After a tough year spent disposing of problem loans and revamping management, is Orrstown Bank back on track?
Top executives at the Shippensburg-based institution say it is, and they aren't the only ones.
Orrstown's fourth-quarter results suggest it has "basically rounded the corner on credit quality," said Matt Schultheis, an analyst with Boenning & Scattergood Inc. in West Conshohocken, Montgomery County.
"They have room to really boost earnings," he said. "It looks to me they're starting to head in the right direction."
It was the company's first quarterly profit since the third quarter of 2011. Orrstown lost $32 million in 2011 as a whole and $38.5 million in 2012, the profitable fourth quarter notwithstanding.
Those losses include noncash charges that the company expects to recoup. In particular, Orrstown recorded a $20 million "valuation allowance" in 2012 for losses and expenses it expects to recover by setting them against future tax liabilities.
Orrstown's troubles stemmed mostly from commercial real estate loans that turned sour, particularly in the Hagerstown, Md., market, bank officials said.
Hagerstown boomed as a Washington, D.C., exurb in the mid-2000s, but the recession hit it hard. Real estate values in the area fell nearly 50 percent from their peak, Orrstown President and CEO Thomas Quinn said.
"Many of our customers were adversely impacted by that," he said.
By December 2011, total problem assets stood at $113.8 million, according to Orrstown's financial releases.
Maryland was a relatively new market for Orrstown, and the bank may have overestimated the stability of the growth taking place there, Schultheis suggested. Every community bank doing business in Hagerstown took its lumps, he said.
In March, Orrstown announced it had entered into enforcement agreements with the state Department of Banking and the Federal Reserve Bank of Philadelphia. The agreements call on Orrstown to strengthen management and board oversight and decrease the risk in its loan portfolio.
Orrstown worked with regulators to aggressively remediate its problems, Quinn said.
The bank overhauled its management team, making at least three important hires: Jeffrey Seibert, chief operating officer; David Boyle, chief financial officer; and David Keim, chief risk officer, a new position.
The bank unloaded tens of millions of dollars in distressed loans in two major sales to private investors. It charged off $68.8 million in bad loans in 2012 and $30.9 million in 2011, compared with $4 million in 2010.
Those actions reduced the bank's problem assets by nearly 80 percent, to $22.9 million. Nonaccrual loans are lower than they were in May 2011, Quinn said.
The bank doesn't expect further loan sales will be needed, Boyle said.
Such actions certainly appear to address regulators' areas of concern. However, officials are barred by statute from making any comment on the status or progress of a bank under an enforcement order, said Pennsylvania Department of Banking and Securities spokesman Ed Novak.
Going forward, Orrstown has plans, announced in December, to reduce costs and increase revenues by $5 million over two years.
The bank is targeting an efficiency ratio of 58 percent to 62 percent, Quinn said in a statement.
Efficiency ratios measure the expenses needed to generate $1 of revenue; a lower number is better, though institutions' ratios can vary widely over time. Orrstown's target would put it in line with industry peers.
Due to 2012's exceptional circumstances, Orrstown's efficiency ratio in December was 72 percent, spokesman Mark Bayer said. In 2011, it was 55 percent.
Many of the savings will come as Orrstown winds down its loan remediation, which involved bringing in outside expertise, Bayer said. The company also is studying ways to streamline its operations.
"This is not a head-count issue," he said, and layoffs are not envisioned, though some positions may be redefined or reassigned.
Since March 2011, the bank's net loans have dropped nearly 30 percent, from $970.4 million to $688.4 million. Quinn called it a "natural result" of the loan sales and the bank's strategy to reduce portfolio risk.
Schultheis, the analyst, concurred.
"You can't scrub a loan book and grow it at the same time," he said.
Putting credit quality issues to rest should enable Orrstown to reduce its loan loss provisions, the money it retains to offset potential write-offs, Schultheis said.
That would boost earnings. For community banks generally, a large share of earnings variability stems from the expansion and contraction of loan loss provisions, he said.
Orrstown is ready and eager to focus on growing its business and diversifying its revenue streams, Quinn said.
"We expect a strong 2013," he said. "We're excited about that."
Orrstown Bank’s financial troubles have led to two shareholder lawsuits.
One — a class-action suit filed in May with SEPTA, the Southeastern Pennsylvania Transportation Authority, as lead plaintiff — alleges Orrstown knowingly misled investors in securities filings about the quality of its loan portfolio.
“We’ll fight those allegations vigorously,” Orrstown President and CEO Thomas Quinn said.
Board members now must live within 50 miles of Orrstown’s headquarters and may not serve on boards of other banks or bank holding companies. PL Capital alleges the board imposed those requirements to keep the two principals of the activist shareholder firm, who live in New Jersey and Illinois and serve on such boards, from seeking a seat.
This matter, too, is in the hands of Orrstown’s attorneys, Quinn said. Orrstown has had local representation on its board since its founding in 1919, he said.