continued to grow even as the one-off items rolled off.
Expenses rose $1.0 million to $37.7 million, driven by a $1.0 million increase in salaries and benefits from merit increases and higher healthcare claims, partly offset by lower seasonal occupancy costs. The combination of lower fee income and higher expenses pushed the efficiency ratio to 60.1% from 56.9%, reversing three straight quarters in the 56%-to-58% range; on an adjusted basis it came in at 58.6%.
Capital strengthened even as the sub-debt redemption reshaped the balance sheet. CET1 rose to 12.0% from 11.8% and Tier 1 leverage climbed to 10.1% from 9.7%, while total risk-based capital slipped to 13.2% from 13.5% as the note redemption reduced Tier 2-eligible capital. Tangible book value per share rose to $26.71 from $25.76 quarter-over-quarter and from $22.77 a year earlier, with the tangible common equity ratio improving to 9.5% of tangible assets from 9.2%.
Net income declined to $21.2 million, or $1.09 a diluted share, from $21.8 million, or $1.12, as return on assets slipped to 1.53% from 1.59% and return on equity fell to 13.96% from 14.76%, even as both metrics grew from $19.4 million, or $1.01 a share, a year earlier. A sharp drop in the effective tax rate to 14.2% from 20.7%, driven by a $1.6 million benefit from the purchase of federal income tax credits, partially cushioned the bottom line.
The quarter's story is less about the reported margin decline than what sits beneath it: a bank absorbing a one-time cost from cleaning up expensive legacy debt while deposit costs finally began to ease and credit metrics improved across the board. Whether the efficiency-ratio deterioration proves transitory will depend on wealth management's fee momentum holding up without the help of one-time items that flattered results a quarter earlier.