Earnings Call Transcript - ORRF Q4 2025

Operator, Operator

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Orrstown Financial Services, Inc. Fourth Quarter 2025 Earnings Conference Call. I will now turn the call over to Tom Quinn, President and Chief Executive Officer of Orrstown Financial Services, Inc. and Orrstown Bank, who will begin the conference. Mr. Quinn, please go ahead.

Thomas Quinn, CEO

Thank you, operator, and good morning. I'd like to thank everyone for participating in Orrstown's Fourth Quarter 2025 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, www.orrstown.com. Once there, you can click on the Investor Relations link and then 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 the information are included in the earnings release, the investor presentation, and our SEC filings. The earnings release and investor presentations also include non-GAAP financial measures. The appropriate reconciliations to GAAP are included in those documents. Joining me on the call this morning are Orrstown's Senior Executive Vice President and Chief Operating Officer, Adam Metz; our Executive Vice President and Chief Financial Officer, Neil Kalani; our Chief Revenue Officer, Zach Khuri; Chief Risk Officer, Bob Coradi; and our Chief Credit Officer, Dave Chajkowski, will also participate in the call. Our financial highlights: Orrstown achieved the highest reported annual net income in the company's history of 106 years. Net income was $80.9 million or $4.18 per diluted share. Our return on average equity was 14.76%, return on average assets was 1.49%. Net interest margin came in at 4.04% and fee income of $52.3 million contributed to 21% of the total operating income. We demonstrated our ability to maintain net interest margin near the top of peers, enhanced fee income, and created efficiencies, all while maintaining our focus on leading with risk. Regularly investing in the future remains a key strategy for the bank. We brought in several talented team members in 2026 and will continue to do so. With that has come a strong loan pipeline and enhanced growth opportunities going forward. Overall, it was a highly successful year for Orrstown, particularly with the numerous challenges presented to us along the way. We are proud that we have consistently demonstrated the ability to maintain strong profitability in any environment and expect that to continue going forward. I will now turn the call over to Adam Metz, who will speak about our quarterly results.

Adam Metz, COO

Thank you, Tom, and good morning, everyone. Our quarterly financial highlights are summarized on Slide 3 of our deck. As was the case with our annual results, our fourth quarter earnings were impressive. Net income was $21.5 million or $1.11 per diluted share. We maintained a strong net interest margin, which, coupled with noninterest income growth, drove our continued earnings and capital generation in the fourth quarter. Noninterest income as a percentage of operating revenue was 22% in the fourth quarter; that's the third consecutive quarter where this ratio exceeded 20%. As Tom said, enhancing noninterest income and investing in the future remain key strategic priorities for the bank. We recently announced the hiring of Matt Alpert as our Chief Wealth Officer. Matt's proven track record in team leadership and its client-first approach aligned perfectly with our mission to deliver personalized high-quality financial advice and trust services. Over time, we will look to Matt to bring additional talent to the organization. Our proven philosophy remains that investing in the right people today will lead to continued growth in the future. We are also looking for newer sources of fee income, such as our recently increased presence in the merchant services space. Loan growth was steady during the fourth quarter coming in at 4%. Loan growth was tempered by some projected closings being pushed into the first quarter of 2026. Growth has been balanced across our footprint and our product set, a nice mix of C&I and CRE, and we have also seen the benefit of our investment in the middle market team. We remain confident in our pipelines, which remain strong, and the ability of our experienced relationship bankers to continue to responsibly grow the loan portfolio. Credit quality remains strong, highlighted by minimal provision expense, a reduction in classified loans, and a healthy reserve coverage ratio. The bank recorded a provision expense of $0.1 million and net charge-offs of $0.5 million during the quarter. Classified loans decreased by $5.7 million from the prior quarter. The allowance for credit losses on loans as a percentage of total loans ended the quarter at 1.19% compared to 1.21% at the end of the prior quarter. We believe the allowance is properly aligned with the makeup of the loan portfolio. While delinquencies have increased, we do not believe it is indicative of a broader trend. We continue to build capital, which will create flexibility for us in the future. Capital ratios increased across the board quarter-to-quarter. We remain well capitalized by all measures. Our shareholders remain our top priority. We remain focused on building shareholder value through strong earnings and an attractive dividend. As a result of our strong earnings performance, the Board voted to increase our quarterly dividend by $0.03 per share from $0.27 to $0.30 per share. This is the fourth dividend increase in the past 18 months, and our dividend has increased by 50% since the merger date. Neil Kalani, our CFO, will now discuss our fourth quarter results in more detail.

Neelesh Kalani, CFO

Thank you, Adam. Good morning, everyone. As Adam noted, we finished '25 strong with $21.5 million of net income or $1.11 in earnings per diluted share. ROA was 1.55% for the quarter and ROE was 14.7%. I'll start on Slide 4 of the earnings deck with my discussion. The net interest margin was 4.00% in the fourth quarter, down from 4.11% in the third quarter. There are a couple of factors that played into this. First, purchase accounting accretion impact to the margin was about 6 basis points lower in the fourth quarter. Also, the Fed rate cuts in September and October resulted in reduced interest income on our variable rate loans. Continued market pressure has lengthened the lag in deposit rate reductions. We expect funding costs to come down starting in the first quarter of '26 and I'm projecting a net interest margin in the range of 3.90% to 4% for 2026. As I've stated in previous earnings calls, we have anticipated some compression due to the asset-sensitive balance sheet, coupled with the lag in deposit pricing. So the fourth quarter margin compression was expected, and we will be focused on maintaining it around current levels. If there were no rate cuts in 2026, the margin, I do expect, would come in a little higher. The margin excluding purchase accounting impact was 3.53% in the fourth quarter as compared to 3.59% in the third quarter, primarily because of deposit rate lag. Purchase accounting accretion impact, excluding any unanticipated acceleration, should continue to decline modestly going forward. The core margin, I believe, will increase in the first quarter and stabilize from there. We also maintain our focus on replacing the accretion income from the acquired loan portfolio as it runs off, and we remain on pace to do so. Slide 5 covers fee income, which increased to $14.4 million in the fourth quarter from $13.4 million in the third quarter. Noninterest income for the fourth quarter was more than 22% of total revenues. Wealth management income was $5.7 million and swap fees were $1.1 million in the quarter. As Adam noted, we're excited about the opportunities ahead of us in the wealth space and expect to continue to make investments to grow that business. Service charges are up from the prior quarter as we grow our treasury management business, including merchant services, which has grown substantially since the prior year and represents 17% of treasury management revenue. Mortgage activity has been stable for several quarters. And due to the volatility in some of the components, I'm projecting a quarterly run rate for noninterest income to be in the range of $13 million to $14 million in 2026. Now I'll cover noninterest expenses on Slide 6. Expenses are elevated a little this quarter at $37.4 million, up $1.1 million from the third quarter. Salaries and benefits were higher with increased healthcare costs and some additional items that on the professional services line, which were a little elevated that drove the overall noninterest expense number up. With recently communicated and planned future investments in wealth management and other sales teams, I expect expenses to run at a quarterly rate of around $37 million going forward. However, we do regularly seek opportunities to invest in talent that will drive future growth. Slide 7 covers credit quality. Provision expense was just $75,000 for the quarter. We had approximately $500,000 in net charge-offs, which were mostly offset by the impact of favorable economic factors in the allowance calculation. Our allowance coverage ratio was 1.19% at December 31, '25, which was a slight decline from September 30 that we believe is more than adequately aligned with the risk profile of our loan portfolio. Classified loans are down mainly due to paydowns. Non-accruals are up from the prior quarter primarily due to one relationship and not indicative of any broader trends. Nonperforming assets remain very low as a percentage of total assets. Our earnings and performance metrics are shown on Slide 8. All metrics remain strong. TCE is now at 9%, and tangible book value per share continues to build at a rapid pace. Our loan portfolio is discussed on Slide 9. Loans grew 4% in the quarter, with some anticipated closings pushing into January. Loan yields did decline during the quarter due to the impact of lower rates on the variable loan portfolio. We had $207 million of loan production during the fourth quarter and continue to have a robust pipeline. We feel good about achieving loan growth of 5% or better in 2026. On Slide 10, deposits were relatively flat, declining slightly by $5 million. The loan-to-deposit ratio remains at a comfortable level of 89%. The cost of deposits was 1.98% for the fourth quarter. Due to the deposit pricing lag, I would expect deposit cost reductions to be more clearly reflected in the first quarter of 2026. Lowering overall funding costs is a regular discussion item for management as well as expanding wallet share and an emphasis on bringing in operating accounts. The investment portfolio is covered on Slide 11. We gradually repositioned the portfolio over time, taking opportunities as they present themselves in the market. During the fourth quarter, market dynamics led us to make a bigger shift. We purchased $125 million of Agency MBS and CMO and sold about $42 million of securities. This was a strategic decision to help address the asset sensitivity on the balance sheet. The sales did result in a small gain. The majority of the purchased securities are at a fixed rate, which will benefit us as rates decline. The investment portfolio yield of 4.58% reflects a decrease from the prior quarter of 4.67% due to the impact of declining rates on the floating rate investments. With excellent yield and declining unrealized losses, we believe the investment portfolio is positioned well to be a driver of earnings growth as well as proper balance sheet alignment. Our regulatory capital ratios are covered on Slide 12. After the redemption of subordinated debt on September 30th, the total risk-based capital ratio has returned to where it was at June 30th. Capital generation is expected to be strong going forward based on projected earnings, and we believe we are positioned to take advantage of various capital allocation options. Finally, the guidance that was presented in the deck presents a conservative look at what we know we can achieve. We remain confident that we can either exceed current analyst consensus.

Adam Metz, COO

Thank you, Neil. As Tom said, we are proud that we have consistently demonstrated the ability to maintain strong profitability in any environment. We intentionally guided to assumptions we're confident we can deliver against. When you put these pieces together: unchanged loan growth, higher fee income, disciplined investment, the earnings profile for 2026 remains intact and, in our view, more reliable. We are optimistic about the future, both in the short and long term. We would now like to open the call to questions. Before we get started, the operator will briefly review the instructions with you.

Operator, Operator

Your first question comes from Tim Switzer with KBW.

Timothy Switzer, Analyst

You covered this briefly on the call a little bit, but I want to ask about the increase to the guidance on both the noninterest income and expenses. What was the primary driver for both of those? And does it reflect any change in strategy or the business or anything from relative to last quarter?

Neelesh Kalani, CFO

So a couple of things. This doesn’t reflect a change in strategy, as we continue to focus on finding talent to drive future earnings. We have been successful in the past by investing in talent. This approach starts with expenses, which translates into income and will continue to do so. We have taken some actions, including bringing in talent on the lending side, and we've announced Matt Alpert as the Head of Wealth to help advance our efforts. There will be additional investments on the OFA side to support that business. Whenever we identify opportunities to strengthen our team, we will invest in quality talent to propel us forward. This is reflected in our current expense guidance, depending on opportunities, whether that involves enhancing the lending team or other initiatives, we may extend within that range. However, based on our current situation, I anticipate being on the lower end of that range while still allowing room for investment in talent to increase not only net interest income on the loan side but also fee income as well. On the flip side, regarding noninterest income, we have seen a few quarters where we've consistently performed at a higher rate than before, exceeding $14 million, marking our highest quarter historically in noninterest income. I can’t guarantee that the $14.4 million run rate will continue since swap fees can fluctuate quarterly. However, it's been a strong quarter, influenced by market dynamics in wealth revenue. I am confident we can raise our guidance, which is supported by the talent we've already acquired and the benefits we expect to see from new hires in the future.

Timothy Switzer, Analyst

Got it. Okay. That was very helpful. And then if you could help clarify a little bit the NIM trajectory over the course of the year. So it sounds like the core NIM should go up in Q1, and you're already at the top end of your guidance going into the year. So I would assume that reflects some moderating purchase accounting accretion over the rest of the year that brings you down what you mentioned. Are you able to maybe quantify the pace of purchase accounting and how that should go down over time?

Neelesh Kalani, CFO

On a quarterly basis, excluding acceleration is challenging for us to predict, but generally, we see a decline of about 2 to 3 basis points each quarter. The loan production we’re implementing is compensating for that decline, although it's at lower rates, which will slightly reduce the margin further. We are anticipating 75 basis points with three 25 basis point cuts in 2026, and if those do not happen, we expect to exceed the high end of our range. We are proactively considering market conditions and believe there is potential for better performance. We remain focused on managing our funding costs and are optimistic about maintaining our margin around the 4% level, although there are factors that could cause it to decrease.

Operator, Operator

The next question comes from Gregory Zingone with Piper Sandler.

Gregory Zingone, Analyst

Just pivoting into the wealth management side for a second. Would you be able to tell me what AUM or AUA was at quarter end? And then also, if you have any numbers on how successful you've been in bringing some of the Codorus Valley customers onto your platform?

Neelesh Kalani, CFO

Total AUM was a little over $3 billion. Did you want to address?

Adam Metz, COO

I'm sorry, Gregory, what was the second half of your question?

Gregory Zingone, Analyst

I was just curious if you had any numbers on how successful you've been in bringing some of the Codorus Valley customers onto your wealth management platform.

Adam Metz, COO

Yes. I don't know that I'm sitting here with an exact statistic, but we've seen no significant decline in the portfolio, either from the wealth side or from the depository side from the commercial side. So as you saw in the fourth quarter of last year, fourth quarter of 2024, and the first quarter of 2025, we did take a proactive approach from a commercial loan portfolio perspective where we identified certain loans that didn't necessarily meet our sort of credit box, and we proactively moved them out, and you saw that. But from a client retention standpoint on the wealth side or on the depository side, we've seen pretty good stickiness.

Gregory Zingone, Analyst

Awesome. And then you guys had mentioned a little bit about the hiring aspect, and you guys are not too scared to hire new people, new teams when you see fit. Is there an area of the focus for the company this year, whether it is on the lending side, wealth, technology, or other back-of-the-house functions?

Adam Metz, COO

Yes, I can answer that. I would tell you that in mid-2025, we made a move to build out a middle market commercial lending platform. That has already generated significant results in our investments. So we feel very good about that, and we feel like there's additional opportunity there. On the wealth management side, as I think we shared with several of you, we feel like there's additional opportunity in our growth markets: Maryland, Lancaster, Harrisburg. We feel like we're just scratching the surface there. I think Matt and his experience, and certainly around recruitment and team building will benefit us greatly there. And from a technology side, we're always looking at that stack. I think in this quarter and going forward, we're making investments to make sure we have the state-of-the-art CRM platform and training the teams to appropriately identify the full breadth and scope of the client relationships, so that we make sure that we're bringing all the products and services to the client.

Gregory Zingone, Analyst

Awesome. And just one more from me. Seeing that your capital is building at such a nice pace, I'm curious where M&A ranks as a priority for capital deployment.

Adam Metz, COO

Yes. I appreciate the question. I think we have a very strong organic growth model. Frankly, that’s what we're focused on. We feel like, as I just shared, we have a lot of opportunities in the business lines, not only that we have today, but enhancing those. That’s sort of where we’re focused on. Our capital build does present optionality. We've done 3 in 106 years, so we're pretty picky about the partners, and we'll sort of go from there.

Operator, Operator

The next question comes from Kyle Gierman with Hovde Group.

Kyle Gierman, Analyst

I'm on for Dave Bishop. Kind of on that same question, could you provide an update on the company's current thinking around share buybacks and kind of what is like the near-term outlook for repurchases?

Neelesh Kalani, CFO

We are continuously examining that opportunity. Our valuation compared to tangible book value is an important consideration. We will take necessary actions as the situation requires, especially since our recent stock price has not positioned us as we would like. However, we are actively monitoring the situation and still have shares available for purchase. We remain open to all capital allocation strategies depending on our current standing.

Kyle Gierman, Analyst

Great. And then regarding the recent security purchases of the CMOs and MBS, could you share the yields achieved on those purchases and maybe the overall goals of the portfolio going forward?

Neelesh Kalani, CFO

The average yield on our purchases was 4.92%. We have always viewed this not just as an investment portfolio or a liquidity management tool, but also as a strong generator of earnings and an efficient use of capital. We will remain active with the portfolio as opportunities arise. We anticipate some benefits moving forward, in addition to what we experienced in the fourth quarter from the investment portfolio, though we expect the yield to remain around its current levels.

Operator, Operator

That concludes the Q&A portion of the presentation. Mr. Quinn, I turn the call back over to you for concluding remarks.

Thomas Quinn, CEO

Thank you, operator. As always, if we can clarify any of the items discussed this morning on this call or on the earnings release, please feel free to give us a call. Wishing you a wonderful day. Thank you very much.

Operator, Operator

This concludes today's conference call. Thank you for joining. You may now disconnect.