-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RCgYkq/dk9Ss6vd+Poau1NEpAliCLXHwrmAT6zHyF9ra7PMB5HATCPBFPJqqQh4+ Cbelik9aLr5RRUqCYQJ7eQ== 0000826154-97-000003.txt : 19970326 0000826154-97-000003.hdr.sgml : 19970326 ACCESSION NUMBER: 0000826154-97-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970325 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ORRSTOWN FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000826154 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232530374 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-18888 FILM NUMBER: 97562204 BUSINESS ADDRESS: STREET 1: 77 E KING STREET STREET 2: P O BOX 250 CITY: SHIPPENSBURG STATE: PA ZIP: 17257 BUSINESS PHONE: 7175326114 MAIL ADDRESS: ZIP: 00000 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 Commission file number: 33-18888 ORRSTOWN FINANCIAL SERVICES, INC. (Exact name of registrant as specified in its charter) Pennsylvania 23-2530374 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 77 East King Street P. O. Box 250, Shippensburg, Pennsylvania 17257 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 532-6114 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title of each class Common Stock, No Par Value The Common Stock is not registered on any exchange. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of January 29, 1997, 976,863 shares of the registrant's common stock were outstanding. The aggregate market value of such shares held by nonaffiliates on that date was $ 33,213,342. DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholders report for the year ended December 31, 1996 are incorporated by reference into Parts I and II. Portions of the Proxy Statement for 1997 Annual Meeting of Security Holders are incorporated by reference in Part III of this Form 10-K. - -1- Item 1. Business. History and Business Orrstown Financial Services, Inc. (OFS) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Orrstown Financial Services, Inc. was organized on November 17, 1987, under the laws of the Commonwealth of Pennsylvania for the purpose of acquiring Orrstown Bank ("Orrstown"), Shippensburg, Pennsylvania, and such other banks and bank related activities as are permitted by law and desirable. On March 8, 1988, Orrstown Financial Services, Inc. acquired 100% ownership of Orrstown, issuing 131,455 shares of Orrstown Financial Services, Inc.'s common stock to the former Orrstown shareholders. Orrstown Financial Services, Inc.'s primary activity consists of owning and supervising its subsidiary, Orrstown Bank, which is engaged in providing banking and bank related services in South Central Pennsylvania, principally Franklin and Cumberland Counties, where its six branches are located in Shippensburg (2), Carlisle (2), Spring Run, and Orrstown, Pennsylvania. The day-to-day management of Orrstown Bank is conducted by the subsidiary's officers. Orrstown Financial Services, Inc. derives a majority of its current income from Orrstown. Orrstown Financial Services, Inc. has no employees other than its six officers who are also employees of Orrstown, its subsidiary. On December 31, 1996, Orrstown had 64 full-time and 19 part-time employees. Business of Orrstown Orrstown was organized as a state-chartered bank in 1987 as part of an agreement and plan of merger between Orrstown Financial Services, Inc. and Orrstown Bank, the predecessor of Orrstown, under which Orrstown became a wholly-owned subsidiary of Orrstown Financial Services, Inc. As indicated, Orrstown is the successor to Orrstown Bank which was originally organized in 1919. Orrstown is engaged in commercial banking and trust business as authorized by the Pennsylvania Banking Code of 1965. This involves accepting demand, time and savings deposits and granting loans. The Bank grants agribusiness, commercial and residential loans to customers in South Central - -2- Pennsylvania, principally Franklin and Cumberland Counties. The concentrations of credit by type of loan are set forth on the face of the balance sheet (as shown on page 15). The Bank maintains a diversified loan portfolio and evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based on management's credit evaluation of the customer and collateral standards established in the Bank's lending policies and procedures. All secured loans are supported with appraisals of collateral. Business equipment and machinery, inventories, accounts receivable, and farm equipment are considered appropriate security, provided they meet acceptable standards for liquidity and marketability. Loans secured by equipment and/or other nonreal estate collateral normally do not exceed 70% of appraised value or cost, whichever is lower. Loans secured by real estate do not exceed 80% of the appraised value of the property which is the maximum loan to collateral value established in the Bank's lending policy. Loan to collateral values are monitored as part of the loan review, and appraisals are updated as deemed appropriate in the circumstances. Administration and supervision over the lending process is provided by the Bank's Credit Administration Department via loan reviews. The loan review process is continuous, commencing with the approval of a loan. Each new loan is reviewed by the Credit Administration Department for compliance with banking regulations and lending policy requirements for documentation, collateral standards, and approvals. The Credit Administration Department continues to monitor and evaluate loan customers utilizing risk-rating criteria established in the lending policy in order to spot deteriorating trends and detect conditions which might indicate potential problem loans. Reports of the results of the loan reviews are submitted quarterly to the Directors' Credit Administration Committee for approval and provide the basis for evaluating the adequacy of the allowance for loan losses. Through its trust department, Orrstown renders services as trustee, executor, administrator, guardian, managing agent, custodian, investment advisor and other fiduciary activities authorized by law. - -3- As of December 31, 1996, Orrstown had total assets of approximately $ 158 million, total shareholders' equity of approximately $ 15.8 million and total deposits of approximately $ 137 million. Regulation and Supervision Orrstown Financial Services (OFS) is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (BHC Act), and is registered as such with the Board of Governors of the Federal Reserve System (FRB). OFS is subject to examination by the FRB and is restricted in its acquisitions, certain of which are prohibited and certain of which are subject to approval by the FRB. Under the BHC Act, a bank holding company is, with limited exceptions, prohibited from (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or (ii) engaging in any activity other than managing or controlling banks. With the prior approval of the FRB, however, a bank holding company may own shares of a company engaged in activities which the FRB determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, federal law imposes certain restrictions on transactions between OFS and its subsidiary, Orrstown Bank. As an affiliate of Orrstown Bank OFS is subject, with certain exceptions, to provisions of federal law imposing limitations on, and requiring collateral for, extensions of credit by Orrstown Bank to its affiliates. The operations of Orrstown are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, and to banks whose deposits are insured by the Federal Deposit Insurance Corporation. Bank operations are also subject to regulations of the Pennsylvania Department of Banking, the Federal Reserve Board and the Federal Deposit Insurance Corporation. The primary supervisory authority of Orrstown is the Pennsylvania Department of Banking, who regularly examines such areas as reserves, loans, investments, management practices and other aspects of bank operations. These examinations are designed primarily for the protection of the Bank depositors. Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, the loans a bank makes and collateral it takes, the maximum interest rates a bank may pay on deposits, the - -4- activities of a bank with respect to mergers and consolidations, and the establishment of branches, and management practices and other aspects of banking operations. See Note 13 of the Notes to Financial Statements for a discussion of the limitations on the availability of Orrstown Financial Services' subsidiary's undistributed earnings for the payment of dividends due to such regulation and other reasons. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) provides that a financial institution insured by the Federal Deposit Insurance Corporation (FDIC) sharing common ownership with a failed institution can be required to indemnify the FDIC for its losses resulting from the insolvency of the failed institution, even if such indemnification causes the affiliated institution also to become insolvent. OFS currently has only one subsidiary and as a result has not been significantly affected by the aforementioned provisions of FIRREA. Regulatory authorities have issued guidelines that establish risk-based capital and leverage standards. These capital requirements of bank regulators, are discussed on page 35 under "Capital Funds". Failure to meet applicable capital guidelines could subject a bank to a variety of enforcement remedies available to the regulatory authorities. Depending upon circumstances, the regulatory agencies may require an institution to develop a "capital plan" to increase its capital to levels established by the agency. In 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted. Among other things, FDICIA provides increased funding for the Bank Insurance Fund of the FDIC by granting authority for special assessments against insured deposits through a general risk-based assessment systems. FDICIA also contains provisions limiting activities and business methods of depository institutions. FDICIA requires the primary federal banking regulators to promulgate regulations setting forth standards relating to, among other things, internal controls and audit systems; credit underwriting and loan documentation; interest rate exposure and other off-balance sheet assets and liabilities; and compensation of directors and officers. FDICIA also contains provisions limiting the acceptance of brokered deposits by certain depository institutions, placing restrictions on the terms of "bank investment contracts" that may be offered by depository institutions and provisions requiring the FDIC - -5- to study the current rules applicable to the aggregation of accounts of depositors at an institution that are entitled to FDIC insurance. Finally, FDICIA provides for expanded regulation of depository institutions and their affiliates, including parent holding companies, by such institutions' primary federal banking regulator. Each primary federal banking regulator is required to specify, by regulation, capital standards for measuring the capital adequacy of the depository institutions it supervises and, depending upon the extent to which a depository institution does not meet such capital adequacy measures, the primary federal banking regulator may prohibit such institution from paying dividends or may require such institution to take other steps to become adequately capitalized. The earnings of Orrstown Bank, and therefore the earnings of Orrstown Financial Services, are affected by general economic conditions, management policies, and the legislative and governmental actions of various regulatory authorities including the FRB, the FDIC and the Pennsylvania Department of Banking. In addition, there are numerous governmental requirements and regulations that affect the activities of Orrstown Financial Services. Competition Orrstown's principal market area consists of the north central portion of Franklin County, Pennsylvania, and Cumberland County, Pennsylvania. It services a substantial number of depositors in this market area, with the greatest concentration within a radius of Shippensburg and Carlisle, Pennsylvania. Orrstown, like other depository institutions, has been subjected to competition from less heavily regulated entities such as brokerage firms, money market funds, consumer finance and credit card companies and other commercial banks, many of which are larger than Orrstown Bank. Orrstown Bank is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. Item 2. Properties. Orrstown Bank owns buildings in Orrstown, Pennsylvania, Shippensburg, Pennsylvania (3), Carlisle, Pennsylvania and Spring Run, Pennsylvania. Offices of the bank are located in each of these buildings. In 1996 the Bank began - -6- leasing building space for a second office location in Carlisle, Pennsylvania, which opened in January 1997. One of the offices located in Shippensburg is an "Operations Center" which does not operate as a branch, but rather as an accounting office. The bank completed the renovation of a property located adjacent to the downtown office, which expanded its trust department and certain administrative facilities. The Bank also owns property adjacent to the Orrstown office which it intends to hold for future expansion purposes. Item 3. Legal Proceedings. Orrstown Financial Services, Inc. is an occasional party to legal actions arising in the ordinary course of its business. In the opinion of Orrstown Financial Services, Inc.'s management, Orrstown Financial Services, Inc. has adequate legal defenses and/or insurance coverage respecting any and each of these actions and does not believe that they will materially affect Orrstown Financial Services, Inc.'s operations or financial position. Item 4. Submission of Matters to Vote of Security Holders. None Executive Officers of Registrant The following table sets forth selected information about the principal officers of the holding company, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board. Age Held Bank Employee as of Name/Office Held Since Since 3/15/97 Galen L. Myers, Chairman of Board 1989 (1) 58 Joel R. Zullinger, Vice Chairman of the Board 1991 (1) 48 Jeffrey W. Coy, Secretary 1988 (1) 45 Kenneth R. Shoemaker, President and Chief Executive Officer 1987 1986 49 Stephen C. Oldt, Executive Vice President 1987 1987 54 Philip E. Fague, Vice President and Trust Officer 1990 1988 37 Robert B. Russell, Vice President and Treasurer 1988 1982 43
(1) Mr. Myers, Mr. Zullinger and Mr. Coy are not employees of the Bank. - -7- Senior Operating Officers of the Bank Age Held Bank Employee as of Name/Office Held Since Since 3/15/97 Kenneth R. Shoemaker, President & Chief Executive Officer 1987 1988 49 Stephen C. Oldt, Executive Vice President & Chief Operating Officer 1987 1987 54 Philip E. Fague, Vice President/ 1990/ Senior Trust Officer 1993 1988 37 Bradley S. Gerlach, Vice President Director of Sales & Marketing 1995 1995 37 Robert S. Nickey, III, Vice 1993/ President/Senior Loan Officer 1994 1993 34 Robert B. Russell, Vice President/ 1982/ Chief Accounting Officer 1993 1982 43 Patricia A. Corwell, Vice President and Assistant Secretary 1982 1954 62 James B. Dubbs, Vice President & 1983/ Cashier/Community Office Manager 1982 1976 38 Charles E. Ferguson, Vice President Human Resource Manager 1995 1995 60
Part II Item 5. Market for Registrant's Common Stock and Related Security Holder Matters. Orrstown Financial Services, Inc.'s common stock is not traded on a national securities exchange, but is traded inactively through the local and over the counter local markets. At December 31, 1996, the approximate number of shareholders of record was 1,500. The price ranges for Orrstown Financial Services, Inc. common stock set forth below are the approximate bid prices obtained from brokers who make a market in the stock. Market Cash Market Cash Price Dividend Price Dividend (1) 1996 1995 First Quarter $ 32.00 $ .17 $ 27.00 $ .14 Second Quarter 33.00 .17 27.00 .15 Third Quarter 34.00 .18 30.00 .15 Fourth Quarter 34.00 .19 30.00 .17
(1) Note: Cash dividends per share for 1995 were based on weighted average shares of common stock outstanding in 1995 after giving retroactive recognition to a 5% stock dividend issued in July 1995. See "Notes to Consolidated Financial Statements" for restrictions on the payment of dividends. - -8- Item 6. Selected Financial Data. 1996 1995 1994 1993 1992 Income (000 omitted) Interest income $ 11,981 $ 10,829 $ 8,571 $ 8,250 $ 8,632 Interest expense 5,139 4,542 3,241 3,129 3,800 Provision for loan losses 240 270 71 121 366 Net interest income after provision for loan losses 6,602 6,017 5,259 5,000 4,466 Securities gains (losses) ( 5) ( 45) 95 ( 5) 77 Other operating income 1,282 980 765 607 616 Other operating expenses 4,793 4,256 3,964 3,593 3,369 Income before income taxes 3,086 2,696 2,155 2,009 1,790 Applicable income tax 838 742 520 525 452 Net income $ 2,248 $ 1,954 $ 1,635 $ 1,484 $ 1,338
Per share amounts are based on following weighted averages: 1996 - 976,863 1994 - 976,863 1992 - 956,443 1995 - 976,863 1993 - 976,777 1996 1995 1994 1993 1992 Income before income taxes $ 3.16 $ 2.76 $ 2.20 $ 2.06 $ 1.87 Applicable income taxes .86 .76 .53 .54 .47 Net income 2.30 2.00 1.67 1.52 1.40 Cash dividend paid .71 .61 .52 .47 .43 Book value 16.23 14.98 12.65 11.87 11.06
1996 1995 1994 1993 1992 Year-End Balance Sheet Figures (000 omitted) Total assets $ 157,556 $ 145,998 $ 123,004 $ 113,581 $ 106,191 Net loans 107,306 101,424 89,639 74,449 69,865 Total investment securities 34,355 31,563 24,318 30,381 28,488 Deposits-non- interest bearing 16,322 13,962 13,262 13,417 11,678 Deposits-interest bearing 120,937 113,368 93,103 85,165 82,553 Total deposits 137,259 127,330 106,365 98,582 94,231 Liabilities for borrowed money 2,339 2,345 2,350 1,000 0 Total stockholders' equity 15,856 14,633 12,353 11,597 10,583
Ratios 1996 1995 1994 1993 1992 Average equity/ average assets 9.8 10.00 10.34 10.23 10.00 Return on average equity 14.9 14.40 13.36 13.24 13.02 Return on average assets 1.47 1.44 1.38 1.36 1.30
- -9- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Management's discussion and analysis of financial condition and results of operations on pages 31 through 35 of the annual shareholders' report for the year ended December 31, 1996 are incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. The report of independent auditors and the following consolidated financial statements and schedules of Orrstown Financial Services, Inc. are submitted herewith: Page Independent auditor's report 11 Consolidated balance sheets December 31, 1996 and 1995 12 Consolidated statements of income for the years ended December 31, 1996, 1995 and 1994 13 Consolidated statements of changes in stockholders' equity for the years ended December 31, 1996, 1995, and 1994 14 Consolidated statements of cash flows for the years ended December 31, 1996, 1995, and 1994 15 and 16 Notes to consolidated financial statements 17 - 29 Summary of quarterly financial data (unaudited) 30 - -10- INDEPENDENT AUDITOR'S REPORT Board of Directors Orrstown Financial Services, Inc. Orrstown, Pennsylvania We have audited the accompanying consolidated balance sheets of Orrstown Financial Services, Inc. and its wholly-owned subsidiary as of December 31, 1996 and 1995 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years ended December 31, 1996. These consolidated financial statements are the responsibility of the corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Orrstown Financial Services, Inc. and its wholly- owned subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years ended December 31, 1996 in conformity with generally accepted accounting principles. Chambersburg, Pennsylvania January 29, 1997 - -11- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1995 ASSETS 1996 1995 (000 omitted) Cash and due from banks $ 5,236 $ 4,330 Interest bearing deposits with banks 1,554 1,289 Federal funds sold 2,936 2,317 Securities available for sale 33,421 30,694 Federal Home Loan Bank, Federal Reserve and Atlantic Central Bankers Bank stock, at cost which approximates market value 934 869 44,081 39,499 Loans Commercial, financial and agricultural 8,401 8,211 Real estate - Mortgages 82,687 75,731 Real estate - Construction and land development 4,304 5,706 Consumer 13,534 13,209 108,926 102,857 Less: Allowance for loan losses ( 1,620) ( 1,433) 107,306 101,424 Bank premises and equipment, net 3,916 3,042 Accrued interest receivable 929 993 Other assets 1,324 1,040 Total assets $ 157,556 $ 145,998 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 16,322 $ 13,962 Interest bearing 120,937 113,368 137,259 127,330 Liabilities for borrowed money 2,339 2,345 Accrued interest and other liabilities 2,102 1,690 Total liabilities 141,700 131,365 Stockholders' equity Common stock: No par value - $ .2083 stated value per share, 2,000,000 shares authorized with 976,863 shares issued at December 31, 1996 and 1995 204 204 Additional paid-in capital 10,625 10,625 Retained earnings 4,786 3,232 Unrealized holding gains, net of tax - $ 124 - 1996 and $ 295 - 1995 241 572 Total stockholders' equity 15,856 14,633 Total liabilities and stockholders' equity $ 157,556 $ 145,998
The Notes to Consolidated Financial Statements are an integral part of these statements. - -12- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 (000 omitted) Interest and Dividend Income Interest and fees on loans $ 9,638 $ 8,996 $ 6,882 Interest and dividends on investment securities U.S. Government and agencies 1,265 1,083 963 Exempt from federal income tax 601 529 512 Other investment income 477 221 214 Total interest and dividend income 11,981 10,829 8,571 Interest Expense Interest on deposits 4,981 4,349 3,092 Interest on borrowed money 158 193 149 Total interest expense 5,139 4,542 3,241 Net interest income 6,842 6,287 5,330 Provision for loan losses 240 270 71 Net interest income after provision for loan losses 6,602 6,017 5,259 Other Income Service charges on deposit accounts 477 375 349 Other service charges, commissions, and fees 295 218 180 Trust department income 384 297 185 Securities gains (losses) ( 5) ( 45) 95 Other income 126 90 51 Total other income 1,277 935 860 Net interest income and other income 7,879 6,952 6,119 Other Expenses Salaries and employee benefits 2,621 2,326 2,115 Occupancy expense of bank premises, net, and furniture and equipment expenses 665 559 486 FDIC insurance premiums 2 125 221 Other operating expenses 1,505 1,246 1,142 Total other expenses 4,793 4,256 3,964 Income before income tax 3,086 2,696 2,155 Applicable income tax 838 742 520 Net income $ 2,248 $ 1,954 $ 1,635 Net income per share $ 2.30 $ 2.00 $ 1.67
The Notes to Consolidated Financial Statements are an integral part of these statements. - -13- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1996, 1995 and 1994 Unrealized Additional Holding Common Paid-In Retained Gains Stock Capital Earnings (Losses) (000 omitted) Balance, December 31, 1993 $ 194 $ 9,393 $ 2,010 $ 0 Net income 0 0 1,635 0 Cash dividends ($ .52 per share) 0 0 ( 512) 0 Unrealized loss on investment securities available for sale 0 0 0 ( 367) Balance, December 31, 1994 194 9,393 3,133 ( 367) Net income 0 0 1,954 0 Cash dividends ($ .61 per share) 0 0 ( 599) 0 Stock dividends issued 10 1,232 ( 1,242) 0 Cash paid in lieu of fractional stock dividends 0 0 ( 14) 0 Unrealized gain on investment securities available for sale 0 0 0 939 Balance, December 31, 1995 204 10,625 3,232 572 Net income 0 0 2,248 0 Cash dividends ($ .71 per share) 0 0 ( 694) 0 Unrealized loss on investment securities available for sale 0 0 0 ( 331) Balance, December 31, 1996 $ 204 $ 10,625 $ 4,786 $ 241
The Notes to Consolidated Financial Statements are an integral part of these statements. - -14- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 (000 omitted) Cash flows from operating activities: Net income $ 2,248 $ 1,954 $ 1,635 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 329 265 212 Provision for loan losses 240 270 71 Deferred income taxes ( 62) ( 78) ( 200) (Gain) loss on disposal of other real estate 5 ( 4) ( 10) (Gain) loss on disposal of bank premises and equipment ( 20) 1 4 Securities (gains) losses 5 45 ( 95) (Increase) decrease in accrued interest receivable 64 ( 260) 43 Increase (decrease) in accrued interest payable 278 290 11 Other net 64 ( 2) 9 Net cash provided by operating activities 3,151 2,481 1,680 Cash flows from investing activities: Net (increase) in interest bearing deposits with banks ( 265) ( 1,039) ( 250) Sales of available for sale securities 2,392 6,387 6,945 Maturities of available for sale securities 3,508 6,694 4,450 Purchases of available for sale securities ( 9,134) ( 18,843) ( 5,743) Purchases of FHLB stock ( 65) ( 61) ( 49) Net (increase) in loans ( 6,291) ( 12,055) ( 5,261) Proceeds from sale of bank premises and equipment 36 0 0 Proceeds from disposal of other real estate 142 22 20 Purchases of bank premises and equipment ( 1,178) ( 266) ( 691) Net cash (used) by investing activities ( 10,855) ( 19,161) ( 10,579) Cash flows from financing activities: Net increase in deposits 9,929 19,997 7,783 Net decrease in federal funds purchased 0 ( 644) ( 456) Proceeds from debt 0 0 1,350 Payment on debt ( 6) ( 6) 0 Cash dividends paid ( 694) ( 599) ( 512) Cash paid in lieu of fractional stock dividends 0 ( 14) 0 Net cash provided by financing activities 9,229 18,734 8,165 Net increase (decrease) in cash and cash equivalents 1,525 2,054 ( 734) Cash and cash equivalents, beginning balance 6,647 4,593 5,327 Cash and cash equivalents, ending balance $ 8,172 $ 6,647 $ 4,593
The Notes to Consolidated Financial Statements are an integral part of these statements. - -15- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 (000 omitted) Supplemental disclosure of cash flows information: Cash paid during the year for: Interest $ 5,418 $ 4,252 $ 3,230 Income taxes 892 800 543 Supplemental schedule of noncash investing and financing activities: Other real estate acquired in settlement of loans 169 22 27 Unrealized gain (loss) on investment securities available for sale (net of tax effects) ( 331) 939 ( 367) Other real estate transferred to bank premises 0 136 0 Property, equipment and other assets purchased with assumption of deposit liabilities in connection with branch acquisition 0 968 0
The Notes to Consolidated Financial Statements are an integral part of these statements. - -16- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Nature of operations Orrstown Financial Services, Inc.'s primary activity consists of owning and supervising its subsidiary, Orrstown Bank, which is engaged in providing banking and bank related services in South Central Pennsylvania, principally Franklin and Cumberland Counties. Its six branches are located in Shippensburg (2), Carlisle (2), Spring Run, and Orrstown, Pennsylvania. Principles of consolidation The consolidated financial statements include the accounts of the corporation and its wholly-owned subsidiary, Orrstown Bank. All significant intercompany transactions and accounts have been eliminated. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the corporation's allowances for losses on loans and foreclosed real estate. Such agencies may require the corporation to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term. Investment securities In accordance with Statement of Financial Accounting Standards No. 115 (SFAS 115) the Bank may segregate their investment portfolio into three specific categories: "securities held to maturity", "trading securities" and "securities available for sale". Securities held to maturity are to be accounted for at their amortized cost; securities classified as trading securities are to be accounted for at their current market value with unrealized gains and losses on such securities included in current period earnings; and securities classified as available for sale are to be accounted for at their current market value with unrealized gains and losses on such securities to be excluded from earnings and reported net as a separate component of stockholders' equity. - -17- Note 1. Summary of Significant Accounting Policies (Continued) Investment securities (Continued) Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the corporation has the ability at the time of purchase to hold securities until maturity or on a long-term basis, they are classified as securities held to maturity and carried at amortized historical cost. Securities to be held for indefinite periods of time and not intended to be held to maturity or on a long-term basis are classified as available for sale and carried at fair value. Securities held for indefinite periods of time include securities that management intends to use as part of its asset and liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and resultant prepayment risk changes. The corporation has classified all of its investment securities as "available for sale". Realized gains and losses on dispositions are based on the net proceeds and the adjusted book value of the securities sold, using the specific identification method. Unrealized gains and losses on investment securities available for sale are based on the difference between book value and fair value of each security. These gains and losses are credited or charged to shareholders' equity, whereas realized gains and losses flow through the corporation's results of operations. Cash flows For purposes of the Statements of Cash Flows, the corporation has defined cash and cash equivalents as those amounts included in the balance sheet captions "Cash and Due From Banks" and "Federal Funds Sold". As permitted by Statement of Financial Accounting Standards No. 104, the corporation has elected to present the net increase or decrease in deposits in banks, loans, and time deposits in the Statements of Cash Flows. Premises, equipment, furniture and fixtures and depreciation Buildings, improvements, equipment, furniture and fixtures are carried at cost less accumulated depreciation. Depreciation has been provided generally on the straight-line method and is computed over the estimated useful lives of the various assets as follows: Years Buildings and improvements 10-40 Equipment, furniture and fixtures 3-15 Repairs and maintenance are charged to operations as incurred. Computer software is amortized over 3-5 years. Advertising The corporation follows the policy of charging costs of advertising to expense as incurred. Advertising expense was $ 86,910, $ 54,224 and $ 71,619 for 1996, 1995 and 1994, respectively. Loans and allowance for loan losses Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Loan origination and commitment fees and certain direct costs are deferred and the net amount amortized over the contractual life of the loan as an adjustment of the loan's yield. If a loan is sold, any deferred fees not yet amortized are recognized as an adjustment to the gain or loss on sale. The allowance for loan losses is established through a provision for loan losses charged to expenses. - -18- Note 1. Summary of Significant Accounting Policies (Continued) Loans and allowance for loan losses (Continued) Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Nonaccrual loans The accrual of interest income on loans ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest accrued but not collected as of the date of placement on nonaccrual status is reversed and charged against current income unless fully collateralized. Subsequent payments received either are applied to the outstanding principal balance or recorded as interest income, depending on management's assessment of the ultimate collectibility of principal. Foreclosed real estate Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at the lower of carrying value or fair value of the underlying collateral. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Earnings per share of common stock Earnings per share of common stock were computed based on a weighted average of 976,863 shares of common stock outstanding in 1996, 1995 and 1994 after giving retroactive recognition to a 5% stock dividend issued in July 1995. Federal income taxes For financial reporting purposes the provision for loan losses charged to operating expense is based on management's judgment, whereas for federal income tax purposes, the amount allowable under present tax law is deducted. Additionally, deferred compensation is charged to operating expense in the period the liability is incurred for financial reporting purposes, whereas for federal income tax purposes, these expenses are deducted when paid. As a result of these and timing differences in depreciation expense, deferred income taxes are provided in the financial statements. See Note 10 for further details. Fair values of financial instruments Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in - -19- Note 1. Summary of Significant Accounting Policies (Continued) Fair values of financial instruments (Continued) many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the corporation. The following methods and assumptions were used by the corporation in estimating fair values of financial instruments as disclosed herein: Cash and Cash Equivalents. The carrying amounts of cash and short-term instruments approximate their fair value. Securities to be Held to Maturity and Securities Available for Sale. Fair values for investment securities are based on quoted market prices. Loans Receivable. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Deposit Liabilities. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed- term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposits and IRA's are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected maturities on time deposits. Short-Term Borrowings. The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements. Long-Term Borrowings. The fair value of the Bank's long- term debt is estimated using a discounted cash flow analysis based on the Bank's current incremental borrowing rate for similar types of borrowing arrangements. Accrued Interest. The carrying amounts of accrued interest approximate their fair values. Off-Balance-Sheet Instruments. The Bank generally does not charge commitment fees. Fees for standby letters of credit and their off-balance-sheet instruments are not significant. - -20- Note 2. Investments At December 31, 1996 and 1995 the investment securities portfolio was comprised of securities classified as "available for sale", resulting in investment securities being carried at fair value. The amortized cost and fair values of investment securities available for sale at December 31 were: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value (000 omitted) 1996 U. S. Treasury securities and obligations of U. S. Government corporations and agencies $ 10,830 $ 65 $ 36 $ 10,859 Obligations of states and political subdivisions 11,397 381 10 11,768 Mortgage-backed securities 10,413 37 149 10,301 Equity securities 417 78 2 493 Totals $ 33,057 $ 561 $ 197 $ 33,421 1995 U. S. Treasury securities and obligations of U. S. Government corporations and agencies $ 7,912 $ 110 $ 0 $ 8,022 Obligations of states and political subdivisions 11,329 676 0 12,005 Mortgage-backed securities 10,272 88 34 10,326 Equity securities 314 27 0 341 Totals $ 29,827 $ 901 $ 34 $ 30,694
The amortized cost and fair values of investment securities available for sale at December 31, 1996, by expected maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Cost Fair Value (000 omitted) Due in one year or less $ 1,203 $ 1,207 Due after one year through five years 7,244 7,380 Due after five years through ten years 4,677 4,765 Due after ten years 9,103 9,275 Mortgage-backed securities 10,413 10,301 Equity securities 417 493 $ 33,057 $ 33,421
- -21- Note 2. Investments (Continued) Proceeds from sales of securities available for sale during 1996, 1995 and 1994 were $ 2,391,746, $ 6,369,602 and $ 6,944,826, respectively. Gross gains and losses on 1996 sales were $ 16,440 and $ 21,455, respectively. Gross gains and losses on 1995 sales were $ 37,559 and $ 53,389, respectively. Gross gains and losses on 1994 sales were $ 222,089 and $ 127,019, respectively. Included in shareholders' equity at December 31, 1996 is $ 241,000 of unrealized holding gains on securities available for sale, net of $ 124,000 in deferred taxes. Included in shareholders' equity at December 31, 1995 is $ 572,000 of unrealized holding gains on securities available for sale, net of $ 295,000 in deferred taxes. The bank owns $ 691,200 of Federal Home Loan Bank stock, $ 54,000 of Atlantic Central Bankers Bank stock and $ 189,000 of Federal Reserve Bank stock at December 31, 1996. At December 31, 1995 the bank's stock ownership was $ 625,900 of Federal Home Loan Bank stock, $ 54,000 of Atlantic Central Bankers Bank stock and $ 189,000 of Federal Reserve Bank stock. Market value approximates cost since none of the stocks are actively traded. Securities carried at $ 10,517,100 and $ 10,036,000 at December 31, 1996 and 1995, respectively, were pledged to secure public funds and for other purposes as required or permitted by law. Note 3. Concentration of Credit Risk The bank grants agribusiness, commercial, residential and consumer loans to customers in South Central Pennsylvania, principally Franklin and Cumberland Counties. The concentrations of credit by type of loan are set forth on the face of the balance sheet. The bank maintains a diversified loan portfolio and evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the bank upon the extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but generally includes equipment and real estate. Note 4. Allowance for Loan Losses Activity in the allowance for loan losses is summarized as follows: 1996 1995 1994 (000 omitted) Balance at beginning of period $ 1,433 $ 1,200 $ 1,125 Recoveries 15 14 12 Provision for loan losses charged to income 240 270 71 Total 1,688 1,484 1,208 Losses 68 51 8 Balance at the end of period $ 1,620 $ 1,433 $ 1,200
Note 5. Bank Premises and Equipment A summary of bank premises and equipment is as follows: 1996 1995 (000 omitted) Land $ 424 $ 424 Buildings and improvements 3,107 2,306 Furniture and equipment 2,202 2,006 Construction in progress 120 49 Total 5,853 4,785 Less accumulated depreciation and amortization 1,937 1,743 Bank premises and equipment, net $ 3,916 $ 3,042
- -22- Note 5. Bank Premises and Equipment (Continued) Depreciation expense amounted to $ 287,624 in 1996, $ 250,769 in 1995, and $ 213,000 in 1994. Note 6. Loans to Related Parties The bank has granted loans to the officers and directors of the corporation and its subsidiary and to their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $ 2,005,000 and $ 1,758,000 at December 31, 1996 and 1995, respectively. During 1996, $ 830,000 of new loans were made and repayments totalled $ 793,000. During 1995, $ 310,000 of new loans were made and repayments totalled $ 379,000. Outstanding loans to bank employees totalled $ 610,000 and $ 954,000 for years ended December 31, 1996 and 1995, respectively. Note 7. Nonaccrual Loans The following table shows the principal balances of nonaccrual loans as of December 31: 1996 1995 1994 Nonaccrual loans $ 14,000 $ 132,000 $ 27,000 Interest income that would have been accrued at original contract rates $ 560 $ 1,616 $ 401 Amount recognized as interest income 0 0 0 Foregone revenue $ 560 $ 1,616 $ 401
The corporation had no impairment of loans during 1996 or 1995 as defined by Statement of Financial Accounting Standard No. 114. Note 8. Financial Instruments With Off-Balance-Sheet Risk The bank is a party to financial instruments with off-balance- sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the bank has in particular classes of financial instruments. The bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Contract or Notional Amount 1996 1995 (000 omitted) Financial instruments whose contract amounts represent credit risk at December 31: Commitments to extend credit $ 20,691 $ 14,074 Standby letters of credit and financial guarantees written 3,014 2,348
- -23- Note 8. Financial Instruments With Off-Balance-Sheet Risk (Continued) Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The bank evaluates each customer's creditworthiness on a case- by-case basis. The amount of collateral obtained if deemed necessary by the bank upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, real estate, equipment, and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The bank holds collateral supporting those commitments when deemed necessary by management. Note 9. Employee Benefit Plans The bank maintains a 401(k) profit-sharing plan for those employees who meet the eligibility requirements set forth in the plan. Employer contributions to the plan are based on bank performance and are at the discretion of the bank's Board of Directors. In addition, there is a provision for an employer match of 50 cents on the dollar for employee contributions up to 6% of the employees' eligible compensation. Substantially all of the bank's employees are covered by the plan and the contribution charged to operations was $ 306,379, $ 260,334, and $ 219,193 for 1996, 1995, and 1994, respectively. The bank has a deferred compensation arrangement with certain present and former board directors whereby a director or his beneficiaries will receive a monthly retirement benefit at age 65. The arrangement is funded by an amount of life insurance on the participating director calculated to meet the bank's obligations under the compensation agreement. The cash value of the life insurance policies is an unrestricted asset of the bank. The estimated present value of future benefits to be paid, which are included in other liabilities, amounted to $ 171,331 and $ 179,253 at December 31, 1996 and 1995, respectively. Total annual expense for this deferred compensation plan was $ 20,153 for 1996 and $ 19,064 for 1995 and 1994. A supplemental discretionary deferred compensation plan for executive officers and directors was started during 1995. The plan is funded annually with salary and fee reductions which are placed in a trust account invested by the Bank's trust department. Total amount contributed to the plan was $ 55,950 and $ 48,273 for 1996 and 1995, respectively. Note 10. Income Taxes The components of federal income tax expense are summarized as follows: 1996 1995 1994 (000 omitted) Current year provision $ 900 $ 820 $ 570 Deferred income taxes (benefits) ( 62) ( 78) ( 13) Accrued refund due 0 0 ( 37) Net federal income tax expense $ 838 $ 742 $ 520
- -24- Note 10. Income Taxes (Continued) Federal income taxes were computed after reducing pretax accounting income for non-taxable income in the amount of $ 661,000, $ 599,000, and $ 589,000 for 1996, 1995, and 1994, respectively. A reconciliation of the effective applicable income tax rate to the federal statutory rate is as follows: 1996 1995 1994 Federal income tax rate 34.0% 34.0% 34.0% Reduction resulting from: Nontaxable interest income and deferred taxes 6.8 6.5 9.9 Effective income tax rate 27.2% 27.5% 24.1%
Deferred tax liabilities have been provided for taxable temporary differences related to accumulated depreciation and unrealized gains on available for sale securities. Deferred tax assets have been provided for deductible temporary differences related to the allowance for loan losses, directors' deferred compensation and unrealized losses on available for sale securities. The net deferred tax assets included in other assets in the accompanying consolidated balance sheets include the following components: 1996 1995 Total deferred tax assets $ 553,000 $ 472,000 Total deferred tax liabilities ( 256,000) ( 410,000) Net deferred tax asset $ 297,000 $ 62,000
The corporation has not recorded a valuation allowance for the deferred tax assets as they feel that it is more likely than not that they will be ultimately realized. Note 11. Deposits Included in interest bearing deposits at December 31 are NOW and Super NOW account balances totalling $ 18,163,000 and $ 13,215,000 for 1996 and 1995, respectively. Also included in interest bearing deposits at December 31, 1996 and 1995 are money market account balances totalling $ 10,569,000 and $ 13,104,000, respectively. At December 31, 1996 and 1995 time deposits of $ 100,000 and over aggregated $ 7,767,000 and $ 6,447,000, respectively. Interest expense on time deposits of $ 100,000 and over was $ 373,000; $ 337,000; and $ 220,000 for 1996, 1995 and 1994, respectively. At December 31, 1996 the scheduled maturities of certificates of deposit are as follows: 1997 $ 45,883,000 1998 10,703,000 1999 2,793,000 2000 3,120,000 2001 1,029,000 2002 and thereafter 1,054,000 $ 64,582,000
The bank accepts deposits of the officers and directors of the corporation and its subsidiary on the same terms, including interest rates, as those prevailing at the time for comparable transactions with unrelated persons. The aggregate dollar amount of deposits of officers and directors totaled $ 1,103,000 and $ 1,195,000 at December 31, 1996 and 1995, respectively. - -25- Note 12. Liabilities For Borrowed Money At December 31, 1996 and 1995 the corporation had two long-term notes with the Federal Home Loan Bank of Pittsburgh as follows: Amount Maturity Date Interest Rate $ 1,000,000 2004 6.42% 1,000,000 2003 6.58% $ 2,000,000
Interest rates are fixed and interest only is paid on a monthly basis. The notes contain prepayment penalty charges, but management has no intention to pay off early. In addition to the aforementioned long-term notes the bank obtained a term loan in 1994 totaling $ 350,000 with the Federal Home Loan Bank of Pittsburgh. The maturity dates and applicable fixed interest rates on the remaining balance at December 31, 1996 are as follows: Amount Maturity Date Rate $ 5,570 2/97 4.61% 5,863 2/98 5.00% 6,173 2/99 5.21% 6,498 2/00 5.48% 315,579 2/01 5.58% $ 339,683
In addition, the bank has available a line of credit with the Federal Home Bank of Pittsburgh which is limited to 10% of the corporation's total assets. Collateral for the line consists of the corporation's 1-4 family mortgage loans totaling $ 60,070,000 at December 31, 1996. The corporation also has available an unused line of credit with Atlantic Central Bankers Bank of $ 3.5 million at December 31, 1996. Total interest on the aforementioned borrowings charged to operations in 1996 and 1995 were $ 148,859 and $ 149,083, respectively. Note 13. Orrstown Financial Services, Inc. (Parent Company Only) Financial Information The following are the condensed balance sheets, income statements and statements of cash flows for the parent company: Balance Sheets December 31 Assets 1996 1995 (000 omitted) Cash $ 107 $ 186 Securities available for sale 493 341 Investment in Orrstown Bank 15,321 14,154 Furniture and equipment (net of depreciation) 1 1 Total assets $ 15,922 $ 14,682 Liabilities Accrued management fee $ 40 $ 40 Accrued taxes and other liabilities 26 9 Total liabilities 66 49
- -26- Note 13. Orrstown Financial Services, Inc. (Parent Company Only) Financial Information (Continued) 1996 1995 (000 omitted) Stockholders' Equity Common stock, no par value - $ .2083 stated value per share, 2,000,000 shares authorized with 976,863 shares issued at December 31, 1996 and 1995 $ 204 $ 204 Additional paid-in capital 10,625 10,625 Retained earnings 4,786 3,232 Unrealized holding gains 241 572 Total stockholders' equity 15,856 14,633 Total liabilities and stockholders' equity $ 15,922 $ 14,682
Income Statements Years Ended December 31 1996 1995 1994 (000 omitted) Interest and dividend income $ 17 $ 20 $ 16 Net gain on sale of investment 0 0 112 Cash dividends from wholly-owned subsidiary 796 614 512 Equity in undistributed income of subsidiary 1,531 1,401 1,077 2,344 2,035 1,717 Less: Operating expenses 96 81 82 Net income $ 2,248 $ 1,954 $ 1,635 Statements of Cash Flows Years Ended December 31 Cash flows from operating activities: Net income $ 2,248 $ 1,954 $ 1,635 Adjustments to reconcile net income to cash provided by operating activities: Security (gains) 0 0 ( 112) Equity in undistributed income of subsidiary ( 1,531) ( 1,401) ( 1,077) Increase (decrease) in accrued liabilities 0 34 6 Net cash provided by operating activities 717 587 452 Cash flows from investing activities: Net decrease (increase) in interest- bearing deposits with banks 0 250 ( 250) Purchase of available for sale securities ( 102) ( 52) ( 60) Sales of available for sale securities 0 0 315 Net cash provided (used) by investing activities ( 102) 198 5 Cash flows from financing activities: Cash dividends paid ( 694) ( 599) ( 512) Cash paid in lieu of fractional stock dividends 0 ( 14) 0 Net cash (used) by financing activities ( 694) ( 613) ( 512) Net increase (decrease) in cash ( 79) 172 ( 55) Cash, beginning balance 186 14 69 Cash, ending balance $ 107 $ 186 $ 14
- -27- Note 13. Orrstown Financial Services, Inc. (Parent Company Only) Financial Information (Continued) Statements of Cash Flows Years Ended December 31 1996 1995 1994 (000 omitted) Supplemental disclosure of cash flows information: Cash paid during the year for: Income taxes $ 8 $ 6 $ 0
Dividends paid by Orrstown Financial Services, Inc. are generally provided from the bank's dividends to the parent company. Under provisions of the Pennsylvania Banking Code, cash dividends may be paid from accumulated net earnings (retained earnings) as long as minimum capital requirements are met. The minimum capital requirements stipulate that the bank's surplus or additional paid-in capital be equal to the amount of capital. Orrstown Bank is well above these requirements and the balance of $ 8,831,000 in its retained earnings at December 31, 1996 is fully available for cash dividends. Orrstown Financial Services' balance of retained earnings at December 31, 1996 is $ 4,786,000 and would be available for cash dividends, although payment of dividends to such extent would not be prudent or likely. The Federal Reserve Board, which regulates bank holding companies, establishes guidelines which indicate that cash dividends should be covered by current period earnings. Note 14. Leases The bank leases land and building space associated with its downtown Carlisle office and various remote automated teller machines under agreements which expire at various times through 1997 and 2001. Total rent expense charged to operations in connection with these leases was $ 14,260, $ 16,920, and $ 17,520 for 1996, 1995, and 1994, respectively. The total minimum rental commitment under operating leases at December 31, 1996 is as follows: Due in the year ending December 31: 1997 $ 15,710 1998 12,653 1999 13,291 2000 13,953 2001 13,365
Note 15. Compensating Balance Arrangements Required deposit balances at the Federal Reserve were $ 65,000 at December 31, 1996 and 1995. Required deposit balance at Atlantic Central Bankers Bank was $ 585,000 at December 31, 1996 and 1995. These balances are maintained to cover processing costs and service charges. An additional $ 16,560 is on deposit with First Union National Bank of Florida as a reserve for potential clearing losses related to the credit card operations. - -28- Note 16. Fair Value of Financial Instruments The estimated fair values of the corporation's financial instruments were as follows at December 31: - - - - 1996 - - - - - - - - 1995 - - - - Carrying Fair Carrying Fair Amount Value Amount Value (000 Omitted) FINANCIAL ASSETS Cash and due from banks $ 5,236 $ 5,236 $ 4,330 $ 4,330 Federal funds sold 2,936 2,936 2,317 2,317 Interest bearing deposits with banks 1,554 1,554 1,289 1,289 Securities available for sale 33,057 33,421 29,827 30,694 Other bank stock 934 934 869 869 Loans receivable 108,926 108,774 102,857 102,621 Accrued interest receivable 929 929 993 993 FINANCIAL LIABILITIES Deposits 137,259 137,451 127,330 127,616 Borrowed funds 2,339 2,348 2,345 2,353 Accrued interest payable 1,165 1,165 887 887
Note 17. Commitments In November 1996 the bank entered into a lease for the location of a new branch office in downtown Carlisle, Pennsylvania. Renovations of the space were completed and the office opened in January 1997. The remaining commitment on contracts for the renovations and equipment acquisitions was $ 56,000 at December 31, 1996. - -29- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY SUMMARY OF QUARTERLY FINANCIAL DATA The unaudited quarterly results of operations for the years ended December 31, 1996 and 1995 are as follows: 1996 1995 ($ 000 omitted Quarter Ended Quarter Ended except per share) Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31 Interest income $ 2,906 $ 2,994 $ 3,054 $ 3,027 $ 2,430 $ 2,661 $ 2,808 $ 2,930 Interest expense 1,260 1,286 1,297 1,296 968 1,089 1,208 1,277 Net interest income 1,646 1,708 1,757 1,731 1,462 1,572 1,600 1,653 Provision for loan losses 60 60 60 60 30 30 30 180 Net interest income after provision for loan losses 1,586 1,648 1,697 1,671 1,432 1,542 1,570 1,473 Securities gains (losses) ( 4) 8 ( 7) ( 2) ( 21) ( 2) ( 21)( 2) Other income 260 293 325 404 209 236 243 293 Other expenses 1,101 1,184 1,134 1,374 1,010 1,082 968 1,196 Operating income before income taxes 741 765 881 699 610 694 824 568 Applicable income taxes 207 227 273 131 176 217 231 118 Net income $ 534 $ 538 $ 608 $ 568 $ 434 $ 477 $ 593 $ 450 Net income applicable to common stock Per share data: Net income $ .55 $ .55 $ .62 $ .58 $ .44 $ .49 $ .61 $ .46
- -30- MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the selected supplementary financial information presented in this report. OPERATING RESULTS Net income was $ 2,248,000 for 1996, compared to $ 1,954,000 for 1995, representing an increase of $ 294,000 or 15.0%. Net income on an adjusted per share basis for 1996 was $ 2.30, up $ .30 from the $ 2.00 per share realized during 1995. Interest income for 1996 was $ 11,981,000, up $ 1,152,000, or 10.6% over 1995. The volume of earning assets increased 13.6% in 1996 and 14.9% in 1995. Average rates remained constant throughout 1995 and 1996. Loan demand diminished somewhat during 1996 causing lower increases in loan volumes from 1995. Gross loans at December 31, 1996 stood at $ 108,926,000 compared to $ 102,857,000 as of December 31, 1995. Increases in earning assets in 1996 were mixed between loans (70%) and investment securities (30%). An overall increase of 5.9% in loans was realized with most of the loan growth being concentrated in mortgage and commercial loans. This growth is consistent with management's plans for continuing expansion into the Carlisle, Pennsylvania market. Net interest margins were maintained at desired levels throughout 1996 by closely monitoring rates. Total interest expense was $ 5,139,000 for 1996, an increase of $ 597,000 over the $ 4,542,000 for 1995. The increase in total deposits was 7.8% in 1996 compared to 19.7% in 1995. The increases realized in 1996 are more indicative of the planned growth through marketing efforts and the introduction of new products as compared to 1995 whereby approximately 11.3% of the increase was due to the September 1995 purchase of the Spring Run branch from another local bank. An important factor is where the deposit growth has occurred, as indicated in the following trends: O Noninterest-bearing deposits increased 18.1% over the previous year O Average balances of interest-bearing demand and savings decreased 10.2% and 9.9%, respectively O Time deposits increased 7.3% in 1996 By realizing a more balanced mix of deposit growth, interest costs were maintained at desired levels as rates remained constant throughout 1996. Management continues to direct its marketing efforts toward attracting more low cost retail deposits while continuing to competitively price its time deposits in order to maintain favorable net interest margins. Net interest income is the difference between total interest income and total interest expense. Interest income is generated through earning assets which include loans, interest on deposits with other banks and investments. The amount of interest income is dependent on many factors including the volume of earning assets, the interest rate spread and the changes in interest rates, and volumes of nonperforming loans. The cost of funds varies with the volume of funds necessary to support earning assets, the rates paid to maintain deposits, rates paid on borrowed funds and the level of interest-free deposits. Net interest income for 1996 totaled $ 6,842,000, up $ 555,000 over 1995 compared to an increase of $ 957,000 from 1994 to 1995. Management continuously monitors liquidity and interest rate risk through its ALCO reporting, and reprices products in order to maintain desired net interest margins. Other income represents service charges on deposit accounts; fees received for ATM transactions, loan insurance, credit cards, travelers' checks and other services; fees for trust services; securities gains and losses and other income such as safe deposit box rents and gains (losses) on sales of property and equipment and real estate acquired in foreclosure. - -31- Other income increased $ 342,000 from 1995 to 1996 compared to an increase of $ 75,000 from 1994 to 1995. The increase in 1996 was due largely to increases in Trust Department income, service charge income, and income from the sale of mutual funds. In 1996 the corporation completed an expansion of the Trust Department and other administrative facilities at its King Street, Shippensburg office. The enhancement of its facilities and increase in Trust Department personnel over the past three years have facilitated the growth of its Trust activities. Management expects this growth to continue as it looks toward implementing on-site trust services at its Carlisle, Pennsylvania offices. The noninterest expenses are classified into four main categories: salaries and employee benefits; occupancy expenses and furniture and equipment expenses which include depreciation, maintenance, utilities, taxes, insurance, rents and maintenance; FDIC insurance premiums; and other operating expenses which include all other expenses incurred in daily operations. Employee related expenses increased 12.7% and 10.0% for 1996 and 1995, respectively, due to increases in personnel and normal salary and related benefit increases. The largest proportionate increase in noninterest expenses was for occupancy expense which increased 19.0% and 15.0% in 1996 and 1995, respectively. This increase is due to the expansion of the King Street, Shippensburg office and the purchase of new data processing equipment in 1996. Management expects increases in employee related expenses and occupancy expense to continue with the addition of a second branch office in Carlisle. Other operating expenses increased 10% in 1996 primarily in promotion and advertising costs; ATM expenses; amortization of deposit premium on the Spring Run branch acquisition; and outside data processing services, offset somewhat by the reduction of FDIC insurance premiums. Applicable income taxes changed between 1994, 1995 and 1996 as a result of changes in pre-tax accounting income and taxable income. The effective tax rate for 1996 decreased slightly from 1995 due to the proportionate increase in nontaxable interest income in relation to total income. FINANCIAL CONDITION Total assets at December 31, 1996 were $ 157,556,000, a 7.9% increase over December 31, 1995. Gross loans at December 31, 1996 totaled $ 108,926,000, an increase of $ 6,069,000 over the $ 102,857,000 level at December 31, 1995. The provision for loan losses was $ 240,000 in 1996 compared to $ 270,000 in 1995. The provisions were based on management's evaluation of the adequacy of the reserve balance and represents amounts considered necessary to maintain the reserve at the appropriate level based on the quality of the loan portfolio and economic conditions. The bank's history of net charge-offs has traditionally been better than peer group performance with an average rate of .04% of average Loans outstanding over the past five years. While this trend is expected to continue management recognizes the need to build the reserve to meet the expected increased risks associated with a growing loan portfolio and an expanding customer base. Therefore, it is management's intention to maintain the reserve at appropriate levels based on an ongoing evaluation of the loan portfolio. Loans 90 days or more past due (still accruing interest) and those on nonaccrual status were as follows at December 31 (in thousands): 90 Days or More Past Due Nonaccrual Status 1996 1995 1996 1995 Real estate mortgages $ 11 $ 322 $ 0 $ 92 Installment loans 58 82 14 34 Demand and time loans 129 4 0 0 Credit card 5 9 0 6 Total $ 203 $ 417 $ 14 $ 132
There were no restructured loans for any of the time periods set forth above. - -32- Total deposits increased to $ 137,259,000 at December 31, 1996 compared to $ 127,330,000 at December 31, 1995. Increases were balanced between core deposits and certificates of deposit as mentioned earlier. Stockholders' equity reached $ 15,856,000 at December 31, 1996 for a 7.7% increase over the prior year. Total stockholders' equity represented 10.0% of total assets at the end of 1996 and 1995. The primary source of capital growth in 1996 has been from retained earnings. Cash dividends paid in 1996 were up $ 95,000 over the previous year. It is the management and the Board of Directors' intention to continue paying a fair return on the stockholders' investment while retaining adequate earnings to allow for continued growth. As described in Note 1 of the Notes to Consolidated Financial Statements, deferred income taxes have been provided for timing differences in the recognition of certain expenses between financial reporting and tax purposes. Deferred income taxes have been provided at prevailing tax rates for such items as depreciation, provision for loan losses, deferred compensation and unrealized holding gains (losses) on available for sale securities. At December 31, 1996, deferred taxes amounted to $ 297,000. If all timing differences reversed in 1996, the actual income taxes saved by the recognition of the aforementioned expenses would not be significantly different from the deferred income taxes recognized for financial reporting purposes. The current level of nontaxable investment and loan income is such that the bank is not affected by the Alternative Minimum Tax rules. The schedule below reflects comparative changes in income and expense included in the Consolidated Statements of Income for 1996 and 1995 together with changes in asset and liability volumes associated with these income and expense items. 1996 Compared to 1995 1995 Compared to 1994 Average Volumes Income/Expense Average Volumes Income/Expense ($ 000 omitted) $ % $ % $ % $ % Loans 8,117 8.3 642 7.1 15,922 19.8 2,114 30.7 Investment securities 3,743 14.6 254 15.8 1,469 6.1 137 9.3 Other investments 194 16.7 256 115.8 56 5.1 7 3.3 Total 12,054 9.7 1,152 10.6 17,447 16.3 2,258 26.3 Interest/borrowed funds ( 720) (23.5) ( 35) ( 18.1) 679 28.5 43 28.7 Interest bearing demand deposits 2,553 10.2 64 10.4 ( 2,184) ( 8.0) ( 50) ( 7.6) Savings deposits 2,355 9.7 34 4.4 ( 225) ( .9) 43 6.1 Time deposits 10,417 19.2 534 17.8 15,824 42.2 1,265 74.0 Total 14,605 13.8 597 13.1 14,094 15.4 1,301 42.1 Net interest income 555 8.8 957 18.0 Provision for loan losses ( 30) ( 11.1) 199 280.3 Net interest income after provision for loan losses 585 9.7 758 14.4 Security transactions 40 88.8 ( 140) (147.4) Other operating income 302 30.8 215 28.1 Income before operating expense 927 13.3 833 13.6 Salaries & employee benefits 295 12.7 211 10.0 Occupancy & equipment expense 106 19.0 73 15.0 FDIC insurance premiums ( 123) ( 98.4) ( 96) ( 43.4) Other operating expenses 259 20.8 104 9.1 Total operating expenses 537 12.6 292 7.4 Income before income taxes 390 14.5 541 25.1 Applicable income taxes 96 12.9 222 42.7 Net income 294 15.0 319 19.5
- -33- FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June of 1996 the Financial Accounting Standards Board issued SFAS No. 125 Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Management has not concluded on the impact on future operations. This statement may significantly affect accounting for and disclosures about certain bank transactions including the following: d Assets subject to prepayment risk d Servicing assets and liabilities d Securities lending transactions d Loan participations d Extinguishment of liabilities d Collateral controlled by an institution as a secured party This statement is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996. LIQUIDITY Liquidity and interest rate sensitivity are related but distinctly different from one another. Liquidity involves the bank's ability to meet cash withdrawal needs of customers and their credit needs in the form of loans. Liquidity is provided by cash on hand and transaction balances held at correspondent banks. Liquidity available to meet credit demands and/or adverse deposit flows is also made available from sales or maturities of short-term assets. Additional sources of funds to meet credit needs are provided by federal funds and other borrowings, including special programs available through Federal Home Loan Bank. Interest rate sensitivity is the matching or mismatching of the maturity and rate structure of the interest-bearing assets and liabilities. It is the objective of management to control the difference in the timing of the rate changes for these assets and liabilities to preserve a satisfactory net interest margin. The following table approximately reflects the matching of assets and liabilities maturing within one year and thereafter, which management feels is adequate to meet customer cash and credit needs while maintaining a desired interest rate spread. Due Due Due Due Due 0-30 31-90 91-180 181-360 After (000 omitted) Days Days Days Days 1 Year Total Rate Sensitive Assets Interest bearing deposits with banks $ 1,554 $ 0 $ 0 $ 0 $ 0 $ 1,554 Other short-term investments 2,936 0 0 0 0 2,936 Investment securities 3,510 595 843 286 28,187 33,421 Real estate, commercial and consumer loans 26,878 6,459 14,054 23,995 37,540 108,926 $ 34,878 $ 7,054 $ 14,897 $ 24,281 $ 65,727 $ 146,837 Rate Sensitive Liabilities Certificates of deposit over $ 100,000 $ 436 $ 1,669 $ 976 $ 1,440 $ 2,246 $ 6,767 Other certificates of deposit 4,844 11,687 8,388 14,598 18,297 57,814 Money market deposit accounts 828 1,656 2,486 4,971 0 9,941 Other interest-bearing deposits 3,868 7,736 11,604 23,207 0 46,415 Long-term borrowings 0 5 0 0 2,334 2,339 $ 9,976 $ 22,753 $ 23,454 $ 44,216 $ 22,877 $ 123,276 Cumulative GAP $ 24,902 $ 9,203 $ 646 ($ 19,289) $ 23,561
- -34- Money market accounts totaling $ 9,941,000, interest bearing checking accounts totaling $ 18,163,000, and regular savings totaling $ 26,300,437 have been included proportionately in rate sensitive liabilities of one year or less due to these funds being subject to immediate withdrawal. However, in monitoring and evaluating liquidity throughout the year, management normally does not consider regular savings to be particularly rate sensitive due to the fact that rates are generally consistent among institutions in Orrstown's trading area; nor does management consider all interest bearing checking accounts to be due within one year since it is unlikely that 100% of these deposits will be withdrawn within the next 360 days. Therefore, management generally considers 50% of these funds to be due within one year when repricing deposits and evaluating liquidity. CAPITAL FUNDS Internal capital generation has been the primary method utilized by Orrstown Financial Services, Inc. to increase its capital. Stockholders' equity, which exceeded $ 15 million at December 31, 1996 has steadily increased. Regulatory authorities have established capital guidelines in the form of the "leverage ratio" and "risk-based capital ratios." The leverage ratio compares capital to total balance sheet assets, while the risk-based ratios compare capital to risk-weighted assets and off-balance-sheet activity in order to make capital levels more sensitive to risk profiles of individual banks. A comparison of Orrstown Financial Services' capital ratios to regulatory minimums at December 31 is as follows: Orrstown Financial Services Regulatory Minimum 1996 1995 Requirements Leverage ratio 10.0% 10.0% 4% Risk-based capital ratio Tier I (core capital) 13.2% 15.4% 4% Combined Tier I and Tier II (core capital plus allowance for loan losses) 14.6% 17.1% 8%
Orrstown Financial Services, Inc. has traditionally been well above required levels and expects equity capital to continue to exceed regulatory guidelines and industry averages. Certain ratios are useful in measuring the ability of a company to generate capital internally. The following chart indicates the growth in equity capital for the past three years. 1996 1995 1994 Equity capital at December 31 ($ 000 omitted) $ 15,856 $ 14,633 $ 12,353 Equity capital as a percent of assets at December 31 10.0% 10.0% 10.0% Return on average assets 1.47% 1.44% 1.38% Return on average equity 14.9% 14.4% 13.4% Cash dividend payout ratio 30.9% 30.7% 31.3%
STOCK MARKET ANALYSIS AND DIVIDENDS The corporation's common stock is traded inactively in the over-the-counter market. As of December 31, 1996 the approximate number of shareholders of record was 1,500. Market Cash Market Cash Price Dividend Price Dividend (1) 1996 1995 First Quarter $ 32.00 $ .17 $ 27.00 $ .14 Second Quarter 33.00 .17 27.00 .15 Third Quarter 34.00 .18 30.00 .15 Fourth Quarter 34.00 .19 30.00 .17
(1) Note: Cash dividends per share for 1995 were based on weighted average shares of common stock outstanding in 1995 after giving retroactive recognition to a 5% stock dividend issued in June 1995. - -35- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY For additional information concerning liquidity, refer to statistical disclosures applicable to the investment and loan portfolio. Closely related to the management of liquidity is the management of rate sensitivity which focuses on maintaining stability in the net interest margin. As illustrated in the table below the tax equivalent net interest margin ranged from 4.7% to 5.0% of average earning assets during the past 3 years. An asset/liability committee monitors and coordinates overall the asset/liability strategy. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY Interest Rates and Interest Differential Tax Equivalent Yields Years Ended December 31 ASSETS 1996 1995 Average Average (000 omitted) Balance Interest Rate Balance Interest Rate Investment securities: Taxable interest income $ 20,899 $ 1,333 6.4% $ 18,355 $ 1,083 5.9% Nontaxable interest income 9,881 601 6.1 8,488 529 6.2 Total investment securities 30,780 1,934 6.3 26,843 1,612 6.0 Loans (net of unearned discounts) 105,779 9,638 9.1 97,662 8,996 9.2 Other short-term investments 7,637 409 5.4 2,406 221 9.2 Total interest earning assets 144,196 $ 11,981 8.3% 126,911 $ 10,829 8.5% Allowance for loan losses ( 1,528) ( 1,257) Cash and due from banks 4,520 3,143 Bank premises and equipment 3,486 2,727 Other assets 2,471 4,124 Total assets $ 153,145 $ 135,648 LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing demand deposits $ 27,601 $ 681 2.5% $ 25,048 $ 617 2.5% Savings deposits 26,555 791 3.0 24,200 758 3.1 Time deposits 63,767 3,509 5.5 53,350 2,974 5.6 Short-term borrowings 0 0 0.0 715 44 6.1 Long-term borrowings 2,340 158 6.7 2,345 149 6.3 Total interest bearing liabilities 120,263 $ 5,139 4.3% 105,658 $ 4,542 4.3% Demand deposits 16,078 13,833 Other liabilities 1,728 2,587 Total liabilities 138,069 122,078 Stockholders' equity 15,076 13,570 Total liabilities & stockholders' equity $ 153,145 $ 135,648 Net interest income/net yield on average earning assets $ 6,842 4.7% $ 6,287 5.0%
- -36- Year Ended December 31 ASSETS 1994 Average (000 omitted) Balance Interest Rate Investment securities: Taxable interest income $ 17,170 $ 963 5.6% Nontaxable interest income 8,148 512 6.3 Total investment securities 25,318 1,475 5.8 Loans (net of unearned discounts) 81,740 6,882 8.4 Other short-term investments 3,394 214 6.3 Total interest earning assets 110,452 $ 8,571 7.8% Allowance for loan losses ( 1,136) Cash and due from banks 4,208 Bank premises and equipment 2,530 Other assets 2,334 Total assets $ 118,388 LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing demand deposits $ 27,232 $ 668 2.5% Savings deposits 24,425 714 2.9 Time deposits 37,526 1,710 4.6 Short-term borrowings 77 3 3.9 Long-term borrowings 2,304 146 6.3 Total interest bearing liabilities 91,564 $ 3,241 3.5% Demand deposits 12,991 Other liabilities 1,595 Total liabilities 106,150 Stockholders' equity 12,238 Total liabilities & stockholders' equity $ 118,388 Net interest income/net yield on average earning assets $ 5,330 4.8%
For purposes of calculating loan yields, the average loan volume includes nonaccrual loans. For purposes of calculating yields on nontaxable interest income, the taxable equivalent adjustment is made to equate nontaxable interest on the same basis as taxable interest. The marginal tax rate was 34% for 1996, 1995 and 1994. ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CHANGES IN NET INTEREST INCOME TAX EQUIVALENT YIELDS 1996 Versus 1995 Increase (Decrease) Due to Change in Total Average Average Increase Volume Rate (Decrease) (000 omitted) Interest Income Loans (net of unearned discounts) $ 747 ($ 105) $ 642 Taxable investment securities 150 100 250 Nontaxable investment securities 86 ( 14) 72 Other short-term investments 481 ( 293) 188 Total interest income 1,464 ( 312) 1,152 Interest Expense Interest bearing demand 131 ( 67) 64 Savings deposits 73 ( 40) 33 Time deposits 583 ( 48) 535 Short-term borrowings ( 44) 0 ( 44) Long-term borrowings ( 1) 10 9 Total interest expense 742 ( 145) 597 Net interest income $ 555
- -37- 1995 Versus 1994 Increase (Decrease) Due to Change in Total Average Average Increase Volume Rate (Decrease) (000 omitted) Interest Income Loans (net of unearned discounts) $ 1,337 $ 777 $ 2,114 Taxable investment securities 66 54 120 Nontaxable investment securities 21 ( 4) 17 Other short-term investments ( 62) 69 7 Total interest income 1,362 896 2,258 Interest Expense Interest bearing demand ( 53) 3 ( 50) Savings deposits ( 9) 52 43 Time deposits 728 537 1,265 Short-term borrowings 25 16 41 Long-term borrowings 2 0 2 Total interest expense 693 608 1,301 Net interest income $ 957
Changes which are attributed in part to volume and in part to rate are allocated in proportion to their relationships to the amounts of changes. ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY The following table shows the maturities of investment securities at book value as of December 31, 1996, and weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% federal income tax rate. After 1 year After 5 years Within but within but within After 1 year 5 years 10 years 10 years Total (000 omitted) Bonds: U. S. Treasury Book value $ 1,002 $ 6,756 $ 1,072 $ 0 $ 8,830 Yield 6.04% 6.08% 6.06% 0% 6.08% U. S. Government agencies Book value 0 0 2,000 0 2,000 Yield 0% 0% 7.42% 0% 7.42% State and municipal Book value 201 488 1,605 9,103 11,397 Yield 6.71% 6.20% 6.5% 5.86% 5.96% Total book value $ 1,203 $ 7,244 $ 4,677 $ 9,103 $ 22,227 Yield 6.15% 6.09% 6.79% 5.86% 6.14% Mortgage-backed securities: Total book value $ 10,413 Yield 6.97% Equity Securities: Total book value $ 417 Yield 3.0% Total Investment Securities $ 33,057 Yield 6.36%
- -38- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY LOAN PORTFOLIO The following table presents the loan portfolio at the end of each of the last five years: 1996 1995 1994 1993 1992 (000 omitted) Commercial, financial and agricultural $ 8,401 $ 8,211 $ 6,970 $ 5,281 $ 5,630 Real estate - Construction 4,304 5,706 5,038 3,758 3,493 Real estate - Mortgage 82,687 75,731 68,458 57,278 52,711 Installment and other personal loans (net of unearned discount) 13,534 13,209 10,373 9,257 9,073 Total loans $ 108,926 $ 102,857 $ 90,839 $ 75,574 $ 70,907
Presented below are the approximate maturities of the loan portfolio (excluding real estate mortgages, installments and credit cards) at December 31, 1996: Under One One to Over Five Year Five Years Years Total (000 omitted) Commercial, financial and agricultural $ 1,261 $ 1,512 $ 5,628 $ 8,401 Real estate - Construction 646 774 2,884 4,304 Total $ 1,907 $ 2,286 $ 8,512 $ 12,705
The following table presents the approximate amount of fixed rate loans and variable rate loans due as of December 31, 1996: Fixed Rate Variable Loans Rate Loans (000 omitted) Due within one year $ 7,187 $ 64,969 Due after one but within five years 18,886 0 Due after five years 17,884 0 Total $ 43,957 $ 64,969
- -39- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY SUMMARY OF LOAN LOSS EXPERIENCE Years Ended December 31 1996 1995 1994 1993 1992 (000 omitted) Average total loans outstanding (net of unearned income) $ 105,779 $ 97,662 $ 81,740 $ 72,576 $ 67,871 Allowance for loan losses, beginning of period $ 1,433 $ 1,200 $ 1,125 $ 1,042 $ 716 Additions to provision for loan losses charged to operations 240 270 71 121 366 Loans charged off during the year Commercial 20 0 0 17 0 Personal credit lines 17 3 1 3 6 Installment 31 48 7 31 45 Total charge-off's 68 51 8 51 51 Recoveries of loans previously charged off: Commercial 3 0 0 0 0 Installment 12 14 12 13 10 Personal credit lines 0 0 0 0 1 Total recoveries 15 14 12 13 11 Net loans charged off (recovered) 53 37 ( 4) 38 40 Allowance for loan losses, end of period $ 1,620 $ 1,433 $ 1,200 $ 1,125 $ 1,042 Ratio of net loans charged off to average loans outstanding .05% .04% 0.0% .05% .06%
The provision is based on an evaluation of the adequacy of the allowance for possible loan losses. The evaluation includes, but is not limited to, review of net loan losses for the year, the present and prospective financial condition of the borrowers and evaluation of current and projected economic conditions. - -40- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY LOANS The following table sets forth the outstanding balances of those loans on a nonaccrual status and those on accrual status which are contractually past due as to principal or interest payments for 30 days or more at December 31. 1996 1995 1994 1993 1992 (000 omitted) Nonaccrual loans $ 14 $ 132 $ 27 $ 0 $ 781 Accrual loans: Restructured $ 0 $ 0 $ 0 $ 0 $ 0 30 through 89 days past due 1,976 1,949 1,553 1,468 1,974 90 days or more past due 203 417 155 150 63 Total accrual loans $ 2,179 $ 2,366 $ 1,708 $ 1,618 $ 2,037
See Note 7 of the notes to consolidated financial statements for details of income recognized and foregone revenue on nonaccrual loans for the past three years. Management has not identified any significant problem loans in the accrual loan categories shown above. - -41- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY The following is an allocation by loan categories of the allowance for loan losses at December 31 for the last five years. In retrospect the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current conditions. Accordingly, the entire allowance is available to absorb losses in any category: Years Ended December 31 1996 1995 Percentage Percentage Allowance of Loans to Allowance of Loans to Amount Total Loans Amount Total Loans (000 omitted) Commercial, financial and agricultural $ 125 7.71% $ 114 7.98% Real estate - Construction 64 3.95 80 5.55 Real estate - Mortgage 1,229 75.91 1,055 73.63 Installment 202 12.43 184 12.84 Total $ 1,620 100.00% $ 1,433 100.00% Years Ended December 31 1994 1993 Percentage Percentage Allowance of Loans to Allowance of Loans to Amount Total Loans Amount Total Loans (000 omitted) Commercial, financial and agricultural $ 113 9.42% $ 78 6.99% Real estate - Construction 67 5.58 56 4.97 Real estate - Mortgage 844 70.33 853 75.79 Installment 176 14.67 138 12.25 Total $ 1,200 100.00% $ 1,125 100.00%
- -42- Year Ended December 31 1992 Percentage Allowance of Loans to Amount Total Loans (000 omitted) Commercial, financial and agricultural $ 76 7.24% Real estate - Construction 51 4.93 Real estate - Mortgage 763 73.22 Installment 152 14.61 Total $ 1,042 100.00%
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY DEPOSITS The average amounts of deposits are summarized below: Years Ended December 31 1996 1995 1994 (000 omitted) Demand deposits $ 16,078 $ 13,833 $ 12,991 Interest bearing demand deposits 27,601 25,048 27,232 Savings deposits 26,555 24,200 24,425 Time deposits 63,767 53,350 37,526 Total deposits $ 134,001 $ 116,431 $ 102,174
The following is a breakdown of maturities of time deposits of $ 100,000 or more as of December 31, 1996: Maturity (000 omitted) Certificates of Deposit Three months or less $ 2,116 Over three months through six months 3,427 Over six months through twelve months 2,124 Over twelve months 100 $ 7,767
RETURN ON EQUITY AND ASSETS (APPLYING DAILY AVERAGE BALANCES) The following table presents a summary of significant earnings and capital ratios: (dollar amounts in thousands) 1996 1995 1994 Average assets $ 153,145 $ 135,648 $ 118,388 Net income $ 2,248 $ 1,954 $ 1,635 Average equity $ 15,076 $ 13,570 $ 12,238 Cash dividends paid $ 694 $ 613 $ 512 Return on assets 1.47% 1.44% 1.38% Return on equity 14.90% 14.40% 13.36% Dividend payout ratio 30.90% 30.7% 31.3% Equity to asset ratio 9.8% 10.0% 10.34%
- -43- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED SUMMARY OF OPERATIONS Years Ended December 31 1996 1995 1994 1993 1992 (000 omitted) Interest income $ 11,981 $ 10,829 $ 8,571 $ 8,250 $ 8,632 Interest expense 5,139 4,542 3,241 3,129 3,800 Net interest income 6,842 6,287 5,330 5,121 4,832 Provision for loan losses 240 270 71 121 366 Net interest income after provision for loan losses 6,602 6,017 5,259 5,000 4,466 Other income: Trust 384 297 185 157 119 Service charges - Deposits 477 375 349 308 294 Other service charges, collection and exchange, charges, commission fees 295 218 180 163 170 Other operating income (loss) 121 45 146 ( 26) 110 Total other income 1,277 935 860 602 693 Income before operating expense 7,879 6,952 6,119 5,602 5,159 Operating expenses: Salaries and employees benefits 2,621 2,326 2,115 1,908 1,725 Occupancy and equipment expense 665 559 486 405 394 Other operating expenses 1,507 1,371 1,363 1,280 1,250 Total operating expenses 4,793 4,256 3,964 3,593 3,369 Income before income taxes 3,086 2,696 2,155 2,009 1,790 Income tax 838 742 520 525 452 Net income applicable to common stock $ 2,248 $ 1,954 $ 1,635 $ 1,484 $ 1,338 Per share data: Earnings per common share $ 2.30 $ 2.00 $ 1.67 $ 1.52 $ 1.40 Cash dividend - Common $ .71 $ .61 $ .52 $ .47 $ .43 Weighted average number of common shares 976,863 976,863 976,863 976,777 956,443
- -44- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY STATEMENTS OF AVERAGE BALANCES AND AVERAGE RATES ($ 000 omitted) 1996 1995 1994 1993 1992 LOANS Personal credit lines $ 4,859 $ 4,425 $ 4,113 $ 3,710 $ 3,556 Tax free 996 1,207 1,229 1,215 1,092 Commercial 33,432 28,725 21,512 16,958 15,048 Mortgage 47,057 46,728 42,919 39,874 37,006 Consumer 19,099 16,329 11,888 10,819 11,169 Credit card 336 248 79 0 0 Total loans 105,779 97,662 81,740 72,576 67,871 INVESTMENT SECURITIES U.S. Government 8,384 7,378 7,891 10,385 10,273 U.S. Government agencies 11,159 9,815 8,173 9,201 7,257 State & municipal 9,881 8,488 8,148 8,451 7,069 Other 1,356 1,162 1,106 1,148 1,110 Total investment securities 30,780 26,843 25,318 29,185 25,709 OTHER SHORT-TERM INVESTMENTS Interest-bearing deposits 1,261 1,006 0 0 0 Federal funds sold 6,312 1,328 3,196 1,031 2,668 Certificates of deposit 64 72 198 0 19 Total other short-term investments 7,637 2,406 3,394 1,031 2,687 TOTAL EARNING ASSETS 144,196 126,911 110,452 102,792 96,267 TOTAL ASSETS $ 153,145 $ 135,648 $ 118,388 $ 109,552 $ 102,761 Percent increase 12.9% 14.6% 8.1% 6.6% 7.9% DEPOSITS Demand $ 16,078 $ 13,833 $ 12,991 $ 12,052 $ 10,406 Interest-bearing demand 27,601 25,048 27,232 25,746 23,553 Savings 26,555 24,200 24,425 21,780 17,090 Time 63,767 53,350 37,526 35,998 39,629 Total deposits 134,001 116,431 102,174 95,576 90,678 OTHER BORROWINGS Federal funds purchased 0 715 77 521 288 Liabilities for borrowed money 2,340 2,345 2,304 728 0 TOTAL INTEREST-BEARING LIABILITIES 120,263 105,658 91,564 84,773 80,560
- -45 ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY STATEMENTS OF AVERAGE BALANCES AND AVERAGE RATES (CONTINUED) 1996 1995 1994 1993 1992 AVERAGE RATES EARNED % % % % % Loans Commercial 9.6 10.1 9.0 8.4 8.7 Mortgage 8.2 7.9 7.6 8.0 9.1 Consumer 9.5 9.6 10.0 11.6 11.9 Tax free 9.0 8.8 9.5 7.8 9.2 Personal credit lines 10.0 10.5 8.8 8.2 8.7 Credit card 9.4 9.0 6.5 0.0 0.0 Total 9.0 9.0 8.4 8.7 9.4 Investment Securities U.S. Government 6.0 5.7 5.6 6.7 7.8 U.S. Government agencies 6.8 6.8 6.3 6.4 7.6 State & municipal 9.2 9.5 9.5 9.6 10.4 Other 6.0 5.4 4.5 5.2 4.3 Total 7.3 7.3 7.1 7.4 8.4 Other Short-Term Investments Interest-bearing deposits 5.3 6.0 0.0 0.0 0.0 Federal funds sold 5.3 6.0 4.0 2.9 3.3 Certificates of deposit 5.6 4.6 4.0 0.0 4.0 Total earning assets 8.5 8.6 7.8 8.2 9.0 AVERAGE RATES PAID Time & savings deposits 4.2 4.2 3.5 3.7 4.7 Federal funds purchased 0.0 6.1 4.4 3.3 4.0 Liabilities for borrowed money 6.3 6.3 6.3 6.6 0.0
- -46- Item 9. Disagreements on Accounting and Financial Disclosures. Not applicable. - -47- PART III Item 10. Directors and Executive Officers of Orrstown Financial Services, Inc. The information required by Item 10 of Form 10-K with respect to identification of directors is incorporated by reference to the information contained in the section captioned "Election of Directors" in Orrstown's definitive proxy statement for the annual meeting of stockholders to be held April 8, 1997 (the "proxy statement"), a copy of which has been filed with the Securities and Exchange Commission. For information with respect to the executive officers of the registrant, see "executive officers of the registrant" at the end of Part I of this report. Item 11. Executive Compensation The information required by Item 11 of Form 10-K with respect to directors and executive officers' compensation is incorporated by reference to the information contained in the section captioned "executive compensation and other matters" in the proxy statement. For information with respect to a change in control agreement with the CEO of Orrstown, see Exhibit 11 to this report. The information required by Items 12 and 13 is incorporated by reference from Orrstown Financial Services, Inc.'s definitive proxy statement for the 1997 Annual Meeting of shareholders filed pursuant to Regulation 14A. - -48- PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. Financial Statement Schedules and Exhibits (1) Financial statements. See Item 8 of this report for the index to financial statements. (2) Financial statement schedules. Not applicable. (3) Exhibits. Exhibit Numbers (2) Plan of acquisition, reorganization, arrangement, liquidation or succession. Not applicable. (3) (a) Articles of incorporation. Incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-4, Registration No. 33-18888. (b) By-laws. Incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-4, Registration No. 33-18888. (4) Instruments defining the rights of security holders including indentures. The rights of the holders of Registrant's common stock are contained in: (i) Articles of Incorporation of Orrstown Financial Services, Inc., filed as Exhibit 3.1 to Registrant's Registration Statement on Form S-4 (Registration No. 33-18888). (ii) By-laws of Orrstown Financial Services, Inc., filed as Exhibit 3.2 to the Registrant's Registration Statement on Form S-4 (Registration No. 33-18888). (iii) Amendment to by-laws of Orrstown Financial Services, Inc. - filed herewith (9) Voting trust agreement. Not applicable. (10) Material contracts. None. (11) Statement re: computation of per share earnings. Not applicable. (12) Statements re: computation of ratios. Not applicable. - -49- (13) Annual report to security holders. Form 10-Q or quarterly report to security holders. Not applicable. (16) Letter re: change in certifying accountant. Not applicable. (18) Letter re: change in accounting principles. Not applicable. (21) Subsidiaries of the registrant. Filed herewith. (22) Published report regarding matters submitted to vote of security holders. Not applicable. (23) Consents of experts and counsel. Not applicable. (24) Power of attorney. Not applicable. (27) Financial data schedule. Filed herewith. (28) Information from reports furnished to state insurance regulatory authorities. Not applicable. (99) Change in Control Agreement Between Orrstown Financial Services, Inc. and its Chief Executive Officer - filed herewith. (b) Reports on Form 8-K. None. - -50- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ORRSTOWN FINANCIAL SERVICES, INC. (Registrant) By Kenneth R. Shoemaker, President Dated: March _____, 1997 (Duly authorized officer) By ______________________________ Robert B. Russell, Controller (Principal Financial Officer) Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date President and Chief March , 1997 Kenneth R. Shoemaker Executive Officer and Director Director March , 1997 Dr. Anthony F. Ceddia Director March , 1997 Robert T. Henry Assistant Secretary March , 1997 William O. Hykes and Director Vice Chairman of the March , 1997 Joel R. Zullinger Board and Director Secretary and Chairman March ____, 1997 Jeffrey W. Coy of Executive Committee and Director Director March , 1997 Ned R. Fogelsonger Chairman of the March , 1997 Galen L. Myers Board and Director Director March , 1997 Frank S. Heberlig Director March , 1997 Raymond I. Pugh ____________________________ Director March ____, 1997 Denver L. Tuckey ____________________________ Director March ____, 1997 Andrea Pugh - -51- Exhibit Index Exhibit No. Sequentially numbered pages 21 Subsidiaries of the Registrant 53 99 Change in Control Agreement between Orrstown Financial Services, Inc. and its Chief Executive Officer 54 - 59 - -52- EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT 1. Orrstown Bank, Orrstown, Pennsylvania; a state-chartered bank organized under the Pennsylvania Banking Code of 1965. - -53- EXHIBIT 99 CHANGE IN CONTROL AGREEMENT THIS AGREEMENT is made as of the 23rd day of January, 1997, between ORRSTOWN FINANCIAL SERVICES, INC., a corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its principal place of business in Orrstown, Pennsylvania (hereinafter referred to as the "Corporation"), ORRSTOWN BANK, a wholly-owned bank subsidiary of the Corporation organized and existing under the laws of the Commonwealth of Pennsylvania and having its principal place of business in Orrstown, Pennsylvania (hereinafter referred to as the "Bank"), and KENNETH R. SHOEMAKER, an individual residing at 53 West King Street, Shippensburg, Pennsylvania 17257 (hereinafter referred to as the "Executive"). WITNESSETH: WHEREAS, Executive is now serving as the President and Chief Executive Officer of the Corporation and of the Bank; and WHEREAS, the Corporation, Bank and the Executive desire to enter into an Agreement whereby the Corporation and the Bank will agree to make certain payments to the Executive under specific conditions in order to induce the Executive to continue in employment with the Corporation and the Bank. NOW, THEREFORE, in consideration of the employment of the Executive and intending to be legally bound hereby, the Executive, the Corporation and the Bank agree as follows: SECTION I COMPENSATION UPON A CHANGE IN CONTROL (A) Definition: Trigger Event. Executive shall have the right to receive the compensation provided for in paragraph (D) of this Section I upon the occurrence of any of the following events ("Trigger Events") within three (3) years after the date of any "Change in Control" (as defined in paragraph (B) of this Section 1): (i) Executive's employment is terminated by the Corporation, the Bank or an acquiror or successor of either without "Good Cause" (as defined below), or (ii) One of the following events occurs and Executive thereafter terminates his employment: (A) the nature and scope of Executive's duties or responsibilities with the Corporation, the Bank or an acquiror or successor of either are materially reduced from that which he enjoyed immediately prior to the Change in Control; or (B) Executive's base salary immediately prior to the Change in Control is reduced or material benefits provided to Executive (excluding the reduction or curtailment of benefits which affect all similarly situated employees) are eliminated; or (C) Executive is assigned, without his consent, to a principal place of employment which is more than fifty (50) miles from Shippensburg, Pennsylvania. - -54- (B) Definition: Change in Control. For purposes of this Agreement, Change in Control shall mean any of the following: (i) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), other than the Corporation, a subsidiary of the Corporation, an employee benefit plan (or related trust) of the Corporation or a direct or indirect subsidiary of the Corporation, or affiliates of the Corporation (as defined in Rule 12b-2 under the Exchange Act), becomes the beneficial owner (as determined pursuant to Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing more than 20% of the combined voting power of the Corporation's then outstanding securities or announces a tender offer or exchange offer for securities of the Corporation representing more than 20% of the combined voting power of the Corporation's then outstanding securities; or (ii) the liquidation or dissolution of the Corporation or the Bank or the occurrence of, or execution of an agreement providing for, a sale of all or substantially all of the assets of the Corporation or the Bank to an entity which is not a direct or indirect subsidiary of the Corporation; or (iii) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation or other similar transaction or connected series of transactions of the Corporation as a result of which either (a) the Corporation does not survive or (b) pursuant to which shares of the Corporation common stock ("Common Stock") would be converted into cash, securities or other property, unless, in case of either (a) or (b), the holders of Corporation Common Stock immediately prior to such transaction will, following the consummation of the transaction, beneficially own, directly or indirectly, more than 50% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors of the corporation surviving, continuing or resulting from such transaction; or (iv) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation, or similar transaction or connected series of transactions of the Corporation, if, upon consummation of such transaction or transactions, the persons who are members of the Board of Directors of the Corporation immediately before such transaction or transactions cease or, in the case of the execution of an agreement for such transaction or transactions, it is contemplated in such agreement that upon consummation such persons would cease, to constitute a majority of the Board of Directors of the Corporation or, in a case where the Corporation does not survive in such transaction, of the corporation surviving, continuing or resulting from such transaction or transactions; or (v) any other event which is at any time designated as a "Change in Control" for purposes of this Agreement by a resolution adopted by the Board of Directors of the Corporation with the affirmative vote of a majority of the non-employee directors in office at the time the resolution is adopted; in the event any such resolution is adopted, the Change in Control event specified thereby shall be deemed incorporated herein by reference and thereafter may not be amended, modified or revoked without the written agreement of Executive. - -55- Notwithstanding anything else to the contrary set forth in this Agreement, if (i) an agreement is executed by the Corporation or the Bank providing for any of the transactions or events constituting a Change in Control, as defined herein, and the agreement subsequently expires or is terminated without the transaction or event being consummated, and (ii) a Trigger Event, as defined herein, has not occurred prior to such expiration or termination, for purposes of this Agreement it shall be as though such agreement was never executed and no Change in Control event shall be deemed to have occurred as a result of the execution of such agreement. (C) Definition: "Good Cause". For purposes of this Agreement, "Good Cause" shall mean: (i) the commission of gross malfeasance in office constituting dishonesty, the conviction (or entering a plea of nolo contendere) of a crime involving fraud, misappropriation, embezzlement, dishonesty or other violation of law of a similar nature and severity or (ii) the willful breach of a fiduciary duty owed to the Corporation or the Bank. No act, or failure to act, on Executive's part shall be considered willful unless done, or omitted to be done, by Executive, not in good faith and without reasonable belief that Executive's action or omission was in the best interest of the Corporation or the Bank. The burden of establishing the validity of any termination for "Good Cause" shall rest upon the Corporation or the Bank. (D) Compensation Upon a Change in Control. If a Trigger Event shall occur pursuant to a Change in Control, then the Corporation or the Bank (or any acquiror or successor thereto) shall provide the following to the Executive: (i) Executive's compensation shall be continued for a period of three (3) years, commencing as of the Trigger Event, but not beyond the date on which Executive dies. For purposes hereof, compensation shall mean the greater of (a) Executive's base salary in effect immediately prior to the Trigger Event, plus any cash bonuses or annual incentive cash compensation earned by Executive with respect to the calendar year immediately preceding the date of the Trigger Event, or (b) Executive's base salary in effect immediately prior to the Change in Control, plus any cash bonuses or annual incentive cash compensation earned by Executive with respect to the calendar year immediately preceding the Change in Control. Each payment during the three (3) year payment period shall be reduced by Executive's earned income from all sources during the three (3) year payment period; provided, however, that Executive shall have no duty to mitigate damages by earning income during the period; and (ii) Executive shall be provided, for a period of three (3) years, commencing as of the Trigger Event, but not beyond the date on which Executive dies, with life, disability and accident and health insurance coverages comparable to employer sponsored plan coverages in effect for Executive immediately preceding the Trigger Event. Executive shall continue to be responsible for the cost of comparable insurance coverages following the Trigger Event to the same extent as other similarly situated active employees of the Corporation or the Bank as of the Trigger Event or, if there are no similarly situated employees, then to the same extent, on a percentage of total cost basis, that Executive was responsible for the cost of available insurance coverages prior to the Trigger Event. With respect to health insurance coverage, Executive's spouse - -56- and/or eligible dependents, if covered under any employer sponsored accident and health insurance plan in effect for Executive as of the Trigger Event, shall also be provided with health insurance coverage for the three (3) year term set forth above (regardless of Executive's death or attainment of age 65 prior to the end of the three (3) year term), and under the same cost sharing method as described above. (iii) Should the total of all payments made hereunder to Executive upon the occurrence of a Trigger Event, together with any other payments which Executive has a right to receive from the Corporation, the Bank, any of the other subsidiaries of the Corporation, or any successors of any of the foregoing, result in the imposition of an excise tax under Internal Revenue Code Section 4999 (or any successor thereto), Executive shall be entitled to an additional "excise tax" adjustment payment in an amount such that, after the payment of all federal and state income and excise taxes, Executive will be in the same after-tax position as if no excise tax had been imposed. Any payment or benefit which is required to be included under Internal Revenue Code Sections 28OG or 4999 (or any successor provisions thereto) for purposes of determining whether an excise tax is payable shall be deemed a payment "made to Executive" or a payment "which Executive has a right to receive" for purposes of this provision. The Corporation (or its successor) shall be responsible for the costs of calculation of the excise tax by the Corporation's independent certified accountant and tax counsel and shall notify Executive of the amount of excise tax due prior to the time such excise tax is due. If at any time it is determined that the additional "excise tax" adjustment payment previously made to Executive was insufficient to cover the effect of the excise tax, the gross-up payment pursuant to this provision shall be increased to make Executive whole, including an amount to cover the payment of any penalties resulting from any incorrect or late payment of the excise tax resulting from the prior calculation. (E) Payments Not Exclusive. The payments provided by paragraph (D) of this Section I shall not affect Executive's rights to receive any payments or benefits to which Executive may be or become entitled under any other existing or future agreement or arrangement of the Corporation. The Bank or any successor with the Executive, or under any existing or future benefit plan or arrangement of the Corporation, the Bank or any successor in which Executive is or becomes a participant, or under which Executive has or obtains rights, including without limitation, any qualified or nonqualified deferred compensation or retirement plans or programs. Any such rights of Executive shall be determined in accordance with the terms and conditions of the applicable agreement, arrangement or plan. (F) Withholding for Taxes. All payments required to be made under this Agreement will be made in accordance with the Corporation's or the Bank's normal payroll schedule and will be subject to withholding of such amounts relating to tax and/or other payroll deductions as may be required by law. - -57- SECTION II EXPENSES (A) Legal Action. If Executive determines in good faith that the Corporation, the Bank, or any successor to either of them, has failed to comply with its obligations under this Agreement, or if the Corporation, the Bank, or any successor to either of them, or any other person takes any action to declare this Agreement void or unenforceable, or institutes any legal action or arbitration proceeding with respect to this Agreement, each of the Corporation and the Bank hereby irrevocably authorizes Executive from time to time to retain counsel of Executive's choice, at the expense of the Corporation and the Bank, to represent Executive in connection with any and all actions and proceedings, whether by or against the Corporation, the Bank, any acquiror or successor, or any director, officer, stockholder or other person affiliated with any of the foregoing, which may adversely affect Executive's rights hereunder. (B) Excise Tax Matters. It is the intention of the Corporation and the Bank that Executive not be required to incur any expenses associated with determination of the amount of any "excess parachute payment" under Internal Revenue Code Section 280G or the amount of any excise tax imposed on Executive pursuant to Internal Revenue Code Section 4999 (or any successor provisions thereto). Therefore, the Corporation and the Bank agree to pay all expenses, including the expenses of the Corporation's independent certified accountant and tax counsel, related to the determination of any excess parachute payment and excise tax, and to pay the legal costs and expenses of any tax audit of Executive to the extent such expenses relate to the amount of the excise tax determined by the Corporation or the Bank. SECTION III MISCELLANEOUS (A) Termination of Employment. This Agreement shall not in any way obligate either the Corporation or the Bank to continue the employment of the Executive, nor shall this Agreement limit the right of the Corporation or the Bank to terminate Executive's employment for any reason. Prior to the occurrence of a Change in Control, as defined herein, Executive's employment may be terminated at any time by the Corporation or the Bank, in which case Executive shall have no further rights under this Agreement. (B) Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, executors, administrators, successors and, to the extent permitted hereunder, assigns. All of the obligations of the Corporation and the Bank hereunder shall be legally binding on any successor to the Corporation or the Bank, including without limitation, any successor as a result of the consummation of a Change in Control. The right of Executive to receive payments hereunder may not be assigned, alienated, pledged or otherwise encumbered by Executive and any attempt to do so shall be void and of no force or effect. (C) Entire Agreement. This Agreement contains the entire agreement of the parties hereto with respect to the subject matter hereof and supersedes all prior agreements among the parties hereto with respect to said subject matter including, without limitation, that certain Agreement dated May 7, 1986 between Executive and the Bank. This Agreement may be amended only by an instrument in writing signed by all of the parties hereto. - -58- (D) Jurisdiction. The parties hereto consent to the exclusive jurisdiction of the courts of the Commonwealth of Pennsylvania in any and all actions arising hereunder. (E) Governing Laws. This Agreement shall be governed and construed under the laws of the Commonwealth of Pennsylvania, without regard to the conflicts of laws principles thereof. (F) Unfunded Obligations. The obligations to make payments hereunder shall be unfunded and Executive's rights to receive any payments hereunder shall be the same as those of any other unsecured general creditor. (G) Individual Agreement. This Agreement constitutes an agreement solely between the Corporation, the Bank and Executive named herein. This Agreement is intended to constitute a nonqualified arrangement for the benefit of a key management employee and shall be construed and interpreted in a manner consistent with such intention. (H) Headings. All headings preceding the text of the several paragraphs hereof are inserted solely for reference and shall not constitute a part of this Agreement, nor affect its meaning, construction or effect. (I) Waiver. Failure by either party to insist upon strict compliance with any of the terms, covenants or conditions hereof shall not be deemed a waiver of such terms, covenants or conditions, nor shall any waiver or relinquishment of any right or power hereunder at any time or from time to time be deemed a waiver or relinquishment of such right or power at any other time or times. IN WITNESS WHEREOF, the Corporation and Bank have caused this Agreement to be executed and attested to on their respective behalf by their duly authorized officers, and the Executive hereunto has set his hand and seal, all as of the day and year first above written. ATTEST: ORRSTOWN FINANCIAL SERVICES, INC. _________________________ By: ______________________________ (Assistant) Secretary Chairman (SEAL) ATTEST: ORRSTOWN BANK _________________________ By: ______________________________ (Assistant) Secretary Chairman (SEAL) WITNESS: EXECUTIVE: __________________________ ______________________________(SEAL) Kenneth R. Shoemaker EX-27 2 ARTICLE 9 FDS FOR 10-K
9 1,000 12-MOS DEC-31-1996 DEC-31-1996 5,236 1,554 2,936 934 33,057 33,057 33,421 108,926 1,620 157,556 137,259 0 2,102 2,339 204 0 0 15,411 157,556 9,638 1,866 477 11,981 4,981 5,139 6,842 240 (5) 4,793 3,086 2,248 0 0 2,248 2.30 2.30 4.7 14 203 0 0 1,433 68 15 1,620 1,620 0 0
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