Executive Summary / Key Takeaways

• Orrstown Financial Services has successfully integrated its merger with Codorus Valley, completing the core system conversion and positioning the company to refocus on organic growth and operational efficiency.
• The company reported solid core earnings in Q1 2025, with adjusted net income of $19.3 million or $1.00 per diluted share, and expects operating results to normalize as merger-related expenses become insignificant.
• Proactive risk management actions, including reducing commercial real estate concentrations and stress testing portfolios, have strengthened asset quality metrics, with declines in classified and nonaccrual loans quarter-over-quarter.
• Strong capital and liquidity positions, including an 84% loan-to-deposit ratio and increasing regulatory capital ratios, provide significant strategic flexibility for accelerating lending, evaluating M&A, and potentially considering capital actions like buybacks.
• Management is guiding for mid-single-digit loan growth, further expense reductions, and continued capital build, underpinned by a strong loan pipeline and renewed focus on client engagement post-integration.

A Community Bank's Evolution and Strategic Foundation

Orrstown Financial Services, Inc., rooted in a history stretching back to 1919, has long served its communities as a commercial bank offering a comprehensive suite of financial services. From its origins, the company has provided essential lending activities spanning commercial, residential, and consumer needs, alongside core deposit services. Over decades, ORRF expanded its geographic footprint and diversified its offerings to include fiduciary, investment advisory, insurance, and brokerage services, establishing itself as a key financial partner in south-central Pennsylvania and surrounding areas.

A transformative chapter in this history unfolded on July 1, 2024, with the completion of a merger of equals with Codorus Valley Bancorp (CVLY). This strategic combination was designed to significantly enhance ORRF's market position, creating a contiguous and expanded branch network across Central and Eastern Pennsylvania and the Greater Baltimore, Maryland area. The merger aimed to leverage complementary product suites, increase lending capacity to fuel growth, and enhance overall risk management capabilities. While the integration process, including a complex core system conversion finalized in Q1 2025, involved significant operational focus and associated costs, its successful completion marks a pivotal moment, allowing the company to pivot back to its core mission: growing the franchise and maximizing shareholder value.

Within the competitive landscape of regional banking, ORRF operates alongside peers like Franklin Financial Services (FRAF), WesBanco (WSBC), and Mid Penn Bancorp (MPB). These institutions vie for similar commercial and consumer clients within overlapping geographic markets. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, ORRF holds an estimated 1-2% aggregate market share in its primary regions. Competitors like WSBC, with a larger asset base, often possess advantages in scale and potentially more advanced digital infrastructure, offering faster transaction processing and lower operating costs per customer compared to ORRF's historical systems. MPB presents competition particularly in small-business lending, often demonstrating strong cost efficiency. Indirectly, ORRF faces pressure from fintech firms and online banks that offer alternative, often lower-cost, digital-only services, posing a challenge to traditional banking models.

ORRF's strategic response to this environment is multifaceted. Leveraging its expanded post-merger network provides a key competitive advantage, fostering stronger customer relationships that can translate into higher recurring revenue and improved capital efficiency. The company is also actively investing in its technological capabilities, recognizing the need to maximize automation and drive operational efficiencies to compete effectively on speed and cost. New executive hires in information and operations are specifically tasked with scaling these capabilities. While specific quantifiable performance metrics for ORRF's internal technology are not detailed, comparative analysis suggests its digital platforms, enhanced through recent upgrades and integration efforts, offer faster processing speeds and lower operating costs per unit compared to some rivals like MPB and WSBC, contributing to improved gross margins. This focus on technology and operational enhancement is foundational to ORRF's strategy to enhance its competitive moat and drive future profitability.

Financial Performance: Post-Merger Realignment and Core Strength

The first quarter of 2025 provides the clearest look yet at ORRF's post-merger financial profile, demonstrating solid core performance despite the lingering impact of integration costs. Net income for the three months ended March 31, 2025, totaled $18.1 million, a significant increase from $8.5 million in the same period of 2024, reflecting the scale benefits of the merger. Excluding merger-related expenses of $1.6 million (down from $3.9 million in Q4 2024), adjusted net income reached $19.3 million, or $1.00 per diluted share. Management anticipates operating results will normalize in the second quarter as these non-recurring expenses become insignificant, with approximately $1 million of Q1 non-interest expenses expected to be removed from the run rate by the end of Q2.

Net interest income saw a substantial increase, rising by $21.9 million to $48.8 million in Q1 2025 compared to $26.9 million in Q1 2024. This growth was primarily fueled by a $27.2 million increase in interest income on loans and a $4.3 million increase in interest income on investment securities, largely attributable to the higher average balances acquired in the merger and the positive impact of purchase accounting mark accretion. The net accretion impact on net interest income was a notable $6.9 million in Q1 2025, representing 51 basis points of the net interest margin. While total interest expense also increased by $11.0 million, primarily due to higher funding costs on acquired deposits and borrowings, the increase in interest-earning asset yields outpaced the rise in liability costs. The taxable-equivalent net interest margin expanded by 23 basis points year-over-year to 4.00% in Q1 2025. Management noted that funding costs, particularly for deposits, have begun to decline, and with flat interest rates, there is an opportunity to further improve the margin by optimizing funding costs and deploying excess liquidity into higher-yielding assets.

Noninterest income increased by $5.0 million to $11.6 million in Q1 2025, primarily driven by the merger's impact on wealth management income, service charges, and interchange income. Fee income represented 19% of total revenues in Q1, with management targeting over 20% going forward. Noninterest expenses rose by $15.7 million to $38.2 million, reflecting the larger operational footprint post-merger and increased intangible asset amortization from acquired intangibles. However, data processing expenses saw a decrease following the core system conversion, and professional services costs are expected to decline as integration activities wind down. The efficiency ratio, while impacted by merger costs, is expected to improve as expenses normalize.

Comparing ORRF's financial performance to peers based on available TTM data, ORRF's Net Profit Margin (13.69%) and Operating Profit Margin (32.11%) appear somewhat lower than WSBC's (25% and 31% respectively, though WSBC's operating margin is close) and MPB's (28% and 34%), but potentially comparable to FRAF's (16% and 19%). This suggests that while the merger has increased scale and revenue, operational efficiency and profitability relative to some peers are areas where ORRF may still be realizing benefits or facing higher costs, potentially related to integration or ongoing investments. The expected expense saves and focus on automation are critical steps to close these gaps and enhance profitability metrics like ROE (8-10% estimated vs. WSBC's 10-12%).

Asset Quality, Capital, and Liquidity: Fortifying the Foundation

A key focus for ORRF post-merger has been fortifying its balance sheet through proactive risk management and capital build. Total loans decreased by $55.2 million, or 1.4%, in Q1 2025 compared to year-end 2024. This reduction was a conscious strategic decision to manage risk in the portfolio, including reducing commercial real estate (CRE) concentrations ahead of potential economic headwinds. Management noted that CRE concentration relative to risk-based capital stood at 302% at quarter-end, below their internal tolerance of 350%, providing runway for prudent future CRE lending.

Asset quality metrics showed improvement quarter-over-quarter. Nonaccrual loans decreased by $1.4 million to $22.7 million, representing 0.59% of gross loans at March 31, 2025, down from 0.61% at December 31, 2024. Classified loans also declined by 14% to $76.2 million. Net charge-offs were nominal at $331 thousand in Q1 2025, and management clarified that higher charge-offs in Q4 2024 were isolated incidents, not indicative of a broader trend. The Allowance for Credit Losses (ACL) totaled $47.8 million, representing 1.23% of total loans, slightly down from 1.24% at year-end but remaining near the top of the peer group. The ACL coverage of nonperforming loans was a robust 210.34%. Management's ACL methodology incorporates qualitative factors to adjust for current and expected economic conditions, acknowledging the inherent subjectivity but expressing confidence that the current level adequately addresses expected credit losses.

Capital ratios increased across the board in Q1 2025. The Total Risk-Based Capital ratio rose to 13.1%, and the Tier 1 Leverage ratio increased to 8.6%. All applicable regulatory capital ratios exceeded the levels required to be deemed "well-capitalized." Tangible Common Equity also increased to 7.9% of tangible assets. This capital build, driven by strong post-merger earnings and balance sheet management actions, positions ORRF favorably compared to its pre-merger levels and provides a strong foundation for future growth.

The company maintains a strong liquidity position, with cash and cash equivalents totaling $287.1 million at March 31, 2025, an increase from $248.9 million at year-end. This increase was influenced by the decrease in loans and strong deposit retention. The loan-to-deposit ratio stood at a comfortable 84%, providing ample capacity to fund loan growth without heavy reliance on external borrowings. ORRF also has significant borrowing capacity from the FHLB ($1.9 billion maximum, with $101.2 million outstanding) and available unsecured lines of credit. This enhanced liquidity and capital strength provides ORRF with significant strategic flexibility, enabling management to accelerate commercial lending for strong credits, evaluate potential expansion or acquisition opportunities, and potentially consider capital actions such as share buybacks or sub debt redemption, all aimed at maximizing shareholder value.

Outlook and Strategic Priorities: Charting the Course Forward

With the core integration successfully completed, Orrstown Financial Services is poised to return its full focus to driving growth and enhancing operational performance. Management is guiding for mid-single-digit loan growth, supported by a loan pipeline that has increased over 40% since year-end. While acknowledging the potential for economic uncertainty and factors like tariffs to cause some borrowers to delay expansion plans, the team remains confident in its ability to generate prudent growth due to the strength of its client relationships and lending capabilities.

The strategic priorities outlined by management underscore this forward-looking focus:

• Recruit Talent: Continuing to invest in talent across the footprint, particularly in sales and operational roles, is seen as crucial for driving future growth and efficiency.
• Maximize Automation: Leveraging the integrated technology platforms to automate processes and drive further efficiencies is a key operational goal, expected to contribute to expense savings beyond the initial merger targets.
• Return Focus on Loan and Deposit Growth: With integration complete, the sales teams are fully dedicated to deepening client relationships and generating new business.
• Deploy Excess Liquidity: Strategically allocating the current excess cash and investment portfolio runoff (approximately $15 million per month) into higher-yielding loans and investments is expected to benefit the net interest margin.
• Evaluate Expansion and Acquisition Opportunities: The company is open to both organic expansion and potential acquisitions that align with its strategic vision, culture, and offer compelling shareholder value, though they emphasize a disciplined approach.
• Continue to Build Capital: Building upon the strong capital ratios achieved post-merger, management expects to continue increasing these ratios at a good pace, further enhancing financial stability and strategic flexibility.

While the economic climate, including potential impacts from tariffs and interest rate volatility, remains a key risk, ORRF believes its proactive risk management actions, fortified balance sheet, and renewed strategic focus position it well to navigate these challenges. Competition from regional peers and fintech disruptors necessitates ongoing investment in technology and operational efficiency to maintain competitiveness. However, the successful integration of the merger, coupled with a clear strategic roadmap and a focus on prudent growth and capital management, provides a compelling narrative for ORRF's future.

Conclusion

Orrstown Financial Services has emerged from a period of significant transformation following its merger with Codorus Valley Bancorp with a larger footprint, a more diversified business, and a fortified balance sheet. The successful completion of the core system conversion marks a critical inflection point, allowing the company to shift its focus from integration challenges back to core banking activities and strategic growth initiatives.

The solid core earnings performance in Q1 2025, coupled with management's guidance for normalized operating results, further expense reductions, and continued capital build, underscores the potential for enhanced profitability and shareholder value creation. The proactive approach to credit risk management has resulted in improving asset quality metrics, while strong capital and liquidity positions provide the strategic flexibility necessary to pursue prudent loan growth, evaluate expansion opportunities, and navigate potential economic uncertainties. As ORRF leverages its expanded network, invests in automation, and intensifies its focus on client relationships, the company appears well-positioned to execute on its strategy and build upon its foundation as a premier community bank franchise in its markets.