Operator
Good morning. My name is Holly and I will be your conference operator today. At this time, I would like to welcome everyone to the Orstown Financial Services, Inc. third quarter 2026 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 one on your telephone keypad. If you would like to withdraw your question, press star one again. I will now turn the call over to Adam Metz, President and Chief Executive Officer of Orristown Financial Services, Inc. and Orristown Bank, who will begin the conference. Mr. Metz, please go ahead.
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 Gap are included in those documents. Joining me today on the call is Neil Kalani, Orstown's Chief Financial Officer. Also participating in the discussion are Zach Corey, Chief Revenue Officer, Bob Karate, Chief Risk Officer, and Dave Cikowski, Chief Credit Officer. Orstown 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 pure 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 decrease 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. 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% to 4.15%. We'll reevaluate this range next quarter as we get a better sense of the market dynamics. Since the Cadoris Valley merger in 2024, we've been focused on replacing the loan accretion as it winds down. We've been addressing this with strong loan growth and prudent pricing. While we've been achieving that goal, it hasn't 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 26, 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 Worstown Financial Advisors recorded historical 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 health 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 to $56 million. Moving to slide six, non-interest expenses decreased by $400,000 to $37.3 million in the third quarter of 26. 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'm 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 26 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% that's September 30th, 26, 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, 26, 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. The 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, but 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 30th, 26, as we utilize borrowings to fund the loan growth. The team will maintain its attention on the deposit mix and driving growth in 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 26. 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 26 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. 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. Before I close, I want to share a piece of exciting external recognition that we received this morning. We are proud to share that Orrstown Bank has been ranked 77th on the Fortune 100 fastest growing companies list for 2026, which is based on annualized total return alongside our revenue and earnings growth over the last three years. It is a testament to the hard work of our team and the momentum we are building. We would now like to open the call to questions. Before we get started, Holly will briefly review the instructions with you.
Operator
At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Emily Graves with Havdate Group. Emily, your line is now open. Please go ahead.
Good morning, everyone. I'm stepping in for Dave Bishop today. I want to start off with third quarter loan growth, very good, driven by multiple portfolios. What additional factors would need to improve for loan growth outlook to move even higher from here? And then also, what have prepayment volumes looked like over the past quarter?
Yeah, we remain confident in our team's ability to generate loan growth. The pipeline, as we look at it today, remains robust, and so our guidance is the mid-signal digits, but the team is focused. We're also cognizant of our rising interest rates and our team's ability to sort of adapt and talk to our clients, but as of right now, as we look at going into 2027, we're pretty confident in our ability to produce.
And on the prepayment side, where the volume's lower, we're still experiencing some prepayment activity. It's certainly lower than what it was earlier in the year.
Great. Thank you. And then do you have a new loan origination yield versus roll-off yield?
Yeah, the new spreads on the floating rate loans are probably in the 225 to 250 range on average. Fixed rates are coming in the low sevens.
Okay. And then – sorry, go ahead.
Sorry. You highlighted overall very sound credit quality in the quarter. I might have missed it. Are you seeing any signs of stress among commercial or consumer borrowers from these higher rates?
No, we've not seen anything yet. We routinely proactively look at the portfolio, perform various stress tests. We've stressed the entire CNI portfolio under our most conservative stress test. The portfolio metrics still hold up within our tolerance ranges. We recently conducted a repricing analysis for any fixed rate loans that are due to reset within the next 12 months. The results of that analysis have been very favorable as well. We've not identified anything where we would anticipate any risk rating, downgrades, or losses of any kind.
Thank you guys for your time.
Operator
Your next question comes from the line of Ken Cahoot with Raymond James. Ken, your line is now open. Please go ahead.
Hi, good morning, guys. Hope you're doing well. Good morning, Ken. Maybe start – yeah, good morning. Maybe starting with the C&I low growth during the quarter, it looked really impressive. I'm just wondering how much of that growth is attributable to the middle market lending team that you've been building out over the last year. And, you know, where are you seeing these strong growth opportunities? Is it in certain markets or certain industries? So any color there would be great.
Yeah, Ken, I don't have the exact number. I would say a significant portion of that increase was drived by our lower and middle market efforts. And it does span the entire footprint. And so as we brought in this expertise, we've enabled the teams to sort of serve that lower-end middle market client more effectively. And so we continue to want to invest in that space, and it's been very beneficial to us.
Great. Thanks. And then also on loans, I noticed you guys purchased $15.5 million of home equity loans during the quarter. and you recently discussed home equity as an area of focus. I don't recall you ever discussing purchases specifically, so I'm just wondering if this is a new initiative to supplement organic growth or was it just like an opportunistic transaction that you guys took advantage of?
We really do. It's an opportunistic transaction. If opportunities come up with loan portfolios that become available, If it makes sense from a permit, certainly from a yield standpoint, if it fits in with our portfolio, it's something we monitor. But I wouldn't necessarily say it's part of our overall growth strategy.
But the core of the growth, Ken, has come from our clients. Just as the mortgage market has been a little soft, our home equity product remains a very viable solution to our clients. And so we do have a very good product, and it's performed.
And I would add that our core loan growth for the quarter was 7%, even without the purchases. So that is our primary focus and will continue to be.
Great. Thanks for that, caller. And then lastly, for me, just on expenses, so you got it to $153 million, $157 million annualized through 2027. I think, Neil, you said it's primarily coming from technology and people. So do you expect to be at that low end of the range or annualized range in 4Q and then kind of gradually increase throughout 2027? Is that the right way to think about it?
Yeah, 4Q, I would expect to be somewhat consistent with third quarter. We'll see – we'll continue to see the impact of new hires. And obviously, once we hit mid-year next year, salary increases. So it'll slowly, it'll slowly build up, but I, we do have some assumptions in there of, of hiring new, new team members. So that's, that's built in. And continued investments on the technology side that ultimately will facilitate our, really with the goal of setting up our sales teams with all the data and ability to, to do what we need them to do.
All right. Got it. Thanks. I really appreciate you guys taking my questions. Thank you.
Operator
Your next question comes from the line of Jake Cervello with DA Davidson. Jake, your line is now open. Please go ahead.
Great. Thank you. Good morning, Adam. Good morning, Neil. Good morning, everybody. so the the new 27 outlook calls for nim of the range of 405 to 415 is it fair to say that core nim would probably be expected to be flat ish and then accretion income will continue to trail lower through next year i would expect some some increase in in the core nim um these and as we have shown we the core nim if you exclude the purchase accounting we're at 372 if you recall a couple quarters ago.
We're in the 340, 350 range. So we continue to see some growth there. I do think we'll get some benefit from increasing rates as well to help push the core NEM forward. And like I indicated in my comments, it is the focus of ours to which we have accomplished is replacing that accretion.
That's helpful. I mean, what rate assumptions do you have kind of baked in for for that 405 to 415 range so our modeling assumes another another two increases over the course of the next year 25 bps i assume yes yes yeah okay um thank you the wanted to ask about But really, this is kind of the first outlook extending through 27. What do you think are the biggest risks to hitting what your expectations are?
And then ultimately, I guess what my question is driving at is how do you drive incremental profitability improvement from here? um the biggest risk is just the the economic environment is some of the assumptions we have laid out whether they they do occur um so that that is a focus of ours and and um ultimately the the team is pushing towards hitting hitting our goals the opportunities that we have continue to be um the lending team maintaining and improving upon the loan production volumes we do think we can potentially do higher than the 5% that we put out there, and that is the internal focus for the team. And so both on the Lightning side, and we've talked about OFA and opportunities there, and continued focus there. And we're internally having a lot of discussions on formalizing full relationships where they don't exist currently. So there's a lot of opportunity there and the investments that we're putting in on the technology side, which again will arm our sales teams with more data. One example of that is some of that HELOC growth that we've seen in the last couple of quarters is because of the availability of more client data. We're targeting certain groups that haven't necessarily had the utilization in the past, and we're starting to see the benefit from that, and we expect to continue to improve upon that.
No, I would just echo what Neil said. I think we're very well poised to laser focus on the goals. But the biggest unknown certainly is the economic factors and what that could play into the forecast. But right now, as we look here and sit here today, clients are very engaged. They're moving forward with projects. Our pipelines remain strong. So that's helpful.
Thank you both. And just one more question, kind of following up on Neil's comments about the kind of hopefulness for loan growth to meet or exceed that 5% number for next year. So how comfortable are you funding loan growth with wholesale borrowings versus core deposits if the deposit efforts don't come to fruition as expected?
So our focus right now in the short term is there will be some reliance on time deposits, money markets, wholesale deposits. But overall, the company's got a mid to longer term strategy that impacts the short term as well. But to focus on driving core deposits that's across the sales team, the commercial side as much as the retail side is heavily focused on that and also on mix. So we've seen the bulk of that increase in deposits for the full year is on the, at least from a mix standpoint, is on the non-interest bearing deposit side. We've increased about 40 million year over year there. And that's also benefited the margin. We continue to focus on that. But so we there will be near term reliance on to answer your primary question. We're comfortable with that strategy, but internally, we're heavily focused on driving core deposit growth over time.
Yeah, I would just add that, you know, our teams are laser focused on our deposit efforts and not only the growth, but also the mix, which I think we've demonstrated year to date. You know, one of the key strengths of Orristown Bank is our relationship-centric approach, and we'll be leaning into that more. We'll also be exploring additional talent in our efforts, along with sort of our product suite and our technology offerings. So it is a laser focus on it, and we'll remain confident in our ability to execute.
I appreciate it. Thank you both.
Operator
Your next question comes from the line of Daniel Cardenas with Breen Capital. Daniel, your line is now open. Please go ahead.
Good morning, everybody. So just a couple of follow-up questions here on the lending front. Maybe if you could give us some color on what competitive factors are looking like. I'm assuming they're still fairly intense. But, you know, is the market still rational or are you beginning to see some irrational actions from competitors?
I would not say that, you know, you certainly have those one off situations where you scratch your head and you take a pass, whether it's pricing or credit structure. But for the most part, I would say that it's still, you know, people are acting, you know, in their normal fashion. And, you know, our ability to add value to the relationship really is what differentiates and leads to our success and our growth to date. And we'll continue to focus on that. But I would not describe the market yet as irrational.
Okay, good, good. And then maybe just some color on the $15 million of home equity loans that you bought. What kind of yield were coming with those loans? And just maybe some additional information on the vintage. On average, what's the average age of the portfolio that you bought?
So the yields are in the 8% range. I'm trying to confirm if we have the average life. Let me, I'm trying to see if I can get that answer for you as we're talking here, but.
Okay. And they're all high quality performing, low loan values, et cetera.
Yeah, it's all strong, strong FICO.
Good quality EOX for sure. Average weighted coupon is $8.58. $8.58. on the the rate in average life are those in market loans they are not they're spread they're throughout the country okay um the remaining average remaining term is uh 357 months the seasoning on those was the average seasoning was only three months they were 360 month uh loans It's relatively neat with their 30-year.
Perfect. And then as I think about capital levels for you guys, the capital levels is out. And just kind of wondering if you could give us a little bit of color to what you're seeing on the M&A front of anything.
Yeah, I mean, I would say our focus remains internal. We feel like we have an incredible internal growth story, and we certainly are open to discussions if it makes the right financial sense, and culturally it makes sense, geographically it makes sense, but right now we're focused on the internal growth story.
And just backing up on your previous question, that's the estimated, our projected average life on the thinking box is six years.
And then last question for me, just on the margin, appreciate all the information you've provided.
So for every 25 basis point increase that we see from the Fed, what kind of impact does that have on here? um so from a net interest income standpoint every 100 basis points is about 2 million um so about a quarter so about 500 000 impact um for every 25 on a on a ramp basis um and that would equate to about five five basis points for every quarter to the margin appreciate that I'll step back.
Thank you, guys. Great quarter. Thank you.
Operator
Your next question comes from the line of Tim Switzer with KBW. Tim, your line is now open. Please go ahead.
Hey, good morning. Thank you for taking my question.
One quick follow-up on the impact of a Fed rate hike there what are your deposit beta expectations um and you know how does that change maybe over the course of a fed rate hike cycle say we get like three or four over the next year um does that beta start to you know creep up a little bit higher as competition gets more intense um so we're still in the process of assessing that because this is a little um early in this cycle that i can point to the previous the previous rate hike cycle where our beta was on the lower side 25 basis points i do expect in this environment it'll be something higher than that um and that's what we've that's what we've modeled um to your other question it's a little bit unknown um what's going to happen um with it's going to be market driven and competition driven. So it's a little hard to predict whether that would change. We do see significant and are feeling it now as there's competition out there from a rate perspective, but I can't directly say whether the beta would significantly increase with each rate hike. It is something we've focused heavily on. We've been successful certainly in the past and managing our funding costs and both increasing and decreasing rate environments. We'll continue to heavily focus on how to manage that.
Okay. How has deposit competition in your markets trended so far? Is it mostly in line with your expectations or a little bit more promos than you would have expected or rate increases?
It's mostly in line. There's some outliers out there. I'm sure everybody's seeing these significant cash handouts, particularly from some of the larger banks. So it's interesting seeing the cities of the world and those institutions getting heavily involved here and paying significant dollars. So I would say it's probably a little more than what I expected, but not a complete surprise either.
But that beta and during the last rate sort of cycle was low because of our relationship model. And we will continue to lean into that. Now, you know, we've modeled slightly more than what our historical performance has been. But, you know, we will continue to lean into that relationship model.
OK. And then one one last one for me. It sounds like you guys don't have a lot of interest in M&A right now. What would be your plans for capital deployments, just given the excess capital levels you're sitting at right now? Is it continued dividend increases like you've done more recently, or should we see you kind of turn on the buyback at some point?
Yeah, we like the optionality that we have, Tim. I mean, you know, certainly if the right M&A opportunity came up, we would explore that. But we also would look at our dividends, share repurchase, whether it's team lift outs, you know, branch optimization. But there are a number of things that we look at from a capital allocation perspective. And like I said, we sort of like the optionality that we have today.
Yes, nice to have. All right. Thank you for taking my question. Thank you.
Operator
That concludes the Q&A portion of the presentation. Mr. Metz, I turn the call back over to you for concluding remarks.
Thank you, Holly. And thanks, everybody, for participating today. As always, if we can clarify any of the items discussed on this call or in the earnings release, please contact us. Have a great day.
Operator
This concludes the Orrstown Financial Services, Inc. Third Quarter 2026 Earnings Conference Call. You may now disconnect your line at this time.
