Pennsylvania Bankers Give Crash Course in Biting the Bullet

Memo from the desk of Thomas Quinn: If you are a struggling community banker seeking a magic bullet, forget about it.

Quinn, president and chief executive of Orrstown Financial Services (ORRF) in Shippensburg, Pa., over the past two years has dealt with a rash of nonperforming loans, a string of executives' departures and new enforcement orders from regulators.

In a recent interview, Quinn and David Boyle, who recently left PNC Financial Services Group (PNC) to join Orrstown as chief financial officer, described their multipronged strategy to address the $1.3 billion-asset bank's woes. None of the moves were quick or easy.

Those include a broad cost-cutting initiative and luring executives away from larger banks. More recently, Orrstown has sold two portfolios of nonperforming loans, although at a steep discount.

Here is an edited excerpt of the interview:

What type of loans did you sell recently?

QUINN: The majority of loans were ones we'd had on the books for a while—commercial real estate, land and development, residential-rental. It was an eclectic group of assets. They were nonperforming loans that we felt we needed to move on. They all had one thing in common—they weren't performing the way we wanted them to. We feel we've removed the bulk of our issues. The bank has been very steadfast in doing what needs to be done.

BOYLE: Our reserve will be far healthier than it was before the crisis. Our nonperforming loans and asset-quality ratios will be at or slightly below precrisis levels. We expect our reserve ratios will be well in line, if not superior to most of our peers.

Where were the borrowers on these nonperforming loans located?

BOYLE: It was across all our markets. We had some concentration in [Hagerstown] Maryland from the first sale in July, and probably the largest portion of assets from this sale was from Maryland.

Do you expect there will be future sales of nonperforming loans?

BOYLE: With the asset-quality and risk profiles changing so dramatically this week, future loan sales are unlikely.

Where do you plan to cut expenses?

QUINN: In multiple areas. From a corporate governance standpoint, we're looking at every area. The board has asked us to do that. Obviously we have had visitors here for last the couple of years; the consultant area and legal fees are areas [where we will save money]. In operations, we will gain efficiencies through technology we've put in place over the last year to two years. While we were fixing the company, we took an opportunity to make sure we were enhancing our systems and procedures. Our directors agreed to take a 25% cut in their directors' fees.

We are targeting an improvement in our efficiency ratio to between 58% and 62% over the next 36 months. (Orrstown's efficiency ratio stood at 74% as of Sept. 30.)

BOYLE: I did a lot of these efficiency exercises at PNC. Every part of the company is looking at every penny they spend. We're actually looking at return on investment on every dollar we're spending. We're taking things out that we don't need and investing where we do need it. We're very focused on looking at what it costs to run this company and what our shareholders expect. We're pushing our returns to be well above the cost of capital we allocate to those businesses.

Will the expense program include job cuts?

BOYLE: This is not a headcount issue. We're not going out and lopping off a bunch of employees. We're trying to take those employees and redeploy them in more efficient positions. The costs will come from all over the company, from cellphones to iPads to paper costs.

QUINN: There are no sacred cows. We will look at everything.

BOYLE: The other side of the efficiency ratio is the revenue, not just expenses. We're very focused on driving operating leverage. We're building our mortgage business [and expect it to perform well] as long as the refi boom continues. We've got a very good trust and wealth business to expand. And we're looking at diversifying the balance sheet away from commercial real estate. There are opportunities in commercial-and-industrial lending, which we have not done particularly robustly in the past. We have not focused a lot on retail lending. We will have a robust organization.

How is Orrstown progressing on meeting the terms of the written agreement with the Federal Reserve and the consent order with the Pennsylvania Department of Banking?

QUINN: We can't talk about that, but it's a constant dialogue. We see value in speaking to them on a regular basis. [The state of Pennsylvania and the Federal Reserve Bank of Philadelphia] have provided great insights into the bank. It's not easy, but I have to say, we have frequent conversations with them.

What are you seeing in terms of loan demand?

QUINN: We're refocusing our business on small-business lending and trying to produce more efficient products there. About 75% of our business came from commercial lending, and the majority of that from commercial real estate. That can be a recipe for an issue if there is a market downturn. Our Hagerstown, Md., market had a 47% decline. Clearly, a diversification strategy is in the best interest of the company.

To build loan demand, have you looked at expanding into the Pittsburgh market?

QUINN: We do business along the Interstate 81 corridor. We have business along I-70 and we have many employees on the I-83 corridor. The bulk of our franchise is in central Pennsylvania. Pittsburgh is three hours away. We're starting to see green shoots in the Pennsylvania markets where the companies that had difficulties are starting to come back. We're starting to see indications of business bouncing back. I would also say, through the whole process, we've been able to hire people from PNC and from Susquehanna Bancshares (SUSQ). We think we'll be able to attract many of their customers as well. We're seeing growth, and we have a loyal shareholder and customer base

Can you describe your communications with [activist investors] Richard Lashley and John Palmer of PL Capital, who threatened the company with litigation]?

QUINN: I had a call from Lashley before our third-quarter earnings report and we had a wonderful call. He actually agreed to give me a call after we released earnings. We had not heard from him until he filed [a document with the Securities and Exchange Commission threatening litigation], and I was surprised by the tone of the document. Our board is committed to the long-term shareholders. I understand PL Capital has not been in our stock for that long, but they are our largest shareholder and we want to do what is in the best interests of our long-term shareholders. I have looked at [PL Capital's] stated returns, and we feel pretty good about where we're headed and that there are better days ahead.

Would you consider putting the company up for sale or a capital raise?

QUINN: I'm not going to comment on looking for a buyer, or another capital raise. We feel that we can return to shareholders the type of performance they had grown accustomed to. Our board has met over 175 times this year, including committee meetings. I've gotten directors out of bed, and put them to bed.