Orrstown Financial Services, Inc. Announces Second Consecutive Profitable Quarter and Continued Positive Momentum in Asset Quality Trends

Provision for Loan Losses

The Company recorded no provision for loan losses for the three months ended March 31, 2013, compared to $19.2 million for the same period in 2012, and $1.0 million for the linked quarter ended December 31, 2012.  The Company continues to reduce its level of nonperforming and restructured loans, and with lower charge-offs in the last two quarters, it was determined that a provision for loan losses was not required in the first quarter of 2013.  Despite no provision and net charge-offs of $1.3 million, the reduction in nonperforming loans allowed for improvements in the ratio of the allowance for loan losses to nonaccrual and restructured loans still accruing from 110.1% at December 31, 2012 to 126.7% at March 31, 2013. 

See further discussion in the "Asset Quality" section below. 

Noninterest Income

Noninterest income, excluding securities gains, totaled $4.3 million for the three months ended March 31, 2013, compared to $4.0 million for the same period in 2012.

In the first quarter of 2013, two of the Company's non-margin lines of business continued their positive revenue momentum experienced in 2012. Mortgage banking revenue was favorably influenced by the continued low interest rate environment allowing for favorable refinancing conditions and partial recovery of its mortgage servicing rights fair value, coupled with greater stability in the real estate market.  For the three months ended March 31, 2013, mortgage banking revenues totaled $752 thousand, an increase of 52.8% over the same period in the prior year.  Orrstown Financial Advisors, which generates trust and brokerage income, recorded revenues of $1.8 million for the three months ended March 31, 2013, an increase of 17.8% over the $1.5 million earned in the same period in 2012. Favorable market conditions, combined with new business opportunities led to the enhanced revenue stream.  

Securities gains totaled $122 thousand for the three months ended March 31, 2013, compared to $2.2 million for the same period in 2012.  In 2013, asset/liability management strategies and interest rate conditions led to the sale of securities.  These same factors, as well as maintaining capital levels factored into the decision as to the extent and timing of security gains taken in 2012.   

Noninterest expenses

Noninterest expenses amounted to $10.9 million for the three months ended March 31, 2013, consistent with the same period in 2012.   However, the components of the noninterest expenses between the two periods differed, and reflect the Company's ongoing transition from a focus on asset quality concerns to growth in the balance sheet and fee based revenue generating lines of businesses. 

Asset quality related costs, including collection and problem loan and real estate owned expenses, totaled $225 thousand for the three months ended March 31, 2013, an $870 thousand reduction from $1.1 million for the same period in 2012.  In addition, during the first quarter of 2013, the Company has been able to lower its consulting expenses, which are included in professional services, by $215 thousand over the same period in 2012.  These reductions in expenses are consistent with the Company's previously disclosed 'Operation Bottom Line' initiative, in which certain expenses were targeted to be reduced 25% over a two year period.   

Growth in salaries and employee benefits were experienced in the first quarter of 2013, with total expenses for the first quarter totaling $5.7 million, an increase of $1.0 million over the same period in 2012.  A large component of the difference pertains to health insurance costs, in which favorable cumulative claims history allowed for the reduction of a self-insured reserve of $400 thousand in the first quarter of 2012, with no similar benefit in 2013.  In addition, with the Company's return to profitability, certain incentive based employee benefits have been restored, which has resulted in approximately $250 thousand in increased charges.  

As a result of the slight increase in noninterest expenses combined with declining net interest income, the Company's efficiency ratio for the three months ended March 31, 2013 increased to 84.3%, compared to 67.7% reported in the same period in 2012. The efficiency ratio expresses noninterest expense as a percentage of tax equivalent net interest income and noninterest income, excluding securities gains.

Income Taxes

Income tax expense totaled $30 thousand for the three months ended March 31, 2013, on pre-tax income of $1.6 million, compared to income tax benefit of $4.8 million recorded on pre-tax loss of $13.1 million for the three months ended March 31, 2012. During the third quarter of 2012, an evaluation was completed on the net deferred tax asset that existed, which principally resulted from credit and credit related losses and expenses that the Company experienced.  As a result of the taxable losses that were generated during 2012, and our inability to fully offset the tax to the two preceding carryback years allowed by tax regulation, our net deferred tax asset was dependent on tax planning strategies and future taxable income.  Based on forecasted taxable income in the near future, combined with limited tax planning strategies, we were not able to conclude that the deferred tax asset would more likely than not be realized in its entirety, and as such, a valuation allowance was established for the full amount beginning in the third quarter of 2012.  An updated evaluation was completed at March 31, 2013, and we continue to believe that the valuation allowance is appropriate, and as such, the $30 thousand expense for the quarter pertains to alternative minimum tax, in which an incremental valuation allowance is required on the deferred tax asset. 

FINANCIAL CONDITION

Assets decreased $35.6 million to $1.197 billion at March 31, 2013 from December 31, 2012.  During the first quarter of 2013, the Company began to transition from an emphasis on working out troubled credits to a focus on growing the loan portfolio.  As the Company restores its loan pipeline, repayments on existing loans outpaced new loans originated, and is the primary reason for the reduction in assets.  At March 31, 2013, loans, net of the allowance for loan losses, have declined by $28.4 million, or 4.1%, from December 31, 2012. 

Shareholders' Equity                                                                

Shareholders' equity totaled $88.8 million at March 31, 2013, an increase of $1.2 million, or 1.3%, since December 31, 2012.  This increase was primarily the result of net income of $1.6 million posted for the three months ended March 31, 2013, offset by a decline in accumulated other comprehensive income.  The Company's regulatory capital ratios continue to exceed all regulatory minimums to be considered well capitalized, and have shown improvement since December 31, 2012.  At March 31, 2013, the Company's regulatory capital ratios consisted of a Tier-1 leverage ratio of 7.2%, a Tier-1 risk-based capital ratio of 11.5%, and a total risk-based capital ratio of 12.7%, an increase over December 31, 2012's ratios of 6.8%, 10.9% and 12.2%, respectively.  Net income recorded for the quarter combined with a reduction in assets resulted in the improved ratios. 

Asset Quality

In the first quarter of 2013, the Company continued to reduce its nonaccruing loans and other risk assets.  Risk assets, defined as nonaccrual loans, restructured loans, loans past due 90 days or more and still accruing, and real estate owned, totaled $19.2 million at March 31, 2013, a $3.7 million, or 16.1% decrease from December 31, 2012's balance of $22.9 million and a 78.2% reduction from $88.3 million at March 31, 2012. 

The allowance for loan losses totaled $21.9 million at March 31, 2013, a decrease of $1.3 million from $23.2 million at the December 31, 2012, due to the net charge-offs during the period.  Despite no provision for loan losses and the net charge-offs recorded during the first quarter of 2013, the allowance for loan losses as a percent of total loans only declined slightly, from 3.29% at December 31, 2012 to 3.25% at March 31, 2013.  Despite the lower allowance for loan losses balance and lower ratio to outstanding loans, the allowance to loan losses coverage ratio of nonaccrual loans and restructured loans has increased to 127% at March 31, 2013 from 110% at December 31, 2012, and increased substantially from 33% at March 31, 2012.  The increase in the coverage ratios reflect lower levels of risk assets, particularly the decrease in non-performing assets discussed above. 

Asset quality will remain a focus of the Company, however, with the lower level of risk elements, the Company has been able to reduce its personnel devoted to loan workouts, and has redeployed several of these employees to loan origination roles.  Management believes that the enhancement of the Company's loan policies and operating procedures during the past 24 months have improved the ability to capture and monitor credit risk within its loan portfolio and to mitigate losses in the future.

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
			(Unaudited)		(Audited)*		(Unaudited)
			March 31,		December 31,		March 31,
(Dollars in thousands)			2013		2012		2012
Assets
Cash and cash equivalents			$             94,770		$           150,688		$          154,672
Securities available for sale			349,733		301,970		311,485
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